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The Re-emerging International Framework for Protection of Investment (1997)

This is an article I published in the Philadelphia Lawyer, p. 20 (Fall 1997) (PDF), about the now-defunct Multilateral Agreement on Investment, or MAI. At the time I was in favor of it and somewhat naively optimistic that a fairly universal pro-private property rights agreement might be adopted. Sigh.

For more background on related matters, see my book International Investment, Political Risk, and Dispute Resolution: A Practitioner’s Guide (Oxford University Press, 2005) and my Online Appendix XVII, “Online Resources”.

The Re-emerging International Framework for Protection of Investment

By Stephan Kinsella1

(version submitted to The Philadelphia Lawyer, September 1997 issue)

We’ll take and take until not even the nails in their shoes are left.  We will take American investments penny by penny until nothing is left.

                                                                                                 —Fidel Castro, 19602 

Less than seventy-five years after it officially began, the contest between capitalism and socialism is over: capitalism has won.

                                                                                        —Robert Heilbroner, 19893 

American entrepreneurs are, by and large, used to operating within a relatively fixed and predictable background of overarching state and federal laws.  If something goes wrong with a business transaction—e.g., one party breaches a contract or intentionally defrauds or harms another—the wronged party that he can very likely resolve the matter in some court, according to some applicable law, whether federal or state.

Similarly, if an investor’s property rights are damaged or otherwise taken by the government, the investor can obtain redress, typically in the form of compensation, in court.  In the West, though protection of property rights is far from perfect, it is largely taken for granted that the government is constitutionally prohibited from taking one’s property (including investments) without due process and just compensation.  Thus, trade and investment flourish in western countries, since both contractual and property rights and protected.

International trade, and investment in foreign countries (known as foreign direct investment), require protection as well.  With respect to foreign trade—for example, trade between an American company and a foreign company—the parties cannot simply assume that they are both subject to jurisdiction in the courts of the same nation.  Despite this seeming difficulty, however, foreign trade has been able to thrive since disputes can be settled, and contracts enforced, even between parties of different nations.  This has long been possible with the international Law Merchant, in which disputes between merchants of different countries are settled in neutral, largely private arbitration proceedings.

Today, for example, private arbitration is frequently conducted in accordance with the rules of the International Centre for the Settlement of Investment Disputes (ICSID), the International Chamber of Commerce (ICC), or the American Arbitration Association (AAA).  In addition, dispute resolution and other aspects of foreign trade are buttressed to some extent by the foreign trade framework established by multilateral agreements such as the General Agreement on Tariffs and Trade (GATT), and its successor, the World Trade Organization (WTO).  Thus, private parties have been and continue to be able to rely on and enforce the contracts necessary for foreign trade.

Foreign direct investment is another matter.  Companies investing in other countries are not able to rely on private measures such as arbitration agreements to ensure that the host state (the state hosting foreign investment) does not interfere with investments.  States have sovereignty over property within their territory, and thus foreign investment is always subject to the threat of expropriation by the host state.  Investing in foreign regimes is thus said to be subject to “political risk,” especially in those states with a history of hostility to capitalism and property rights, such as the former communist states and other developing economies.

Nevertheless, international law does provide certain rules that states must follow in expropriating foreign investment.  Prior to this century, host states generally adhered to such rules.  For example, it has long been established under background or general principles of international law that a host state may expropriate the property of foreign investors only if the expropriation is non-discriminatory, for a public purpose, and accompanied by “appropriate” compensation—otherwise, the expropriation is “illegal” under international law.  Indeed, these rules were considered so sacrosanct that, until the early part of this century, force was sometimes used or threatened by a home state against another state in response to a taking of the property of the home state’s nationals.

The strength of these rules has been diluted in this century, however, roughly concurrently with the rise of socialism and socialist ideologies—naturally enough, since capitalism and the property rights that underlie foreign investment are anathema to such worldviews.  The rise of such anti-property-rights ideologies and other factors have led many states to disregard or deny the existence of international law limits on expropriation, leading to a wave of expropriations and nationalizations up until the 1970s, by states such as the Soviet Union, Mexico, China, Egypt, Cuba, and Libya.

In addition, some states and anti-Western commentators fomented controversy and debate over the meaning of the “appropriate compensation” requirement of international law.  While it seems clear that it must mean full compensation—compensation for the fair market value of the investment expropriated—as, for example, must be awarded in America if property is expropriated by government, others have argued that something far less than full compensation can be awarded, especially in “special” circumstances such as when an entire industry is nationalized and the government would be unable to engage in the nationalization if it had to pay for it with the fair market value of the property taken.

Thus, international law rules meant to protect foreign investment have become clouded with some uncertainty (although many would argue that international law always has and still does require full compensation, despite the vociferous protests to the contrary).  Additionally, the use of force against a nation solely for an act of expropriation would nowadays be politically unthinkable, and international law has evolved to the point where such force would probably be considered illegal, as well.

