ISDS: A Little Bit of Knowledge is a Dangerous Thing

I was preparing to write a different blog post when I came across a news article that got me so fired up that I have switched topics for today.  

There is an article in The Guardian that quotes Michael Moore, of the Public Health Association, at length.  He argues that a provision in the upcoming Trans-Pacific Partnership (TPP) negotiations will wreck the Australian government’s ability to protect public health.

This provision, known as Investor-State Dispute Settlement (ISDS), has gotten an astonishing amount of airtime lately.  Nearly all of the commentary around what ISDS does and what it does not do is, frankly, wrong.

So, let’s see if we can straighten out the record somewhat, using the misguided statements attributed to Mr. Moore, written by Gabrielle Chan, as our guideposts.

First, the article suggests that Australia’s efforts to change labeling laws to include clear provisions on country-of-origin could be undermined by the TPP.  The Australian government wants to change the way it labels produce to help eliminate problems like a recent hepatitis A outbreak related to imported frozen berries.  (We will skip over, for now, the issue of whether such labeling would, in fact, reduce the risks of hepatitis or the fact that better product testing might be a more sensible response to such a risk.)

The Australian government, like every government, has always had the right to regulate in the interest of public health, as well as animal and plant health.  This right is enshrined in the multilateral trading system under the World Trade Organization (WTO) and has been carried through in every single preferential trade agreement since then.  There is nothing in the TPP or any other trade agreement that will fundamentally undermine the government’s sovereign right to ensure the safety of its citizens.

No government would ever agree to an agreement that would abrogate this right either.  Thus, the argument that somehow the TPP has forced governments like Australia to take decisions that violate their own rights to regulate simply does not make any sense.  Government officials are just not that stupid.

Second, the TPP’s investor state dispute settlement (ISDS) clause does not give companies the right to sue governments over being given an “unfair advantage” as Mr. Moore claims.  The ISDS provisions of this agreement run to over 60 pages and spell out, as specifically as possible, exactly what constitutes an example of government expropriation of rights under which a foreign investor could consider launching an ISDS suit.

The basic issue that ISDS is trying to address is the following.  Governments sometimes seize property (expropriate) for the public interest.  The clearest example is when the government decides to build a road through your shop.  In many countries, the rules that govern what happens in this situation are murky.  Investors may suddenly find their property seized without warning or without receiving fair compensation for their loss of the shop.

ISDS is designed to make the provisions around expropriation much more clear.  A good clause explains in detail what sort of conditions must be in place when a government decides to act.  Note that ISDS does not prevent the government from acting—if the road must be built through my shop, the government has the right to do so.  Instead, the rules spell out how I am to be notified about this decision, how I will be compensated, and what I can do if I want to appeal what I think is an arbitrary decision or an unfair amount of compensation.

The reason why I, as a foreign investor, might want to use an outside arbitrator to resolve my potential dispute with the government is that I am not always confident that the court system in the other country will rule fairly on my dispute.  Remember that the issue here is whether or not the government has followed the proper procedures.  Not every judge in every country will be willing to find against its own government.

But what I cannot do as an investor is simply claim that I am losing revenue somehow because other products get an “unfair advantage.”  ISDS does not say anything about making or losing money. 

Globally, there are more than 3,000 different bilateral investment treaties (BITS) as well as hundreds of free trade agreements.  Of these, more than 90 percent contain ISDS provisions.  The total number of disputes using ISDS is amazingly small, particularly given the volume of foreign investment covered by this welter of treaties.

What makes this relatively small number of disputes even more impressive is that the earlier versions of ISDS were much broader than later versions.  In other words, the earlier ISDS rules were quite expansive, allowing investors to use the arbitration system relatively easily.  Yet, most businesses do not resort to an outside system but continue to use the domestic court procedures to resolve disputes. 

In part this stems from a lack of certainty about how any given arbitration case will be resolved which adds an element of risk to a decision to sue.  Plus, most investors would prefer to remain in their host country and recognize the chilling effect that suing the government tends to have on their business operations.  Hence, few investors are likely to sue, even if their case would likely be ruled in their favor. 

