Cato Online Forum

TTIP and Investment Protection: Reason for Failure or Impetus for Reform?

By Axel Berger
October 2015

Emerging from relative obscurity, the issue of investment protection has become the main bone of contention in the increasingly heated debate about the Transatlantic Trade and Investment Partnership (TTIP). For the past five decades, investment protection has been a niche topic that only a small circle of negotiators of bilateral investment treaties (BITs) and international investment lawyers took interest in. Until recently, BITs had been negotiated under the public radar and drafted largely in isolation of broader public policy objectives, such as poverty reduction, environmental protection or public health care. While a number of high-profile, investor-state dispute settlement (ISDS) cases launched under the provisions of Chapter 11 of the North American Free Trade Agreement led to a critical debate in North America, resulting in the reform of key treaty provisions over ten years ago, the collective myopia that prevented a critical discussion of the benefits and drawbacks of investment protection continued on the other side of the Atlantic.

Since the late 1950s, European countries have negotiated approximately 1,300 BITs, which have enabled European investors to sue developing and transition countries on various occasions. From the perspective of European investors, BITs seemed to be serving their purpose well. But the inclusion of rules for investment protection in the TTIP negotiations turned the issue upside down in Europe. Indeed, opposition to including investment protection in TTIP has been the main driver of the anti-TTIP movement in Europe, particularly in Germany, where opposition gained real momentum in mid-2014.

Critics argue that investment treaties typically grant foreign investors more extensive rights than are afforded domestic investors, including the right to bypass host-country legal systems and bring ISDS cases against their host-country governments. The fact that some European countries recently have been facing investment arbitration claims, combined with the fear that the large volume of U.S. investments in Europe could lead to an onslaught of new ISDS cases from “litigious” U.S. multinationals, concerns not only NGOs and left-leaning politicians but, increasingly, a general public without prior exposure to the topic.

Meanwhile, proponents of treaty-based investment protection and arbitration have had difficulty alleviating the public’s concerns. This essay addresses three common arguments put forward to support the idea of including investment disciplines in the TTIP.

First, investment protection (and ISDS in particular) is needed to spur investment flows.

The European Commission favors having investment protections in the TTIP and occasionally reminds the public that discrimination against European investors is not explicitly prohibited under U.S. law. Other ISDS proponents cite allegedly unpredictable courts in some EU states, especially in East Europe. They emphasize that without investment protection rules in TTIP, European and U.S. investors would be reluctant to invest across the Atlantic. Of course, one might wonder how the transatlantic investment relationship could be so robust — with the United States and European Union one another’s largest investment destinations – in the absence of an investment treaty. (Granted, nine Central and Eastern European countries negotiated investment treaties with the United States during the 1990s). But maybe investment flows would flourish even more as a result of investor protections in the TTIP. If that is the implication, it would be useful for investor protection proponents to furnish actual empirical evidence to support claims of a positive relationship between such investment rules and investment flows.

Empirical studies on the impact of investment treaties on investment flows to developing countries are inconclusive.1 Some studies show a positive relationship, others find no effect. Interestingly, “strong” treaties (i.e., those that include an ISDS clause) have not been found to increase investment any more than “weak” treaties without such clauses.2 This inconclusiveness is not surprising given the empirical challenges in measuring the impact of investment agreements on investment flows.

Moreover, if the absence of investment protections deters investment, there are other instruments available with which foreign investors can hedge perceived risk. They could enter into individual investment contracts with their host states. They could purchase political risk insurance. Incidentally, not even the European Commission seems to believe any more that investment rules lead to more investment flows.3

Second, the TTIP should include investment disciplines to set a precedent

Proponents have argued that failure to include ISDS in TTIP will make it more difficult to insist on its inclusion in future treaties with third countries. They typically refer to China, with which both the United States and the European Union are currently negotiating separate investment treaties. Former EU trade commissioner Karel De Gucht, for example, stated: “I think it will be difficult one day to claim that we must avoid ISDS provisions with the U.S. because they are dangerous and then the next day insist to include the same kind of provisions in agreements with others such as China.”  This argument is a variation of the broader narrative of TTIP proponents that the European Union and the United States must set high standards, otherwise emerging markets — China, in particular — will take over the role of global rule-setters.

