Attacking public interest regulation: north and south

What does a ballot initiative in four US states next month have to do with interprovincial trade in Canada? The answer is that both are attacks on the capacity of governments to regulate in the public interest, based on a theory known as “regulatory takings”.

The “regulatory takings” movement is more well known south of the border, and is encapsulated in the notion that if a government brings in a new regulation that affects somebody’s profits, it is tantamount to expropriation. Historically, if the government wants to build a highway through your property, they can exproprite your land but must pay you fair market value. Regulatory takings goes well beyond this and in its broadest conception could include all manner of public interest regulation, including environmental protection, labour market regulations, consumer protection, even urban planning.

Some in Canada may be familiar with this concept, as it has been built into the North American Free Trade Agreement’s Investment chapter, and is known as “investor-state” dispute settlement. If a foreign investor thinks that a measure by government (regulations but also laws and administrative directives) undermines their profits, they can avail themselves of “investor-state”, which is a process of international commercial arbitration outside the domestic legal system. Suffice it to say that investor-state has proven controversial.

In Canada, a new precedent for investor-state or regulatory takings is in the BC-Alberta Trade, Investment and Labour Mobility Agreement (TILMA), due to take effect in April 2007. It has often been claimed by business advocates that there are large barriers to trade in Canada, but this is not actually the case. There are no border crossings or customs inspection stations, no currency conversions required. But there are differences in regulation across provinces, and the TILMA creates a process by which those regulations can be attacked.

Previously, under the 1995 Agreement on Internal Trade, a similar process was set up but it required companies to go to their governments first and get them to pursue the case. TILMA cuts out the middleman and allows investors to sue directly for up to $5 million per case. On the surface, $5 million may not seem like much but the total bill will depend on the number of litigants, and for a small city council, $5 million is a lot of money that could otherwise be better spent. As usual, there are a number of exemptions from this provision, so it is not necessarily carte blanche for investors, but what matters is how a panel of trade lawyers (most of whom make their incomes working for large companies) would interpret the agreement. And even the prospect of such challenges creates a “chill” over new regulations.

In the US, there are four Western states with referenda coming up next month that have put regulatory takings front and centre (also known as “property rights initiatives”). Oregon is the template, having passed such a law in 2004. The basic idea is that governments have to pay in order to regulate. A good overview of the initiatives and their problems can be found here.

The irony in all of this is that well-crafted regulations can make markets function more efficiently if they lead to internalization of externalities (eg. ensuring that polluters cannot offload some of their costs of production onto the environment, downstream residents or workers). This extreme view of property rights uber alles supports entrenched interests at the expense of functioning markets. And it is a hyper-individualistic view that assumes that private decisions have no other impacts on those not party to the transaction, when in fact externalities are pervasive.

My usual response is to tell advocates I just purchased the property next door to them, and that I am going to be building a meat-rendering plant.