Putting NAFTA into context
NAFTA has always been a hot topic in Americans elections since inception. However, such a discussion is not isolated, but a global phenomenon. For me, it is essentially the age-old struggle of ideologies -between Globalization and Regionalism, between Collectivism and Individualism. To understand the complexity of the issue, let us start with what is free trade.
Free Trade Agreements (FTA)
Whenever someone says “Trade” or “Trade agreement,” what comes to my mind is the massive trade Federation vessels from Star Wars and how it was used to invade the planets in the republic. It could also be because I am an Indian and British East India company used the same technique to colonize India. Adding the word “free” in front of it does not ease the uncomfortableness either. In my mind, trade agreement benefits only one party while free trade benefits all the parties involved. The smarter side wins in the long run. However, what does the free trade even mean?
In an open market world, the local industries and their products must compete not only with the local competitors but also with the international ones who constantly try to penetrate the market. In such cases, the government imposes tariffs and regulatory barriers on these imported goods to protect the domestic industry.
Free trade agreements eliminate such tariffs and barriers, allow fair competition and cross border movement of goods and services and increase investment opportunities (North American Free Trade Agreement , ). Free trade agreement essentially merges markets under different jurisdiction, different monetary and fiscal policy into one large super market space. Value, wealth, and prosperity for all. It is truly every globalists dream! A borderless world! NAFTA, European Economic Area, and Mercosur are three such examples and huge markets in the world.
NAFTA and the American dream
The North American Free Trade Agreement (NAFTA) came into effect in 1994, creating one of the world’s largest free trade zones and was signed between Canada, United States, and Mexico. It has shown that how free trade agreements could lay the foundations for strong economic growth and prosperity for the member states. However, there are many theories about the formation of this treaty.
First and foremost is the mutual benefits and improving the wealth, which is a given. More than that, second, NAFTA is a geopolitical strategy by the US to secure its neighborhood by forming strong alliances with the neighboring countries on both the fronts. By sharing some wealth with Mexico and improving their standard of living, the criminal influx from Mexico into the US would also reduce. Finally, US gets access to cheap oil in Mexico and Canada.
The Needs of the many outweigh the Needs of the few
Trade Agreements always spark controversy and divide the society. One side supports the trade agreements and the benefits it brings to the community in terms of revenue and employment, while others complain of unemployment. The “needs of the many outweigh the needs of the few” is the typical stance that people who support such agreements take. Regardless of which side one might take, the question is who are the many here and who are the few? Who gets let out and who stands to gain?
Formation of European Economic Area saw many winners (I am talking about you Germany) among the member countries whose cultures and monetary policies were already aligned with the idea. Others like Greece suffered from the alliance. Globalization ends up creating an intertwined and interdependent network of stakeholders across the borders. In the end, all the parties are in a gridlock that no one can back out without losing millions of dollars of investments and revenue.
Take the example of NAFTA. Mexico is the biggest export market for US gasoline and oil (Parraga, 2017), and Canada is the largest purchaser of US exports (Bottoni, 2017) with employment and GDP boosting in all three countries. Canada already had an FTA in effect with the US, even before NAFTA. It is hard to know how much of that growth can be attributed to factors such as interest rates and the strength of the Canadian dollar, let alone the direct effect of NAFTA or the U.S.-Canada FTA (Brownell, 2017).
The members continually blamed each other from the very beginning of the treaty on various important subjects as listed below.
Anti-dumping duties are tariffs set by the government to protect their domestic industries. While ideally, such kind of duties are against the idea of free-trade agreements, some of them still exist between NAFTA members, which had recently resulted in many controversies.
For example, Canada sets tariffs to protect its dairy, egg and poultry industries (Controlled Products, n.d.)against foreign competition from countries such as U.S, New Zealand and Australia (Bottoni, 2017) giving an unfair advantage to Canadian dairy and eventually threatening the American dairy industry (Hauck, 2017). U.S has threatened to escalate this issue further to WTO as it feels such tariffs are a violation of trade laws. High tax rates on Tobacco products in Canada can be interpreted as a measure to make the market unattractive for foreign corporations.
On the other hand, U.S imposed duties on Canadian soft lumber imports in the similar manner, which brings us to the next issue.
