UNCITRAL and ISDS Reform: Plausible Folk Theories

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As observers of the UNCITRAL process, we watch the debates with great interest, writing about the emergence of different camps, giving perspectives on how the process fits within broader geopolitical developments, and offering potential models for moving forward. One thing that we are often struck by is how some of the field’s underlying narratives are being contested and reframed. In any reform process, some scripts about the old system are kept and others are discarded or rewritten. What does that process look like? At UNCITRAL in late January, we were able to watch it occur with respect to one long-held narrative: that investment treaties with investor–state arbitration are important for attracting and retaining foreign investment.

Plausible Folk Theories

Terence Halliday, a professor of the sociology of global governance and a long-time observer of UNCITRAL, coined the term ‘plausible folk theories’ to refer to the way in which ‘vast enterprises of global regulation and lawmaking [often] proceed on weakly founded justificatory rhetorics’. What he means by this is that many rules and regulations are passed at the global level based on assertions that are not subject to empirical testing. Instead, negotiators and policy makers frequently rely on assertions that sound reasonable but remain unverified.

A plausible folk theory isn’t necessarily wrong about the facts, it just isn’t verified. It may be contrary to empirical evidence, it may not. In the absence of factual support, what makes a folk theory plausible? Parsimony (it is simple), face validity (it sounds right), rhetorical compactness (it can be easily expressed), ambiguity (it papers over divisions), affinity with extant beliefs (it accords with prior assumptions), and unexamined premises and logics (it relies on assumptions and isn’t designed to withstand rigorous testing). Of all of these, the first two are probably the most important: does it have the simple sound of truth?

Arguably, the investment treaty system has long been built on plausible folk theories. If asked why states sign investment treaties, most people in the field historically would have answered ‘because it depoliticizes investment disputes’ or ‘because it increases foreign investment’ or ‘because it contributes to the rule of law’. These arguments sound right. They are plausible. They have the sound of truth to them. Yet, as the field has evolved, these claims have come under scrutiny in the academic literature and some have not stood up well. But is this evidence used in global governance debates? If not, why?

Multiple plausible folk theories are at play in UNCITRAL Working Group III. Some, like those above, are core justifications for investor–state dispute settlement, while others are newer and emerging within reform debates. We will discuss a variety of these plausible folk theories in this blog series as the reform process unfolds so that readers can see how certain rhetorical claims are made, narrative battles are fought, and evidence is or is not used. The example that we feature this time is a claim about the impact of investment treaties and structural reform on investment flows.

The effect of investment treaty reforms on investment

The notion that states signing investment treaties has the effect of increasing foreign investment is a plausible folk theory. Yet many academic studies now exist on the topic and their conclusions are decidedly mixed. For anyone wanting a primer, Jonathan Bonnitcha, Lauge Poulsen, and Michael Waibel’s book provides an exhaustive list of these studies and thoughtful discussion of their conflicting findings (relevant chapter available here). They conclude, like many academics, that the evidence is inconclusive. Yet this conclusion diverges from the statements of states. Time and again in this UNCITRAL process, states have affirmed their belief in the importance of investment treaties in providing a stable legal environment to encourage and facilitate investment.

This plausible folk theory came up during UNCITRAL this time, but with a new twist. Two observers, representing corporate counsel (CCIAG) and American corporations (USCIB), respectively, spoke repeatedly, which is interesting because the private sector has been less vocal in earlier meetings. These actors framed several of their interventions around what would happen to investment if investor–state arbitration is jettisoned in favor of a multilateral investment court. CCIAG or Corporate Counsel, as they were sometimes referred to on the floor, also made a written submission, which states:

Competition among states to attract foreign capital is increasing. In this environment, it is more important than ever that states take steps to promote and facilitate foreign investment. Among the most important of these is the development of stable and transparent reinvestment regimes protected by access to effective ISDS mechanisms.

