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The Bottom Line For NAFTA And Free Trade In North America

The North American Free Trade Agreement known as NAFTA, unites the three largest economies on the continent. The trade pact between Canada, Mexico and the United States went into effect as of 1994. In recent times, 14% of world trade takes place inside this trading zone. There has been a great deal of controversy recently, over the benefits and the negatives of this crucial treaty, especially in the United States.

Economic analysis at this point, has indicated a small overall gain in economic growth for the United States. In Mexico, NAFTA has had a significant positive impact. Canada on the other hand, has shown a negligible amount of difference in its economic development.

Overall, North American trade has tripled since the inception of the treaty. The combined trade between Canada, Mexico and the United States, is almost twice the volume of the trade between China and the United States.

Back row, left to right: Mexican President Carlos Salinas de Gortari, U.S. President George H. W. Bush, and Canadian Prime Minister Brian Mulroney, at the initialing of the draft North American Free Trade Agreement in October 1992.

The integration of supply chains across the three countries, has allowed larger economies of scale and efficiencies that has made, industry from North America far more globally competitive.

If NAFTA is eventually abolished, trade between the United States and Canada, would be the least effected among the three nations.

Canada and United States are each others largest trading partners. Canada sends a total of 75% of its exports to the United States. This is equivalent to 20% of domestic GDP (Gross Domestic Product).

If there is to be a revision of the treaty, the Canadians would be most interested in a more open government procurement system for foreign companies to compete on American infrastructure projects and the expansion of temporary work visas for jobs in the United States.

NAFTA simply replaced the free trade agreement that has already existed between the United States and Canada.

Most American and Canadian trade was already duty-free. This is one explanation why the inclusion of Mexico in the trading bloc, had the least amount of effect on Canada.

In its present form, NAFTA has two supplements to the main text. These are the North American Agreement on Labor Cooperation (NAALC) and the North American Agreement on Environmental Cooperation (NAAEC).

NAFTA on a global map

The original goal of NAFTA was to eliminate barriers to investments and trade between Canada, Mexico and the United States.

When the agreement came into force, it brought an immediate removal of tariffs on more than 50% of Mexican exports to the United States. It also led to the proximate disappearance, of more than one-third of American exports to Mexico.

Today almost 60% of all imported goods from Canada and Mexico, are used as components in American manufacturing.

The text of the treaty called for the total discharge of all tariffs between the United States and Mexico by 2004. The only exception was to be some American agricultural exports, that were permitted an additional five years phase out.

An additional goal of NAFTA was to eliminate non-tariff trade barriers, as well as promote the protection of intellectual property rights on traded products.

In the more than 20 years since the trade agreement was signed, Americans have watched in dismay as manufacturing jobs headed south and overseas. The question that must be asked is, how much of this was due to NAFTA?

A Maquiladora in Mexico

The answer to the job losses is difficult to quantify. There is no doubt that many companies located in the United States moved operations to Mexico, to take advantage of the far lower wage structure there. These plants known as maquiladoras, have become a mainstay of trade for Mexico. They essentially use imported components, which are then assembled to produce goods for export.

Income for the maquiladoras portion of the economy, has increased over 15% since the advent of NAFTA. The sector overall depends on the American market, to absorb a great deal of the output produced.

The trade surplus Mexico presently enjoys with the United States is worth $63 billion USD (United States dollar) on an annual basis. It is important to note, that in the course of a single decade that deficit amounts to over half a trillion dollars.

Mexico has become the third largest trading partner of the United States. However before NAFTA, Mexico ran a trade deficit with the United States.

Ontario, Canada dairy farm

Agriculture has always been a major point of contention, between the three trading partners. This part of NAFTA, is the only section of the understanding, that was not negotiated trilaterally. Three separate agricultural accords, were signed between each pair of the parties.

The agreement between Canada and the United States has substantial regulations and quotas, including tariffs, that are designed to provide some protection for domestic production. This is particularly evident in the dairy and poultry industries. It is also quite apparent in the sugar industry.