Chapter 11, Chapter 19 and the Independent Dispute-Settlement process
An independent panel has been setup as per Chapter 19 in the original NAFTA agreement as a mechanism to provide an alternative to judicial review by domestic courts of final determinations in antidumping and countervailing duty cases (Overview of the Dispute Settlement Provisions, n.d.). This panel ruled against the US imposed duties on Canadian softwood lumber. However, US (out of bitterness of failure?) claims that such an independent commission is a violation of its sovereignty and wants to handle such issues in US courts.
Chapter 11 on the other hand, allows corporations or individuals to sue a government of a member of NAFTA for compensation and violation of international laws (Overview of the Dispute Settlement Provisions, n.d.). The cases of Metalclad Corporation and Mexico, and Methanex Corporation and the US played in favor of US government and its interests.
Worth noting that lawyers have been pleased with the NAFTA agreement. Gus Van Harten, a professor at York University’s Osgoode Hall law school, who has studied this dispute settlement process said at least US$2 billion had been spent on legal and arbitration fees in investor-state disputes worldwide since the late 1990s (Brownell, 2017).
Meanwhile, the subsidized corn from the US further impoverished the already poor corn farmers in Mexico (Lederman, 2004). Mexico retaliated by exporting subsidized sugar to the US and slapped high duties on high-fructose corn syrup from US (Adriana Barrera, 2017). There have been some new rays of hope in this direction, with recent agreements between the governments on this matter (Adriana Barrera, 2017).
The US and Canadian softwood lumber industries have been competing for years. US claims that Canadian government subsidizes the industry and gives them an unfair advantage over US softwood lumber in North American market. However, the low price of Canadian softwood is the result of low stumpage rates and transportation costs. Stumpage rates in Canada are lower as the forest lands that are leased for lumber harvest are mainly owned by the government. Meanwhile, in the US, the forest lands are owned by private parties, and the market dictates the price (Top facts to understand about the softwood lumber dispute, n.d.).
Canada protects its finance and telecommunication industries under strong regulatory frameworks. Such a system is advantageous for the domestic corporations. The same regulatory framework shielded Canadian banks from the 2008 financial crisis to an extended. However, it might also lead to monopoly, poor competition and in the end, inferior quality compared to rest of the world. Similarly, Ontario Beer lost to US brands when the US used national security provision to counter the trade. Canadian aluminum is the next possible target.
The imports in the US were $2.7 trillion, and the exports were only $2.2 trillion (Amadeo, 2017). The imports are high may be because the product or service might be cheap to make at the trading partner’s country than in the US, or they do not need what America is good a making or may be that they make more of what America wants. The trade deficit of $11 billion and $63 billion with Canada and Mexico respectively. This imbalance could have arisen from the difference in the soft wood lumber, dairy, automobile, and aerospace trade between Canada and US.
One study suggests that reduction in various barriers as mentioned above could increase the GDP of the member countries (Lester, n.d.). The argument is that the economies of scale would improve as cost incurred by companies to fit their product into different regulatory frameworks of various countries would disappear. For e.g. the pharmaceutical companies might have to retest and go through very similar procedures in every country they try to deploy their products. Automobile safety regulations are another example. The consumers end up paying different prices for the same product in the various countries. Hence reaching a mutual understanding on such issues are important to harness the benefits of an FTA (Non-Tariff Barriers and Regulatory Issues, n.d.).
There are many forces at play here that make the situation so complicated. In the real world, not all parties can be the winners. Some compromises must be made at the expense of a “few.”
Compromise (or a threat?)
The sale of new C series Bombardier aircraft in the US is limited by the higher tariffs that make it difficult for Bombardier to compete with Boeing. As such blockades make the already debt-ridden Bombardier suffer more, Canadian government offered a compromise (or threat). If Bombardier can compete in the US, then Canada would continue with the deals to buy Boeing fighter jets (Canada links fighter jet deal to Boeing’s dumping claims, 2017). Bombardier gets to break into the US market and gets some orders, while Boeing gets to sell some expensive hardware.
The Populist Agenda and Reciprocity
One of the main election arguments by the Trump’s group was that America had taken a step back on the world stage and let the allies abuse its resourcefulness. Apparently, US is not able to strong arm its allies into doing things like agreeing on currency rates (gold standards from the 20th century) and going to wage wars (well, most of them from the 20th century). In my opinion, it just showed rest of the world has become matured enough to look after themselves and doesn’t need the help anymore.
