North American Free Trade Agreement (NAFTA)

What Was the North American Free Trade Agreement (NAFTA)?

The North American Free Trade Agreement (NAFTA), enacted in 1994, established a free trade zone between Canada, Mexico, and the United States. It is the most crucial element of bilateral trade between the United States and Mexico.

North America's three largest countries effectively became a free-trade bloc through this pact. 

Proponents of establishing a free-trade area in North America claimed the arrangement would increase production and trade and bring prosperity. In addition, they expected that this would create millions of high-paying jobs across countries.

Among NAFTA's most significant provisions was the gradual reduction of tariffs, customs duties, and other trade barriers between the three members. Some tariffs were eliminated immediately, and others took up to 15 years. 

Over time, a wide range of manufactured goods and commodities could be traded duty-free between the signatories. As a result, commerce costs were reduced, encouraging small businesses to invest and grow. 

As a result of this agreement, business investors also gained international rights. As a result, increased trade, economic output, foreign investment, and better consumer prices were some of the positive effects.

Products imported from other NAFTA countries were granted "national goods" status, meaning state, local, or provincial governments could not impose taxes or tariffs on these products.

According to the North American Free Trade Agreement, all tariffs and quotas on U.S. exports to Mexico and Canada were eliminated as of January 1, 2008.

As of 2018, Mexico is the third-largest trading partner (after Canada and China) and the second-largest export market of the United States.

In the United States, the two-way trade in goods and services reached USD 678 billion in 2016, directly or indirectly supporting millions of U.S. jobs. 

The United States exported USD 299 billion of goods to Mexico in 2018, including USD 265 billion in products and USD 34 billion in services.

For 27 U.S. states, Mexico is the number one or number two destination for exports. 

The trade agreement covers many services except air transportation, maritime, and basic telecommunication services. In addition, the agreement covers a variety of intellectual property rights protections, such as patents, trademarks, and copyrighted materials.

It should be noted that NAFTA's government procurement provisions apply to goods and contracts made for services and construction in the federal sector. 

Additionally, U.S. investors are guaranteed equal treatment in Mexico and Canada to domestic investors.           

As a result of the North American Free Trade Agreement, a company can ship qualifying goods duty-free to customers inside Canada and Mexico. In addition, goods can qualify for rules of origin in several ways.

Products may be wholly obtained or produced in a country, or they may require a large amount of work and material in a NAFTA country before they are exported. 
Several tariffs, including those related to agricultural products, textiles, and automobiles, were gradually lowered between January 1, 1994, and January 1, 2008.

Overview of NAFTA

The following is the overview of NAFTA:

• The trade agreement was created in 1994 to enhance trade between the U.S., Mexico, and Canada. Its provisions were implemented over 15 years, some immediately, some staggered, and some rolled out in stages over the next 15 years.
• Upon its implementation, tariffs on imports and exports between the three participating countries were reduced or eliminated, creating a huge free-trade zone. Undoubtedly, it was designed to increase cross-border commerce in North America, and that aim has undoubtedly been achieved.
• By establishing high workplace safety standards, labor rights, and environmental protection, businesses could avoid relocating to other countries to take advantage of lower wages or fewer regulations.
  Because low-income countries need increased production and employment, they lower their standards and conditions, which draws more businesses to their countries, thereby increasing their economic growth.  
• The United States-Mexico-Canada signed a new agreement (USMCA) on November 30, 2018. This became effective on July 1, 2020, replacing the previous agreement. As a replacement for NAFTA, the USMCA is intended to mutually benefit workers, farmers, ranchers, and businesses in North America.
• It is controversial. It improved the economy in some areas (trade growth and investment) while negatively impacting others (employment, balance of trade).

NAFTA: Rules of Origin

The agreement was modeled after the European Economic Community (1957-1993), which successfully eliminated tariffs to stimulate trade among its member countries.

The Bush administration began negotiations with President Salinas in September 1990. Mexico, Canada, and the United States sought to liberalize international trade.

The North American Free Trade Agreement was signed by President Bush, Mexican President Salinas, and Canadian Prime Minister Brian Mulroney in 1992.

The rules of origin determine the country that manufactures a product or service destined for export. 

The rules of origin provide information on the origin and protection of goods and help you figure out what is covered by trade agreements.

Even though it appears to be a simple concept, global supply chains make the concept of rules of origin complex, with a definition constantly open to interpretation. 

For example:

• Does a product originate in the country in which it is manufactured? 
• Can we consider the origin of a product based on materials (country in which they were grown or harvested)? 
• How about modern products made up of components from different parts of the world?

