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Abstract

This paper offers an economic analysis of the efficiency and distributive effects of an investor-state dispute settlement (ISDS) in markets with large investors. We first identify a reason for strategic over-investment by the domestic industry, leading to excessively permissive environmental regulation in the absence of an ISDS. We show that an ‘ideal’ investor-state dispute settlement arrangement (transaction-cost free, with untouchable, fully reliable, and unbiased judges) has positive and negative effects. It generates an equal level playing field for domestic and foreign investors, but it magnifies an existing over-investment problem. The results explain anecdotal evidence according to which ISDS institutions are liked by the domestic industry in the host country even if it protects foreign competitors, but ISDS is disliked by other interest groups in the host country.