Download NAFTA Chapter 11 – Issues and Opportunities

REPORT “NAFTA Chapter 11 – Issues and Opportunities”
July 2002
NAFTA Chapter 11 – Issues and Opportunities
Research paper on NAFTA Chapter 11 and its use for illuminating
debate on investment provisions in an Australia-US FTA.
Report
Basics – Chapter 11, Key Provisions
Arguments/theory supporting Chapter 11
Criticism/theory against Chapter 11
Evidence of Chapter’s effects
Policy Lessons, Policy Recommendations
Conclusion
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Supporting Material
Bibliography
Annex 1 – Reservations to Chapter 11
Annex 2 – Case Study Analysis, Methanex & Metalclad
Annex 3 – Criticism, Extended Analysis
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REPORT “NAFTA Chapter 11 – Issues and Opportunities”
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What is NAFTA Chapter 11?
Chapter 11 of the North American Free Trade Agreement
(NAFTA & ‘the Chapter’; NAFTA, 1993: 11.1-29) sets down
the rules protecting foreign investors in the three states bound
by NAFTA: Canada, Mexico and the United States (US). The
Chapter is divided into two sections, the First being substantive
(or describing content), and the Second outlining procedures
for dispute resolution. The Second Section relies on
international jurisdiction between the three states, and on the
use of tribunals under the authority of supra-national bodies
and agreements, namely, the International Centre for
Settlement of Investment Disputes (ICSID) in the World Bank,
and the United Nations International Convent on International
Trade Law (UNICITRAL).
Contoversial Investment Rules
Despite a proliferation of bilateral investment treaties in recent
years, 1 the Chapter is unique as ‘the first comprehensive
international trade treaty to provide to private parties direct
access to dispute settlement as of right’ (Trebilcock & Howse,
2000: 355). While the Chapter’s rules and dispute provisions
have led to only a small number of successful cases (three as of
March 2002), the Chapter has created, and continues to create,
significant controversy. The issues involved are complex,
involving economics; law, and politics. At the nexus of most
debates surrounding the Chapter are issues of legal extraterritoriality diminishing national sovereignty. Due to the high
profile activity of various environmental organizations, 2 the
politics of environmental lobbying have dominated much
debate on the Chapter.
What are the key provisions?
MFN & National Treatment
Articles 1102 & 1103: obligation to accord National
Treatment and Most Favored Nation (MFN) treatment to
foreign investors (Articles 1102, 1103). The National
Treatment and Most Favored Nation status requirements are
modeled on the similar provision in the World Trade
Organization (WTO), where they apply to trade in goods and
services. A decision on whether to negotiate similar provisions
for investment in the WTO will be taken in 2003 at the
Ministerial meeting.
1
There were more than 900 existing bilateral investment treaties as of March 2000 (source: World
Trade Organization).
2
Prominent examples include the International Institute for Sustainable Development, Communities
for a Better Enviornment, and the Centre for International Environment Law.
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Minimum treatment
Article 1105: requirement to accord foreign investors
‘minimum treatment’ as per the norms on treatment of aliens
under international law.
Prohibition on some performance requirements, and
reservations for others
Article 1106: a prohibition on performance requirements on
foreign investors. Article 1106 provides a prohibition of
performance requirements, prohibiting Parties making the right
of investment dependent on fulfilling certain requirements. In
addition to the general exceptions of the Chapter (Article 1108,
below) Article 1106 allows for a range of exceptions for
permitted performance requirements, among others,
• requirements that investments meet generally
applicable health, safety and environmental standards;
• conditioning the receipt of advantage on compliance
with requirements to locate production, provide a service,
train or employ workers, construct or expand particular
facilities, or carry out research and development in a
Party’s territory (i.e., investment incentives are not covered
by the agreement);
• measures necessary to secure compliance with laws and
regulations that are not inconsistent with NAFTA;
• measures to protect human, animal or plant life or
health; and measure necessary for the conservation of
living or non-living exhaustible natural resources;
• qualification requirements for goods or services in
relation to export promotion and foreign aid programs;
government procurement, and
requirements imposed in relation to content of imported
goods to qualify for preferential tariffs or quotas.
The Reservations to the Chapter
Article 1108: reservations and exceptions. Various activities
are excluded for all Parties, including those falling broadly
under the Police Powers of states as these are understood in
international law, and the provision of various public services,
including education; health, and welfare; and procurement;
subisidies; grants, and foreign aid. Furthermore, states may
make reservations for existing measures, and the prompt
renewal of measures which do not increase conformity, under
various annexes to the Chapter. Local government measures
are not subject to direct claims, although non-conforming
measures of local governments have been seen as indirectly the
responsibility of national governments (Metalclad v. Mexico).
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Where not reserved, existing non-conforming measures must
be eliminated within ten years.
Most significant exclusions, including sectoral and “tit for tat”
reservations, are reproduced in Annex 1.
Rules restricting “expropriation”
Article 1110: restrictions on the ability of the state to
expropriate and the obligation to compensate for expropriation.
Article 1110 was designed primarily to protect investments
from Canada and the United States from arbitrary government
action, such as nationalization, in Mexico, where the legal
system was less developed and private property rights less
regularly protected. It has been used to defend investment from
discriminatory government action. Article 1110 prohibits
Parties from nationalizing or otherwise expropriating an
investment or proceeds from an investment of an investor of
another Party, or “taking measures tantamount to
nationalization or expropriation” of such an investment, except
where this done:
for a public purpose;
•
•
on a non-discriminatory basis;
•
in accordance with due process of law, and
where compensation is paid in accordance with the
•
Article.
Thus where it can be found that Parties have expropriated
investments or the proceeds of investments, or have taken
measures “tantamount to expropriation” in a discriminatory
fashion then the Party in question is required to compensate the
investor or investment.
Rules that govern the settlement of disputes
Articles 1115-1138: mechanisms for investor-state dispute
settlement (Articles 1115-1138), Articles 1115-1138 are
separate but do not exclude the dispute settlement procedures
appertaining to the overall agreement which appear in Chapter
20. The key requirement for submitting a dispute is that one of
the states (‘Parties’) to the agreement be in breach of the
provisions of the Chapter, and that the breach has injured the
Party bringing the dispute. The Dispute settlement process
(Second Section) requires investors to submit claims under to
arbitration by ad hoc tribunals under either the ICSID
Convention, where both the disputing Party and the Party of
the investor are parties to the Convention;3 the ICSID
“Additional Facility Rules”, where only one is a party to the
3
This is currently an impossibility, since as of March 2002, only the US is a Party to the ICSID rules.
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Convention, or the UNCITRAL Arbitration Rules, where
neither Party is a party to the ICSID rules.
The dispute mechanism Section has further requirements,
among others, that the investor or enterprise has suffered loss
or damage due to the breach (Articles 1116(1) and 1117(1));
that the disputing parties have attempted to settle the claim
through consultation or negotiation, but have failed (Articles
1118 and 1120(1); that six months have elapsed since the
events giving rise to the claim (Article 1120(1)); that the
disputing investor or enterprise in a claim consent to the
NAFTA arbitration rules and waive the right to initiate or
continue any proceeding for compensation in respect of the
same measure before domestic courts and tribunals (Article
1121). However, with regard to the last provision, the disputing
Party (or, the Party accused) is not required to consent to
arbitration, i.e., the state Party must go to arbitration once
initiated by the investor. Tribunal awards have binding force
only between the disputing Parties and in respect of the
individual case (Article 1136(1)).
What Purpose does the Chapter serve: Arguments For
Arguably, the Chapter can increase investment through
reducing barriers. At a most basic level, the theoretical
economic and political basis for the Chapter’s provisions lies in
the principles of the sanctity of private property against random
or unaccountable government action, and that of well-regulated
market forces being most able to allocate private investment
efficiently, thereby increasing productivity and general welfare.
