It’s been a rough month for Pakistan’s Prime Minister Imran Khan.
It started off with the International Monetary Fund approving a US$6 billion dollar loan to the country. The strict conditions on the loan meant that instead of expanding the welfare state, Khan’s government had to impose “shock therapy” austerity measures.
Unsurprisingly, this resulted in nationwide strikes.
Then, less than two weeks later, a secretive World Bank tribunal ordered Pakistan to pay a mining company US$5.8 billion dollars — nearly as much as the IMF loan — to resolve an eight year-long dispute.
Why would an arm of the development pillar of the Bretton Woods system require a country in crisis to do something that would completely undermine the actions of the financial stability tenets of that same system?
What does it say about the state of global economic governance? Is it broken?
Protecting corporate profits
The International Centre for the Settlement of Investment Disputes was established in 1966 as part of the World Bank Group. The centre oversees arbitrations between foreign companies and states in a process known as the investor-state dispute settlement (ISDS).
ISDS is hugely controversial for a variety of reasons ranging from the secrecy of the hearings to the substantial costs associated with defending a claim and the ability of corporations to challenge health and environmental measures.
The case that cost Pakistan $5.8 billion did not revolve around such measures but rather the decision of a provincial government to backtrack on a sweetheart deal that had been offered to a mining firm, allegedly the result of corruption. Leaving the merits of the case to one side — it is difficult to assess the tribunal’s reasoning when the award isn’t public, after all — let’s take a closer look at the payout.
According to the mining company — Tethyan Copper, partially owned by Canada’s Barrick Gold — it spent US$220 million on exploration activities before things went south. One might argue that a fair outcome, if the government was solely to blame, would be for the award to cover these sunk costs. Instead it was more than 25 times that amount. That is because the tribunal chose to award the company “lost future profits” from the project.
No crystal balls
Arbitrators don’t have crystal balls. They don’t know what the value of a mineral will be in a year, let alone 30 years. And they are lawyers, not market analysts. So how do they decide how much profit a firm would have made in a hypothetical alternative future?
The answer is, partially, that they rely on “experts” brought in by each of the parties to the dispute. These experts provide a best guess for what they think a project is worth. International law scholar Robert Howse calls this “junk science.”
Unsurprisingly, the state’s expert often provides a low-ball estimate for the value of a project and the investor’s expert gives an inflated value. Faced with this discrepancy, arbitrators will often choose to go down the middle and pick an arbitrary value. Tethyan Copper had originally sought more than US$11 billion in damages, suggesting that the tribunal in this case may have taken this approach.
When it comes to the calculation of damages, there are very few constraints on arbitrators. As noted in one award, a tribunal generally has the freedom to “arrive at a figure with which it is comfortable in all the circumstances of the case.”
Did the arbitrators in this case consider that the owners of Tethyan Copper —Antofogasta of Chile and Barrick Gold — had long ago written off the project and continued to be very profitable firms? Did they consider the records of these companies in terms of alleged corruption and human rights abuses in other countries?
Did they consider that US$5.8 billion is one eighth of Pakistan’s total government budget for 2019/20? Did they consider that the country is facing an economic crisis? It seems the answer may have been “no” on all counts though, again, we are left guessing about the tribunal’s justifications for its award.
A way out
An international process is currently underway to come up with reforms to ISDS, and excessive damages awards have been identified as an area of concern for states. A number of countries, most recently South Korea, have come to the wise decision that the best way forward is to opt out of ISDS altogether.
In practice, this means individual states terminating the thousands of investment treaties that provide access to arbitration, which can be a difficult and time-consuming process. A preferable approach would be for states to co-ordinate their efforts, for example through a multilateral exit agreement.
Abolishing ISDS won’t solve all of the problems of global economic governance. But it seems a very good place to start.