The agricultural concord between the United States and Mexico in contrast, was attempting to be far more open, after the expiration of a number of phase out periods. It therefore has become more combative, as growers of fresh fruits and vegetables in the United States, watched a portion of their domestic market disappear.

Packaging bananas at the Rancho La Duena in Paso de Telaya, San Rafael, Veracruz.

The new American President Donald Trump, continues to insist that NAFTA was the worst trade deal ever signed by the United States. He has pledged to either renegotiate the treaty or failing that, pulling the country out of the agreement.

Mexico in response has offered to look at making some changes, fully aware of the importance of the agreement to their domestic economy.

President Trump blames the loss of American jobs especially in manufacturing, on the provisions contained in NAFTA and similar negotiated trade pacts made in the past. For example, the President attributes the 25% downsizing of auto industry jobs since 1994, primarily to NAFTA.

It is important to note, that statistics still show manufacturing’s share of U.S GDP overall, has been quite stable for a number of decades.

There are many economists in the field, who claim that it is technology not trade, that has eliminated so many manufacturing jobs on a global basis.

Trump has done more than pay simple lip service to the principle. He has insisted that American based companies will pay the price, if they continue to relocate vital operations to Mexico and other lower waged supported economies. The firms of Carrier and Ford are just two of a growing list, that have decided it makes more sense to maintain operations in the States, under the present political environment.

Companies that agree to stay in the United States have been awarded tax incentives and will later benefit from the overall corporate tax reduction, that President Trump has pledged to enact as a way to help American businesses. The presently high 35% rate, may be slashed to a low of 15%.

Two other auto companies General Motors and Toyota, have both been threatened with a border tax, if they attempt to build new factories in Mexico for the American market. The former is American the latter Japanese, but both of them remain concerned over the seriousness of the issue. A 35% border tariff as the rate mostly mentioned, would make their cars uncompetitive in the United States.

If these tariffs are actually imposed, they would be in full violation of the terms of NAFTA.

Obama, Peña Nieto and Harper at the IX North American Leaders’ Summit (informally known as the Three Amigos Summit) in Toluca took place in 2014.

President Trump might still attempt to put tariffs in place against certain Mexican imports anyway. He would have the domestic authority to do so, on an emergency basis regardless. He could invoke this power through two laws, that exist giving a president this type of discretion.

An American 1962 law permits higher tariffs, to combat a threat to national security. If that would fail, he could more legitimately use a 1974 act. This legislation permits the president the power to respond to any discriminatory behavior, emanating from a trading partner.

The American court system, could well strike these types of executive orders down. However, President Trump could also decide to withdraw from NAFTA altogether. This action does not require congressional approval. The President would simply announce the nullification of American participation and after six months, the trade treaty would consequently lapse.

Following that trade relations between the United States in regards to Canada and Mexico, would revert to the normal situation, that exists under the rules of the World Trade Organization. The Most Favored Nation tariff rate comes in around 3.5%, with varying exceptions.

Mexican President Enrique Peña Nieto, left, Canadian Prime Minister Justin Trudeau, centre, and U.S. President Barack Obama, right, at the North American Leaders’ Summit in Ottawa, Canada, on June 29, 2016.

To set tariffs at a much higher rate, Mr. Trump would need to use the aforementioned legislation. As previously stated, a number of court challenges under these circumstances would be likely.

A complete withdrawal from NAFTA, will be economically chaotic for numerous American companies. The supply chains that presently exist, especially along the southwestern border would be severely impacted.

The economic impact on those American states adjacent to the border will be dramatic. Texas for example,derives near 6% of its GDP from exports to Mexico. On the national level it is only 1.3%. The United States on the whole, exports to Mexico goods that are valued at around $240 billion USD.

In some cases, states that are geographically far from the border will also take a major hit. Take the case of Michigan, the export of car parts worth billions of dollars, will be reduced with the re-imposition of tariffs with Mexico.

The trade deficit the United States presently runs with Mexico is only about 0.3% of GDP on an annual basis.

