When investors subvert states

NEW DELHI — Imagine a scenario where a private company effectively creates and controls its own jurisdiction within a sovereign country. This company introduces its own currency, enacts laws, and establishes courts, prisons, police forces and even intelligence services. It formulates its own tax, labour and environmental regulations (or lack thereof), regardless of their compatibility with national laws.

Now imagine that this company adopts Bitcoin as its official currency and announces plans to privatise public services. It replaces the existing judicial system with an “arbitration center” and even introduces a fee-based citizenship model that requires signing a “social contract” designed to encourage good behaviour. Eventually, the country’s democratically elected government steps in to stop this nonsense and affirm that national laws apply equally to this jurisdiction. But instead of complying, the company sues the government for billions of dollars, citing its projected financial losses.

This scenario, seemingly lifted straight out of a dystopian novel, is precisely what is happening today in Honduras. The Honduran government is currently contending with seven international investor-state dispute settlement (ISDS) claims filed by various private corporations. One US company based in Delaware, Honduras Próspera, is suing the country for a staggering $10.7 billion, which represents two-thirds of the government’s projected budget for 2023.

The story begins with the 2009 military coup that ousted the democratically elected Honduran president, Manuel Zelaya. Following the coup, the new government quickly enacted a law to establish Special Development Regions with the characteristics described above. In 2012, Honduras’s Supreme Court struck down the law, owing to its blatant infringement on Honduran sovereignty. In response, the National Congress impeached several of the justices and replaced them with more amenable appointees. This judicial overhaul set the stage for the introduction of the similar Zones for Employment and Economic Development (ZEDE) law in 2013.

There are currently three ZEDEs in Honduras: Próspera, Orquídea and Ciudad Morazán. These entities operate as independent city-states, inspired by the libertarian fantasies of billionaire investors like Peter Thiel and Marc Andreessen, who have long dreamed of crypto-based tax havens that flout basic democratic norms. Laws permitting unlimited expansion have facilitated the expropriation of land belonging to local residents. In the Próspera ZEDE, 44 per cent of the governing authority’s members are directly appointed by the corporate owner, and an additional 22 per cent are elected by landowners whose votes are proportional to the size of their property.

These developments triggered widespread public outrage both within Honduras and around the world. After the leftist Libre party, led by President Xiomara Castro, won the 2021 election, the new administration quickly fulfilled its campaign promise to repeal the ZEDE law, a move that was widely supported by the Honduran public.

But Próspera pushed back, claiming that its agreement with the previous government guaranteed a 50-year period of legal stability, acknowledged the supremacy of investor rights and privileges, and included “safeguards” under international investment law through the Dominican Republic-Central America Free Trade Agreement and the United States-Honduras bilateral investment treaty. While Próspera continues to operate St John’s Bay, its “flagship city”, the company is seeking compensation from the Honduran government for daring to enforce its own national laws.

Governments, especially in low- and middle-income countries, are understandably wary of ISDS mechanisms that allow foreign investors to seek compensation for policy changes that affect their business. Originally, ISDS was meant to prevent the expropriation of private assets through nationalisation. But the definition of expropriation has been expanded to such an extent that it can now include any government action that investors believe could negatively affect their profits, such as new regulations and taxes.

When disputes arise, they are resolved through international arbitration tribunals. There are now several such tribunals, including public ones, such as the World Bank’s International Centre for the Settlement of Investment Disputes (ICSID) and the United Nations Commission on International Trade Law, and private bodies like the London Court of International Arbitration and the Singapore International Arbitration Centre. But these tribunals overwhelmingly favour investors. Arbitrators can force governments to pay huge damages, with no legal recourse to appeal decisions. Moreover, the system is designed to allow corporations to bring claims against states while preventing governments from suing private companies. This apparent bias has prompted some developing countries to withdraw from the ICSID.

The US has played a pivotal (and regrettable) role in establishing this system. In 2020, then-presidential candidate Joe Biden strongly criticised ISDS, writing, “I don’t believe that corporations should get special tribunals that are not available to other organisations.” Biden went on to say that he opposed “the ability of private corporations to attack labour, health, and environmental policies” through the ISDS process, as well as the “inclusion of such provisions in future trade agreements”. Since then, Biden has honoured his promise to exclude ISDS clauses from future trade agreements. But they still apply to existing treaties like the one currently affecting Honduras.

In May, more than 33 members of Congress, led by Senator Elizabeth Warren and Representative Lloyd Doggett, sent a letter to US Trade Representative Katherine Tai and Secretary of State Antony Blinken, urging them to support Honduras in the ISDS case. But the Biden administration has allowed this obscene process to unfold in US courts, even though it contradicts the president’s stated position regarding the unjust and undemocratic nature of the ISDS process.

The Honduras ISDS case represents a crucial test for the Biden administration. Allowing such extreme double standards to prevail, particularly in a matter as clear-cut as this, would irreparably damage any remaining US claim to global leadership.

Jayati Ghosh, professor of Economics at the University of Massachusetts Amherst, is a member of the Club of Rome’s Transformational Economics Commission and co-chair of the Independent Commission for the Reform of International Corporate Taxation. Copyright: Project Syndicate, 2023. www.project-syndicate.org