The North American Free Trade Agreement (NAFTA) created one of the world’s leading free trade areas, comprising the United States, Canada and Mexico, which together account for 28% of global GDP.¹ NAFTA recognized existing trade patterns and facilitated the growth of new ones. Geopolitical strategic factors were also priorities of its proponents during the late 1980s and early 1990s. However, the agreement’s longevity and the evolution of political and economic factors since its 1994 enactment recently prompted leaders of its member countries to clarify their vision for its future.

In this article, we provide a historical perspective on NAFTA’s origins and objectives, present details of current trade patterns among NAFTA countries and highlight various changes that have been agreed to in its update as the U.S.-Mexico-Canada Agreement (USMCA) in 2018.

NAFTA’s Origins

As early as 1854, the U.S. and Canada saw merit in facilitating bilateral cross-border trade. The nations signed a Reciprocity Treaty that relaxed barriers to the flow of Canadian natural resources into the United States. The U.S. ended this arrangement in 1865 following suspicions of Canadian support for the Confederacy during the Civil War. Although several attempts were made in both countries to reinstate free trade policies during the late 19th and early 20th centuries, none were successful. Only the 1934 Reciprocal Trade Agreements Act, passed to incrementally alleviate tariffs raised by the 1930 Smoot-Hawley Act, provided a measure of bilateral tariff reduction between the U.S. and Canada over the next century.²

In recognition of the geographical integration of the automotive industry, principally in the Great Lakes region, the U.S. and Canada agreed to the 1965 Auto Pact, which allowed for duty-free movement of auto parts and some motor vehicles between the two countries. Two decades later in 1986, Canada’s Conservative Mulroney government and the U.S. Republican Reagan administration began negotiating the Canada-U.S. Free Trade Agreement (CUSFTA), which was signed on January 2, 1988, and then ratified by the Canadian Parliament and U.S Congress.³

CUSFTA was the forerunner to NAFTA. Mexico’s participation had roots in several early trade liberalization initiatives. For example, the U.S. implemented the Border Industrialization Program (BIP) in 1965, which allowed manufacturers in Mexico near the U.S. southern border to import materials duty-free and then to assemble or process and export finished goods.⁴ These border factories became known as maquiladoras, the Spanish term for “miller.” One of the main drivers of the BIP was to alleviate unemployment and poverty along the U.S.-Mexico border; however, U.S. manufacturers quickly discovered labor cost efficiencies there and established affiliates in northern Mexico.

After CUSFTA, negotiations began for the addition of Mexico to the trading bloc and continued until 1992. NAFTA was signed on December 17, 1992, by leaders of the three countries – Brian Mulroney, George H.W. Bush and Carlos Salinas de Gortari – and ultimately went into effect on January 1, 1994. But first, NAFTA had to be ratified by all three nations, including both houses of the U.S. Congress.

Support for the agreement was far from universal, and within NAFTA one can observe an emergence of mobilized coalitions in the U.S. both for and against the expansion of free trade. Earlier U.S. trade liberalization efforts enjoyed broad bipartisan support. For example, the AFL-CIO supported President Kennedy’s 1962 Trade Expansion Act, viewing it as a way to create jobs by expanding trade.⁵ By the early 1990s, however, a general economic downturn and years of job losses in the U.S. manufacturing sector began to erode the free trade consensus.

Key opponents emerged during the 1992 U.S. presidential campaign and amplified NAFTA into a central issue. These included candidates on the right – such as Patrick Buchanan, who opposed NAFTA and ran a primary challenge against then-President George H.W. Bush – successfully garnering over 20% of the vote across a geographically diverse group of states.⁶ On the left, environmental, labor (including the AFL-CIO) and other grassroots activists (such as Ralph Nader’s Public Citizen organization) began voicing their opposition to NAFTA as early as 1990, citing what they viewed as weak environmental and labor standards in Mexico.⁷ Rounding out the opposition to NAFTA from across the political spectrum was independent candidate H. Ross Perot, who made the economy and immigration central planks of his platform.

