Possible Effects of the North American Free Trade Agreement on the Economies of Canada, Mexico, and the United States

The North American Free Trade Agreement (NAFTA), approved by the United States Congress in November of 1993, will change the economies of the three member nations who each individually approved it - Canada, Mexico, and the United States. The extent of those changes, however, is not agreed on by everyone. Opponents in all three countries claim that NAFTA will cause an overall loss of jobs in their country, which, if everyone were correct, could not be possible. Proponents of the agreement argue that free trade is a good thing, and all three nations will benefit economically from it. Reality tells us not to expect such a perfect outcome, from anything. Arguments and opinions aside, NAFTA was created in order to change the member nations' economies for the better. That is its main objective. If any of the member nations didn't have at least some belief that NAFTA would benefit them, then they wouldn't, or shouldn't, have approved it. The fact that Mexico, Canada, and the United States all passed the agreement in their respective legislatures shows that there is faith in NAFTA to perform. Faith, however, has little to do with reality, and only through the implementation of NAFTA will its effects become indisputable.

NAFTA is an agreement between Mexico, Canada, and the United States which sets rules and guidelines for the elimination of trade barriers between the member nations for most goods and services originating from within North America. These trade barriers include tariffs (import taxes), import and export laws, and health and safety standards. NAFTA sets timelines for the gradual (up to 15 years for some industries) reduction and elimination of these trade barriers between the members.[1]

Also included in the "NAFTA package" are two side agreements, proposed by President Clinton, to address the two most attacked aspects of the agreement - NAFTA's lack of environmental protection measures, and lack of labor rights provisions. The first side agreement would establish an office in Canada to investigate environmental abuses by any of the three member nations. If a member was not enforcing their environmental laws, they could be fined and sanctioned by the other members, effectively removing that member from the free-trade bloc until they had corrected their problems. The second side agreement would establish an office in the United States to investigate labor abuses in any of the member nations, and also create a smaller office in each country to perform their own investigations. Fines and sanctions could be imposed if a member nation failed to enforce labor safety regulations, child labor laws, or minimum-wage standards.[2]

The agreement additionally establishes a set of rules known as the "Rules of Origin", which state that only goods manufactured using a certain percentage (which varies by industry) of North American materials are eligible for the reduced tariffs. A Japanese auto plant in Mexico using Japanese parts would still pay tariffs if it exported to the United States. If the plant used at least 62.5%[3] Mexican, Canadian, or American parts, its cars would be eligible to pass from Mexico to America duty-free.[4]

NAFTA, by removing trade barriers between Mexico, Canada, and the United States, three nations that are already heavy traders with each other[5][6], will create a free trade bloc with 360 million consumers and a gross domestic product (GDP) of $6.5 trillion. NAFTA and the European Economic Community (EEC) would be roughly the same size, both in population and in GDP[7]. This would almost double the potential market for American goods, and triple Canada's and Mexico's current markets. Industries in the NAFTA countries would be able to expand into, and export to, their neighbors without facing the stiff protectionist tariffs in place before NAFTA. Many industries, in all three member nations, will be able to expand in ways never before possible across North American national boundaries[8].

However, industries once protected by tariffs, such as agriculture and textiles, will be forced to deal with the new international competition. Tariffs allow a nation to tax imports, which raises the price on imported goods, letting more expensive locally-produced goods compete with cheaper imports. Without that protection, industries local to one member nation that are more efficiently or cheaply produced in another will likely be eliminated as cheaper imports are allowed to enter the market[9]. This will create some degree of unavoidable job displacement or unemployment in each member nation, which may or may not be balanced out by the expanding of other industries.

Of the three member nations, Canada will likely go through the least amount of change because of NAFTA. In 1988, Canada and the United States entered into a free- trade agreement (FTA) between those two countries.[10] The US-Canada FTA is essentially similar to NAFTA, although less concrete, allowing interpretation by both countries on what products were and weren't eligible for free trade. Since the installment of the FTA, Canada has lost 15% of its manufacturing jobs, and Canada's economy has been in a recession, with unemployment at 11% in December of 1992.[11] In Canada, NAFTA has not had much popular support[12], but still was signed by former Prime Minister Brian Mulroney and passed by the Canadian Parliament. Canadian manufacturing has blamed the United States' lack of labor unions for industrial moves from Canada to the United States, resulting in a loss of Canadian jobs. Because a lower percentage of Americans workers belong to labor unions than Canadian workers, Canadian manufacturers could move to the US and save on wage costs and taxes.[13] Canada's unemployment problems and its recession, which have roots dating back to the installment of the Canada-US FTA, may have another cause: American business expansion into the Canadian market. An influx of cheaper American imports would account for a fall in Canadian manufacturing and a rise in American manufacturing between 1988 and 1991.[14] For the short time that Canada has been participating in free trade, it does not appear to have benefited from the experience.

