Investor-state arbitration (ISA) used to be a pretty obscure field.  Many free trade agreements include provisions that allow foreign investors to take a government to international arbitration if they’re treated unfairly, such as if their property is expropriated.

Recently, however, multinational corporations have tried to use ISA to challenge environmental and human rights policies of developing countries, such as mining companies’ attack on South Africa’s black empowerment laws, Chevron’s claim against the Ecuadorian government for alleged unfair treatment in environmental litigation in the Amazon, and Pacific Rim Mining’s suit against El Salvador for refusing to issue exploration permits.

Now the Australian government has announced that it will no longer seek to include ISA clauses in trade and investment agreements.  Apparently the government is worried that its own policies might be at risk from challenges by foreign investors, but its statement expressly warns Australian businesses that “they will need to make their own assessments” about the risks of investing abroad.

I hope this is the start of a trend, as governments realize that giving corporations the right to challenge public policy in an international arbitration forum is maybe not such a good idea.

Before ISA, such cases could only be pursued internationally if the investor’s claims were “espoused” by their own government–for example, the U.S. government could challenge Ecuador’s actions if they thought Chevron was being treated unfairly, but Chevron could not.  This meant that such challenges were uncommon and they were subject to international political constraints.

The argument for ISA is that giving investors direct enforcement rights increases their confidence in the system, which in turn increases foreign investment. But an Australian government analysis also found no sound economic reasons for these clauses, raising questions about whether they’re really serving this purpose.

Political constraints on allowing challenges to a sovereign nation’s public policy are not necessarily a bad thing.  Foreign investors are always free to challenge government decisions in the local courts.  If this were their primary or only remedy, nations seeking to attract investment would need to improve the administration of justice domestically–something that would benefit everyone–rather than just create a system that gives special rights to foreign investors.

Let’s hope that the U.S. and other countries follow Australia’s lead.  When the first foreign company takes the U.S. government to binding arbitration over Obama’s health care policy, alleging that it somehow diminished the value of its investment, the administration may think twice about the wisdom of this system.