It should not be surprising that rules of origin are frequently subject to interpretation during free trade negotiations. This is how rules of origin are defined and subsequently applied, which can significantly affect exporters.

In the case of goods that are not wholly obtained, there is a need to meet the product's rule of origin, which is usually accomplished through a Tariff Shift or a Regional Value Content procedure.  

A list of rules of origin (ROO) can be found in the final text of the free trade agreement. 

From time to time, a particular ROO may be revised. The latest updated version of the ROOs is available on the Harmonized Tariff Schedule of the United States, General Notes - General Note 33. 

The role of ROO has become increasingly relevant in international trade policy as they are used for assessing tariffs, enforcing trade remedies (such as antidumping and countervailing duties), and for statistical purposes. 
It is possible to qualify a product as per the rules of origin using the following methods:  

• A producer may be able to reduce the value of non-originating materials used in the production of the good by accumulating these resources.  
• The de minimis rule allows the exporter to disregard a very small percentage of non-originating materials that do not satisfy a tariff shifting rule.
• Direct Shipment is goods that need to be shipped directly between two FTA parties and cannot be sent through a third party.
• A fungible good or material is a product or material (component) that is interchangeable for commercial or industrial purposes and whose properties are essentially identical.
• The indirect materials are goods used in the production, testing, or inspection of a good but not physically incorporated into that good.

Main Goal

The North American Free Trade Agreement aimed to create a free trade zone between the United States, Canada, and Mexico. It was intended to reduce the costs of doing business for U.S. companies (and vice versa) by eliminating the red tape.

Workings

It provided a framework in which Mexico, Canada, and the U.S. could eliminate tariffs and other trade barriers on agricultural and manufactured goods and services. 

By removing investment restrictions, it protected investor intellectual property rights, and the provisions addressed environmental and labor concerns, establishing a standard that would be comparable across all countries.

Understanding the NAFTA

The agreement was designed to encourage economic activity among three major economic powers in North America. Several proponents claimed that the agreement would lower tariffs and promote free trade.

In 2016 Donald Trump campaigned on a promise that he would repeal this and other trade agreements that were unfair to the USA. 

During a press conference on August 27, 2018, President Donald Trump announced that a new trade deal with Mexico would replace the agreement.

In addition to maintaining duty-free access for agricultural goods on both sides of the border and eliminating non-tariff barriers, the U.S.-Mexico Trade Agreement would encourage more agricultural trade between the two countries.

The agreement was modified on September 30, 2018, to include Canada. USMCA, or the United States-Mexico-Canada Agreement, came into effect on July 1, 2020, replacing the previous agreement's entirety. This agreement will expire on July 1, 2029, if not renewed.

The U.S. and Canada Trade Offices issued a joint press release on September 30, 2018, stating:

• With USMCA, local workers, farmers, ranchers, and businesses will benefit from more accessible markets, fairer trade, and robust economic growth. 
• In addition to creating good-paying jobs, it will also create new opportunities for the nearly half a billion people who call North America home.

History Of NAFTA

Its origins can be traced back to the economic crisis of the early 1980s. The United States, Canada, and Mexico struggled to improve their competitiveness and accelerate economic growth.   

Free trade negotiations between Canada and the U.S. began in the fall of 1985 and ended in the fall of 1987

Mexico closely watched the Canada-US free trade talks. Finally, President George H.W. Bush and Mexico's former president, Carlos Salinas de Gortari, agreed to begin negotiations toward a U.S.-Mexico free trade agreement in June 1990.

The agreement's fate was doubted when Bill Clinton defeated George H.W. Bush in the 1992 U.S. presidential election. Clinton had advocated a different economic policy. 

Several side agreements on labor and the environment were included in the agreement to make it more palatable to members of his party. 

There were two side agreements, a labor agreement and an environmental agreement. The aim was to pressure each state to enforce its laws in these areas.

In 1993, President Bill Clinton signed the North American Free Trade Agreement into law. As a result of the agreement, Clinton hoped other nations would also work toward a broader global trade agreement.

As of 2019, one in four U.S. imports, such as crude oil, machinery, gold, vehicles, fresh produce, livestock, and processed foods, came from Mexico or Canada, the second and third-largest suppliers of imported goods. 

In addition, the United States exports approximately one-third of its products to Canada and Mexico, including machinery, vehicle parts, mineral fuels, oils, and plastics.