Theory exists to explain both the positive effects of foreign
investment on an economy through increasing the available
capital stock and through the effect of technology “spillovers”
(Caves, 1960; Teece, 1977; Dunning, 1981, Graham &
Krugman, 1995), and of the general empirical evidence
available, much (though not all) suggests positive effects of
foreign investment on a country’s competitiveness (Caves,
1974; Globerman, 1979; Blomstrom & Persson, 1983;
Blomstrom & Wolff, 1989; Xu, 2000). 4 If high levels of
investment are important for developing productivity then
discrimination between investment on the basis of origin
(foreign or domestic) is counterproductive. Furthermore,
economic theory suggests the importance of transparency and
codified regulatory frameworks for attracting foreign
investment (Caves, 1960).
4
Xu Bin’s study (2000) examines US firms operating in 40 different countries and finds positive
spillover effects in all.
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What are the effects on sovereignty?
It is not government regulation or policies that serve as the
antithesis of investor rights, but discriminatory, capricious
government action, based on national difference, or in any way
otherwise discriminatory. Thus, government measures taken to
regulate the activity of investors ought to be based on
demonstrable policy aims. If not, general welfare will suffer
from the political influence of those best placed to prefer one
investment over another.
Codifying the expectations of investors allows for stability, and
limits the discretionary abuse of government power. An
important distinction exists between sovereignty which is
ceded willingly in a multilateral framework and which can be
restored as desired, and intrusions into the sovereignty of one
country by another, against the will of the first country and
falling outside multilateral frameworks. The first way of ceding
sovereignty allows states mutually to recognize certain rights
and obligations, for mutual benefit. In this sense, the agreement
does represent a curb on government dictate, as do all
international agreements (be they economic, social or
otherwise) and as do all national laws to some extent, as is
concomitant with the theory of a balance of powers in a
capitalist democracy. In another sense, the Chapter actually
does not severely limit national sovereignty, insofar as
measures which respect sovereignty are those which do not
mandate unilateral sanctions or justify extra-territorial reach of
national measures.
Thus, the Chapter is a codified, multilateral agreement entered
into and maintained freely by sovereign governments.
Do the rules mean governments must ensure the success of all
investments?
Significantly, this theoretical basis does not require a
government to regulate in such a way as to ensure the success
of all investment in its jurisdiction. On the contrary, the
relevant economic theories imply the cyclical success and
failure of businesses based on their efficient or inefficient use
of funds and resources, this being the primary mechanism to
spur growth. Underlying issues of the protection of private
property; the promotion of market forces to guide investment,
and the limitation of sovereignty is the economic theoretical
question of the role of governments and markets in the efficient
control of investment. This question underlies much of the
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controversy surrounding the agreement. The fundamental
divide falls between policy that promotes the role of
government in directing private investment, to achieve various
social policy goals, and policy which sets codified regulation
on investment, but permits the market to determine where
investment will be most profitable. Of particularly relevance,
since environmental groups have dominated much debate on
the Chapter, are theories of how best to regulate the
environmental cost of investment (Pigou, 1912; Coase, 1960).
What are the criticisms of the Chapter – Arguments Against
Most criticism surrounds Article 1105, minimum treatment,
Article 1110, expropriation, and the Articles 1115-1138 on the
procedures for dispute resolution. Further criticism is not
directed at any particular Article, as outlined below. A separate
strain of criticism surrounds Article 1109, which prohibits
restrictions on capital transfers, thus prohibiting Parties from
putting controls on inflows or outflows of portfolio capital.
Significantly, much of the criticism deals with the inequalities
between a developed country (Canada and the US) and a
developing country (Mexico).
The Chapter’s major critics are environmental groups. The
main groups are the International Institute for Sustainable
Development (IISD), led by Konrad von Moltke; the Centre for
International Environment Law; and Public Citizen
(Organization).5
Sustainability – theories environmental or economic?
While arguments are made concerning the effects of the
Chapter on environmental sustainability, the same arguments
also often rely on economic theory, including theory on the
benefits of codifying foreign investment as a way to attract
investment, and the effects of short term and long term
investment on development (Weisbrot & Watkins, 1999: 6, 16,
17; Bissio, 1999: 25; Mann & von Moltke, 2002: 5).
How important is protecting investment?
Mann and von Moltke’s (2002) first criticism is that, while
investment is important to growth, protecting foreign
investment from government action is a small factor in the
5
These three groups have well-established positions on the need to use controls on investment as one
basis for ensuring environmental protection and standards, and on the importance of the precautionary
principle (basically, a zero tolerance for environmental risk, at any cost, even in opposition to scientific
evidence) in environmental regulation. Papers are available at www.iisd.ca, www.ciel.org, and
www.citizen.org.
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decision-making of multinationals on where to invest.6 Since
this is the case, they argue, protecting investment from
arbitrary government action is less important than protecting
the environment through allowing governments policy
discretion against investors. While this criticism is dealt with in
detail in the critcism section in available in Annex 3, the
following is an immediate theoretical response.
Mann and von Moltke implicitly acknowledge that the legal
stability of investment is a factor in foreign investment
decisions. It seems convoluted to argue that, in the interests of
effective environmental regulation, discrimination among
investment on the grounds of origin should be permitted, for
the reasons that such discrimination has little impact on the
investment decisions of firms on whether or not to invest in an
economy. Such discrimination is of itself economically
distortionary and counterproductive, regardless of its effects on
environmental policy-making. As such, there is no economic
argument for permitting such distortion.
Fairness for domestic firms
Secondly, Mann and von Moltke (2002) and CIEL (1999)
argue that the expropriation provision Article 1110 on the basis
that foreign investors enjoy a level of treatment not accorded to
domestic investors. The expropriation article is one of the most
controversial of the Chapter, and all of the three successful
cases, this Article was upheld. Von Moltke et al. argue that the
Chapter has diminished the ability of states to regulate,
particularly on environmental issues, for fear of litigation. They
claim that while the Article was designed to permit companies
defensive action in the case of seizure of their property, it has
been used as a tool to challenge legitimate regulation. The
Article dealing with expropriation in the Chapter arises from a
US and Canadian desire to protect investment from random
nationalization in Mexico’s much less predictable governance
6
Mann and von Moltke (2002: 5) write: “The empirical evidence that does exist suggests that risk
reduction element associated with traditional investment protection is at best a marginal factor in
business decision-making on FDI.” UNCTAD and UNELAC studies are subsequently quoted as
supporting the claim that risk management is “one, but only one, investment factor”. This last
statement is not in doubt. The paper (2002: 5) later states: “the creation of an international framework
for investment will not by itself change investment flows”. This also is not in doubt. However, the
scope of “risk management” as a category envisaged in such reports may not encompass the notion of
discrimination permitted for under the Chapter. Furthermore, the Chapter involves the dynamic effects
of on-going protection, and the associated market profile: in several of the cases which have come
before Chapter 11 tribunals discrimination has meant the closure of a venture, making these issues of
foremost importance for the investors involved. In this light it is reasonable to assume that these cases
would result in a large profile for legal checks on government mandate in the minds of other investors
in similar industries, who might one day be subjects of similar action.
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systems. Much controversy stems from the definition of
expropriation. Significantly, this second claim effectively
belies the previous claim that recourse to legal action is
unimportant to investors.
Expropriation
The definition and jurisprudence of “expropriation” in
international law is narrow and weak compared to its
equivalents in Canadian and US law, and there are several key
differences between Canadian and US law and jurisprudence
on this point (Johnson, 1998: 223; Trebilcock & Howse, 2000:
354). The critics appear to employ theory from environmental
economics to support their view on the scope of expropriation:
Under a broad construction of expropriation, a
government could be required to “pay to regulate”
polluters if a court or international arbitration panel
were to decide than an environmental regulation
(e.g., refusal to permit construction) had reduced the
value of a foreign investment, either directly or
indirectly. Such an approach to environmental
regulation would turn the polluter pays principle on
its head – the government would have to pay the
corporation for not polluting.
Refuting this argument theoretically is best done in the context
of empirical analysis, available in Annex 2, case studies, and
Annex 3, criticism analysis. Briefly to summarise this analysis,
however, the three successful claims of expropriation have not
revolved around environmental issues, therefore the important
issue of regulating environmental cost has been circumvented
by NAFTA tribunals. Instead, the findings of all three tribunals
have been narrow but pertinent interpretations of nonenvironemntal policy issues.
