Re-evaluating Dynamic Inconsistency in Light of Neo-Liberal Propaganda

The past few decades have shown how developing countries have been entering into numerous Bilateral Investment Treaties (“BITs”) which provide an immense amount of protection to investors while sacrificing sovereign authority. The resultant situation is one where absolute protection to investment would clash with public policy measures like the right to water, protection of cultural rights, and the rights of indigenous people. Given this, the question that arises is — why at all did developing countries enter into such detrimental BITs?      

Addressing Dynamic Inconsistency      

Dynamic inconsistency refers to a situation in behavioural economics where an agreement, optimal at one point of time to an actor, may later no longer be optimal to it. Host States often make promises to investors to attract investment that would benefit the country, but once the cost of protecting the investor exceeds the investment, then the State no longer feels obliged to maintain their initial promises. In an ordinary contract, there are adequate mechanisms that can prevent such an overt violation, but States hold a unique position that renders such mechanisms ineffective.    

A State, unlike a private actor, can unilaterally change the domestic legal structure governing a particular contract when it no longer deems it beneficial to its interest. International law, on the other hand, cannot be unilaterally changed by a host State. Nevertheless, it fails to provide adequate protection for investors as it still does not fully recognise private actors like firms. This is where BITs emerged to solve this supposed problem.      

The History of Neo-Liberal Propaganda      

Neoliberal propaganda originated in the Cold War era. The tussle between the two behemoths over which economic policy should reign supreme was being observed carefully by several newly formed nations. These nations were placed in a precarious position of choosing which side to join as they were promised a number of economic incentives from both the blocs. However,  other newly independent nations were wary of taking sides, fearing that once again they would be under the mercy of a dominant nation once again.      

With the fall of the Soviet Union, it became clear which ideology was the victor. This also marked the period of corporate ascendancy, where corporations became the herald of large reservoirs of capital. This capital was urgently required by developing countries in the hope that they could develop their economies to the same prerogative of the western developed countries. Both the success of the market theory and the need for funds led to a policy where these multinational corporations had to be courted to receive investment. The neo-liberal wave went into full swing when developing countries began to compete for foreign investment from the multinational corporations.      

The neo-liberal wave advocated for the dissolution of trade barriers, privatization, and a uniform system of trade and investment. These ideas did exist prior to this period, but it was only in 1989 that they began to be linked with the ‘Washington Consensus’. The consensus created by developed countries and international financial institutions like the IMF believed that the economic ills of developing countries were attributable to the lack of movement towards neo-liberal policies. A paternalistic climate was created where developed countries saw the protection of foreign investment as being of prime importance for the development of developing countries. Thus, foreign investment law was modified to provide higher protection to multinational corporations, and seldom took into consideration the harm that may be caused to the host state (see here, developing countries moved away from the Hull principle towards more liberally worded provisions of expropriation that increased their liability).      

All the developments in the investment environment led to the assumption that by signing a greater number of BITs, developing countries could attract a greater amount of FDI. This along with the ideas propagated from the Washington Consensus ensured that not only were more BITs signed, but also that these BITs had to provide greater protection to investors. The structure of international law was such that only developed countries were given authority to create the investment law regime, and their faith in the Washington consensus was so strong that the neoliberal regime only became stronger. In fact, members of that academic discourse also sat as arbitrators which further reinforced the neoliberal ideology of protecting investors.      

Crisis of Neo-liberal Policies

Developing countries first saw the repercussions of the neo-liberal wave in 1990, when an arbitral tribunal expanded the interpretation of a BIT far beyond the host state’s intention in AAPL v Sri Lanka. The dissenting opinion of Samuel K.B Asante points to the error being made by the majority of the tribunal. The tribunal in this case applied the Most Favoured Nation (“MFN”) principle to extend Sri Lanka’s liability to be of strict or absolute liability. A threshold which Sri Lanka never intended to create with the United Kingdom when it signed the Sri Lanka-UK BIT. Such an erroneous interpretation was never seen before and served as a precedent for future tribunals to allow a State to be liable for damages well beyond the agreed upon provisions in a BIT. 

Then came a series of controversial decisions following the economic crisis in Argentina. Argentina in the wake of the crisis took a number of steps to stabilize the economy, but foreign investors were less sympathetic to the State’s actions and initiated multiple arbitral proceedings. The tribunals deciding the cases provided contrasting decisions to nearly identical sets of facts and ignored Argentina’s justifiable argument of necessity. In CMS Gas Transmission Company v Argentina, the tribunal dismissed the argument of necessity provided by Argentina, but in the subsequent case of LG&E Energy Corp. v Argentina, the tribunal ruled in favour of Argentina and recognised their argument of necessity. While contradictory decisions were given, this did not prevent the investor in CMS to legitimately make the claim for the enforcement of their award. Thus, frustrating the Argentinian government which led to their refusal to enforce the award. It became clear to developing countries that their quick acceptance of the neo-liberal regime meant that the States regulatory powers were severely curtailed.      

More recently, countries have decided to discontinue previous treaty obligations. Such was seen following the decision in White Industries Australia v The Republic of India. The tribunal permitted a sudden transplantation from a vaguely worded MFN, allowing a country to be penalised for simply possessing an over-burdened legal system. This led to India completely re-evaluating its current BIT obligations and creating a new model BIT after this decision. This new model BIT forced all other existing BITs with India to require reconfirmation and resulted in a termination notice being sent to over 57 countries. Similarly, South Africa has passed the “Promotion and Protection of Investment Bill” to exclude the enforceability of fair and equitable treatment, MFN and recourse to international arbitration. Brazil on the other hand has altogether sought to eliminate ISDS mechanisms in its newly signed BITs. 

Conclusion      

The current international investment regime will require radical restructuring to change the balance of powers and allow tribunals to take a more equitable stance towards developing countries. A stance that is supported by persuasive reasoning and overlooking historical blunders of developing countries that put them in an unfair position. If this does not occur, then the current investment regime may be on route to a rupture where developing countries (which can already be seen with India and Brazil) may be so disenchanted with the current regime that they break all ties with previous structures of dispute settlement. 


Pushkar Reddy is a student at Jindal Global Law School, and is also the Co-Director of the Jindal Forum for International and Economic Laws. 


Image: Eleanor Shakespeare / The Guardian

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