27 June 2018

In Praise of Limiting Democracy: a Defense of ISDS

Defending sovereignty is becoming a defining generation Z subject. Many seem to be concerned about the integrity of the nation state, the ability of the people (within national boundaries) to order and determine their fates. The bugbears of our time are foreign judges, unelected elites, corporate overlords and, very often, bankers. There is one area where these four (judges, elites, corporates and bankers) come together to ‘fight’ the nation state. This area is Investor State Dispute Settlement or ISDS.

There is little that excites anti-globalization campaigners more than ISDS. Try searching for #ISDS on social media and you will find horror stories about how the Energy Charter Treaty allows corporations to sue states, hampering the transition to a low carbon economy; how American civil society is rising up against the dispute resolution provisions in NAFTA; how resistance to CETA is following on from fighting against TTIP. Media are awash with concern about foreign corporate interests usurping democracy, placing a legal straitjacket around sovereign discretion, making public wishes and political agendas irrelevant or impossibly expensive. It is all terribly depressing, until you realize that a little bit of constraining sovereign discretion, of limiting democracy, might be exactly what we need.

What is this fearsome beast? Many international investment agreements, bilateral and multilateral (like NAFTA for instance) mandate standards of treatment for investors that are in many ways superior to legal protections offered to nationals. In particular, treaties allow in some instances investors to sue governments if they introduce new laws or policies that might reduce profits. This takes place in investor state dispute settlement (ISDS) tribunals. Lawsuits are brought before international arbitration panels that operate under rules similar to those used for the resolution of international commercial disputes. The main issue about ISDS is that it allows foreign corporations to sue governments not only for hostile behavior that we associate with coups and revolutions (like nationalizing industries and expropriation), but also for policies in the public interest with solid democratic credentials. This is why, while this mechanism is widely accepted in international business, it became hugely controversial when companies started to use it to challenge measures introduced by governments to protect the environment and public health. An illustrative example is Spain. After the country changed its incentives structures for the generation of renewable energy in the midst of the financial crisis, it got sued by most foreign investors in ISDS under the Energy Charter Treaty (ECT), with some of them actually winning substantial amounts in compensation.

This sounds pretty bad, so why should we not view ISDS as a threat to national wellbeing? The reason is that sometimes we need constraints on sovereign discretion. Democracy can produce less than optimal outcomes (to put it politely) especially in terms of economic policy. Trump and Brexit are contemporary examples. The current US administration has made America an unpredictable trade partner, a potentially rogue state which may violate at will agreements for political reasons. Seen this way, the US is now a state whose sovereign reach needs to be curtailed. Canada, for instance, by maintaining ISDS in NAFTA, could try to prevent Trump from legislating parts of his agenda that may hurt international investors who rely on free trade. This is not an unusual objective. When parties are unpredictable or considered a political risk, external constraints on their policy-making help stabilize the investment environment, providing an additional layer of protection for businesses.

Looking at Brexit, a consequence of ousting the jurisdiction of the European Court of Justice from the UK is that a gap develops in dispute resolution mechanisms. The EU is, understandably, concerned about leaving the rights of its citizens and businesses to the jurisdiction of domestic courts. This is not because it does not trust British judges, but because it does not trust the government that controls the legal framework within which they make decisions. While we do not know yet what the enforcement mechanism will be for any resulting UK-EU deal, ISDS is already exerting a tempering influence on the UK, by raising the price tag of a potentially disorderly Brexit through existing investment deals. This is good for the investment climate and good for the country, regardless of what one thinks of the underlying government policies and their mandate, or lack thereof.

Therefore, contrary to a rather hysterical global debate, ISDS does not make democracy irrelevant. What it does instead is place a price tag on the exercise of sovereign discretion. No one is telling politicians what to do, or how to do it. They can still act within their nationally determined constitutional boundaries. They also have choices even if this means transcending international boundaries, like those established by international investment treaties. What they cannot do is ignore the cost of their discretion. Think of it this way. I am not allowed to park my car on a double yellow line (prohibiting a vehicle from remaining stationary for more than a moment in a specific location). Can I still do it? Yes, I can, but I will have to pay a fine. Double yellows do not take away my freedom, they give it direction -they frame it- for the common good. Constraining sovereign discretion in order to create a predictable investment environment is done in order to entice investors to invest in the country. Making the environment unpredictable, or subjecting it to caprice, democratic or otherwise, can still be done, but it will cost both in terms of compensating existing investors whose legally protected expectations are frustrated, and by poisoning the investment environment for the future. Limiting sovereign discretion can be for a nation’s own good.

