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Trump Kills the Trans-Pacific Pact and Why That is a Good Thing

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One of the first Executive Orders signed by President Trump withdrew the United States from the Trans-Pacific Partnership negotiations. Better known as simply “TPP” this mega-trade deal was a signature effort by President Obama to craft a free trade area around the Pacific that would exclude China, allow America and her partners to “set the rules of the game” for Asian commerce and become the soft power component of the Pivot to Asia strategy. None of that will now come to fruition.

The reaction to Mr. Trump’s announcement has been decidedly mixed. Free trade supporters and foreign policy wonks are in an uproar, accusing the new President of giving away Asia and ensuring China’s regional dominance. Opponents of the TPP, including Senator Bernie Sanders and many traditionally democratic union leaders, instead argue that the trade deal was overly secretive, badly written, would have cost more American jobs for little return benefit and contained provisions that would have been harmful to US sovereignty. Both sides can claim merit for some of their arguments, but the TPP did suffer from some fatal flaws.

Critics were dead on when they said the negotiations were secretive; so secretive that not even members of Congress were allowed to read the drafts of the treaty. They could request information regarding it, but the information was conveyed verbally and no notes could be taken. Members of Congress!! To sceptics, this was a clear red flag that the terms contained conditions that would be harmful to the public interest and which supporters would try to ram through Congress with as little debate as possible. This was further confirmed when President Obama requested fast track authority for the TPP: this would have limited public scrutiny and debate to 30 days, eliminated the possibility of Congress introducing amendments, and required an up-or-down vote. Congress never gave Mr. Obama this authority[i].

Leaked – and hacked – documentary evidence revealed at least one of the reasons why the corporate lobbyists government negotiators didn’t want the public to read early drafts. The treaty called for a major strengthening of the Investor State Dispute Settlement (ISDS) regime. Also known as the Investment Court System, this is a mechanism designed to protect foreign investors from the capriciousness of governments by establishing a private arbitration board with authority to issue rulings on disputes between said investors and the state in which they have put their money. Like many such ideas, it had a practical, even laudable beginning. Western investors were understandably wary of developing countries where dicey courts, systemic corruption, frequent changes in government and an irresistible itch to nationalize foreign assets made long-term investing a game for the very bold or the very foolish. By taking disputes out of the hands of corrupt local courts, foreigners could be assured of a fair – even sympathetic – hearing by the arbitration panel, who were always corporate lawyers and usually Westerners themselves. It was argued that this was the only way to encourage the foreign direct investment that would help lift these underdeveloped nations out of poverty; and that was at least partially true.

More recently, investors have gotten wise to the fact that the ISDS mechanism doesn’t just apply to the underdeveloped world; it has been inserted into more and more trade treaties in developed economies too. It is highly revealing that the US has insisted on including strong ISDS provisions in its negotiations for the Transatlantic Trade and Investment Pact (TTIP) even though legal protections and the court system is as strong as that in the United States. So ISDS must not only be about protecting investors from corrupt judicial systems. In fact, the proliferation of ISDS provisions has raised interesting possibilities, which foreign investors have been quick to exploit.  Now, if Germany passes a law which imposes a carbon tax on fossil fuels, the foreign investors in foreign fossil fuel companies could potentially sue the German government for infringing their right to make money. Or an smoking ban could bring about a suit from investors in tobacco companies. And the case would not go before a German court; it would go to the unelected, unaccountable arbitration committee that sits in Switzerland. Should the committee find against the German government, the damages awarded could be in the hundreds of millions of dollars, all paid for by the German taxpayer to the foreign investor. And the German government would have to annul that pesky carbon tax, because otherwise they would be sued by more “injured investors”. Indeed, governments would have to think very carefully before passing any legislation at all, since it might affect some foreign investor interest or other.

It sounds like a far-fetched scenario. After all, who would sue the reasonable governments of Europe or North America? And even if they did, why wouldn’t they use the wholly independent and honest court systems in these advanced nations? It may seem a bit outlandish, but it has already happened more than once. The number of cases being brought before arbitration has exploded from one or two a year in the 1980’s and 1990’s to over 50 per year recently.

ISDS provisions therefore act to dampen national legislation that is in the public interest, no matter how “reasonable” or non-discriminatory it may be[ii]. Australia and New Zealand, for example, are both involved in arbitration suits brought by Phillip Morris in relation to tobacco warning requirements on cigarette packages, and both have suspended new regulations until the cases are resolved. The provisions themselves are discriminatory: they protect only the rights of foreign investors. In the example of the German carbon tax, if a German firm wanted to bring suit against their government under the exact same circumstances, they would not be able to use the ISDS provision to do so. This creates a set of rights for foreign companies not enjoyed by their domestic competitors and unbalances the playing field. And the obligations are only one way: ISDS creates obligations on the state, but no countervailing obligations on the foreign firms.

The arbitration panels themselves are of questionable character. The people who sit on them are legal experts in corporate law, yet there is no requirement that they leave their existing practices while considering arbitration cases, leading to a huge potential conflict of interest. Even if there was a reclusion provision, the “revolving door” nature of the business would ensure that these people would show a preference towards their past and future clients, rather than towards governments who are unlikely to employ them. Add to this the secretive nature of the arbitration (there is no usually no requirement for public disclosure of proceedings) and the fact that arbiters are paid $600-$700 per hour and you have a great deal of incentive to maximizing arbitration and drag out cases.

As the leading global proponent of ISDS, the United States has aggressively pursued these clauses in both its major trade initiatives, TPP and TTIP. That would have been disastrous from a public policy perspective. The US, which has never lost an ISDS case to date, would have been exposed to attack from European and Japanese firms far more than today and in many more fields. US states as well could have suffered: California’s tougher emission standards would almost certainly have become a target of Japanese and German automakers. Negative environmental impact assessments affecting foreign energy firms would also have become targets of litigation – as former President Obama’s executive order on the Keystone XL pipeline was when TransCanada sued the government for $15 billion in damages[iii]. An unintended, but not unforeseeable, second order effect of ISDS is to destroy US businesses in regulated areas of the economy; if foreign firms can safely ignore these regulations, or profitably sue the government when they are applied, they will quickly displace their American competitors. That would cost the economy thousands of jobs and the government millions in tax revenue.

President Trump certainly didn’t kill TPP because of his concern for the ISDS provisions in it; if anything, he is almost certainly in favor of them. Yet we should be glad that he did – TPP with its current ISDS provisions would have been an unmitigated disaster: a major erosion of US legal sovereignty. It does mean that the US is left without a viable trade policy to counter China, but it is questionable whether the TPP would really have “forced” China to change its game strategy. The Chinese have consistently outplayed the US in the trade and investment great game; the New Silk Road and the Asian Investment & Infrastructure Bank are two cases in point. Focusing on TPP as the great and only counter to Chinese economic influence has been a grave mistake; it is to be hoped that the new Administration will take the opportunity to conduct a fundamental reassessment of US strategy in Asia and our whole approach to “managing” China’s rise.

I still support free trade deals. I even support multi-lateral free trade deals like TPP and TTIP; but the monster that is ISDS should not be a part of them or any other future deal.


Sources and Notes

[i] Not because they were opposed to ramming highly unpopular provisions down the public’s raw throat, but rather because they would not have given Mr. Obama a pail of water if their own houses were on fire.

[ii] Non-discriminatory in the sense that it applies equally to foreign and domestic firms.

[iii] Given President Trump’s green light on the pipeline, the suit will likely be dropped, but I have not read that it was at the time of writing.

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