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Investor Protection, National Sovereignty, and the Rule of Law

As a candidate, Donald Trump promised to renegotiate—or else repudiate—the North American Free Trade Agreement (nafta), which liberalized trade and other economic activity between the United States, Canada, and Mexico. This fall, his administration began formal talks toward redrafting the Clinton-era trade deal, which is nearly a quarter century old. The nafta renegotiations have been anxiously decried on many sides while also praised as offering a chance to update what was once touted as the model of a “next generation” trade agreement.

What would a “modernized” nafta look like? Ironically, it may end up looking a lot like the failed Trans-Pacific Partnership (TPP), which all three leading presidential candidates said they rejected, and which failed to muster even fast-tracked congressional approval during President Obama’s final term. Yet such is the force of conventional approaches to international economic integration—now extended to “e-commerce” and with added protections for America’s pharma and tech giants—that a redrafted nafta could end up resembling a three-country TPP.

President Trump’s iconoclasm on trade needs no introduction. The nafta talks are, in this respect, a signal test of what an administration rhetorically committed to “America First” means by that slogan—and whether it can achieve its ends in the context of a multilateral negotiation among our closest allies. Predictably enough, given their formal purpose, the released negotiating objectives of the Office of the United States Trade Representative (USTR) provide few details of what to expect. But the reader could be forgiven for experiencing mild whiplash when moving between the president’s aggressive tweets and the mildly reformist negotiating objectives laid out for congressional and public consumption.

From the president’s tweets and other statements by officials—and reading between the lines of the USTR objectives—it appears that what the Trump administration intends by “America First” is a slightly anxious defense of the global economic position of the United States, particularly in terms of its industrial competitiveness. The concern about the current account deficit and the decline in manufacturing has generated a rather conventional, neo-mercantilist approach, a vision of “economic nationalism” that was loudly denounced when associated with former White House adviser Steve Bannon but which has, in fact, been adopted by every past administration in one way or another.

In the context of nafta renegotiations, such a neo-mercantilist approach will promote American commercial competitiveness in vanguard sectors such as tech, finance, and services while beefing up, or at least defending, traditional remedies (safeguards, antidumping, and the like) used to protect declining industrial sectors. The main contrast from earlier decades of neoliberal economic integration appears to be found in the public framing: this approach couples a defense of “national capital,” in directing government support toward the traditional and increasingly beleaguered industries of the heartland, with rhetorical jabs at—and quiet support for—the successfully globalized capital of the coasts. How feasible such a coupling will prove remains to be seen.

But if the nafta renegotiations proceed in a primarily neo-mercantilist register, they will likely prove a disappointment in one area where “America First” might have meant something else: not “economic nationalism” as a campaign slogan, but American leadership in reshaping the global order in another direction. Strikingly, what appears to be missing from the administration’s current trade priorities is a commitment to rethinking one of the most controversial provisions of nafta—its special procedures for resolving disputes between private foreign investors and member states. These investor protections go by a variety of names—investor-state dispute settlement (ISDS) most prominently—and were a major target of antitrade criticism by the Sanders campaign and what has been dubbed the “Warren wing” of the Democratic Party.

So far, the reform of ISDS has not been on President Trump’s agenda for trade, in spite of some widely reported remarks of the U.S. Trade Representative last October that seemed to imply some skepticism about ISDS. It would be unfair—both cynical and too easy—to suggest that this is because Trump is himself a wealthy investor with many foreign projects. More fundamentally, his lack of concern about ISDS seems to track the divide between a neo-mercantilist trade agenda and an economically populist one of the kind advanced by the Sanders campaign, despite some overlap between the two. American corporations have no strong reason to criticize ISDS, even while it repeatedly features among the issues that ordinary Americans (and the citizens of other states) are most opposed to in new trade deals. In maintaining ISDS, President Trump is simply thinking like the billionaire CEO that he is—joined by the many other former CEOs that staff his departments of State, Commerce, Treasury, Education, and elsewhere—and thus advancing a vision of “America First” interpreted through the interests of America’s corporate executives.

