After NAFTA?

The logic is that countries should not gain competitive advantage in trade by undermining or failing to protect workers’ rights and the environment. These commitments typically require adherence to national and/or international labour and environmental standards, laws or conventions.

In the 25 years since the establishment of the first of these clauses, only one case alleging a party’s failure to comply has gone to arbitration. That was a case filed in 2011 by the United States against Guatemala under the U.S.-Dominican Republic-Central America Free Trade Agreement (CAFTA-DR), claiming that Guatemala had failed to effectively enforce its labour laws across a range of issues, sectors and enterprises.

In June 2017 the panel issued its decision: it concluded that, “the United States has not proven that Guatemala failed to conform to its obligations under Article 16.2.1(a) of the CAFTA-DR.”

Given the breadth and detail of the allegations in the complaint, coupled with the widespread documentation of a culture of non-compliance with labour laws and labour rights in Guatemala, the decision came as a shock to most observers.

The panel, made up of one arbitrator selected by the U.S., one selected by Guatemala, and a Canadian chair, reached its decision that Guatemala had not breached its obligations because the violations had not occurred “in a manner affecting trade” between the parties.

That limiting phrase first appeared in the U.S.-Jordan Free Trade Agreement in 2000, and has been included in all subsequent U.S.-negotiated labour and environmental chapters, including the negotiated text of the Trans-Pacific Partnership (TPP). In that draft agreement, the parties—which include the United States, Canada and Mexico—agreed to the following language:

Although the United States has now withdrawn from the TPP and its future status is unknown, there have been indications that the TPP text may be tabled by one or more parties as a basis for the renegotiation of the North American Free Trade Agreement (NAFTA).

The arbitral panel in the Guatemala case adopted an extremely demanding interpretation of what a country would be required to prove to establish that violations had affected trade between the parties. In effect, the accusing party would need to prove that violators of labour laws at the firm level had obtained significant cost advantages through the violations. Demonstrating changes at this level would require access to sensitive internal company accounts. Such a threshold would not be required under domestic labour laws. It could not be met without subpoena power (at a minimum), which does not exist under the trade agreements.

Since this was the first labour-related trade arbitration, the language requiring that violations occur “in a manner affecting trade” had never been tested before. In addition, although the panel did not offer a final interpretation on the other limiting phrase in the labour and environmental chapter obligations (through “a sustained or recurring course of action or inaction”), they pointed toward an equally demanding approach.

The decision is disturbing because of the injustice it imposes on the affected Guatemalan workers. It also violated the parties’ explicit commitment to broad enforcement of labour rights contained both in the obligatory commitments and the overall stated purposes of the agreement. And as the first, and as of now only, arbitration arising from a labour clause (or environmental clause), it has set a precedent for future cases.

The United States has published its key objectives for the renegotiations of NAFTA, including a labour chapter based on the TPP labour language. After the decision and precedent of the Guatemala case, this would result in a de facto evisceration of the labour and environment commitments. Twenty years of negotiated progress regarding other aspects of the scope and rigor of these commitments would be for naught.

It should be noted that there are no such limits to the obligations to protect, for example, intellectual property rights in U.S. trade agreements. Arbitration can be sought regardless of whether alleged violations of such rights affected trade or were part of a sustained or recurring course of action or inaction. The lack of limiting conditions follows the logic that protection of core rights is necessary to level the playing field among trading partners and not allow unfair competitive advantage to be gained through their violation.

The fact that the United States has recognized this and avoided limiting such obligations with respect to intellectual property rights suggests that those rights have been given a higher priority and greater care in negotiations than labour and environment rights. The Guatemala case has proven that the easily exploited loopholes in the enforcement of labour and environment obligations amount to lesser protection for those rights than for intellectual property or, for that matter, for investment or other rights. The stated U.S. approach—that for trade to benefit all partners, there must be convergence on the basic rules of competition and protection for essential rights and public policies—has been shown to have glaring gaps.

The renegotiation of the NAFTA agreement presents an urgent, immediate opportunity to eliminate these gaps. The best solution will be to eliminate the two limiting provisions (“through a sustained or recurring course of action or inaction in a manner affecting trade or investment between the Parties”) entirely, and allow enforcement of the labour and environmental obligations on par with those protecting intellectual property and other rights.

At a minimum, the parties should be pressed to include definitional footnotes that would constrain overly broad interpretations of the limiting phrases. For example, “in a manner affecting trade” could be defined by a footnote such as:

Similarly, “a sustained or recurring course of action or inaction” could be defined as “meaning more than one instance of action or inaction.”

Advocates of labour and environmental rights should insist that, in the current renegotiation of NAFTA, there cannot be limitations on enforcement of labour and environmental commitments that in effect negate the commitments.

The proposal to renegotiate the North American Free Trade Agreement (NAFTA) represents an opportunity to update the vision that prevailed within it: that the invisible hand of the market would solve underdevelopment and, therefore, the environmental and labour problems of North America. The Sustainable Development Agenda 2030, adopted in 2015, is an important advance on this vision, since it includes environmental, social and economic aspects as integral parts of development, making it sustainable.

