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Trade Agreements Rigged to Protect Capital From Democracy

The purpose of the contemporary investment regime has always been to restrict democratic action.

Protesters in Toronto demonstrate against the Trans-Pacific Partnership deal under consideration by President Obama and many other world leaders with moneyed interests on January 31, 2014. (Photo: arindambanerjee /

Barack Obama, like his Democratic predecessor in the White House, has gone all in for free trade. On January 20, the president used his sixth State of the Union address to ask Congress to pass a legal procedure (trade promotion authority) that would enable him to “protect American workers with strong new trade deals,” a reference to two mammoth agreements currently in negotiation: the Trans-Pacific Partnership (TPP), with 11 partners in the Pacific Rim; and the Transatlantic Trade and Investment Partnership (TTIP), with the European Union. The deals would, two decades after the North American Free Trade Agreement (NAFTA), create the largest and second-largest free trade zones in the world.

Opposition to the trade deals is refreshingly widespread. In addition to criticism from the left, bolstered by the perennial trade-related concerns about wages and bargaining, the TPP and TTIP have provoked much suspicion, even among those who might normally be amenable to trade. They are secretive – most of our information comes from WikiLeaks – and, predictably, written in close collaboration with well-heeled corporate lobbyists. What we do know features, among other things, draconian rent-seeking from US copyright holders, threats to public health courtesy of US pharma giants, backdoor efforts to undermine Europe’s fledgling efforts at data protection and significant problems for the environment. However, in recent months, as Obama’s trade agenda has come increasingly to the fore, the headline-grabber of the trade agreements has been clause in the prospective treaties that was until recently an obscure bit of trade law: ISDS, or investor-state dispute settlement, which has dominated discussion, earning high-profile criticism from Elizabeth Warren and coverage in the mainstream media.

ISDS has been christened “corporate sovereignty” by opponents because of how it allows international investors to use trade tribunals to circumvent domestic legal systems.

In the byzantine, technocratic and often boring world of international trade rules, its rare that a bit of legal machinery can inspire even passing attention from nonspecialists. Yet, ISDS – a legal instrument for settling disputes between investors and states – is something of a rock star. Nominally intended to provide a neutral arbitration forum to protect foreign investors from capricious state action, ISDS has been christened “corporate sovereignty” by opponents because of how it allows international investors to use trade tribunals to circumvent domestic legal systems – leading Greg Grandin to compare it unfavorably with another modish four-letter acronym.

In essence, ISDS provisions in treaties – traditionally, bilateral investment treaties (BITs), but more recently, expansive multilateral trade deals such as NAFTA or the upcoming TPP and TTIP – allow foreign investors who feel that their “investments” have been “expropriated” (both terms are rather vague and contentious concepts in trade law, hence the scare quotes) to bring the case before an independent tribunal, usually made up of three trade lawyers and administered by the World Bank-affiliated International Centre for Settlement of Investment Disputes (ICSID).

If ISDS sounds troubling in the abstract, it gets worse in detail. Capitalist baddies straight from central casting, from Big Tobacco to Big Oil, have used investment arbitration to sue over – among other things – plain packaging laws, environmental regulation and minimum wage legislation. Vague wording in the treaties has meant that interpretation of what, exactly, they cover is left to the discretion of the arbitrators themselves, who are generally high-end corporate lawyers from the United States and Western Europe. For example, according to a 2011 report from Corporate Europe Observatory, a group of 15 arbitrators (13 men), including such luminaries as Francisco Orrego Vicuña, Augusto Pinochet’s former ambassador to Margaret Thatcher’s Britain, sit as arbitrators on about 64 percent of disputes of at least $100 million, and 75 percent of those of at least $4 billion (these percentages may have changed in the intervening four years).

