The North American Free Trade Agreement (NAFTA) was a trilateral intergovernmental agreement between the US, Mexico, and Canada. It came into place primarily to reduce tariffs and facilitate higher trade flexibility among the three aforementioned countries.
However, in July 2020, a revised, supposedly profitable treaty known as The United States-Mexico-Canada Agreement (USMCA) replaced the NAFTA.
What is NAFTA?
The trade agreement between the US, Mexico, and Canada was called the NAFTA. The primary aim of the treaty was to establish a large, free trade zone for importers and exporters of the said counties.
In 1980, the then US president, Ronald Reagan, decided to make NAFTA an essential agenda of his presidential campaign. Even though he was successful in doing so, the agreement finally came into existence on January 1, 1994, superseding the Canada United States Free Trade Agreement (CUSFTA) of 1988.
The negotiations were undertaken during the jurisdiction of US president George H. W. Bush, Canadian prime minister Brian Mulroney, and Mexican president Carlos Salinas de Gortari. But, the three leaders didn’t immediately sign the accord and even went through multiple oppositions, discussions, and negotiations.
The three nations filed their respective agreements in 1992, seeking ratification. The NAFTA gained approval only after the addition of the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC) in 1993.
How does NAFTA Work?
Essentially, the NAFTA covered the trading of all goods and services, excluding maritime, telecommunications, and aviation transport services. Additionally, the agreement included provisions for intellectual property such as trademarks, copyrights, and patent rights protection.
In the case of import-export, the treaty allowed US businesses to ship commodities to Mexican and Canadian customers without levying any duties, provided they comply with the rules of origin stated under the NAFTA. Moreover, this agreement comprised civil, criminal, and administrative penalties for business entities that breached either of the three countries' laws.
Apart from the trade of goods and services, it also guaranteed equal treatment to the US investors in Canada and Mexico.
Rules of Origin
If an individual or a business entity wishes to trade goods that aren't ‘wholly obtained’, they must adhere to the rule of origin (ROO). This provision's details are present in the latest Harmonized Tariff Schedule, in the document general notes, under the heading general note 12.
As per the NAFTA, 'wholly obtained' goods and services needed to be entirely produced in one or more countries included in the agreement. Furthermore, chapter four of the NAFTA comprised all the clauses that importers and exporters must abide by to determine the origin of goods.
Apart from the ROO, there are a few ways the trading parties can get their product qualified.
Accumulation
As per this provision, the producer could reduce the non-originating value of a material used in the production if it was considered an originating material in the territory of one of the three parties. Therefore, the products could become eligible for trade under the NAFTA.
For example, a US bicycle manufacturer could consider a seat produced in Mexico as an originating good.
Indirect materials
These are items used in the production process of goods but not physically incorporated into the final products. Producers could disregard these materials while determining the origin of the goods.
For example, a US bicycle manufacturer who makes tires with non-originating materials could consider the finished tire as an originating material.
De minimis
According to this rule, the producer could neglect the non-originating materials if they were about 10% or less of the total value.
For example, a US car manufacturer obtains raw materials equalling 7% of the car's total value, from Germany. The car could have been considered an originating good in such a case.
Fungible items
Final products and identical raw materials and, thus, are interchangeable for sale and purchase can qualify with the ROO.
For example, suppose a manufacturer produces one red pen with originating materials and a precisely similar red pen with non-originating materials. In that case, both these pens can be considered as originating goods.
Direct shipment
If any item is produced in either of the three countries and is directly imported or exported to the other party without crossing the region of any non-member country, it will maintain its originating value. Even if it travels to another country, the product must only remain under the possession of the customs officers and must not have any additions.
For example, if a set of headphones is manufactured in the US and delivered to Mexico via any mode of transport, it will still be considered an originating product. In case the consignment lands in Peru first before reaching Mexico, it will still be considered an originating good as long as it stays under the care of the customs authorities.
NAFTA Certificate of Origin
Once the traders are sure about their product’s qualification for the NAFTA, here are the steps they must follow to enjoy preferential tariff benefits:-
- The exporter must carefully fill out the required NAFTA Certificate of Origin. It is not the importer’s responsibility.
- In case the product shipped to Canada or Mexico is worth less than US$ 1000, the exporter must only make a simple written declaration on the trade invoice. The declaration must state that the product qualifies for the NAFTA.
