Does NAFTA trump countries' laws?

Canadian critics are challenging a controversial NAFTA provision that allows companies to sue governments.

Free trade is supposed to be about leveling the playing field and clearing out the thicket of unfair regulations and tariffs.

But seven years into the North American Free Trade Agreement, the three signatory countries are still wrestling to get the right balance between free-trade principles and local regulation.

Take the case of Metalclad Corp., a hazardous-waste treatment company from California. The firm bought a landfill in Guadalcazar, in central Mexico, with plans to build a waste-treatment center. The company, which already had plants in 11 Mexican states, obtained the required federal permits and started building.

But by the time Metalclad completed the $20 million, state-of-the-art treatment plant in 1995, things had soured. Protesters had demonstrated against the plant, and the state governor designated the site an ecological preserve. Metalclad was forced to withdraw, and eventually it pulled all its business out of Mexico.

Metalclad sought redress under a controversial provision of NAFTA. Chapter 11, which is designed to protect investors from arbitrary or underhanded treatment by governments, allows companies to sue governments directly. Metalclad argued that restrictions put on its property were "tantamount to expropriation" and won $16.7 million last August. In February, Mexico appealed the judgment to a court in Vancouver. A final decision is expected in coming weeks.

This case comes at a critical moment. President Bush has made a hemisphere-wide free-trade pact a pillar of US foreign policy. Later this month, 34 leaders from Canada to Chile will gather in Quebec City to consider how to make it a reality. And that's raising anew questions about whether NAFTA dispute mechanisms such as Chapter 11 are working.

NAFTA's impact

Some free-trade critics say the Chapter 11 provision gives too much power to investors. Last week, Canadian activists and labor leaders filed a constitutional challenge to the provision in Ontario's Superior Court of Justice. The Council of Canadians and the Canadian Union of Postal Workers reportedly argued that Chapter 11 undermines their government's right to protect the safety, health, and well-being of its citizens through the regulatory systems and court.

But advocates say in the world of free trade, investors need the protection of Chapter 11.

In its judgment, the NAFTA panel issued a broad ruling that Mexico's treatment of Metalclad amounted to a denial of "fair and equitable treatment" - which is the benchmark of fairness in the trade world. "They invited us, they welcomed us, and then they delayed and obfuscated," says Grant Kessler, chief executive of Metalclad, noting that his case has been cited in some 30 subsequent legal actions.

But free trade is about encouraging investment and economic development. And, says Fred McMahon, an analyst at the conservative Fraser Institute in Vancouver, the Mexican governor's actions are just the kind that will discourage the outside investment Mexico needs.

This case has nothing to do with limiting local autonomy, he says, but "everything to do with getting sensible regulations in place in the first place."

Some critics of free trade have worried that corporations seeking cheap labor and loose regulations would rush to exploit developing markets - encouraging them to keep their standards low.

According to a recent study of the impact of NAFTA on environmental regulation, based on 230 corporate interviews, researchers have found the opposite.

"Investment is not moving in a pollution-haven seeking way to jurisdictions in which environmental regulation or enforcement is lower," concludes the study by John Kirton of the University of Toronto, attorney Julie Soloway of Davies, Ward, Phillips, & Vineberg, and Alan Rugman of Oxford University.

"NAFTA's trade and investment liberalization is producing an environmental regulatory push to the top, rather than race to the bottom," the study says.

But Howard Mann, an international trade lawyer in Ottawa, predicts slow going for countries trying to get their regulations in place for free trade.

"There's no way the vast majority of developing countries have the capacity" - in terms of analytical skill and trade expertise - to formulate the kind of environmental regulations that will stand up to free-trade challenges, he says. And "the costs of developing a regulation can go into seven figures."

Refining the provision

One reason for the heightened interest in the Metalclad case is that it arms critics of Chapter 11, who want to make sure a similar provision doesn't make it into the Free Trade Agreement of the Americas (FTAA), being discussed at the Quebec City summit later this month.

Canada, which intervened on Mexico's side in the Metalclad case, has a particular interest in the issue, and Canadian Trade Minister Pierre Pettigrew has said he does not want provisions like Chapter 11 in the FTAA accord.

Ottawa has found itself the defendant in several Chapter 11 cases. In one, Canada had placed a temporary ban on the export of PCB waste. That meant SD Myers Inc., an Ohio-based company that was shipping PCBs from Canada to its US disposal plant, was out of luck, while an Alberta company was assured steady business. A NAFTA panel has ruled that Canada's ban was meant specifically to exclude SD Myers. It has yet to assess the damages, and Canada is appealing. Canada faces two other Chapter 11 cases by companies asking for more than US$610 million.

Raising the bar

Even many fans of NAFTA agree that Chapter 11 needs some adjustment, beginning with its format. Cases are heard by secret panels convened by the International Center for Settlement of Investment Disputes, a World Bank-affiliated entity established to deal with contractual disputes between companies. But experts say it wasn't designed to consider public policy issues.

Moreover, the three-member NAFTA panels that hear these cases have tended to interpret Chapter 11 more broadly, analysts say, than the signatory governments expected. But renegotiating the troublesome chapter would mean reopening the entire NAFTA treaty, and that's a can of worms none of the signatories want to open.

Mr. Pettigrew is pushing for a document signed by the NAFTA signatories clarifying the intent behind Chapter 11 - that is, making it harder to use - and perhaps completing it before this month's trade summit in Quebec.

(c) Copyright 2001. The Christian Science Monitor

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