Leiden, a.d. V Kal. Nov. MMDCCLXVIII A.U.C.,
As I discussed earlier, Investors State Dispute Settlement (ISDS) mechanisms allow companies to sue governments, and are included in trade and investment treaties with the aim to protect property rights. This is a very legitimate goal, as property rights are very important for economic growth. However, this does not mean that ISDS is necessarily the best way to do so. We should keep in mind that being taken to court through ISDS for breaching a treaty which allows arbitration though ISDS, is as such not something we can blame ISDS for. We need a better standard to judge ISDS than a standard which might judge it for doing what we asked it to do. So if a country made a blunder when signing the treaty, again, we cannot blame ISDS for doing what it is supposed to do. This means there are two main issues, firstly, ISDS itself should be impartial, secondly, the treaty in which ISDS is created should be prudent. In this post I will look at some cases in which countries were forced to pay companies because of the commitments they made when they signed a trade of investment treaty. I will try to come up with some guidelines for what ISDS and investment treaties should and should not do, based on those examples.
To start, ISDS should provide impartial judgment, based on the content of the treaty and the all the agreements made between governments and companies which that treaty has something to say about. Investment treaties can, but do not necessarily prohibit all kinds of public policy, in fact often they do not. Personally, I have more faith in the well tested legal systems of Western-Europe and North America than in ISDS, but less faith in some of Eastern-Europe’s legal systems. ISDS lacks transparency, incorruptibility and permanence. Most European countries already protect property rights very well, so handing over enforcing power to private lawyers can only make things worse compared to the rule of law we have now. I see how perverse incentives could grow from a system in which an international body, namely the World Bank, gets to decide which private lawyer gets to judge over millions or billions of dollars. This does not sound like an independent judiciary to me. So a permanent court of arbitration, with public hearings and transparency as a core principle, just like in any democratic country where the rule of law exists, is my preferred option to enforce TTIP. So ISDS definitely should not be the first choice. Nevertheless, the EU has already stated that transparency is a must, and in CETA this has already been included, so some of the worst parts of ISDS have already been removed. This is an absolutely required first step.
Then, what should TTIP and CETA not do? Often disputes settled through ISDS treat public policy regarding externalities, such as regulation of companies, environmental policies or taxation. This means that very often citizens have good reason to want to change the existing framework in which companies function, because these companies cause externalities which citizens suffer from. For example, when the government of Quebec wanted to protect the St. Lawrence river and estuary, they prohibited all further fracking. Seeing the beauty and ecological importance of these aquatic environments, relatively minor problems could lead to true ecological disasters. Nevertheless, Lone Pine Resources, the fracking company, has a point that they should be compensated for the now useless purchased leases, paid rentals and money invested in machinery and infrastructure. So a compensation for all the money lost due to a moratorium on fracking seems fair to me. In another case, the German government shut down a nuclear reactor in reaction to the Fukushima disaster. The German government knew well what the risks of nuclear energy were, the disaster did not present us with new knowledge about that. In fact the German government had used nuclear energy in its strategy to limit CO2 emissions. The owner of the nuclear plant participated in that strategy, and suddenly was left with an incredibly expensive building, after they were forced to close the reactor. Again, compensation seems reasonable. However, in other cases it is less clear how companies were treated unfairly. For example, Australia was taken to the Permanent Court of Arbitration by a cigarette company, for introducing a law on plain-packaging of cigarettes. This seems like a policy that should not be precluded by any international treaty.
So ISDS makes using progressing insight, as in the Quebec case, very expensive. As in the case of fracking, at first it may seem that a certain policy carries low risks, but new research shows that this policy in fact has bigger disadvantages than expected. In such a case you want to change the policy, but if you have already sold permits to companies promising to let them frack, you are in trouble if you have signed an ISDS. Given that progressing insight is always a possibility, property rights and policies meant to prevent externalities are always at potential tension with each other. Maybe countries could start selling different kinds of leases, in which externalities to a certain limit are allowed, and compensated through the purchase of leases and rental payments, but when they transgress that limit, there is some mechanism to stop the operation without having to pay too much in compensation. This way companies know in advance that if they cause massive amounts of pollution, they could lose money. Something like this, could be a way to relieve the tension between legitimate concerns about externalities and the legitimate concerns of investors. However, such a policy will only work if we have an absolutely impartial judiciary, as to prevent such contracts from becoming bad excuses for expropriation or whimsical changes in policy.
Things get even more tricky when politicians do not exactly pursue the policies citizens prefer. In the case there has been a change of government from a autocratic state to a democratic state, I would say it is simple: too bad for the company. When you support autocrats, the wrath of the people might turn against you, and that is a risk you were willing to take. Yet, in the case of a change of administrations in a democratic country it is less clear what is just. Theoretically democratic politicians do what the people want, however, we all know that in reality often they do not. So if people vote a politician out of office, because he pursued policies they never agreed with, and then they want to change those policies, is it fair they have to pay billions of dollars? That is a legitimate question to ponder about, however, this is a question that is relevant with or without ISDS and investment treaties. It is a fundamental issue in democracies, ISDS only exacerbates it, because it makes countries pay for ill-conceived previous policy. Yet, with or without ISDS, countries can renege on their promises, and this always has an impact on people with their skin in the game, and it thus might have repercussions for economic growth. This market reaction will (or will not) occur regardless of whether an investment treaty prohibits such actions or not. So in the worst case scenario, breaking contracts puts the country back to where it was before signing the investment treaty, namely with a less trustworthy reputation as people might lose money because of policy changes. So we should ask ourselves, where in between the two extremes, property rights protection and flexible policy against externalities, do we want our policy to be?
Thus, any international investment treaty will have to say something about property rights. Societies should think about the relation between democracy and rights. Do we want to be flexible, with the attached risk that companies are less likely to invest, or do they want more investment and to give up some flexibility? We should think about this question regardless of TTIP, because TTIP does not make much of a difference for the answer, only in how often you can change the answer. The only thing TTIP does is pinning us down at a certain point between those two extremes, so we should make sure it is at the right point.
Bottom Line: ISDS should provide impartial judgment and serves a legitimate function, but I think there are better ways to achieve the same goals. Moreover, investment treaties make government policy less flexible by attaching high costs to breaching property rights and policy changes. How much less flexible is the question we should ask ourselves, in fact, regardless of whether we sign TTIP and CETA.