By: Chandler Foust, Research Associate at the Council on Hemispheric Affairs
On June 12, the U.S. House of Representatives passed Trade Promotion Authority (TPA) while rejecting Trade Adjustment Assistance (TAA). The Senate version of the bill, with TAA and TPA adjoined, passed. Typically, a bill such as TAA would have strong Democratic support because it provides assistance to individuals who lose jobs due to trade deals. However, since the bills were separate in the House and adjoined in the Senate, House Democrats voted it down to prevent TPA from being signed into law. Many Democrats opposed TPA because if signed into law, President Obama would have fast track authority to ratify the Trans-Pacific Partnership (TPP), which many Democrats are against. By rejecting TAA, House Democrats forced the Senate to separate the TAA from the TPA and vote on it again.
President Obama was then left to rely on Republican Senate Majority Leader Mitch McConnell and Republican Speaker of the House John Boehner to deliver the legislation, and they came through. On June 25, the Senate voted to pass TPA, without TAA, which means that the bill will be sent to the President. With TPA sent to the president and the House of Representatives passing TAA the second time around, the Obama Administration can chalk this round up as a victory. Regardless of what happens next though, the fact that the President’s own party initially abandoned him leads to a much-needed discussion on the role trade agreements play in determining policy in a democratic society.
What is the TPP?
TPP, an acronym for the Trans-Pacific Partnership, is a free trade agreement that would create new rules and standards for trade and business investment. If successful it will include 11 other Pacific Rim nations, who are currently responsible for one third of global trade and 40 percent of global Gross Domestic Product (GDP). The TPP’s supporters state that it will increase American exports, enforce labor rights, and establish strong environmental protections. The Obama administration has also advertised the agreement in geopolitical terms. To the administration, the TPP is fundamental in fomenting the U.S.-Asian shift, as well as countering, and in the future hopefully including, China. On the other hand, TPP’s detractors are concerned over the secrecy of the negotiations. They are afraid TPP will offshore American jobs, increase the cost of medicine, roll back Wall Street reforms, and give multinational corporations increased power at the expense of the state.
In a column for the Washington Post on June 14th, Larry Summers, former Secretary of Treasury and economic advisor to President Obama, wrote that failing to pass the TPA “would signal a lack of U.S. commitment to Asia at a time when China is flexing its muscles.” However, starting off with doom and gloom, he also went on to rebuff the importance and role of TPP. Stating that the “era of agreements that achieve freer trade in the classic sense are essentially over,” he labeled the agreement as less of a trade deal and more of a tool for regulatory harmonization between the United States and its partners. This is where the role of trade agreements must be reexamined.
After almost 14 years of the DOHA trade talks reaching no agreement, the U.S. has been eager to establish bilateral and regional trade agreements to increase its influence and create international standards that it deems important. The problem is the secretive nature of the negotiations that determine the standards. These agreements do not hold negotiators accountable to public welfare and increase the influence of special interests. This can undermine a nation’s sovereignty and thus its ability to devise policy that benefits its citizens.
How Trade Agreements Undermine Sovereignty
As noted earlier, due to already low tariffs and quota barriers; the TPP is less about free trade and more about regulatory harmonization. This means reforming the domestic laws in the countries of the agreement so that they are in line with U.S. standards regarding areas such as intellectual property, environment and labor. As in many Free Trade Agreements, the TPP includes an Investor State Dispute Settlement (ISDS). Such settlement structures have protected investors at the expense of states since their infancy. The combined increase in Foreign Direct Investment and increase of nationalization of foreign companies during decolonization in the 1960s led many international investors to advocate for a judicial body that would replace national courts in countries with an unfair rule of law. In 1965, the International Center for Settlement of Investment Disputes (ICSID) was created as a part of the World Bank Group. This created an arbitration mechanism to resolve disputes. The mechanism allowed investors to bring claims against states for treaty violations, but gave the state no recourse. Initially, very few investors used ICSID. Only fifty cases were brought against states between 1965 and 2000. However, by the end of 2013, investors had brought 568 cases.
