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Seminararbeit
Volkswirtschaftslehre

Freie Universität Berlin - FU

2017

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Winter Semester 2016/2017


N.A.F.T.A - NORTH AMERICA FREE TRADE AGREEMENT


PAPER


Freie Universität Berlin

Die Handelspolitik der Vereinigten Staaten

Erasmus Student: Olivier Manzardo

Index


Introduction……………………………………………………………………………………………………………….page3

What is NAFTA………………………………………………………………………………………………………… .page3

NAFTA Goals………………………………………………………………………………………………………………page4

Motivations:

United States motivations………………………………………………………………………………………… .page5

Canada’s motivations………………………………………………………………………………………………….page6

Mexico’s motivations………………………………………………………………………………………………….page7

What did NAFTA accomplish:

Trade volumes………………………………………………………………………………………………………… .page9

Economic growth……………………………………………………………………………………………………….page9

Who has won and who has lost:

United States, Jobs…………………………………………………………………………………………………… page10

United States, Prices……………………………………………………………………………………………… .page12

United States, Growth……………………………………………………………………………………………… .page13

Mexico………………………………………………………………………………………………………………………page14

Canada…………………………………………………………………………………………………………………… .page15

Influences of China, high tech and crisis…………………………………………………………………… .page16

NAFTA and Trump Administration…………………………………………………………………………… page17

What about the rest of the World? .page19

Conclusions……………………………………………………………………………………………………………….page20

Graphs………………………………………………………………………………………………………………………page21

Bibliography…………………………………………………………………………………………………………… .page24


Introduction


In my paper I shall try and analyze how the NAFTA agreement developed from its inception until today.

In particular, I shall try and give an answer, among others, to the following questions:


  • What is NAFTA and how it developed over time?

  • What were the political and economic consequences (positive and negative) for the countries involved?

  • What kind of assessment for the NAFTA Agreement is fair? What has NAFTA accomplished for its members’ economies in terms of trade volumes, GDP growth, jobs creation, prices development and immigration?

  • How is NAFTA interconnected with the other global players on the world trade scene and other economic trends?

  • How will the Trump Administration impact on the Agreement and what could be the consequences for the idea of free trade? How will the economic situation of the NAFTA partners change in case of a significant change in the Agreement provisions or in case of its cancellation?

  • Will this also have an impact on the world trade situation and how?


What is NAFTA?


The North American Free Trade Agreement (NAFTA) is an accord eliminating most trade barriers between the U.S., Canada and Mexico that went into effect on January 1, 1994. Some of its conditions were implemented immediately; others were staggered over the following 15 years. Today, just over a few months into its 24th year, NAFTA appears to be in its ending phase.

U.S. President Donald Trump repeatedly attacked the NAFTA agreement during his campaign, and two days after his inauguration speech, he promised to begin renegotiating the agreement, saying he expected "a very good result for Mexico, for the United States, for everybody involved."

Why do Trump and many of his supporters see NAFTA as "the worst trade deal maybe ever," when others see its main shortcoming as a lack of ambition – and the solution as yet more regional integration? What was promised? What was delivered?

NAFTA’s terms, which were implemented gradually through the years, provided for the elimination of most tariffs on products traded among the three countries. Liberalization of trade in agriculture, textiles, and automobile manufacturing was a major focus. The deal also sought to protect intellectual property, establish dispute-resolution mechanisms, and, through side agreements, implement labor and environmental safeguards.


NAFTA fundamentally reshaped North American economic relations, driving an unprecedented integration between Canada and the United States' developed economies and Mexico, a developing country. In fact NAFTA is considered the first trade agreement between asymmetrically developed economies, covering the largest and most impressive free trade area in the world.

In terms of political support, NAFTA enjoyed bipartisan backing: it was negotiated by Republican President George H.W. Bush and passed through Congress and implemented under Democratic President Bill Clinton. It encouraged a more than tripling of regional trade and cross-border investment between the three countries also grew significantly. Yet NAFTA has remained a perennial target in the broader debate over free trade.