Financial movements
A third strain of criticism from the Centre for International
Environmental Law (CIEL)7 surrounds the freedom of capital
transfer provisions. Mark Weisbrot; Neil Watkins, Roberto
Bissio and CIEL itself (Weisbrot & Watkins, 1999; Bissio,
1999a,1999b; CIEL 1999) all argue that the liberalizing the
capital accounts of Mexico; Malaysia; Thailand, and Korea
was one of the causes of currency crises in these countries.
While monetary crises are not unique to developing countries,
these arguments are mainly applicable to countries with less
rigorous monetary and banking systems, rathert than developed
countries where capital accounts are already liberalized and
7
These papers are referenced as CIEL’s official position on the Chapter, as at
www.ciel.org/Tae/programtae.html., last accessed 18/07/02.
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currencies already on floating exchange rates. In the latter
countries, such as the US and Australia, applying currency
controls and limiting capital flows would be highly unlikely
policy choices, given the extent of financial liberalization. This
criticism is dealt with in the cases studies, available in Annex 2
and 3. Briefly to summarize this analysis: while the ideal
financial architecture for developing countries is a complex
issue, many economists view capital controls as shields for ongoing problems of weak regulatory systems, and moreover a
“potent source of corruption” (Krugman & Obstfeld, 2000:
714).
Other criticisms
Public Citizen Organization (Public Citizen) in the United
States is also a vocal critic of the Chapter. David Waskow,
Mary Bottari and Lori Wallach (2001), writing for Public
Citizen, make similar criticisms of the Chapter to those of
Mann and von Moltke. These are that foreign investors are
permitted to evade legal liability; that there is a lack of
transparency in the tribunal process; that cost to the tax payers
of payouts is too high, that state and local governments are
subject to complaints under the Chapter; that the extent to
which a government action must be capricious and
discriminatory in order to constitute a breach of the Chapter
(that “expropriation” can constitute a defensive action) is too
permissive; that the attack on Sovereign Immunity and the
regulatory chill put on governments is undesirable; that
corporations seek compensation merely for a drop in
profitability; that the Chapter’s environmental protection
clauses are meaningless; that the Chapter permits the
importation of WTO regulations into NAFTA tribunals, and
that arbitrary rulings mean rudeness by government officials
can be a violation of the Chapter. Waskow et al. (2001) use
their reading of the existing and pending case law to support
these criticisms. These criticisms are dealt with below
(“Dispute Outcomes”), and in Annex 3.
Further issues emerging from other less virulent critics of the
Chapter (Hart & Dymond, 2001; Dhooge, 2001) include the
scope of legal expertise permitted the tribunals; the extent to
which foreign investors should attempt domestic resolution of
disputes; the non-permanent nature of tribunals; the status of
the NAFTA secretariat, and the need to resort to supra-national
rules outside of the agreement. These are also dealt with in
Annex 2.
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Existing evidence of the Chapter’s effects
Within the rather broad provisions of NAFTA Chapter 11 there
was considerable scope for varying interpretation. The broad
nature of the agreement is arguably both its greatest strength
and its greatest weakness. However, it is important to look to
the economic and case evidence of the effects of the agreement
in order to assess the benefits and costs of its mechanisms. In
examining both the economic evidence and the relevant case
law it is helpful to consider several underlying issues: the
tension between domestic government power and the limits on
this power set by the Chapter; the issue of the scope
(expanding or otherwise) of the Chapter, and the issue
regarding the increased power of enterprises (which we can
assume to be profit-maximizing entities) and their ability to
challenge what would otherwise be legitimate government
regulation, in the interests of preserving profits.
Economic evidence
The most important economic test of the agreement is the
extent to which the agreement has increased investment flows.
The evidence of the effects of the investment provisions of
NAFTA on foreign direct investment and portfolio flows are
not conclusive. Foreign direct investment increased in all three
countries(NBER, 1997, 1999; ERS, 1998; Sanchez and Karp,
2000), but the relationship with the investment provisions is
likely to be correlative rather than causal, reflecting the effects
of general liberalizations of trade and investment policies
before, during and after the agreement. Importantly, these
findings do not imply that the positive effects on investment
are nil. Magnus Blomstrom and Ari Kokko (1997) predict that
the effects of liberalizing investment will be greater when it
coincides with liberalization in other areas. Much of the
available economic evidence (Lall, 1996; NBER, 1997, 1999;
ERS, 1998; Sanchez and Karp, 2000) suggests increased
investment between Canada, the United States and Mexico, and
increased investment toward Mexico from a range of different
countries. Both Canada and the United States already enjoyed
liberalized investment regimes and therefore the protection of
investment contributed proportionally less to increases toward
these two countries than toward Mexico.
Dynamic Effects
The case of Mexico demonstrates why liberalizations appear to
gather momentum in the eyes of foreign investors. Mexico
carried out a series of investment reforms in 1989, but these
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reforms did not receive the full attention they were
subsequently to attract until the advent of NAFTA. The United
States Economic Research Service (ERS, 1998) writes:
Since the enactment of NAFTA, FDI into Mexico from
other countries has increased even though US FDI
[foreign direct investment] has remained flat. This
indicates that investment policy changes, not market
growth, attracted non-US FDI. One explanation is that
Mexico’s inclusion in NAFTA gave its recently
liberalized investment and trade regime greater
credibility in the eyes of foreign investors.
The study concludes that the effects of the NAFTA investment
provisions have had their greatest effect in concert with other
liberalizations, as is the case when investment provisions are
embedded in wider scale trade agreements.
Dispute outcomes
Twenty-three cases have been or are being notified to NAFTA
tribunals. Of these, only five cases have led to arbitral
decisions; others have either been settled, withdrawn, or remain
pending. Among settlements are cases such as Ethyl v. Canada,
where regulation was changed but awards were not handed
down, when a domestic court found the government act in
question invalid. Of these five, three have been successful,
winning disputes against Parties to NAFTA. The successful
cases are, in chronological order, Metalclad v. Mexico; Pope &
Talbot v. Canada, and S.D. Myers v. Canada. Of these three,
two of the tribunal decisions (Metalclad and S D Myers) have
seen the scope of their findings reviewed and narrowed by
domestic courts (Hart & Dymond, 2002: 19). In all four cases
litigants made expansive interpretations of the Chapter’s scope,
however, as Michael Hart & William Dymond (2002: 11) point
out, “the number of arbitral awards has been small, and the
basis of panel decisions much more narrowly conceived than
the extravagant claims of either the complaining parties”.
Anthony Van Duzer (2002) concurs:
while the broadly worded substantive obligations of
NAFTA states in Chapter 11 may be capable of being
applied in a manner that would impose significant
constraints on sovereignty, they have not been applied
to do so. So far, only egregious state actions which
were either arbitrary, clearly unfair or overtly
protectionist have been found to be contrary to
obligations under Chapter 11. Where tribunals have
created some problems in their decisions, judicial
review or intervention by the Free Trade Commission
with a binding interpretation have restored the balance.
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Thus both Hart and Dymond and Van Duzer make a significant
distinction between the claims of the litigants and the findings
of the tribunals, findings which have been subsequently subject
to review. This distinction reflects the nuanced operation of the
tribunals, within the framework provided for by the agreement.
Further analysis of evidence
Two cases, one decided (Metalclad) and the other still pending
(Methanex), give good frameworks for examining the above
issues in greater detail. This analysis is provided in Annex 2.
Discussion of these cases with reference to the criticism of the
NGOs outlined above is provided in Annex 3.
Policy Lessons
The notion of free trade agreements encompassing more
than trade and becoming “free market agreements” (Oxley,
2002: 1) is concomitant with the World Bank notion of
“deep integration” (World Bank, 2000). Broadly this
argument holds that agreements which follow the model of a
customs union but involve integration of trade, services,
investment, labor and competition regimes are far more likely
to benefit welfare in participating and third countries (World
Bank: 13; Schiff and Winters, 1998a, 1998b) than those that
liberalize selectively. While very few agreements are likely to
achieve absolute integration, it can be argued there is
considerable scope within each of these categories such that
they need not be seen as mutually exclusive.
