What is the North American Free Trade Agreement (NAFTA)?

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Definition:

NAFTA is a trade agreement between the United States, Canada, and Mexico where the members agreed to remove tariffs and trade barriers.

🤔 Understanding NAFTA

The North American Free Trade Agreement (NAFTA) dates back to 1989, when the United States and Canada entered into a trade agreement. In 1994, Mexico joined the treaty, and NAFTA came to be. Under the agreement, the three countries agreed to eliminate tariffs (taxes on imports and exports) on each other’s products and reduce other trade barriers. NAFTA represents the world’s largest free trade area. In 2018, the Trump administration entered into talks with Canada and Mexico to renegotiate the deal. The three countries created the U.S.-Mexico-Canada Agreement (USMCA) to replace NAFTA. On March 13, 2020, Canada became the third and final country to ratify the treaty, meaning it should go into effect 90 days later.

Example

One of the critical ways NAFTA impacts the United States economy is by reducing the cost of consumer goods. These savings occur as a result of eliminating tariffs on the trade of goods between the three member countries.

Suppose you were considering purchasing two different shirts. One was manufactured in Mexico, while the other was made in a country that is not a part of NAFTA. The manufacturers sell the shirts to retailers for the same price. The difference is that there are no tariffs on the shirt from Mexico, but there are tariffs on the shirt from the other country. The firm that imports the shirt pays the tariff, but they probably pass that cost along to the consumer by raising the price of the shirt.

As a result, the shirt from Mexico is cheaper, even though the shirts are identical in every way. Therefore, we have an incentive to purchase goods from our trade allies. It benefits Canada and Mexico, and it helps the consumers buying the products in the United States.

Takeaway

NAFTA is like a members-only country club…

When you join a members-only club, there are a lot of perks to be had. You can use all of the amenities the club has to offer and build relationships with the club’s other members. Membership comes at a cost, though. Similarly, NAFTA has a lot of benefits to its member countries. However, it still comes at a price — In some cases, the cost has come in the form of lost revenue from tariffs, lost jobs, and restrictions on domestic companies.

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What is NAFTA?

On January 1, 1989, the United States entered into a treaty with its neighbor to the north. The deal resulted in the U.S.-Canada Free Trade Agreement. Just two years later, the two countries began negotiations with Mexico. On January 1, 1994, the three countries joined forces to create the North American Free Trade Agreement (NAFTA).

NAFTA is a treaty between the three member countries that created a free trade zone in North America. The agreement eliminates tariffs and other barriers to trade.

Why was NAFTA created?

The idea of NAFTA dates back to nearly a decade before it came to be. President Ronald Reagan initiated the concept of a free trade agreement with Mexico because of the high volume of trade between the two neighbors. At that time, nothing came of the idea.

Under the leadership of President George H.W. Bush and President Bill Clinton, Reagan’s vision came to fruition. NAFTA was passed in the United States on a bipartisan vote to increase jobs, increase wages, and remove trade barriers between the member countries.

Why is NAFTA important?

Since its inception in 1994, NAFTA has remained in place with the same three members: the United States, Canada, and Mexico.

NAFTA was historic from the start — When the United States and Canada joined forces with Mexico, it was the first time a developing country had entered into a regional trade agreement with developed nations. The treaty is also notable because, to this day, it remains the largest free trade agreement in the world.

NAFTA is also significant on the world stage in a financial sense. The region has a collective gross domestic product (GDP) of about $20T — That’s more than a quarter of the global GDP. While the United States is the largest of the three in terms of the size of its economy, all three nations are among the largest global economies.

What is the purpose of NAFTA?

The purpose of NAFTA was to establish a free trade zone and increase barrier-free trade between the United States, Canada, and Mexico.

The first goal of NAFTA was to reduce trade barriers between the three countries. First, the treaty gradually eliminated tariffs over 15 years. Some tariffs went away immediately, while others went through a phase-out. There were provisions put in that allowed a member country to re-impose tariffs if the increase in imports significantly impacted domestic producers.

NAFTA also put into place guidelines for dispute prevention and dispute settlement between the three member countries. The treaty included an arbitration system the countries would use in the case of trade disputes.

Another provision of NAFTA says that each of the member countries must treat suppliers and service providers from the other member countries in the same way they would treat domestic companies. They can’t give preferential treatment to domestic companies that they don’t also give to companies from the other NAFTA countries.

