Earlier this year, Chilean legislators sought to increase taxes on firms in their mining sector to make critical social welfare investments during the COVID-19 pandemic. However, they were quickly reminded that such an action was beyond their regulatory scope because of tax stabilization clauses from previous investment agreements. This is not an unusual phenomenon in the Global South. States are often legally restricted from regulating investments in their own economies because of international investment agreements with shelf-lives of fifteen or more years. Some states go ahead with domestic legislative impetuses to violate investment agreements but thereafter face protracted legal battles in international arbitration; and if tribunals side with the complainant, states can be liable to pay damages in excess of their national income.
How do states arrive at a point where their regulatory power is restricted in such a way? And how might we alter the international investment legal regime so that states retain their sovereignty and can leverage international investment for their development goals?
In the contemporary moment, foreign investment is governed by a myriad of legal instruments, the most used of which is the bilateral investment treaty (BITs). Bilateral investment treaties are agreements between two states that delineate the responsibilities of host states and foreign investors as it relates to investment regulation and security. Once ratified, BITs govern all foreign investment between the two countries, from mining and hydrocarbon extraction to tourism and hospitality services.
The bilateral investment treaty may seem like a reasonable solution to the volatility and unpredictability of investing capital abroad. However, BITs made between core economies in the Global North and periphery economies in the Global South expose drastic asymmetries in power that compromise periphery state sovereignty and significantly restrict the domestic regulatory space.
History of the BIT
The history of the bilateral investment treaty is deeply implicated in the politics of decolonization—it is a response to the efforts of formerly colonized states to exert more meaningful control over national resources, to further development goals, and to break the yoke of dependence on the imperial core.
At the end of World War II, in the decolonization moment, newly independent states asserted control over their national resources and major industries using nationalization and expropriation, instruments which had their legality rooted in domestic legislation and constitutional changes. Formerly colonized nations sought to internationalize this right through UN Resolution 1803 (1962), which crystallized the principle of permanent sovereignty over natural resources. Resolution 1803 was instrumental in wresting control over national resources and productive operations from the hands of foreign investors and managers, who had captured indigenous resources during the colonial era and maintained a monopoly on domestic industries ever since. Under the resolution, foreign investors who had their investments expropriated were entitled to compensation in accordance with domestic and international laws. Additionally, disputes could not be settled by international arbitration until domestic instruments had been exhausted and there was agreement between both contractual parties to have the case decided by an international tribunal.
In 1973, third world leaders led by President Kwame Nkrumah of Ghana, President Gamal Abdel Nasser of Egypt, and Prime Minister Jawaharlal Nehru of India escalated their advocacy when they secured the passage of the New International Economic Order in the United Nations, the culmination of a decade of drafting and advocacy. The New International Economic Order and the accompanying Charter of Economic Rights and Duties of States (UN Resolution 3281), were an ambitious policy framework seeking to secure more equitable membership for formerly colonized nations in the governing of the global economy and the reaping of the benefits of global trade and commerce. It sought to grant periphery economies complete control over foreign corporations and freedom to nationalize and expropriate foreign property according to national rules.
The BIT framework that today dominates the international investment legal regime is a reactionary response to the hard-won political battles periphery economies waged against Euro-American dominance of the global economy. The bilateral investment treaty was further diffused throughout the world system when the global debt crisis of the 1980s emerged and international financial institutions imposed neoliberal aid and loan conditions. This caused states to quickly shift their postures from a preoccupation with the protection of state sovereignty and regulatory power to a preoccupation with attracting foreign investment that would allow them to access the U.S. dollars they needed to pay the foreign debts , denominated in dollars, they had incurred. An intricate web of BITs replaced the resolutions and conventions that had enhanced the ability of periphery states to regulate foreign investment. Now, periphery economies compete with one another for a limited pool of foreign capital, often accepting unfavorable investment terms where they absolve investors from compliance with labor regulations, freeze or suspend tax codes, and forgo the enforcement of environmental regulations at the detriment of the state and its development goals.