- The exporter must then send a copy of the certificate to the importer and one along with the shipment. Additionally, the exporting party must maintain all the essential trade documentation for up to five years from the date of import. Alternatively, they must keep it for a duration specified by the other party.
Here’s the NAFTA Certificate of Origin template by the Customs and Border Protection (CBP). The document also comprises detailed instructions to fill out the certificate.
Other Documentation
Exporters sending goods worth less than US$ 1000 must keep the documentation required to prove that the products qualify as per the NAFTA ROO and the written declaration:-
- For five years from the date of import, in case the products are delivered to Canada.
- For 10 years from the date of import, in case the products are delivered to Mexico.
The chapter 6 of the NAFTA explains the Certificate of Origin in detail. Further information is present on the Free Trade Agreement Certificates of Origin page.
What is the Purpose of NAFTA?
The prime purpose of the NAFTA was to facilitate active economic participation between the three strong economic giants of North America– Mexico, the US, and Canada. Its objective was to eliminate the existing tariffs and other non-tariff barriers to ensure smooth trade between the countries. Conducted to promote free trade, the NAFTA aimed to help the nations become economically stronger through liberated investment flow.
Which Countries are in NAFTA?
As mentioned above, the NAFTA comprised North America’s three major countries– the US, Mexico, and Canada and came into place on January 1, 1994.
What are the Key Features of NAFTA?
The NAFTA came into place after multiple negotiations between the three participating nations. The free trade treaty included an extensive set of rules to reduce tariffs.
The following are the five salient features of the NAFTA.
1) Reduction of goods and services trade barriers:-
An essential component of the NAFTA is the significant reduction of trade barriers between the three member countries. It was decided they would eliminate the tariff on 99% of all goods and services within 10 years.
Although Canada and the US already had multiple provisions for free flow of trade, only Mexico experienced some major changes. However, it's worth noting that the country had been introducing numerous reforms even before entering the treaty. These included bringing down import license requirements from 100% to 11% and reducing tariffs from 27% to 13.5%, among others.
2) North American production:-
Any product will be eligible to enjoy reduced tariffs under the NAFTA only if a set percentage of it is entirely produced in North America. As per the provision, almost 50% of the goods must be manufactured in the US. This provision ensures that the three countries enjoy maximum trade profits, and the non-members don’t take advantage of the situation.
3) Intellectual property rights protection:-
The treaty tightened the protection of intellectual property rights in the three countries, with Mexico having witnessed the maximum impact.
The country was required to offer high-level protection for intellectual property rights. It was to make sure Mexican companies don’t recreate Mexican versions of products such as software, chemicals, etc. (source)
4) Removal of investment restrictions:-
The NAFTA enhanced investment opportunities for the member countries by removing restrictions on:-
- Foreign direct investment
- Real estate
- Portfolio investment
As per the provision, Mexico’s energy and railway, US’s radio communications and airlines, and Canada’s culture industries will receive special treatment. The clause was introduced to strengthen the protection of these industries.
5) Two supplemental agreements:-
Two supplemental agreements were signed in 1993 for the NAFTA to come into place. One was to prevent US companies from resorting to low-paid Mexican labor, and the other was to control the environmental pollution caused due to large-scale industrialization in Mexico.
The following are the two agreements:-
North American Agreement on Labor Cooperation (NAALC): Each member country can impose its own labor rules and standards, which include laws on workplace safety, child labor, and minimum wages, among others.
North American Agreement on Environmental Cooperation (NAAEC): The three countries will take actionable steps to reduce pollution. Additionally, the Commission for Environmental Cooperation (CEC) will ensure the countries follow all the terms and conditions.
What are the Pros and Cons of NAFTA?
While the treaty resulted in inevitable downfalls like the loss of manufacturing jobs and illegal Mexican immigration for work, its advantages are remarkable. Listed below are the pros and cons of the NAFTA in detail.
Pros of NAFTA
Boosted trade: The agreement has dramatically increased trilateral trade between the countries, and even the Congressional Research Service agrees. As per its report of 2017, the trade among these countries has tripled since 1994.
Enhanced economic output: According to the Council on Foreign Relations, the NAFTA led to an increase in the US GDP by about 0.5%. It amounted to an addition of around $80 million on completion.
