Libertarians against investment treaties

Simon Lester makes the libertarian case against investment treaties in a recent Cato Institute briefing paper entitled “Liberalization or Litigation?”

Simon begins by offering a review of the history of these treaties, going back to the 1950s – a history I also touch on here.

In the standard libertarian telling, governments don’t do much right and more government functions should be left to the private sector. Investment treaties allow private companies to sue governments to rein them in and may even chill regulation. Why wouldn’t a libertarian like this?

Simon indeed likes the national treatment rules in investment treaties that can limit anti-foreign discrimination, and suggests that this is the main problem encountered by businesses operating abroad.

But he does outline a case against investment treaties.

First, he argues that the treaty regime creates unjustified distinctions between classes of investors. Foreign firms get (at least) procedural rights not enjoyed by domestic firms, and foreign firms from countries with treaties get better than those from other countries. In an era where capital from many countries is piled into diverse holding structures, investment treaties and their definitions of corporate nationality seem quaint. Thus, instead of encouraging investment generally, Simon believes these nation-to-nation specific rules creates incentives only to investment flows between certain countries.

The treaties may also be socializing risk that should be privately borne. As he notes,

“there is no market failure in the area of foreign investment that needs government action. Investors can buy insurance if they want to mitigate risk, or they can sign specific arbitration contracts when they make their investment.”

His third argument is that the treaty regime has vague rules on expropriation and fair and equitable treatment (FET), which are sometimes interpreted in expansive ways. At their worst, they undermine national sovereignty, or at least create that impression.

Finally, investors can launch frivolous cases, instead of having their home governments filter them – as traditionally happened in international law.

It is a good piece. There probably aren’t many Cato Institute publications worrying that international treaties might undermine sovereignty and regulation. Likewise for the argument that diplomatic corps perform a useful filtering role. Many libertarians would not particularly care about or agree with these (reasonable) points. Apparently when we bleed the government dry, the State Department’s investment dispute filtering arm is one agency we’ll keep. I want to know more about how certain government functions get the libertarian stamp of approval.

Since Simon argued “against type” to some extent, let me do the same… just for fun. Why might investment treaties not be as bad as Simon says?

First, to argue that investment treaties favor only certain classes of investors is to argue that these treaties’ so called “denial of benefits” provisions are particularly effective. It’s not clear that this is the case, as noted here in the subsidiary loophole section.  Indeed, Simon cites an example (that of Philip Morris rerouting shareholding structure through a country with a treaty in order to sue Australia) that shows that any company can potentially take advantage of any treaty with minimal transaction costs. A significant body of research finds support for the conclusion that investment treaties signal openness that draws in investment flows from all nations – not (or not just) between treaty signatory nations. (See (Salacuse and Sullivan, 2005: 105), (Grosse and Trevino, 2005: 136), (Neumayer and Spess, 2005: 1577-1580), (Gallagher and Birch, 2006: 969-971), (Büthe and Milner, 2009: 196-206), (Kerner, 2009: 90-93), (Haftel, 2010: 359-366) and (Allee and Peinhardt, 2011: 422-425)). In sum, the system may be well on its way to being multilateral rather than bilateral in nature. As a programmatic question, getting virtually universal agreement on investment law between country dyads has been more fruitful than attempting to start in a multilateral fashion.

Second, there are mechanisms in investment law to deal with frivolous cases. Out of over 500 investment treaty cases, only around 150 got to the merits stage. This means that the others were settled, or ruled against at the jurisdictional stage, or ruled to be lacking in legal merit at some other preliminary stage. (“Frivolity” can mean different things. If it means, “without value,” then many arbitrations may fit the bill. But if “frivolity” means “unlikely to succeed as a matter of law”, I have not seen data on this. Many notices of arbitrations that I’ve read seem at least plausible as a matter of law.) Also, how different is frivolity internationally than domestically? Investors predisposed to litigious behavior may do so at the international or domestic level – I haven’t seen evidence to suggest that the transaction costs differ significantly between the domestic and international level, at least at the early stages of litigation threatening. Anyone going to the trouble of hiring a lawyer has some skin in the game. (Third party funders may alter the incentives of this a bit, but we still don’t know enough about how.)

Third, I don’t think we have very systematic evidence about whether overtly discriminatory treatment is more of a hold up to investment in poor countries than general anti-investor treatment. I don’t think there’s any good evidence that multinationals create hierarchies between which types of (allegedly) arbitrary treatment they would most like to avoid. They don’t like xenophobic treatment, but they also don’t like environmental laws that they hadn’t budgeted for. The breadth of claimed violations among successful investment arbitrations suggest that companies don’t cling nostalgically to national treatment rules alone. Maybe companies shouldn’t get protection from other types of arbitrary treatment for other (normative) reasons, but I don’t know that we can say because they don’t care about it such treatment when they make their investment decisions.

On a related point, it is not clear to me that national treatment and non-discrimination rules are so narrowly tailored or clearly drafted that exactly the same types of regulation couldn’t be challenged under these or FET-type rules. Many critics of investment treaties worried for years that expropriation disciplines would be the most successful, only to find instead that FET was more successfully invoked. National treatment rules are less successfully invoked in investment law, perhaps because of the difficulty of finding appropriate domestic companies that foreign companies’ treatment can be compared against. In contrast, trade tribunals have leaned more heavily on national treatment and relative standards, and less on other types of provisions that have more in common with the absolute standards of FET. At the end of the day, all of these concepts have proved elastic and malleable. The choice of legal provision makes a difference at the margin, but I’m not convinced that smart lawyers couldn’t argue effectively for either set of rules to create similar consequences for similar fact patterns. (See the recent WTO cases on technical standards for an example of what I am talking about.)

Fourth, there is a major argument as to whether expropriation and FET rules are really so different than the takings and due process rules that one finds under some national constitutions and legal systems. Simon acknowledges and seems to hedge on this point, suggesting that these rules are not bad at the domestic level, and may even be desirable at the international level. It seems to me that expropriation rules could be interpreted broadly or narrowly by international courts, just like takings rules could be interpreted broadly or narrowly by domestic courts. We lack systematic evidence about whether broad or narrow interpretations are likelier to prevail at which level, although there are theoretical reasons to believe (and anecdotes that suggest) that investment tribunals might feel less constrained than domestic courts in the post war period. I can imagine taking issue with BOTH the domestic and international rules as interfering with regulatory imperatives, but it seems difficult to take issue with one or the other without recourse to comparative textual or institutional analysis that shows how they work differently between the two settings. Maybe troublesome rules (like takings) are less troublesome in domestic settings because domestic courts have more legitimacy or are more constrained than international ones? But if this is the case, then one should also be concerned about delegating decisions over national treatment to these tribunals.

Simon touches briefly on one matter that I think deserves more attention: whether the vagueness of investment treaties leads to too much litigation. (To answer this would seem to require some explanation of what the economically optimal amount of litigation would be – a theme taken up by other libertarians.) I would supplement that with another set of queries: what explains differences in litigiousness in legal systems, and what are the consequences of these differences? Are there other aspects of social or legal systems that explain why similar concepts (FET or due process) get interpreted in more or less flexible ways?

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