Bolt to the Future

I don’t often agree with John Bolton, but he is asking some of the right questions on the Iran deal.

W’s ambassador to the UN has a column in today’s NYT. In it, he shakes his bellicose fist at the Obama administration’s most significant diplomatic accomplishment. He chastises them for not credibly keeping the option of war on the table, as he has in past columns where he urged bombing of Iran.

Setting aside these reckless recommendations from a man who never saw wartime action, his latest column poses systemic issues worth considering.

First, setting aside war, what is to keep Iran from violating the agreement? The re-imposition (snapback) of the sanctions that effectively brought Iran to the negotiating table. But there are reasons to think this won’t work as planned:

For the president’s predictions of Iranian behavior to come true (and they are central to successful implementation), Tehran must recognize the inevitability of the pain their country will suffer for straying from compliance.

Yet the very language of the Vienna deal demonstrates the opposite. In two provisions (Paragraphs 26 and 37), Iran rejects the legitimacy of sanctions coming back into force. These passages expressly provide, in near identical words, that “Iran has stated that if sanctions are reinstated in whole or in part, Iran will treat that as grounds to cease performing its commitments under this JCPOA” — Joint Comprehensive Plan of Action — “in whole or in part.”

Thus the inexorable pattern will not be: Iran violates the deal; sanctions snap back; Iran resumes compliance. Quite the reverse. The far more likely future is: Iran violates the deal; sanctions snap back; Iran tells us, using a diplomatic term of art, to take our deal and stuff it.

Abrogating the deal, of course, would come only after Iran had reaped the economic benefits of having its assets unfrozen and the sanctions ended. The Europeans (among others) will have been suckered back into economic relationships that will cause as much pain to them as to Iran if they are abandoned. Sadly, the ayatollahs know the Europeans better than Mr. Obama does.

This last point is worth emphasizing. The sanction regime against Iran was painstakingly constructed over many years. The US succeeded in getting allies to respect it, in part through tough penalties for any multinational company also doing business in the US. Iran’s economy was deep in the doldrums as a result of this regime. Once sanctions become dismantled, and European companies (and others) rush in, they will become lobbyists against re-imposition of tough sanctions. And, if Bolton’s predictions are true, it won’t matter much anyway – if Iran has already gotten what it wants.

Without war, sanctions are the stick the administration would have to wield. If you share Bolton’s assumption that Obama (or future administrations) will not use force under any circumstances, then you should be worried about this. I think he is wrong on this. I instead worry that future sanction ineffectiveness will make war more inevitable.

Bolton also critiques procedural aspects of the deal, including lengthy “dispute resolution” mechanisms that he likens to a “a diplomatic La Brea Tar Pit”.

And what if Russia and China block re-imposition of sanctions? How Obama addressed this possibility is Bolton’s real worry:

Under the deal and Security Council Resolution 2231, if a JCPOA party asserts that a significant violation has occurred, then the council must vote within 30 days on whether “to continue the sanctions lifting.” Thus, in theory, if Washington alleged a breach, Moscow and Beijing would have the burden of keeping the sanctions lifted, rather than Washington having the burden of reinstituting them. Absent a resolution “to continue the sanctions lifting,” sanctions snap back.

By concocting a procedure that elides the Russian or Chinese vetoes, Mr. Obama has surreptitiously accomplished a prized objective of the international left, which always disapproved on principle of the veto power. Through 70 years of United Nations history, one lodestar emerges clearly: Washington’s only immutable protection has been its Security Council veto. Mr. Obama’s end-run around the veto poses long-term risks that far outweigh whatever short-term gain is to be had from boxing in Russia and China now.

What Bolton calls a “dangerous precedent” will be celebrated by many in developing countries, who have long seen the US veto at the UN as locking in various “Washington consensuses” over the years.

But he is right to raise our eyes above the short-term diplomatic quandary at hand. More focus on long-term governance might have avoided the current Greek crisis, and the backlash against international economic regimes.

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Yanis Varoufakis, Greece’s radical ex-finance minister, was the subject of an excellent New Yorker profile by Ian Parker.

