Investor-State Dispute Settlement Mechanism is Critical to NAFTA, the U.S., and Modern Trade

February 28th, 2018


What if the Super Bowl was not played at a neutral site with impartial referees? Can you imagine if one team had home field advantage and got to pick the referees from its own fan base? While those referees might outwardly project an appearance of neutrality, it would be impossible for them to be 100 percent impartial in adjudicating the rules of the game. Everyone can see how this could make the game less fair.

If the U.S. eliminates or weakens the Investor State Dispute Settlement (ISDS) mechanism in the North American Free Trade Agreement (NAFTA), this is exactly the type of “officiating” that U.S. companies will face when they do business or make investments in Canada and Mexico.

At the beginning of the NAFTA talks, U.S. Trade Representative Robert Lighthizer put forward a proposal that would allow the United States to opt out of the dispute mechanism, drawing condemnation from business groups as well as trade and investment experts. Now, there are rumors that the U.S. is onboard with eliminating ISDS altogether. This flies in the face of all modern U.S. trade agreements and flouts the authority to regulate international commerce vested in Congress, which has repeatedly stressed the importance of investor protections.

ISDS reinforces the rule of law and helps protect U.S. businesses and investors from unfair treatment when they make cross border investments. It is a provision in most bilateral investment treaties (BITs) and other international investment agreements, giving investors the opportunity to enter adjudication with states over treaty breaches or discriminatory behavior in a neutral, international tribunal. Mechanisms for protecting foreign investors have been widely accepted as critical to the success and legitimacy of international investment agreements. There are currently more than 3000 trade agreements in effect that contain various forms of an ISDS, of which the United States is a partner in 50.

Providing U.S. companies that operate internationally with strong legal protections is fundamental to a robust and stable business environment. In fact, U.S. law dictates that these protections are required. In 2015, under the umbrella of the Trade Promotion Authority (TPA), Congress enacted the Congressional Trade Priorities and Accountability Act, which mandates that U.S. trade agreements provide investors with “meaningful procedures for resolving investment disputes” and “…secure for investors important rights comparable to those that would be available under United States legal principles and practice…”.

In late August of 2017, Senators Orrin Hatch, John Cornyn, and John Thune sent a letter to Ambassador Lighthizer reminding him about the Trade Promotion Authority mandates,

 “Ensuring that a modernized NAFTA includes strong state-to-state and investor-state dispute settlement provisions not only constitutes advantageous trade policy, but also complies with Congressionally established negotiating objectives… In short, Congress has made clear that in order to win its support, a trade agreement must include effective state-to-state and investor-state dispute settlement provisions.”

The senators also wrote to Ambassador Lighthizer to reiterate the importance of having ISDS in a renegotiated NAFTA.

“Beginning with NAFTA, every U.S. free trade agreement has included a dispute settlement system, and a revised agreement should seek to make the NAFT A dispute settlement provisions more effective and efficient. An updated NAFTA also should include a robust investor-state dispute settlement (ISDS) system that guarantees strong enforceable protections…Both provisions help provide U.S. exporters and businesses the certainty necessary for accessing markets in Canada and Mexico.”

U.S. companies do sometimes face discriminatory barriers when they invest abroad. Strong ISDS provisions, such as NAFTA’s, are crucial to protecting these investments. Weakening or removing ISDS from an updated NAFTA would be harmful for the U.S. economy and businesses.

For example, between 2002 and 2007, investments made by Cargill, a U.S. agribusiness company, in Mexico’s high fructose corn syrup industry were negatively impacted by Mexico’s 2002 adoption of a high fructose corn syrup tax. Cargill alleged that this tax was designed to protect Mexico’s domestic sugar producers and exclude high fructose corn syrup from the country’s soft drink sweetener market. In 2009, a NAFTA arbitration tribunal sided with the company, awarding Cargill a $77.3 million settlement.  Corn Products International, another U.S. business, were a part of similar arbitration against Mexico and were awarded $58.386 million in damages.

Without NAFTA’s strong ISDS protections, both companies would have lost tens of millions of dollars, impacting not only the ability Cargill and Corn Products International to support jobs in the U.S. but also ordinary Americans that own stock in these companies. Without NAFTA’s ISDS provision, Cargill and Corn Products International would have had to bring their arbitration through the Mexican court system, and judges in Mexico would have been under intense political and social pressure to rule in the government’s favor. Ultimately, weakened or non-existent ISDS protections in NAFTA would stunt U.S. investment, at the detriment of not only the United States but also Canada and Mexico.

These points are echoed in a piece by Gary Clyde Hufbauer, a nonresident senior fellow at the Peterson Institute for International Economics and an expert in international trade, investment, and tax issues. Hufbauer writes,

“First, many developing countries want ISDS provisions in their BITs and FTAs [free trade agreements], in order make themselves more attractive to investments by MNCs [multinational corporations]. Second, when countries change political course and decide to expropriate the property of American investors, it is not just Wall Street investors that lose. The “investor class” includes Harvard’s endowment, the major public employee pension funds like Calper’s, and ordinary Americans with retirement savings managed by investment funds. Thus, ISDS is needed to protect the pocketbooks of ordinary Americans.”

From U.S. businesses to elected officials and academics, there is widespread support for a strong ISDS provision in a newly negotiated NAFTA. Without it, the USTR is leaving U.S. businesses and investors at the mercy of foreign politics, threatening investment stability and economic progress. The United States has made protecting U.S. investors from expropriation and discrimination a tenet of its international trade agreements and a renegotiated NAFTA should be no different.