The upshot is that it is uncertain to what extent the investors of today can rely on background principles of international law for protection of foreign investment.  Ironically, in the aftermath of the fall of communism/socialism, it is the formerly communist and developing Third World nations that most need Western investment—investment that is discouraged by the weakening of private property protection brought on by these states’ former hostility to property rights and capitalism.

One way to overcome this uncertainty and strengthen the protection of foreign investment under international law is through the use of treaties.  Treaties may be used to explicitly provide for standards of investment protection superior to those embodied in the background general principles of international law, much like a contract can change the default rules of law applicable to the parties.

By entering into a treaty, a state “internationalizes” the commitments contained therein—i.e., the breach of the obligations undertaken in a treaty is an independent and serious breach of international law, under the principle pacta sunt servanda (agreements are to be respected).  Host states are, therefore, reluctant to breach a treaty obligation that has been voluntarily and expressly undertaken.

Accordingly, by entering into a treaty with one or more other states, a prospective host state can bind itself under international law to respect foreign investment, thereby rendering any arguable uncertainty in general principles of international law moot—even if the host state itself has previously resisted the Western interpretation of general principles of international law.

Currently, some regional treaties, such as NAFTA and the Treaty of the Establishment of the Caribbean Common Market (Andean Agreement), do address investment protection issues on a regional basis, but they do not cover all nations, and hence are not universal.  Similarly, there has been a growing nexus of so-called bilateral investment treaties (BITs), which obligate the signatory parties to respect the property rights of foreign investors.  Hundreds of BITs have been executed to date—America, for example, has concluded dozens of these BITs with countries ranging from Albania to Zaire.  However, since each BIT covers only one pair of countries, there are now an overwhelmingly huge and unwieldy number of BITs, many having different standards and scope.  Also, many pairs of countries do not have BITs in place.  Thus, at this point in time neither the WTO nor any other international agreements provide for substantial, universal, and uniform protection for foreign direct investment.

This gap in international law may be about to be largely repaired by the proposed Multilateral Agreement on Investment (MAI), which is currently being negotiated by the 29 member-countries of the Organization for Economic Cooperation and Development (OECD).4 Talks on the MAI were initiated in early 1995 and were originally expected to be concluded by June 1997, but as of this writing [May 1997] appear likely to continue until late 1997 to mid-1998.  The MAI is aimed at providing protection for foreign investment, by way of having the signatory states enter into a binding treaty obligation to respect foreign investment.

Although being negotiated among the mostly industrialized, developed countries of the OECD, it is hoped that the MAI, once ratified, will be joined by a wide number of countries, including developing countries. The MAI is expected to provide for, among other things, non-discrimination, limits on expropriation, and effective dispute resolution.

Under the MAI, for example, host states are expected to agree to expropriate foreign investment only if the expropriation is: (a) for a public purpose, (b) performed in a non-discriminatory manner, and—the most essential protection—(c) accompanied by prompt, adequate, and effective compensation equivalent to the fair market value of the investment.  The dispute resolution measures should provide for a predictable and peaceable means of settling disputes between foreign investors and the host state, and also for disputes between the investor’s home state and the host state.

In explicitly calling for a fair market value compensation standard, the MAI should remove the uncertainty that has settled on the compensation standard in decades past.  Additionally, since states are reluctant to breach treaties, tying investment protection standards to a treaty should cause developing states to be even more reluctant to expropriate foreign investment in breach of the MAI’s standards.  These standards promise to apply more universally and uniformly than the standards provided by the inconsistent patchwork of BITs and other regional treaties.

Thus, the MAI should serve to lower political risk and thus increase foreign direct investment in such regimes.  It is also possible that the MAI negotiations will be expanded to include provisions to inhibit and deter investments in property expropriated without compensation or otherwise in violation of international law—similar to the prohibitions on “trafficking” in illegally confiscated property in the so-called Helms-Burton or Libertad Act of 1996—which should help further dissuade host states from illegally expropriating investment.5 

The MAI also should improve on other current mechanisms and practices for protecting investment, as well.  For example, some developing states provide for investment protection in national legislation, such as investment codes.  These laws, however, may be changed at will by the host state, without necessarily violating international law: unlike the obligations in a treaty, promised contained in municipal law are not internationalized.  Internationalizing the state’s commitments to protect investment by means of a treaty such as the MAI is, therefore, also superior to merely embodying investment standards in municipal law, since it makes the state more likely to abide by such commitments, and consequently allows investors more security in relying on such commitments to protect their property rights.

Another technique open to some investors is the negotiation of agreements directly between the investor and the host state, referred to as concessions or investor-state agreements.  These agreements, like treaties, can provide for strong protection of the investor’s property and other rights, and can be structured so as to internationalize the host state’s obligations—i.e., to make the host state obligated under international law to respect the agreement.  This option is not usually feasible for smaller investors, however, and in any event is expensive to negotiate and not as desirable as having a ratified umbrella treaty between the investor’s home state and the host state.