Principal supporters of NAFTA at the time were Republican incumbent George H.W. Bush and Democratic candidate Bill Clinton. The Bush administration had, like its Reagan predecessors, shepherded free trade agreements over the course of several years, including NAFTA and, concurrently, the Uruguay Round negotiations of the General Agreement on Tariffs and Trade (GATT), which led to the 1995 creation of the World Trade Organization (WTO). The U.S. business community was solidly behind NAFTA passage, and leading the charge was USA-NAFTA – a coalition of 2,300 businesses that sent leaders into congressional districts to advocate NAFTA passage ahead of congressional votes on the pact in fall 1993.⁸ Overall, it is estimated that U.S. companies spent over $17 million on advertising and lobbying in favor of NAFTA’s passage.⁹

Candidate Clinton’s support for NAFTA in 1992, however, was nuanced. His endorsement of the pact – just one month prior to his election as president – included conditions that the final agreement should contain worker adjustment assistance, tighter environmental rules and the creation of a joint commission to improve labor standards and safety in Mexico.¹⁰ Meanwhile, Bush administration negotiators, led by U.S. Trade Representative (USTR) Carla Hills, secured key provisions to NAFTA in 1992 with a goal of easing its impact and building broad-based support. Tariffs on Mexican exports of agricultural products into the U.S. would be phased out over a 15-year period, rather than immediately. Further, rules of origin standards, which stipulate that a minimum percentage of a product’s contents must originate from the NAFTA countries in order to qualify for tariff-free trade within the bloc, were added to prevent other countries from using Mexico or Canada as a tariff-free export platform into the U.S.¹¹

President Clinton’s USTR Mickey Kantor, ahead of the fall 1993 congressional vote on NAFTA, added to his predecessor’s list of exceptions to broaden support for the pact. A 1993 NAFTA side agreement established a three-nation panel to investigate violations of national environmental laws. A similar panel designed to enforce national labor laws and to force wage increases in Mexico, however, was not agreed to. Lastly, Kantor negotiated sector-based deals to shelter U.S. agriculture producers from an immediate wave of imports, accelerate Mexican tariff reduction on U.S. appliance exports and seek a longer period for the elimination of textile and apparel quotas in the Uruguay Round negotiations.¹²

A combination of Republican support and concessions reached through NAFTA side agreements enabled Clinton to achieve passage of NAFTA by the Democratic-majority U.S. House of Representatives on November 7, 1993, by a margin of 234 to 199. Just 102 of the 258 Democrats in the House voted for NAFTA, while 132 of the 175 Republican members voted in favor of passage^.13 This represents the last time a free trade agreement has been ratified without significant Republican Party opposition. Senate passage was achieved on November 20, 1993, by a vote of 61 to 38, with support from a majority of senators from both parties.

The nearby maps show the degree to which each state’s congressional delegation supported NAFTA ratification in 1993 as well as the importance of NAFTA as a destination for each state’s exports in 1993 and 2017. In observing the percentage of each congressional delegation’s (defined as all U.S. House and Senate members representing the state) support of NAFTA, compared with each state’s percentage of total exports that went to Canada and Mexico in 1993, one can observe the following:

• Congressional delegations generally voted in line with the economic interests of their states – that is, those from states that sent a large portion of their total exports to Canada and Mexico in 1993 strongly supported NAFTA. The opposite was true for states that sent few exports to these countries.
• Notable exceptions were coastal and border states Florida, Louisiana, New Mexico and Washington, whose representatives strongly supported NAFTA, despite their sending a relatively small share of exports to Canada and Mexico at the time. Perhaps these states’ representatives saw an opportunity in greater economic integration through NAFTA?
• Another exception can be observed with border states Michigan and North Dakota, whose congressional delegations strongly opposed NAFTA, despite Canada and Mexico being a significant market for their exports. Perhaps these representatives were concerned by potential threats posed by NAFTA?

