Investors have controversial new rights to sue countries. Here’s why this matters for the U.S.

Nov 30 '15
Protesters stand in the street to block traffic during an anti-Trans-Pacific Partnership (TPP) demonstration in front of the US Commerce Department in Washington, DC, November 16, 2015. AFP PHOTO /JIM WATSON

On Oct. 5, the U.S. finished negotiating a complex and controversial free-trade agreement with 11 other countries, called the Trans-Pacific Partnership, or TPP. Congress is gearing up to vote yes or no on the treaty.  And one provision is especially contentious: ISDS, or Investor-State Dispute Settlement.

Some 3,000 international treaties already exist that allow foreign investors to sue the government of a sovereign country, legally challenging its actions, but outside the country’s own courts. Foreign investors have sued at least 120 different countries more than 650 times between 1990 through 2014.

[People are freaking out about the Trans-Pacific Partnership’s investor dispute settlement system. Why should you care?]

Ezra Klein at Vox writes, “The ISDS system isn’t likely to have much effect on Americans at all.” It’s true that the U.S. has prevailed in the 13 lawsuits brought to judgment against it thus far. So is the outcry over ISDS – from Sen. Elizabeth Warren (D-Mass.) on the left to the Cato Institute on the right – much ado about nothing?

No, it isn’t.

First of all, while one putative justification for ISDS is that it encourages investment, it isn’t at all clear that it does. Second, it hurts to get sued, even if you don’t lose. Third, ISDS doesn’t depoliticize investors’ disputes, as it was supposed to.

Here’s what the research says about the politics around foreign investment, and how it has consequences for the United States, too.

1. ISDS doesn’t do what it’s supposed to.

The purported justification for ISDS is that it’s risky for businesses to set up shop in another country’s sovereign territory. They might find their property confiscated or their investments undermined by government action. However, countries can really benefit from foreign investment, and thus governments want to reassure potential investors. That’s why they sign treaties to promise fair treatment to foreign investors. ISDS is designed as a failsafe: if the government behaves badly, the foreign investor can sue and get compensation.

[Wonder how American tobacco companies can sue countries for antismoking campaigns?]

If ISDS did help soothe the fears of foreign investors, leading them to invest more, it might be worth the tradeoffs. The problem is that there is no clear evidence that these agreements do attract investors. Many scholars have used sophisticated statistical techniques to show, in the end, that investment treaties generate little or no increase in foreign direct investment. Others find some hope. For example, U.S. firms investing in factories, infrastructure, and other physical assets invest a little more abroad when the U.S. has an investment treaty with the partner country. But that’s a far cry from ISDS increasing investment everywhere.

Even if ISDS did work as it was supposed to, it wouldn’t do much for investment into the United States. Investment treaties and ISDS were initially supposed to help very risky developing countries reassure investors that they weren’t stuck if they got tangled up in the developing nations’ unreliable domestic legal systems. Because the United States has a well-functioning legal system, that rationale for ISDS is irrelevant here.

2. Countries that get sued lose future investment and rethink regulations.

For the United States, the real upside of ISDS in the TPP is that American firms get the right to sue other TPP governments. Reasonable people can disagree about whether that justifies the downsides of ISDS.

One key downside to consider is that the right to sue goes both ways. While we know that democracies like the United States interfere with firms’ property rights less often, they still interfere sometimes. And under the TPP, more frustrated investors from more places can sue the U.S.

[The TPP has a provision many will love to hate: ISDS. What is it, and why does it matter?]

The problem is that countries that get sued get less future investment in aggregate, including less investment from compatriots of the firm doing the suing. Just getting sued is enough to scare off other investors: It might not matter whether the U.S. wins its lawsuits or not.

If it is costly to get sued, then rational governments will behave in ways that minimize the risk of getting sued. This is the root of the worry about what ISDS might do to regulation. The U.S. government might think twice about setting regulations that trigger lawsuits.

For instance, what if TransCanada uses the NAFTA ISDS provision to sue the United States for unfair treatment over the Keystone Pipeline? The international law rumor mill is buzzing that such a lawsuit could be filed, even though TransCanada probably wouldn’t win. But being sued might be bad enough to discourage the U.S. from making other controversial regulatory decisions.

This said, in new research we find that ISDS might be good at getting investment from at least one source: reinvestment from the aggrieved investor itself. Well over one-third of investors reinvest after they win a lawsuit, and a quarter of investors reinvest even after they lose a lawsuit—suggesting that some investors may respect the rule of law even if they don’t like the outcome.

3. ISDS doesn’t get the U.S. government off the hook for American firms’ disputes.

Historically, ISDS was supposed to “de-politicize” investment. At the World Trade Organization, governments sue each other. So, firms with trade disputes have to complain to their diplomats first.

ISDS was supposed to keep diplomats from getting pulled into private investment disputes, because firms file their own lawsuits instead. That hasn’t happened. In fact, I wrote a book about how diplomats and national origins shape investors’ political risks today. ISDS made it easier for me to do my research, because disputes that used to be hidden behind closed doors are now heard in public, international tribunals.

Investors want their home governments to remain involved in their disputes abroad for good reason: These disputes can get politically tricky. Countries in general did not know what they were in for when ISDS spread around the world in the last decades. Getting sued can be a real shock. Lawsuits have been centerpieces of political campaigns in countries like South Africa, Ukraine, Indonesia, Bolivia, and so on. Some disillusioned governments have delayed ratifying, renegotiated, or withdrawn from treaties. In short, ISDS can stir up anger that diplomats have to quell.

A large body of research suggests real consequences to a system that, for better or worse, has become part and parcel of modern trade treaties. ISDS seems obscure, but it is already shaping the behavior of American actors. And the TPP doubles-down on it.

Rachel Wellhausen is an assistant professor of government at the University of Texas at Austin. She is the author of The Shield of Nationality: When Governments Break Contracts with Foreign Firms.