The case that has made ISDS internationally famous actually highlights the changes underway in newer ISDS provisions.  Philip Morris sued the Australian government using a BIT between Hong Kong and Australia.  The specific issue was Australia’s new regulations on packaging for cigarettes.  Under the rules, it was not just that the cigarette manufacturers had to put graphic photos of damage done to smokers and others or carry large-size warnings about the dangers of smoking.  Instead, the government required every carton, packet and even every cigarette, to look exactly identical to one another.  Manufacturers were required to use exactly the same courier font, same colors, and same information on every single product. 

As a result, it is not possible to tell one manufacturers product apart from another.  For Philip Morris, this represented more than just a change in labeling.  The company argued it would invalidate the intellectual property (IP) contained in their products—particularly the value of their brands and trademarks since consumers could no longer see at a glance which cigarette was which.

We can argue about whether the result is appropriate or not.  The bottom line is that the BIT used by Philip Morris gave investors the right to sue over expropriation of intellectual property rights, as well as other kinds of rights. 

Recent trade agreements have not been so expansive.  Instead, deals like the TPP have much more narrowly defined the scope of potential lawsuits and many have explicitly set aside IP.  This is the main reason why ISDS provisions have grown in length over time, as governments have tried to strike a more appropriate balance between their right to regulate and the right of investors to ensure that their investments are not unfairly seized.

Elizabeth Warren, an American senator, wrote an op-ed this week in the Washington Post that was also problematic.  She argued that there is no point in including an ISDS provision in the TPP because the domestic court structure in countries like the United States, Japan and Australia can be used to resolve these sorts of disputes fairly. 

There are two reasons to continue to push for ISDS in the TPP that Warren overlooks.  First, although it might be true that the American or New Zealand court systems can handle investor disputes, not every TPP member is equally capable.  The current TPP membership includes 12 countries at diverse levels of development and government capacity.  For example, Mexico is rated 79 out of 99 by the World Justice Project Rule of Law ranking project.  Vietnam is 65 on the same scale and Peru is 62.  

Second, the TPP is also intended to expand further.  Even if all current members are able to handle investment disputes, future members might be less able to do so.  Adding in ISDS at a later date will likely be impossible.

Finally, once governments start to cut out ISDS from some agreements, it might be more difficult to include the provisions in other deals.  Thus, if the United States (in particular) wants to include ISDS in a future trade or bilateral investment treaties (like the one currently under negotiation with China), it could be very problematic to have carved out the ISDS provision in the TPP. 

The World Trade Organization, or What Happens When a Tree Falls and No One Cares

Update:  As if to prove my point, check out this headline in today's Inside US Trade:

• WTO Efforts On Doha Work Program Face Obstacles, May Miss July Deadline

  World Trade Organization members are facing such fundamental differences and are at such a preliminary stage in their efforts to devise a work program to conclude the stalled Doha round that Geneva sources expressed doubts they can meet their July 31 deadline for establishing a detailed blueprint for potential negotiations.

There is an ongoing philosophical debate about what happens when a tree falls in a forest and no one hears it.  Does the falling tree make a sound?

In Geneva, the “tree” of the World Trade Organization (WTO) might be in danger of falling.  It might have already fallen.  Either way, very few seem to even care. 

It’s a bit like watching a slow-motion disaster—a flood or a prolonged monsoon rain period that gradually overwhelms the landscape.  In the case of the WTO, the consequences of drowning will be felt (like in many disasters) by the poorest and least able to cope members of the global community.

In working with British trade officials over the past two days, I have explained how the global framework for dealing with trade in services was built in the GATT/WTO.  In the late 1980s, officials struggled with developing new rules to bring some structure, order and predictability to international trade in services.  This was a very tricky task, since services cannot be easily seen or measured.

Yet clearly, some governments were putting up barriers both large and small that blocked the trade of services like engineering, architecture, medicine, education, travel and tourism, construction and so forth.  At the time—in pre-internet days especially—it was not entirely obvious how some services could be delivered across borders easily. 

Officials had to devise systems to classify the mechanisms for providing services and then go on to discuss ways of opening up markets in services sectors and providing fair treatment of foreign service providers.  These discussions required creativity and boldness and a willingness to try something different.

However, since it was all so new, as the last big round of trade negotiations finished, most governments were reluctant to commit very much in the new General Agreement on Trade in Services (GATS).  As a result, from the moment the Uruguay Round ended, services were placed on the “built-in agenda” for further discussions the next time the new World Trade Organization met for trade liberalization negotiations.

