Tuesday, March 4, 2008

NAFTA Revisited

NAFTA Summit: President George W. Bush of the United States, Prime Minister Stephen Harper of Canada and President Felipe Calderon of Mexico meet in Monticello, Canada in August. (Photo: Eric Draper/The White House)

TRADE BOOM: US-Mexico trade has grown dramatically since NAFTA was implemented in 1994. Here trucks in Laredo, Texas near the Mexican border. (Photo: Federal Highway Administration)

Tuesday, March 04, 2008
NAFTA Revisited


Throughout its duration, NAFTA has been hailed by some and derided by others. Proponents laud the pact’s contribution to regional trade and investment, and argue for an acceleration of the integration process. Critics focus on NAFTA’s impact on wages and jobs because of growing competition and immigration; some fear that increased cooperation will lead to a loss of sovereignty. Labor unions continue to attack trade pacts using their old rallying cry, “No More NAFTAs.” (…)

Why divisive? The fractious NAFTA ratification debate has had lingering effects in Washington, as evidenced by dwindling Democratic support for major trade bills over the past decade in response to constituent pressures and in retaliation for the highly partisan tactics of the Republican leadership during the period 1994-2006. Ironically, NAFTA critics devote less attention to the pact’s most glaring shortcomings. Energy and border security have captured the political spotlight, yet minimal progress has been achieved on both files. Additionally, Mexican GDP growth has averaged only 3 percent per annum since 1993. (…)

NAFTA succeeded in advancing economic integration and achieving the goals agreed to in the pact — though not in reaching the inflated promises of politicians when the agreement entered into force.

While the NAFTA is comprehensive compared to other trade agreements, in some areas its footprint is small. For example, NAFTA has no rules on subsidies, nor on antidumping or countervailing duties; its side pacts on labor and the environment are limited in scope and not backed by meaningful funds; and Mexico avoided significant obligations in the energy sector.

In addition, NAFTA lacks the medicinal powers to cure important ills of North America, including high levels of illegal immigration and trafficking of illegal drugs, slow progress on environmental problems, growing income disparities (particularly within Mexico), and weak growth in real wages. Some of these problems are correlates. Correlates of economic integration and higher incomes, though NAFTA is only a small part of the story. NAFTA was and is foremost a commercial agreement, and in commercial terms the pact is a great success. (…)

U.S.-Mexico trade has expanded at a particularly rapid clip, much faster than U.S. merchandise trade with the world. (…)

One of the key Mexican objectives in NAFTA was to increase foreign direct investment (FDI), and here again the pact has had a positive impact. The stock of FDI in Mexico from all sources has increased more than four-fold since 1993. The real spurt has come from European, Asian and Canadian investment, not the United States, as the NAFTA — buttressed by the peso crisis of 1994-95 — prodded Mexico to adopt broad-based reform of its investment policies. (..)

NAFTA’s first decade coincided with an extended period of strong U.S. economic growth — with positive knock-on effects for its neighbors. Total employment was up in all three countries.U.S. employment rose from 110 million in 1993 to 144 million in 2006 (…) Jobs in the formal sector in Mexico increased from 33 million to 44 million.

But not every worker or community benefited, and national trade adjustment programs for hard-hit workers and communities remain meager.

On an annual basis, depending on who is counting, NAFTA-related job losses in the United States ranged between 60,000 and 190,000. Since the total number of U.S. jobs increased substantially during NAFTA’s first decade, even the top number for annual job losses — running at about 1.9 million over a decade — is small compared to the number of jobs “created”, and represents a fraction of one percent of jobs “lost” through turnover in the dynamic U.S. economy over a decade. In the grand scheme of economic forces, NAFTA is no more than a blip on the U.S. employment picture. Formal employment in northern Mexico has clearly benefited from NAFTA. (…)

What about wages? Some NAFTA critics ( … ) charge that trade pacts drive down wages of unskilled workers. In NAFTA Revisited, we examined the relationship of trade and wages in the NAFTA context, and could not detect a material difference in U.S. wage rates between states and industries with a large volume of U.S. imports from Mexico and those with a small volume. By far the most important channel by which Mexico influences U.S. wages is immigration, legal and illegal. Immigration is a direct result of geographic proximity; it is not driven by NAFTA. (…)

In general, the dispute settlement process has worked relatively well in cases where the NAFTA obligations were clearly defined (including most Chapter 19 cases involving the ex post review of national antidumping and countervailing duty determinations), but poorly in big cases where domestic politics blocked treaty compliance (notably, U.S.-Mexico trucking, Canada-U.S. softwood lumber, and U.S.-Mexico sugar and HFCS). With the exception of U.S.-Mexico trucking, however, even the big cases (softwood lumber, sugar and HFCS) are being resolved with large helpings of political grease.

While antidumping and countervailing cases are by far the most numerous, the most controversial dispute provisions cover investor-state disputes under Chapter 11. When NAFTA was signed, the Chapter 11 provisions were relatively uncontroversial; in fact, NAFTA arbitration was hailed as an improvement over national courts.

In practice, however, rules regarding “indirect expropriation” under Article 1110 and requirements for minimum legal standards under Article 1105 have fostered a broader range of litigation than originally envisaged.

NAFTA critics assert that Chapter 11 tribunals are riding roughshod over state and local environmental standards. There is no basis for this assertion: total awards to date are less than $100 million — a small fraction of the overblown claims of business plaintiffs and a tiny amount compared to three-way FDI within NAFTA, now amounting to almost $900 billion.