The evidence presented here and in Annexes 2 and 3 suggests
that including investment provisions in an Australia-US
market agreement could provide significant economic benefit
to both parties and the firms involved. Recourse to codified,
legal agreements would help to protect and support the
environment for foreign investment. In the event that
investment provisions similar to those in NAFTA were to be
included in an Australia US market agreement, certain
recommendations would be usefully employed from the
findings of this research. Ann Capling (2001) describes the
political argument against incorporating elements of Chapter
11 into an Australia-US FTA, in the context of the rejected
MAI agreement in 1998. Her analysis is examined in Annex 3.
Policy Recommendations
Firstly, the term of expropriation could be usefully avoided,
thereby also avoiding the legal controversy to which it has
given rise. The term was originally employed to protect two
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countries with highly developed legal systems from a country
with a less developed legal system (Rugman & Gestrin, 1996).
An equivalent provision, under the rubric of National
Treatment, could still provide for government damages, and
could deal explicitly with discriminatory and capricious
government action.
Secondly, the secretariat to the agreement, or a coalition
supported by relevant government bodies from both the US
and Australia, could be responsible for the dispute settlement
procedures. A new set of rules or a unique set of supranational rules would be best employed. While a secretariat
could follow rules similar to those in the ICSID and the
UNCITRAL rules, it would avoid the complexity. The rules
could also incorporate domestic investors, thereby providing
for less discrimination (i.e., domestic investors believing they
had suffered discrimination at the hands of governments could
also make claims). Private parties would be required to
exhaust domestic avenues for remedy before resorting to these
mechanisms. Transparency could also be written into the
processes of the dispute settlement. Allowing private parties
avenues of direct complaint would allow cases to be heard
that governments might otherwise be unlikely to undertake,
for fear of political ramifications. A more powerful dispute
resolution body could dismiss frivolous cases quickly and
easily. A process of administrative review could also be built
into the process.
Thirdly, reservations to the investment provisions could be
included, like in NAFTA, for sensitive sectors. These
exceptions would allow review by the relevant investment
boards for particular activities or sectors, where investment
exceeded stated levels of capital. Whereas in the United States
Canada Free Trade Agreement all reserved sectors were
“grandfathered” (or, all existing non-compliant legislation
was permitted), NAFTA provided negative lists of excepted
sectors and areas (Gestrin & Rugman, 1993). The negative list
approach has considerable advantages as it limits the room for
discrimination through the review process (Gestrin &
Rugman, 1996: 64).
Fourthly, explicit provisions dealing with the importance of
bringing state and local governments into alignment with
national directives on supra-national agreements would
remove confusion on this issue.
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Fifthly, discipline on investment incentives at all government
levels is not a feature of NAFTA, although Stephen Gusinger
(1995) makes a strong case for positive effects of such
discipline.
Conclusion
NAFTA Chapter 11’s provisions have led to much
controversy; however, it is not apparent that all the concern is
warranted as of present. While the Chapter has broad
provisions, there are specific requirements that breaches of the
most controversial articles be based in fact, and that they
demonstrate not simply legitimate government regulation, but
discriminatory or confiscatory action. The cases which have
handed down awards have worked on a narrow but pertinent
interpretation of these provisions. The Methanex case is the
first to directly challenge an environmental regulation, and its
decision will be an important contribution to case law.
However, examination of the facts of the Mehthanex case
reveals, in the opinion of this article’s authors, at least the
possibility of discriminatory action. In any case, the litigants’
claims will most likely be further narrowed by panel hearings.
Unlike the controversial MAI, reform of the Chapter has
occurred, allowing for the presence of amicus curiae, and
permitting greater transparency in arbitration. Further reforms
could fit within the existing architecture of the agreement.
The agreement is a unique model which codifies the
expectations of foreign investors and allows them recourse to
tribunal hearings. It does not merely provide negative
assurance against discriminatory government action, but
appears to have improved the functioning of regulatory bodies
through the threat of large scale remedies. While political
necessity has required limitations on the agreement, it is
remains remarkably strong in its ability to reach resolutions in
a narrow range of cases. Political sensitivity itself appears an
insufficient reason to ignore possible benefits of such
legislation. The economic benefits offered through the
codification of investor rights are put significantly at risk by
alarmist analysis of the Chapter. Its general framework and
the informed debate over its shortcomings appear useful in
debating investment provisions of a possible Australia-US
free trade agreement.
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Annex 1 Analysis of Reservations to NAFTA effecting Chapter 11.
Five of these Annexes include reservations on the Chapter. These Annexes variously provide different levels of reservation from the
binding commitments of the treaty. These include reservations on land ownership; review of foreign direct investment (see below);
performance requirements, and scarce resources. A full description of the Annexes to NAFTA which pertain to the Chapter (but not a
full list of reservations) is included in Annex 1 of this report. The reservations fall broadly in to three categories, as described by Alan
Rugman and Michael Gestrin (1994: 60-66):
•
•
•
Sectoral reservations;
“Tit for Tat” reservations; and
Investment Review.
Sectoral reservations are outlined in Table 1, above. America and Canada largely maintained the status quo of the US-Canada FTA,
while Mexico had the largest range of reservations, with Annex III entirely devoted to Mexican sectors.
“Tit for Tat” reservations are those where the each country reserves the opportunity to “mirror” the restrictions in place in the other
two territories in the event that these reservations become damaging. An example is that the US has reserved the right to discriminate,
to the same extent as Canada, against Canadian ownership of US cultural industries. Other “tit for tat” reservations include, Canadian
reservations on the US maritime sector, Mexico against US legal services, and US against Canadian and Mexican mining, petroleum
reserves, pipeline ownership, specialty air services, cable television provision, newspaper publishing, and Canadian ownership of
waterfront land. The US has provided the longest list of “tit for tat” reservations because it has the fewest existing sectoral reservations,
and therefore requires the longest list of sectors for retaliation.
Lastly, probably the most significant reservations is investment review. Both Canada and Mexico maintained investment thresholds
subject to phase outs, above which they continue to review foreign investment proposals. Orignally the threshold above which
investments were subject to review followed the guidelines of the Canada-US Free Trade Agreement (1989, Annex 1607.3, Article
2,a,ii), with the final threshold for direct acquisition being C$150 million. In 1999 the review threshold for a direct acquisition was
C$184 million, which was subsequently extended to all WTO members under changes to the Canada Investment Act concomitant with
Uruguay Round Commitments. Indirect acquisition is no longer subject to review. Acquisitions of businesses engaged in the financial
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services, transportation, uranium and cultural industries are subject to the $5 million threshold for direct acquisitions and $50 million
for indirect acquisitions. Acquisitions in the cultural industries are the most sensitive. Transactions below these thresholds, and the
establishment of new businesses in this sector, may be reviewable if the government so decides.
For Mexico, the applicable threshold was US$25 million for the three-year period beginning on the date of entry into force of NAFTA,
US$50 million for the three year period beginning three years after the date of entry into force NAFTA, US$75 million for the
following three years, and US$150 million for the period beginning nine years after the date of entry into force of the agreement (with
thresholds adjusted annually for cumulative inflation).
While the US government made no reservations for thresholds, this was because it reserved the right for the president to refuse
investment which posed a threat to National Security, under the Exon-Florio legislation (1988) and the Committee on Foreign
Investment in the United States (CFIUS) (Rugman & Gestrin, 1994: 64; Graham, 1996: 40).
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The NAFTA Annexes as they pertain to Chapter 11
Table 1. Sectoral Reservations to NAFTA Chapter 11, by country.
Canada
Cultural Industries; air transport; social
services and agriculture.
Mexico
Energy; air transport; rail transport; agriculture; post
services; media ownership; and social services.
United States
Maritime transport; air transport, radio
communications; social services and agriculture.
Table 2. Reservations in the Annexes to NAFTA as they pertain to Chapter 11.
Annex
Number
1
Pertains to
Chapter Eleven
Yes
Chapter 11 Articles Covered
Extent of Coverage
National Treatment (1102) MFN (1103), local presence
(1105), performance requirements (1106) , and
nationality requirements (1107).
Existing, non-conforming measures maintained (2
years for states and provinces to add their own
restrictions).
2
Yes
Same as above.