One cannot purport to write critically about international finance, trade, and investment in relation to the Global South without discussing the role the International Monetary Fund (IMF) and World Bank play in shaping the global economic landscape. When the United States left the gold standard and the the nation was rapidly becoming a formidable and unchallenged global hegemon, the IMF sought to make the Global South available to U.S.-driven globalization by using structural adjustment programs, which induced a climate that was favorable to foreign investment capital but hostile to the domestic sphere. To achieve creditworthiness and qualify for loans and aid, periphery economies significantly scaled back public investment, removed protections on domestic industries to make way for investment capital from the Global North, and significantly restricted their regulatory power as it relates to foreign investment. Furthermore, the convenient overlap between IMF and World Bank loan conditions, which periphery economies often cannot do without, and the provisions found in BITs show that the institutions exert pressure on periphery economies to enter unfavorable bilateral investment treaty agreements.
Investor Protections & State Sovereignty
Once signed, BITs restrict the sovereignty of periphery economies in the Global South in two major ways: the expansive interpretation of foreign investor protections by international arbitration tribunals and the expansive jurisdiction of the International Center for Settlement of Investment Disputes. The protections for which international arbitrators adopt an expansive interpretation are the fair and equitable treatment clauses (FET), the most-favored nation clauses (MFN), and the full protection and security clauses.
The International Center for Settlement of Investment Disputes derives its legitimacy from the multi-national composition of tribunals and its enforcement of international law which is often assumed to be the outcome of a rigorous and equal deliberation process, void of bias for any nation in particular. However, one cannot ignore the fact that international rules and conventions are outlined by the most powerful states in the world system and therefore continue to perpetuate deep-seated inequalities that enforce a relationship of dependence between core and periphery economies.
The distribution of responsibilities under the international investment legal regime is skewed in favor of foreign investors from the Global North at the expense of periphery economies in the Global South. Host states have greater responsibilities to protect investment and give investors access to the most favorable contractual terms, often at the expense of domestic policy objectives, while foreign investors are only accountable to their corporate boards and shareholders. International investment law largely acts to insulate foreign investment from the domestic sphere in the tradition of the imperial economy, separating periphery economies and communities from many of the supposed benefits of international investment: increases in quality jobs, increased tax revenue, and markets for domestic industries are just some of the benefits advertised by the International Monetary Fund and the World Bank.
The opportunity for arbitrary tribunal decisions that privilege investors over host nations is in the lack of precision and consistency in the interpretation of treaty clauses.
Fair and Equitable Treatment
The fair and equitable treatment clauses are meant to establish a minimum level of protection states must provide foreign investments. However, the precise definition of what constitutes a “minimum level of protection” is unclear and contested, despite FET claims being the most common allegation against host states. Investment tribunals exploit this lack of clarity and continue to raise the floor that defines the minimum level of protection states must provide . In fact, in the last decade, investment tribunals have adopted interpretations of the FET clause that are more generous than customary international law (see Tecnicas Medioambientales Tecmed S.A. v. Estados Unidos Mexicanos (2003) and Occidental Exploration and Production Company v. Republic of Ecuador (2004)).
Core economies like the United States, and semi-periphery economies that have more leverage in the global economy, like South Africa and India, have replaced expansive interpretations of the fair and equitable treatment clauses with narrower ones or have omitted them altogether in their investment treaties. This shows that the clauses do indeed pose threats to the effective deployment of state regulatory power in cases of disputes, as states that can afford to narrow the interpretation of the clauses, or omit them altogether in their treaties, do so.
The most-favored nations clauses are a unique treaty provision, as they allegedly protect investors from discrimination based on nationality by entitling them to the most favorable investment terms the host state has agreed to. This serves to expand the rights of investors by allowing negotiators to export standards and benefits from other agreements with different parties in entirely different contractual contexts. The MFN clauses effectively remove the BIT from the state’s repository of strategic policy tools and prevents states from taking affirmative action in the global economy; periphery economies that enter liberal investment agreements with similarly disadvantaged periphery economies must now make those provisions available to powerful core economies who already have bloated leverage in the international system. And if that core economy happens to be the United States, they have a number of international economic tools they can use to induce favorable investment climates: the supremacy of the U.S. dollar, military strength, and U.S. dominance of international organizations like the World Bank and International Monetary Fund.
