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March 30th 2017 print

Andrew Bragg

Concealed Protectionism Threatens Australia’s Trade

Following the seismic political events of 2016, including Brexit and the election of Donald Trump, we confront the most disruptive landscape in global trade policy in decades. Dozens of new bilateral trade agreements are expected to be agreed with the newly unrestrained United States and United Kingdom. The bookends of the Atlantic also have plans to formulate a trade deal between themselves following Theresa May’s visit to Washington after the US elections in November. A further consequence of Trump’s election is the uncertain future of the Trans-Pacific Partnership, which is dead according to Shinzo Abe but alive according to Justin Trudeau and Malcolm Turnbull. It is unclear where the enormous pan-Asian Regional Comprehensive Economic Partnership or the European Union-US Transatlantic Trade and Investment Partnership will land. Similarly, the fate of a renegotiated North American Free Trade Agreement remains murky.

One issue which is likely to feature heavily in the public debate on every new bilateral or regional trade deal is Investor State Dispute Settlement (ISDS). ISDS clauses provide companies with legal redress typically when unfavourable or unforeseen legislation is passed in a foreign jurisdiction. Unfortunately ISDS has become a damaging myth which gives contemporary cover to protectionism. It needs to be properly evaluated, given ISDS has been known to deprive nations of advantageous trade agreements.

The debate on ISDS in Australia, a nation with a deep history of participation in the international trading system, has been distorted by dogma, few stakeholders taking the time to examine ISDS coolly and methodically. Supporters of mutually beneficial free-trade deals will be forced to consider ISDS in coming years as a coalition of unions and Centre-Left political parties campaign to stop trade deals which contain ISDS.

It is important to get the facts on ISDS on the table so it cannot be used as a reason to block otherwise productive trade agreements between nations. Like most relatively new legal mechanisms, it can be improved. Improvement should be the focus, not using ISDS as a blocking excuse.

There are three pivotal points which are rarely aired on ISDS: one, it supports the rule of law and is a conscious act of sovereignty. Two, investor companies benefit from ISDS protection and it is often a precondition for investment. Three, the tribunals used in relevant cases are not murky bastions of secrecy.

First, a report by Australia’s Centre for Independent Studies says ISDS mechanisms support the rule of law by reinforcing a legal framework that has been a cornerstone of free markets since Magna Carta in 1215. The report states that, to date, just 30 per cent of the 362 ISDS cases have been ruled in favour of foreign investors. In keeping with the averages, only one of the three Australian-initiated cases was successful.

The Australian Greens cite Philip Morris’s attempt to overturn Australia’s landmark plain-packaging cigarette laws in the Permanent Court of Arbitration in Hong Kong as evidence of a loss of sovereignty—even though Philip Morris lost the case. Australia’s former trade minister Andrew Robb describes the threat of ISDS as “dogma”. He told me last year: “We’ve had [them] for thirty years, we’ve got ISDS clauses with over twenty countries and we’ve won the only case brought against us.”

Another test of plain-packaging laws in July 2016 between Uruguay and Philip Morris was also resolved in Uruguay’s favour. But even if the cigarette makers had won, it wouldn’t be a transfer of sovereignty or the overturning of an Australian law—it would be reparation that any company might similarly expect on outbound foreign investment. This is the very reason ISDS emerged in investment and trade agreements in the decades after the Second World War, when commercial interests were nationalised in nations such as Cuba, Egypt and Iran.

Many globalists believe in the value of multilateralism through the WTO and United Nations but do not value international law reflected in ISDS. For instance, Australian Greens Senator Peter Whish-Wilson said in 2014 on the Australia–Korea free-trade agreement: “Including ISDS provisions in our trade deals leaves us vulnerable to being sued by foreign corporations for simply legislating to protect the environment or internet use, if those laws affect corporate profits.” The use of the word vulnerable ignores the fact that agreeing to ISDS clauses is a consciously sovereign act.

Another group, the Australian Fair Trade and Investment Network, argues: “governments should have the right to regulate in the public interest without being sued by global corporations”. The Network is suggesting governments should have rights which are beyond legal reproach—a form of absolutism. Thankfully the liberal grounding of Western civilisation dating back to Magna Carta has abhorred absolutism.

The bottom line on sovereignty is the absence of evidence. No advocate against ISDS can point to a single example where a nation has lost a health, environmental or welfare law in an ISDS case.

Second, the ISDS mechanism provides valuable legal protection and promotes investment. Alan Oxley, a former chairman of the General Agreement on Tariffs and Trade, said:

For one of [Australia’s] big shopping centre businesses establishing in Chicago or Michigan, where in the United States state authorities do intervene, and I can envision a circumstance where they would erode the right in the free trade agreement for that investment to take place, then the natural response would be to use the ISDS system of arbitration to address that.

Companies investing offshore value a legal mechanism that protects their interests. The Chief Operating Officer of Australia’s Servcorp, Marcus Moufarrige, told me: “the role [of government], at a diplomatic level, is to ensure Australian businesses are protected overseas”.

As a former trade minister and adviser to global businesses, Andrew Robb reinforced:

[ISDS has] given confidence to our companies to go into countries where they are not familiar with the legal system. It allows Australian companies to access a framework where a local court would probably never find in their favour. The arguments against ISDS are wrong.

Alan Oxley told me last year, “ISDS is a good idea. It is in the interests of Australian business, which we need to support.”

Very few businesses have the capacity or wherewithal to enter the debate against activists. One of Australia’s umbrella business groups, the Australian Chamber of Commerce and Industry, has presented a clear view with useful examples:

ISDS provides protection for Australian firms when they invest in mines, factories, infrastructure and intellectual property in other countries. It means they can defend their commercial rights and the investment of their shareholders from expropriation by governments that are not on fair and just terms.