Leaving to one side the domestic class conflict this vision obscures, an internationalized version of “what’s good for General Motors” will mean that the United States fails to join the revolt against ISDS gaining traction across a wide range of countries. What’s worse, it may help contribute—as it did in the original nafta—to its further entrenchment around the world.

The Insular World of Foreign Investment Protection

While Bernie Sanders, Elizabeth Warren, and other left-wing critics have made opposition to ISDS a part of their criticism of neoliberal trade policies, Republicans have tended to waffle on the issue because of its perceived benefits to big business. Instead, Republicans direct attention toward more visible but ultimately less consequential international institutions. This ambivalence about whether ISDS is “good for America” is partly due to the opaqueness of the arbitration system, which makes its critical evaluation difficult except to insiders. Not only do the details of this form of dispute resolution require a degree of technical training to grasp, the outcomes of investment disputes are often kept confidential by the parties, making it hard to assess its operation.

Nevertheless, when the Obama administration pushed to expand ISDS as a part of the TPP and the planned Trans-Atlantic Trade and Investment Partnership (TTIP), the controversy over investment arbitration briefly captured public attention. Legal professionals were themselves split. A letter signed by over a hundred law professors and economists denounced ISDS and asked that it be removed from the TPP negotiations,1 but it was soon answered by a letter defending ISDS by over fifty law professors and jurists, many of whom work actively in arbitration.2 More recently, a letter signed by over 230 scholars has requested that the Trump administration make the reform of ISDS a major focus of the nafta renegotiations.3 Whether it will heed this request is doubtful.

What is ISDS and how could it inspire this controversy? ISDS involves the use of private arbitral panels composed of private-sector lawyers to settle disputes brought by foreign investors against participating governments for alleged violations of promised investor protections. These include most prominently the obligation to pay adequately for any nationalized investments (“non-expropriation”) and to observe minimum rules of fair treatment (“fair and equitable treatment”), along with less controversial provisions, such as the obligation to provide the foreign investor the same treatment as domestic investors (“national treatment”) and, often, investors from other foreign countries (“most favored nation”). The interpretation of these and related obligations is left to the arbitral panels, which lack the procedural rules that would accompany formal judicial proceedings. The ISDS system is more or less administered by a handful of elite private lawyers who make a career doing repeat arbitrations, often representing both investors and the accused governments. In a seminal work from the mid-1990s, Yves Dezalay and Bryant Garth observed that this elite group of lawyers was constructing a “transnational legal order” from whole cloth.4 It has generally remained a closed shop: in a recent social network analysis, Sergio Puig concluded that an enormous number of investment arbitrations are adjudicated by a core of just twenty-five “grand old men” or “power brokers” who “dominate the arbitration profession.”5

None of this might matter much if the new transnational legal order were necessary and uncontroversial. Supporters of ISDS contend that it stimulates needed cross-border investment through these special guarantees. However, the extent to which foreign investment requires ISDS—especially in countries with established courts—remains widely disputed. Moreover, critics have both procedural and substantive misgivings about the system itself. Procedurally, the emphasis on confidentiality and on the case-specific mandates of arbitrators has hampered the development of arbitral jurisprudence and publicly accountable reason-giving. Procedural norms have developed glacially, if at all, and can in no way match the procedural protections of national court systems. Practices such as repeat appointments or the revolving door between arbitrators and elite arbitral counsel are not just largely unregulated, but have become routinized phenomena.

Meanwhile, the very high threshold for the annulment of arbitral awards has licensed alleged excesses on the substantive front. In the first place, arbitrators sit in judgment of the sovereign functions of the states that find themselves respondents in the ISDS system. Regulations that diminish the value of foreign investors’ private property are frequently the subject of regulatory disputes alleging “indirect expropriation” as well as a failure of “fair and equitable treatment.” The result has been what is called “regulatory chill,” as in the widely reported decisions of numerous countries against enacting anti-tobacco legislation after Philip Morris filed (ultimately unsuccessful) claims seeking exorbitant damages from Uruguay for its regulations on cigarette packaging. Such cautionary responses are understandably more pronounced in developing countries, for which even the cost of pursuing ISDS proceedings—sprawling, multiyear affairs run by highly compensated counsel—can prove prohibitive. Exacerbating these structural defects are patterns of arbitral excess in interpreting treaty provisions, such as “fair and equitable treatment,” that resemble broad standards rather than tailored rules.