A draft of the agreement was developed by George H. W. Bush during his presidency as a part of his 'Enterprise for the Americas Initiative' in the first phase of his administration.

President Clinton signed it into law in 1993, who believed it would create 200,000 jobs in the United States within two years and about 1 million jobs in five years. This was because exports were a major driving force for U.S. economic growth.

As a result of the lower tariffs, the administration anticipated that there would be a dramatic increase in imports from Mexico.

Additions to the Agreement

Several agreements supplemented the provisions of the North American Free Trade Agreement, including the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC).

These tangential agreements were designed to prevent businesses from relocating to foreign countries to exploit lower wages, more lenient worker safety regulations, and a more relaxed environment.

The agreement did not end all regulatory requirements that apply to companies wishing to trade internationally, such as rule-of-origin regulations and documentation requirements, which determine whether certain goods can be traded.

Apart from administrative, civil, and criminal sanctions, the free-trade agreement also included penalties for businesses that violate the laws and customs regulations of any of the three countries.

Advantages and Disadvantages Of NAFTA

In 1993, the North American Free Trade Agreement was the world's most comprehensive free trade agreement. The United States, Canada, and Mexico were included. In 2020, the gross domestic product of its members was roughly $26.67 trillion.

There was controversy surrounding the agreement as well. There are disagreements among politicians over whether the benefits of the free trade agreement outweigh its drawbacks.

To foster trade and investment across its three member countries, the agreement's immediate aim was to increase cross-border commerce in North America. It achieved this by limiting or eliminating tariffs between its three countries.

Small and medium-sized enterprises benefited from the changes as the costs were lowered, and the requirement that a company is physically present in a foreign country to conduct business was removed.

There has been a considerable increase in trade between the United States and Mexico and between the United States and Canada. Trade between Mexico and Canada has also grown. 

Over the period 1993 to 2015, there was a growth in trilateral trade of $1.0 trillion, an increase of 258.5% in nominal terms (125.2% when adjusted for inflation). 

It should also be noted that real gross domestic product (GDP) per capita in all three countries grew slightly. But, again, this was mainly observed in the United States and Canada.

The NAAEC (National Association for the Advancement of Economic Cooperation) side agreements protected intangible assets such as intellectual property and established mechanisms for dispute resolution.

As a result, the United States became more competitive overseas, and its workplace safety and health standards were exported to other nations.

Despite the supplementary NAALC, critics of the agreement were concerned that the agreement would result in American jobs being lost to Mexico.

Numerous companies did move their manufacturing operations from the United States to Mexico and other countries with lower labor costs. However, the effect was most noticeable on auto and garment workers in the United States.

As a result of the agreement, the U.S. trade deficits (import more than export) rose, especially with Mexico. Inflation also rose during the agreement years.

Many critics cited the growing wave of Mexican immigrants coming to the U.S. following the agreement, partly because the anticipated convergence of U.S. and Mexican wages never took place, making the U.S. more attractive to Mexican workers.

Advantages

The following were the advantages of the NAFTA:

• The surge in cross-border trade and investment brought about by the increase in imports and exports
• The U.S. economy became more competitive because of increased domestic manufacturing.
• It provided opportunities to small businesses by opening new markets to them.
• It improved health, safety, and environmental standards by implementing higher standards universally.

Disadvantages

The following were the disadvantages of the NAFTA:

• It led to the loss of manufacturing jobs in certain sectors.
• Inflation in the United States increased.
• The United States trade deficit widened.
• It is thought to have spurred immigration from Mexico.

NAFTA's Impact On The U.S. and Canada

It is widely accepted by economists and policymakers alike that the agreement has benefitted economies across North America.

However, there are other quarters of the country where the debate rages about whether the agreement will benefit the U.S. economy. 

No doubt, the trade between the United States and its neighboring countries has more than tripled since 1993, from about $290 billion to more than $1.1 trillion in 2016.

In addition to a surge in cross-border investments, the U.S. gross domestic product rose slightly over the same period.

However, economists believe it has been difficult to identify the deal's direct effects in the face of other factors, such as rapid technological change and increased trade with countries such as China.

At the same time, there is a debate regarding its effect on both employment (which was severely hit in certain industries) and wages (which remained stagnant for most of this period).

How did Canada Benefit from the Agreement?

Canada's economy has overwhelmingly benefited from the agreement. In addition to opening up new export opportunities, it has helped businesses build internationally competitive practices and attracted significant foreign investment.

A year after Donald Trump took over the Republican Party, he described NAFTA as "a disaster" and "the worst trade deal ever." His election victory put Canada on notice-the agreement's days were numbered.

