UCLA UCLA Previously Published Works Title Predictability Versus Flexibility Permalink https://escholarship.org/uc/item/8v4897n0 Journal World Politics, 68(3) ISSN 0043-8871 Authors Hafner-Burton, Emilie M Steinert-Threlkeld, Zachary C Victor, David G Publication Date 2016-07-01 DOI 10.1017/s004388711600006x Peer reviewed eScholarship.org Powered by the California Digital Library University of California Predictability,Versus,Flexibility:,Secrecy,in,International,Investment,Arbitration, , Emilie&M.&Hafner.Burton,&Zachary&C.&Steinert.Threlkeld,&and&David&G.&Victor*& , Abstract:,! ! There!is!heated!debate!over!the!wisdom!and!impact!of!secrecy!in!international! negotiations.!This!debate!has!become!central!to!the!process!of!foreign!investment! arbitration!because!parties!to!dispute!nearly!always!can!choose!to!hide!arbitral!outcomes! from!public!view.!Working!with!a!new!database!of!disputes!at!the!world’s!largest!investor= state!arbitral!institution,!this!paper!examines!the!incentives!of!firms!and!governments!to! keep!the!details!of!their!disputes!secret.!!We!argue!that!secrecy!in!the!context!of!investment! arbitration!works!like!a!flexibility!enhancing!device,!similar!to!the!way!escape!clauses!work! in!the!context!of!international!trade.!To!attract!and!preserve!investment,!governments! make!contractual!promises!to!submit!to!binding!arbitration!in!the!event!of!a!dispute,!but! these!promises!can!be!difficult!to!honor!strictly—especially!in!disputes!where!strong! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! *!We!thank!Todd!Allee,!Ken!Abbot,!Alan!Alexandroff,!John!James!Barcelo!III,!Marc!Busch,!Tim!Büthe,! Donald!Childress,!Christina!Davis,!Cédric!Dupont,!Judy!Goldstein,!Leslie!Johns,!Andrew!Kerner,! Robert!Keohane,!Mark!Fathi!Massoud,!Saray!Maxey,!Helen!Milner,!Andrew!Moravcsik,!Martijn!Mos,! Clint!Peinhardt,!Krzysztof!Pelc,!Lauge!Poulsen,!Peter!Rosendorff,!Chris!Rudolf,!Ken!Shultz,! Alexander!Thompson!and!Nicole!Weygandt!for!helpful!comments!on!the!paper,!as!well!as! participants!in!panels!and!lecture!seminars!at!the!American!Political!Science!Association,! International!Studies!Association,!Cornell,!McGill,!Stanford,!UCLA,!UCSD!and!Yale;!Thomas!Baranga,! Scott!Desposato,!Gordon!Hanson,!Thad!Kousser!and!especially!Andy!Brownback!for!advice!on! methodology;!Sergio!Puig!for!advice!on!the!legal!aspects!of!ICSID!and!detailed!comments!on!several! drafts;!and!Susan!Franck,!Meg!Kinnear!and!Antonio!Parra!for!important!preliminary!discussions!as! we!began!the!project.!!Thanks,!as!well,!to!Shu!Shang!and!especially!Linda!Wong!for!research! assistance.!The!Laboratory!on!International!Law!and!Regulation!(ILAR)!is!funded!by!the!School!of! International!Relations!and!Pacific!Studies!(IR/PS)!at!UC!San!Diego,!BP!plc,!the!Electric!Power! Research!Institute!and!the!Norwegian!Research!Foundation.!! ! 1! political!pressures!lead!governments!to!violate!legal!norms.!!Investors,!too,!favor!secrecy! when!managing!politically!sensitive!disputes!over!assets!that!they!will!continue!to!own!and! manage!in!host!countries!long!after!the!particular!dispute!has!passed.!!While!secret! outcomes!help!facilitate!politically!difficult!bargaining,!it!diminishes!one!of!the!central! purposes!of!arbitration:!to!allow!governments!to!signal!publicly!their!commitment!to! investor=friendly!policies.!!By!explaining!secrecy,!we!suggest!it!may!prove!easier!in!future! work!to!explain!more!accurately!the!observed!patterns!of!wins!and!losses!from!investor= state!arbitration!as!well!as!perhaps!patterns!in!investment!! ! ! ! ! 