Particularly fascinating are the details on ways economists, lawyers and politicians varied in their approach to the Greek crisis.

For example, after Yanis told the other Eurozone finance ministers (including Germany’s Wolfgang Schauble) that Greek obligations were to inflexible and that his Syriza party had been elected to break with austerity…

Varoufakis recalled that Schäuble seemed “very cross,” and said, “When there’s a program that everybody has tumblr_nj96laH7YX1un5qroo1_500agreed to, that’s it. Elections cannot change anything, because, then, every time there’s an election everything will change.” (A spokesperson for the German finance ministry said, “Meetings of Eurogroup finance ministers are confidential.”) As Varoufakis put it to me, the idea that elections could change nothing was the “greatest gift one could give to the Chinese Communist Party.” That’s overheated, of course, and democratic governments tend to respect the binding agreements signed by their predecessors. But it was interesting, at Brookings, to hear Schäuble say that “France would be happy if someone could force” its parliament to pass unpopular labor-market reforms. It wasn’t quite clear what Schäuble meant by “France,” if it was neither its people nor its parliament…

Varoufakis said, he’d found no market in Europe for such thoughts. At the level of the Eurogroup, Varoufakis told me, the conversation was “all about the rules.” It was not a forum in which to discuss debt unsustainability, or the rarity of economic growth under austerity conditions. Varoufakis told me that he was “accused of talking about economics.” Once, Varoufakis was asked what Greece’s target surplus should be, if not 4.5 per cent of G.D.P. He “had to give a lecture” about the variables that made the question unanswerable in that form. “They’re not economists,” Varoufakis said. “Most of them are lawyers.”…

According to a Eurogroup official, Varoufakis “didn’t seem to understand that the other people in the room were constrained by their national parliaments. They are bound by certain treaties. Those constraints fly in the face of pure economics. The eurozone is complicated, and he had no understanding or sympathy for that.”…

In the opinion of one troika official, Varoufakis’s disregard for the granular—like the ease with which he requested other European taxpayers to settle Greece’s account—had an undemocratic air. “One may dismiss this as technocrats looking at numbers,” the official said. “But, if something doesn’t add up and there is a gap, the gap has to be financed by somebody.” He went on, “Adding up is the essence of democracy.”

To recap, according to Eurozone officials:

  1. Elections shouldn’t have international consequences.
  2. On the international plane, states are unitary actors across time and space – even if what we mean at cocktail receptions when we name a country is shorthand for its banking class.
  3. Domestically, democracy is about numbers. Making budgets balance. Any cross-subsidization internationally disrupts the democratic pact.
  4. However, the people’s representatives in this numerate democracy need not themselves be numerate. Instead, they are lawyers that can put legal rules and procedures above basic economics.

Is it just me, or does this seem like a regime so complex that we simultaneously get the worst of democracy, economics, and the law?

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Stock-Blocking the Bailouts

The government’s bailout of insurance company AIG was illegal, according to a US judge’s decision last month. The decision is just a latest example of the consequences of delegating adjudication over complex regulatory questions to the legal profession.

A bit of background. The case was launched by AIG’s shareholders in the wake of the financial crisis that brought the company and global economy to its knees. Spearheaded by AIG’s former CEO and largest shareholder Maurice Greenberg and his company Starr International, the plaintiffs alleged that the government’s takeover of AIG’s management and absorption of 80 percent of the company’s shares constituted an illegal taking of shareholder property.

Media and pundits had denounced the claim as frivolous for much of the proceedings. However, Greenberg was represented by the best lawyers money can buy, led by David Boies, who has argued huge Supreme Court cases over the 2000 presidential election, and gay marriage. But some observers – including those familiar with the adventurous claims made in investment treaty arbitration – found it harder to so easily dismiss the claim.