This argument is flawed, at least with regard to the case of China.4 First, China has been concluding investment treaties with comprehensive ISDS provisions for more than 15 years and, unlike many other developing countries, remains a strong proponent of the international investment regime. In light of increasing Chinese outward FDI to the United States and Europe, it can be assumed that China has a growing interest in establishing international arbitration mechanisms. Second, it is highly questionable whether TTIP will materialize before the U.S.-China and EU-China investment treaty negotiations are concluded. Finally, China recently concluded a free trade agreement that includes an ISDS clause with Australia — the same country that refused to include an arbitration clause in its 2005 free trade agreement with the United States. Accordingly, Beijing was not deterred from including investment arbitration clauses in an agreement with a developed country — a developed country that previously refused to include similar provisions in its treaty with the United States. As convenient as it may be to play the “China-card” in support of TTIP, that argument is particularly misplaced when it comes to advocating the need for ISDS provisions.

Third, TTIP could be a catalyst for broader international investment regime reforms.

This argument has recently gained traction in light of the European Commission proposal (which is based on another proposal put forth earlier this year by Germany) to set up a transatlantic investment court system that could serve as the role model for a multilateral investment court.5 The recent European Commission proposal does not question investor-state arbitration as such, but introduces innovations, such as the appointment of permanent judges and the establishment of an appeals mechanism, designed according to the WTO’s arbitration and public law systems. The European Commission has announced its intention to multilateralize this “court-light” arbitration system by setting up a multilateral investment tribunal and appellate mechanism.

Changing the investment arbitration system is indeed one of the few practical avenues to reforming the international investment regime, which comprises more than 3,000 investment treaties. These treaties include systemic inter-linkages, such as most-favored nation clauses and broad investor definitions, which allow foreign investors to take advantage of more beneficial provisions in other treaties. Changing the core set of substantive provisions thus will be a lengthy and arduous undertaking.

At the end of 2014, the international investment regime underwent some procedural reforms. It adopted the Mauritius Convention, which broadened application of the United Nations Commission on International Trade Law (UNCITRAL) Rules on Transparency, substantially increasing the level of openness of ISDS proceedings. More reforms are possible.

Another procedural improvement would be the development of a multilateral appellate mechanism. The current proposal of the European Commission in the TTIP to set up a bilateral appellate mechanism could be the first step to such a multilateral reform, especially in light of the fact that the United States also has referred to the possibility of such a mechanism in its BITs since 2004.  A third possible procedural reform would be to shift from an ad hoc arbitration system to a permanent court, which the European Union has proposed in the TTIP. However, the United States would likely object strongly to this proposal.

Regardless of these reform suggestions, however, even if it is possible that TTIP leads to incremental improvements in the global investment arbitration system, it is unlikely that this would be enough to justify a transatlantic ISDS mechanism. Widespread discrimination against foreign investors, beyond anecdotal stories of occasional government misconduct, are absent in both the U.S. and EU legal and political systems. Thus, the case for a TTIP investment chapter — whether “reformed” or not — that includes an arbitration mechanism remains weak.

Notes:
1 http://www.die-gdi.de/uploads/media/BP_9.2015.pdf.
2 https://www.ifw-members.ifw-kiel.de/publications/more-stringent-bits-less-ambiguous-effects-on-fdi-not-a-bit.
3 http://www.euractiv.com/sections/trade-society/positive-effects-ttip-tribunals-investment-unclear-317665?utm_source=EurActiv+Newsletter&utm_campaign=182c880a61-newsletter_daily_update&utm_medium=email&utm_term=0_bab5f0ea4e-182c880a61-245796693.
4 http://www.die-gdi.de/fileadmin/user_upload/pdfs/publikationen/externe_publikationen/
2014/20150202_Columbia_FDI_Perspectives_Berger.pdf
.
5 http://trade.ec.europa.eu/doclib/docs/2015/september/tradoc_153807.pdf;
http://www.bmwi.de/BMWi/Redaktion/PDF/M-O/modell-investitionsschutzvertrag-mit-investor-staat-schiedsverfahren-gutachten,property=pdf,bereich=bmwi2012,sprache=de,rwb=true.pdf.

The opinions expressed here are solely those of the author and do not necessarily reflect the views of the Cato Institute. This essay was prepared as part of a special Cato online forum on The Economics, Geopolitics, and Architecture of the Transatlantic Trade and Investment Partnership.

Axel Berger is a trade and investment treaties researcher at the German Development Institute.