In the Trump Administration’s opinion, they would like to bring “America First” (When did they put America over the others?) again and make America great again by being the lesser of two evils for its allies. One of the ideas was to limit the entire supply chain to the US itself, isolating itself from rest of the world and then push the American goods to its trading partners to reverse the trade surplus.
China had been doing this for so long by limited access to its market but at the same time having excessive trade surpluses with its trading partners. China raised tariffs on foreign goods (for e.g. foreign cars are costly in China), subsidized and funded its local industries heavily (remember how Uber had to turn back from China) and used regulations to cut external access (financial and information markets). In an ideal world, trading partners should have reciprocity – equal access and the opportunity to each other’s markets.
The Trump Administration wish to access the markets of its trading partners by forcing them to cut down protective barriers on their imports. At the same time protect American markets from imports. By restricting the supply chain inside the US, it reduces the dependency on other countries for services and goods, and hence reduce the trade surplus.
Rule of Origin
The Rule of Origin clause in NAFTA gives its members undue advantage of lower tariffs that protect the member countries from foreign competition (North American Free Trade Agreement (NAFTA) – Rules of Origin, n.d.). The Rule of Origin clause along with cheap labor cost, free trade accords with dozens of nations had made Mexico a favorable location for American automobile manufacturers (Angulo, 2017).
The renewed “reciprocity” rules would mean losing the “Rule of Origin” advantage. Such measures would drastically affect the Canadian and Mexican border provincial economy, as they are heavily dependent on cross border exchange of goods and services.
The “America First” policy is expected to bring jobs and wealth back to the US. This is one of the reasons why the idea of supply chain restriction and changes in reciprocity seen as favorable in the US. However, what the most supporters do not realize is that even though supply chain restriction gives an advantage to an extent, it does not help American goods compete with labor costs in Asia. That is why industrial robotics has become more important now for cost leadership. Ultimately, it will result in the currently employed workers in Canada and Mexico losing their jobs, and no similar jobs will be created in the US as well (Semuels, 2015). Only the corporations are to gain from this exercise. Unemployment leads to economic and social unrest and fails the American notion of “secure neighborhood” through FTAs.
One thing I liked about the Trump campaign was that he brought issues like soft wood lumber, coal, and jobs losses due to international trade to the mainstream. It was always someone else’s problem in the past, but now it is everyone’s, thanks to Trump’s lack of political correctness. In many parts of US, especially the states in the Rust, NAFTA is a potent political symbol. Most of the job losses in Tennessee have been attributed to NAFTA (NAFTA job losses: Tennessee No. 3, 2011). For the people affected, they had a life changed drastically after NAFTA. These were entirely unexpected consequences.
On the other hand, the regional protectionism in NAFTA meant that manufacturing would become cheaper if done in this region. Foreign automobile manufacturers such as Volkswagen (in Tennessee!) moved their plants to NAFTA region adding more value to the existing ecosystem and creating more jobs in the process (Guillén, 2017). This process, of both creating new jobs and destroying others, is called “creative destruction,” and it is a fundamental aspect of a market economy. The same process has taken place in many other manufacturing industries, from aerospace to furniture, electronics, and toys. Moreover, the job losses could also be due to increased automation. In fact, making NAFTA less attractive through changes in trade reciprocity would only create more unemployment (Harrington, 2016).
The businesses are deeply divided on the matter. On the one hand, cost reduction from offshoring and on the other hand cost reduction from subsidies and automation. The degree of uncertainty has made them as confused as a crab who managed to cross till the middle of a busy highway.
The Canadian Prime Minister and Mexican President had a bad start Trump administration. Prime Minister Trudeau was deemed to be “Anti-Trump” from the very beginning. The Mexican President Enrique Peña Nieto and Trump have had disagreements over the wall between Mexico and US. All the three leaders had solid reasons to take their positions other than the ideological differences. Trump has to show who is the boss, Mexican President and Canadian Prime Minister had to improve their approval ratings before the upcoming elections. So Trump administration might use the urgency of the situation to pressure Mexico and Canada to negotiate the treaty by December.
The interest rate is one of the tools used to stimulate economy and control wages using monetary policies. In theory, if the capital cost is reduced to zero, people will have to compete with machines directly. This is where the subsidized capital competes with labor. The effectiveness of using tools such as interest rate in monetary policies will reduce to nothing in the presence of subsidies. Without such tools, the central bank cannot control and protect its economy. Besides, subsidies fail the idea of free trade and fair competition.