It’s been 20 years and we are still waiting for the next round of global services talks. 

The rest of the WTO agenda remains equally stalled.  No new rules have been written for vast swaths of trade at the multilateral level in more than two decades.  The Doha Development Agenda (DDA), launched with great fanfare in November 2001, has gone almost nowhere.

But it actually gets worse than that.  The WTO General Council met in November 2014 and managed to achieve the following (after a nearly 20-year record of failure, missed deadlines, incomplete negotiations, and mounting costs):   

Decides as follows:

•  — Work shall resume immediately and all Members shall engage constructively on the implementation of all the Bali Ministerial Decisions in the relevant WTO bodies, including on the preparation of a clearly defined work program on the remaining DDA issues as mandated in paragraph 1.11 of the Bali Declaration.

•  — As per paragraph 1.11 of the Bali Declaration, Members agree that the issues of the Bali package where legally binding outcomes could not be achieved, including LDC issues, shall be pursued on priority.

•  — The deadline for agreeing on the work program mandated in the Bali Declaration shall be July 2015.

Seriously?  The tree has fallen and cannot get up.

Let’s examine the evidence here.  “Work shall resume immediately and all Members shall engage constructively on the issues.”  Keep in mind that 160 governments are members of the WTO and many keep whole embassies full of staff members permanently based in Geneva to work on trade issues.  These people have, surely, been working on something for the past 13 years.  (If not, taxpayers really ought to monitor this much more closely.)

The WTO ambassadors agreed to create a program on the DDA.  This is a trade agenda first prepared more than a decade ago.  Business is utterly uninterested in rules of the trading game that might have been appropriate at the time but may be completely useless now.  What good is it to discuss the rules and market opening for cassette tape players in a world increasingly ruled by smart phones?

Ambassadors said that they need a “clearly defined” work program to get to an outcome that hardly anyone cares about.  This must surely be the very definition of futility. 

The second bullet point (which is written so poorly that it does not make sense on its own terms) says that officials need to try to get to an agreement in areas where they were unable to get to an agreement.  I suppose it could have been worse—it could have said something like, “We agree that we have agreed on a few items.”

Finally, it finishes with the statement that the work program will be decided in another 8 months.  This is not the same thing as saying that we will finally finish the deal in a few months.  This simply says that they might, possibly, given enough good will and constructive engagement, achieve a plan to discuss the things that they have been discussing for more than a decade.  

Now, there are no doubt individuals who will fiercely argue that the WTO did or has, in fact, accomplished a bit more than I have suggested.  The General Council has agreed on, for example, a different work plan to implement a deal that they all agreed they would implement on trade facilitation more than a year ago (the Bali declaration from December 2013).  There was a little bit on food stockpiling and cotton.

But I think my broader point remains.  Take a look at what was finally agreed on issues of importance to the Least Development Country (LDC) members:

Decides as follows:

1.1. With a view to facilitating market access for LDCs provided under non-reciprocal preferential trade arrangements for LDCs, Members should endeavour to develop or build on their individual rules of origin arrangements applicable to imports from LDCs in accordance with the following guidelines. These guidelines do not stipulate a single set of rules of origin criteria. Rather, they provide elements upon which Members may wish to draw for preferential rules of origin applicable to imports from LDCs under such arrangements.

That’s it.  To help the very poorest members of the community, members ought to endeavor to use some guidelines.  Not necessarily—mind you—guidelines actually developed by the very body that claims to create rules for global trade.  But, rather, to use some guidelines as a starting point in crafting potentially individualized rules that apply only to each member. 

There are so many tragedies here it’s hard to know where to start.  However, when years and years of negotiations yield only the weakest set of guidelines for one part of one element of a deal aimed at the least developed members of a community, it is very hard to face the situation in multilateral trade with any sort of optimism.  Whether or not this particular tree made a sound when it crashed seems to make very little difference. 

Future posts will discuss some of the potential solutions (and perhaps allow my friends at the WTO to continue to talk to me in the future).  Stay tuned!

Blocking Trade With a Label

Trade policy experts frequently discuss non-tariff barriers (NTBs) or non-tariff measures (NTMs) that hamper the movement of goods across borders.  But much of this discussion takes place at a high level of generality with few specific examples.

