Managing Risk: TPPA Edition

The treaty document has been out for a couple of months now, and the treaty itself was signed last week. But there's still plenty of opposition to the pact, as we will have another couple of years two go under the ratification process - yup, it still isn't a treaty we have to abide by yet.

In any case, some of that opposition is getting a bit shrill, repeating nostrums that don't really apply any more. Part of the problem is the sheer length of the treaty document; another is the legalese language used.

Take ISDS for example. There seems to be this notion that ISDS would override the ability of governments to regulate, including matters of national interest such as labour laws, health and the environment. That's not true.

ISDS provisions came about nearly half a century ago due to forced take overs of foreign owned assets by some developing countries - over 400 cases in the 1970s alone - with resultant heavy losses for foreign investors. ISDS and similar mechanisms under free trade agreements and bilateral investment treaties provided an avenue for investors to reclaim fair compensation for such expropriated assets, and will continue to do so under the TPPA with much stronger safeguards against corporate abuse than have previously existed.

The point here is that ISDS remains an avenue for compensation, not a rollback of measures or regulations that a government might take. In fact, most issues of national interest like health and the environment (for example, tobacco control), are excluded from ISDS arbitration. While there might be other issues involved (does the threat of ISDS discourage regulation as opposed to stopping it?), the paramount issue is really the possibility of having to pay compensation, not the loss of sovereignty.

But if that's the risk at the heart of the matter, my instinct says - buy insurance.

Comprehensive political risk insurance is already available to investors by both private providers and public bodies such as the US Overseas Private Investment Corporation (OPIC) and the World Bank's Multilateral Investment Guarantee Agency (MIGA). I seem to recall that there's one program that's available for governments as well (if I ever track it down, I'll post it here).

But even if such a product isn't available, governments can self-insure. There's precedent for this - international reserves are a form of self-insurance against capital outflows. How hard could it be to set aside a budget allocation specifically to manage the risk of ISDS? It would actually be actuarially easier to calculate, since the record of ISDS cases and awards are publicly available.

That helps handle the problem of ISDS compensation both directly, by reducing the impact of compensation payouts, as well as addressing any potential "chill out" effect on government regulation.

Let's take this principle a step further.

In economic theory, comparative advantage benefits two trade parties by allowing each to specialise. But the structural change this implies means that in both countries, some industries will benefit while some will lose out, although the net change is positive as labour should shift from the "losing" industry to the "winning" one. Its thus theoretically possible to tax the "winners" and compensate the "losers", thus benefiting the whole economy without anybody losing out.

In real life of course, things are a lot more complicated. Labour skills that might be appropriate for one industry might be worthless in the next. Same thing with machinery, which means investors and capital owners will be stuck. An education system geared towards producing factory workers might not be so effective in producing creative types, and so on. Another crucial issue for a government transfer policy is identifying exactly who benefited (and thus can be taxed) and who lost (and thus needs help). In a complex, modern economy, which is continuously subject to other shocks outside of trade treaties, identifying winners and losers from trade treaties becomes impossible.

So, what to do? Buy insurance of course, social insurance in this case.

This would be a good idea with or without the TPPA - there have been plenty of jarring shocks to the economy, from the emergence of China over the past decade, the commodity price boom and crash, to plenty other forces that create structural change. There needs to be an adjustment mechanism to address the impact these forces have on the labour force and capital owners alike.

For a foundation, we need a social protection scheme that would protect workers out of a job. Unemployment insurance is already in the works, but we should have it in place before the TPPA comes into force. Second, a structural adjustment fund to address worker retraining and reskilling was mooted under the New Economic Model. That's an idea that should be revived, or alternatively the HRDF should be strengthened and expanded. Third, bankruptcy laws need to be amended to protect entrepreneurs and shareholders from creditors, akin to the US Chapter 11. Bankruptcy laws in Malaysia are too penal (one strike, you're out), and don't allow for a reallocation of capital and entrepreneurial talents. The tax structure would also probably need to be reformed to fund some of these measures, but that's where the taxing the "winners" part comes in.

I'm probably scratching the surface here, but like in the ISDS insurance idea above, the point is that there are legitimate risks to domestic workers and companies, and these risks can and should be addressed/insured against as part of a TPPA package. Leaving these risks to market forces alone might mean a non-Pareto equilibrium - while the net gain may be positive, somebody is losing out. Also like the above, addressing these risks would operate on multiple levels - not only are "losers" compensated, but the reduction in social risk could mean an uptick in entrepreneurship and business activity in general, which the latest research from this angle tantalisingly suggests.

In practice, even a comprehensive social insurance scheme won't always fully compensate the "losers" from a trade treaty, but given the multiplicity of shocks any open economy has to deal with, that would be the case with or without the TPPA.

That doesn't mean we shouldn't try.