NAFTA in the Grand and Small Scheme of Things

by Boris Kozolchyk

May 3, 1994

I. The Winds of Political and Economic Freedom

On April 12, 1811, a decade or so after the French Revolution called for "freedom, equality, fraternity," Beethoven wrote the following note to Goethe, who had authored the tragic story of Egmont, the nobleman who fought to liberate the Netherlands from Spain's political, economic and religious oppression: "You will shortly receive ... the music for Egmont, that glorious Egmont which, through you, I have considered, felt and set to music with the same warm emotions I experienced when I read it." The warmth and depth of Beethoven's emotions are apparent in music every bit as glorious as Goethe's drama, and in Egmont's heroine Claire's words: "The drum rolling, the fife playing, how my heart beats, how my blood wells up..." The enemy already retreats... What joy beyond measure, to be a man."

Scarcely two decades later, Turner painted the Fire of the Houses of Parliament, a fire so forceful that it seemed to consume not only the buildings, but the corrupt political system they housed. Turner also provided his indelible version of the struggle of the human spirit against the seemingly overpowering forces of nature. The sea and its awe inspiring, glistening swells and vortexes of cylindrical waves symbolized the forces man had to overcome to realize his destiny.

Fierce winds of freedom were blowing through Europe when Turner painted his fires and storms and Goethe and Beethoven wrote their Egmonts. These winds sought to liberate political and religious expression as well as economic activity. The French monarchy of the ancien regime, in many ways Europe's model, was as absolutist as it was legalistic. When Louis the XIVth proclaimed L'etat, c'est moi, he included the power to imprison anyone who disagreed with him, without trial or time limit. Louis the XIVth's powers also included the determination of what his subjects could contract for, sell or lend to, buy or borrow from the rest of the world.

Louis the XIVth reigned over a feudal system that collected seigniorial dues and ecclesiastical tithes from the peasantry and controlled internal and external trade through state monopolies. Any conveyance of valuable property had to be approved in advance by the central government. Imports or exports were also subject to prior approval and unannounced inspections. Trade with the colonies was closed to traders from other nations except those in alliance or cahoots with the French monarchy.

In attempting to implement its call for liberty, equality and fraternity, the French Revolution did away with many feudal institutions, including the restrictions on freedom of contract. Article 1134 of the French Civil Code of 1804 (also known as the Code Napoleon) granted to private persons the freedom to enter into binding contracts when it stated: "Lawfully executed contracts have the force of law between the parties..." In this manner, the French Civil Code emancipated and enfranchised the will of the contracting parties. Henceforth, private parties had the right to trade within France's continental and colonial borders without any restriction other than formalities of execution of contracts or mandatory laws, public policy and morality.

Yet, freedom of contract did not mean international free trade. Even after the adoption of the likes of Article 1134, many Asian, European and Western hemisphere nations continued to restrict their international trade throughout the 19th and a good part of the 20th century, either directly through export and import controls or through cartels and trusts. The Sherman and Clayton Anti-Trust Acts of the United States and their foreign counterparts notwithstanding, large portions of the world's trade remained cartelized or controlled by private trusts. Similarly, international trade remained subject to protectionist tariff or non-tariff barriers until the end of the Second World War. Even a business-minded and trading nation such as the United States enacted in 1930 the protectionist Smoot Hawley Tariff that helped to bring on the Great Depression.

II. The Winds of International Free Trade

The era of free international trade, although encouraged by 19th century Great Britain, was born at the end of the Second World War. In his history of the Second World War, Winston Churchill reflected on the mistakes made by the victors of the First World War and counseled the victors of the Second World War to be magnanimous. This wise counsel was heeded by the Truman Administration. It implemented a Marshall Plan that made it possible for the devastated Western Europe, including the very nation that caused the devastation, to regain its economic strength. The Second World War allies also created three institutions that made free international trade and development economically possible: the International Monetary Fund and the World Bank were placed in charge of preserving the stability of world currencies and treasury systems and of aiding the rebuilding of Europe and the economic expansion of developing nations. A third entity, the World Trade Organization, was charged with eliminating barriers to international free trade.

