5/11/2018 The arbitration game - Investor-state dispute settlement

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Investor-state dispute settlement

The arbitration game

Governments are souring on treaties to protect foreign investors

Print edition | Finance and economics

Oct 11th 2014

https://www.economist.com/finance-and-economics/2014/10/11/the-arbitration-game 1/6
5/11/2018 The arbitration game - Investor-state dispute settlement

IF YOU wanted to convince the public that international trade agreements are a way
to let multinational companies get rich at the expense of ordinary people, this is
what you would do: give foreign rms a special right to apply to a secretive tribunal
of highly paid corporate lawyers for compensation whenever a government passes
a law to, say, discourage smoking, protect the environment or prevent a nuclear
catastrophe. Yet that is precisely what thousands of trade and investment treaties
over the past half century have done, through a process known as “investor-state
dispute settlement”, or ISDS.

ISDS rst appeared in a bilateral trade agreement between Germany and Pakistan in
1959. The intention was to encourage foreign investment by protecting investors
from discrimination or expropriation. But the implementation of this laudable idea
has been disastrous. It has become so controversial that it threatens to scupper
trade deals the European Union is negotiating with both America and Canada.

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Multinationals have exploited woolly de nitions of expropriation to claim

compensation for changes in government policy that happen to have harmed their
business. Following the Fukushima disaster in Japan in 2011, for instance, the
German government decided to shut down its nuclear power industry. Soon after,
Vattenfall, a Swedish utility that operates two nuclear plants in Germany,
demanded compensation of €3.7 billion ($4.7 billion), under the ISDS clause of a
treaty on energy investments.

https://www.economist.com/finance-and-economics/2014/10/11/the-arbitration-game 2/6
5/11/2018 The arbitration game - Investor-state dispute settlement

This claim is still in arbitration. And it is just one of a growing number of such
cases (see chart). In 2012 a record 59 were started; last year 56 were. The highest
award so far is some $2.3 billion to Occidental, an oil company, against the
government of Ecuador, over its (apparently lawful) termination of an oil-
concession contract.

There are several reasons for the sharp rise in contentious arbitrations, says Lori
Wallach of Public Citizen, a watchdog group. Companies have learnt how to exploit
ISDS clauses, even going as far as buying rms in jurisdictions where they apply
simply to gain access to them. Arbitrators are paid $600-700 an hour, giving them
little incentive to dismiss cases out of hand; the secretive nature of the arbitration
process and the lack of any requirement to consider precedent allows plenty of
scope for creative adjudications.

At the same time, academics have begun to question whether ISDS delivers the
bene ts it is supposed to, in the form of increased foreign investment. Foreign
investors can protect themselves against egregious governmental abuse by
purchasing political-risk insurance, points out Terra Lawson-Remer, an economist
at the Brookings Institution. Brazil continues to receive lots of foreign investment,
despite its long-standing refusal to sign any treaty with an ISDS mechanism.

Other countries are beginning to follow Brazil’s lead: South Africa says it will
withdraw from treaties with ISDS clauses and India is considering doing the same.
Indonesia plans to let such treaties lapse when they come up for renewal. Australia
brie y forswore ISDS in the wake of a complaint by Philip Morris about its
requirements for health warnings on cigarette packets. But its new government
says it will consider allowing such mechanisms in future treaties.

Disgruntled investors in these places will have to take their chances in local courts.
But there are other, less radical routes to reform. Recent treaties have used far more
precise de nitions of expropriation. Other possible improvements include
requiring rms to exhaust domestic legal remedies before an arbitration can begin
and making arbitration more transparent, with greater reliance on precedent.

So far, the country showing least interest in moving away from the current practice
is America. Je rey Schott of the Peterson Institute, a think-tank, reckons that
America’s insistence on an arbitration clause in its deal with the EU does not stem
from any concern about the strength of property rights in Europe. Rather, it is a
marker for future negotiations for a bilateral trade deal with China. “America wants
to set a precedent for China by creating a world-class template for trade
agreements,” he says. Even so, given Barack Obama’s reputation for bashing
business, his administration’s steadfast support for a special privilege that many
multinationals have abused is odd.

Print edition | Finance and economics

Oct 11th 2014

https://www.economist.com/finance-and-economics/2014/10/11/the-arbitration-game 3/6