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Should NAFTA 2.0 Keep ISDS?

April 4, 2018
Clint Peinhardt
Perhaps the biggest loss from excluding ISDS in NAFTA 2.0 would be stepping away from the conversation to make ISDS provisions better.

Clint Peinhardt is an Associate Professor of Political Science, Public Policy, and Political Economy at the University of Texas at Dallas. His recent research investigates non-trade provisions in trade agreements, international investment agreements, and political risk for multinational corporations.

The North America Free Trade Agreement (NAFTA) renegotiations are currently underway, and negotiators are hurried owing to the possibility that Andres Manuel Lopez Obrador, a leftist populist, will win Mexican elections in July of this year. Requiring quick negotiations is difficult given the treaty’s complex issues, such as rules of origin and intellectual property. While each of those has received some attention, another important disagreement concerns the treatment of foreign investors, usually multinational corporations.

Chapter 11 of the original NAFTA agreement embedded rules for treatment of foreign investors, and a dispute resolution process that enabled companies to sue foreign governments directly via international arbitration. According to the UN Conference on Trade and Development, there have been a total of 61 claims of treaty violations under NAFTA. NAFTA is not unique in its adoption of this system, which is often referred to as Investor-State Dispute Settlement (ISDS). However, ISDS has become more controversial in recent years, particularly in countries that have been frequently challenged in international investment arbitration as a result of ISDS provisions.

In NAFTA 2.0, Canada and Mexico remain in favor of an ISDS provision. Recent moves by both countries have reinforced their commitments. Both are party to the newly negotiated Trans-Pacific Partnership (TPP), for example, which has retained ISDS as a key feature despite the preferences of Australia and New Zealand to jettison it. Along with withdrawing from the TPP, the current administration’s position is against ISDS. U.S. negotiator Robert Lighthizer has publicly argued against including ISDS in NAFTA 2.0, in part because such investor protections tend to encourage investment in Mexico. These negotiation stances seem inconsistent with the countries’ individual experiences with the ISDS process. While the United States has not lost any ISDS cases, Canada has, and foreign firms have targeted Canada much more often than either the U.S. or Mexico.

Advocates of ISDS often portray it as a mechanism for preventing developing countries like Mexico from nationalizing foreign firms. A look at more recent investor-state disputes shows that these outright expropriations rarely happen anymore, and when they do, ISDS forces countries to pay market prices to the companies whose assets were seized. Strikingly, the number of ISDS cases has ballooned even as expropriation cases have declined.

So, should NAFTA 2.0 keep ISDS? Many American multinational companies are lobbying to retain ISDS as a NAFTA provision. Like the current administration, they argue that removing ISDS provisions will make Mexico a less attractive investment destination. If so, then excluding investment provisions may jeopardize the many cross-border supply chains that have helped make Texas such an attractive place for businesses over the last couple of decades.

Both Mexico and Canada have had negative experiences with ISDS, but they remain committed. They feel that any problems with ISDS can be mitigated by improving the language in treaties or by changing the dispute settlement process so that frivolous cases can be quickly dismissed. It is strange that the United States is the country most opposed to ISDS – in contrast to virtually every other country that now opposes ISDS, American opposition is not based on any direct negative experience. The U.S. has been fortunate not to lose an ISDS case, and as a result, any negative reaction against ISDS has been muted. Eventually, the American government is bound to lose or settle a dispute, in which case taxpayer funds will go directly as damages to a foreign company. The political backlash will follow, so removing it could keep ISDS salience low in the US.

To the extent that ISDS is no longer about the danger of expropriation in Mexico, excluding it altogether may not have the promised negative consequences on investment in Mexico. Excluding ISDS would not necessarily prevent companies from accessing international arbitration. Just like individual consumers agree to arbitration in our credit card agreements, any government-firm contracts can also include them. Energy, mining, and telecom companies that operate via concessions therefore have access to ISDS via other means. Other companies may be able to use “treaty shopping” in order to incorporate subsidiaries in countries that have treaties with Mexico (or Canada). A NAFTA 2.0 without investment provisions would not end ISDS for Mexican, Canadian, and American companies. In fact, the new TPP agreement guarantees a continued ISDS relationship between Mexican and Canadian firms, so any American company could gain access by having a Canadian subsidiary with controlling interest in an operation in Mexico.

Perhaps the biggest loss from excluding ISDS in NAFTA 2.0 would be stepping away from the conversation to make ISDS provisions better. If the U.S. government is not engaged in that international legal conversation, then it will allow the revisions to take place in ways that may disproportionately benefit the European Union, Canada, and other countries currently focused on maximizing regulatory space.  The result could be a series of de facto precedents that might actually be bad for American companies.