Simon Lester is a trade policy analyst at the Cato Institute.
One of the most contentious debates in trade policy right now is over investor-state dispute settlement, a set of provisions that allows foreign investors to sue host country governments when they believe their rights have been violated. ISDS provisions are now a standard part of many countries’ trade agreements, but are often criticized for giving multinational corporations too much influence over developing countries’ sovereignty and democracy.
For the debate to make any headway, it needs to be informed by the origins of ISDS. When the historical context is understood, it becomes clear that the provisions are outdated in many ways — it may be time to find new ways to define the relationships of multinational corporations to the developing countries where they invest.
Many former colonies became independent nations in the post-World War II era. After an initial wave of industry nationalizations in the 1950s through the ’70s, private enterprise came back into favor, and Western multinationals began to expand their operations throughout the developing world. The result was stronger economic growth in many of these previously poor countries, but also continued conflict between governments and foreign investors.
In their original form, investment treaties containing ISDS were seen as a way to manage this conflict. International courts were proposed as a way to challenge nationalizations and takeovers that took place without fair compensation. Foreign investors were given the right to raise claims directly against host country governments, avoiding local judiciaries who were not always independent and impartial. The idea was to promote a stable business environment and encourage investment.
The ISDS regime was fairly quiet and obscure for many years, but as treaties encouraging foreign investment proliferated, more claims were brought. That’s because enterprising lawyers recognized that the broad language used in these treaties covered more than just factory expropriations or nationality-based discrimination, and began to push the boundaries of the claims. Soon, what many people would consider normal government action — such as environmental regulation or litigation arising from contract law disputes in domestic court — was being challenged by multinational corporations through ISDS lawsuits. Today, the system is used more for general disputes about supposed unfairness in government behavior than for its original purpose of protecting investors against nationalistic bias or expropriation.
Today’s world is nothing like the world after World War II, and we should no longer stereotype all non-Western or developing governments as incompetent or corrupt. In truth, there is a great deal of diversity among these countries. Many have fairly sophisticated legal and political systems, comparable to the Western ones we set up as examples. Former dictatorships such as South Korea and Chile, for example, are now stable and reliable partners in world affairs. It’s odd that a system designed to address nationalizations and other extreme acts taken by dictators should be applied to countries such as these.
As for authoritarian regimes that do still exist, it is unclear whether these international investment rules are even helpful. Some proponents argue that international obligations such as ISDS can set an example for fair regulation and litigation, which will then spread to domestic systems. But there is no clear evidence that this is happening. In practice, the situation is that wealthy foreigners are able to assert their rights against authoritarian governments, while ordinary citizens cannot.
It is also worth noting that there are other more narrow and tailored alternatives available to manage conflict. ISDS has led to unanticipated, potentially spurious claims, such as tobacco companies bringing lawsuits against tobacco control regulation. A better approach might be for foreign investors to use arbitration clauses in the contracts they sign with governments. This would make the limits on government action clear from the outset, rather than relying on a broad and vague investment treaty.
To determine what international trade rules are needed (if any!), we need to define the issues more clearly. People talk vaguely about arbitrary government actions or corrupt courts abroad. No doubt these things exist. Yet the problem of governments brazenly taking over privately owned property has been on the decline for a while. So what is ISDS really addressing today? What exactly is the problem, and in which countries?
Overall, what we need is a more balanced approach to international economic agreements with developing countries. Too often, these agreements mainly reflect the demands of Western business groups and non-governmental organizations.
Before taking the extreme step of creating a private right-to-action under international law, we should first identify the problem we are solving and think carefully about the scope and nature of the rules we adopt. Otherwise, the current state of affairs — with proliferating challenges to domestic statutes, regulations and judicial decisions — will continue to undermine domestic autonomy in ways that many civil society groups and others find objectionable.