Review: The Legalization of Dispute Resolution in Mercosur

Wednesday, January 8, 2014 - 16:15

The Legalization of Dispute Resolution in Mercosur from Christian Arnold and Berthold Rittberger, published in August 2013 in the Journal of Politics in Latin America, discusses how Mercosur, one of the world’s largest trading blocs and examples of economic regionalization, revised its dispute settlement system (DSS) in 2002 from one based on diplomatic negotiations and ad hoc tribunals to one much more legalized and institutionally deep. This was accomplished by establishing a standing court with a more independent judiciary and improved access to the court’s jurisdiction. This article, published in 2013, helps to develop research on Mercosur, which has been underexamined compared to other regional trading blocs like the Eurozone, NAFTA, or ASEAN. Mercosur has encountered frequent criticism for its inability to properly coordinate macroeconomic policy beyond setting a common external tariff and abandoning internal tariffs, so the strengthening of Mercosur’s DSS can be seen as a crucial step towards building the supranational status necessary to subordinate the sovereign and self-interested motivations of its member states, especially Brazil and Argentina.

The article adopts a ‘rational institutionalist’ explanation for why Mercosur has shifted towards the legalization of the DSS, and provides hypotheses that account for member states’ preferred degree of legalization (the why), the timing of shifts in legalization (the when), and the institutional form that legalization takes (the how). Arnold and Rittberger draw on contracting theory and the rational actor model of institutional reform, which explain that though the preferences of actors (the strongest preference is to get elected or remain in power) don’t change, strategies adapt over time in response to external factors (in this case, financial or economic crises) to suit these preferences.

Arnold and Rittberger present three hypotheses to explain why Mercosur has become more legalized by making institutional reforms to the DSS. Their first hypothesis states that:

“Stronger states tend to be less in favor of legalization, while weaker states will demand international commitment institutions or complete contracts that are closely specified. The more modest the power asymmetries are, the more likely it is that states will agree on commitment institutions and hence advances in legalization.”

This hypothesis, according to the authors, is backed by contract theory because institutions are a corollary for incomplete contracts. This makes governments of weaker states anxious about long-term consequences of international treaties, as more powerful states can alter the initial agreement. Since weaker governments tend to be smaller and more dependent on trade, the authors expect nations such as Paraguay and Uruguay to be more in favor of legalization than Brazil and Argentina, which have less to gain from cooperation. Legalization acts as a “commitment institution,” which will keep large, less dependent states from leveraging their bargaining power to renegotiate initial agreements.

Arnold and Rittberger’s second hypothesis states that:

“In times of economic crises, the legalization of dispute settlement systems signals governments’ commitment to economic cooperation and economic integration to transnational economic actors and investors.”

Here, the authors argue that two mechanisms are necessary to explain the timing and content of institutional reforms. First, external factors (such as financial crises) transform the strategic context for cooperation and shift member states’ strategies and bargaining positions. Mercosur members modify cooperation strategies and, in this case, seek legalized forms of dispute resolution in order to foster confidence in the economic vitality of the region as a whole. Outside investors can then interpret political and economic stability as a positive signal and continue to commit foreign direct investment (FDI) to the various member states. Second, policymakers design institutions within a context of imperfect information. It is not until the transaction costs and distributional consequences become apparent that political actors are motivated to modify their strategies. Both of these mechanisms explain how governments and policymakers may revise their strategies to favor deeper regional cooperation and integration via legalization of the DSS in the hopes of increasing their probability of re-election.

The third hypothesis states that:

“If governments learn that an existing dispute settlement system produces unexpected transaction costs or distributional effects, they readily adapt their strategies and press for the terms of the contract to be renegotiated.”

This hypothesis has similar implications to the previous hypotheses. The two supposed drivers of Mercosur’s DSS reform – an economic crisis and the institutions’ unexpected distributional and welfare impacts – are necessary to explain both the timing and the scope of institutional reforms. The occurrence of economic crises explains the timing and the push towards more universal methods of dispute resolution. Unexpected distributional and welfare impacts contribute to the authors’ understanding of the timing and content of steps towards legalization and increased interdependence.

Arnold and Rittberger cite several sources of evidence to support their hypotheses. Their first hypothesis demonstrates the more economically dependent states in Mercosur, Paraguay and Uruguay, should lobby for “commitment institutions” and higher levels of legalization in order to prevent being dominated by Argentina and Brazil. Indeed, Argentina and Brazil are much less economically dependent on trade than Paraguay and Uruguay, and were therefore historical opponents of the legalization of the DSS.

The main suggestion of the second hypothesis, that the economic crises in South America (which had a particularly strong impact on Argentina and Brazil) would encourage further legalization and signaling of economic stability, also appears to be true looking at the historical record. Argentina and Brazil did become stronger advocates of legalization and economic regionalization following the crisis in the early 2000s.

In reference to the third hypothesis, the authors argued that policymakers learn about the effects of the DSS once the system is in place and the consequences can be observed, and will update the rules and renegotiate agreements to improve their positions once the institutional effects have taken place. Historically, this is supported by the shift from diplomatic negotiations and ad hoc panels to the legalization institutions of a standing court with an independent judiciary and improved access to the court’s jurisdiction.

Apart from a retrospective confirmation of their hypothesis for why Mercosur’s member states sought to increase the legalization of the DSS, the authors rely on diplomatic documents and interviews of members of government, ministry officials involved in the negotiations, representatives of interest group members, and lawyers tied to relevant politicians. The authors refer to this research as empirical, but it seems to be standard qualitative research through review of primary documents and interviews.

Although the authors contributed to the explanation of why Mercosur’s member states, especially the strong and independent members like Argentina and Brazil, chose to negotiate to further legalize the DSS in 2002, their hypotheses seem to have been tailored to these developments after they happened. Traditionally, social scientists will either explain a phenomenon using theoretical methods or empirical data, or will offer a hypothesis, test the hypothesis, and reject or accept it according to the evidence. Arnold and Rittberger seem to mix these different approaches to ‘prove’ why institutional developments occurred after the fact. It is interesting to learn that Uruguay and Paraguay pushed for a more legalized DSS because they feared domination of Argentina and Brazil, and that Argentina and Brazil only negotiated following an economic crisis to credibly signal economic stability to outside investors, but the piece is much more of a case study than the empirical study that the authors purport it to be.

Nonetheless, the piece provides an important contribution to the study of institutional developments in Mercosur, which have been understudied compared to other similar trading blocs. More research in this vein should be conducted, but academics should be careful whether they are offering explanatory case studies or drawing conclusions from genuine empirical research.

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