Increased job opportunities: In 2008, the FTA partners directed about 17.7 million jobs to the US in total. Moreover, about 92% of these employment gains were from the NAFTA alone.
Augmented foreign direct investment: The trilateral investment witnessed a significant rise from 1993 to 2012 as the US increased its FDI from US$ 15.2 billion to US$ 104.4 billion in Mexico. Besides, the country raised its FDI from US$ 69.9 billion to US$ 352.9 billion in Canada from 1993 to 2015.
Cheaper imports: Due to the reduction of tariffs, the US didn’t import oil from the Middle East. The country enjoyed significantly lower oil prices from Mexico, reducing gas, transportation, and food costs.
Cons of NAFTA
Loss in jobs: Certain industries like manufacturing, electrical appliance, automotive, computer, and textiles experienced a significant loss in jobs.
Low wages: The US companies menaced workers to shift to Mexico, preventing the formation of labor unions. As a result, employees had to bear suppressed wages.
Mexican farmer exploitations: The NAFTA permitted the introduction of US-subsidized commodities in Mexico. Since the farmers couldn't compete with the low prices, they were forced to migrate illegally.
Maquiladora workers faced disparities: As per the Maquiladora program, US-owned companies appointed cheap Mexican workers near the border. The goods produced here were then exported to the US at low prices. These stations abused labor rights by following practices like 12-hour-long work days.
Mexican environmental degradation: To compete with the cheap prices of US products, Mexican farmers increasingly used chemicals and fertilizers. This led to massive rates of pollution and large-scale deforestation.
How did NAFTA Affect the US Economy?
Several reports and studies, including the Congressional Research Services 2018 Report, stated that the NAFTA had a relatively modest impact on the overall US economy. Nevertheless, it is positive, as the significant claims related to job losses were slightly exaggerated.
Recent studies explain how the NAFTA only affected job losses in the manufacturing sector to a small extent, while 87% of these resulted from automation.
At the same time, since the total trade with Mexico and Canada makes for a relatively small portion of the US GDP, the predicted economic gains were also an overstatement.
Nevertheless, the agreement has undoubtedly strengthened the global stance of North American manufacturing industries. The reduced trade barriers empower the countries to produce goods jointly, bolstering the international supply chains.
How has the North American Free Trade Agreement Affected its Signatories?
Due to vast tariff cuts, the NAFTA proved beneficial for both Canada and Mexico to a great extent.
An article published by the University of Toronto states how Canadian industries experienced a productivity increment of 15% due to tariff cuts. Additionally, some plants witnessed 12% unemployment due to contractions.
Another study of 2012 states that Canada only experienced a rise of 11% in trades with Mexico and the US. It is relatively less compared to a 118% increase for Mexico and a 41% increase for the US.
While the impact of the NAFTA on Mexico was relatively minimal, it proved to be beneficial in terms of higher private investment. On the contrary, it also spiked the unemployment rates due to the high competition with the US-subsidized goods. Additionally, foreign-owned companies resorted to employing low-wage Mexican laborers for manufacturing, reducing the employment rate in the local firms.
Overall, the reduced prices of Mexico's agricultural imports (corn) and increased costs of the country's major agricultural exports (fruits) facilitated by the tariff cuts of the NAFTA helped the small-scale Mexican farmers more than the larger farmers. Additionally, it benefited middle-class families due to the lower average cost of necessities.
Conclusion
The NAFTA’s final impact on its signatories is somewhat conflicting. Each member country experienced visible gains and losses, while some of its impacts still remain unraveled.
This is so primarily due to the inability to isolate NAFTA’s effects due to the rapid technological advancements and other contributing factors. These include the September 11 attacks, the financial crisis of 2008, and China’s significant rise.
As a result, the NAFTA gets the blame for causing significant losses that are a consequence of other national and international events.
All three member countries of the agreement have now renegotiated the terms, calling for the revised deal of USMCA. This NAFTA 2.0 was initiated in November 2018 and ratified in March 2020.
The USMCA enhances the export rate of American dairy products to Canada, heightens the manufacturing tariff provisions to maximize North American production, and reinforces copyright terms, among other clauses.
With the additional provisions in favor of the North American local production, the refined version aims to strengthen the US, Mexican, and Canadian economies. Additionally, the deal will be reviewed every six years and rewritten every 16 years to eliminate flaws.