Despite this, the relationship between Prime Minister Justin Trudeau and the new U.S. president seemed to get off to a positive start, with some kind words and some friendly (but awkward) handshakes that gave the impression that Canada had nothing to fear.

According to the Canadian government's website, the agreement positively affected the Canadian economy. 

It has opened new export opportunities, acted as a stimulus for building internationally competitive businesses, and attracted significant foreign investment.

Furthermore, since its implementation, NAFTA has been able to triple the number of investments that U.S. and Mexican companies have put into Canada. 

Within the past quarter of a century, U.S. investments alone have risen from $70 billion in 1993 to over $368 billion in 2013. 

There has been a ninefold increase in trade between Canada and Mexico since 1993, and it has more than doubled between Canada and the United States.

Is it Still in Effect?

It is a fact that the agreement has been effectively replaced by the United States-Mexico-Canada Agreement (USMCA). The law was signed by President Donald Trump on November 30, 2018, and came into full effect on July 1, 2020.

USMCA vs. NAFTA

The USMCA agreement, in many ways, is a continuation of the original NAFTA agreement.

The agreement aims to promote and protect free trade among the three countries that make up North America. The new plan includes several updates to regulations that date back over a quarter-century.

Despite the similarities, there are some noticeable and significant differences, such as:

Building Labor Protection in Mexico

In Mexico, workers are protected against discrimination based on race, nationality, sexual orientation, religion, marital status, age, gender, and disability. Mexico also protects its employees during the hiring process and their employment.

About three million workers are employed in the farm sector in Mexico, including two million who produce goods primarily for Mexican consumers and a million who produce goods for export, primarily to the U.S.  

The cost of labor in Mexico remains cheaper than in the United States. The USMCA offers additional protections to Mexican workers to ensure that the playing field is level:

• A violation of labor laws is punishable by the cancellation of a shipment.
• Products produced with forced labor are prohibited from being imported.
• Workers will have the right to organize and bargain collectively.

Reducing Protections for Drug Companies

The pharmaceutical industry was provided protections under the agreement that enabled drug companies to satisfy the needs of lucrative subdivisions of the industry. These protections have been removed.

Gains in other areas have balanced the loss:

• There is no longer 10-year protection against generic biologics.
• Copyrights now have a lifespan of 70 years, not 50 years, as under the agreement.

Increasing Protections for Technology Firms

As a result of the new laws, technology and data companies now have more protection related to intellectual property and privacy concerns:

• Tech companies are no longer allowed to request source code from the government.
• Electronic transmissions are not subject to duties.

Incentivizing North American Manufacturing

The USMCA will boost NAFTA's efforts to keep North American production in the region and away from competing nations. As a result, the United States supports U.S. businesses investing in industrial buildings in Mexico for their companies. 

A three-pronged trend is reshaping manufacturing: a rising demand for goods, a convergence of technologies, and shifting global value chains.

The United States remains one of the most lucrative markets in the world, and this will remain a key advantage for North American manufacturing. 

Despite stagnant income growth, access to the North American market remains a powerful magnet for manufacturers. Moreover, a surge in public investment could boost demand for the region's heavy machinery, equipment, and building materials.

In the aftermath of the agreement, preferential trading with Mexico made it profitable for U.S. and multinational companies to produce goods in America since they could export these across North America without tariff restrictions. 

All three countries involved in the new trade agreement will be able to widen access to the market. To qualify for zero tariffs, automakers, for example, need to do the following:     

• The government now requires automobile manufacturers to produce 75% of their content in North America instead of just the 62.5% required under the previous agreement.
• The bill would require automobile manufacturers to utilize high-wage factories (the minimum wage of $16 per hour) to manufacture at least 40-45% of the automobile's parts.
• Ensure that at least 70% of the steel and aluminum used in a new vehicle are melted and poured within the boundaries of North America.

Dismantling a Controversial Arbitration System

There are several very significant yet shadowy changes to the Investor-State Dispute System (ISDS), which enabled companies to sue governments over their right to conduct business in a particular country:

• Currently, such a mechanism does not exist between the U.S. and Canada. 
• The terms of this agreement severely constrain Mexico-USA cases.

These regulations offer significant differences between USMCA and the existing NAFTA equivalents. Other new concepts are not part of NAFTA. Even so, the spirit of the new agreement is the same as that of the old one.

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• International Monetary Fund (IMF)
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• Trade Wars
• Utility Theory