Businesses on the ground are not particularly interested in vague discussions about NTBs.  Instead, they are occupied with trying to understand and respond to specific issues that prevent their goods from getting into or out of markets.  One underappreciated problem for companies is product labeling. 

Governments can certainly use labeling laws and regulations as a means to protect their markets from foreign competition.  Often, however, government regulatory bodies and legislators view product labels as a necessary tool to protect their citizens from harm or to provide customers with important information.

Global and regional trade rules all allow governments to regulate in the interests of public health, animal health and plant life.  For companies, ensuring safe products with reliably high quality is also important.  Hence, both government and firms would agree that regulations for product labeling are necessary. 

But many governments appear to be asking for excessive information to be included on products.  For smaller companies in particular, onerous regulations on labels can make it impossible for otherwise competitive firms to trade. 

As an example, here are the rules for exporting food products to Laos:

Food distributed directly to consumers in Laos must carry Lao language wording in a font and size that is clearly visible. Foreign language wording is also permitted.

In principle, food product labels are required to indicate the following:

·      name of product

·      registration number for food products

·      name and location of producers or company that packed products for distribution

·      country that produced the product

·      quantity of product (expressed in metric system)

·      important contents of products in percentage in relation to gross weight, in decreasing order

·      production date or expiry date, depending on products

·      if available, advice on storage, preparation methods, use of preservatives and colorings

In practice, it may be that regulations requiring Lao language labels are not always enforced.  Uncertainty is one of the biggest challenges for businesses.  Uneven enforcement of the rules means that companies could be caught out at any moment if the regulations are not strictly followed.

Thailand has equally complex rules around labels, with particularly strict provisions for dairy, baby foods, canned foods, vinegar, beverages, edible oil and fats, and gourmet powder (defined as an article containing monosodium glutamate (MSG) and used for food seasoning).  Food products must be approved and registered with the Thai Food and Drug Administration (FDA). When seeking registration, importers must supply two samples of each product, details of the exact composition by percentage of each ingredient, and six labels. Foodstuffs in sealed containers are subject to specific regulations.

Assuming a company survives this far, food products for shipment into Thailand must show labels in Thai with the following information for consumers:

·      Name and brand of the product (both generic and trade)

·      Registration number

·      Name and address of the manufacturer

·      Name and address of the importer

·      Date of manufacturing and expiry

·      Net weight and volume

·      Any additives used

·      Health and nutritional claims (if any)

Alcoholic beverages must advise the percentage of alcohol content. There must also be a health warning, printed in Thai, on the label or on a sticker, with specific wording.

Cosmetics have to be labeled in Thai with:

·      The name and type of the product

·      The name of manufacturer and address

·      Directions for use

·      Net contents

·      A statement of caution if irregular use may cause injury

These rules from Thailand are so complex, overall, that firms may have to use a local agent or importer to help register foreign products and help with labeling.  Again, for smaller firms, meeting these rules may prove impossible.

These examples may be on the extreme end, but juggling different requirements for labeling of products, boxes, packaging and so forth is a common issue across companies, countries and sectors.  If labeling rules get to be too onerous, firms will simply bypass markets entirely. 

Future posts will continue to highlight specific examples of labeling and other non-tariff barriers as well as explore how free trade agreements can conflict with labeling rules and create outcomes that governments do not always appear to appreciate.

TPP: Waiting for Godot?

The news that the next scheduled ministerial for the Trans-Pacific Partnership (TPP) negotiations have been postponed from March until April will cause many people to wonder again whether we are all waiting for Godot.  Will the TPP ever get across the finish line or will the goal posts keep getting shifted backwards?

The 5th anniversary of negotiations is just around the corner.  The first substantive talks in Australia began in March 2010 with tremendous enthusiasm.  Here was a rare trade agreement that would take high ambition and high quality as objectives from the opening moment. 

The intervening years have been a long, hard slog.  Adding new members along the way (like Malaysia, Canada, Mexico and Japan) complicated talks.  Moving to a deal with 12 members increased the potential benefits but also brought new sets of sensitive issues to address. 

Getting the agreement done means that 12 countries have to convince themselves that the deal on the table is the best possible outcome at this point in time.  There is no way that every member will be able to receive all of their original objectives, so each must decide how far to compromise. 