Conflicts of interest are rampant, as arbitrators can sit as “neutral” judges for cases involving parties for whom they have recently worked. The largest investor-state payout in history was the 2012 decision in Occidental Petroleum v. Ecuador, in which Rafael Correa’s government was forced to pay the US oil giant a total of $2.3 billion (including interest) in response to Ecuador’s decision to cancel a contract for oil exploration in the Amazon. The award was equivalent to about 2.62 percent of Ecuador’s 2012 GDP; Ecuador’s military spending that year was around 3 percent of its GDP. One of the arbitrators in the Occidental case, L. Yves Fortier, is a former board member of Rio Tinto mining company. While not a directly interested party in the case, Rio Tinto certainly has an interest in cowing governments of the global South into submission to resource extraction multinationals (Rio Tinto is perhaps most famous for being the object of Norway’s “ethical divestment” due to environmental damage at its Grasberg mine in West Papua, an operation that also involved shady collaboration with Suharto’s secret police).

Supporters of the inclusion of ISDS in the agreements – concentrated heavily in the business and policy elite on both sides of the Atlantic – counter that investor-state arbitration is necessary to promote investment and economic growth (a dubious assertion, to be charitable – given FDI giants Brazil and China’s refusal to participate in the arbitration regime). More convincingly, they argue that ISDS has long been a feature of the international trading system and that there has been no qualitative shift that could explain the sudden surge of opposition (Presumably, current troubles represent elites’ failure to explain the benefits to the uncomprehending mob). This latter argument represents a half-truth. Rather than hypocrisy, however, newfound opposition to ISDS is rooted in the changing nature of capitalism and its relationship to the state.

History of Investor-State Arbitration

The contemporary investment regime has its prehistory in what are called friendship, commerce and navigation treaties, or FCNs. FCNs initially had little to do with investment per se – the first one was signed in 1778 between the newly independent United States and France, and provisions ranged from most-favored nation status (i.e., that the best terms offered to any nation also be offered to the signee) to the restoration of property stolen by pirates. In the early 20th century, and especially after World War II as the United States shifted from a capital-importing to a capital-exporting economy, investment came to occupy a central position in the American FCNs.

The bilateral investment treaty, or BIT, was originally the European alternative to FCN treaties, and had from the beginning more explicitly colonial overtones. The development of the BIT was spurred by the West German state, which, having had its imperial pretensions decisively crushed in two wars, nevertheless needed a means by which to protect and promote the interests of German capital abroad. The world’s first BIT was signed by West Germany and Pakistan in 1959, and, with innovation of investor-state arbitration added during the 1960s, these agreements became the standard way for European states to govern relations with their capital-starved former colonies.

FCNs and BITs, while similar, were not identical. FCNs, which included provisions about everything from currency convertability to humanitarian issues, had a number of disadvantages vis-à-vis BITs from the perspective of capital. For one, they were more difficult to negotiate, as they touched on more sensitive areas of policy that many states were unwilling to trade away, and provisions were often directly enforceable by national courts, making both negotiating partners more hesitant. FCNs were also sometimes negotiated between highly developed countries, meaning that legal equality for the negotiating partners was more than an academic question.

Many cases have followed traditional practice by seeking punitive damages from periphery countries with the nerve to place citizens’ welfare over the interests of investors in the capitalist core.

In contrast, BITs were generally concluded between highly developed European economies and capital-poor, lesser-developed countries, and were characterized by a formal equality in wording masking a total asymmetry of power. The United States, negotiating an FCN with a capital-rich country like the Netherlands, may have hesitated to sacrifice sovereignty to the whims of foreign investors; no such scruples would have existed for France in negotiating with Senegal, given assumptions about the unidirectional flow of investment. In essence, however, both treaty types were attempts to “depoliticize” investment after direct Western rule had come to an end with postwar decolonization. The “Hull rule,” formulated in 1938 by US Secretary of State Cordell Hull in response to Mexico’s nationalization of assets belonging to US citizens, stated that “no government is entitled to expropriate private property, for whatever purpose without provision for prompt, adequate, and effective payment.” In 1961, this became the developed-world standard when it was incorporated into the Organization for Economic Cooperation and Development’s (OECD) binding “Code of Liberalization of Capital Movements.” (1)

