new federalism in Mexico and foreign economic policy: An alternative two-level game analysis of the Metalclad case, The

Latin American Politics and Society, Winter 2001 by Tamayo, Arturo Borja

ABSTRACT

This article examines, through a two-level game model, the case of the first investment dispute under NAFTA between a private U.S. firm and the Mexican government. It argues that the clue to understanding why the Mexican president could not cooperate with the U.S. president lies in Mexico's domestic "ratification" process. The analysis yields two theoretical propositions. First, federalism represents an important variable in explaining foreign economic policy. Second, two-level game logic should not be applied only to formal international negotiation situations; instead, by specifying the dependent variable as cooperation or noncooperation, these models connecting domestic and international politics can be productively applied to study foreign economic policy.

In a letter dated March 6, 1995, the Metalclad Corporation, a firm with headquarters in Newport Beach, California, proudly announced to its shareholders in New York and Chicago the imminent opening of its new "state-of-the-art hazardous waste treatment and confinement facility," to be located in the municipality of Guadalcazar in the Mexican state of San Luis Potosi. According to Grant Kesler, the president of the corporation, the new facility represented a significant contribution toward solving the terrible problems Mexico faces in properly disposing of industrial waste. Therefore, the letter continued, the opening "will be heralded simultaneously by the governor of San Luis Potosi, by federal environmental officials in Mexico City, including members of President Zedillo's cabinet, and by the office of the Mexican ambassador to the United States." For these reasons, the letter praised the operation as "the classic NAFTA model in that it combines U.S. capital, U.S. technology and U.S. training with opportunities in Mexico" (Metalclad 1995a).

Unfortunately, the Guadalcazar facility never fulfilled the president's promise to Metalclad's shareholders. In the months after the letter was issued, a conflict of interest between Metalclad and the state and municipal governments emerged. It caused a serious dispute between the local governments and Mexico City, making local and national headlines. It also led to a minor diplomatic incident with Washington. One result was that as of mid-1996, the company's stock had lost about 80 percent of its value.

A coalition of social groups and environmental NGOs effectively mobilized against the opening of the facility and forged a political alliance with local authorities. Metalclad, for its part, had the active support of Mexico's central government throughout the process, including the official imprimatur of the agencies in charge of enforcing federal ecological laws. Nevertheless, the municipality, with the political support of the state government, denied Metalclad the construction permit and succeeded in preventing the commercial opening of the plant.

This came as a surprise not only to Metalclad but also to many federal bureaucrats in Mexico City, for this was not the way things usually work in the country. Historically, the construction permit issued by municipal authorities would not represent an obstacle to foreign investors, especially not for foreign companies that, like Metalclad, were willing to invest in policy programs designed and promoted by the president.

As a result, in January 1997, Metalclad, which had invested $22 million in the facility, filed a claim under the terms of Chapter 11 of the North American Free Trade Agreement (NAFTA) demanding compensation in the amount of $90 million (Millman 1997). Paradoxically, what was supposed to represent a model of NAFTA investment became instead the first investment dispute between a U.S. firm and the Mexican federal government under the regional agreement.

According to NAFTA Chapter 11, the parties to an investment dispute may be the investors and one of the three North American federal governments, and not two states, as has usually been the case. The International Center for the Settlement of Investment Disputes (ICSID) heard the suit. Three arbitrators, including the president of the tribunal, were appointed in early 1997, and the first session took place on July 15 of that year. NAFTA investment dispute cases are conducted in secrecy, and neither the files nor the sessions of the tribunal are open to the public.1 Finally, in August 2000, the tribunal ruled in favor of Metalclad, awarding the firm compensation from the Mexican federal government in the amount of $16.7 million (Los Angeles Times 2000).

The ruling in the case reinforced two concerns that the Canadian government had previously expressed regarding the provisions of NAFTA Chapter 11 for investment disputes. The first problem is that private investors like Metalclad are allowed directly to sue federal governments. The second is that the Canadian government considers the term expropriation too ambiguous as the NAFTA treaty defines it. Metalclad, and other private investors that have sued the Canadian government under Chapter 11, have presented their legal cases precisely as expropriations by the federal governments. Ottawa believes that as a result of these shortcomings, private firms can circumvent local legislation, particularly environmental legislation (El Financiero 1999).