Full Protection & Security
Similar to the fair and equitable treatment clauses, the full protection and security clauses lack standardized application and are often liberally interpreted by international arbitrators. Generally, full protection and security should not exceed the general duty to protect foreign nationals as articulated in the customary law of aliens.
Despite the reasonable general interpretation of the full protection and security clauses, two cases decided by international arbitration under the ICSID expose the extent to which agreements undermine state sovereignty.
In Asian Agricultural Products Limited (AAPL) v. Republic of Sri Lanka (1990), international arbitrators ruled that the Sri Lankan government's counter-insurgency military operations that destroyed the main producing farm of Serendib Seafoods Ltd, a company in which AAPL is an equity stakeholder, was unnecessary and therefore violated AAPL’s right to full protection and security. The tribunal claimed that the Sri Lankan officials did not do their due diligence to protect AAPL’s assets during the military operation. This raises the question: is it the place of arbitrators under the ICSID convention to determine whether a sovereign state’s military efforts were necessary?
In Gauff v. Tanzania (2000) arbitrators determined that fair and equitable treatment clauses extend to the actions not only of the host state but also third parties with no state affiliation. Under this expansive interpretation, states are responsible for external threats in addition to its already significant responsibility to protect foreign investments legally and commercially.
Both cases show the extent to which states cede valuable regulatory power in bilateral investment treaties—especially provisions that require disputes to be handled by international arbitration rather than national courts or other settlement arrangements. Compared to domestic arbitrators and judges, international tribunals lack the local context and expertise needed to make investment dispute settlement decisions that are truly even-handed.
Opportunities for Greater Periphery Control
There is no doubt that the current state of the international investment legal regime is untenable. States are becoming increasingly aware of the unfavorable nature of bilateral investment treaties and are moving to discontinue or seriously augment their agreements with core economies. However, the ability to recalibrate investment relationships along more equitable lines is not equally enjoyed among the nations of the world. Core and semi-periphery economies have much more discretion to delineate their investment agreements to affirm their development and policy objectives.
Despite this, there are a number of instruments periphery economies can use to assert greater control over foreign investments. First, if possible, states should exercise their right to renegotiate or terminate unfavorable investment treaties. In situations where a number of states compete for few foreign investment dollars and adopting stricter BIT provisions could diminish the state’s comparative advantage, periphery economies should negotiate investment treaties regionally. Developing regional postures to foreign investment from the Global North combats the divide and conquer approach core economies adopt when faced with more progressive investment treaties in individual states. The Economic Community of West African States (ECOWAS), in 2008, adopted the Supplementary Act on Common Investment Rules for ECOWAS which established progressive international investment rules to govern investment amongst West African states. In the south, the Southern African Development Community has adopted a model BIT to aid Southern African states in their treaty drafting process. These same states would benefit immensely from developing an external posture for those agreements and using them to govern the management of foreign investment from the Global North.
When it comes to international arbitration under the ICSID, states should use Article 71 of the ICSID convention to denounce use of the international arbitration process for investment disputes within the country. Latin American nations have led the charge in this regard, with Bolivia denouncing the ICSID convention in 2007, Ecuador in 2009, and Venezuela in 2012. If states find that international arbitration could be useful for some classes of foreign investment, states can use Article 24, section 4 of the ICSID convention to notify the Center of classes of disputes that the state will not allow to be settled by international tribunals. Ecuador, for instance, notified the ICSID that they will not allow international dispute settlement when disputes involve the management of the nation’s renewable resources.
There are a number of ways that states can retain aspects of their sovereignty while balancing their need to attract foreign investment to pay dollar-denominated debts and purchase imports. By using any of the policy tools outlined above, states can undermine the rigidity of their bilateral investment treaties and salvage the wins secured through UN Resolution 1803, the New International Economic Order, and the advocacy of formidable third world leaders.
The leaders of the post-World War II decolonization movement had to think strategically about advancing their development goals in an era of bipolar dominance by the United States and the Soviet Union. Now, as the world system approaches another moment of bipolarity between the United States and China, states in the global periphery must again utilize all the tools at their disposal to secure a more equitable role in their domestic economies and in the global economy.
The image used in this article is licensed under an Attribution-Non-Commercial-ShareAlike 2.0 Generic license. It has not been altered from the original, which was taken by Fred Inklaar and can be found here.