The North American Free Trade Agreement (NAFTA)

The North American Free Trade Agreement (NAFTA) established a free-trade area for Canada, the United States, and Mexico. The agreement came into effect on January 1, 1994, after a difficult ratification by the U.S. Congress and approval by the Canadian and Mexican legis­latures. The North American Free Trade Agreement gave rise to the second largest free-trade zone (in terms of population) in the world after the European Union—465 million people and a joint gross domestic product exceeding $18 trillion. The agreement constitutes one of the most comprehensive free-trade pacts ever negotiated among regional trading part­ners. It is also the first reciprocal free-trade pact between a developing nation and industrial countries (Hufbauer and Schott, 1994). Canada and the United States agreed to suspend the operation of the Canada-U.S. Free Trade Agreement so long as both countries are parties to NAFTA and to establish certain transitional arrangements.

1. Negotiating Objectives

1.1. The United States

Since World War II, the United States has advocated trade liberalization and the elimination, on a reciprocal and nondiscriminatory basis, of measures that restrict commercial transac­tions across national boundaries. To achieve this, it had relied on the GATT, now the WTO, and had demonstrated its commitment through its active participation in the successive rounds of trade negotiations under the GATT framework. However, the GATT process has been slow and ineffective in liberalizing trade, particularly in certain sectors such as agricul­ture. The regional approach was thus considered an attractive alternative to the multilateral framework for achieving rapid progress in trade liberalization. Second, the proliferation of regional common markets and the continued expansion of the European Union are consid­ered to be important factors in influencing the United States to enter into a regional free-trade agreement as a response to the prevailing trend in international economic relations. Third, it was logical to embark on a free-trade arrangement with Canada and Mexico not only due to their geographical proximity but also because they are the most important trading partners of the United States. The United States is the destination for more than 70 percent of Canadian and Mexican exports. Both countries also import about one third of U.S exports. The United States is also the largest investor in both countries. It was in the interest of the United States to maintain and expand existing trade and investment opportunities through a regional trade arrangement (Table 2.2).

1.2. Canada

The North American Free Trade Agreement permits Canadian firms to achieve economies of scale by operating larger and more specialized plants. It also provides secure access to a large consumer market. Even though tariff rates between the United States and Canada have de­clined over time, there had been an increase in protectionist sentiment and use of aggressive trade remedies to protect domestic industries in the United States. These measures created uncertainty for producers with respect to investment in new facilities. The North American Free Trade Agreement reduces this uncertainty since it provides rules and procedures for the application of trade remedies and the resolution of disputes.

1.3. Mexico

The North American Free Trade Agreement provides secure access to the U.S. and Canadian markets for Mexican goods and services. Its low labor costs and access to the U.S. market attracts FDI to Mexico (Echeverri-Carroll, 1995; Lederman, Maloney, and Serven, 2005). In view of the adverse impact of its import substitution policy in the 1980s and the debt crisis, trade liberalization was considered to be an effective means of fostering domestic reform and achieving sustainable growth. Ostry briefly describes Mexico’s objectives:

So NAFTA is a means of consolidating an export-led growth path both by improving secure access to the U.S. market and encouraging a return of flight capital as well as new investment. (Quoted in Randall, Konrad, and Silverman, 1992, pp. 27-28)

2. Overview of NAFTA

2.1. Market Access for Goods

The North American Free Trade Agreement incorporates the basic national treatment obli­gation of the GATT. This means that goods imported from any member country will not be subject to discrimination in favor of domestic products. It provides for a gradual elimination over fifteen years of tariffs for trade between Mexico and Canada as well as between Mexico and the United States except for certain agricultural products. Under the Canada-U.S. Free Trade Agreement, tariffs between the two countries were eliminated in January 1998.

By January 1998, tariffs had been phased out on about 65 percent of all U.S. exports to Mexico. For certain import-sensitive sectors in which quotas are imposed, the agreement provides for a replacement with a sliding tariff quota over ten or fifteen years. The North American Free Trade Agreement also provides for a gradual elimination of nontariff barriers such as customs user fees, import licenses, export taxes, and duty drawbacks on NAFTA- made goods. Since NAFTA would gradually phase out tariffs within the free-trade area, such drawbacks will no longer be necessary. To qualify for preferential market access, however, goods must be wholly or substantially made or produced within the member countries. For example, farm goods wholly grown or substantially processed within the NAFTA region would qualify for NAFTA treatment.