Judge Thomas Wheeler’s decision essentially split the baby. First, he found that the AIG takeover was not a regulatory taking of property, but rather an illegal exaction. The liability implication for the government is essentially the same in either case, but the judge argued that – to be considered a taking – there must be a legally authorized government action in question, which Wheeler found the takeover was not. (More on that later.) Second, because AIG stock was essentially worthless at the time of takeover, the government – although it behaved illegally – did not owe any money to the shareholders. Predictably, both sides are appealing the split decision. Wheeler’s full decision is available here. I have a few takeaways. Continue reading

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Fast Track Changes the Conversation, Not the Law

Financial regulation is having a walk-on role in the raging trade debate between Obama and progressive legislators.

Sen. Elizabeth Warren (D-Mass.) is claiming that the Fast Track trade legislation could be used to undermine the Dodd-Frank Wall Street reforms. Her erstwhile partner in passing that bill – President Obama – virulently disagrees:

She is absolutely wrong… Think about the logic of that, right? The notion that I had this massive fight with Wall Street to make sure that we don’t repeat what happened in 2007, 2008 [the recession], and then I sign a [trade] provision what would unravel it? … I’d have to be pretty stupid.

The claim continues to be litigated in the secondary opinion market, with Bloomberg’s Mike Dornan backing up Warren…

Warren says she’s concerned that Republicans could include provisions in a future trade deal undercutting Dodd-Frank. They could then pass it with a simple majority in the U.S. Senate because the fast-track bill would prevent Democrats from blocking the legislation through a filibuster. Normally, it takes 60 votes to break a filibuster… On Warren’s side: One of the nation’s preeminent constitutional law scholars, Laurence Tribe of Harvard University, who counts Obama as a former student. “Any act of Congress or duly ratified treaty overrides any contrary prior federal legislation,” he said in an e-mail.

… and Matt Yglesias at Vox casting doubt on her claims…

Warren is right about this, but it’s also irrelevant. A Republican president looking to gut Dodd-Frank isn’t going to need anything as labyrinthine as a trade pact with Europe to wreck Obama’s signature financial regulation initiative.

For one thing, House Republicans keep passing bills to repeal parts of Dodd-Frank. They don’t pass because the Obama administration opposes them. But with the Cruz administration’s support, huge swaths of the bill would simply be repealed the old-fashioned way.

Beyond that, there is a lot of regulatory discretion in Dodd-Frank. The new president will appoint new personnel to run the SEC, CFTC, and CFPB and the Treasury Department. Later, the new president will appoint a new Fed chair and colleagues on the board. If these people want to go easier on the banks than Obama, that is exactly what is going to happen. Unlike in the case of environmental or civil rights regulations, there are no private causes of action that a regular citizen can take if she feels bank supervision is excessively lax.

Long story short, while it is easy to image a scenario in which a Republican president undermines bank regulation in 2017 it is difficult to imagine a scenario in which possession of Trade Promotion Authority is the linchpin of the scheme.

As someone who spent nearly a decade researching Fast Track and financial services trade issues, I am excited to see these issues break into the mainstream debate. Too often, reporters and politicians simplify the trade debate into a tariff reduction story. But tariffs are low, and most of modern trade deals are about behind-the-border regulation of the kind Warren is talking about.

But some of these interventions are conflating various issues, and confusing the debate as a result.

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Creeping multilateralism

The debate over Fast Track is heating up, and President Obama is getting more riled up by the details of the investor-state dispute settlement mechanism, or ISDS, than I’ve ever seen a sitting president get. On a recent conference call with reporters discussed by Greg Sargent, Obama said:

This is the notion that corporate America will be able to use this provision to eliminate our financial regulations and our food safety regulations and our consumer regulations. That’s just bunk. It’s not true.

ISDS is a form of dispute resolution. It’s not new. There are over 3,000 different ISDS agreements among countries across the globe…

ISDS has come under some legitimate criticism, when they’re poorly written, because they’ve been used in particular by some tobacco countries in some countries to challenge anti-tobacco regulation. That’s why we have made sure that some of the legitimate criticisms around past ISDS provisions are tightened, are strengthened, so that there is no possibility of smaller countries or weaker countries getting clobbered by the legal departments of somebody like R.J. Reynolds so that they can’t pass anti-smoking regulations.

