- NAFTA history, significance and trade
- What are the key contentious issues hindering the NAFTA renegotiation?
- What is the current standing of NAFTA members regarding the deal?
North American Free Trade Agreement (NAFTA) renegotiation has been the talk of the town with seven rounds of negotiations having taken place over the past seven months, but without any final agreement. This blog explores the origin and formation of NAFTA. Which were the member that gained the most from the agreement? What factors led to its renegotiation and which member stands to lose the most in the worst-case scenario if the agreement gets terminated?
Origin: North American Free Trade Agreement (NAFTA), a trilateral free trade agreement between the United States, Canada and Mexico was signed by the US President George H.W. Bush, Mexican President Salinas and Canadian Prime Minister Brian Mulroney in 1992 and came into effect from January 1994. Although, it was signed by George Bush, but the talks were initiated by Ronald Reagan during 1980, who was one of the proponents for free trade, to increase the competitiveness of North America in the global marketplace. Prior to NAFTA, Canada and the US signed a free trade agreement in 1989 and the Mexican president approached George Bush in 1992 to form a similar pact with Mexico. Henceforth, Mexico also joined Canada-US free trade agreement to form NAFTA.
Preamble: NAFTA is the world’s largest regional trading bloc out of more than 450 trade agreements currently in force and its member countries generated GDP of over USD 22 trillion in 2017. Prior to NAFTA, there were quantitative restrictions such as trade barriers and tariffs between the three countries. However, NAFTA changed the economic landscape of North America by opening the market for member countries on assertion that the free market will increase prosperity through free movement of capital, goods and services and will boost the competitiveness in a global setting.
NAFTA benefitted member countries by increasing productivity, food supply, labour mobilization and employment. Mexico being the emerging country benefitted from the latest technology it received from the US manufacturers, which shifted their base to Mexico to gain from low wages in the nation. Similarly, the US reliance shifted to Mexico and Canada from the Middle East for crude oil and petroleum led by non-tariff imports.
Impact of NAFTA on member nations
Flow of trade and services: The supply chain interlinkage of the US, Canada and Mexico which began with the onset of NAFTA paved the way for growth of all the three countries because of wide choices, low wages and increased foreign direct investments. The US trade with NAFTA partners grew more than three times after the pact with elimination of tariffs, while the US economy grew by 187% between 1993-2017. Mexico became the third largest trading partner of the US with trade of USD 622.7 billion (2017). Mexican exports grew from USD ~40 billons (1993) to USD ~346 billion (2017). The US is the biggest market for Mexican export as well as import as it sends more than 80% of its exports and receives 50% of its imports from the nation (this has been declining steadily from over 70% since 2002 as it is replaced by China). Mexican GDP per capita at purchasing power parity has grown after NAFTA. However, the disparity has not been bridged between Mexico and its northern counterparts to an extent as thought by its initiators. Canada is one of the biggest trading partners of the US with trade of over USD 680 billion in 2017. The largest share of the US exports is contributed by Canada. However, this contribution by Canada was up to 2008, as China has been the largest contributor in terms of the US imports of goods and services since 2009. China not only overtook Canada in terms of the US import share, it also contributed to around 59% of the US current account deficit in 2017, the largest trade deficit the nation has experienced with a country.
Although, the US exports grew from USD 580.6 billion to USD 2.34 trillion from 1993 to 2017, the nation has continuously seen trade deficits in the past two decades, this was prior to the existence of NAFTA. Further, as the US grew its exports to other countries, imports grew more feverishly, widening its trade deficit to an even higher level.
Furthermore, the bifurcation in the balance of goods vis-à-vis services reveals that the US is importing more goods than its exports. However, the nation is having surpluses in the trade of services. Nevertheless, the deficit in trade of goods is way higher than the surplus in services causing the US to support large trade deficits through fiscal deficits. This large trade deficit of the US worried its politicians and prompted for a reconsideration of their foreign trade pacts.
Employment and investment trends: Canada is the fourth largest foreign direct investment (FDI) contributor to the US, the nation’s FDI stock grew from USD 65 billion (1997) to USD 371.5 billion (as of 2016). Moreover, the US FDI in Canada grew from USD 96.6 billion to USD 363.9 billion during the same period, this stands below the US FDI investment in Canada by USD 7.5 billion. Mexico, on the other hand, is largely a recipient of the US FDI, this stands at USD 87.6 billion as compared to outward FDI of USD 16.7 billion as of 2016.
The below chart is showing the position of the FDI which is a stable and long-term source of investment, whereas portfolio flows are volatile hence, these were not included.