The Origins of ISDS

These features of the ISDS system may prove less surprising when we consider its origins. The ISDS system began in the late 1950s to protect capital-exporting developed countries from the instability of new postcolonial regimes, whose national court systems were deemed inadequate or otherwise untrustworthy in adjudicating complaints brought by private foreign nationals against their government. From an initial bilateral investment treaty (BIT) signed by Germany and Pakistan in 1959, which protected investors in each country and provided for investment arbitration of disputes, the ISDS system has spread. The 1960s and 1970s saw its expansion in spite of—or perhaps because of—the wave of decolonization and the subsequent push for a “New International Economic Order.” The two main arbitral bodies were established in the mid-1960s, one associated with the World Bank (the International Centre for the Settlement of Investment Disputes), the other with the UN (the United Nations Commission on International Trade Law). Even after the increasing regularization of the ISDS system, however, it remained a mechanism mainly for protecting foreign investment from the rich world against the instability of new postcolonial governments. While obligations on states were, of course, reciprocal in the nature of a treaty, the investment flows were asymmetric: it was generally clear whose foreign investments were supposed to be protected, and which party was making guarantees to attract them.

Nafta changed all that. The inclusion of an investment chapter in the North American treaty meant that two developed countries, Canada and the United States, were now bound in ISDS along with Mexico. With the end of the Cold War, what had been a tool for managing investment flows to countries without established judicial systems became a technique for managing a newly globalized economic integration.

Nafta set off a rush of global rulemaking to protect cross-border investment against possible interference by signatory states. The mechanisms for the expansion of ISDS included trade-investment linkage—as in the inclusion of an investment chapter in trade treaties such as nafta—and the proliferation of standalone BITs with ISDS provisions. The UN Conference on Trade and Development, which tracks international investment flows, calculates a total of 367 international investment agreements signed between 1965 and 1989, compared with 2,663 new agreements between 1990 and 2007—with many more of the agreements in the latter period containing ISDS provisions. Moreover, prior to 1990, following decades of the slow expansion of ISDS, there had been only a single ISDS case, whereas in the succeeding period, 1990–2007, there were 291 ISDS cases. Since 2008, another 316 ISDS cases have been recorded, as the system set in place began to operate at full steam.6

A Global Revolt

Following the financial crisis of 2008, we have seen two opposing trends in the global reach of ISDS. On the one hand, it is no exaggeration to diagnose a growing revolt against ISDS, particularly on the part of large democracies in the developing world. This major trend extends to many of the populations in the developed world (but not to their instrumentalities of government, as I discuss further below). On the other hand, the last decade has seen the further entrenchment of ISDS in the developed world, through new trade agreements such as the Canada-EU Trade Agreement (CETA) and proposed ones like the TPP.

Many major developing countries, which once willingly signed on to investment treaties in order to attract foreign capital, have taken a cautious step away from ISDS. A number of Latin American countries, particularly states that have unhappily borne the brunt of ISDS claims, have denounced the system altogether, and triggered mechanisms for withdrawal from treaties such as the icsid Convention. A much larger group of countries have reconsidered the terms of their engagement with ISDS and have suspended their commitments to standard treaty obligations in favor of alternative regimes for governing foreign investment. India, for example, has recently terminated the vast majority of its BITs with an eye towards replacing them, and is seeking to bilaterally impose new constraints on the interpretation of its remaining treaty obligations. It is widely accepted that this is in reaction to adverse arbitral awards.7 Brazil, which has always maintained caution regarding ISDS, has instituted an alternative regime altogether: “Cooperation and Facilitation Investment Agreements” (CFIAs), which promote cooperative and consultative investment governance rather than the adversarial ISDS. Substantively, CFIAs impose scarcely any constraints upon the regulatory autonomy of the state beyond minimal and uncontroversial obligations such as nondiscrimination. South Africa, meanwhile, has opted to govern its foreign investment through a domestic statutory scheme in place of supranational commitments through investment treaties, substituting the credibility of its domestic rule of law for reciprocal ISDS commitments with other states.8 These departures represent only a few of the many approaches to ISDS reforms that are being pursued throughout the developing world, particularly the democratic developing world.