The CCIAG paper goes on to critique the proposed multilateral investment court and appellate mechanism, arguing that a court, for instance: tilts the balance of dispute settlement against investors, eliminates party autonomy in the selection of arbitrators, reduces the pool of qualified arbitrators, and introduces uncertainty. One of their primary concerns is that, if all of the judges are selected by states, they will be biased in favor of states – an important claim that we will return to in a future blog.

In the Working Group, Corporate Counsel reiterated that investor–state arbitration was designed to incentivize investment, and if the proposed structural reforms occur, ‘we may throw baby out with bathwater and see investment suffer as a result.’ In issuing this warning, Corporate Counsel exhorted states to consult their investors.

In response, two major capital exporters took the floor to make clear that they were actively consulting their investors and hearing that their investors did not oppose structural reforms of ISDS.

China succinctly addressed several of the critiques raised by Corporate Counsel, on this point noting that ‘China consults with our investors. Some of our investors clearly want an appeal mechanism. Investors appreciate greater predictability and consistency, benefits that an appeal mechanism can bring. None of our investors oppose an appeal mechanism. We assume every state here will consult with their investors.’

Germany spoke first in its capacity as a capital importer: ‘We have not heard from any foreign investor in Germany that they make their investment contingent on being able to pick their judge. Our courts are perceived as independent, neutral and effective. We want to create exactly that [with a permanent investment court].’ Then Germany spoke in its capacity as a capital exporter: ‘We’ve also heard investors would stop investing if they did not choose their own adjudicators. This is new to us. We regularly speak with our investors and they have never raised this point with us. Sure, they may prefer arbitration, but they will adapt. As one of world’s largest capital-exporting states, we have an interest in ensuring our investors are protected.’

China and Germany were not weighing in on the general debate about whether investment treaties are important for facilitating foreign investment flows; rather, they were refuting the suggestion that structural reform would make a meaningful difference to investment patterns.

In response, Corporate Counsel challenged Germany’s knowledge of its own investors’ views, suggesting that he had contrary information based on his own discussions. He then doubled down on his causal claim: he outlined a scenario in which an investor has opportunities in two different countries, one of which has adopted structural reform, but the country next door has not, and argued an investor will view the neighbor as a much more attractive place. He addressed himself to capital-importing countries: ‘What would you do when investment starts moving to countries that have not adopted this new system?’

During this intervention, one official from a least developed country could be seen smiling and shaking his head. In the next break, this official explained: ‘he is trying to scare us out of reform. But I speak with foreign investors, that is part of my job. They will stay, they will still come, if we join the reform.’[1] Yet, strikingly, no primarily capital-importing state took the floor to speak about their experiences or their views. Some states have already taken measures, such as terminating investment treaties or removing investor–state arbitration, and they would presumably have evidence of what impact, if any, this had on investment flows. But no state publicly took a position or shared their experiences as a capital-importer.

We wait with interest to see what experiences states might share in the future; this is important evidence.

So where are the academic studies?

States reporting their experiences is one kind of evidence, academic studies are another. Yet no states cited academic literature about the impact of investment treaties on investment flows. Academic studies were only brought into the debate by an observer from Friends of the Earth International, who said:

I’d like to briefly respond to the intervention from CCIAG. We have heard similar threats of investor flight and investor strike for many years, whether to countries that are proposing to terminate their BITS, or to challenge arbitral awards or to restrict foreign investments on constitutional or critical public policy grounds. Participating states should be reassured that authoritative research by academics and international institutions does not support those claims. 

For example, an OECD study from 2018 that comprehensively reviews the existing evidence states the following: 

[T]he several dozen econometric studies that have tested whether there is a correlation between the existence of [BITs] and FDI inflows to developing countries show diverse and at times contradicting results. Some studies found positive correlation, at least in certain configurations, some found a very weak, no, or even negative correlation, and some studies found correlation between [BITs] and greater inflows, but not necessarily from the States with which a treaty has been concluded.