In Canada's favor under NAFTA, however, will be the opening of Mexico to duty- free Canadian goods, and to Canadian investment. Canada's annual trade with Mexico is only $2.5 billion, compared to $175 billion in trade with the United States[15], but has a much higher possibility of expansion than does trade with the United States. As NAFTA gets underway, the belief is that Mexico will eventually grow into a richer country, with per capita income increasing, resulting in more buying power by the Mexican population. This expansion in Mexico is where Canada will be able to find new markets for it's products[16]. Canada's exporting to the United States, on the other hand, will likely remain fairly static unless American incomes begin to grow.

Overall, Canada needs NAFTA, and couldn't afford to pass it by. First, any reneging on the original FTA could threaten the United State's current $175 billion annual trade with Canada. Second, if Canada had not agreed to join NAFTA, the United States and Mexico would likely have gone on and codified the agreement between themselves.[17] Canada would not have any holds in Mexico, which is the new market it needs to be able to expand, and the United States would have free reign in North America, being the only nation able to trade freely with both Canada and Mexico. Canada needs these opportunities more than the United States does, and would have severely limited itself by withdrawing from the agreement.

The United States is the big player in NAFTA. The US's annual GDP of $5.9 trillion is almost 20 times larger than Mexico's GDP of $334 billion, and over 10 times larger than Canada's GDP of $552 billion (all 1992).[18] As a result, the US is hoping for a bigger payoff from NAFTA. As opposed to Canada, the US has not fallen into a recession in recent years, and is not trying to make up for recent losses. And unlike Mexico, the US is not hoping to significantly increase its standard of living or its position in the global economy. What the US hopes to gain from NAFTA is increased North American trade with its neighbors.

Much as the United States and Canada have been integrating their economies in recent years, because of the US-Canada FTA, the US and Mexico have also been enjoying increased trade. Some American industries have had factories along the Mexican-US border, called maquiladoras, for a decade or more. These factories, on the Mexican side of the border, hire cheap unskilled Mexican labor for assembling American-made parts into finished products. The resulting goods are then exported back to the United States, tariff free.[19] Even without the maquiladoras, and with Mexico's average 10% tariff on American goods, American exports to Mexico have been expanding with a steady rate over the last 5 years.[20] In many ways, NAFTA will be putting on paper what has been happening between the US and Mexico already.[21]

With the loss of Mexican tariffs, American industry will have an easier time expanding into Mexico. Exporting to Mexico will become cheaper, and American goods will be able to compete with domestic Mexican goods. Because of lower tariffs, both large and small American businesses will have the opportunity to enter Mexico, where it was once too expensive for all but the largest companies to export to Mexico.[22] The US Commerce Department computes hat every $1 billion in exports supports 19,000 American jobs.[23] American exports to Mexico have grown from $26.2 billion in 1988 to an estimated $48.5 billion in 1992[24], therefore creating approximately 420,000 new jobs in the United States since 1988. As trade with Mexico increases, so will American employment.

At the same time, Mexican industries will be fluxing into American markets. American industries that can't compete with the cheaper Mexican-produced goods will be at a disadvantage, and could find themselves out of a domestic market. Undoubtedly there will be some unemployment caused by this, but the actual displacement should be lessened by the successful expansion of other industries into Mexico.

Much of the American criticism of NAFTA has been by labor organizations who fear that American jobs will be lost when American industries relocate in Mexico to take advantage of low labor costs (an average of $3 per hour, compared to America's average of $10)[25], softer environmental regulations, and relaxed labor laws.[26] In reality, American industrial relocation to Mexico will not be as severe as opponents claim. Recently President Salinas of Mexico has pledged to link Mexican wages to productivity, and will raise real wages in Mexico.[27] For most industries, it would be impractical to relocate to Mexico merely to take advantage of cheaper labor, since labor accounts for only 25% of an industry's overhead.[28] In the maquiladoras, employee turnover is between 10 and 20% per month, and well over 100% per year.[28] Taking high turnover, retraining, and other factors into account, George Baker, a consultant to American maquiladoras owners, calculates that total hourly expenditure per employee in a maquiladora can reach $10.[29] In order to build a stable work force, businesses must offer higher-than-minimum wages, and be willing to help their employees in more ways than through wages alone. Housing, schooling, and transportation, all of which are in short supply in Mexico, offered by factories help to keep employees working, and to keep morale high,[30] but come at a high cost to the company. With the passage and implementation of NAFTA and the side agreements, worker safety and labor rights will no longer be able to be compromised by factories like has happened in the maquiladoras, which are world renowned for their atrocious working conditions and waste dumping.[31] American factories have little need to relocate to Mexico for cheap labor. If wages were a significant attraction for industry, nations like Bangladesh and Ethiopia would be sprawling with high-output, low-wage factories.[32]

Two other areas of American expansion into Mexican and Canadian markets will be the ability of American companies to purchase Mexican companies (such as banks and brokerages)[33], and for American services to be involved in Canadian procurement contracts[34]. Both of these areas were previously protected by their nation's trade barriers, but will be opened to the other member nations by NAFTA.