2.2. Services

The agreement governs financial, telecommunications, trucking, and rail services. With re­spect to financial services, NAFTA commits each party to treat service providers such as banks and insurance companies from other NAFTA parties no less favorably than its own service providers in like circumstances. It also commits members to gradually phase out, during the transition period, limits on equity ownership by foreign individuals or corpo­rations and on market share by foreign financial institutions. Mexico was allowed to put temporary capital limits for banks, securities firms, and insurance companies during the transition period. The agreement allows members to take prudential measures to protect the integrity of the financial system or consumers of financial services. It includes a freeze on restrictions governing cross-border trade in financial services and also provides for consulta­tions, as well as a dispute settlement mechanism.

The North American Free Trade Agreement commits members to impose no conditions (i.e., reasonable and nondiscriminatory terms) on access to or use of public telecommunica­tion networks unless they are necessary to safeguard the public service responsibilities of the network operators or the technical integrity of the networks. It also imposes an obligation to prevent anticompetitive conduct by monopolies in basic services.

The agreement (1) removes most limitations on cross-border trucking and rail and lib­eralizes Mexican investment restrictions in these sectors, and (2) preserves existing cabotage laws, that is, laws that allow a truck to carry goods to and from a given destination but not to make additional stops unless the vehicle and cargo are registered in the country.

2.3. Investment

Investment includes majority-controlled or minority interests, portfolio investments, and investments in real property from member countries. All three countries agree to (1) provide national treatment to investors from member countries, a treatment that is not less favorable than that given to an investor from a non-NAFTA country; (2) prohibit the imposition and enforcement of certain performance requirements in connection with the conduct or opera­tion of investments, such as export requirements or domestic content; (3) severely restrict or prohibit investment in their most strategic industries, such as energy (Mexico), cultural industries (Canada), and nuclear energy and broadcasting (all three countries). Both Canada and Mexico reserve the right to screen potential investors in certain cases. The parties also agree to subject disputes raised by foreign investors to international arbitration.

2.4. Intellectual Property

The North American Free Trade Agreement mandates minimum standards for the protec­tion of intellectual property rights (IPRs) in member countries and requires each country to extend national treatment to IPRs owned by nationals of other countries. The scope of IPR protection includes patents, trademarks, trade secrets, copyright, and industrial de­signs. It also extends to semiconductors, sound recordings, and satellite broadcast signals. Patents are to be provided for products or processes that are new, useful, and nonobvious. They are valid for twenty years from the date of filing or seventeen years from the date of grant. The agreement permits the use of compulsory licensing (i.e., a requirement to grant licenses to local companies or individuals if the patent is not used in the country) in limited circumstances. The North American Free Trade Agreement protects registered trademarks for a term of no fewer than seven years, renewable indefinitely. It harmonizes members’ laws on trademark protection and enforcement. The agreement prohibits “trademark-linking” requirements in which foreign owners of trademarks are to use their mark in conjunction with a mark owned by a national of that country. The North American Free Trade Agree­ment requires adequate protection for trade secrets and does not limit the duration of protection. Copyright protection is extended to computer software and provides owners of computer programs and sound recordings with “rental rights” (i.e., the right to authorize or prohibit the rental of programs or recordings). It ensures protection of copyright for a minimum period of fifty years and gives effect to the 1971 Berne Convention on artistic and literary works.

2.5. Government Procurement

Purchase of goods and services by government entities in member countries is estimated at more than $1 trillion. The North American Free Trade Agreement extends the national treatment standard (equal treatment to all member country providers) for all goods and services procured by federal government entities unless specifically exempted. Procurement contracts must, however, meet certain minimum value thresholds: $50,000 for contract of goods and/or services and $6.5 million for construction contracts procured by federal gov­ernment entities. For government enterprises, the threshold is $250,000 for contract of goods and/or services and $8 million for construction services. For U.S. and Canadian entities, the Canada-U.S. Free Trade Agreement maintains the threshold at $25,000 for goods contracts. It provides tendering procedures and bid-challenging mechanisms to seek a review of any aspect of the procurement process by an independent authority.

2.6. Safeguards

If a surge in imports causes serious injury to domestic producers, a member country is al­lowed to take emergency action temporarily, for up to four years, to protect the industry.

A request for emergency action is usually initiated by a domestic industry. A number of fac­tors are considered by the investigating tribunal in arriving at a decision on injury: the level of increase in imports, market share of the imports, changes in sales, production, profits, and employment, and other pertinent variables.

2.7. Technical and Other Standards

The North American Free Trade Agreement requires a member to provide sixty days’ no­tice before adopting new standards to allow for comments before implementation. It pro­hibits members from using standards as a disguised restriction to trade. Working groups are established to adopt or harmonize technical and other standards pertaining to specific sectors.