She continued, highlighting one empirical study showing ‘it is exceedingly rare for foreign investors to factor in investment treaties when committing capital abroad’ and that ‘Numerous studies, including by the World Bank and UNCTAD, indicate that BITs are hardly the determining factor for investors when making the decision to invest.’

The studies to which the observer referred typically examine the general folk theory about the effect of investment treaties on investment flows. To our knowledge, there is not yet academic evidence on whether structural reforms would make a difference to investment flows. It is possible to believe that investment treaties in general have a positive effect on investment flows but to consider the choice of investor–state arbitration versus a standing mechanism to be too trivial to have an effect. However, it is hard to see how one could reject the general claim that investment treaties have an effect on investment flows and yet accept the claim that investment decisions would be swayed by the arbitration-versus-court choice.

Again, we wait with interest to see what studies emerge on this question in the future; they too could provide important evidence.

Questions we are left asking

Halliday introduces the notion of plausible folk theories but does not tell us what to expect once they are subject to scrutiny. Watching the way plausible folk theories are offered and accepted, or offered and countered with alternative folk theories or empirical studies, has raised several questions for us as academic observers.

First, when plausible folk theories are subjected to scrutiny, is it possible for them to be refined and evolve into more specific statements backed by empirical evidence, or is the only outcome likely to be a polarization into believers and non-believers? As Austria and Bahrain noted at different points during the week, investors are diverse. They operate in different industries, come from different cultures, have different sizes and structures, and we cannot expect them all to speak with one voice.

One way forward is to disaggregate. Bonnitcha, Poulsen, and Waibel observe, ‘the literature suggests that investment treaties do have some impact on some investment decisions in some circumstances, but that they are unlikely to have a large effect on the majority of foreign investment decisions.’ Here we could ask, in what circumstances is an investment treaty more (or less) likely to be taken into consideration? For which actors? Are there significant differences by industry or home country or corporate structure, for instance?

In assessing these claims, different types of evidence are likely to be brought forward. China and Germany put forward evidence based on specific consultations with their investors. In contrast, academics tend to prize evidence that is more generalized and, often on this question, quantitative rather than qualitative. But both types of evidence are important – specific and general, qualitative and quantitative. The process may yet produce more evidence. For instance, the UNCITRAL Secretariat plans to cooperate with the International Chamber of Commerce on a roundtable to hear the views of investors on reform options.

As this process unfolds, the general folk theory of investment treaties leading to more investment could be refined into a series of narrower claims backed by specific evidence.

Second, when plausible folk theories are subject to scrutiny, does it enable us to see the interests at stake more clearly? Cui bono, or ‘in whose benefit’, is an old question that scholars still use to try to work out underlying interests. In this regard, it is notable that observers from the private sector in Working Group III are overwhelmingly, if not exclusively, lawyers. Most work for law firms, while a few work for litigation funders or are in-house counsel or barristers. On one hand, we might expect this to be the case since ISDS is a legal field. On the other hand, it raises the question of whether any difference exists between how these reforms are perceived by industry and by industry lawyers (who themselves are an industry).

Even if a difference exists between industry and industry lawyers, multiple explanations might exist for it. We’ve heard some discussion in the corridors that ISDS lawyers have a stronger interest in maintaining the current ISDS system than the industries they represent because they are the ones most directly affected by the reforms. Yet is it also possible that lawyers in general weigh legal factors more seriously than other business representatives when thinking about investment decisions because their legal training make risks and, in particular, legal risks much more salient to them. Whether or not such a difference exists and, if it does, what explains it remain open questions.

If a systematic difference were to exist between how in-house counsel and general managers or other business representatives perceive the importance of ISDS, then it raises an important question: whose voice matters? Who speaks for industry? This question has two dimensions. The first is within the firm – probing who exactly is surveyed or consulted in studies could help to explain diverging findings. The second dimension is between the firm and those who speak for it. Who best represents the views of foreign investors if corporate counsel says one thing and their home states say another? Is it possible that these different representatives are speaking to different actors within the firm, such as industry lawyers versus general managers?