Not only is ISDS a protective mechanism, it also drives investment. In recent years, research on the connection between ISDS or investment treaties and foreign investment has emerged. Neumayer and Spess of the London School of Economics found that “developing countries that sign more bilateral investment treaties receive more FDI inflows”. Unsurprisingly, higher investment levels are linked to a desire for legal enforceability: “[treaties] guarantee certain standards of treatment that can be enforced via binding investor to state dispute settlement outside the domestic judicial system”.

A similar point is made by Asian Development Bank research fellow Alisa DiCaprio, who argues that the Asian region has long accepted ISDS as a mechanism of investment promotion. According to DiCaprio, “it is telling that all ASEAN countries have multiple bilateral investment treaties” and many Asian nations see “an ISDS clause is likely to promote foreign investment”.

More outbound investment is occurring into rapidly growing Asian nations, some of which is into recently signed free-trade agreements or countries with less familiar legal systems. As at 2015, Australia had $542.6 billion in foreign direct investments overseas. This more than doubles the amount of foreign investment overseas in 2001, which stood at $230 billion. China has emerged as Australia’s fifth-largest direct investment destination. In 2001, foreign direct investment stood at $395 million. In 2014, Australia has $14.6 billion invested in China—approximately 2.6 per cent of our total investment. Investment into ASEAN economies has grown from 6.3 billion in 2001 to 37.6 billion in 2015. ASEAN economies make up 7 per cent of Australian FDI investment abroad as at 2015. These countries have less familiar legal structures than the traditional destinations of outbound investment which has usually been into the “Anglosphere” nations such as the UK and USA.

Yet one of Australia’s major political parties is wedded to a view that ISDS has none of these benefits. Labor’s last trade minister, Craig Emerson, said in 2012:

We do not and will not support investor-state dispute settlement provisions … This is government policy … It’s the result of a cabinet decision in April last year, reaffirmed at the [Labor Party’s] national conference.

Labor has maintained this position since in its years in opposition. Launching the Labor Party’s trade policy during the 2016 federal election campaign, the shadow minister for trade Penny Wong said:

There are also ISDS provisions in four of Australia’s earlier free trade agreements and in 21 bilateral investment treaties. Some of these provisions were drafted many years ago and do not contain the safeguards, carve-outs and tighter definitions of more contemporary ISDS provisions. A [future] Labor Government will develop a negotiating plan to remove ISDS provisions in these agreements.

If future Australian governments seek removal of ISDS from existing trade agreements, it would be a large and controversial body of work which would necessitate the review of almost every Australian trade and investment agreement. Any ISDS removal project would require a significant investment of diplomatic resources. Foreign governments might use the opportunity to negotiate further changes. It is unlikely all governments will agree to removing ISDS, and therefore whole trade agreements and export opportunities will be lost. Removing ISDS would also send a message to the domestic business community that the government will not pursue legal mechanisms to protect or encourage outbound investment.

Third, its opponents argue that the tribunals and processes of ISDS are secret. Yet the plain-packaging case against Australia was heard by the Permanent Court of Arbitration, which was set up by the Hague Convention, hardly a flimsy or discredited heritage. The second test of plain-packaging laws occurred between Uruguay and Philip Morris in July 2016, which was resolved in Uruguay’s favour in the International Centre for Settlement of Investment Disputes. The Centre is part of the World Bank—an institution established following the Second World War and the Bretton Woods conference of 1944. The Centre itself was established in 1965 and its enabling treaty has been ratified by 151 nations.

There is always room for improvement, and the UN Conference on Trade and Development has recommended “tailoring of the ISDS system”, including the creation of a standing international investment tribunal. This is a sensible suggestion which would provide more confidence that the legal processes will be clear and consistent. At least, it might stop Centre-Left parties such as Labor from needlessly blocking or changing trade agreements.

Before Donald Trump scuttled the TPP, many citizens of the Pacific Rim may have heard of the TPP only when mentioned in conjunction with ISDS. To formalise the established convention that governments do not give away rights under ISDS, the TPP exhaustively protects legislators’ rights to legislate for public welfare, health, safety and environmental reasons. As Dartmouth trade expert Douglas Irwin wrote in Foreign Affairs in 2016:

And despite populist claims to the contrary, the TPP’s provisions for settling disputes between investors and governments and dealing with intellectual property rights are reasonable. In the early 1990s, similar fears about such provisions in the WTO were just as exaggerated and ultimately proved baseless.

In other words, we have seen this film before. We just have to remember the scenes and call out concealed protectionism as necessary.

Australia provides a great case in point of the impact of anti-ISDS sentiment on executive government, trade policy and a nation’s economic opportunities. ISDS is one of the reasons Australia’s trifecta of North Asian bilateral agreements were not concluded during the Labor administration of 2007 to 2013. Yet it is more likely to be the result of poor research rather than ideological obsession. Australia’s governments did not understand ISDS clauses particularly well and their concerns about ISDS were overblown. Similarly, the potential benefits and protections Australian investors stood to receive were not considered. During this malaise New Zealand was able to conclude an agreement with China which delivered transformational benefits to the New Zealand dairy industry, partly at Australia’s expense.

The benefits of a bilateral agreement during this disruptive period of trade policy should not be overlooked. Once Australia’s new trade agreement with China was agreed, in the first three quarters of 2016 (the first nine months of operation) the value of Australian exports to China more than doubled for cherries, abalone, medicaments, grapes, wine and oranges. Australia also gained ground against New Zealand’s dairy industry with a 28 per cent increase in fresh cheese exports.

ISDS should be retained, supported and improved in future trade agreements. At the very least if national leaders want to go down the discredited protectionist route, let them do it transparently, not by using the fig leaf of ISDS.

Andrew Bragg is the Director of Policy and Research at the Menzies Research Centre.