Alas, the World Trade Organization died stillborn, victim of increasing isolationism in the U.S. Senate. The GATT (General Agreement on Tariffs and Trade) concluded in 1947 as a set of rules to govern international trade was to serve for 48 years not only as the most influential international trade norms but as an ad hoc organization to enforce these rules and to resolve disputes concerning them. GATT's mission was to reduce tariffs and to eliminate non-tariff barriers such as quotas and other administratively imposed restrictions to the free flow of goods. GATT forbade these barriers except under certain limited conditions as when surges in imports caused serious injury to domestic producers, or, temporarily, to deal with balance of payments problems. From a quantitative standpoint, GATT accomplished much. It has significantly reduced tariff and non-tariff barriers and dramatically increased the number and volume of freely traded goods, especially when the results of the recently concluded Uruguay Round are considered. In addition, GATT brought about significant qualitative changes in the standards of fairness and equality that govern international free trade.

GATT's application of unconditional "most favored nation treatment" and "national treatment" to GATT participants locked in a standard of equality that did much to encourage international trade. Truth to tell, equality of treatment was first articulated as a legal doctrine in medieval European charters that granted the "peace of the marketplace" to foreign traders. Where such peace was not granted, itinerant traders could easily be jailed (or worse) if town dwellers simply alleged that the itinerant foreigners or their countrymen owed debts or compensation for misdeeds suffered by their local accusers. Thus, the peace of the marketplace assured foreign traders that they would be treated the same as local traders.

Prior to GATT, some U.S. treaties of the so called "friendship, commerce and navigation" type and other bi-lateral trade agreements accorded a similar treatment to foreign goods. Most favored nation treatment, in turn, assured nations "C" and "D" that if nation "A", a GATT participant, granted a certain reduction of tariffs to nation "B", also a GATT participant, "C" and "D" as GATT participants would be entitled to the same treatment as "B", without having to provide any benefits in return. In addition, once B's, C's or D's goods had been imported into "A", they had to be treated in the same manner as domestically produced goods. This is the principle of "national treatment" which introduced an additional measure of equality and of fairness. For not only was it necessary to treat the goods of other nations as favorably as those of the most favored nation, but once the goods had entered a member's territory, these goods had to be treated as if they were the importing member nation's own. As ancient as are trading man's aspirations for universal equal and fair treatment, GATT was the first multinational agreement to turn these aspirations into working rules.

III. NAFTA's Own Version of Equality and Fairness

NAFTA shares with GATT the aim of reducing tariff and non-tariff barriers but unlike GATT it focuses on the north-american region – Canada, Mexico and the United States. Even though NAFTA will eliminate tariffs for intra-regional trade, thus departing form the "MFN" principle, NAFTA is not in violation of GATT because it does not raise tariffs on imports from non NAFTA GATT nations. Under the GATT exception for free trade areas such as NAFTA, MFN treatment is maintained for external trade, and it is anticipated that the trade expansion generated by NAFTA will benefit other nations as well. (For example Mexico's imports from China have been increasing in part as a result of NAFTA).

However, NAFTA goes beyond GATT in some significant respects. It grants national treatment not only for imported goods (as under GATT) but also for investments and services as diverse as banking, brokerage, insurance, law and transportation. In doing so, NAFTA prescribes unbiased and transparent administrative procedures. Thus, in the case of government procurement of goods or services, these procedures are designed to ascertain that governmental contracts, grants, concessions or franchises are, on the whole, adjudicated not on the basis of family or friendly connections or bribery, but on the basis of a publicly advertised, lowest-bidder basis.

NAFTA and its "North American Agreement on Environmental Cooperation" also include provisions designed to preserve and improve environmental conditions in all member nations, an absolute first in the history of multinational trade treaties. Finally, NAFTA goes beyond GATT in institutionalizing the dispute resolution procedures which proved so useful in the U.S.-Canadian Free Trade Agreement. These NAFTA procedures include the use of bi-national arbitral "panels" representing both nations involved in disputes over specific unfair trade practices or the proper interpretation and application of NAFTA.

