A Pareto-Improving Compensation Rule for Investment Treaties

Investment treaties grant foreign investors legal rights to compensation for losses caused by certain host state conduct. Many states are reconsidering their involvement in these treaties because they perceive the risks to outweigh the benefits. We start from the normative premise that participation in investment treaties should benefit both ‘host’ and ‘home’ states. Using a law and economics approach, we model a variety of common fact scenarios that arise in investment treaty arbitration. Our modelling demonstrates that being party to an investment treaty does not necessarily benefit a host state. The objective of mutual benefits would be achieved if investment treaties were modified to provide only the minimum protection necessary to solve time inconsistency problems for the host state and, thereby, deter opportunistic conduct. The treaties should not place wider constraints on legal and policy change. Our specific proposal is that a state should only have to compensate the investor if it breaches or modifies the domestic legal regime governing the investment and that compensation should be the lesser of the investor’s loss and the host state’s gain from the host state not having had the new legal regime in place when the investment was made.