NAFTA to USMCA: Impact on North American Trade

This blog was published on Trademo.com/blog.

On January 1, 1993, the landmark North American Free Trade Agreement (NAFTA) came into effect between the U.S, Canada, and Mexico, eliminating barriers, tariffs, and taxes over trade between the three countries. It created the world’s largest trade bloc. It also led to an explosion of trade between the three countries and an integration of their economies over the next two decades, with trade within the bloc more than tripling between 1993 and 2017, touching $1.1 trillion in 2016. However, an analysis of the impact of the treaty, and its biggest gainers and losers, is far more complex. For instance, despite all its gains, the agreement has also been criticized for contributing to job losses and outsourcing in the United States. In this blog, we will consider the impact of NAFTA, its main gains and losses, and its evolution into the USMCA (United States–Mexico–Canada Agreement) which came into effect in July 2020.

NAFTA: The Significance

When NAFTA was first proposed in the early nineties, one of the key goals of the agreement was to integrate Mexico with the more developed U.S. and Canadian economies. The inclusion of a less developed economy, such as Mexico, in a free trade agreement was at that time unprecedented. But, in the U.S., the agreement had bipartisan support. While U.S. President Ronald Reagan campaigned for it, President George H.W. Bush signed it in 1992, President Bill Clinton negotiated its labor and environmental provisions in 1993, and the agreement came into force in 1994. The next 15 years saw a series of tariffs being eliminated between the three countries related to agricultural products, dairy, meat, and automobiles. Most economic analysis now concurs the agreement benefitted North American trade. But it also transformed and sometimes disrupted the economies of the three countries in diverse ways.

NAFTA in Mexico: When NAFTA was first introduced in Mexico, its President Carlos Salinas de Gortari predicted the agreement would make it possible for the country to “export goods not people”. Indeed, after NAFTA, farm exports from Mexico to the U.S. and Canada tripled, foreign direct investment (FDI) into the country increased 14 times, non-oil exports rose fourfold, and thousands of jobs were created in the auto manufacturing sector. It also transformed Mexico from a protectionist economy into a free market. Yet, economic gains in Mexico remained slow in comparison to its neighbors. Between 1993 and 2015, Mexico’s real per-capita gross domestic product (GDP) grew by 24.1% to $9,511 USD. Compare this to 39.3% for the U.S. and 40.3% for Canada, while in fact as an emerging market Mexico should have enjoyed higher growth rates than the two other counties.

In addition, while FDI into Mexico soared, hitting $32.9 billion USD in 2019, it was almost twice higher for Brazil, where it reached $72 billion during the same period. Finally, in the agricultural sector, small Mexican farmers found themselves unable to compete with low-cost, subsidized American grain, which took the blame for putting Mexican farmers out of business.

The slower growth rate in Mexico has also been attributed to other factors. First, the devaluation of the Peso in 1994 drove the economy into recession. Second, China’s expansion in global trade made it difficult for Mexico to leverage the gains from NAFTA, as it was China that emerged as the biggest U.S. trade partner.

Also Read: Trademo Simplifying Global Trade Businesses

NAFTA in Canada: Like Mexico, Canada too experienced gains in both trade and FDI as an outcome of NAFTA. In fact, investment from the U.S. and Mexico tripled in the first decade, with FDI from the U.S. moving from $110 billion USD to $346 billion USD by 2013. U.S.-Canada trade also grew by 225% to reach $518.2 billion USD by 2015, while Canada-Mexico trade was the fastest growing partnership, increasing by 432.5% to hit $34.3 billion USD by 2015.

But the most important impact of NAFTA on Canada was its increased reliance on the U.S. Canada today relies on the U.S for at least 75% of exports. Yet most countries restrict trade with a single partner to not more than 20%.

NAFTA in the U.S: For the U.S., the North American bloc emerged as its most significant trade partner. Together, its exchange with Mexico and Canada, even surpassed its trade volumes with China, touching $982 billion USD by 2016. It accounts for close to 30% of the country’s trade.

Yet, on the ground, these numbers tell a more complex story. While its partnership with Canada stands at a trade surplus, this is not the case with Mexico. Here, the U.S. has a trade deficit, which means it imports far more than it exports. The gap was at a staggering $58.8 billion USD in 2016, a fiftyfold increase from $ 1.7 billion USD in 1993.

Further, while U.S. President George H.W. Bush had initiated NAFTA believing it would create more jobs in the U.S, the reality was mixed. First, the devaluation of the Mexican Peso and the subsequent recession, brought a wave of immigrants to the U.S. Second. While NAFTA did increase U.S. competitiveness by bringing in cheaper raw materials, it also did lead to a shift in manufacturing jobs to low-cost locations in Mexico. Worst hit were workers in the automobile industry, with Mexico emerging as a manufacturing hub for global leaders such as Fiat Chrysler, Ford Motor, General Motors, Honda, Nissan, Toyota, and Volkswagen. Yet, while job losses did disrupt specific industries, Americans did benefit from lower prices. Further, all employment reductions could not be attributed to NAFTA alone. These were also triggered by increased automation and the growing influence of China in world trade.