The problem is that no individual member has an incentive to be the first to drop their objections or to accept less than ideal outcomes in their most important areas.  Negotiators have to believe that they are in the final moments of bargaining before they can solve the last, most challenging topics. 

This is why the shifting goalposts are problematic.  If the finish line keeps moving backwards, then officials can never be certain that the time has come to resolve the toughest issues. 

Why did this latest “deadline” change?  It’s not entirely clear, but two explanations are likely.  First, some members of Congress have been very blunt about how the TPP agreement cannot be concluded until Congressional authorization in the form of Trade Promotion Authority (TPA) is in place.  The push is on to get TPA concluded in Washington, but will likely take until March before this vote will take place.  Thus, any announcement of TPP “substantial closure” cannot take place at the time of the originally scheduled TPP ministerial round in March.

Second, the deal cannot be substantially concluded until members agree that they are ready to close.  Most of the focus has been on Japan and their difficulties in getting a suitable bargain on the remaining agricultural items (the five “sacreds” as noted in an earlier Talking Trade post). 

These are certainly challenging.  But a focus on Japan has obscured other member issues.  The United States, for example, will likely have to concede something on autos.  For example, American negotiators have apparently been holding out for phase-outs on tariff reductions in cars for 25-30 years.  This is clearly incompatible with the timelines used elsewhere in the deal (and certainly flies in the face of the “high ambition” objectives of the agreement).

The Canadians have not yet prepared their own market access concessions in dairy.  Any change in Canada’s supply management system is highly sensitive and politically challenging.  Yet getting the TPP done means that Canada cannot expect to receive 100% of what it wants at the end.  Crafting a bargain that will satisfy both Canada and its partners that want ambitious market openings in this sector takes time.   In the end, the best deal might be the one that leaves everyone the least unsatisfied or unhappy.

There are other challenges in timing as well.  Some of the most sensitive points that remain to be locked into the agreement are still not confirmed—like the extent and reach of state owned enterprise (SOE) rules, the listing of rules and regulations that will not change after the TPP comes into effect (non-conforming measures), specific timing for implementation of rules for different members in areas like intellectual property rights (where some members will have longer timeframes for implementation of certain provisions), and so forth.

Officials appear to have decided that getting it all done will take more than a few more days and will require another round of talks at the chief negotiator level (with a few working groups also feverishly trying to wrap up their outstanding issues).  Thus, the hoped-for “final” ministerial has been pushed to April.

Perhaps, this time, the April “deadline” will stick and we will finally be able to stop waiting for Godot to arrive. 

Currency: Manipulating an End to the TPP?

One persistently bad American idea, periodically raised in the context of trade negotiations, is to build into the text of any agreement some clauses that prevent countries from “manipulating” their currencies.  The inclusion of such a clause at this point in the Trans-Pacific Partnership (TPP) negotiations may be the straw that breaks the proverbial camel’s back, leading to the collapse of the entire enterprise.

Any sort of currency manipulation clause is unlikely to solve the problem it is ostensibly trying to address.  Worse, in order to ensure that American interests are not undermined, the provisions would have to be carefully crafted such that they might never be triggered.  The final point of damage—even if there are virtually no circumstances under which such clauses might be used, America’s trade partners in the TPP might simply refuse to conclude negotiations at all.

Despite three excellent reasons for not moving ahead with such an idea, more than half the members of the last Congress already went on record supporting the inclusion of currency manipulation in all U.S. trade agreements.  Last week, a bill to address manipulation was introduced in both Houses.

So what is the problem so many backers of such legislation are trying to address?  In brief, governments can give a competitive advantage to their export industries if their currency is lower in value than their export partners.  The difference in currency values effectively makes imported goods cheaper in the foreign market, encouraging consumers and producers to buy more, relatively cheaper, foreign goods than relatively more expensive domestic items. 

How would a government go about making this happen?  If a government intervenes in currency markets, it can drive down demand for its own currency (or drive up demand for foreign currencies) by buying and selling currency. 

Another way to accomplish the same thing is to print more money domestically.  If there is more money in circulation now, the value of any given note is lower.  However, governments engaged in such behavior often argue that such policies are not aimed specifically at artificially depressing the value of the currency for the purpose of generating an unfair trade advantage. Therefore, such behavior is not considered currency manipulation, at least as members of Congress appear to want to define it. 

