Developing a New Normative Framework for International Investment Law – International Rule of Law and Embedded Liberalism

Developing a New Normative Framework for International Investment Law – International Rule of Law and Embedded Liberalism

[Prabhash Ranjan is a Senior Assistant Professor, Faculty of Legal Studies, South Asian University, India.]

Reportedly, the Regional Comprehensive Economic Cooperation (RCEP) – a free trade and investment agreement comprising of 16 big Asian and Australian economies – will not have an investor-State dispute settlement (ISDS) mechanism. This is a huge decision and is consistent with the backlash that one has been witnessing against ISDS and bilateral investment treaties (BITs), over the last few years. Several countries have been contesting BITs because they believe that these treaties constrain severely their right to regulate and lead to a transfer of State’s decision-making power to undemocratic forums like ISDS tribunals. Arguably, BITs and ISDS are part of hyper-globalisation forces that have given rise to what is known as undemocratic liberalism or rights without democracy.

This backlash against BITs and ISDS has coincided with the rise of populism and economic nationalism. While populism comes in different forms, as Cas Mudde explains, most populists perceive politics as an expression of the will of ‘pure people’ as against the ‘corrupt elites’. In the context of BITs and ISDS, the populist argument, championed by both leftists and rightists, is that the current system is rigged in favour of the elites (foreign corporations, arbitrators, law firms) against the sovereignty of independent nations that rests in ‘pure people’.  

The backlash against BITs and ISDS can also be seen as a manifestation of a larger backlash against international courts and tribunals evident in practice of several countries ranging from Latin American countries pulling out of the ICSID convention to the US blocking the appointment of members to the Appellate Body of the WTO. This attack on BITs, ISDS, and international courts could end up undermining the liberal international economic legal order that the global community has so assiduously built after World War II.

There is no gainsaying the fact that the current system has produced some bad decisions by broadly interpreting BIT provisions imposing a social and political cost on States. Monstrous damages have been awarded in some instances and questions have been raised about systemic and actual bias in the ISDS system favouring foreign investors. However, it is also true that ISDS tribunals have upheld the sovereign right to regulate host States in many cases; States have won more cases than foreign investors; and damages awarded to foreign investors have been much less than claimed. Thus, the ISDS system cannot be looked at in a binary manner. Moreover, while it is true that foreign investors misuse the system for their advantage, it is also true that host States abuse their public powers to the detriment of hapless foreign investors. Thus, the challenge is how to build a system where the interests of the underdogs – hapless foreign investors requiring protection from capricious actions of States and over-powered foreign investors bending the system to the impairment of States – are protected.  

The argument of this piece is that BITs and ISDS system require a new normative framework to tackle the concerns of the underdogs of the system. This framework should have two critical elements: international rule of law and embedded liberalism.

International Rule of Law

While it is difficult to agree on a definition of international rule law, rule of law at the international level is often understood in formal, not substantive, sense. The following elements are generally considered central to the formal version of international rule of law. First, exercise of public power must be controlled by law and should be based upon authority conferred by law; second, the requirement of formal legality, such as rules, must be set out and applied in a manner that meets a certain threshold of non-discrimination, predictability and clarity; third, public powers cannot set or change the law at will; and fourth, there must be a process of independent adjudication in order to ensure accountability of exercise of public power.

The first generation BITs, i.e., investment treaties signed from 1959 until the 2000s, contain some of these international rule of law characteristics. For example, BITs, directly or indirectly, impose conditions on the host State’s exercise of public power in order to prevent undue interference with the rights of foreign investors. Similarly, the ISDS mechanism in BITs enables holding host State’s accountable for the exercise of their public power. Also, BITs lay down the rights foreign investors enjoy and contain basic non-discriminatory norms, thus establishing a certain degree of predictability and clarity in how the law pertaining to foreign investment shall be applied.   

However, BITs cannot be justified by merely using the language of international rule of law because the restrictions imposed on host State’s public power could be too severe or the method to hold State’s accountable could be flawed, as several argue. Thus, the compromise of ‘embedded liberalism’ becomes important.

Embedded Liberalism

John Ruggie, borrowing from the work of Karl Polanyi, argued that the post World War II international economic order, such as the one reflected in the General Agreement on Tariffs and Trade (GATT), was based on the compromise of ‘embedded liberalism’:

[U]nlike the economic nationalism of the [1930s], it [was] multilateral in character; unlike the liberalism of the gold standard and free trade, its multilateralism [was] predicated upon domestic interventionism.

This ‘embedded liberalism’, different from laissez faire liberalism of the late 19th century where markets were dis-embedded from society, represented a principled compromise or a grand bargain between free market orthodoxy and the State intervening in favour of political and social stability. In Ruggie’s vision, the core of embedded liberalism includes two things: first, a shared set of normative commitments; second, a body of rules and institutional forms that could be used to achieve these shared commitments. 

This compromise of ‘embedded liberalism’, though reflected in GATT, is missing in the first generation BITs. One reason for this is that bulk of these investment treaties were signed when the post-war international economic order had moved away from the embedded liberalism era towards neoliberalism in 1980s, an era that placed significant hope in the forces of free markets and deregulation, which were not embedded in the social community. The first generation BITs follow a neoliberal template, providing broad and substantive investment protection guarantees with a minimalist State, i.e. limited scope for the host State to deviate from treaty obligations for social or other objectives. For example, most BITs give investors a broad right to transfer funds in and out of the host State with very limited exceptions. This right extends not just to current but also to capital account transactions, which, in turn, could lead to liberalization of a country’s capital account. Such liberalisation could make States vulnerable to external shocks. Likewise most first generation BITs do not contain general exception clauses of the kind given in Article XX of GATT that permit States to intervene in the markets for social, environmental and other reasons. Thus, BITs modelled on laissez faire liberalism template do not provide opportunities for sharing social adjustment costs that free markets unavoidably produce.  

Therefore, for the wider acceptability and sustainability of BITs as tools that advance international rule of law, they need to be remodelled using the compromise of “embedded liberalism”. This recalibration should keep two things in mind: first, BITs should reflect a principled compromise between different values, i.e. imposing limits on host State’s exercise of public power for investment protection and respecting State’s right to intervene in the markets for social imperatives; second, the institutional design of BITs and ISDS should clearly reflect this principled compromise. Thus, BITs should continue to hold host State’s accountable for the exercise of their public power through ISDS or any other international dispute settlement forum, including a multilateral investment court. However, for States to readily submit themselves to the jurisdiction of such tribunals, the working of the tribunals should be fair and transparent, in theory, in appearance, and in practice.   


For the sustainability of the liberal internationalism project to advance international rule of law, it has to be embedded in the social order. This compromise is critical to stem the rise of populism where populist leaders increasingly seek to break free from international institutional controls. A BIT and ISDS framework based on normativity of international rule of law and embedded liberalism will ensure that the interests of the underdogs – hapless investor subjected to whimsical State behaviour and States failing to protect their interests before over-powered foreign investors – shall be protected. This embedded liberal internationalism on foreign investment will be like a new social compact between the market and the State and civil society consistent with Joseph Stiglitz’s template of progressive capitalism to replace neoliberalism.    

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