In 1999, after a study by the university of California at Davis warned that the chemical MTBE may cause cancer in humans, California became the first U.S. state to phase out its use as a gasoline additive. (MTBE from leaking underground storage tanks contaminates soil and groundwater.) But the Canadian corporation Methanex, which produces the MBTE ingredient methanol, viewed California's action as a confiscation of its property. So Methanex pursued a novel avenue of redress--one that leaps across three separate levels of law and governance.
Though its quarrel was with a state law, Methanex sued the federal government of the United States for $970 million under the North American Free Trade Agreement (NAFTA). The company's litigation strategy was made possible by NAFTA's Chapter 11, which provides sweeping property-rights protections for foreign companies, including a ban on all hostgovernment actions deemed "tantamount" to expropriation. This sleeper provision also contains a revolutionary dispute-resolution mechanism--the first of its kind in a multilateral trade agreement--that gives foreign corporations standing to sue sovereign governments directly when alleging unfair treatment. The claims are then arbitrated, corporate-style, before secretive World Bank or United Nations tribunals. Mexico and Canada have already lost Chapter 11 cases to U.S. corporations. Methanex's suit is the first NAFTA challenge to a state environmental regulation in this country.
NAFTA's implementation act calls upon the United States, Canada, and Mexico--all nations with federal forms of government --"to overrule inconsistent state law through legislation or civil suit." NAFTA's supersized version, the projected Free Trade Area of the Americas (FTAA), would very likely extend NAFTA's investor protections throughout the hemisphere, greatly multiplying the number of challenges brought against state laws in the United States.
This prospect doesn't sit well with California legislators. The Methanex case is Exhibit A for the California senate's Select Committee on International Trade Policy and State Legislation, which is the first of its kind in the 50 states. The committee, chaired by State Senator Sheila Kuehl (a Democrat who inherited the post from her populist predecessor, Tom Hayden), has been investigating the impact of trade agreements like NAFTA on California's ability to enact and enforce its own laws.
The core concern is sovereignty--in this case, the ability of a state to set antipollution standards that are tougher than the federal minimums. California, home to freeways and smog, has long prided itself on having pollution regulations more stringent than those mandated by Congress and the U.S. Environmental Protection Agency. Washington has never preempted that right directly--but NAFTA apparently repeals it through the back door.
In a January letter to Robert Zoellick, George W. Bush's designated United States trade representative (USTR), Kuehl and a group of fellow legislators wrote: "We find it disconcerting that our democratic decision-making ... is being second-guessed in a distant forum by unelected officials." Zoellick, in a somewhat evasive response, assured the lawmakers that states had nothing to worry about because NAFTA rules "do not have direct effect in U.S. law." But what will happen if Methanex wins its case? Will the federal government try to force California to pay the damages rather than foisting the cost off on innocent taxpayers in the other 49 states? Will it bully California into removing other regulations for fear of similar challenges? "The United States, the USTR informs us in his letter, of course can't do away with state laws because of federalism," observes Kuehl. "But I can imagine the kinds of pressure that might be brought to bear."
Don't Mess with California
The fact that Sheila Kuehl is asking such questions of the USTR could prove a far more serious challenge to the current process of corporate-friendly globalization than any ruckus the street activists can muster. Anti-FTAA demonstrators have been lampooned as naive opponents of foreigners or of trade. But the California story makes clear just what NAFTA and the proposed FTAA really threaten: the ability of states and nations to opt for a regulated and democratically governed form of capitalism rather than a laissez-faire and politically insulated one.
After last April's demonstrations against the FTAA in Quebec City, protesters were also caricatured in the media as overeducated rich kids who had arrogantly appointed themselves spokespersons for the hemisphere's poor--while behind closed doors, the real, elected leaders sat down to cut a trade deal. (See Leah Platt, "What Democracy Looks Like," TAP, June 4, 2001.) But this criticism cannot touch Kuehl or her fellow senators, each of whom represents some 800,000 constituents. Indeed, in the sheer size of its economy, California dwarfs every sovereign party to the FTAA except for the United States.
By pursuing questions few have asked about how NAFTA and FTAA undercut regulatory sovereignty, California is demanding--and receiving--answers. Instead of protesters banging their heads against walls specially constructed to keep them out, as occurred in Quebec City, state legislatures could help open global-trade negotiations to public examination and make them responsive to civil-society concerns.
Asleep at the Switch
If Sheila Kuehl gets her way, the FTAA will not get by without intense scrutiny, particularly of investment provisions and their effect on the ability of states to regulate. Such was emphatically not the case with NAFTA. Indeed, after hearing committee testimony on Chapter 11's power to roll back environmental regulations, California State Senator Mike Machado looked stunned by what he had heard. Of NAFTA's private right of action for foreign corporations, he exclaimed: "We don't even have that between our own states!" And yet during the original NAFTA debate, Chapter 11 got a free pass. "In large measure, it was not on the radar screen of those who were looking to bring environmental sensitivity to NAFTA," says Daniel Esty, who directs the Yale Center for Environmental Law and Policy and served as the Environmental Protection Agency's lead NAFTA negotiator.