It is worth noting that the policy options available to countries questioning ISDS run the gamut from repudiating ISDS commitments in favor of a return to national courts, as India and South Africa have done, to setting up novel dispute-resolution systems, as Brazil is now trying to do. A basic reform might be to reassert the familiar rule that “local remedies” must be exhausted before any move to international dispute resolution can occur. With very few exceptions, a presumption in favor of local remedies exhaustion operates across most international law. It is far from clear why the protection of cross-border investment should be made an exception to this default. A more limited reform would be simply to rein in the most ambiguous investment commitments in new or renegotiated investment agreements—for example, removing or clarifying the commitment to provide “fair and equitable treatment” so that it does not become an open-ended invitation to creative arbitral decision-making.

An alternative proposal—now gaining traction in the European Union and among some of its trading partners—suggests the reform of ISDS by eliminating its frequent ad hoc character and regularizing new supranational institutions for investment dispute resolution. This proposal fits with the opposing trend noted above: the continued consolidation of ISDS in the developed world—among precisely those countries which, on the traditional reckoning, did not need special investment protections given the strength of their domestic judicial systems.

Note that, as with the developing democracies surveyed above, opinion polls suggest widespread opposition to ISDS by the citizens of the developed world. But their governments have been able, so far, to press forward with ISDS regardless, reflecting decades of growing insulation of international economic policy-making from the demands of domestic majorities. In the United States, “fast track” procedures allow trade deals, including those with an investment chapter, streamlined treatment and an up or down vote (which eliminates the ability of Congress to alter ISDS provisions negotiated earlier by the USTR). Likewise, in the EU, the European Commission’s agenda has been at variance with both the European Parliament and many national populations which oppose ISDS, albeit with an openness to regularizing ISDS within a supranational investment court (after the usual manner of European unification). Canada, as part of its new trade deal with Europe, the CETA, has taken early steps toward a permanent appellate body for investment via a “closed list” of professional arbitrators. It is expected that future EU trade deals may similarly feature such a move toward regularizing ISDS in new regimes that would call states to account for alleged infractions.

Thus, alongside a growing revolt against ISDS in the developing world, occasioned by an interest in reasserting state sovereignty over domestic regulatory agendas, is a continued consolidation of ISDS in the rich world, tied increasingly to an agenda of supranational institution-building, particularly in Europe. How these two basically opposed trends will play out remains to be seen.

China’s role in this conflict remains ambiguous. As one might expect from a major capital-exporter (and the major recipient of foreign direct investment), it has moved from an oppositional stance to one that generally supports ISDS. In its early BITs, which were negotiated at the beginning of its economic liberalization (with Sweden in 1982; Sri Lanka and Japan in 1987), it either rejected ISDS in favor of direct state-to-state arbitration, limited the extent of awardable damages, or predicated the use of ISDS on state consent. By the late 1990s, however, in line with its reorientation toward neoliberalism (and in parallel with its negotiations to join the WTO), China began allowing ISDS in its BITs. While this move was initially meant to reassure its foreign investors, it now includes ISDS in new international investment agreements to protect its outbound foreign investment. China’s stance toward reform proposals—from eliminating or curtailing ISDS altogether to establishing a permanent investment court—is therefore hard to predict, particularly as it appears interested in seeing its own arbitration industry mature and establish itself globally.

The Problem of Sovereignty

The Trump administration’s nafta renegotiation now provides a major opening for the United States to reconsider its commitment to ISDS, joining the growing movement to limit or repurpose investment arbitration. It could insist, for example, that U.S. courts are entirely competent to hear disputes between federal, state, or local governments and foreign investors with the same competence and neutrality with which they handle a wide range of other disputes, including ones in which the government is a party. Many existing international investment agreements already contain a nod toward local remedies, and the United States could insist on taking these seriously—renewing the Calvo Doctrine (or some variant on it) for the world of twenty-first-century capitalism. If national sovereignty means anything in juridical terms, it surely means that the U.S. court system should have a first crack at getting international disputes right—and that our life-tenure, professional judges are at least as neutral and competent as the elite lawyers who replace them in privatized arbitration under ISDS.

