ISDS: A Litmus Test for Japan’s Liberal Leadership

If the acronym “ISDS” sounds familiar, it probably strikes a negative connotation. Investor-state dispute settlement mechanisms are legal provisions in investment treaties and free trade agreements that set the terms for how states settle disputes with foreign investors. But ISDS have been under attack from governments and nongovernmental organizations alike for allegedly being biased in favor of investors and undermining states’ ability to govern. The controversy has practical repercussions. While the EU-Japan economic partnership agreement was widely praised as an example of how Japan and the EU can advance liberal economic governance amidst rising illiberalism, its investment chapter remains unsettled as the EU and Japan have not yet been able to reach an agreement on ISDS provisions. Whether Japan is capable of overcoming both this specific situation and the controversy over ISDS in general will signal its ability to manage the future of the liberal international order.

ISDS aims to accomplish two things: provide an agreed-upon process for settling disputes between states and the foreign investors they host, and provide investors with legal mechanisms to protect themselves in the event that the host state violates the terms of the investment treaty that they’re operating under. The system was designed to replace state-to-state dispute settlement procedures, where investors would petition their home governments to resolve disputes on their behalf, which either overwhelmed a government’s diplomatic corps, led the home government to play favorites among the petitioning companies, or – in extreme cases – resulted in gunboat diplomacy where an investor’s home government would intervene militarily on an investors’ behalf. The goal of ISDS was to create a legal pathway for governments and investors to resolve disputes among themselves.

As foreign investment soared in the 1990s, so did the number of disputes and controversy with some charges being more valid than others. For example, while many argue that ISDS is biased in favor of investors, in reality, states win most settlements and ISDS does not allow companies or tribunals to overturn domestic legislation. One of the most high-profile cases, Philip-Morris’s dispute with Australia over the country’s plain packaging laws for tobacco sales, was an attempt to seek damages for the expropriation of Philip-Morris’s advertising trademarks registered in Australia rather than a demand that the country overturn its plain packaging law. Philip-Morris lost its ISDS case and the following appeal and was ordered by the World Trade Organization to cover Australia’s legal costs. In short, the system works in terms of providing a rules-based legal mechanism to settle disputes.

Even the loudest critiques of ISDS have been overblown, politically the damage has been done

But the damage has been done. The controversies lodged against ISDS mechanisms speak less to the system itself and more to the perception that private international investment is politically controversial for many key stakeholders and, by extension, for the governments that they represent. The inclusion of ISDS in the original TPP agreement was a key source of opposition from the left in the United States. Australia opted out of the investment chapter of TPP-11 over concerns with its ISDS provisions and the EU walked away from ISDS entirely in 2015, instead advocating for an investment court system (ICS) that would consist of a permanent panel of arbitrators (rather than the ad-hoc panels included under ISDS provisions). Efforts by China and France to suggest a two-tiered system (ISDS for the initial dispute and ICS for appeals) were rejected by NGOs as insufficient.

Japan, meanwhile, continues to advocate for ISDS and hasn’t yet to offer its own alternative. This is probably in no small part due to the support for the status quo by the Keidanren – a coalition of Japanese business and key stakeholders in investment policy since it allows investors to select their own arbitrators for dispute settlement procedures. Japan is reluctant to accede to a new mechanism such as ICS, because Japanese firms are not as confident about using a new, untested mechanism to pursue claims. At the same time, Japan has set an ambitious goal of concluding 200 bilateral investment treaties (BITs) by 2020 (Japan has already concluded 76 with 24 still under negotiation) in order to diversify its outbound investment and keep pace in the international competition for natural resources and energy.

But the issue for overcoming the impasse over ISDS isn’t about finding a technical solution that will solve the controversies since there are already plenty of those to be found. What’s missing isn’t the “right” fix so much as a process for moving forward. The problem is political and requires finding a solution that is legitimate and acceptable to all of the different stakeholders involved. The situation requires more finesse than simply creating a better mechanism or hoping that the controversy will eventually pass. Finding a way forward will be about finessing a path between the political demands and the technical necessities to facilitate overseas investment.

The problem is political and requires a solution that is legitimate and acceptable to all of the different stakeholders

Japan may have something to offer in this regard. One way that Japan has attempted to address potential disputes between investors and host countries is the inclusion of a chapter on “Improvement of the Business Environment” in its agreements. This mechanism attempts to confront issues at the outset of an investment partnership by facilitating dialogue between investors and host country governments on issues related to the business environment, such as infrastructure, bureaucratic and legal procedures. The end goal of this mechanisms is less dispute resolution and more investment facilitation, essentially managing the process in a way that heads off potential problems and reduces the need for dispute settlement in the future. According to the ISDS database of the UN Conference on Trade and Development (UNCTAD) – the body which handles trade and investment issues, Japan has never faced an ISDS case and its overseas investors have only four pending cases while U.S. investors have been claimants in 183 cases.

Japan’s ability to lead a path forward is in no small part due to its domestic political dynamics and other interested states should be receptive to Japan’s approach. There is far less outbound investment from Japan compared to the United States, and Japan’s few cases means that ISDS is less controversial in the first place, and the NGOs that rattle European politicians are not nearly as influential in Japan. But if this political space and practical experience can help Japan create a new regime from the shell of an old one, then it would demonstrate that it has the guile and not just the interest to support a liberal rules-based order.

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Paul Nadeau is an adjunct assistant professor at Temple University's Japan campus, a visiting research fellow at the Institute of Geoeconomics, and an adjunct fellow with the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS). He was previously a private secretary with the Japanese Diet and as a member of the foreign affairs and trade staff of Senator Olympia Snowe. He holds a B.A. from the George Washington University, an M.A. in law and diplomacy from the Fletcher School at Tufts University, and a PhD from the University of Tokyo's Graduate School of Public Policy. He should be general manager of the Montreal Canadiens.

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