It should be recalled that, in NAFTA, environmental and labour matters were introduced through parallel agreements and not as integral parts of the treaty, as happens in trade agreements subsequent to NAFTA. As a condition for the latter to be approved by Congress, those agreements introduced a model based on dispute resolution and sanctions, despite the fact that the word “cooperation” was used in their names. The ultimate goal of such mechanisms as citizen petitions was to prevent the “possible” non-application of environmental legislation, principally in Mexico, becoming a magnet for foreign investment and consequently weakening environmental and labour standards in the United States and Canada. Although the effectiveness of these mechanisms has been questioned, the hypothesis that Mexico would attract investments due to having less robust environmental standards has not been confirmed.

Since 1992, Mexico has made significant progress in the development of its environmental institutional framework, having created the Secretariat of Environment and Natural Resources, the Federal Environmental Protection Agency and other agencies in the environment sector, largely as a result of negotiating NAFTA. Today, Mexico has robust environmental legislation; for example, it is one of the few countries in the world with a General Law on Climate Change.

Nonetheless, these advances have not prevented a degradation of the environment and natural resources associated with economic growth in Mexico, a cost that is calculated at 7 per cent of annual Gross Domestic Product. Some critics point out that, by boosting the expansion of fruit and vegetable production for export, NAFTA has led to an excessive use of water, fertilizers and other chemicals in agriculture, as well as deforestation. Clearly, trade liberalization is just one of many other factors, including subsidies, the lack of a price for water and the absence of support for sustainable agriculture, that have a possibly greater impact on the deterioration of natural resources. One could say the same about the environmental impact of the expansion of trade in fossil fuels and other products, such as motor vehicles and electronics, in North America. But in the last instance, the cause of this environmental impact is rooted in the North American countries’ development models and not in the trade agreement per se.

Perhaps one of the most obvious areas to insert a vision into NAFTA—that is not solely focused on economic interests but that also includes environmental ones—is the investor­–state dispute mechanism in Chapter 11 of the treaty. Through this mechanism, companies can bring proceedings against the states of the three countries in tribunals with supranational powers if the actions of these states amount to expropriations of the investment in question. It has been successfully used on nine occasions against Canada and seven against Mexico, for sums amounting to $170 million and $240 million, respectively. While these are small amounts compared to the universe of foreign direct investment in these countries, many of the cases were related to suits that understood certain environmental regulations as de facto expropriations.

It is surprising that the Commission for Environmental Cooperation, the only trinational institution created with NAFTA, should have played a rather marginal role in these cases. With renegotiation of the treaty, an opportunity arises to give it an important role both in promoting an agenda of environmental cooperation in North America and in articulating a vision of development that takes the Sustainable Development Goals as its guide.

One urgent concern is how foreign investors have successfully used NAFTA Chapter 11 to make Canadian taxpayers fund damages, including lost profits, when Canada applies its environmental laws so as to reject foreign investors’ projects.The worst example is the March 2015 arbitral ruling against Canada on jurisdiction and liability in the Clayton/Bilcon case.

Two of three arbitrators found Canada violated Chapter 11 by applying its environmental laws to reject a New Jersey company’s project to mine basalt on the Digby peninsula in rural Nova Scotia because of impacts on the Bay of Fundy and local communities. As the dissenting arbitrator noted, this is an egregious result. Now, Canadian taxpayers will have to pay (Canada is likely to lose its challenge to the ruling in federal court). The Clayton/Bilcon ruling is a terrible precedent, and it could rear its ugly head in other pending NAFTA Chapter 11 cases, such as claims by U.S. energy companies for damages due to Quebec’s moratorium on shale gas fracking under the St. Lawrence River and elsewhere in Quebec.

Clayton/Bilcon have filed their brief for damages—but, in yet another travesty, they are not even required to inform Canadians how much of our public funds they seek. How is it possible that this information can be kept from the public? Just look at the redactions they were allowed to include in the public version of their brief.

Meanwhile, the pathetic counterweight in NAFTA to the strong protections for investors is a meaningless provision: NAFTA section 1114(2) timidly implores the NAFTA countries not to weaken their environmental, health or safety laws and regulations to benefit investors. All three countries—but especially Canada and the United States—have ignored that provision many times since NAFTA took effect in 1994, from the scaling back of U.S. environmental protections to promote logging in the 1990s and repeal of environmental protections under President George W. Bush, to Canada’s overt appeal for foreign investment in Canada’s natural resource sector in light of rollbacks of environmental law in the Harper government. But, those examples pale in comparison to the drastic environmental rollbacks that have already begun in the Trump administration, with many more to come. Not surprisingly, NAFTA 1114(2) this is an entirely forgotten provision that no country has ever used to challenge another country’s environmental rollbacks—neither under NAFTA nor under post-NAFTA agreements with similar provisions.

