On March 21, 2018, United States Trade Representative Robert Lighthizer was summoned before Congress to defend the Trump trade agenda. There was a lot riding on his testimony. Talks with Canada and Mexico to renegotiate the North American Free Trade Agreement (NAFTA) were hitting a wall, and Congress was growing increasingly skittish about the tariff-happy president’s rejection of the bipartisan consensus in favor of free trade. They turned to Lighthizer, an experienced trade litigator and mainstream Republican, for assurance that there was an adult at the controls. And one of their most important requests was that Lighthizer continue to defend a cornerstone of American trade policy: a shadowy system known as investor–state dispute settlement (ISDS).
ISDS allows foreign investors to sue governments for decisions that harm the value of their investments. America’s trade agreements with foreign states require that each party’s investors get “fair and equitable” treatment from the other party’s government. But if a dispute arises and the agreement provides for ISDS, the foreign investor doesn’t go to the domestic courts of the host country. Instead, he brings his claim before a panel of three private arbitrators, chosen by the parties, who have the power to award enormous judgments without any outside review or appeal. ISDS enjoys bipartisan support in Congress because it protects Americans who invest in countries with weak judiciaries and corrupt regulators. Those countries agree to ISDS in order to incentivize American investment. It’s supposed to be a win-win.
But at its worst, ISDS allows foreign businesses to seek damages simply for being subject to the laws of the host state. When a Canadian conglomerate called the Loewen Group was successfully sued in Mississippi state court for violating contracts, they retaliated by filing a claim against the United States under NAFTA’s ISDS provision seeking $725 million in damages because the Mississippi jury’s verdict was too harsh. U.S. taxpayers were on the hook simply for making a foreign company go through the same legal procedures that apply to any American. Luckily, the tribunal dismissed the claim on a technicality.
So it was somewhat remarkable when Lighthizer, months after his testimony, announced the conclusion of a revised NAFTA that all but did away with ISDS. The new U.S.-Mexico-Canada Agreement (USMCA) replaces NAFTA’s robust ISDS provision with a scaled-down system that excludes Canada entirely and provides for only limited arbitration between the U.S. and Mexico. Congress now must vote on the USMCA, but the agreement’s rejection of ISDS has jeopardized its passage. Ninety-nine Republican congressmen issued a stern letter to Lighthizer, warning that “ISDS is an essential enforcement mechanism for investor protections and must be maintained rather than weakened or abandoned.”
ISDS has never been popular on the progressive left, where it is viewed as a device to allow corporations to steamroll environmental and labor regulation. But because of new fissures within the conservative coalition, progressive opponents of ISDS now have allies on the right. Nationalists empowered by Trump view ISDS as a violation of American sovereignty. Forty-one Republican state legislators recently joined 229 Democrats to sign a letter supporting Lighthizer and calling for the removal of ISDS from NAFTA. Meanwhile, the establishment wings of both parties defend ISDS as grease for the wheels of international investment. The issue has become a perfect embodiment of our new political battle lines, pitting populists against globalists regardless of party affiliation.
During his testimony before Congress, Lighthizer articulated nationalist and conservative arguments against ISDS. First, the system undermines American sovereignty by allowing foreign investors to bypass American courts and seek damages from what Lighthizer described as “three guys in London.” Those three guys can unilaterally decide that laws duly passed by the representatives of the American people give rise to liability for damages, paid by American taxpayers to foreign multinationals. America has not yet lost any of the 22 ISDS claims that have been brought against it, but if the system continues, that day will come.
Second, ISDS amounts to the socialization of investor risk. American investors are perfectly capable of insuring themselves against expropriation and other political risks, but ISDS makes taxpayers pay for protection that investors could have purchased themselves.
When investors get free protection from ISDS, it comes with plenty of costs on everyone else — they’re just difficult to see. The threat of ISDS claims can scare governments out of passing laws in the public interest. For example, otherwise efficient proposals requiring cigarettes to be sold in plain packaging were abandoned when tobacco companies threatened ISDS suits under NAFTA. The claims failed, but the threat of high litigation costs helped slow the adoption of public-health measures that would have lowered health-care costs.
Next, ISDS gives foreign investors an advantage over domestic companies — foreigners can vindicate their rights in both ISDS tribunals and domestic courts, whereas domestic companies have access only to domestic courts. This means that foreign companies enjoy stronger legal protections in America than American companies do. For example, the old NAFTA’s ISDS system gave foreign investors stronger protections against government “takings” of private property than even the U.S. Fifth Amendment. Domestic American companies were operating at a disadvantage.
This is especially curious given that American courts and property rights are some of the strongest in the world. These features ought to be a competitive advantage, but they aren’t so special in a world where investors have recourse to ISDS. If an American investor can get similar legal protections abroad as he could get in America, he has weaker incentives to keep money home. That encourages outsourcing.
ISDS does help Americans who have investments abroad, but there is no evidence it actually increases total investment volume. ISDS is highly controversial in many countries and creates enormous transaction costs during the negotiation of trade agreements. ISDS was a major factor in the collapse of the Transatlantic Trade and Investment Partnership negotiations between the U.S. and the EU, and many countries that are subject to ISDS claims simply cancel the underlying trade agreement. Even when agreements are signed, America’s trading partners view ISDS as a concession and so may ask the U.S. to give up things in exchange, such as settling for less market access. The result is a reduction in trade volume.
All of these are costs that are borne by the American public but could be avoided if investors were responsible for protecting themselves against political risks by buying private insurance and using the domestic courts of their host country. This is why Lighthizer described ISDS as the socialization of investor risk, and it’s why he removed it from NAFTA. “I view myself as a conservative and a sovereigntist,” Lighthizer told Congress, “and it’s not the job of the United States government to put our finger on the scale and encourage you to move your plant [to Mexico].”
ISDS amounts to corporate welfare of the most objectionable kind, assisting U.S. companies that move money out of the country while giving foreign companies an advantage over domestic American competitors. There’s no reason why the American government needs to encourage these behaviors beyond what the market is already demanding. Nationalists may be joining with progressives to oppose ISDS, but in the end, traditional conservative principles cast enough aspersion on it. Investors should bear the costs of their own risk.
Unfortunately, that’s an unfamiliar concept for many members of Congress from both parties. When it comes time to vote on the new NAFTA, Lighthizer may help them rediscover it.