Existing, non-conforming measures maintained and
reservations of right to adopt new or more
restrictive measures in sectors and activities listed.
3
Yes
Blanket Coverage.
Constitutional restrictions reserving complete
control of certain sectors for the Mexican state.
4
Yes
MFN (1103).
Existing international arrangements, any
international agreements negotiated within two
years, and any future agreements dealing with
aviation, fisheries, maritime matters, and
telecommunications.
5
Yes
None.
Existing, non-discriminatory measures which the
parties commit to trying to liberalize (1 year for
states and provinces to add restrictions).
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6
No
None. (Pertains to Various Articles in Chapter 12 –
Cross Border Provision of Services).
-
7
No
None. (Various Articles in Chapter 14 – Financial
Services).
-
Source: Alan M Rugman and Michael Gestrin, “The Investment Provisions of NAFTA”, in Steven Globerman and Michael Walker, eds., Assessing NAFTA: A Trinational
Analysis (Vancouver: Fraser Institute, 1993) pp. 271-92.
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Annex 2. Case study analysis
Metalclad v. Mexico
Mexico’s National Ecological Institute (INE) issued a federal permit to a Mexican firm known as Coterin to construct a hazardous
waste landfill in La Pedrera valley in the State of San Luisi Potosi, which falls in the local government jurisdiction of Guadalcazur.8
Subsquently, Metalclad, a Delaware corporation, acquired Coterin, together with its permits, in order to construct and operate the
facility. The State of San Luisi Potosi granted Coterin a land use permit for the landfill, subject to compliance with applicable
technical requirements and the caveat that the permit did not authorize the facility’s operation. According to Metalcald, the INE and
the Mexico Secretariat of Urban Development and Ecology (SEDUE) had advised Metalclad that, except for a federal operating
permit, all required permits for the facility had been secured.
When landfill was about to begin, Metalclad discovered that a City permit was required. Furthermore, the INE and other related
bodies began to carry out research on the environmental effects of the landfill operation, in response to intense public opposition. This
research determined that the site was suitable for the landfill operation. The other outcome of the research was for the State
government to create a raft of measures which Metalclad was required to carry out (including among others, designating a portion of
its property as a reserve for native species; creating a scientific advisory committee to monitor its operations; and providing seminars
on hazardous waste management). This agreement was reached as a “convenio”. The landfill was closed during this process of
negotiation, after which Metalclad was officially permitted to begin operations. However, the City government did not accept the
agreement between Metalclad and the State Government, and sought an injunction against the operations. As a result of the injunction
the site remained dormant. The municipal permit was not granted. Finally, the State Government reversed it decision, and the
Governor, who was near the ending of his term, issued a decree which declared the site to be protected natural area.
Metalclad submitted a claim to arbitration under the Chapter, contending that Mexico was responsible under international law for the
conduct of its political sub-divisions, and that it had not received “fair and equitable treatment” (Article 1105), and that Mexico had
breached Article 1110, which prohibits any party from “directly or indirectly expropriating investments, or taking any measure
“tantamount” to expropriation, without compensation. The tribunal found in favor of Metalclad on both counts. The arbitrators (Kass
& McCaroll, 2000: 2) stated that:
8
The details of the case are taken from the ICSID web page at www.worldbank.org/icsid/cases/awards.htm#award8, last accessed 31/7/02/
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An underlying purpose of NAFTA is to increase cross-border investments and, to this end, the “transparency” of relevant legal
requirements…Once the authorities of the central government of any party… become aware of any scope for misunderstanding or
confusion in this connection, it is their duty to ensure that the correct position is promptly determined and clearly stated so that
investors can proceed with all appropriate expedition in the confident belief that they are acting in accordance with all relevant
laws.
Stephen Kass and Jean McCarroll (2000: 4) write:
Guadalcazar had denied a construction permit for reasons related to the landfill’s proposed operation and had done so without even
minimum procedural due process. Moreover, the federal government itself failed to ensure a transparent and predictable framework
for Metalclad’s business planning and investment.
The tribunal found that the decision was not inconsistent with Article 1114 (which permits Parties to ensure that environmental
standards are met), since “both the federal permits and the Convenio demonstrated that Mexico was in fact satisfied with the project’s
environmental impacts” (Kass & McCaroll, 2000: 2). The tribunal found (Appelton, 2001: 15):
Expropriation under NAFTA includes not only open, deliberate and acknowledged takings of property, such as outright seizure or
formal or obligatory transfer of title in favor of the host government, but also covert or incidental interference with the use of
property which has the effect of depriving the owner, in whole or in significant part, of the use or reasonably-to-be expected
economic benefit of property even if not necessarily to the obvious benefit of the host State.
Significantly, it was not the environmental standard which was the object of Metalclad’s complaints, but the protracted discriminatory
and inconsistent dictates of the different Mexican governments involved. Dhooge (2001: 19) argues that in the within the Chapter and
in the Metalclad case the intent of the relevant government bodies is unimportant relative to the effect caused by their measures. It
appears, rather, that in the Metalclad case the intent and effect of failing to make consistent the regulatory requirements for operating
the business once the plant had been purchased coincide, being to hinder or bring to a halt the operation of the facility. It is also
important that, while the claim was a breach of “National Treatment”, the case for discrimination on the basis of different nationality
is not at the heart of the issue. It is unclear whether a Mexican firm in the same situation would have suffered the same fate, however,
the fact that the Mexican government carried out several, separate government actions which unreasonably singled out a particular
foreign investment or enterprise is thus discriminatory under the Chapter’s provisions.
Methanex v. United States
Methanex is a Canadian company, whose sole product is methanol, and who is the world’s largest methanol producer. Methanex sells
methanol to producers of Methyl tertiary butyl ether (MTBE), which is used in the production of gasoline.9 MTBE was used originally
9
The details as represented here are supported by Dhooge (2001), who makes exhaustive direct references to the existing trial documents and related material.
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in gasoline as a source of octane in unleaded fuel, and then as an oxygenate, within the requirements of the Clean Air Amendment Act
(1994) (Dhooge, 2001: 475). Methanol competes in the Californian oxygenate market with ethanol, which is heavily subsidized by the
Californian state government (Dhooge, 2001). In 1999 the Governor of California, Gray Davis, issued an order (the “Order”) which
banned the use of MTBE in the production of gasoline, claiming that “although MTBE had proven beneficial in achieving clean air
standards, …this benefit was overshadowed by the “significant risk” to ground and drinking water as a result of leakage from
underground fuel storage tanks’ (Dhooge, 2001: 475). The result of the ban was that Methanex lost its market in California.
Broadly speaking, Methanex submitted claims under NAFTA Chapter 11 on the basis that the ban was discriminatory, because it
recognized only the risk of MTBE to ground water, and not the equal or greater risk of substitute products. Specifically, Methanex
claimed, firstly, that the Order was not based on scientific evidence; secondly, that the phase out unfairly penalized one form of
gasoline; thirdly, that the Order failed to consider alternative effective measures to mitigate the effects of gasoline releases into the
environment; fourthly, due to the state’s “failure or delay in enacting or enforcing legislation to reduce or eliminate gasoline releases
into the environment” (Methanex, 1999: 11) it had failed to act responsibly in environmental terms; fifthly, the ban’s purported failure
to consider Methanex's legitimate business interests. The claims were brought citing breaches of National Treatment (Article 1102);
fair and equitable treatment under international law (Article 1105), and the prohibition on expropriation or measures tantamount to
expropriation (Article 1110). Further information related to the claim includes lobbying of Governor Davis’ administration, carried out
by a Californian ethanol producer, to support its interests with regard to any pending legislation.
Under Article 1102 and 1105 (national treatment and fair and equitable treatment) Methanex contended several separate issues. Firstly,
that the company was not alerted or consulted on the possibility of a ban. The company pointed out that had it been alerted, it might
have been able to make suggestions on how the problem might better be addressed. Secondly, given that the Order included plans to
boost ethanol production, and the majority of methanol production was in Canadian hands, that the ban was expressly discriminatory
on the basis of nationality.