President Donald J. Trump says the deal has shifted U.S. manufacturing production, and jobs, to Mexico, and his administration has vowed to renegotiate or withdraw from it.


NAFTAs Goals


When negotiations for NAFTA began in 1991, the goal for all three countries was the integration of Mexico with the highly developed, high-wage economies of the United States and Canada which, since 1988 had already signed the CUFTA bilateral trade Agreement. The hope was that free trade would bring stronger and steadier economic growth to Mexico, providing new jobs and opportunities for its growing workforce and discouraging illegal migration from Mexico.

For the United States and Canada, Mexico was seen both as a promising new market for exports and as a lower cost investment location that could enhance the competitiveness of U.S. and Canadian companies.


If we look at NAFTAs Article 102 we can read the official objectives of the agreement:


  • Promote regional trade and investment

  • Increase employment, improve working conditions and living standards in each of
    the countries

  • Provide a framework for the conduct of trilateral trade relations and for the
    management of disputes

  • Strengthen and enforce environmental laws and basic workers’ rights

  • Work together to promote “further trilateral, regional, and multilateral
    cooperation to expand and enhance the benefits of this agreement”


As a general rule, free trade agreements occur most likely among countries that are in geographic proximity. If we look at the list of free trade agreements in today’s world, it is easy to notice that they are all regional; Greater Arab Free Trade Area (GAFTA), South Asia Free Trade Agreement (SAFTA), Southern African Development Community (SADC), Southern Common Market (MERCOSUR), Economic Community of West African States (ECOWAS), Central European Free Trade Agreement (CEFTA), and many more.

Countries that are physically close to each other have historically always been the biggest trading partners. Prior to NAFTA, Mexico’s largest trading partner was the United States accounting for almost one third of its exports and seven percent of its imports. Similarly, Canadian exports to the United States counted for 69 percent while imports from the United States reached 21 percent.

The reason for such great trade flux within a region is that those markets are usually very similar in their preferences as well as their problems.

What were the reasons for the three countries for joining NAFTA? Some were common reasons others were more country specific. The common reasons were pretty obvious and stated in the Article 102 of the Agreement. Let us look now at the more country specific motivations for joining NAFTA.


Motivations

United States of America’s


Why would the United States – the largest and strongest economy in the world – want to sign Free Trade Agreements with one considerably smaller economy such as Mexico? The most important general reason is capital’s risk aversion. Since the investors are not interested in the opportunities with politically unstable countries which inherently impose a threat on their capital, FTA’s are seen as a way to support the growth of political pluralism in a given country.

So the first two reasons why the United States would enter into a trade agreement are to use its influence to a) support stability in a given country, and b) protect its capital.

Another motive that made the United States to consider seriously a common market with its southern neighbor came from the 1970s oil crisis in the United States and major discoveries of oil in Mexico. The United States wanted to ease and secure the access to the Mexican oil reserves as an important source of energy. Of course, for that reason the United States could have also turned to the Middle East and reach trade agreements with some of them, but here is where the earlier mentioned geographic proximity plays an important role.

Another reason why the United States wanted NAFTA was that FTAs similar to NAFTA had been created in Europe and Asia. These FTAs had the potential of aggregating power and eventually imposing a threat to the United States international position. The creation of NAFTA was the United States reaction to the increasing number of multinational trade agreements and a foot in the doors of new markets.


Canada’s Motivations


Canada trade was, just like in the case of Mexico, heavily dependent on the United States. In 1985 Canada started to seek freer trade with the United States which resulted in creation of CUFTA. Political analysts agree that a trade agreement with Mexico was never a part Canada’s ambitions, but once the negotiations between the United States and Mexico took place, Canada decided to join in.

Canada obviously entered trade agreements with the United States for different reasons than it did with Mexico. The first motive for Canadian officials to join NAFTA was strictly defensive - they did not want to be left behind. There are two parts to this motivation. First, Canada wanted to avoid allowing the United States, which was heading for two bilateral trade agreements, to become the center of North American trade.

