Regulatory chill and the effect of investor state dispute settlements

Abstract

Legal conflicts between multinational firms and host governments are often decided by international arbitration panels-as opposed to courts in the host country-because of provisions in international investment agreements known as investor state dispute settlements (ISDS). Critics fear that investor protection such as ISDS make governments reluctant to adopt appropriate policies (regulatory chill). In this paper I develop a theoretical model in which the outcome of cases brought to court is uncertain owing to the vagueness of the law protecting investors and a court's inability to correctly identify a state of nature with certainty. I show that from a world welfare perspective there is no underregulation, only an overregulation problem. However, from a national welfare perspective "frivolous" lawsuits may lead to regulatory chill. I also identify conditions under which ISDS can lead to a Pareto improvement that involves simultaneous changes in compensation payments and protection rights relative to a national court.

The economics of investor protection: ISDS versus national treatment

“…First, the panel will not play the role of a mere arbitrator, but any effective ISDS mechanism will authorize the panel to issue a binding verdict. 26 Second, there will be substantial discretion in how the panel rules on a dispute over "expropriation", and consequently from an ex ante perspective the panel ruling will be stochastic. We assume that any given realization of θ 2 , observed only by the government, generates a noisy signalθ 2 with a distribution function H θ 2 (θ 2 ).…”

“…Hence, compensation will almost always take place through direct monetary transfers. 26 This does not rule out that the agreement provides for a due process where the government may file an appeal. However, filing an appeal is much different from simply rejecting an arbitrated solution.…”

Economics and Politics of International Investment Agreements

“…Second, international courts are more prone to rule in favor of investors than domestic courts. Janeba (2016) shows how the incentive for a country to form an investment agreement depends on the losses from unfavorable determinations, and the benefits for its own foreign investors from discrimination in their favor in the partner country. Kohler and Stähler (2016) examine consequences of a particular interpretation of the "legitimate expectations" notion that sometimes has been employed by arbitration panels.…”

Large investors, regulatory taking and investor-state dispute settlement

“…A …xed-cost component is important for the analysis, but we may allow for an additional proportional-cost component 10. This assumption is (together with the assumptions about i and K i ) su¢ cient to ful…ll globally the second-order condtions in the maximization problems of D and F in the regimes N and ISDS and to yield thresholds as in(19) and^ as in(32) in the two regimes…”

“…The error-free decision rule is assumed here to remove a possible shortcoming of ISDS from the picture. For a departure from this assumption and some of the important implications seeJaneba (2016).…”