The North American Agreements on Labor Cooperation and on Environmental Cooperation were negotiated and appended to the NAFTA in 1993 at the behest of President Clinton to encourage U.S. Congressional ratification of the pact. These side agreements announced three specific objectives: monitor implementation of national laws and regulations pertaining to labor and the environment, provide resources for joint initiatives to promote better labor and environmental practices, and establish forums for consultations and dispute resolution. In practice, however, the two side agreements have furthered only marginal improvements in labor and environmental
conditions. (…)

The NAFTA was state of the art when negotiated in the early 1990s. [Today], the pact could benefit from renovation, for three reasons:
Important items were excluded from NAFTA coverage (including some farm products, energy investment in Mexico, rules on subsidies and dumping, and migration).
Several NAFTA provisions were poorly constructed and should be recast (including rules of origin, labor and environmental side accords, and some dispute settlement procedures and definitions).
New conditions have emerged that were not on the radar screen of the original NAFTA draftsmen — importantly security concerns and electronic commerce.
In other words, despite a decade of progress, the three NAFTA partners still have a lot of work. Melding the security and economic objectives of the three countries will require large doses of political will and diplomatic skill.

To take full advantage of NAFTA’s opportunities, Mexico must invest heavily to redress its own energy shortages, and to upgrade its roads, ports, telecommunications networks and public services. Doing so would create better opportunities for economic development in the poorer regions of southern Mexico and would curb the “Mexico cost” that weighs heavily on the international competitiveness of Mexican industries. (…)

Resolving the trucking dispute with Mexico will be an essential component of the larger security agenda.

The NAFTA partners now face an increasingly competitive and security conscious world. To enhance the global competitiveness of North America, the Regulatory Cooperation Framework was created in 2006 to reduce redundant testing and promote compatibility of regulations. The Intellectual Property Action Strategy targets counterfeiting and piracy. While the Montebello Summit, held in August 2007, confirmed progress in both areas, these are modest achievements.

We recommend bolder progress in three concrete areas. First, by adopting a NAFTA common external tariff, the partners could promote commerce among themselves while reducing distortions generated by NAFTA rules of origin. (Since 2005, three rounds of reforms on rules of origin have already facilitated an estimated $130 billion in trilateral trade).

Second, the NAFTA partners need a higher level of cooperation on domestic regulatory standards, particularly in the area of food safety.

Third, leaders in the three countries should direct their ministers to ensure that longstanding trade disputes are resolved. The most prominent disputes involve softwood lumber, sugar and trucking. All three are on track towards resolution; what leaders must do is ensure that the disputes don’t jump off their tracks. (…)


The U.S.-Mexico trucking dispute is another lingering disagreement. The North American trucking sector was to have been fully liberalized in January 2000, but the United States repeatedly appealed to safety and environmental issues to prevent the entry of Mexican trucks. The real issue, of course, was opposition from the Teamsters union. The consequence was the creation of a highly inefficient “commercial zone” at the border which requires the use of drayage trucks to link U.S. and Mexican long-haul trucks.

In February 2007, the United States and Mexico finally agreed on a pilot program that allows 100 trucking companies based in Mexico to make deliveries in the United States, and 100 U.S. companies to do business in Mexico. (See U.S. Truck Program: Mexico's Views). (…)

Tremendous numbers of Mexicans and Canadians cross the U.S. border each year: most legally for commercial reasons, employment, or tourism; some, including an estimated 400,000 Mexicans, illegally. There is a clear security imperative to better monitor and control these flows; at the same time, there is an economic imperative to maintain unfettered access for legitimate purposes. The Security and Prosperity Partnership launched in 2005 aims to achieve a balance between the two goals. The need for increased cooperation and mutually acceptable inspection protocols was reiterated by the U.S., Canadian and Mexican leaders at the Montebello summit. (…)

The NAFTA labor and environmental side agreements were not designed with enough ambition to address labor and environmental problems that have been decades in the making. For labor, we recommend that NAFTA institutions should concentrate their attention on basic standards relating to workplace conditions, child labor, and forced labor.

For the environment, we recommend substantial financial commitments to underpin existing and new initiatives. The North American Development Bank (NADBank) is woefully under-funded, and Mexican municipalities are starved of revenues. The NADBank’s capital base should be increased incrementally from $4.5 billion to $10 billion. Instead of a 50-50 split between the United States and Mexico, the funding should be 75-25. For its part, the Mexican federal government should assist municipalities to levy and collect property taxes and dedicate the revenues to environmentally sound infrastructure improvement — basic needs like water, sanitation, and paved roads.

The […] Montebello summit clearly identified the pressing need for an integrated approach to climate change and energy security, while reducing barriers to the development of new and clean technologies. The energy science and technology agreement, signed in July 2007, aims to promote progress in those technologies. (…)

Given increasingly tough global competition and global security threats, the three countries need a more integrated response from North American leaders. So far, leaders have allowed the North American agenda to slip further down on their priority lists.

This column is based on a longer article from October 2007. The authors are senior fellows at the Peterson Institute for International Economics in Washington.. They were assisted by Claire Brunel, a research assistant at the Institute. Opinions expressed are the views of the authors, and not necessarily the views of the Peterson Institute or its staff. Republished with permission from the authors.

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