October 21, 2016

Every Trade Deal Needs a Referee

Tyler Cowen

Holbert L. Harris Chair of Economics at George Mason University

Worries about dispute-resolution courts seem especially out of place for a large and powerful country such as the U.S. The presence of the U.S. is often required to give a trade treaty reach and legitimacy, and so future extensions of the settlement process are likely to respect American interests.

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While the economic arguments for freer trade are strong, many people remain skittish about proposed trade deals involving the U.S., Asia and Europe. In particular, critics are focusing on provisions of these deals that set up tribunals to rule on disputes between governments and companies.

The critics charge that these Investor-State Dispute Settlement panels would have too much power to elevate corporate interests over the democratic will under the pretext of enforcing trade rules, and would allow companies to unjustly sue governments.

A closer look, however, shows that the core features of this dispute-settlement system, embedded in the Trans-Pacific Partnership of 12 Pacific-Rim nations and the Transatlantic Trade and Investment Partnership between the U.S. and European Union, have been a largely unobjectionable part of the status quo for some time.

One criticism is that the tribunals could force governments to pay compensatory “takings” to foreign companies that incur costs as a result of safety or environmental regulations. But it has long been standard practice for trade treaties to protect foreign companies, for example by limiting the nationalization of foreign investment. Investors don’t always trust the courts of the nations they are investing in, and indeed from 1990 to 2013, at least 150 foreign-owned firms were nationalized, typically in emerging economies, or otherwise subjected to confiscation of value. Agreeing to refrain from such practices can attract more foreign investment and raise living standards.

Nonetheless, investor-state settlement clauses are growing more controversial, in part because the symbolism of a foreign company suing a domestic government is bound to occasion opposition. It therefore may make tactical sense to leave the clauses out. That said, ISDS clauses, when present, are not sufficient reason to oppose trade treaties.

For instance, the U.S. and Vietnam have had a bilateral investment agreement since 2001, and with few if any negative consequences. More generally, there are now more than 2,000 bilateral investment treaties worldwide, 41 with the U.S. at last measurement, and they typically have some form of investor-state dispute resolution. So does the 1994 North American Free Trade Agreement between the U.S., Mexico and Canada. Over this same period, trade and investment have brought global living standards to unprecedented heights.

National sovereignty has not exactly disappeared. Trade treaties typically recognize that governments have a legitimate interest in regulating safety and the environment, and most of the world’s trading nations have made good progress in those areas.

Part of the discomfort over dispute-resolution panels is the notion that their private deliberations circumvent the democratic process. But it is a basic feature of most democratic governments that the legislature sets up legal institutions that subsequently act outside of direct democratic control. 

Regulatory agencies, cabinet meetings or prosecutors, for instance, all make plenty of decisions “in secret,” although that is a misleading phrase. The more prosaic truth is that full transparency and direct media scrutiny are not practical for a wide class of detail-oriented government decisions; this is widely recognized in numerous non-trade contexts. If a government signs a treaty, it can’t realistically expect for its domestic courts to have the final say in all matters, or that every part of the treaty be subject to democratic control.

As of 2015, only 13 investor-state settlement cases have been brought against the U.S. over decades, and the U.S. has not lost such a case, although a pending case related to the Keystone pipeline may become the first American loss. More generally, the settlement mechanisms have found on behalf of business in only 29 percent of the broader international sample. In other words, dispute-resolution courts are hardly the lackey of corporate interests. 

While the number of cases would probably expand with more trade agreements, most forms of growth and progress bring a greater reach for the law, whether we like it or not. Furthermore, some bad decisions are the price of any legal process, including of course domestic laws in every country. 

It is a legitimate concern that too many lawsuits will be brought if the TPP and TTIP treaties pass. Still, excess litigation is a more general problem in many countries, worthy of redress, but it would be odd to place the main blame on trade agreements. 

Worries about dispute-resolution courts seem especially out of place for a large and powerful country such as the U.S. The presence of the U.S. is often required to give a trade treaty reach and legitimacy, and so future extensions of the settlement process are likely to respect American interests. If foreign businesses tried to sue the U.S. en masse, the U.S. is well positioned to demand treaty renegotiation.

As the world becomes more complicated and interdependent, global agreements will carry more administrative and international law into domestic political decisions, whether for climate change and water rights, or trade, investment and intellectual property. 

If the resulting treaties are going to work, they simply have to embed some constraints on the decisions of individual governments, and thus it always will be possible to criticize those agreements on nationalistic grounds. The truth is that when you make a deal – even the best deal – you don’t get everything you want.