Canada did not want to take part in the United States – Mexico free trade negotiations, but the idea of being left out was equally troubling. As the second part to this motive, the U.S. market historically absorbed almost one third of Canada’s total exports, and Canada could not afford to lose its share in the United States market to Mexico. Because of the size and wealth of the United States market, as soon as Mexico proposed a free trade agreement with the United States, Canada was prompted to join the talks as well.

Canada’s decision to enter a trade agreement with Mexico came incrementally and indirectly through Canada’s interest in the United States. Still, as its second motive, Canada wanted to play a role in building Mexico in spite of the potential costs, such as losing share in the US market to Mexico. Assuming that Mexico, supported by NAFTA, would experience economic growth and increase in purchasing power, a large new market with an enormous appetite for imports, capital, technology and know-how would be created.

The third reason why Canada decided to join NAFTA was the shortcomings of CUFTA. CUFTA had several important achievements, such as lowering tariffs and dispute settlement, but several points remained unresolved. Most notably subsidies, government procurement, energy sector investment, transportation, and intellectual property rights still needed to be addressed, or addressed in a more efficient way.

Canada wanted to revise many of these topics under NAFTA.

Although geographical proximity was already mentioned as a general rule in the creation of free trade agreements, this argument was particularly important in the case of Canada. To understand it, we need to know that nearly 90 percent of Canadian population lives within 200 kilometers from the United States border. A high level of social and economic development in both of the countries, same language, and ease of transportation created great trust and a soft border between the two.


Mexico’s motivations


Since World War II, Mexico used all possible tariff and non-tariff means to shelter its domestic market. A direct result of its protectionist policy was the 1980s debt crisis, in spite of recently discovered oil resources on Mexican soil. Throughout that same period (1980s) any idea of Mexico entering free trade with the United States had been firmly rejected. The country was on its knees and it became obvious that some structural changes had to be made.

Presidents Miguel de la Madrid and Carlos Salinas undertook a series of reforms to liberalize trade, make foreign investment easier, better control public enterprises and liberalize and privatize financial system.

In 1986, Mexico joined GATT ( General Agreement on Tariffs and Trade ) and made adjustments to its trading system making it more liberal. Mexico desperately needed economic growth, and its leaders rightly recognized that it could only be achieved through liberating trade, increase exports, and foreign investment. In that sense, joining GATT represented the first step toward the North American Fare Trade Agreement.

It was a sign of good will and made Mexico a much more attractive trading partner to its northern neighbors.

Changes in Mexico’s trade policy were not the motive for joining NAFTA, but they were a reason why the negotiations started. The first motive that Mexico had to join NAFTA was to overcome domestic political obstacles to economic reform. Mexico expected that an external influence from the United States and Canada would support, justify, and reinforce undergoing domestic changes.

Mexico could have joined an economic agreement of Latin American countries, MERCOSUR. However, Mexico wanted to leave the South and underdevelopment behind. Those countries were facing the same economic problems and political instability as Mexico. Greater benefits in terms of financial, political, and social influence were to be expected from the developed nations such as the United States and Canada.

The second important motive Mexico had to join NAFTA was to attract foreign investments. It was not only foreign investments from the United States and Canada that Mexico was after, but from the whole world. Mexico had two valid reasons to believe that foreign capital would be interested in coming. First, it was a once-in-a-lifetime opportunity to buy valuable state-owned enterprises, such as telephone companies.

By creating closer relations with the United States and Canada, Mexico would appear to be a trustworthy business partner.

It is a fact that all capital, including that from Europe or Asia, is risk averse and it looks for a stable environment to be deployed.

The third important motive Mexico had to push for the trade negotiations with its neighbors was the world trend of creating free trade agreements. This is most of all true in regards to Europe which was the second largest investor in Mexico. After the fall of communist bloc and Europe’s integration there was a fear that potential European investment will be diverted from Mexico to the newly opened opportunities in Eastern Europe.

The Mexican government reacted by initiating its own trade union - NAFTA. By integrating its market with the United States and Canada, Mexico would appear to have more muscle vis-à-vis EU, giving the impression of stability and become more attractive for the foreign investments.