SUGGESTED CITATION  Glinavos, Ioannis: In Praise of Limiting Democracy: a Defense of ISDS, VerfBlog, 2018/6/27, https://verfassungsblog.de/in-praise-of-limiting-democracy-a-defense-of-isds/, DOI: 10.17176/20180627-100327-0.


  1. Martin Wed 27 Jun 2018 at 14:45 - Reply

    While I fully agree with the matter as presented, there is some caveat missing in those treaties to allow progress for the common good (such as taking in account policies designed to respect the Paris agreement, for instance) and not sanction states and politics when they go in the right direction

  2. Mittelwert Wed 27 Jun 2018 at 22:33 - Reply

    The gist of this article seems to be that, at times, ISDS has a positive influence on politicians’ decisions about (economic) policy and the relevant legal framework by putting “a price tag on the exercise of sovereign discretion”.

    But I have some problems with this kind of reasoning: First of all, not everything should be judged by a monetary price. There are values beyond the economical realm that must not just be replaced by a price-tag consideration. Furthermore, the ISDS kind of price is very much artificial. Making bad decisions about economical policy come with a natural price already: a worse performance of the economy.

    In many situations, putting an artificial price on some behaviour to dicourage it is a good idea, e.g. in the case of container-deposit legislation. Here, the artificial price is useful because the natural price of environmental pollution is paid by the public, not the individual that is actually responsible. (As ISDS compensations are not paid by the polticians, their effectiveness is probably somewhat lower.)

    But a more important point, in my opinion, is that the decision to introduce an artificial price needs more legitimacy than the behaviour it is supposed to prevent. The democratic introduction of a law for a purpose in the public interest is obviously more legitimate than selfish disregard for the environment, to elaborate on the above example.

    ISDS not only ignores this requirement, it even raises private for-profit companies to the level of states: Investor and state go into the ISDS proceedings essentially as equals. Thus, a political decision (by simple majority) on a treaty or agreement determines that later democratic decisions are to be restricted in favor of the economic interests of some private parties.

    In conclusion, I think that states should only be subject to the decisions of arbitration bodies established by themselves or their associations. (How ridiculous would it be if a plaintiff at an administrative court were entitled to select half of the judges for his case!)

    Although I do not agree with the narrow focus on economic freedom of some ECJ decisions, the European Union for instance is not only a union of states, it even has constitutional legitimacy. That means some restrictions on everyday policy decisions can be justified very well here.

    • Mittelwert Wed 27 Jun 2018 at 22:46 - Reply

      (or her case or their case! – what is the correct word, if the plaintiff isn’t a natural person?)

  3. Ioannis Glinavos Thu 28 Jun 2018 at 10:33 - Reply

    Mittelwert “Thus, a political decision (by simple majority) on a treaty or agreement determines that later democratic decisions are to be restricted in favor of the economic interests of some private parties.”

    But the whole point is that the economic interests defended are those of the state as well (a stable and welcoming investment climate). Plus the investor doesn’t often win.

    Don’t get me wrong, I am not an ISDS enthusiast, but I am concerned that the near universal condemnation of the process in social discourse isn’t evidence based.

    • Mittelwert Thu 28 Jun 2018 at 16:09 - Reply

      ISDS mechanisms do not defend the economic interests of the state, they just add an artificial price to certain economic policy decisions. Bad economic policy, as I said, has a natural price already; the consequences of scaring investors are a part of that.

      Artificial price tags merely have the advantage that they are rather easy to quantify – that is, after the settlement has been enacted. (Western states in particular have been surprised greatly by some ISDS decisions.) The problem is that the damages awarded benefit the investor, who is thereby favoured over domestic actors. I do not consider the fact that international investors may be encouraged by this favourable treatment a priori an advantage of ISDS.

      What exactly is the public interest, not only with respect to the economy, is a political question subject to changing majorities. I do not want to prevent the conclusion of binding international treaties or agreements, but cementing the viewpoint on economic policy of a simple majority by the threat of sizeable ISDS damage awards isn’t unconditionally legitimate.
      In a liberal democracy, the responsibility to balance the public interest and the rights of private parties is shared by political institutions, the administration and the public courts. In my view, the fact that ISDS heavily favours foreign investors, materially as well as procedurally, over their domestic counterparts clearly tilts the balance toward the illegitimacy of this instrument.

    • Seb Tue 3 Jul 2018 at 05:36 - Reply

      Brexit isn’t evidence-based, and it looks very much like it is going ahead anyway. ISDS can only increase the price the U.K. will pay for a hard Brexit, it cannot stop a Brexit that is irrational anyway. So I don’t think Brexit can support your argument.
      In my opinion, ISDS has no place in societies where the democratic rule of law applies. That should offer sufficient protection.

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