Iowa corn picker in the United States

In addition to the manufacturing sector it is the agricultural states, that will bear a disproportionate burden, if the tariff agreements reached under NAFTA are removed. A wide rage of goods including dairy products, chicken, corn syrup and potatoes would face substantial duties. Iowa, Nebraska and Texas would face the largest hurdles. The Mexican tariff on corn syrup alone, would be a whopping 100%.

Mexico for its part, would slide into a recession as the economy would need to re-balance. The Mexican economy has become quite dependent on trade with the United States. Rising corporate bond defaults by Mexican companies, would also hurt American banks.

Near 80% of all Mexican exports are sold in the American market.

NAFTA GDP – 2012 : IMF – World Economic Outlook Databases (Oct 2013)

Another side effect of this state of affairs, would be a much higher unemployment rate inside Mexico.

It has been estimated that over 7 million jobs in the United States and over 3 million jobs in Mexico are either directly or indirectly, related to the robust trade between the two countries.

As growth inside Mexico stagnates, it would create a new impetus for migration of the jobless to head north. So the number of individuals entering the United States illegally, would certainly increase. It could create an even more chaotic environment on the border.

The political pressure to close the border between Mexico and the United States, would mount as crime and prohibited migration surged. The illegal trade in drugs would only worsen. The proposed wall would undoubtedly be harder to manage, once constructed.

If Mexico retaliates against the United States, which would be a likely outcome based on the domestic politics there, prices would consequently rise on both sides of the border. The long term effect, would be higher consumer prices, especially in certain sectors like fresh fruits and vegetables.

Harvesting Strawberries is labor intensive

If security on the border is tightened fewer Mexicans and Central Americans will be arriving in the United States. This will necessarily reduce the labor pool, available in agriculture at present wages. At that point, either American farmers move towards more automation or they will have to absorb higher labor costs. These increased expenditures inevitably, will need to be passed on to consumers in the United States.

Although there is no doubt that Mexico has benefited enormously under the provisions of NAFTA, there has been painful adjustments domestically as well. The efficiency of American firms have forced thousands of Mexican enterprises out of business over the years.

Smaller scale Mexican agriculture was devastated, leading millions of farmers to abandon their small holdings. These individuals often moved to the rapidly growing cities or in many cases the United States.

According to data from the Organization for Economic Cooperation and Development average annual wages in Mexico from 1994 to 2015 actually dropped nearly 12%. In the United States they rose 32% and in Canada they increased 38%, for the same time period.

Yet at the same time, millions of Mexicans were raised out of poverty, as they took jobs in the rapidly expanding export sector.

A tablet PC and touch screen computer / television made by Mexican Meebox

The unelaborated success of NAFTA has encouraged Mexico to become one of the most open economies in the world. The country allows duty free access to 46 countries around the world. In fact, Mexico is hoping to conclude an expanded trade deal with the European Union this year and is trying to lower trade barriers with a number of other nations.

Mexico is also looking to pick up the remnants of the Trans-Pacific Partnership, now that the United States has decided not to move forward with the treaty.

Even if President Trump is successful in passing a large tariff on Mexican imports, much of its effect will be negated by the precipitous fall of the peso, that has already occurred in relation to the American dollar. The Mexican peso has declined in value by around 20%, since Mr. Trump began to win states in the Republican primaries last spring and summer.

Trump campaigning in Laconia, New Hampshire, on July 16, 2015

The end of NAFTA will likely see a noticeable change in governmental policy coming from Mexico. There will shortly arrive Mexican politicians, that will be more populist and nationalist in response to what is going on in the United States. This may well be quite contrary to American foreign policy interests.

An update of NAFTA perhaps, is the best solution for all three countries. A type of renegotiation that narrows the trade deficit between Mexico and the United States, would allow a reasonable outcome for both sides. A far smaller adjustment with Canada may also prove necessary, but it the end the survival of NAFTA in some form, will be to the benefit of all three countries.

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