The United States belatedly moved to adopt the BIT in the 1970s at the urging of an increasingly militant US business community which, squeezed at home by high wages and taxation, had come to view the unwieldy FCN system as a competitive disadvantage vis-à-vis European capital, and had grown hostile to the Carter administration’s stated policy of neutrality on investment (i.e., indifference toward inward and outward investment flows). The last US FCN, with Thailand, was ratified in 1967, and a decade of failed attempts at new agreements followed before the first US BIT, with Hosni Mubarak’s Egypt, was signed into law by Ronald Reagan in 1982. The new US BIT, however, had a number of significant modifications appropriate to its neoliberal origins.

For one, while the neoliberals in the Reagan administration accepted the European practice of negotiating narrow agreements with weak, under-developed partners, the United States saw an additional opportunity to use its BITs a tool to rewrite international rules on investment. Conservative legal scholars had, by the late 1970s, revived expansive interpretation of what constituted “regulatory takings,” or expropriation via regulation, which incorporated the Hull rule and added that “compensation had to reflect the ‘fair market value …’ and be paid in a form that was ‘effectively realizable [and] fully transferable at the prevailing market rate of exchange on the date of expropriation.'”

As Leo Panitch and Sam Gindin note, this expansive interpretation was extremely particular to US jurisprudence at the time (and not even fully accepted within the United States), and yet, through its incorporation into US BITs and eventually NAFTA, (2) ultimately became the international standard. Supporters at the time even argued that a major indirect benefit of BITs was to “lend weight in the international legal community to the United States’ position on various points of international law and practice”; though what these “various points” were remained unspecified. BITs proliferated rapidly in the following two decades (accelerated especially by the lifting of the Iron Curtain), with the number of active treaties quintupling from 385 at the end of the 1980s to 1,857 at the end of the 1990s.

The Rise of ISDS

The explosion of treaties brought the massive expansion of investor-state cases, and the numerous problems sketched above. Active investor-state cases expanded from a total of 38 in 1996 to over 568 by the end of 2013. Duplicative and vaguely worded treaties have (by design) left the door open to various forms of chicanery by clever corporate lawyers, including the use of shell corporations and liberal application of most-favored nation clauses to “treaty shop” – i.e., to bring identical cases simultaneously under a variety of different treaties in order to increase the chances of a result favorable to the investor, a practice which leads, inevitably, to directly contradictory rulings on the same case. Many cases have followed traditional practice by seeking punitive damages from periphery countries with the nerve to place citizens’ welfare over the interests of investors in the capitalist core.

This article, a collaboration between The Nation and Foreign Policy in Focus, lists a litany of abusive lawsuits that multinationals – mostly North American mining and resource extraction companies – have filed against Central American countries in response to environmental, health and safety regulations, including a $300 million lawsuit by the Pacific Rim mining company against El Salvador for the denial of a mining permit and a $21 million suit by TECO against Guatemala in response to that country’s attempts to keep down electricity rates. A French company, Veolia, is currently suing Egypt for a variety of costs incurred during the revolution, most notably an increased wage bill as a result of minimum wage hikes.

These core-periphery cases remain a crucial feature of the international landscape. However, the rise of new multilateral treaties with investment chapters, such as NAFTA and the Energy Charter Treaty (ECT) as well as the proposed TPP and TTIP, has meant that Western states are increasingly being forced to cede sovereignty to a restrictive international legal regime. UNCTAD, the UN agency that monitors investor-state arbitration, reported that in 2013 almost half of the total cases were filed against developed states, mostly in Europe. Many of the highly publicized cases involve Western respondents being taken to court for “common-sense” regulation. Among those most often cited are Philip Morris Asia v. Australia, in which the tobacco giant argued that Australia’s plain packaging laws constituted an indirect form of expropriation (prompting the Labor government of Julia Gillard to renounce ISDS); Lone Pine Resources Inc.’s $250 million NAFTA lawsuit against Canada in response to Quebec’s decision to institute a moratorium on oil and gas exploration under the St. Lawrence River; and Swedish energy giant Vattenfall’s twin suits against Germany over environmental regulations and the planned phaseout of nuclear energy.