Foreign investors also often deal with political risk by acquiring political risk insurance.  Such insurance is available from a number of sources, including state-sponsored insurance agencies such as the United States’ Overseas Private Investment Corporation (OPIC), private insurers such as Lloyd’s of London, and multilateral agencies such as the World Bank’s Multilateral Investment Guarantee Agency (MIGA).  Of course, it is preferable to investors to be able to have political risk itself lowered, so that expropriation is less likely (and also so that political risk insurance becomes cheaper).  Additionally, government-sponsored insurance—which dominates the field—is morally and economically problematic since it involves redistribution of wealth and the economic inefficiencies that inevitably accompany government intervention in the market.6 Thus the MAI is also to be welcomed, to the extent that it reduces the resort to government-sponsored investment insurance schemes.

The MAI promises to improve on the present international regime for the protection of foreign direct investment and to strengthen the protection afforded to such investment.  If drafted to properly embody strong protection for foreign direct investment, and if ratified by a large number of both developing and developed states, the MAI stands to benefit both investors and host states, and thereby to further increase the wealth of nations.

  1.  LL.M., University of London; J.D., M.S., B.S., Louisiana State University.  The author is a member of the Intellectual Property Department and International Law Practice Group of Schnader Harrison Segal &amp; Lewis in Philadelphia, and co-author <i>Protecting Foreign Investment Under International Law: Legal Aspects of Political Risk</i> (Dobbs Ferry, New York: Oceana Publications, 1997).  Email: nskinsella@shsl.com; http://www.shsl.com.  The views expressed herein are those of the author alone, and should not be attributed to any other person or entity.   []
  2.  New York Times, 21 August 1960, § 3(F), p. 1, quoted in Eric N. Baklanoff, Expropriation of U.S. Investment in Cuba, Mexico, and Chile 112 (1975). []
  3.  Robert Heilbroner, “The Triumph of Capitalism,” The New Yorker, Jan. 23, 1989, p. 98.  The superiority of capitalism over socialism had been rigorously proved back in 1920 by the great Austrian economist Ludwig von Mises.  See Ludwig von Mises, Economic Calculation in the Socialist Commonwealth (1990) (1920); see also Ludwig von Mises, Socialism: An Economic and Sociological Analysis (J. Kahane trans., 3d rev’d ed. 1981) (1922).  Mises’s ideas were initially thought to have been refuted by socialist economists, in what is known as the “socialist calculation debate.”  The false conclusion that the socialists won the debate by disproving Mises’s claims was perpetuated in the following decades by economists such as Heilbroner.  See, e.g., Robert Heilbroner, Between Capitalism and Socialism (1970), pp. 88-93, in which Heilbroner claimed that Mises was wrong, that socialist economic calculation was possible, and that the “superior performance” of socialism would “soon reveal the outmoded inadequacy of a free enterprise economy.”  Despite decades of unjust and unfortunate neglect, Mises has finally been vindicated by the universally acknowledged failure of socialism as a viable economic system.  See Gertrude E. Schroeder, “The Dismal Fate of Soviet-Type Economies: Mises Was Right,” Cato J., v. 11, no. 1 (Spring/Summer 1991), p. 13; “Labor Party leader flips on policy,” Philadelphia Inquirer, Apr. 8, 1997, p. A2 (describing the British Labor Party’s endorsement of privatization of state-owned enterprises and recent elimination of a Marxist clause in its constitution advocating common ownership of the means of production).  Even Heilbroner now admits: “It turns out, of course, that Mises was right.”  Robert Heilbroner, “After Communism,” The New Yorker, Sept. 10, 1990, p. 91, 92.  See also Mark Skousen, “‘Just because socialism has lost does not meant that capitalism has won’: Interview with Robert L. Heilbroner,” Forbes, May 27, 1991, p. 130.  For further discussion of the socialist calculation debate, see Murray N. Rothbard, “The End of Socialism and the Calculation Debate Revisited,” 5 Rev. Austrian Econ. 51 (1991); Don Lavoie, Rivalry and Central Planning: The Socialist Calculation Debate Reconsidered (1985); David Ramsay Steele, From Marx to Mises: Post-Capitalist Society and the Challenge of Economic Calculation (1992). []
  4. For further discussion of the MAI and related issues, see “American Bar Association Section of International Law and Practice Report to the House of Delegates: Multilateral Agreement on Investment,” 31 International Lawyer 205 (1997); and William H. Witherell, “Developing International Rules for Foreign Investment: OECD’s Multilateral Agreement on Investment,” 32 Business Economics 38 (January 1997).  Other information regarding the current status of the MAI negotiations was obtained from the U.S. Department of State, Office of Investment Affairs, International and Financial Development, Bureau of Economics and Business Affairs, and from the OECD web site at <http://www.oecd.org>. []
  5.  See, e.g., Stuart E. Eizenstat, “A Multilateral Approach to Property Rights,” Wall Street Journal, Apr. 21, 1997. []
  6. But see Maura B. Perry, “A Model for Efficient Foreign Aid: The Case for Political Risk Insturance Activities of the Overseas Private Investment Corporation,” 36 Va. J. Int’l L. 511 (1996) (arguing that OPIC provides more efficient than private political risk insurance because, inter alia, it is able to actually reduce political risk because host states are reluctant to illegally expropriate an investment insured by an agency of the U.S. government). []
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