2! ! There!is!long=standing!debate!over!the!appeal!of!publicly!transparent!international! institutions.!The!shared!provision!of!information,!it!is!thought,!helps!to!set!norms!and! stabilize!expectations!around!which!actors!can!organize!complex!and!politically! challenging!domestic!policies.1!It!can!encourage!participation!and!accountability!and!lend! legitimacy!to!governance!institutions.2!Information!can!tie!hands!by!raising!the!cost!of! reneging!on!agreements,!a!logic!that!is!central!to!most!theories!that!explain!how! international!institutions!facilitate!the!creation!of!credible!commitments.3!These!logics!help! explain!why!most!international!tribunals!on!boundary!disputes!are!required!to!rule! publicly!when!they!settle!zero!sum!matters!such!as!shifting!borders—decisions!that!would! be!nearly!impossible!for!governments!to!implement!without!credible,!visible!external! pressure.4!They!also!explain!why!all!WTO!dispute!panel!decisions!are!publicly!released,! partly!on!the!logic!that!countries!will!find!it!easier!to!make!domestic!policy!adjustments! after!their!hands!are!publicly!tied.5!Yet!‘open!door’!negotiations,!as!well,!can!create!strong! incentives!for!parties!to!posture!in!public.6!Publicity!can!raise!transaction!costs!and!impede! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 1!Keohane!1982;!1984.! 2!Buchanan!and!Keohane!2006;!Keohane!1998.! 3!Fearon!1997.! 4!Allee!and!Huth!2006.! 5!Davis!2012;!WTO!2014.! 6!Stasavage!2004.! ! 3! negotiations!needed!to!resolve!entrenched!disputes.7!It!can!also!make!it!harder!to!hide!and! manage!the!fallout!of!inconvenient!decisions.8! Nowhere!is!this!debate!over!the!function!of!public!information!within!international! institutions!more!heated!or!economically!consequential!than!over!the!regulation!of!foreign! investment!that!now!totals!nearly!1.5!trillion!(U.S.)!dollars!a!year!in!capital!flows.9!!Firms! that!invest!overseas!fear!that!obsolescing!bargains!and!time!inconsistency!problems!will! put!their!investments!at!risk!of!expropriation!or!other!harmful!treatment!in!the!hands!of! host!governments.10!To!mitigate!this!fear—and!attract!FDI—governments!have!created!an! expansive!legal!regime!designed!to!boost!investor!confidence!and!create!a!more! predictable!environment!for!investors.11!!The!keystone!to!that!regime!is!binding! independent!arbitration!that!provides!direct!access!to!an!international!resolution!that,!in! theory,!depoliticizes!the!process!and!subjects!decisions!to!objective!legal!criteria.12!Nearly! all!of!the!existing!bilateral!investment!treaties!(BITs),!along!with!some!trade!agreements! (such!as!the!North!American!Free!Trade!Agreement),!thus!allow!private!investors!to!invoke! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 7!Rabinovich=Einy!2002.! 8!Kurizaki!2007;!Levenotoglu!and!Tarar!2005.! 9!For!recent!work!on!investment,!see!the!World&Politics&special!issue!on!the!Global! Economy,!FDI!and!the!Regime!for!Investment,!ed.,!Milner!2014.!! 10!Tobin!and!Rose=Ackerman!2005;!Tobin!and!Busch!2010;!Bütte!and!Milner!2014.! 11!See!Milner!2014.!There!is!debate!over!whether!investment!treaties!actually!increase!FDI.! See!Neumayer!and!Spess!2005;!Tobin!and!Rose=Ackerman!2005;!Büthe!and!Milner!2008.! 12!Norris!and!Metzidakis!2010.! ! 4! arbitration!by!filing!complaints!when!they!feel!wronged!by!a!foreign!host!government.!!By! most!accounts,!the!promise!of!arbitration!helps!countries!to!credibly!signal!their! commitment!to!investor=friendly!policies.13!!Because!that!regime!is!being!replicated!in! major!new!trade!and!investment!agreements,!investor=state!arbitration!has!assumed! central!importance!in!debates!over!the!future!of!international!economic!institutions.!! As!a!device!for!sending!credible!information!about!a!country’s!commitment!to! protecting!investors,!most!investment!arbitration!has!the!peculiar!feature!that!the!filing!of! disputes!is!public!knowledge!yet!the!official!outcomes!of!negotiations!and!the!final!rulings! need!not!be.!In!most!disputes,!any!party!can!formally!choose!to!hide!the!results!of! arbitration!(known!as!the!“award”)!from!the!public,!including!from!other!governments!and! investors.!!Indeed,!in!two=fifths!of!the!246!investment!cases!concluded!by!the!beginning!of! 2012!at!the!World!Bank’s!International!Centre!for!Settlement!of!Investment!Disputes! (ICSID),!the!dominant!investor=state!arbitration!mechanism,!there!is!no!official!public! record!as!to!whether!or!why!the!government!was!found!guilty!of!improperly!harming!the! investor!nor!whether!the!investor!was!actually!compensated.!This!concealment!of! information!can!be!costly!for!the!disputing!parties!and!for!the!system!of!arbitration!itself.!! It!makes!it!difficult!for!other!parties,!including!other!potential!investors,!to!determine! whether!the!government!actually!honors!its!commitments.!It!reduces!the!predictability!of! the!arbitration!process!and!outcomes.!And!it!prevents!determination!of!whether!the!law!is! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 13!See!Büthe!and!Milner!2008;!2014;!Haftel!2010;!Neumayer!and!Spess!2005;!Tobin!and! Busch!2010;!Tobin!and!Rose=Ackerman!2011;!Poulsen!and!Aisbett!2013;!Simmons!2014.! See!Allee!and!Peinhardt!2014!for!an!alternative!view.! ! 5! being!applied!consistently!and!effectively.14!The!risks!associated!with!making!investments! thus!rise,!which!can!deter!rather!than!attract!FDI.15!As!one!arbitrator!put!it,!“transparency! generates!certainty;!ignorance!panic”.16! Accompanying!these!costs!is!a!wave!of!attempted!reforms!aimed!at!reducing!the!use! of!secret!arbitration.!Since!the!early!2000s,!when!arbitration!over!a!series!of!publicly! controversial!investments!began!to!tread!into!the!domain!of!regulatory!policy!on!issues! such!as!environmental!protection!and!access!to!water,!there!has!been!growing!pressure! from!certain!governments,!the!arbitral!institutions!themselves,!and!civil!society!for!parties! undergoing!arbitration!to!make!the!full!record!public!and!thus!further!raise!the!costs!of! engaging!in!secret!arbitration.17!Yet!secrecy!remains!pervasive,!diluting!the!broader!public! signal!that!arbitration!provides!a!credible!commitment!to!protect!investor!rights.! We!argue!that!secrecy!in!the!context!of!investment!arbitration!works!like!a! flexibility!enhancing!device,!similar!to!the!way!escape!clauses!work!in!the!context!of! international!trade.18!To!attract!and!preserve!investment,!governments!need!to!make! commitments!to!provide!investor=friendly!policies,!which!they!do!by!making!contractual! promises!to!submit!to!binding!arbitration!in!the!event!of!a!dispute.!Yet!governments!also! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 14!ICSID!2006c;!Tahyar!1986.! 15!Brown!2001.! 16!Hernandez!2013,!27.! 17!Parra!2012,!ch!10.! 18!Rosendorff!and!Milner!2001;!Mansfield!and!Milner!2012;!Milner,!Rosendorff,!and! Mansfield!2011.! ! 6! know!at!the!time!they!make!this!commitment!that!political!situations!may!arise!that!create! incentives!to!undermine!their!promises.!They!also!know!that!the!credibility!of!their! investment!agreements!will!decline!if!they!are!seen!to!violate!their!commitments!too! frequently—investors!will!stop!spending!and!other!governments!will!stop!signing! investment!agreements.!Secrecy!provides!some!measure!of!flexibility!in!precisely!those! situations!where!hiding!information!about!their!wrongdoing!would!be!most!immediately! beneficial!to!the!government.! Our!starting!point!to!identifying!those!situations,!consistent!with!other!work!on! bargaining,19!is!the!assumption!that!bargainers!in!a!dispute!care!both!about!the!substantive! outcome!of!a!particular!bargain!as!well!as!the!impact!of!the!process!on!their!public! reputations.20!Both!affect!how!the!parties!assess!their!future!investment!strategies.!!As!we! will!argue,!secrecy!can!affect!substantive!outcomes!by!creating!the!flexibility!to!allow!hard! bargains!that!would!otherwise!be!impossible—making!it!possible!for!investor!and!host! country,!alike,!to!prolong!their!relationship.!!Secrecy!can!also!have!an!impact!on!how!the! process!of!arbitration!affects!reputations!since!secrecy!allows!governments!to!hide! information!about!their!wrongdoing!that!could!undermine!the!credibility!of!their!broader! public!commitment!to!investor!rights!more!generally.! We!see!at!least!two!broader!implications!of!this!argument!of!relevance!for!world! politics.!First,!the!decision!to!engage!in!secrecy!may!at!once!facilitate!hard!bargains!and! prevent!posturing!over!politically!sensitive!disputes!while!also!blunting!the!ability!of! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 19!Stasavage!2004.! 20!While!we!draw!upon!Stasavage’s!assumption,!our!focus!in!this!paper!is!different!than!his.! ! 7! governments!to!signal!their!broader!commitment!to!investor=friendly!policies!in!precisely! the!most!contentious!cases.!!Second,!the!incentives!for!secrecy!help!explain!why!the!public! is!least!informed!about!those!cases!where!the!most!is!at!stake—where!investors!and!host! governments!do!not!want!to!be!held!publicly!accountable!for!politically!difficult!decisions.!! Combined,!these!implications!help!explain!why!the!legitimacy!of!investment=state! arbitration!remains!highly!controversial.!!Despite!many!efforts!to!promote!transparency,! we!see!no!statistical!evidence!that!those!efforts!have!altered!the!underlying!incentives!for! secrecy.!!These!insights!may!also,!we!speculate,!help!explain!the!empirical!finding!that!BITs! do!not!always!increase!FDI.!!!! The!article!proceeds!to!develop!the!argument!in!several!steps.!Several!institutions! handle!the!burgeoning!caseload!of!investment!disputes!but!ICSID—the!empirical!focus!of! this!paper—has!emerged!as!the!dominant!venue!and!accounts!for!more!than!60%!of!all! investor=state!arbitrations.21!We!begin!by!explaining!the!core!features!of!the!ICSID!process! that!relate!to!the!decision!to!conceal!a!case—that!any!party!to!arbitration!can!unilaterally! demand!secrecy,!a!decision!that!is!made!prior!to!the!final!ruling.22!Next,!we!develop!our! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! 21!There!is!no!reliable!universe!of!arbitrations!and!thus!this!fraction!is!based!on!the!most! reliable!estimates!from!UNCTAD,!which!reports!on!treaty=based!cases!through!2011! (UNCTAD!2012).!Recent!discussions!with!practitioners!has!confirmed!this!number.! 22!We!model!the!choice!for!secrecy!(which!any!party!can!make)!rather!than!transparency! (which!requires!the!joint!decision!of!all!parties).!We!do!this!because!secrecy!is!the!outcome! that!most!concerns!ICSID,!which!has!made!public!claims!to!the!effect!that!secrecy!is!in! decline,!and!also!because!the!total!number!of!cases!limits!our!ability!to!precisely!model!the! ! ! 8! theoretical!arguments!to!explain!when!arbitration!is!most!likely!to!be!concealed,!and!then! provide!an!account!of!the!efforts!to!reform!the!ICSID!process!with!the!explicit!goal!of! reducing!the!instances!of!secrecy!over!time.!!Empirically,!we!focus!on!the!secrecy!of!arbitral! outcomes—that!is,!the!“awards”!that!are!the!final!substantive!decision!from!a!panel!of! arbitrators—but!we!are!mindful!of!similar!debates!over!secrecy!in!proceedings,!access!for! third!parties,!confidentiality!of!documents!and!related!topics.23!We!focus!on!awards! because!they!are!the!key!outcome!and!have!the!greatest!substantive!importance!for! governments!and!investors!alike.!!We!then!evaluate!the!observable!implications!of!our! argument!on!a!new!dataset!we!collected!from!all!registered!cases!at!ICSID!from!1972!to! 2011!(and!the!first!12!of!2012).24!We!offer!a!unique!illustration!of!a!case!that!was!intended! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! strategic!interaction!between!claimants!and!responding!governments!that!would!be! essential!to!assessing!transparency.!However,!we!return!to!the!question!of!transparency!in! the!empirical!analysis.!! 23!E.g.,!Parra!2012;!Kinnear,!Obadia,!and!Gagain!2013;!Waibel!et!al.!2010;!Yackee!and!Wong! 2010.!!! 24!For!other!efforts!to!collect!data!on!arbitration!see!Caddel!and!Jensen!2014;!Shultz!and! Dupont!2014;!and!Franck!2007.!!Caddel!and!Jensen!are!interested!in!which!parts!of!a! government!are!involved!in!investment!disputes!and!have!coded!163!of!the!264!cases! completed!through!the!end!of!2012.!!Franck!looks!at!all!public!awards!before!2006,!the!vast! majority!of!which!are!ICSID=based.!!We!extend!these!by!making!the!claimant!the!unit!of! analysis,!incorporating!more!home!and!host!country!features,!including!non=public!cases!in! our!analysis,!and,!where!feasible,!relying!on!leaked!documents!for!information.!!Other!work! ! ! 9!