Similarly, in international trade, if the exports of a country are being threatened, then they will not be able to pay for the imports as well. So, closing doors in one direction will not necessarily help in bringing balance to trade deficits. Hence the new American protectionist policies can only do more harm than good.
The Game Changers – Future of NAFTA
Ripping the agreement
President Trump’s claimed during his election campaign that he would rip the trade agreement. Even though he signs an order, it must go through the congress and will take years to get approved and phase out finally. So, it will mean effectively ripping the agreement very slowly. Also, the bureaucratic inertia can slow down the process even more. So Trump’s ripping argument is not as easy as it sounds on tweets.
A Non-Traditional Negotiation Approach
The three countries agreed to renegotiate the agreement with the first round set for August (NAFTA Negotiations 1st Round Set For August, 2017). How the various forces that we discussed in this article would play out is to be seen. Also, given the degree of uncertainty of Trump administration, things can change drastically in a weeks’ time. An entirely new approach is required. Trump survived bankruptcies, marriages, a brutal election campaign and attacks from the liberal media. He will survive this as well. Traditional tactics may not work with his administration.
The promise of Shale Oil
The American shale oil discovery and production have a revolutionary effect on its economy. The Trump administration had been rebranding the US as an energy exporter as a geopolitical strategy (Gardner, 2017). The increased production will not only help reduce the trade deficits but also promote more on shoring through cheap power and raw materials.
However, the most important issue of all is the public dissent generated over the job losses created by trade agreements, competition, and disruptive technologies. As discussed earlier, this dissent was never given much attention beyond election campaigns and results in brewing up in the form of violence and intolerance. The trade agreements should consider this matter when the deals are being made. The problem is that there is no way to foresee job losses. In many instances, it difficult to prove that the trade agreement is the sole cause of unemployment.
In Denmark, the displaced workers are provided with a lump sum to start a new life and ease the transition. Such trade adjustment assistance programs and other social compensatory measures do not work exactly for the reason that FTA cannot always be blamed. In the case of US, people are tied closely to services in the locality like healthcare and education. They do not prefer moving even though there are no prospects of employment in the current location anymore.
Governments should get to grassroots and try to reduce the dependency on the exports related industries by cross training and to look for new markets. In this way, the population can be prepared for technology and market disruptions.
Compromises and trade-offs have been discussed to buy American in exchange for Canadian or Mexican goods, which was never the part of the trade agreement itself. Anti-dumping and subsidies continue all sides without checks. The uncertainty has pushed members to look for new trading partners.
Canada has been trying for a long time to come out from the shadow of US and take its position in the world. It has been negotiating the TPP with Mexico and various partners (without the US) to put pressure on the US indirectly. It has also been in talks with India, China, Ireland and EU on various free trade agreements. By diversify the trade, Canada and Mexico look to minimize the risk trade loss if US falls apart from NAFTA. US continues talks with UK, EU and Saudi Arabia for more cooperation on trade.
Meanwhile, the NAFTA members follow various hostile strategies to put pressure on each other -restrict imports, raise the tariff on digital payments and information technology which was not part of the original trade agreement. The takeover of Norsat in Canada by a China-based firm could also be one such strategy to put pressure on US (Francis, 2017).
6. Data Regulations
Data regulation and information privacy is not part of these trade agreements. Trade agreements are commercial arrangements that are market-based. The changes in data-based services and products were little known when the NAFTA was signed. Increased digitization means using and processing personal data has become part of many companies’ daily routine. However, many countries have put restrictions on the free flow of data, with privacy, security, surveillance and protectionism core reasons for these restrictive measures (Industry Trend Analysis – Free Trade Agreements Must Also Consider Free Data Flows, 2017).
The data and information exchange could become a significant influence on NAFTA negotiations as multi-national corporations in Silicon Valley feed on it. It is also important to Toronto as it rises to worlds capital for artificial intelligence research.
Conflicts fail the very purpose of having an FTA in the first place. The advocates of FTA might feel a little heartbroken as such a utopia where countries open their borders to people, goods and services flow freely, and everything is fair and balanced might never exist at all. The world is reshaping itself under new trade agreements, under both balanced and unbalanced ones. Globalism continues to struggle against protectionism and “bloc” formations that resemble Cold War era. The wars for commodities are taking a new shape.
( The discussion in this article is heavily influenced by a talk I attended, conducted by the Globe and Mail in Toronto)
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