Third, and most importantly, why does the scrutiny of plausible folk theories that we observe at Working Group III occur within certain bounds? We are often asked why the Working Group III debate is bounded. Why are the big questions not being asked? Why are the system’s foundational premises not being re-examined in the light of new evidence?

Being observers in the room leads us to reframe that question: who has a mandate to ask these sorts of big questions? Many delegates, when asked, emphasize that they have a limited mandate and feel they are constrained by various precedents. Many states, especially those with capital-exporting companies, seem to have a common interest in having a bounded debate. These states seem to believe the boat can be rocked, but it should not be allowed to capsize.

Many academics, civil society groups, and some governments would prefer that states start by getting rid of the boat (for instance, by considering treaty termination) and then ask what, if anything, should replace it. Does it make sense, they ask, to pursue structural reform without first asking fundamental questions? Wouldn’t it make more sense, they suggest, to update the objectives of investment treaties and then consider designs in light of those new objectives? The bounded nature of debate at the Working Group mean that those who wish to pose more fundamental questions are likely to continue to be dissatisfied.

Yet, as observers, we have noticed that even states that are not willing to publicly scrutinize plausible folk theories have softened and shifted their rhetoric in recent years. For instance, many states now claim that investment treaties are important for facilitating a stable business environment and promoting the rule of law, rather than making direct causal claims about investment flows. There could be several reasons why officials prefer to shift or incrementally narrow a plausible folk theory rather than discard it outright. Many officials seem resistant to calling into question fundamental premises on which the field and their professional lives have been based. Some questions are not only beyond their mandate, but may also be too big and existential to ask.

We don’t know how this process will unfold and we don’t have answers to our questions about what happens when plausible folk theories are subjected to scrutiny. But these sorts of exchanges in the Working Group are going to provide fuel for much academic theorizing and analysis in the years to come. In the process, which plausible folk theories will survive and which will be rewritten? For the next instalment in this drama of narration and renarration, stay tuned for our blogs following New York in April …

[1] The quotations in our blogs are generally from the audio record; if specific quotations are used from outside the negotiations on the audio record, then they are quoted only with written consent. For this week, we have provided quotations from our notes because the audio recording is not yet public. In case of a difference between our notes and the audio recording, we will update the blog once the audio recordings are released.

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Kishor Dere says

February 13, 2020

After reading references to "Plausible Folk Theories" in this interesting blog, one is reminded of Karl Popper's use of "black swan" in his Logic of Scientific Discovery(1959)to show how scientific ideas can never be proven true irrespective of how many observations seem to support them. However, a single contrary result can prove a theory to be false. Likewise, Brazil's example of not signing any Bilateral Investment Treaty (BIT)can certainly disprove the conventional wisdom on BITs attracting foreign investment. Brazil signs Cooperation and Facilitation Investment Agreements(CFIAs)which seek a greater balance between investment protection and host state's development agenda. As the authors rightly mention in the blog, research suggests that investors do not always give priority to BITs until the dispute arises. This point is another "black swan" that reveals inherent flaws in the "plausible folk theories" on BITs attracting foreign investment.

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Kishor Dere says

February 13, 2020

After reading references to "Plausible Folk Theories" in this interesting blog, one is reminded of Karl Popper's use of "black swan" in his Logic of Scientific Discovery(1959)to show how scientific ideas can never be proven true irrespective of how many observations seem to support them. However, a single contrary result can prove a theory to be false. Likewise, Brazil's example of not signing any Bilateral Investment Treaty (BIT)can certainly disprove the conventional wisdom on BITs attracting foreign investment. Brazil signs Cooperation and Facilitation Investment Agreements(CFIAs)which seek a greater balance between investment protection and host state's development agenda. As the authors rightly mention in the blog, research suggests that investors do not always give priority to BITs until the dispute arises. This point is another "black swan" that reveals inherent flaws in the "plausible folk theories" on BITs attracting foreign investment.