Mexico's place in NAFTA is unique, and it stands to benefit the most from the agreement. As a Third World nation involving itself with two industrialized nations, Mexico is in a position to gain a lot from it's new found trading partners. In opening itself to the United States and Canada specifically, Mexico has established itself as a developing nation that is looking for foreign investment and business. Using the US and Canada as its initial partners, Mexico can first gain a reputation with those two well-known and trusted nations, and then attract other international investment based on positive feedback from them.[35] Mexico's President Salinas is not only looking to Mexico's immediate future, but is also setting up Mexico's economic path for decades to come, if NAFTA behaves as expected.

Much the same as Canada and the United States, under NAFTA Mexico will have access to foreign markets that did not previously exist. Mexican trade with the US has been growing in previous years, but NAFTA should accelerate the process of economic integration by totally removing protectionist trade barriers. In Canada, Mexico can look for even more markets for those goods that it produces cheaply and well. Small Mexican business, though, will be hit hardest by NAFTA. Products that America or Canada can manufacture more efficiently and cheaply than Mexico will compete heavily with domestic products, and smaller Mexican companies will be eliminated if they can't adequately compete. Unfortunately for Mexico, small business accounts for about 90% of all Mexican businesses.[36]

Mexico's economy can expect to grow under NAFTA through increased employment, and through foreign investment. Employment can come from two sources: American and Canadian industries moving to Mexico, and increased exporting from Mexico. Foreign investment will come first from the United States and Canada, and later from other international sources.

Some American and possibly Canadian jobs will move to Mexico. Every report written on NAFTA has said that some job migration is inevitable. Not only low-skill, low-tech jobs, but also mid-range manufacturing jobs will find their way south. Under Salinas' new wage plans[37], however, wages will not be limited by the government as much as they are tied to productivity. Maquiladora-type factories will not survive in free-trade Mexico, but wages might still be artificially kept down in order to attract business.

Much of the wage-limiting done by the government is done in order to limit inflation, which President Salinas has taken a stand very strongly against.[38] As the Mexican economy becomes more stable, rising wages will be less of a threat to the economic well being of the nation. Salinas has already pledged to raise real wages[39] to give labor a head start on NAFTA. But it will be years[40] before Mexican wages really begin to reach American levels. Too fast of an increase will create damaging inflation, while too slow of an increase will doom Mexico to be a Third World nation.

Mexico's other hope from NAFTA is to attract foreign investment. As of 1991, almost two-thirds of Mexico's foreign investment came from the United States. Under NAFTA, the economic policies that President Salinas has pursued will be permanent, making the Mexican economy more stable and therefore attractive to foreign investors[41][42]. Increased investment in Mexico will create more jobs.

Mexico's overall use of NAFTA is twofold. First, NAFTA will widen Mexico's marketplace to include the United States and Canada, two large sources of business and capital. As the trade barriers come down, Mexico will likely lose much of its small business, but will also find new markets for its surviving industries. Mexico will gain production and manufacturing employment from American and Canadian industries, giving work to a highly unemployed nation. Mexican wages will rise, slowly, building up Mexico's per capita income and bolstering the economy.

Second, NAFTA will allow other countries, not only North American, to invest in Mexico with confidence that its economy and trade policy will remain relatively stable despite any possible political changes. This investment will in turn create more jobs in Mexico, and help the Mexican economy to grow.

The effects of NAFTA will neither be quick nor remarkable for any of the member nations. Trade barriers will not be completely eliminated in all industries until 2009, although most will end over the next 10 years. Over a time period of perhaps 30 years, real progress will begin to be made. NAFTA will not be a quick remedy for the ailing Canadian economy, nor a rocket for Mexico's slow economy. Over time, though, all three members' economies should benefit from the creation of NAFTA.

In Mexico, NAFTA will cause Mexican labor to get a long-awaited wage raise, and a pay-for-productivity plan from the government. Jobs will be lost to incoming foreign competition, but also gained by foreign demand for Mexican goods and labor. Other nations will no longer be as reluctant to invest in Mexico, since its economic changes are not limited to one president or political party's term of office, but instead by a pact with the United States and Canada. Slowly, the growing Mexican labor force should see a gain in per capita income, and the Mexican economy will grow.

With the growing of Mexico's economy and buying power, American and Canadian industry will benefit from the growing market for their goods. In the meantime, they can take advantage of Mexico's lower wages to move some industry south. The United States and Canada will have to deal with the immediate loss of some employment to Mexico, with the knowledge that more jobs will be created as Mexico begins to import more. In order for this to happen, the United States and Canada must support wage increases and labor rights in Mexico, or the Mexican economy will never grow large enough to handle what America and Canada want it to. The worst thing the US and Canada could do is to treat Mexico as merely a cheap source of labor, and to keep wages down and the standard of living low. Canadian and American business needs growth in Mexico much more than it needs cheap labor. Without Mexican growth, they will have no new markets except with each other.

NAFTA will depend on the cooperation of politics and economics from all three member nations in order to survive. Without thinking in terms of the long run, past the year 2000, hasty decisions will doom the agreement, and Mexico, to inadequacy. As a possible model for other nations, NAFTA is not perfect, but it is a good step in the right direction.

Tyler Jones, December 4, 1993