The major effect of NAFTA has been employment growth in all the three countries, the unemployment rate in the US, as well as Canada and Mexico, declined sharply after the implementation of the NAFTA. Currently, the US unemployment rate stands at historically low levels of 4.1%, which spiked to 10% after the financial crisis of 2008. While the overall effects of NAFTA might have been positive for the employment, but the impact has been unequal across regions and sectors. Agriculture has been the focus area of its critics, which asserts that the small farms of Mexico were not able to compete with the large and resourceful farms in Canada and the US. There was a large shift from farm to non-farm labour across Mexico due to non-tariff and subsidised agriculture exports from the member countries, this gave rise to illegal immigration.
Onset of renegotiation: The main reason for the renegotiation of NAFTA is the trade deficit of the US with its trading partners. Although, NAFTA forms a small part (12% in 2017) of the US trade deficit, the nation is having the largest deficit in the world. The US trade deficit in 2017 was a whopping USD 568.4 billion, 3% of the annual GDP, which was mostly comprised of imports from China. Additionally, the trade balance from the perspective of NAFTA critics, constitute the trade deficit in goods (not including services) which is faced by the US from both the Canada and Mexico, this led the US President Trump to attack NAFTA.
Another major Trumps’ rhetoric for the scrapping of NAFTA is due to job losses faced by the US. The President has accused NAFTA, especially Mexico for stealing hundreds of thousands of manufacturing jobs from the US middle class. Notwithstanding, there have been various studies that claimed NAFTA’s effects on the jobs in the US are marginal and hard to be quantified.
Key issues of renegotiation for NAFTA: The renegotiation of NAFTA began on August 16, 2017, thereafter there have been repeated threats by the US President Donald Trump to back away from the deal as the exit from or renegotiation of NAFTA was one of his political commitment before assuming the office. However, the renegotiation hinges on the US demand, which needs to be addressed by member nations before reaching a revamped final agreement, few of the most contentious issues are:
- The foremost issue is the US demand of sourcing higher auto component from North America. The existing rule is to source 62.5% auto content of a vehicle from North America which the US propose to revise to 75 percent before entering the duty-free status. In addition, after dropping an earlier proposal to source 50% auto content from the US, its trade representative Robert Lighthizer proposed to set a wage floor at USD 15/hour for few components to be sourced from North America. This proposal seeks to source greater content from the US and Canada where wage rates are higher instead of Mexico’s average of USD 3-6/hour, which as per the industry veterans would make the US auto industry less competitive in international trade and increase the cost for domestic users.
Vehicles and auto parts constitute the biggest category of Mexican exports to the US, the second biggest from Canada to the US and highlight the tightly integrated supply chain of the US automakers.
- The other issue is the insertion of a sunset clause according to which NAFTA will cease to exist after a period of every five years unless all the three countries agree to extend the agreement, this can evoke too much uncertainty for the long-term investments.
- Further, issues like opening of Canada’s supply-management system for dairy and poultry, entry of Mexican carriers in the US border, trade dispute resolution clause, limits on the bidding of federal contracts by Canada and Mexico, etc. are left to be addressed.
Conclusion: NAFTA has been a crucial trade deal for the North America, which played a significant role in trade and welfare. Though, the US has been criticising Mexico for its labour conditions and transfer of the US manufacturing jobs to Mexico, it has been reaping the benefits of large welfare led by cheap availability of raw materials such as food, oil and consumables from Mexican exports. NAFTA also helped the US auto industry to remain competitive towards Europe and Asia led by cheap Mexican labour.
Addedly, the current global trade climate is vastly distinct from 1994 when NAFTA was signed. Asia, especially China has emerged as a global player in the trade and technology. China not only made itself self-reliant in terms of goods and services but also became a global manufacturing powerhouse. In the light of the changing global dynamics, it is imperative for the US to strengthen its ties with allies to stand firm against uprising Asian power.
In the meanwhile, President Trump in a desperate attempt placed tariffs on steel and aluminium imports for 25% and 10% respectively in March 2018. However, granted extension to Canada and Mexico until May 1, 2018, in light of the ongoing NAFTA negotiations. Thus, as the deadline nears only six out of the 30 chapters were closed during the negotiations but the wide differences remain on various crucial aspects mentioned above. It would be interesting to see the US stance on the extension of the tariffs to Canada and Mexico after May 1, 2018. However, falling apart on NAFTA is a remote possibility given the huge trade synergies enjoyed by the member nations.
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