Other glossy environmental “commitments” in NAFTA and its environmental side agreement were supposed to be about promoting upward harmonization of environmental standards in North America, but it has just not happened in any significant way. In fact, Environment Minister McKenna’s disappointing recent announcement that pending regulations on methane emissions from oil and gas operations will be delayed because of the Trump administration’s shameful environmental policies was more typical. As well, the meager rights offered to North American citizens to seek review of weak environmental enforcement have been almost completed eroded. (I led the citizen submission process at the NAFTA environmental commission from 2000 to 2007.)

Yet, the NAFTA model for trade and environment has been replicated over and over again in U.S. and Canadian post-NAFTA trade agreements, even as it has become more and more clear that international trade contributes to mounting global ecological impacts such as climate change, biodiversity loss and pollution of ecosystems with human-driven nitrogen and phosphorus loads. Post-NAFTA adjustments to environmental provisions just have not come close to being sufficient to date—including those in CETA. If NAFTA is going to be renegotiated, these shortcomings need to be addressed in a much more serious way. Unfortunately, I am not holding my breath.

This paper uses an economic trade model to simulate the impacts of a 20 per cent tariff increase in North American industries such as energy, steel, cement and automobiles.

Ending NAFTA tariff preferences in these areas would entail migrating tariff levels to multilateral most-favoured nation (MFN) levels, as set out by the World Trade Organization, although most MFN rates fall below the 20 per cent threshold used in this study.

A key finding of this research is that a 20 per cent tariff hike would not trigger significant absolute economic losses in all three countries: the U.S. economy has the most to lose, at roughly USD 3.4 billion a year in terms of GDP, and approximately USD 5 billion in welfare losses. (The concept of welfare is an aggregation of producer and consumer gains and losses. Free trade enhances consumer welfare by making products cheaper, therefore reversal results in consumer losses.)

The biggest industry loss is in the Canadian steel sector, where output declines by some 13 per cent, compared to 6.5 per cent in Mexico. The U.S. would increase its output marginally perhaps for domestic use in appliance sectors and the auto sector.

The simulated tariff hike, coupled with an increase in various non-tariff barriers, would have a small effect on total energy output in Canada, Mexico and the U.S. This is an important finding from a climate change perspective: the use of trade barriers to halt trade in energy and electricity trade would not be an effective tool to reduce carbon-intensive energy output in coal and oil, nor would such a blunt instrument lead to any measurable reduction in greenhouse gas emissions. Moreover, increasing trade barriers would bring about a reduction in renewable energy, and a switch to increased liquefied natural gas (LNG), which would in turn require substantial new investments and a need to significantly increase related infrastructure within each country.

Significant Employment Losses in All Sectors

Due to the lack of a diversified economy and reliance on the U.S. market, Canada would suffer the highest relative decline in employment, followed by Mexico and then the U.S.

Increased trade barriers would see a loss of 600,000 U.S. jobs in the energy sector, 120,000 jobs in Canada and 260,000 jobs in Mexico. In the gas sector, the U.S. would lose over 100,000 jobs versus 26,000 in Mexico and 10,000 in Canada. Nearly 460,000 people would be displaced in the steel industry in the U.S., with 240,000 in Mexico and nearly 75,000 in Canada. In the cement industry, nearly 2 million people would be displaced in the U.S., followed by over 200,000 in Canada and another 200,000 in Mexico. In the auto industry, some 800,000 people would be displaced in Mexico, with 750,000 in the U.S. and nearly 150,000 in Canada. Since cement and steel are important inputs in the shale gas and construction industry, as well as other energy sectors, unemployment in these sectors would affect downstream sectors too.

Effects of a Border Carbon Tax

The study also examined the possible effects of a USD 40 per tonne border carbon tax applied on electricity and a basket of export-intensive, trade-exposed goods—including automobiles, steel and a wide range of agricultural and resource-based products. In the analysis, the U.S. does not use a carbon tax while Canada and Mexico impose a carbon tax on emissions, which they adjust at the border for U.S. imports.

Assuming that exports increase and imports decrease for Canada and Mexico with a border carbon tax, their currencies would appreciate vis-à-vis the U.S. dollar. Exports would become less competitive and imports more competitive, thus negating the effects of the border tax adjustment.

The largest overall gains in this scenario are for Mexico, followed by Canada and the U.S. However, as only energy-intensive trade exposed industries are likely to be affected, the overall changes are smaller than in the case of an overall tariff hike of 20 per cent. Thus, while a border tax adjustment would not compensate Canada and Mexico fully for the output, employment, GDP and welfare losses consequent to a tariff hike under NAFTA, it would go at least halfway towards doing so.

In the end, whether it is a tariff hike or a border carbon tax, all three countries will suffer. The greatest losses, however, will be borne by the United States.

This is an excerpt from the commentary Renegotiating NAFTA: Pros and cons for Canada and Mexico.