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Honduras threatens ICSID withdrawal over $11 billion ‘neo-colonial’ special economic zone claim

Bretton Woods Project | 19 July 2023

Honduras threatens ICSID withdrawal over $11 billion ‘neo-colonial’ special economic zone claim

SUMMARY

  • $11 billion compensation claim brought under ICSID against Honduras over the repeal of a law permitting SEZs
  • Claim relates to a ‘charter city’ characterised as a “crypto-libertarian paradise”
  • ICSID criticised as a “faulty and undemocratic” dispute resolution mechanism

Honduras is threatening to withdraw from the World Bank’s International Centre for Settlement of Investment Disputes (see Inside the Institutions, What is the World Bank’s International Center for the Settlement of Investment Disputes (ICSID)?) over an $11 billion claim by Honduras Prospera, a US company, arguing ICSID has breached “law and procedure”. In April 2022, the Honduran government repealed a 2013 law that allowed the US company to establish a charter city in a special economic zone (SEZ) in 2021.

Prospera’s $11 billion claim for damages amounts to about two-thirds of Honduras’s annual budget. US-based publication The Atlantic described Prospera as neo-medieval and neo-colonial, while Bloomberg described it as “a mini startup nation with its own set of laws.”

The case highlights serious issues with both SEZs and investor-state dispute settlement (ISDS) arbitration panels like ICSID (see Observer Summer 2020), raising critical questions about national sovereignty and effective democratic oversight over economic governance in the Global South.

Honduras pushes back against SEZs

The Honduran SEZ law that permitted the establishment of Prospera allowed these zones to operate subject to Honduran criminal law but with their own civil code and administration. It was initially ruled unconstitutional by the Supreme Court in 2012, but was reversed after several Supreme Court Justices were replaced and the constitution changed. The model Prospera followed was based on former World Bank Chief Economist Paul Romer’s idea that poor countries could grow rich by encouraging foreign-run ‘charter cities’. Finally established in 2021, it became what tech news website Rest of World described as a “crypto-libertarian paradise.”

In a promotional video, Prospera asked if Honduras’ SEZs are “Tax havens or catalysts for competitiveness?” Prospera’s neighbours in Honduras were less enthusiastic, fearing the zone could expand and expropriate their land. According to Peace Brigades International-Honduras, the new SEZs in Honduras, of which at least three are known, are strongly reminiscent of “predatory extractivist policies of past decades, such as the mining and banana enclaves of the late 19th and early 20th centuries.”

Crucially, there is no actual evidence that SEZs are economic dynamos capable of supercharging national economies. A study by Shahid Yusuf, Chief Economist of The Growth Dialogue, published in April 2023 by the Center for Global Development, noted that at best, SEZs display an initial growth spurt, then revert to the growth rate of the rest of the economy, while the incentives provided only increase the cost to the host country. Even the World Bank itself now broadly acknowledges SEZs have failed to live up to their promise.

ISDS: Pervasive, difficult to escape and of no discernible benefit

Unfortunately, even if Honduras does withdraw from ICSID over Prospera’s claim, ISDS cases could still be brought against the country. It would still have to defend Prospera’s $11 billion claim, and any others filed within a six-month window of formal withdrawal notification. Honduras could also potentially be subject to further cases through one of the eight bilateral investment treaties it has signed that refers arbitration to ICSID.

Despite the proliferation of ISDS clauses in trade and investment agreements, evidence does not indicate investment agreements actually stimulate investment, or benefit the host country. A 2018 study from the Columbia Centre for Sustainable Development (CSD) concluded “the expected benefits have not clearly materialized, whereas the costs have been unexpectedly high”, while a 2020 meta-analysis by researchers Jozef Brada et al found “robust evidence that [the] effect of international investment agreements is so small as to be considered zero.”

Civil society has long argued that ICSID is “seriously flawed” with a “perceived bias against states”, and that ISDS clauses constrain the policy space available to states to act in the interests of people. UN special rapporteurs have also been highly critical, calling out states for prioritising investments over human rights, the rule of law and democracy.

A May 2023 letter signed by five US Senators and 28 members of the US Congress noted, “Large corporations have weaponized… this faulty and undemocratic dispute settlement regime to benefit their own interests at the expense of workers, consumers, and small businesses globally.” The power relationships in investment treaties are often inherently asymmetrical, with investors from Global North states more likely to win their claims.

CSD noted these agreements undermine the ability of Global South states to govern, reducing the policy space available to them and increasing the cost of regulating their own economies, and this problem is particularly acute for states navigating the green economic transformation. These concerns are likely to become even more salient as discussions on reform of international development finance progress. The World Bank’s Evolution Roadmap explicitly refers to increased support for ICSID as efforts are made to mobilise more private capital (see Observer Summer 2023).

Can ISDS be challenged?

Momentum is gradually building against ISDS. In 2020, US President Joe Biden signed a campaign pledge to exclude ISDS clauses from future trade deals. The letter from US Senators and members of Congress requested the US administration “investigate any and all options at your disposal to eliminate ISDS liability from existing trade and investment agreements.” The EU Court of Justice has also issued a series of rulings to the effect that ISDS clauses between members of the bloc are incompatible with EU law, but there has been pushback from national courts and ICSID itself, and the issue is unresolved.

However, the web of international treaties and obligations containing ISDS clauses means the system of protection for international investments, embodied in thousands of investment treaties and in ICSID itself, will be more difficult to unravel. As the CSD notes, “it is particularly difficult to course-correct in a fragmented and often conflicted international investment law regime that lacks meaningful checks and balances.”

Unfortunately, this leaves Honduras likely facing a budget-busting $11 billion claim for reasserting its sovereignty over a foreign enclave a previous government sanctioned on its soil.