For all these reasons, despite the subsequent controversy around NAFTA in the U.S., as many as 63% of Americans believed NAFTA was good for the U.S. economy. While they did want free trade to stay, many believed reforms in NAFTA were necessary.

Why USMCA?

The most significant impact of NAFTA was seen in its ability to drive trade volumes across North America. There was also a period of economic prosperity, reflected in the increase in GDP in the region over the next 20 years, albeit if Mexico grew at a slower pace. The agreement integrated the economies of the U.S., Canada, and Mexico better than at any time in history.

Yet, despite this profound transformation, concerns on employment losses and the weakening of national economies had to be addressed. Further, as the poor working conditions in Mexican factories were highlighted in the past, safeguards were demanded for the Mexican labor force. In addition, Canada wanted stronger environmental safeguards to be built into the agreement, while all three countries needed a simpler legal redressal mechanism.

The United States-Mexico-Canada Agreement (USMCA) sought to address these longstanding concerns by introducing new checks and balances into the NAFTA framework. The new agreement was signed by U.S. President Donald Trump, Canadian Prime Minister Justin Trudeau, and Mexican President Enrique Peña Nieto on November 30, 2018. After it came into effect on July 2020, its approval ratings among the U.S. public were as high as 80%.

The Road ahead with USMCA

Often viewed as NAFTA 2.0, USCMA sought to extend the benefits of free trade, while addressing the views of all three countries on the previous agreement’s shortcomings. But even when it retained NAFTA’s framework for free trade in North America, USMCA made several important corrections:

• Safeguarding labor rights: As an increasing number of companies moved manufacturing to low-cost locations within Mexico, this was sometimes done without providing for suitable working conditions. USCMA included new provisions to protect the rights of Mexican workers, making it possible to even cancel shipments from companies violating labor laws.
• Reforming arbitration: It also dismantled the Investor-State Dispute Settlement (ISDS) arbitration mechanism, which made it possible for businesses to sue governments. While no such system now operates between U.S. and Canada, its applicability to U.S.-Mexico cases has also been restricted.
• Incentivizing North American manufacturing: USCMA prioritized manufacturing in North America over other regions. Now, in the automobile sector, automakers manufacturing 75% of a product within this trading bloc can qualify for zero tariffs.
• Reducing protection for pharmaceutical patents: The protection from free trade offered to pharmaceutical companies has now been removed, but the validity of copyrights has now been extended.
• Strengthening safeguards for technology firms: On the other hand, technology companies were made more secure, especially in areas related to intellectual property and privacy.
• Caring for the environment: USMCA has also put an emphasis on environmental safeguards, including a commitment to improve air quality and reduce maritime litter. These environmental standards are no longer enforced by the ISDS, but national authorities.

Call it NAFTA 2.0 or USMCA, but the new agreement has given us a framework for all international trade agreements in the future, which will continue to shape free trade negotiations of tomorrow as well.

How does it impact you?

As USMCA brings in a new era of trade for North America, it creates new opportunities and supply chain risks for businesses. On the one hand, trade has been further simplified for North America, with new areas such as the dairy sector opening for trade. On the other hand, companies must steer through reforms implemented for both traditional and new-age industries. Let us look at some of these new regulations.

• Customs and trade facilitation: USMCA reduces the paperwork required for trade between the three countries, even admitting informal documentation to complete certificate of origin. However, while doing this, it also raises the threshold for the entry of low-value goods duty free into each country. This has been raised to $150 CAD (for customs duties) and $40 CAD (for taxes) in Canada, $117 USD (for customs duties) and $50 USD (for taxes) in Mexico, and $800 USD in the U.S.
• Impetus for dairy products: It increases opportunities for U.S. dairy, poultry, and egg producers, who now have access to 3.6% of Canada’s dairy market. In addition, barriers to importing U.S. ultra-filtered milk have been reduced, but Canada’s dairy supply management system stays.
• Automotive sector regulation: Now, to qualify for zero tariffs the total required North American content in a vehicle is raised to 75%, which is an increase from the previous limit of 62.5%. In addition, 70% of the steel, aluminum, and glass used in the vehicle must be manufactured in North America. Mexico and Canada would each get a tariff-free passenger vehicle quota of 2.6 million passenger vehicles exported to the United States annually.. Mexico will get an auto parts quota of $108 billion annually, while Canada will get a parts quota of $32.4 billion annually in the event of U.S. autos tariffs. The quotas are significantly above existing production volumes in each country, allowing for some export growth. A common minimum low wage is set for the sector across North America.
• Steel and Aluminium: Besides the gains for steel and aluminum in North America through the automotive sector, the U.S. retains its right to impose tariffs in this sector on the grounds of national security.
• Intellectual property: USMCA also acknowledges the importance of intellectual property to drive innovation. Copyright terms also get a fillip, with an extension of 20 years, which now expires 70 years after an author’s death.
• Digital trade: USMCA is also the first U.S. trade agreement to have a digital trade chapter. Among its other provisions, it encourages digital trade in products and services, and it prohibits any tariffs on digital products transmitted electronically.

These revisions to the agreement are based on the experience of the last two decades. While free trade in North America is here to stay, these new provisions set the tenor and framework for the years ahead.

This blog was originally published on Trademo.com/blog

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