Presiding over the cases are three arbitrators, one appointed by each party and the third mutually agreed upon. The private lawyers acting as arbitrators are held to loose ethical standards and motivated by the pay they receive for advising the opposing parties. Many arbitrators have held “several roles at the same time, such as counsel, government representative, expert witness, and academic.” Currently the process is dominated by a handful of international law firms that have turned it into a gold mine. In fact, 55 percent of known disputes have been handled by a group of fifteen lawyers. Recently, for claimants, ISDS cases have cost on average around $8 million USD, with some costing over $30 million USD. In an OECD estimate, arbitration lawyers charge $1,000 USD an hour on average, which helps to explain the broad interpretation given to International Investment Agreements (IIAs).
The two main clauses in IIAs that are invoked by investors are the Fair and Equitable Treatment (FET) Clause and the Indirect Expropriation Clause. The FET Clause has been interpreted so broadly that new laws or taxes can be seen as violating the investment agreement if they deride an investor’s “legitimate expectations.” The Indirect Expropriation Clause, on the other hand, refers to an action that would affect an investor’s ability to profit from any asset they own in the country. Arbitration is so secretive that domestic groups are not able to hold arbitrators accountable, and the open-ended nature of IIAs allows for considerable leeway in the arbitrator’s decision. Essentially, the arbitrators are interpreting very broad investment rules through the lens of private commercial actors and in effect creating rules on how governments treat foreign investors without the consideration or input of the public. On top of this, the arbitrator’s decision is binding and put into effect immediately. In response, some countries have resorted to ignoring the arbitrator’s decision due to the perceived unfairness of judgments made by those with considerable interest in interpreting IIAs in a way that increases their future caseload.
Even though the U.S. has never lost a case in ISDS that does not mean it cannot happen. For instance, Germany, who many consider the “grandfather of investor-state arbitration,” has numerous businesses that have sued foreign governments from the 1980’s onward. However, in 2009, this was turned around on them. After establishing strict environmental controls on a coal-fired power plant, Swedish company Vattenfall sued the German government. A local court found that the environmental regulations were too strict and Germany agreed to a settlement. There are many other examples of ISDS being used as a tool to force states’ from acting in the public interest as well.
In 1999, Occidental Petroleum signed a contract with the Ecuadorian Government to explore a rainforest for hydrocarbons. A year later, in order to better fund the operation, the company sold 40 percent of the share to the Canadian Alberta Energy Corporation, which is now ENCANA. Occidental Petroleum failed to inform the Ecuadorian government of the deal and, when news of the deal reached Ecuadorians, they launched protests against the corporation. Responding in kind, Ecuador ended the contract and seized Occidental’s property in Quito along with its oil fields. In response, Occidental filed a complaint under the U.S.-Ecuadorian Bilateral Investment Treaty (BIT) and entered into arbitration. After six years, the arbitrator ordered Ecuador to pay $1.8 billion USD, an amount almost equal to Ecuador’s yearly health budget. They argued that while Occidental did violate the law by entering into a side deal without informing the Ecuadorian Government, Ecuador’s response was too harsh. Ecuador, however, has requested for the case to be annulled and currently refuses to pay.
Another example of ISDS’s potential to undermine state sovereignty is the case between El Salvador and Pacific Rim. In the early 2000s, the Canadian mining company Pacific Rim began exploring for gold in the Central American nation. Pacific Rim was given exploratory permits, but right before the company was to receive the necessary extraction permits, in 2008, a “clean water crisis” began in San Sebastian due to mining operations polluting the local water supply. In turn, the Salvadorian Government chose to end mining in the country, due to concerns that further mining would cause permanent damage and pollution of the water supply. The government wanted time to figure out the environmental impact of the operation. Pacific Rim, however, said it already completed its review of the environmental impact and wanted to move ahead with extraction. The Salvadorian Government stuck by its ban and Pacific Rim sued. At first, Pacific Rim’s claim was that El Salvador’s actions violated the Central American Free Trade Treaty (CAFTA), but in 2012 the arbitrator found that, since the company is Canadian, CAFTA does not apply to them. Switching gears, Pacific Rim sued again, but this time claiming that by refusing to grant a permit to dig for gold El Salvador violated its own investment law. Pacific Rim is suing for $284 million USD in damages, around 2 percent of El Salvador’s GDP and larger than the amount of foreign aid the nation received last year. The case is ongoing and will be decided in the coming months.