Chapter 11 drew on language from a number of bilateral investment treaties--agreements generally made between developed and developing countries to protect investors from the former against political instabilities in the latter. These treaties have contained similar investor provisions, but NAFTA radically altered their application. That change occurred because NAFTA shifted investor rights from a developing-country to a developed-country context. "Cameroon investors are not going to be coming into the United States and messing with any laws passed by the state of California," notes Jeffery Atik, a professor of law at the Loyola Law School in Los Angeles. "But Canadians are."
NAFTA's investor protections were aimed in particular at Mexico, which had a history of nationalizing foreign investments. Thus, they were primarily defensive in nature. But in a recent paper prepared for Esty's Yale Center for Environmental Law and Policy, Howard Mann and Monica Araya observe a "historic change in the use of investment agreements from a shield into a sword." Chapter 11, they argue, has morphed from a narrow tool to protect against expropriation into a broad license allowing disgruntled foreign companies to target regulations that, though clearly within the sovereign powers of a state or nation, may have cost them a profit.
The canonical example is the first NAFTA Chapter 11 case, in which the U.S.-based Ethyl Corporation sued Canada over a ban on Ethyl's product, a gasoline additive known as MMT. Canada settled the case in 1998, agreeing to remove the regulation and pay $13 million to Ethyl. With this settlement, the sword was drawn. Instead of having to pay, the polluter got paid. The very next day, another NAFTA Chapter 11 case was filed by another U.S. company--the hazardous-waste-disposal corporation S.D. Myers--against a different Canadian environmental law.
Not surprisingly, a delighted u.s. business community wants Chapter 11-style investor protections extended to the FTAA as all-purpose weapons against national regulation. In his May 8 testimony before the U.S. House Ways and Means Subcommittee on Trade, Daniel Price-- who helped negotiate Chapter 11 as the USTR's deputy general counsel--attributed the current boom in foreign investment on a global scale to "strong, stable legal regimes to protect property rights." Similarly, in an April letter to Robert Zoellick, a consortium of business groups, including the U.S. Chamber of Commerce and the Council for International Business, extolled the way investment agreements "create stable business environments, which in turn generate substantial growth opportunities."
But viewed through a slightly different lens, these same agreements create unstable regulatory environments, which in turn generate uncertainty about permissible state and national regulatory actions--for investors as well as for governments. Unlike U.S. courts, with their rules of deference and precedent, NAFTA panels are not bound by the rulings of previous panels--a circumstance that makes it difficult to predict how they will rule at any given time. Meanwhile, Chapter 11 cases are relatively easy to initiate. The result is a serious threat to state and national governments' sovereign powers to regulate in the public interest.
Ironically, the uncertainty generated by Chapter 11's untethered legal regime appears to be nipping the U.S. business community as well. Probably one reason for the letter of concern that businesses sent to the USTR in defense of investment protections is their fear that such provisions could self-destruct even before they make it into the FTAA. A backlash against cases like the Methanex lawsuit, for example, could undermine public support for Chapter 11-style mechanisms in future agreements. This may be why the United States has tapped former Secretary of State Warren Christopher to fill its one appointed seat on the three-person United Nations arbitration panel in the case. (In yet another sop to corporations, NAFTA allows Methanex to appoint one arbitrator as well.) Faced with the risk of being stung by an agreement it carelessly signed on to, the United States is bringing out its big guns. If Methanex wins, "it could be the end of NAFTA investor rights," speculates the Georgetown University law professor Robert Stumberg. "That's why Warren Christopher is on the case. He's there to protect NAFTA."
The BC Model
Even if Methanex loses or settles with the United States, that won't alter California's concern that NAFTA allowed the suit to be brought in the first place--and that the FTAA would multiply such claims. Nor will it change the fact that, at present, the 50 U.S. states have no real seat at the negotiating table in trade agreements whose provisions could diminish their sovereignty.
California's Select Committee on International Trade Policy and State Legislation bears a strong resemblance to a special committee created by the legislative assembly of British Columbia in 1998. That committee examined the Multilateral Agreement on Investment (MAI) then being negotiated under the auspices of the Paris-based Organization for Economic Cooperation and Development.
The MAI would have extended NAFTA's investor protections--including expropriation provisions, rights to sue nations, and broad minimum standards of treatment--on a global scale. This triggered fierce resistance, particularly from environmental groups concerned about the use of expropriation claims to challenge environmental regulations. In the face of such opposition, the MAI talks collapsed--possibly the most serious setback yet in the ongoing process of global-trade liberalization. To many observers, the precedent suggests that the FTAA's investment provisions, which are modeled on NAFTA, could be similarly vulnerable.
British Columbia's committee stood at the center of mounting opposition to the MAI, and this suggests an obvious model for California with respect to the FTAA. Drawing upon expert testimony but also traveling throughout the province to take public comments, the Canadian committee focused in on the way the MAI could impair British Columbia's local powers of government. "It contained all of the very negative elements of NAFTA Chapter 11 and in addition some even worse characteristics," notes Noel Schachter, international director of the British Columbia Ministry of Employment and Investment. In its final report, British Columbia advised the Canadian federal government to oppose the MAI. But the committee's more lasting impact may have been its gathering and dissemination of information on the arcana of international investment agreements, a contribution that fanned the Canadian public's growing outrage over NAFTA's Chapter 11.