In observing the change in percentage of exports going to Canada and Mexico between 1993 and 2017, one can see that half (25 of the 50 states) have seen an increasing share of exports going to these two countries since NAFTA. Twenty-two states have sent a decreasing share of exports to Canada and Mexico, and the remaining three have seen no change. Predictably, though, most of the states registering double-digit increases in the share of exports going to Canada and Mexico were border states such as Alaska, Arizona, New Mexico, North Dakota and South Dakota.

In a sign of shifting public moods and political priorities, later attempts to add Chile to NAFTA and to create the Free Trade Area of the Americas (FTAA) throughout the Western Hemisphere were both scuttled. In a further blow to trade liberalization, Congress revoked the president’s “fast-track” authority to negotiate trade agreements from 1994 to 2002 and 2007 to 2015.¹⁴ Congress, in July 2018, allowed what is now known as the president’s trade promotion authority (TPA) to remain in place until July 1, 2021.

An Illustration of Current Trade Patterns Among NAFTA Countries

It is difficult to overstate the significance of interregional trade among the NAFTA countries, which constitute $1 trillion in trade annually. In fact, Canada was the largest bilateral trading partner of the U.S. until 2015, when it was surpassed by China. As the nearby table illustrates, the NAFTA countries have a well-integrated trading relationship, particularly as it pertains to the U.S. as a destination for Canada’s and Mexico’s exports. Both Canada and Mexico source approximately half of their imports from the U.S., and the U.S. is the destination for 76% of Canada’s total exports and 81% of Mexico’s. The nearby charts also illustrate that NAFTA trade is concentrated in manufacturing vs. the import/export of raw materials or intermediate goods.

In terms of current U.S. imports from Canada, transportation (autos, aircraft, railcars and ships) is the leading sector at $64 billion in goods, with coal, oil and natural gas following closely behind at $57 billion. Since NAFTA’s enactment, however, oil and gas imports have doubled as a portion of total exports by 33%, while transportation (primarily autos) and lumber have dropped in share by 33% and 50%, respectively.

With respect to current U.S. imports from Mexico, the machinery, appliances and electronics sector and transportation (primarily autos) sector combined comprise 64% of the total, at $112 billion and $75 billion, respectively. Agricultural products represent a very small share of U.S. imports from both Mexico and Canada (at around 5% of total exports from each country). Significant changes in U.S. imports from Mexico since NAFTA are twofold. First, U.S. oil and gas imports from Mexico are today one-quarter of the share of total imports that they were in 1993. Second, appliances and transportation (autos) have grown significantly as a share of imports, reflecting Mexico’s growth as a manufacturing center for re-export to the U.S. under NAFTA.

For current U.S. exports to Canada, the leading categories are industrial machinery at $64 billion, transportation (autos and aircraft) at $50 billion and chemicals, plastics and fertilizers at $37 billion. In relative terms, industrial machinery and transportation have both fallen as a share of total exports since 1993, while chemicals, plastics and fertilizer as well as oil and gas have increased as a share of the total. Iron and steel exports are largely unchanged, with Canada as the leading importer of U.S. steel, at just over 2 million metric tons, or 59% of all U.S. steel exports in 2016.¹⁵

With respect to current U.S. exports to Mexico, the same sectors are leaders as with Canada (industrial machinery at $82 billion, transportation at $23 billion and chemicals, plastics and fertilizer at $33 billion). Oil and gas as well as iron and steel have increased as a share of total U.S exports to Mexico since 1993, and agriculture exports have fallen slightly. Mexico remains the second largest export market for U.S. steel at 2 million metric tons, or 38% of all U.S. steel exports in 2016.¹⁶

Key Objectives of NAFTA Renegotiation

The U.S., Canada and Mexico announced their intention to renegotiate NAFTA in 2017. On October 1, 2018, leaders of the three countries agreed on a revised pact to be known as the USMCA going forward. Following, we highlight key priorities that each country prioritized during the renegotiation process.

