Privatization, Free Trade and the Erosion of

Government Authority

Jennifer GerbasiPresented to

Economic Policy Institute Washington, D.C.April 2003

OverviewMarket Structuring Role of Local GovernmentDemocratic Deficit Created by Free Trade AgreementsImplications for Privatization

Cornell University, 305 West Sibley Hall, Ithaca, NY 14853607/255-6647 * jcg28@cornell.edu

Market Structuring Role

The Subtext Government needs to actively shape the market

Government sets the proconditions and presuppositions of markets Define property rightsCreate a framework for bargainingBalance public and private interestsRespect a process for dispute resolution

Market Structuring Role

Specific to Privatization Privatization requires government intervention into the administration of markets – undermines market independence

Ensure competition, and attention to public values

The contract negotiation by the government is keyMonitoring, reliability, qualityAccess, process transparency, public participation

Government is the primary actor in privatization

Free Trade Regime Goals

Inhibit government manipulation of the marketPerceived barriers to the flow of money and goodsRely on market disciplines to make businesses

efficientRegulations, guidelines and rules are viewed as

non-tariff barriers to trade and unnecessary Increase Foreign Direct Investment (FDI) Rise above the politics of place

Free Trade Regime Mechanisms

Eliminate local requirements for contracting

Limit purchasing criteria to quality and quantity

Eliminate practices that favor public provision

Recent Trade Agreements

North American Free Trade Agreement (1994) New Investor Rights - Chapter 11

World Trade Organization (1995)Binding/Financial Penalties

General Agreement on Trade in Services (1996)Liberalizes Services

Free Trade Area of the AmericasExtends the above to all 34 north, central and south

American countries excluding Cuba.

FTAs Erode State and Local Government

AuthorityReplacing democratic voice and participation with enhanced investor rights

Change in property rights limits the framework for bargaining and security in contract negotiations

Limiting the expression of collective preference through state and local legislation

Undermining judicial authority by substituting private tribunals for the public courts

Investor rights

Foreign Investors are on par with nations Investors

Enforce treaty obligations in investor-state disputes that traditionally were nation-nation

Do not need the approval of their home nationComment on Proposed Legislation

Defined:An investor is any person or entity with a financial

interest in the property including individual shareholders and lenders

Investor Property Rights

Under free trade agreements property includes: market share market access future profits

Compensation could be awarded when a regulation interferes substantially with the enjoyment of property

Not considered “property” in the US.

Partial Takings

US companies would not get compensation if:Owners equally impactedOther uses of the propertyRationally related to a legitimate public purpose

Compensated only for: physical occupation or Close to 100% of the property value was lost

Mexico customarily subjugates private rights to the public good

Preemption of Legislative Authority

Harmonization Precautionary Principle The choice of mechanism or law must be

the “least trade restrictive”

US Laws/CourtsIrrelevant

Foreign investors can challenge US laws in secretive international tribunals

The federal government is a party The state or locality is not privy The investor and country choose the law (usually international) No deference is given to precedence in the national courts or previous tribunals

Democratic Deficit

No effective mechanism for citizen input/debate Citizen voice shared by foreign investors Investor needs placed above public values and

accountability Government action can be

interpreted as a barrier to trade Tribunals preempt legislation and court system

Methanex v. US Facts:

California well water was contaminated Studies showed it was MTBEIt is used to make gas burn cleaner MTBE is carcinogenicThere are substitutes

Government Reaction:Courts award $50 million to municipalities for

ground water contaminationCalifornia banned its use as of 2003

Resulting NAFTA Challenge

Canadian manufacturer claims:Loss of Profit/Market ShareDiscrimination in favor of domestic productsOther countries find no leakagesCalifornia should enforce LUST laws more

stringently rather than ban MTBE Damages requested:

$970 million US

UPS v. Canada

Facts: The Canadian Royal Post delivers parcels

on letter routes. The government owned corporation

parallels the US Postal Service

Government Action: No new action. Traditional role.

Resulting Challenge

UPS, a United States corporation, claims: This constitutes an unfair cross-subsidy Public is competing unfairly with the

private firm

Damages Requested: Equal access to letter carriers or Cash awards equal in value to the subsidy

Traditional Government Services Liberalized by

GATS Business Construction Distribution Educational Environmental

Health Tourism Recreational Cultural Transport

Market StructuringRole Threatened

Subsidies to government services must be extended to foreign investors

Zoning may be challenged Licensing may be harmonized No residency requirements No performance requirements Bonds may be prohibited Tax revenues may be affected

Free Trade Agreements Create a Governance

Deficit Need a balance between governance and economic development goals.

Market solutions to public goods require government intervention

Free trade agreements strip state and local governments of that authority

Facts: Metalclad got Federal and Regional

government approvals to build a toxic waste processing plant

The EIS said the ground water would be affected

Government response: The local government denied permit The area was designated a nature preserve

Metalclad v. Mexico

Resulting Challenge

Metalclad claimed: Expropriation of investment Unfair treatment

Award: The full cost of the completed building - $16.8 million US

Free Trade Agreements Erode Local and State Government

Authority.

“If you are worried over state sovereignty, my advice to you is ‘Get over it.’”

US Trade Representative Negotiator David Price

FTAs Erode State and Local Government Authority

1. Foreign Investors on par with Nations2. Redefinition of takings to include regulatory

takings and provide compensation for loss of potential profits and market share.

3. Substitution of private tribunals for public courts

4. Preemption of sub-national legislative authority

The Loewen Group, Inc. v. United States challenge is an example of this threat. Loewen, a Canadian funeral home, has been granted standing by a NAFTA tribunal to sue the United States for requiring a bond before the appeals process. Loewen was found guilty of illegal competitive tactics and was fined $400 million punitive damages award in the Mississippi Supreme Court. Mississippi requires that appellants post a bond (equal to 125%) for the award that would be due if the appeal fails. Loewen settled the case for $175 million. Still dissatisfied with the outcome, in 1998 Loewen turned to the NAFTA process for relief. Loewen is claiming that the actions of the awarding jury and the court have been influenced by their status as a foreign company, and therefore are challenging the damages award. If Loewen is successful, there will be broad implications for all U.S. courts. If the NAFTA tribunal protects Loewen by declaring the Mississippi law invalid, then the impact of NAFTA will be that

• International Institute for Sustainable Development, 2001. Public Rights, Public Problems: A guide to NAFTA's controversial chapter on investor rights. World Wildlife Fund, Canada.

investors will not be required to exhaust remedies before going to arbitration, investors can go through the court system and then challenge it if not satisfied, the court decisions will not be given weight by the tribunal or considered in their deliberations, no civil dispute with a foreign investor can be considered settled until a tribunal has also considered it. The U.S. court system could be circumvented entirely. These are not changes to the treaty, but a lenient

interpretation that mirrors the lack of deference integral to the treaty. The way the treaty is written the arbitration panels are under no requirement to give the court or the state laws deference. A single foreign shareholder, without the consent of the company or country of origin, could claim an investment loss and challenge the legitimacy of the American court system. The courts would lose their ability to interpret the law for foreign cases. There would be two standards for disputes, one for foreigners set by NAFTA, and the traditional U.S. law for domestic companies and

investors.