Ironically, however, the United States can only insist on its own judicial priority by renegotiating a range of treaties, thus working with its trading partners to reimagine what investment protection should look like in a world of mature states and established judicial systems. This will require dialogue, persuasion, and a critical reexamination of the normative underpinnings of the rule of law, domestically and internationally. It would need to avoid isolationism precisely to recover its sovereignty. Indeed, upholding national sovereignty and the rule of law domestically will require working with our democratic allies to make the entire world safe for the responsible exercise of national sovereignty. In such an effort, the United States would need to join India, South Africa, Brazil, and many Latin American neighbors not only in opposing the ISDS system as it has been constructed but in making a joint effort to rework it altogether.

The do-nothing alternative is to persevere in a system that faces increasing public opposition and whose ad hoc nature renders it vulnerable to ongoing crises of legitimacy. The predictable response to this circumstance will be to regularize ISDS, creating a permanent supranational agency in charge of investment arbitration. Many longstanding U.S. allies will push for this, and will do so with the support of powerful corporate constituencies that prefer the convenience and consistency of ISDS over navigating the foreign judicial systems of the countries in which they choose to invest.

Perhaps the single most important reason for the United States to revisit its commitment to ISDS is its foundational premise: that national courts cannot be counted on to fairly adjudicate disputes between their home governments and foreign investors. The premise is attractive in an era of increasing supranational governance, which mistrusts state sovereignty and tends to sequester decision-making power beyond the reach of ordinary citizens. If followed out, its logic will also extend beyond investment disputes alone. For if national courts cannot be trusted to treat foreign investors fairly, why should they be allowed to hear the complaints of any foreign national—or, indeed, of any national citizen—against its government?

Investor-state dispute settlement began simply as a contingent strategy for managing an alleged weakness in regions transitioning from being imperial colonies to independent states. Making it a permanent feature of a new world economic order would suggest that the “rule of law” can only be achieved by agencies outside—above or without—the state. Yet because the rule of law depends essentially on the state and the sophisticated, neutral exercise of its capacities, such a move will prove ultimately self-undermining. With states cast as mere interested parties in an adjudicatory regime that is supposed to function above them, yet which relies on them all the same, the rule of law itself risks slowly coming apart. What will replace it remains unclear: perhaps the rule of multinational corporations or global capital or technocratic “elites” speaking on its behalf but ultimately undisciplined by law as we now understand it.

It is not obvious that this point will be grasped by an administration that has tipped its hat to “America First” rhetorically while continuing the essentially oligarchic policies of past administrations, both Democratic and Republican. But it is not obvious that any other administration will have the temerity, or perhaps recklessness, to reopen nafta—and with it, the possibility of renewing the rule of law by reforming or repudiating our commitment to ISDS.

This article originally appeared in American Affairs Volume II, Number 1 (Spring 2018): 17–28.

1Letter to Majority Leader McConnell, Minority Leader Reid, Speaker Boehner, Minority Leader Pelosi, and Ambassador Froman,” Alliance for Justice, March 2015.

2Letter to Majority Leader McConnell, Minority Leader Reid, Speaker Boehner, Minority Leader Pelosi, and Ambassador Froman,” McGill University Faculty of Law, April 2015.

3Letter to President Trump,” Public Citizen, October 25, 2017.

4 Yves Dezalay and Bryant G. Garth, Dealing in Virtue: International Commercial Arbitration and the Construction of a Transnational Legal Order (Chicago: University of Chicago Press, 1996).

5 Sergio Puig, “Social Capital in the Arbitration Market,” European Journal of International Law 25, no. 2 (May 2014): 387.

6 United Nations Conference on Trade and Development, World Investment Report 2015 (Geneva: United Nations, 2015), 121.

7 As in White Industries Australia v. India, in which a most favored nation clause was expansively interpreted to import dispute resolution commitments from India’s treaties with other nations to a context in which ISDS was not guaranteed. India’s 2015 “model” BIT therefore omits a most favored nation clause, in addition to imposing other restrictions upon its investment treaty obligations.

8 The Protection of Investment Act of 2015.

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