CIAO DATE: 02/03

Economic Issues Raised by Treatment of Takings Under NAFTA Chapter 11

Abstract

This working paper examines, from an economic perspective, the treatment of takings (property rights) under NAFTA Chapter 11. To be more precise, the paper examines the treatment of takings as environmental groups fear might be established as the result of investor dispute settlement under this chapter; as of the date of this writing, most of the cases that have the potential to be precedent-setting have not been finally decided, albeit one—the Metalclad case—has been decided in a way that is unsettling to environmentalists. The author attempts to determine whether requiring public compensation of private investors for diminishment of value resulting from government regulatory action has the potential of achieving anything close to an “optimal” outcome from a societal cost-benefit point of view (defined below). This determination makes use of tools of economic analysis and, in particular, Coase’s theorem regarding achieving optimal outcomes where negative externalities are present. The overall conclusion is that, although Coase’s theorem can be invoked to argue that such an outcome can be achieved either via a “polluter pays” approach or a “public pays” (or “public must compensate”) approach, as a matter of practical application, the first approach is preferable to the second for a number of reasons, including government “fiscal illusion” and “moral hazard.”

Section 2 of this paper reviews Coase’s theorem and establishes the main result that follows from it: if a bargaining process can be established and properly managed under the right circumstances, either of the two approaches noted above can in principle yield the same outcome in terms of achievement of a goal to reduce an external cost. As is well known, the two approaches do yield differing results with respect to who actually bears the costs associated with this reduction. Sections 3 and 4 then discuss respectively the issues posed by fiscal illusion and moral hazard; the conclusion in each is the same—that in spite of the neutrality in principle of Coase’s result regarding the best direction for public policy to take with respect to whether to assess the polluter or the public for costs of pollution abatement, the former dominates the latter when issues of practicability are considered. The overall conclusion then is that, although the case for public compensation of investors for diminished value of investments induced by environmentally motivated regulations is not wholly without merit, as a practical matter, application of the “polluter pays” principle is preferable. To the extent that this is correct, it is also arguable that use of NAFTA Chapter 11 as a vehicle to force such compensation for such diminished value is likely to lead to nonoptimal results. This of course would suggest that the expropriation provisions of NAFTA Chapter 11 should be interpreted, or perhaps even amended, so that these would not cover this type of taking; this matter is discussed in the concluding section (section 5).

Full Text (PDF, 21 pages, 344 KB)