Under Article 1110 (expropriation) Methanex contended that the ban constituted a unnecessarily severe burden on their business given
that, firstly, the ban was not based on scientific evidence, and secondly, the ban failed to attack the problem of MTBE contamination
at its root: the leaks in underground storage tanks. In these circumstances, any number of different gasoline additives could equally
have caused water contamination, suggesting once again that the ban may have been politically motivated. Lastly, the size of the
effective ‘expropriation’ was also important, contributing to the unreasonable nature of the ban. The relative ‘size’ of the expropriation
can be measured, firstly, by the scope of the effect on Methanex’s business in the state, which was absolute, forcing the company to
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cease operations; secondly, by the size of financial loss, estimated (by Methanex itself) to be over US$900 million (Methanex, 1999:
13), and lastly, by the severity of the government measure, i.e., banning rather than less drastic measures. Of July 2002, the panel was
considering whether it had jurisdiction over Methanex's claims. A decision in the first phase of the case is expected in the near future.
In this light it appears the measure may have constituted discriminatory action. This is despite the fact that the measure, the Order,
applied to both Methanex and domestic methanol firms. In terms of examining the tension between investor rights and government
power to regulate, it is also interesting to hypothesize, as does Dhooge (2001), whether the Californian government could legally and
within the constraints of the Chapter, set up a measures to limit the use of MTBE with a view to reducing the risk of contamination,
instead of with the intent to limit the profitability of a particular competitive foreign investor. This is one hypothetical test of the
extent to which the Chapter might limit the regulatory scope of a Party sub-national government. It also helps to illuminate some of
the debate surrounding differing interpretations of expropriation. It appears, as Dhooge seems to conclude, that such measures would
have been possible, provided Methanex had been consulted with regard to due process, and the limits were based on sound scientific
evidence which demonstrated that they could materially improve the risks of water contamination; or the program included a longer
implementation period, and measures to address similar issues among competing and equally pollutive products, e.g., attempted to fix
the leaky tanks. However, in a similar way to the Metalclad case, there were inconsistencies in the American domestic regulatory
framework which would have made such a measure fraught, given that under the Clean Air Amendment Act (1994), state
governments were not granted sufficient jurisdiction to carry out Executive orders such as the ban on MTBE (Dhooge, 2001).
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Annex 3. Discussion of the case studies with reference to NGO criticism
To return to the three issues mentioned above, what do the Metalclad and Methanex cases reveal of the tensions between expanding
investor rights and national sovereignty, and of the expanding powers of the Chapter? Firstly, it is important to recall that the litigants
in all three successful cases have involved a much broader interpretation of the Chapter then the ultimate tribunal findings. In this way,
the Methanex claims may be also be broader in scope than the findings which determine any final award. Secondly, the Metalclad case
was ultimately upheld on rather narrow and specific issues, surrounding the protracted and contradictory behavior of local and state
governments. Several possible outcomes were mooted at several stages during the events which could have served to represent the
environmental concerns of the governments in question, and existence of the Chapter and its dispute settlement process did not in
itself circumvent the right of the government to regulate or make the right of establishment dependent on passing health; safety or
environmental requirements.
Thus the criticism that the Chapter will put a regulatory ‘freeze’ on environmental regulation is not supported by the evidence.
Regulation most at risk will be regulation that over the long term is either non-transparent, inconsistent, unclear or discriminatory.
Hart and Dymond write (2002: 14):
To date only one complaint directly challenges an environmental regulation – Methanex vs. the United States – and it remains to be
decided. A number of other complaints have touched on environmental matters, but each revolved around issues of discrimination only
indirectly related to environmental regulation per se. … In none did the complaining party question the validity of the environmental
regulation or objective; rather, each complained about its discriminatory and confiscatory application.
With regard to the ambiguity on the exact scope of “expropriation”, the small body of existing case law (three successful submissions
of the expropriation law: Pope & Talbot, Metalclad and A.D. Myers) also implies that the confusion and ambiguity may in fact be
declining as the number of cases increases. Appelton notes:
Perhaps the most controversial issue arising from NAFTA expropriation provisions arises from its requirement of application to
“measures tantamount to expropriation”. This phrase has been the subject of considerable debate in international investment law as to
whether its inclusion actually extends the customary international law meaning of expropriation. …Both the Metalclad decision [and]
the Pope & Talbot decision came to a similar conclusion: a government action that deprives a property holder sufficiently is an
expropriation. Following the established practice of international law, both tribunals required that this harm be based on a finding of fact
by the tribunal.
While the original expropriation article has its roots in American bilateral agreements of the early 1980s (Vandervelde, 1992; Hart &
Dymond 2001: 12), the interpretation of the three cases above reflects norms of international law, based on specific facts of
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discriminatory, confiscatory or permanent action. One of the two cases to reach arbitration but where the state was successful in its
defense was Azinian v. Mexico. The finding of the tribunal in this case further demonstrates the factual basis for interpreting
NAFTA’s provisions: the finding (ICSID, 1999: 26) stated:
The problem is that the Claimants’ fundamental complaint is that they are victims of a breach of the Concession Contract. NAFTA does
not, however, allow investors to seek international arbitration for mere contractual breaches. Indeed, NAFTA cannot possibly be read to
create such a regime, which would have elevated a multitude of ordinary transactions with public authorities into potential international
disputes. The Claimants simply could not prevail merely by persuading the Arbitral Tribunal that the Ayuntamiento of Naucalpuan
breached the Concession Contract [emphasis original].
While the case of expropriation was made duly under the principles of international law, the finding continued:
Labeling is, however, no substitute for analysis. The words “confiscatory”, “destroy contractual rights as an asset,” or “repudiation” may
serve as a way to describe breaches which are to be treated as extraordinary, and therefore as acts of expropriation, but they certainly do
not indicate on what basis the critical distinction between expropriation and an ordinary breach of contract is to be made
Discussing the status of expropriation in international law more broadly, Appelton concludes:
Accordingly, it can now be said that a substantial part of the controversy over this question in international expropriation law has been
settled.
The findings in the Methanex case will qualify this debate. Nonetheless, the findings to date belie the alarmist tone of much
existing criticism (Public Citizen, 2001; Mann & von Moltke, 2002) of the Chapter’s mechanism and workings.
If the above interpretation of “expropriation” represents a balance in tribunal findings and policy-making between the interests of
investors and the power of governments, rather than a “regulatory freeze”, or the requirement for inaction among policy-makers
the findings National and Most Favored Nation Treatment are similarly balanced. Trebilcock and Howse (1998: 31) argue
similarly that:
The principle of effective equality of opportunity (not outcome) lies at the heart of the National Treatment principle, and exceptions to it
should require a demonstration that policy measures that have a substantial disparate impact on foreign trade (a) genuinely serve some
legitimate (non-trade related) domestic policy objective and are not merely a disguised form of discrimination (the sham principle) and
(b) are not an unjustified means of attaining those objectives (the least trade restrictive or proportionality principle). Thus, the policy
objective should be genuine and the means of attaining it proportionate.
Thus current evidence supports the existence of a narrow but pertinent interpretation of “expropriation” and “minimum treatment”
under the Chapter’s provisions. With regard the environmental scope of the Metalclad decision, Kass and McCarroll (2000: 2) write:
The long-term environmental significance of Metalclad may be to emphasize the importance of predictable environmental standards and
permit procedures, at both federal and local levels, in each of the NAFTA countries. While this may impose short-term burdens on the
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federal regulators in all three countries, over the longer term it could also contribute to improved environmental regulation for the public
and for both foreign and domestic investors.
Thus the impact of this interpretation on regulation is not necessarily negatively restrictive. The need for an expropriation clause in
investment provisions embedded in current free market agreements is discussed in the policy recommendations section.