The president is correct about the widespread proliferation of investment treaties. Indeed, I can’t think of another category of international pact that is equally bounteous.

Notably, most of these treaties – UNCTAD estimates nearly 80 percent – include most-favored nation provisions. MFN rules have a long history, and are premised on the notion that – when King Sam extends privileges to King Jack, he should do the same for King George. Fast forward to investment treaties, and MFN means that the US must treat German investors as well as it treats Canadian investors, and Argentine investors, and so on.

As legal scholar Martins Paparinskis has shown, investment treaty arbitrators have had a field day with MFN provisions. Arbitrators have found that investors from Country A investing in Country B get to have access to equal treatment as Country B offers investors from Countries C, D and so on. But this “treatment” goes beyond Country B’s direct relations with the investor in question, and can include the benefit of the substantive and procedural treaty provisions that Country B negotiated with those other nations.

Pause for a moment to imagine the mischief this allows. Let’s say that we take Obama at his word that his investment agreements are better than past ones – perhaps by blocking challenges of health measures. Great. But if the past pacts continue to exist, then investors could pluck the most pro-investor provisions from a country’s entire roster of treaties. Such use of MFN sharply diminishes the utility of treaty-by-treaty reform efforts.

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Business in Court(s)

Obama’s trade push has brought unparalleled levels of attention to investor-state dispute settlement. Mark Bittman writes in the NYT about Obama’s Trans-Pacific Partnership (TPP):

The agreement would even allow countries to challenge one another’s laws… If our laws are seen as restraining trade or limiting profits, they could be challenged in special courts, per the TPP’s “investor state” clause. Philip Morris is suing Uruguay over that country’s antismoking laws under just such circumstances; there are several examples of American companies’ flouting local laws and citing trade agreements as an excuse; and Mexico has been sued repeatedly for theoretically diminishing investor profits.

Underlying this argument seems to be that investment treaties’ “special courts” are more pro-business (or less pro-public interest) than national courts. At least, that seems to be the appropriate comparator.

Yesterday’s US Supreme Court oral arguments challenge that assumption. As Adam Liptak writes:

With scorn bordering on anger, some of the Supreme Court’s more conservative members on Wednesday gave a hostile reception to a government program dating to the Great Depression meant to increase raisin prices by keeping some raisins off the market.

“Central planning was thought to work very well in 1937,” Justice Antonin Scalia said, “and Russia tried it for a long time.”…

The case, Horne v. Department of Agriculture, No. 14-275, arose from the activities of Marvin D. and Laura Horne, raisin farmers in Fresno, Calif., who in 2002 set up a business arrangement that they claimed allowed them to avoid the program.

The Agriculture Department imposed fines, and the Hornes defended themselves on the ground that aspects of the program violated the takings clause of the Fifth Amendment, which says private property may not be taken for public use without just compensation….

“It doesn’t help your case that it’s ridiculous,” Justice Scalia said…

Despite the scorn, the raisin program apparently has some merits. Justice Breyer noted that the program left the raisin farmers better off than without the program. The government defense, moreover, emphasized that farmers that didn’t like raisin regulations could move into different crops – a seemingly reasonable argument that nonetheless attracted conservative ire (“That’s a pretty audacious statement,” the chief justice said. “If you don’t like our regulations, do something else.”).

The raisin case wasn’t the only unconventional takings dispute working its way through the US court system this week. As Aaron Kessler writes, US judges have been more willing to entertain a fanciful takings claim by AIG shareholders against the US government financial bailout than most observers would have thought possible. I’ve written about this case before. At its core, as Kessler notes, is about whether a government measure that actually salvages value in a bankrupt company could nonetheless be so forceful that it counts as a taking. If the US loses (which seems a bit more possible than it did a year ago), the taxpayer could be on the hook for billions.

These cases take place against the backdrop of an evolutionary debate in US law about the balance between business and public interests. As Will Baude notes over the Volokh Conspiracy, there is an ongoing debate within US constitutional law as to what kinds of property and deprivation are covered by the “takings clause”. The frontier of these rules have moved over time, from total state discretion in the early days of the Republic (as William Treanor argues here) to gradually more categories of compensable takings today (as Matt Porterfield argues here).