Underlying these NAFTA features rests a standard of commercial fairness born of national self-interest and of the willingness to share a common economic and environmental destiny. Investment in their free trade region as well as free trade with regional neighbors, give investors and traders an automatic stake in their neighbors' and region's well being. After all, if one's neighbor's purchasing power declines, one's products or services could not continue to be sold profitably to him. Similarly, if one's neighbor's pollution threatens one's own or the entire region's environment, there will be an added incentive to remedy the common problem. Finally, if regional dispute resolution panelists are biased or xenophobic, how could they avoid harmful retaliation and unequal treatment of their own country's products? NAFTA's standard of equality and fairness, then, is such, that each member nation acquires a stake in the region's economic and environmental progress. It is for this reason that a regional association such as NAFTA which results from each of the participating nations' self interest, does not require a supra-national court of compulsory jurisdiction and coercive sanctions to enforce fairness of treatment.

IV. NAFTA in the Small Scheme of Things: The Continuous Legal Highway

The large increases in trade and investment associated with NAFTA require that freely traded goods and services travel over a continuous legal "highway." This highway makes it possible that the rights and duties acquired, assumed or imposed in the place where a contract is concluded, goods are shipped or payment is made, are not lost or diminished when the goods or services cross a national boundary. A binding offer to buy or sell made in the United States must be as enforceable in Mexico as in the place of issuance in the United States. Similarly, a "through" transport document should convey to the consignor and consignee similar rights on the cargo regardless of whether the goods are in Canada, in the United States or in Mexico. Also, the buyer's or borrower's payment, whether in a documentary or paperless format, should be as enforceable in the seller's or creditor's place of business as in the buyer's or borrower's place.

A legal highway without continuity causes not only the proliferation of unnecessary disputes, but also discourages third party assumption of commercial or legal risks. No insurer in "B" would want to share risks with insurers in "A" unless B's law supports the coverage of these risks and A's law allows B's reimbursement. In the absence of a consistent legal regime to settle reciprocal insurance claims, the apportionment of regional risks will be simply too expensive.

At this time, NAFTA's continuous legal highway is beginning to be built by two national law centers. The United States National Law Center for Inter-American Free Trade (NLCIFT), in conjunction with the Instituto de Investigaciones Juridicas at the Universidad Nacional Autonoma de Mexico (National Autonomous University of Mexico-UNAM) are initiating this building effort. Unlike the European Common Market's Treaty of Rome or the Canada and the United States' Free Trade Agreement, NAFTA applies to transactions among nations with sharply different legal systems and commercial and legal cultures. Because of NAFTA's legal and cultural diversity, sharply different legal consequences often flow from the same document or transaction.

Some of NAFTA's legal discontinuities occur because different formalities are required for the same transaction in neighboring countries. Take, for example, a sale of Mexican real property by an Arizona seller. A customary Arizona power of attorney executed by the Arizona seller will not comply with the formal requirements of Mexican notarial law. Mexico, as most civil law countries, delegates the validation of economically significant transactions to legal officials known as notary publics who, unlike their United States counterparts, are highly trained and respected lawyers. Hence, the Arizona seller would need to execute a lengthier and more formal power of attorney and obtain the Mexican Consul's "notarization" before his Mexican agent could fully represent him. In addition, if an Arizona broker submitted an offer to purchase the Mexican property in the form of an everyday Arizona "deposit receipt and agreement", it would also be unenforceable under Mexican sales law for lack of an essential formality.

In addition to contrasting formalities, significant differences can be found in the rules that govern virtually every type of business transaction between Mexico and the United States. Consider the following, merely illustrative, enumeration. Contracts among distant parties are subject to inconsistent rules on time or moment of formation; personal, real and intellectual property, as well as secured transactions rights, are acquired and protected differently, some rights common in one country cannot be acquired or protected in the other; commonly used clauses in one country's commercial paper are invalid or never used in the other. The same is true with respect to agency relationships, transport documents and documents of title, insurance contracts, corporate charters and by-laws and so on.

This illustrative list of discontinuities amounts to what has been described elsewhere as "mechanical" obstacles, i.e. obstacles that result from the disparities of legal texts or underlying concepts north or south of the Rio Grande. These disparities can be removed by agreeing on similar or equivalent concepts and by drafting uniform or harmonized texts of statutes, regulations, model contracts or individual contract stipulations. Yet, what about such obstacles as the low esteem in which trade, credit and their practitioners have been held until very recently by Spaniards and their Latin American descendants? Such dislike and distrust have not only stunted the development of commercial credit, but has also inspired a system of monopolized enterprise which has limited the access of local and foreign merchants to numerous forms of commercial ventures and commercial credit. Conversely, what about the epidemic of litigation that prevails among United States businessmen and consumers? The volume and high cost of litigation in the United States has already placed a significant damper on local as well as foreign investment in United States industry and services sectors. It is very likely to have the same effect upon NAFTA transactions. Since these "structural" obstacles are ingrained in the business and legal attitudes of private and public entities throughout the NAFTA region, they are the costliest and hardest to remove.