The public outrage in Canada was also stimulated by the government's settlement of the Ethyl case. By contrast, though several Chapter 11 suits are pending in the United States, there has been no such outcome yet to galvanize resistance. Nevertheless, state legislatures are beginning to pay attention. Oregon's legislature recently passed a joint measure calling on the U.S. Congress to monitor proposed trade agreements for conflicts with state sovereignty; Washington State has shown similar interest. And in Massachusetts, which like California has seen one of its laws challenged by Canadian investors under NAFTA, State Representative Byron Rushing has submitted a bill that would create a commission to monitor the effects of international trade agreements on state laws and regulations. (In California, Sheila Kuehl has submitted two such bills, one monitoring labor laws and one focused on the environment.) "Really, we are just now educating legislators," says Rushing. "Except for California and Washington State, the average state legislator in the United States does not know anything about this stuff."
One express purpose of the California committee is to create an exportable model for other states. And there's already an umbrella structure in place to channel states' mounting concerns. The National Conference of State Legislatures (NCSL) has a stern official policy on "Free Trade and Federalism": When it comes to new international agreements like the FTAA, "provisions must be made to deny any new private right of action in U.S. courts or before international dispute resolution panels." In the event of a tribunal award to a foreign investor requiring the United States to pay damages, the NCSL asserts flatly that "the federal government must fulfill its promise to pay those damages itself, rather than shift the cost to states."
Still, these are baby steps, hardly capable of derailing the FTAA negotiations. Kuehl's is only a select committee in the California senate, not a standing one. Yet even such low-level activities can help increase comprehension of just how sweeping NAFTA's Chapter 11 investor protections are.
Another impediment is the use of states'-rights rhetoric, which could prove to be a double-edged sword. Phrases like "laboratories of democracy" are never far from the lips of Robert Stumberg, director of Georgetown University's Harrison Institute for Public Law and a consultant to California's Select Committee on International Trade. A leading theorist of a kind of three-tiered sovereignty--state, national, and international (treaty-based)--Stumberg is a hard-core crusader for subsidiarity: the principle that the government closest to the people is the most responsive.
Stumberg's localist sympathies can seem to put him in odd company. The conservative U.S. Supreme Court has dredged up a pre-1938 version of the commerce clause and states' rights to overturn such federal laws as the Violence Against Women Act. If critics challenge global-trade agreements in the name of state regulatory sovereignty, they must be able to articulate just when localities and subnational actors can legitimately be preempted or disciplined by national (or international) actors and when their sovereignty should be left inviolate. Is it that liberals believe states are the most appropriate regulators, or that they are skeptical of international free-trade agreements?
Stumberg answers this question by comparing NAFTA's Chapter 11 and the 14th Amendment to the U.S. Constitution, which was adopted during Reconstruction to ensure equality for all citizens regardless of race. Both were adopted by the national government and had the effect of diminishing the powers of states. But a key difference, as Stumberg sees it, was the method of adoption. After long deliberation, the 14th Amendment passed Congress and was ratified by three-fourths of the states. By contrast, NATFA's Chapter 11 was all but invisible. You can't even find a reference to it in the 1993 NAFTA congressional debate. In the case of the 14th Amendment, says Stumberg, "the states participated. Some opposed, some supported, but they reached their constitutional majority, and it became the law of the land. And that's why you have states bucking against the pressures being created by trade agreements. Because they were not part of the process."
Another answer is that Washington has long allowed states and cities to have regulations in many areas that go beyond a federal floor--in minimum-wage laws, clean-air restrictions, and human rights protections, for example. Treaties like NAFTA allow foreign companies to challenge federal and state regulations alike, with recourse to corporate-friendly panels that are a far cry from American-style due process of the law.
During the original debate over NAFTA in Congress--an exchange that conspicuously lacked discussion of NAFTA's Chapter 11, much less of state-sovereignty concerns--the two sides were largely cast as defenders or enemies of free trade. The result was, not surprisingly, a rhetorical and public relations battle that left NAFTA's advocates victorious on virtually all counts. After all, who could oppose the abolition of barriers to free trade?
Since NAFTA's approval, however, the ground has shifted significantly. The agreement's most contentious provision, Chapter 11, does not involve trade at all, but protections for foreign investors. The core question, therefore, is not whether trade regimes should be liberalized but whether governments bound by international trade treaties will be forced to cede their sovereign power to regulate in the public interest.
That this shift could occur virtually unnoticed is a serious condemnation of the original NAFTA deliberations. The NAFTA that passed was, in crucial respects, not the NAFTA that was discussed.
Still, both the business community and the USTR want the same model for the FTAA. But they are vulnerable now in a way that they weren't in 1993. Following California's lead, states can demand and receive answers from the USTR. In the process, they may be able to throw open the FTAA negotiations process to public scrutiny and halt the erosion in government's ability to regulate.