This domestic evolution has seemed to play out in reverse in the investment arbitration world. After years of worry that international arbitrators would stretch anti-expropriation rules in investment treaties beyond that allowed in the analogous domestic takings rules, they have rarely found against states under these provisions. For example, in Merrill Ring v. Canada (a NAFTA case from 2010) entertained a logging investor’s claim against Canada’s decades-old policy of regulating the logging industry. Despite some lengthy pro-business musing in the text of the award (the lead arbitrator was none other than one of Augusto Pinochet’s diplomats), the arbitral tribunal decided that nothing in international law allowed the forestry regulations to be considered takings (or even violations of the considerably looser “fair and equitable treatment” standard). In Biwater Gauff v. Tanzania, a government was found to owe nothing after its forced invasion of a water concessionaire before its contract was up. The reason? The government action was mostly reasonable in an emergency situation, and actually salvaged some of the value in a worthless company.

These parallel developments are a bit of a puzzle. I would predict that national judges would be more restrained to follow state interests than arbitrators in ad hoc international arbitration (where investors bring the case load and the pay days). These cases – then – are somewhat confounding. Why would US judges be more willing to scrutinize decades-old agricultural policies and emergency bailouts than arbitrators whose fees come from business? Coming up with adequate answers would require more understanding into the effective opportunity and constraint structure facing US judges in a time of US political gridlock, as compared with investment arbitrators in a time where even food columnists write scathing attacks on them.

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No Methanext Time

As @jonathanweisman reports, Wikileaks has leaked the investment chapter of the Trans-Pacific Partnership. In response, critics and proponents of the Obama trade deal have trotted out their favored arguments against and for the deal’s investor state provision, which allows foreign investors to directly sue states. Some of the arguments on the pro side, such as the fact that the US has never lost a case, that 3,200 of these treaties already exist without the world imploding, and that the US is already sued a lot in domestic courts, are difficult to counter.

However, one argument raised in the piece seems less compelling. From the NYT,

[In 1999] California banned the chemical MTBE from the state’s gasoline, citing the damage it was doing to its water supply. The Canadian company Methanex Corporation sued for $970 million under Nafta, claiming damages on future profits. The case stretched to 2005, when the tribunal finally dismissed all claims. To supporters of the TPP, the Methanex case was proof that regulation for the “public good” would win out […] as long as a government treats foreign and domestic companies in the same way, defenders say, it should not run afoul of the trade provisions. “A government that conducts itself in an unbiased and nondiscriminatory fashion has nothing to worry about,” said Scott Miller, an international business expert at the Center for Strategic and International Studies, who has studied past cases. “That’s the record.”

This narrative about Methanex may pass muster in the court of the public opinion, but it has not fared as well in the courts of investment treaties.

The quirk about investment treaties is, there is no binding precedent. So it’s a fairly unpredictable legal system where different ad hoc tribunals come to different conclusions on similar matters and legal provisions. So the pro-regulatory reading of Methanex (which is not the only reading of the award, BTW, as I show below) has not been consistently followed in subsequent cases. Not even, as it turns out, by its creators (who are, as an additional quirk, also not bound by their previous decisions either). The rub? Citing any one case as support for a favored proposition is a pretty merit-less exercise.

To examine Methanex’s legacy, I pulled together the 32 finalized arbitration awards since that time that cite the decision. Although not binding, past cases do influence later ones, as evidenced through citation. Although not a random sample of the 137 cases in my dataset (which features all public and finalized merits cases from the first award in 1990 to the end of 2013), it is a nice cross-section of a good chunk of awards.

The Methanex decision was rendered by an ad hoc tribunal led by UK arbitrator VV Veeder, who was joined by Michael Reisman of Yale Law School (selected by the US) and Canadian lawyer J. William Rowley (selected by the investor). I will first highlight its conclusions on expropriation, which are the ostensible basis for some of the claims by Miller above. (Later on, I will address a few other aspects of the case.)

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