Removal of mechanical and structural obstacles requires a reciprocal familiarization with the obstacles and an understanding of the needs of free trade and investment by businessmen, government officials, lawyers, judges and legislators. It also requires an understanding of our respective approaches to law making (individually and as trading societies) and to legal education and adjudication. NAFTA's wheels of commerce however, cannot remain idle while we all become educated. Education must become an integral part of the process of crafting NAFTA's norms of everyday trade and investment.

NLCIFT's methodology for attaining standardization of practices and uniformity or harmonization of law reflects the need for this dual process. The methodology used by NLCIFT for removing the mechanical and structural obstacles to free trade relies on a traditional "top to the bottom" and a not so traditional "bottom to the top" approach. The top to the bottom approach involves drafting of treaties or model laws by committees of experts from each of the participating countries. Accordingly, the NLCIFT has coordinated the drafting of text for a multilateral convention on standby letters of credit and bank guarantees with the United States State Department Select Advisory Group to the Office of the Legal Advisor. It has also coordinated the drafting of a hemispheric treaty on the law applicable to international (hemispheric) contracts with the Organization of American States. Finally, it has coordinated the drafting of a model law for the enforcement of foreign judgments in the NAFTA region with the Association of Chief Justices of Mexico's State Supreme Courts.

The top to the bottom approach, by itself, cannot bridge the extensive business and legal cultural gap between Canada and the United States on one side and Mexico on the other, especially when the expected large increases in the volume and speed of transactions require the highest possible level of standardization of business practice and uniformity of law. Such uniformity can only be attained when the top to the bottom norm becomes part of everyday usage and vice-versa when everyday practice is reflected in the text of the top to the bottom norm.

The bottom to the top approach requires that the disparities in business practices and application of the law be clearly and exhaustively identified and thereafter removed by standardization of documentation, and/or by harmonization or unification of law and practice. Each aspect of every business and legal practice, no matter how seemingly detailed or insignificant, must be part of the description of disparities. The reason for "exhaustiveness" is that often a seemingly unimportant detail such as the location of the endorsement by a bank of first deposit in a check sent for collection to a drawee bank in another NAFTA nation, or the exclusive possession of a truck bill of lading by a trucker can be a serious obstacle when standardizing practice or harmonizing law. Only after these obstacles have been identified, it is possible to determine which obstacles can be removed by unofficial trade association agreements and which require governmental treaties, statutes or administrative regulations.

The standardization of practice requires that each nation involve representative and respected practitioners of each trade, investment or service sector. As with the identification of disparities, standardization of documents and rules of practice by the trade associations must be as comprehensive and exhaustive as possible. Agreement must first be obtained with respect to format and layout. After obtaining such an agreement, the practitioners must agree on data content, including the rights and duties of the participants in the practice in question. Not only is it necessary to agree on the specifications of each document and its component parts, but also on acceptable deviations. For example, to insure uniformity of practice in the clearance and payment of checks, Canadian, Mexican and United States bankers' associations must agree, first, on the components of the check subject to standardization, including the location of the endorsement to the bank of first deposit, the number of digits in each data field, including their "micr-encoding." For only if the check format and dimension is uniform and compatible with the requirements of the machines that read, sort and route checks in each country, can checks from one country be effectively routed, read, sorted and re-routed in the other.

This methodology is applicable regardless of sector, trade or investment activity. Take, for example, surface transportation. Trucking and rail carriers on both sides of the Rio Grande must ascertain everyday practice by providing answers to questions such as: What document do you accept as a valid truck or rail bill of lading to deliver goods to the consignee?; Is your truck or rail bill a mere receipt of the goods or a document of title?; Who completes the truck or rail bill and when?; Who issues it and when?; Who retains it and until when?; Who can receive it and when? and so on. As with the check rules, detailed rules of practice permit an easier and more uniform observance of those practices most consistent with the goals of NAFTA and facilitate the transition to the inevitable paperless or electronic environment.