The purchase of assets by the government can also change the value of currencies, even if the objective is to stimulate the domestic economy.

Singapore loosened monetary policy two weeks ago in response to weaker oil prices and low domestic demand.  The government argued it was using one of the primary items in its tool kit to address low inflation, since it does not use interest rates as a tool.

Thus, governments may have lots of legitimate reasons for adjusting currencies without the specific intention of getting a leg up for exports.

It may be important to note that not every country is able to manipulate currencies.  If the country is small, especially with limited demand, the value of the currency is more likely set by market forces.  A country with limited resources cannot intervene very much to buy or sell currencies.  And, finally, the United States has a unique position in the global economy.  Since the U.S. dollar functions as a reserve currency, it allows the United States to have different options than anyone else in the markets (for the moment, at least, but that is another story).   Let me also note that because of this position, the United States does not have to intervene in currency markets like anyone else.

Efforts to stop countries from “unfairly manipulating” their currency will not work. 

There are many reasons why not, but start with the fact that most countries in a position to manipulate currencies also have complex economies.  These economies rely on both exports and imports.  For many firms, exports can only be produced with imported content.  By depressing the value of the currency to make exports cheaper, imports become more expensive.  As a result, firms may not actually be competitive in the export market since the price of imported content of the final goods might be more than offset by whatever the discount on the export side might be.

Equally key, for the most complex products, the value of the benefit from a depressed currency is likely to be small.  Consider an i-Pod, for instance.  Imagine that China were, in fact, manipulating their currency to a massive extent—say 50% off the presumed “normal” value of the yuan.   In this hypothetical context, it might appear that Chinese intervention is dramatically affecting the price of the device in the American market.  But, in fact, the total amount of Chinese content in an i-Pod could be as little as $4 of the $150 sales price.  Thus, the extent of the “unfair” advantage of Chinese currency might make a whole $2 difference to the final buyer.

Recall that this example gives figures for a truly exceptional rate of currency intervention at 50%.  The actual extent of manipulation is likely to be considerably smaller.  This means that the total price difference could be literally pennies.

While other products may not show such dramatic figures, the point is that—in most complex, higher value items—the content is likely to be provided by multiple countries.  As a result, even crazy high manipulation is unlikely to affect the final price very much. 

The Big 3 auto companies are driving the issue of currency manipulation in Washington.  But a car in the modern, globalized economy is very much like an i-Pod.  Even if you could determine that a China or a Japan was intervening to depress currency prices by a lot, the total difference in the price of a finished car is still likely to be much more modest than people realize.

To make this pressure by the Big 3 auto companies more surprising, many of the cars sold in the United States today are actually manufactured in whole or part in the United States (or NAFTA countries).  Thus, the value of potential manipulation on the total cost of a car is small. 

Practically speaking, a currency manipulation clause has additional challenges.  How can the specific amount of currency tweaking be measured?  Currencies change regularly in the open market, so a trade agreement has to take this into account somehow.  Even in the alleged cases of Japanese or Chinese manipulation, few could agree on the extent of intervention—was it 10 or 45% or something in between?

What is the appropriate response to such intervention?  Even if a trade agreement could specify the triggers for determining manipulation, then what?  Many of the proposed “solutions” appear to run afoul of other laws and regulations.

The United States, clearly, does not want to become ensnared in its own rules either.  Depending on how defined, basic American policy in the independent Federal Reserve could be challenged by foreign governments.  Problems like this make whatever provisions that might end up in trade agreements so tightly restrictive that they can never be applied or it might mean that the United States breaches the rules and argues for non-intervention in its own affairs. 

Finally, none of the specific partners currently negotiating the TPP are keen to see rules on currency manipulation included.  This agreement has been under discussion for nearly five years.  To add a controversial (to put it mildly) item so late in the game is to risk imploding the whole deal.

Some may argue that TPP partners have already accepted proposals and provisions that they do not like.  What is different about currency manipulation from other American ideas?  At some point, however, pushing too hard may make others snap.  This is likely to be that point.  Adding a very unpopular and unworkable idea like currency manipulation clauses into the TPP mix at this late day is a truly dreadful idea that should be discarded immediately.