Police Powers, Regulatory Takings and the Efficient Compensation of Domestic and Foreign Investors*

Abstract

Modern international investment agreements have challenged the customary exclusion of public good regulations from being considered government 'takings' subject to compensation rules. Full compensation for regulatory takings can, however, lead to over-investment and excessive entry in risky industries. An alternative is to 'carve-out' apparently efficient regulation from compensation requirements. We design a carve-out/compensation rule that induces efficient regulation and firm-level investment even when the regulator suffers fiscal illusion and has private information about the social benefit from regulation. We also show that a carve-out reduces the subsidy to risky industry implicit in compensation rules, and thus mitigates the entry problem.

The economics of investor protection: ISDS versus national treatment

“…with respect to s 1 and φ, where φ is the threshold level of the entry cost. Expression (2) nicely demonstrates the two relevant distortions in our model. Due to the participation constraint, the government seemingly maximizes global welfare, i.e., the sum of all profits plus spillovers and regulation benefits, minus the entry cost.…”

“…The number of initiated arbitrations has experienced some variation in the last years, with a low of 68 in 2013 and a high of 83 in 2015. 2 Why should foreign investors enjoy a treatment that is denied to domestic investors?…”

Regulatory chill and the effect of investor state dispute settlements

“…The paper contributes to different types of literature. The paper is closely related to the work by Aisbett, Karp, and McAusland (2010a, 2010b), who analyze how changes in the legal extent to which a government does not have to pay compensation in the case of regulation (police power carve out, PPCO) affects investment decisions of firms and regulation. In Aisbett et al.…”

“…In Aisbett et al. (2010a) an optimal PPCO mechanism is studied that leads to efficient regulation and that reduces but does not eliminate the excessive entry problem of firms into host countries. The firm does not initiate litigation but rather a court decides on compensation based on a noisy signal about the possible harm from firm activity.…”

“…The parameter 1− q can be interpreted as a measure of “carve out,” the extent to which there are situations in which the firm does not have to be compensated when facing harmful regulation, while q is a measure of the protection of the firm (see Aisbett et al. [2010a, 2010b] for their modeling of carve outs). If q = 1 or q = 0, the law is clear cut and the firm is always or never to be compensated when regulation takes place.…”