The assumption behind this dual-track approach is that effective standardization and uniformity will only be attained by those rules and practices that satisfy the fairness requirements of both individual transactions as well as of NAFTA's national (equal) treatment provided for each sector or type of transaction. The requirement of fairness for individual transactions can only satisfied by those agreements, stipulations or rules that incorporate what I have described elsewhere as the fairness of the marketplace and, in exceptional cases, the fairness of a commercial brotherhood. The fairness of the marketplace requires that each party to a contract treat the other in a manner consistent with the treatment expected by a regular participant in the market in question when viewing his own advantage. The fairness of a commercial brotherhood is incorporated into contracts or stipulations when a contractually weaker party substantially entrusts the other to handle his or her goods, money or services. In such a case, the entrusted party is deemed to assume "brotherly" duties which require not only greater diligence than that expected from a regular market participant but also, when necessary, the foregoing of profits. Standards of fairness that fall short of the requirements of the marketplace or of the commercial brotherhood will simply fail to provide the re-assurance needed by the contractual "strangers" in Canada, Mexico and the United States when dealing with each other.

At this time, the NLCIFT is engaged in twelve different, dual track approach projects, ranging from uniform formats and rules for truck and rail bills of lading, cargo liability insurance, checks, commercial invoices, powers of attorney and warehouse receipts to a model law on uniform real estate brokerage licensing, and uniform documentation for medical and para-medical procedures. Its most ambitious project is the creation of a uniform tri-national electronic registry to facilitate secured financing in the NAFTA region and possibly in the rest of the hemisphere.

V. NAFTA in the Grand Scheme of Things

Recently, the governors and economic development officials of the western regions of Canada, Mexico and the United States met under the auspices of Arizona Governor Fife Symington to create a trade corridor that would extend northward from Sinaloa, Mexico to Alberta and British Columbia in Canada. During this meeting, James N. Gardner, representing the northwestern region of the United States, delivered a thoughtful speech in which he reflected on the legacy of the last decade of world events. He concluded that during this decade, two seemingly contradictory forces pulled at the very fabric of civilized society with increasing intensity. The first force was tribalism, which he defined as the clamoring by virtually every "subnational" ethnic group for independence and self-determination. The second force was globalism, which he defined as the onrushing integration of the international economy. Globalism's symbol and essence was the mighty transnational corporation and the emergence of a "borderless" world.

Mr. Gardner disagreed with the pessimists who are convinced that the centrifugal-tribal forces whether in Yugoslavia, Russia, Yemen or Canada will make it impossible for the pre-existing national centers to hold. In his opinion, the drive for regional autonomy may turn out to be the catalyst of "limited supra-national governance." He foresees a new spirit of regionalism whose premise is that each and every tribe united by custom, language or history ought to enjoy its unique place in the sun subject to a federalist social pact. For federalism can accommodate both national regionalism and transnational globalism. "Why do European regions want to become smaller fish in a much bigger pond?" asked Mr. Gardner. Because in that enlarged pond, they believe that they will have more freedom of action as regions, while bound by ever fewer purely national constraints.

Having represented the United States at the United Nations Commission on International Trade Law (UNCITRAL) and the United States Council on International Banking at the International Chamber of Commerce (ICC), and I am not as sanguine about the European countries' willingness to become smaller fish in the bigger economic community pond. Both at UNCITRAL and at the ICC, I have witnessed the disintegration of what often started out as a European voting block once a particular nation's self-interest was at stake. Puzzled by the implications of the Maastricht accord, I asked some European colleagues whether their countries would be happy with the transfer of the national authority to issue money and drawing rights to a group of supra-national bureaucrats dominated by the Bundesbank. I asked, "What if these bureaucrats were to decree, say, that because the French, Italians and Spaniards spend too much time drinking wine, arguing over politics or in sexual pursuits, they do not deserve as many monetary entitlements as other more productive and ascetic Europeans?" My colleagues replied that de facto, some, if not much, of the transfer of authority had already taken place and that their respective central banking authorities regularly took their cues on monetary and credit policies from the Bundesbank. At the same time, however, they conceded that large segments of their population agreed with Margaret Thatcher's arguments in favor of retaining monetary (and thereby political) sovereignty and resented giving up national control over monetary and credit policy. They assumed that this control would be reclaimed if their economies continued to deteriorate seriously.