The USTR identified in 2017 more than 100 items to be addressed in NAFTA renegotiation.¹⁷ Chief among these was the rules of origin threshold, which exempted automobiles from cross-border tariffs if 62.5% of their content was from the U.S., Canada or Mexico. The U.S. sought to increase this threshold in order to promote U.S. manufacturing and to restrict the prevalence of parts originating from non-NAFTA countries in autos it imports from Canada and Mexico.¹⁸

Given their relative dependence on the U.S. as an export destination, Canada and Mexico (who send 76% and 81% of their exports to the U.S., respectively), largely sought to maintain the status quo. Both countries pushed back on significant changes proposed by the U.S. during negotiations. One such example was the U.S. proposal to eliminate Chapter 19, which gives countries the right to challenge each others’ anti-dumping and countervailing duty decisions in front of an expert panel with members from both countries. Historically, Canada has had a positive track record in Chapter 19 disputes involving softwood lumber.¹⁹

Highlights of the New USMCA Agreement

The new USMCA does not represent a wholesale change from NAFTA, despite its new name. Notably, Canada and Mexico prevented some of the more profound changes proposed by the U.S., including elimination of the Chapter 19 dispute resolution process and the establishment of a five-year sunset clause (a 16-year sunset was agreed to). The new agreement further manages trade in automobiles and auto parts (the leading sector of trade among the three countries), increasing the rules of origin threshold from 62.5% to 75% and that 40% of auto content be made by workers making at least $16 per hour.²⁰

These changes, however, raise more questions than they answer. What are the relative compliance costs of higher rules of origin thresholds, and how will compliance be effectively enforced? And will a $16 wage threshold bring auto manufacturing jobs back to the U.S., while also increasing Mexican wages? Only time will tell.

Even the significance of one of Canada’s biggest concessions under USMCA, further opening of its dairy sector, is circumspect. Today, the U.S. exports $427 million in dairy products to Canada annually.²¹ This is just 4% of the total $12 billion in agriculture products that the U.S. exports to Canada, and agriculture in total constitutes less than 5% of U.S. exports to Canada. Moreover, the U.S. currently sends over half of the dairy products that Canada already imports today. As such it is difficult to see this provision of USMCA having a profound impact beyond concentrated groups of dairy farmers on either side of the border.

The prior issue of the Commodity Markets Update addressed the recent Section 232 U.S. tariffs on imported steel and aluminum.²² Since then, the Trump administration has threatened to apply similar tariffs on automobile and auto parts imports on Section 232 (national security) grounds. While the steel and aluminum tariffs remain in place under USMCA (for the time being), side agreements were achieved that largely protect Mexico and Canada from future auto and auto parts tariffs applied under Section 232.

Some key parts of USMCA are the first provisions of their kind in any free trade agreement, addressing new issues that will undoubtedly be part of future trade negotiations:

• Pharmaceuticals: Biologic pharmaceutical products are given an extended period (of 10 years) for exclusive patent protection from generic facsimiles.
• Data Flows: Individual companies’ data flows across borders remain unrestricted, and national governments may not require a company to locate its data storage or computer infrastructure in a country as a condition of doing business there.
• Data Protection: National governments’ ability to require disclosure of individual companies’ source code and algorithms is limited, benefiting digital suppliers.
• Arbitration: Should companies investing in Mexico (e.g., oil and gas producers) become involved in a dispute with the Mexican government, they may seek resolution through an international arbitration panel, outside Mexico’s court system.
• Currency Manipulation: USMCA member countries are required to refrain from competitive currency devaluations.
• Online Commerce: Canada will now allow for cross-border duty-free shipments of up to CA$150, and Mexico will allow the same for up to $117 of value, which will likely benefit online retailers and small and medium-sized businesses.

In closing, the next few months will likely see a flurry of USMCA-related activity as the leaders of U.S., Canada and Mexico meet to sign the agreement and subsequently work to ensure its ratification by the respective legislative bodies of the three member countries.