One last motive for Mexico to enter a free trade agreement was the trend that, since World War II, Mexicans emigrated to the United States in search of better paid jobs. In the first years after the war they were welcomed by the United States officials, but since 1967, United States’ immigration rules kept getting stricter. Still, stricter rules did not prevent drainage of labor force.

The only way Mexico could prevent labor emigration was to create more of the better paid jobs and NAFTA had a potential of doing that.



Trade Volumes


NAFTA's most important objective was to increase cross-border commerce in North America, and in that respect it succeeded with no doubts. By lowering or eliminating tariffs and reducing some nontariff barriers, such as Mexican local-content requirements, NAFTA caused an increase in trade and investment. Most of this increase came from U.S.-Mexico trade, which totaled $481.5 billion in 2015, and U.S.-Canada trade, which totaled $518.2 billion.

Trade between Mexico and Canada, though by far the fastest-growing channel between 1993 and 2015, totaled just $34.3 billion.

That combined $1.0 trillion in trilateral trade has increased by 258.5% since 1993 in nominal terms. The real – that is, inflation-adjusted – increase was 125.2%.


It is probably safe to give NAFTA at least part of the credit for doubling real trade among its signatories.


Economic Growth (refer to the Real per capita GDP graph in the appendix)


From 1993 to 2015, the U.S.'s real per-capita gross domestic product (GDP) grew 39.3% to $51,638 (2010 USD). Canada's per-capita GDP grew 40.3% to $50,001, and Mexico's grew 24.1% to $9,511. In other words, Mexico's output per person has grown more slowly than that of Canada or the U.S., despite the fact that it was barely a fifth of its neighbors' to begin with.

Does that mean that Canada and the U.S. are NAFTA's winners, and Mexico is its loser? Perhaps, but if so, why did Trump debut his campaign in June 2015 with, "When do we beat Mexico at the border? They're laughing at us, at our stupidity. And now they are beating us economically"?

Because, in a way, Mexico does beat the U.S. at the border. Prior to NAFTA, the trade balance in goods between the two countries was modestly in favor of the U.S. Today Mexico sells close to $60 billion more to the U.S. than it buys from its northern neighbor. NAFTA is an enormous and enormously complicated deal; looking at economic growth can lead to one conclusion, while looking at the balance of trade leads to another.

Even if NAFTA's effects are not easy to see, however, a few winners and losers are reasonably clear.


NAFTA, who has won and who has lost

United States


Jobs

When Bill Clinton signed the bill authorizing NAFTA in 1993, he said the trade deal "means jobs. American jobs, and good-paying American jobs." His independent opponent in the 1992 election, Ross Perot, had warned that the flight of jobs across the southern border would produce a "giant sucking sound."


Finding a direct link between NAFTA and overall employment trends is difficult. The partially union-funded Economic Policy Institute estimated in 2014 that 851,700 net jobs had been displaced by the U.S.'s trade deficit with Mexico, which amounted to 0.6% of the U.S. labor force at the end of 2013. In a 2015 report, the Congressional Research Service (CRS) said that NAFTA "did not cause the huge job losses feared by the critics." On the other hand, it allowed that "in some sectors, trade-related effects could have been more significant, especially in those industries that were more exposed to the removal of tariff and non-tariff trade barriers, such as the textile, apparel, automotive, and agriculture industries."

NAFTA's implementation has coincided with a 30% drop in manufacturing employment, from 17.7 million jobs at the end of 1993 to 12.3 million at the end of 2016. (refer to the US manufacturing jobs graph in the appendix)

Whether NAFTA is directly responsible for this decline is difficult to say, however. The automotive industry is usually considered to be one of the hardest-hit by the agreement; yet although the U.S. vehicle market was immediately opened up to Mexican competition, employment in the sector grew for years after NAFTA's introduction, peaking at nearly 1.3 million in October 2000. Jobs began to slip away at that point, and losses grew steeper with the financial crisis.


Evidence supports the idea that these jobs went to Mexico. Wages in Mexico are a fraction of what they are in the U.S. All major American car makers now have factories south of the border, and prior to Trump's twitter campaign against offshoring, a few were openly planning to ship more jobs abroad. Yet while the job losses are tough to deny, they may be less severe than in a hypothetical NAFTA-less world.

