Is ISDS really needed to promote foreign investments?

Nowadays, there is an intense debate raging over the benefits and drawbacks of investment rules – and investor-state dispute settlement (ISDS) in particular – in trade and investment agreements currently under negotiations. In Europe, a growing number of observers is questioning the rationale of including an ISDS provision in the Transatlantic Trade and Investment Partnership (TTIP). Personally, I don’t think that ISDS is needed in TTIP and I have my doubts about the argument that we should include ISDS in TTIP because of its precedential value for the negotiations with China. ISDS is not only being critically debated in Europe, but also in the US especially in the context of the negotiations of the Trans-Pacific Partnership between the US, Japan, Canada, Australia and eight other economies.

One of the main questions in this debate is whether strong investment treaties, i.e. those that include ISDS, do actually increase foreign investment flows. With the aim of shedding some light on this question, the Peterson Institute for International Economics recently posted the blog “What Do the Data Say about the Relationship between Investor-State Dispute Settlement Provisions and FDI?”. The blog post concludes with the claim that “BITs are the best test case we have for the effectiveness of ISDS provisions. The evidence is not perfect, but it does suggest that packages of investment protections, of which ISDS provisions are a key part, encourage FDI. For this reason, ISDS provisions should be included in the investment chapter of TPP.”

I have my doubt about this conclusion. Although the majority of econometric studies finds a positive effect of investment treaties on investment flows, a number of other studies using alternative methods question this finding. At best, one could argue that the evidence on the effectiveness of investment treaties is mixed (see this UNCTAD paper). With regard to the more specific question whether ISDS helps attracting (more) foreign investments, a paper I have co-authored shows that the empirical evidence for this claim is missing. We conclude:”Stricter dispute settlement provisions do not necessarily result in higher FDI inflows so that the effectiveness of BITs as a credible commitment device remains elusive.” Interestingly, this paper is also cited in the PIIE blog post but the author seems to have overlooked this sentence from the abstract. In another paper, though, we have found that market access commitments have a positive effect on investment flows.

In light of the ongoing debate about investment rules in TTIP and TPP I would argue that policy makers – who want to increase investment flows – should focus on negotiating comprehensive market access clauses and should stop worrying about ISDS. There may be other arguments in favor of ISDS, but it is actually not needed to promote investment.

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