The argument proposed by several environmental advocates who have criticized NAFTA’s provisions (von Moltke, 2000; Mann &
von Moltke, 2002: 19) is based broadly on the economic theory of internalizing the negative externalities of pollution (through
government subsidies and taxes, or through assigning particular conditions on an investment, defined as “property rights”) and thereby
requiring the polluter to pay the cost of pollution (Pigou 1912; Coase, 1960, 1988). These theories originally focused on a model
which permitted a market for pollution, making it marginally more expensive to pollute, depending on the extent of the pollution
thereby also making it important to consider the relative values of products of pollutive activity. This is called “internalizing”, or
bringing into the firm’s microeconomic model the cost of environmental damage. The original statements of this theory came in two
different forms: firstly, by Arthur Pigou and then by Ronald Coase. Pigou theorized that the best way to internalize environmental cost
was for government to direct investment and other funds through subsidies and taxes, thereby correcting such market failures (a
market failure being that the environmental cost is not borne by the producer and its clients). Pigovian analysis relied more heavily on
the role of the government in commanding the flow of investment and funds through controlling supply and demand. The second
version of this theory, as proposed by Ronald Coase, held that, contrary to Pigou’s finding, it was best to render the cost of the
negative environmental externalities in the “property rights” (conditions of ownership) to the good. The fundamental theory behind the
Coasian critique of Pigou was the emphasis on reliance on existing market demand through assigning property rights, to determine
who bears the extra, internalized cost of polluting.
In an attempt to employ Coasian theory, Howard Mann and Konrad von Moltke (2002) argue that by requiring governments to
consider the impact of environmental regulation on particular foreign investors and allowing investors to litigate against
discrimination, the Chapter forces the government to pay the cost of pollution, instead of requiring the extra payment from the investor
or polluter. Mann and Von Moltke (2002: 19) write:
…any environmental law worth adopting will affect business operations and may substantially modify or even end the use of, or trade in,
certain processes or products, and therefore will have a significant impact on the business in question. The ultimate effect of this nascent
NAFTA doctrine would be to reverse a central tenet of sound environmental policy: that the environmental costs of economic activities
should be internalized in prices so that polluters bear the costs of their pollution, rather than enjoying a right to pollute which they must
be paid to cede [emphasis original].
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Von Moltke’s first contention, that there is a fundamental divergence, or even diametric opposition, between the interests of
environmentalists and the interests of industry has gained considerable currency in the recent years (Economist, 2002: 2). The
theoretical basis he states is Coasian, and is not disputed here. Von Moltke’s second contention, however, that the NAFTA provisions
force the cost of pollution and environmental regulation on to the polluter, is not supported by the evidence as outlined above in the
Metalclad case study.
CEIL (1999: 46), on the other hand, employs a version of Pigovian welfare economics to imply that the government is responsible for
expropriating the extra “rent” which flows from the private use of nonrenewable resources:
Performance requirements and demands for technology transfer are mechanisms for governments to capture the rent on their
nonrenewable resources for the benefit of their citizens. … Rents from non-renewable resources [collected by governments] must be
reinvested in other productive assets, such as education or new technology, which will yield returns to later generations in order for a
nation to maintain a sustainable income over time…
Here the description the role of government as a regulator is expanded to include re-directing funds not just for education and
promoting new technology in general (as would be commensurate with the activities of the welfare state using the taxes it receives)
but for environmental cost specific to a given investment. This posits a productive role for government as environmental regulator, and
as such, it is a position which receives very little credence among economists, despite the CIEL analysis being couched in the rhetoric
of economic theory.
Despite the fact these criticisms vary in their theoretical standpoints, neither is supported by the evidence of the case presented here. In
the Metalclad case there was a raft of environmental requirements proposed to Metalclad that would have significantly increased the
cost of operating the facility, thereby internalizing the cost of polluting through government regulation. While Metalclad accepted this
cost, it was subsequently still refused both the municipal permit and the right to operate as subsequently retracted at state level. Thus
the issue of how best to regulate the environmental cost was circumvented by the random and capricious actions of the governments
involved. Specifically, the fundamental policy issue involved was not one of environmental cost, but instead that of a sub-national
government not complying with the direction of a national government to follow the regulations of a binding multilateral agreement.
CEIL and various authors writing for CEIL criticize the financial transaction rules, as outlined in the Criticism section above. They
make a distinction between portfolio and direct investment, where the latter is inherently more volatile. While quoting leading
economists on this issue, the authors singularly omit to mention the importance of semi-fixed exchange rates among the causes of the
crisis: a policy which caused moral hazard among both investors and lenders domestically and internationally, such that investors and
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lenders believed that relevant central banks would bail out the currencies in the event that the currencies began to lose value rapidly.10
Thus, there may have been inconsistencies in the domestic framework or, a lack of sequencing of financial and economic reform. The
authors therefore refer, indirectly, to a cogent argument made by several leading economists that financial liberalization occurred in
many of the East Asian economies out of sequence with other reforms, namely, before the floating of national currencies (e.g., the
Thai baht and Malaysian ringgit) and before full institutionalization of mechanisms that deal with risk (Rodrik, 1998; Bhagwati, 1998).
Krugman and Obstfeld (2000: 714) write:
Some respected economists, including Columbia University’s Jagdish Bhagwati and Harvard University’s Dani Rodrik, have argued
that developing countries should keep or reinstate restrictions on capital mobility to be able to exercise monetary autonomy while
enjoying stable exchange rates. …However, most policymakers, both in the developing world and in the West continued to regard
capital controls as either impossible to enforce or too disruptive of normal business relationships (as well as a potent source of
corruption). Thus most discussions of financial architecture focused instead on meliorative measures – on ways to make the remaining
choices less painful.
Thus there is an emphasis on ex post measures, recognizing the importance of a competitive financial regime to an economy (up until
the time of a crisis), and crucially, the pitfalls of ad hoc regulation of capital flows. Despite the consensus Krugman describes, there is
much debate surrounding the ideal “financial architecture” for developing countries since the Asian crisis, however, more
transparency and stronger banking systems appear central (Bhagwati, 1998; Rodrik, 1998; Krugman & Obstfeld, 2000: 714-5). This
issue is specific to countries which lack powerful institutional mechanisms for dealing with risk, and as such, it is not dealt with in the
“Policy Recommendations” section below, since this section deals specifically with Australia and the United States, both countries
highly unlikely to restore any capital controls in the event of a weakening currency. However, in the interests of clarifying the
theoretical debate, it is valuable to reach a theoretical conclusion on this issue.
Given that the signature of NAFTA preceded the re-emergence of the debate on financial architecture in 1998, future agreements
along similar lines and which involve developing countries with under-developed financial mechanisms could include clauses to allow
10
There is a theoretical identity here concerning the policy choices of macroeconomic financial regime. It has been dubbed “Krugman’s impossible triangle”. In
broad terms, there is a limit to the number of goals policymakers with open capital accounts (free movement of capital in and out of an economy can achieve),
among: exchange rate stability (currency boards) freedom of capital, and autonomy of monetary policy (changing the value of money to accelerate or decelerate
economic growth) only two can co-exist. The most advanced capital markets, such as Australia’s, choose the second two, opting for freely floating exchange
rates and autonomy in monetary policy.
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delays on capital withdrawal in the instance of a full-scale currency crisis. This measure would be ex post and temporary.11 Similar
clauses also appear in many bilateral investment treaties (Brewer & Young, 2000: 75). This would slow panic selling, but would not
require an economy to otherwise delay codifying investment rules with other countries; given the mutual benefit such codification
confers. In this context, this clause might only rarely be used: financial crises rarely continue to occur repeatedly in one country, and
usually precipitate the recognition that financial reforms are needed, such as those mentioned above (strengthening banking and
lending systems, and promoting greater coherence of monetary and financial policies).
The criticisms of the Chapter from Waskow et al (2000), writing for Public Citizen, are not supported by the existing tribunal findings.
Firstly, the criticisms of the extent to which a government action must be capricious and discriminatory in order to constitute a breach
of the Chapter (that “expropriation” can constitute a defensive action); that the Chapter constitutes an attack on Sovereign Immunity
and a regulatory chill on governments, and that corporations seek compensation merely for a drop in profitability, are not supported by
the narrow and pertinent definition of “expropriation” found by the tribunals. Where Waskow et al (2001: vi) describe “Governments
subject to endless second-guessing” they imply an unreasonable level of liability under NAFTA, supported neither by the successful
Metalclad finding or the by unsuccessful finding in the Azinian case.