2.8. Other Areas

The agreement (1) requires members to create and maintain rules against anticompetitive business practices; (2) allows for temporary entry of businesspersons and certain pro­fessionals who are citizens of another member country (NAFTA does not create a com­mon market for the movement of labor); (3) establishes institutions such as the Free Trade Commission (FTC) to supervise the implementation of the agreement and resolve disputes; and (4) creates a secretariat, composed of national offices in each country, to support the commission. The agreement also allows any country or group of countries to join NAFTA, subject to approval by each member country and on such terms as agreed upon by the Free Trade Commission.

2.9. Dispute Settlement

Disputes arising over the implementation of the agreement may be resolved through (1) consultations; (2) mediation, conciliation, or other means of dispute resolution that might facilitate an amicable resolution; or (3) a panel of nongovernmental experts. If the decision is made by a binding panel (binding dispute settlement), the parties are required to comply within thirty days, or else compensation/retaliation may result. If the decision is reached by a nonbinding panel, parties shall comply or agree on another solution within thirty days, or else compensation/retaliation may result. Panel reports are not automatically enforceable in domestic law.

There are separate dispute settlement mechanisms for certain specialized areas such as financial services, investment, environment, standards, and private commercial disputes, as well as dumping and subsidies.

3. Preliminary Assessment of NAFTA

The full impact of NAFTA can only be determined in the long term after the necessary eco­nomic adjustments have taken place. Although a short-term assessment of such a compre­hensive agreement is often inadequate and sometimes misleading, a cursory discussion of economic conditions since NAFTA will be presented.

3.1. Overall Increase in Trade between Members

There has been a marked increase in trade among the three member countries since the agreement went into effect, in January 1994. Intra-NAFTA trade jumped from $304 billion in 1993 to $1.1 trillion in 2011, while NAFTA’s trade with the rest of the world increased from $536 billion to $3.14 trillion during the same period. An increasing portion of Canadian and Mexican trade is conducted with the United States. The United States accounted for 74 percent of Canadian exports (62 percent of its imports) and 78 percent of Mexican ex­ports (56 percent of its imports) in 2011. During the same year, the two countries accounted for about 32 percent of U.S exports (19 percent for Canada and 13 percent for Mexico).

3.2. Increase in the U.S. Trade Deficit

The U.S. merchandise trade deficit with Canada and Mexico quadrupled since the inception of NAFTA. U.S. merchandise (services) exports to Canada and Mexico grew from $142 ($27) billion in 1993 to $478 ($82) billion in 2011. However, this was not sufficient to offset the growing trade deficit with both countries. U.S. merchandise trade deficit with Canada and Mexico stood at $38 billion and $67 billion (U.S.), respectively, in 2011. A substantial part of the deficit is attributed to imports of crude oil from Canada and Mexico. In services, the United States has a trade surplus of $28 billion with Canada and $12 billion with Mexico. In agri­culture and manufactured products, the United States also registered a trade surplus of $2.6 billion and $14.5 billion with Canada and Mexico, respectively, in 2011.

3.3. NAFTA’s Uncertain Impact on Jobs

There is no conclusive evidence on the effect of NAFTA on jobs. There are certain indications, however, that NAFTA may have had a negative effect on jobs. Between 1994 and 2002, the U.S. Department of Labor certified 525,000 workers for income support and training due to loss of jobs arising from shifts in production to Mexico or Canada. In view of its narrow eligibility criteria, the program covers a small number of workers who lost their jobs due to NAFTA. The Economic Policy Institute contends that 682,900 U.S. jobs have been lost or displaced due to NAFTA and the resulting trade deficit (Scott, 2011). Most of the job dislocations appear to be concentrated in apparel and electronic industries. This may be attributed to the growing trade deficit with both countries that often leads to declines in production and employment. There are also some studies that show the negative effects of NAFTA on agricultural employ­ment and real wages in manufacturing in Mexico. The Canadian Center for Policy Alterna­tives states that the Canadian government reduced social spending (such as qualification for unemployment insurance) to enhance its competitiveness (Campbell, 2006).

The U.S. Chamber of Commerce study (2012), however, shows that trade with the two countries supports nearly 14 million jobs, of which five million are attributed to the increase in trade generated by NAFTA.

3.4. Substantial Increase in Foreign Investment in All Countries

Since NAFTA, there has been a substantial growth in inward FDI in member countries (Weintraub, 2004) (Table 2.3).

Source: Seyoum Belay (2014), Export-import theory, practices, and procedures, Routledge; 3rd edition.

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