In my opinion, NAFTA's model, and not that of supra-national federalism is more likely to become universally acceptable. In the grand scheme of international cooperative forces, NAFTA is the model most consistent with the nature of the modern nation state and with the limits of man's cooperative impulses. As a treaty, NAFTA incorporates the marketplace and commercial brotherhood standards of fairness described above. And, as noted earlier, these are the only standards of fairness that have proven viable in commercial and especially internationally commercial trade. Almost from the time of recorded writing, theologians and moral philosophers (either in their philosophical or economic garb) have attempted to determine the relationship between self-interest and social progress on a national and international scale. In the "Fable of the Evil Impulse" based upon Talmudic writings, at least 13 centuries old, the writer described what would happen to mankind if man's "evil desire" were subdued:

"If you kill him, (the evil impulse) the world would expire. For three days the evil impulse was imprisoned, temptations vanished, disappeared, greed and pride ceased ... the sex impulse was won... Alas, a fresh egg is needed, there is none. At last it dawned – truth profound. In scheme divine – A principle sound; Vicious forces as passion, avarice and greed are vehicles of progress the world doth need..."

Roman Ohrenstein, an insightful historian of economic thought pointed out the obvious parallel in 18th century economic liberal and moral philosophical thought. Bernard de Mandeville's famous satire "The Fable of the Bees", of considerable influence on Adam Smith's wealth of nations, notes the paradox that "parties directly opposite, assist each other as for spite". Thus, the apparently discordant passions strangely harmonize to the end that private vices are turned into public benefits. And, Adam Smith's "Wealth of Nations" points out that the individual's exertion brings the greatest benefit not only to himself but also to society. For, Adam Smith's individual "neither intends to promote the public interest nor knows how much he is promoting it... He is led by an invisible hand to promote an end which was no part of his intention... By pursuing his own interest he frequently promotes that of society.

The common message of talmudists, moral philosophers and economists is that there is the possibility of good in evil and, one might add, evil in good, or at least in perceived good. With the best of intentions, many of us try to do good by giving, when restraint would have best instilled responsible management and the need for reciprocity in the recipient. Moreover, tribalism and globalism, no more than one's good and evil, are not necessarily contradictory forces. The ancient Jewish sage's dilemma, "If I am not for myself who will be for me, and if I am only for myself, who am I?" underlies every decision to give away one's possessions, including one's sovereignty. Yet, this dilemma vanishes once I acquire a significant stake in my neighbor's well being and vice-versa, because from that moment on, individual or national self interest will require me to be for my neighbor and vice-versa.

The NAFTA model does not require the creation of a new sovereignty, as does the federalist model. Each participant retains its full sovereignty and is free to pursue its own national interest as it sees it. The Talmudist's and Mandeville's evil (and selfish) impulse is allowed to produce its regional good. This impulse, however, is subject to the constraints imposed by the common good upon trade, investment, services and use of the environment. At the transactional level, as demonstrated by the NLCIFT work of standardization, harmonization and unification, the constraints are the same.

In the brave new world of a highly competitive global marketplace, individual nations, old and new, stand the best chance of competing effectively by forming regional trade associations that take advantage of the resources, human and material, that exist within their own region and by acquiring a vested interest in the success of their former enemies. In this respect, Nelson Mandela's invitation to white South Africans to retain their stake in the success of post-apartheid South Africa is as encouraging as Israel's offer to set up a free-trade zone with its neighbors and historical enemies. Trade has always been a better alternative to man's survival than war. It is quite possible that the free trade formula embodied in GATT, and now in NAFTA, can be the key to a more peaceful and prosperous future for the whole of mankind.

Unlike the era of political and economic freedom ushered in by the French Revolution, the era of International Free Trade would not have made the likes of Beethoven feel that the drum was rolling, the fife was playing, and his blood was welling up, nor would it have evoked the heroic, overpowering beauty of the storms imagined or survived by Turner. Free trade, let us face it, is a less dramatic accomplishment than the modicum of political and religious freedom ushered in by the French Revolution. Yet, we may well be witnessing a revolution every bit as significant and momentous as that which called for freedom, equality and fraternity. For, if successful, this revolution could well provide mankind with the first realistic chance at a sustained economic development based upon those same principles.