The CRS note that "many economists and other observers have credited NAFTA with helping U.S. manufacturing industries, especially the U.S. auto industry, become more globally competitive through the development of supply chains." Carmakers did not move their entire operations to Mexico; they now stretch the border. A 2011 working paper by the Hong Kong Institute for Monetary Research estimates that a U.S. import from Mexico contains 40% U.S. content.

For Canada the corresponding figure is 25%. Meanwhile it is 4% for China and 2% for Japan.

While thousands of U.S. auto workers undoubtedly lost their jobs as a result of NAFTA, they might have fared worse without it. By integrating supply chains across North America, keeping a significant share of production in the U.S. became an option for car makers. Otherwise they may have been unable to compete with Asian rivals, causing even more jobs to depart. "Without the ability to move lower-wage jobs to Mexico we would have lost the whole industry," UC San Diego economist Gordon Hanson told the New York Times in March 2016. On the other hand, it may be impossible to know what would have happened in a hypothetical scenario.

Not only are none of these other countries members of NAFTA – none has a free trade agreement with the U.S.


Prices

An important point that often gets lost in assessments of NAFTA's impacts is its effects on prices. The Consumer Price Index (CPI), a measure of inflation based on a basket of goods and services, rose by 65.6% from December 1993 to December 2016, according to the Bureau of Labor Statistics (BLS). During the same period, however, apparel prices fell 7.5%. Still, the decline in garment prices is no easier to pin directly on NAFTA than the decline in garment manufacturing.

Because people with lower incomes spend a larger portion of their earnings on clothes and other goods that are cheaper to import than to produce domestically, they would probably suffer the most from a turn towards protectionism – just as many of them did from trade liberalization. According to a 2015 study by Pablo Fajgelbaum and Amit K. Khandelwal, the average real income loss from completely shutting off trade would be 4% for the highest-earning 10% of the U.S. population, but 69% for the poorest 10%.




Part of the justification for NAFTA was that it would reduce illegal immigration from Mexico to the U.S. The number of Mexican immigrants – of any legal status – living in the U.S. nearly doubled from 1980 to 1990, when it reached an unprecedented 4.3 million. Supporters of the Agreement argued that uniting the U.S. and Mexican markets would lead to gradual convergence in wages and living standards, reducing Mexicans' motive to cross the Rio Grande.

Mexico's president at the time, Carlos Salinas de Gortiari, said the country would "export goods, not people."

Instead the number of Mexican immigrants more than doubled – again – from 1990 to 2000, when it approached 9.2 million. According to the Pew Research Center, the flow has reversed, at least temporarily: 140,000 more Mexicans left the U.S. than entered it from 2009 to 2014, likely due to the effects of the financial crisis. One reason NAFTA did not cause the expected reduction in immigration was the peso crisis of 1994-1995, which sent the Mexican economy into recession.


Trade Balance and Volume (refer to the US trade balance with Mexico and Canada graphs in the appendix)

Critics of NAFTA commonly focus on the U.S.'s trade balance with Mexico. While the U.S. enjoys a slight advantage in services trade, exporting $30.8 billion in 2015 while importing $21.6 billion, its overall trade balance with the country is negative due to a $58.8 billion 2016 deficit in merchandise trade. That compares to a surplus of $1.7 billion in 1993 (in 1993 USD, the 2016 deficit was $36.1 billion).

But while Mexico is "beating us economically" in a mercantile sense, imports were not solely responsible for the 264% real growth in merchandise trade from 1993 to 2016. Real exports to Mexico more than tripled during that period, growing by 213%; imports outpaced them, however, at 317%.

The U.S.'s balance in services trade with Canada is positive: it imported $30.2 billion in 2015 and exported $57.3 billion. Its merchandise trade balance is negative – the U.S. imported $9.1 billion more in goods from Canada than it exported in 2016 – but the surplus in services trade hides the deficit in merchandise trade. The U.S.'s total trade surplus with Canada was $11.9 billion in 2015.



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