Waskow et al.’s (2001: viii) criticism that the Chapter’s environmental protection clause is meaningless, since it has not been invoked
successfully in defense, does not seem reasonable, given that among the existing cases Methanex is the first to directly oppose an
environmental regulation; others being in reality based on other policy issues. The criticism that State and Local governments are “not
safe” (Waskow et al, 2001: vi) from NAFTA tribunals is concomitant with accountability of state and local governments to their
federal or national governments. The criticism of the size of the payment can be countered with economic reasoning. Using such
reasoning, governments ought to be liable, up to the extent of damage, once it is found that their actions were wanting, since the value
of the investment lost and the loss to overall production would have been avoided if the government had not committed the breach.
This also appears reasonable since governments at all levels would have expected to extract rent in relative amounts from the value of
any investment which would otherwise have gone ahead.
The claim that the Chapter allows for the importing of other NAFTA law and WTO obligations is also concomitant with the coherence
of NAFTA Chapters as a whole, and the overlap of GATT rules on to those of international law generally. The claim that rudeness
11
Working on the assumption that having opened capital accounts to portfolio investment withholding this investment permanently would constitute massive
expropriation.
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singularly constituted a breach of the Chapter appears to ignore the activities of tribunals and subsequent appeals which have
narrowed the interpretation of litigants’ claims.
While the tone of the Waskow et al. (2001) article is alarming, the facts of the Metalclad case are presented in what appears a selective
fashion. The paper appears only briefly to recognize the issue of competition between methanol and ethanol as pollutive products. The
recognition is framed with the reference to MTBE being “(a suspected carcinogen, highly soluble in water posing a greater risk to
drinking wells than similar additives) [emphasis added]” (Waskow et al., 2001: vii). No study is quoted to support this assumption.
More importantly, the fact that tribunals found leaks in the wells (rather than the pollutive aspect of one oxygenate) to be the root
cause of the problem is omitted. Also omitted is the fact that Metalclad accepted the government directed environmental measures, but
was still refused a municipal permit.
Further issues emerging from other less virulent critics of the Chapter (Hart & Dymond, 2001; Dhooge, 2001) include the scope of
legal expertise permitted the tribunals; the extent to which foreign investors should attempt domestic resolution of disputes; the nonpermanent nature of tribunals; the status of the NAFTA secretariat, and the need to resort to supra-national rules outside of the
agreement.
The issue of transparency was addressed by an appending “Interpretation” (2001) to NAFTA completed eight years after the signing
of the initial agreement. The Interpretation deals broadly with the need to make public litigants pleadings and the workings of
tribunals on the basis that they represent issues of public policy and therefore ought to be open to public scrutiny. The Interpretation
(NAFTA, 2001:1) works explicitly within the architecture of the original agreement:
In accordance with Article 1120(2), the NAFTA parties agree that nothing in the relevant arbitral rules imposes a general duty of
confidentiality or precludes the Parties from providing public access to documents submitted to, or issued by, Chapter Eleven tribunals,
apart from the limited specific expectations set forth expressly in those rules.
The need for secrecy was originally designed to protect commercial interests; the Intepretation makes exclusion only for confidential
business information, information which is privileged or protected by domestic law, and information which the Party must withhold
pursuant to the relevant arbitral rule (NAFTA, 2001: 1). Hart and Dymond write that the transparency provisions could productively
be taken further, to define who should have access to documents, who should be able to attend and intervene in tribunal hearings. The
Interpretation appears to provide scope for almost unlimited transparency in the accessing documents from the tribunal process. The
issue of who may intervene at hearings is addressed below.
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Hart and Dymond (2001) argue convincingly several possible reforms of NAFTA, revolving primarily around strengthening its
working basis. Firstly, making the tribunals permanent rather than ad hoc might discourage tribunals from accepting less worthy cases,
as ad hoc tribunals are formed solely upon the decision to hear a case. Secondly, tailoring a unique dispute settlement process would
allow tribunals to avoid using three sets of settlement dispute rules; rules which were not originally designed with policy aims in mind.
Thirdly, the use of amicus curiae (supplementary briefs) to provide legal or other expertise at the discretion of the tribunal would help
to broaden the factual basis for disputes. Fourthly, requiring foreign investors to exhaust domestic avenues for complaint, and
permitting domestic investors access to the NAFTA dispute process might create a less discriminatory regime for all investors in all
three states. Lastly, all these reforms would benefit from a stronger and more independent NAFTA Secretariat. While Hart and
Dymond (2001: 19) argue that these reforms can be addressed within the current architecture of the agreement, some of the more
fundamental reforms, such as the exact dispute mechanism, seem embedded in the agreement. As argued above, this does not appear a
large cause for concern, as existing cases have produced a narrow but pertinent understanding of the key provisions. However, these
questions of reform are a good starting point for examining the Chapter as a model for future bilateral investment provisions
embedded in market agreements.
This paper firstly examines the key provisions of the Chapter. Secondly, the paper reviews theoretical economic and policy
arguments supporting the Chapter and the key arguments made against the Chapter. Thirdly evidence of the Chapter’s effects is
economic evidence on the Chapter’s effects, and legal evidence in the form of existing case law. In Annex 2, two particular cases are
examined in detail: the Metalclad v. Mexico and the Methanex v. Canada cases. In Annex 3, this evidence is used to further illuminate
the political; economic, and legal debate on the Chapter in discussion. Lastly, the paper suggests policy lessons from the Chapter for
Australian policy makers seeking possible approaches for including similar investment provisions in future regional trading
agreements.
In the case of Australia and its own free trade agreements (FTAs) Ann Capling (2001) has argued that the provisions of NAFTA are
likely to be perceived as radically liberal and therefore “highly contentious” (Capling, 2001: 23). Capling’s view appears to be that the
political risk inherent in arguing for investment provisions is so great as to make the consideration of the issue futile. Capling contends
that the Multilateral Agreement on Investment (MAI) caused uproar after criticism from environmental groups, and that similar
provisions would cause uproar. Given the popular appeal and success of the anti-MAI campaign, Capling’s contention is not
unreasonable. However, the logic of denying debate on the topic of including investment in an Australia-US free trade agreement on the
basis of the political risk involved circumvents the issue of the value which the agreement might confer.
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The MAI was brought down not only by a successful campaign among environmental lobby groups, but also by the French, who sought
to protect their cultural industries from foreign competition. In Australia, a position was taken where criticism and concern also revolved
around concern for the diminution of sovereignty. outlined in the Parliamentary Committee report (JSCT, 1998) dealing with the MAI.
Examining the case of the MAI, Trebilcock and Howse outline the campaign which led the controversy:
Some of the groups [activists from OECD countries] often make grossly exaggerated and hypothetical claims about the
damage likely to flow from these agreements to the social welfare state. With the MAI, their approach was shrewder and
more careful. They linked a more general critique of globalization driven by corporate interests with a highly plausible
analysis of specific provisions of the draft MAI, or omissions from it, as well as a critique of the way it was negotiated. …
However much of the rhetorical tone of this attack may reflect an unjustified conspiratorial or even paranoid view of
transnational corporations, its substance could be defended on the basis of concrete features of the negotiating texts…
The major criticisms were based on the lack of transparency in the negotiations and the omission of several key provisions in the
draft text, notably, provisions on the environment, labor standards and health and safety. However, negotiations for a US-Australia
free trade agreement would be open to wider scrutiny than the WTO was prior to the anti-MAI campaign. Furthermore, if the
Chapter were used as a basic model for including investment in a United States Australia free trade agreement, it is unlike the
MAI draft in that it has specific articles dealing with health and environmental standards. Describing Canada’s situation Capling
(2001: 24) writes:
These provisions have caused a great deal of anxiety for the Canadian government. … Environmental groups are
understandably up in arms and Ottawa is under considerable pressure to re-open the NAFTA agreement. In these
circumstances, the Australian public is very unlikely to support an Australian-United States trade agreement that includes
NAFTA style investment provisions, especially once Australians realize that these provisions formed the basis of
Multilateral Agreement on Investment.
In this context the distinction between the Chapter and the MAI become important in any public debate over the possibility of including
investment provisions in an Australian US free trade agreement. The Chapter instead represents a possible model for what has otherwise
proved unworkable in multilateral fora.
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