How does NAFTA affect the U.S. economy?

Overall, economists estimate that NAFTA has had a relatively small effect on the United States economy. The deal is also thought to have had little-to-no impact on the wages of either skilled or unskilled workers in the United States.

Though NAFTA has had only a small impact on the U.S. economy, it’s difficult to separate the effects of NAFTA from other external factors. At the time when NAFTA went into effect, trade between the United States, Canada, and Mexico was already increasing. This trend would likely have continued with or without NAFTA. And despite the striking increase in trade with the member countries since the inception of NAFTA, that trade hasn’t directly led to economic or employment growth in the United States.

The results of NAFTA have certainly been somewhat significant in the industries that were targeted with the reduction of tariffs and trade barriers. Those industries include agriculture, apparel, textiles, and automobiles.

Let’s look specifically at the automotive industry. According to economists, NAFTA has done a lot to make U.S. auto manufacturers more competitive on the global market. This trend is partly a result of the reduction of international barriers that have made it easier for auto manufacturers to produce cars and car parts wherever it’s most efficient — Often, this is in Mexico.

What about the economies of the other two member countries?

Like the United States, Canada’s economy has seen little impact from NAFTA. For many Canadians, this is good news. There was a lot of fear in Canada that NAFTA would shift control of many of its resources to the United States.

Mexico was still a developing country when it joined NAFTA, and so its economy has seen the most significant impact. Parts of the country have seen both economic and social benefits from the agreement. Mexico has also seen an increase in manufacturing productivity since the inception of NAFTA.

What are the pros and cons of NAFTA?

NAFTA can sometimes be a controversial topic, partly because it’s difficult to pinpoint all of the positive and negative effects it has had on its member countries. There are a few we can identify, though.

First, trade between the NAFTA members has more than tripled since they signed the treaty. Trade growth within NAFTA has grown significantly faster than trade between the member countries and the rest of the world.

NAFTA has also helped to reduce costs for consumers in all three countries. Because of the elimination of tariffs, individuals can buy products at lower prices.

Finally, though there’s some disagreement among economists as to whether NAFTA has increased the number of jobs in the United States, the U.S. Chamber of Commerce argues that 5 million jobs in the United States were created as a result of the trade that NAFTA has generated. NAFTA has particularly benefited some specific industries, such as agriculture and services.

Despite the good it has done for its member countries, however, NAFTA has had some considerable downsides as well.

First, because NAFTA made it easier and cheaper for U.S. companies to manufacture goods in Mexico, some industries have seen job losses in the United States. The automotive industry, in particular, saw many of its jobs leave the country.

The deal may also have been less than ideal for U.S. manufacturing workers with jobs that remained in the United States. Companies used potential moves to Mexico as a way to discourage American workers from unionizing, which resulted in lower wages.

Finally, NAFTA provisions were harmful to Mexico’s agricultural industry. Farm subsidies in the United States allowed under NAFTA made it difficult for Mexican farmers to compete with their prices, and farms were forced to go out of business. An estimated 1.3M farm jobs disappeared in Mexico.

Is NAFTA successful?

Whether NAFTA has been successful is somewhat subjective. Opponents of the agreement argue that it has resulted in a loss of jobs in the United States, particularly in specific industries, such as auto manufacturing. Data also show that the treaty has had little impact on the wages of American workers. If this is the bar by which you judge the success of NAFTA, then perhaps it has not been successful.

But if you consider the correlation between the passage of NAFTA and the volume of trade between the United States, Canada, and Mexico, then the agreement has been a success. After all, trade between the three countries has more than tripled since the inception of NAFTA.

What is the difference between NAFTA and USMCA?

In 2020, NAFTA will be replaced by the United States-Mexico-Canada Agreement (USMCA) — Many refer to USMCA as “the new NAFTA.” The leaders of the United States, Mexico, and Canada signed the agreement in November 2018. By 2020, all three countries had ratified the new deal.

USMCA differs from NAFTA in a few critical ways. Among other things, it increases the standard for the country of origin rule for the auto industry (now requiring 75% of a vehicle’s parts to be made in one of the three USMCA countries to avoid tariffs when traded between the nations), it strengthens labor and environmental protections, and it expands intellectual property rights and digital trade.

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