What has changed today in the Western world is not capital’s relation to democracy but to the Western state.

Despite the increasing number of highly developed states named as respondents, however, it would be a mistake to think that these encroachments upon sovereignty are somehow an aberration, or symptoms of a system gone out of control. Regarding the TTIP, transatlantic elites in business and government have been in lockstep over the necessity of including strong investor protections in the agreement, despite the fact that the nominal rationale for these protections in the first place was to protect investors from biased or underdeveloped legal systems – a condition obviously lacking in either negotiating partner.

In Europe, opposition has forced some belated concessions to transparency and brave words from Social Democrat ministers (later to be walked back, of course), but the principals – Merkel and Malmstöm – have shown little willingness to substantively engage on ISDS. In the United States, where TPP is currently the focus of more attention than its transatlantic sister, the response of Obama and his trade ambassador Michael Froman – himself a former executive at Citigroup, classmate of Obama’s at Harvard Law, and walking metonym for the identity of interests of American state and capital – has been refreshingly simple: complete secrecy when possible, lying through the teeth when not.

This eagerness to trade away sovereign prerogatives like regulation comes from the fact that elites on both sides of these agreements recognize that the purpose of the international trade and investment regime – ISDS included – is precisely this capacity to protect capital from the threat of democracy. The American state and the European Union do not exist to protect and expand the regulatory authority of their respective state institutions per se, but to construct and reproduce an international legal order conducive to capital accumulation. As Stepan Wood and Stephen Clarkson argue of NAFTA’s investment chapter, but in an analysis that can and should be readily extended to TPP, TTIP, and a host of other bilateral and multilateral agreements, this represents an attempt to create a global supraconstitution – one that “constrains the area of public authority” and is, once in place, exceedingly difficult to change. This is an obvious and transparent attack on democracy understood in anything other than an empty juridical sense.

Christopher Caldwell, a conservative journalist writing for the Weekly Standard, notes in a perceptive comment that while Cold War capitalism justified itself in the language of democracy, its most recent iteration is “most interested in a set of international rules that make countries more transparent to investors – by making those countries less answerable to voters.” Those of us on the left will counter that Western piety about rights and democracy – perhaps true intermittently and incompletely at the core – has long acted as a mystification of the brute repression and exploitation that has always obtained at the periphery. What has changed today in the Western world is not capital’s relation to democracy but to the Western state.

The United States’ position as the anchor of global capitalism in the postwar era has always meant, in the words of Perry Anderson, that the “US state … [must] act, not primarily as a projection of the concerns of US capital, but as a guardian of the general interest of all capitals.” For a long time, this meant indulging our capitalist competitors – Japan and Germany, most especially – in various economic policies that hurt US capital, but maintained the health of the system as a whole. While important, this function was largely invisible to much of the US population, and did little to directly affect or restrict domestic politics.

Today, as the fortunes of the international investor class are becoming increasingly detached from national performance, and Cold War pieties about democracy fade into the background, the United States is again attempting to safeguard the system for accumulation – by protecting (often rentier) profits from the threat of democratic action by populations in the Western world. As the growth of the United States’ terrifying global security apparatus shows, this does not necessarily mean the disappearance of the state – there will still be computers attempting to predict when and where trouble may pop up, and a drone waiting for when it does – but it does mean, if unchecked, the slow dismantling of those aspects of bourgeois society that let us once tell ourselves, even if mistakenly, that we lived in a democracy. The only dignified option is to resist.


1. Leo Panitch and Sam Gindin. The Making of Global Capitalism (Verso: New York 2013), 116.

2. Ibid., 277-231.

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