Argentina has also been in frequent disputes with investors, having more cases brought against it than any other country. In October 2013, the country agreed to pay $677 million USD to five different companies. In its most recent case, French water company Suez sued Argentina for revoking the company’s water and sewage treatment contract in Buenos Aires in 2006. Initially, the company sought $1.2 billion USD in damages, but this figure was brought down to $405 million USD, which an arbitrator found Argentina must pay. The state still has 20 pending cases in ICSID.
Lastly, Uruguay’s legal battle with tobacco giant Philip Morris, which has higher profits than Uruguay’s GDP, is a prescient example of possible future cases for partners of TPP, especially considering Senator McConnell’s avid work to include tobacco companies on the ISDS provision of the TPP. To combat smoking, Uruguay implemented a massive anti-smoking campaign that includes a requirement that all cigarette packages have health warnings and pictures illustrating the effects of smoking that cover 80 percent of the package. Phillip Morris is seeking damages of $25 million USD under the BIT between Switzerland and Uruguay, stating that Uruguay’s regulations disregard its past commitments.
What these cases all have in common is the use of ISDS to stop government regulations or a policy that investors feel harms their business, and establishes rules for how governments treat foreign investors. While nations have resorted to ignoring the rulings, they still have to pay for the high legal costs involved in defending themselves. In the ongoing case in El Salvador, the government banned mining in order to protect the environment and to prevent water pollution. It is a ban that is in the interest of its citizens and by all means within the powers granted to it as a sovereign state, but since Pacific Rim views it as reneging on previous commitments made to the company, the nation could suffer an enormous financial penalty for simply governing. This is the same in Ecuador and Uruguay. In Ecuador, the government responded to the demands of its citizens and ended a deal with a company that broke the law, while in Uruguay the government has attacked a massive public health concern and is being sued for it as well. Multinational Corporations use ISDS to extract compensation from states and ensure that domestic policies do not interfere with their bottom line.
In addition to containing ISDS provisions that undermine a nation’s ability to make policy, the TPP will bring minimal economic benefits to the U.S. The Peterson Institute stated that U.S. incomes would increase $78 billion USD by 2025 or by 0.38 percent. In fact, Vietnam will be the main beneficiary because its two principal exports, apparel and footwear, face high protection barriers in partner markets. On top of mainly benefiting other nations, the U.S. would, according to the Peterson Institute, lose 40,000 to 50,000 jobs a year from 2014 until 2017 and on average 100,000 jobs a year in 2018 and 2019. This would necessitate the creation of 900,000 jobs a year to sustain full employment. While it is undeniable that a nation such as Vietnam’s economic improvement is a plus for the U.S. and the world, it remains to be seen whether increased exports of cheaply made goods will actually benefit the average Vietnamese, which leads to a larger point.
Trade deals such as the TPP are negotiated in secret and are susceptible to capture by special interest. Other controversial aspects of the TPP are its inclusion of stringent intellectual property rights and patents on pharmaceuticals. Dean Baker, co-founder of the Centre for Economic Policy and Research (CEPR), makes a strong point when he states that the proponents of TPP have it all wrong. Tariffs and quota barriers are already extremely low and at worst, raise the cost of goods 20 to 30 percent. Strict copyright protections and patent laws, on the other hand, could raise the price of protected items from 2,000 percent to 20,000 percent in some cases. He then adds that every dollar spent on artificially expensive drugs or computers is one less dollar that could be spent to increase the demand on products Americans export.
Lastly, the U.S. needs to play a leading role in the world, but it must reconsider using trade agreements as a means to set up its standards. Not only do these secretive standards hold little accountability to the public welfare, but also they are broad and open to interpretation. ISDS mechanisms in the majority of U.S. trade agreements, not only ensures that non-elected, highly paid arbitrators– with an incentive to interpret cases so as to increase future caseloads– set the rules governing how states treat investors, it has opened itself up for a counterattack, as shown in the German example. Instead of reflexively supporting free trade agreements, the countries involved must reexamine and engage in intelligent discussions about the implications and repercussions involved.
By: Chandler Foust, Research Associate at the Council on Hemispheric Affairs
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Featured Photo: Leader of TPP Member States. From: Gobierno de Chile.
 “Trade and Development Report.” United Nations Conference on Trade and Development, 2014, 136-41. Accessed June 22, 2015. http://unctad.org/en/PublicationsLibrary/tdr2014_en.pdf.