What Is the North American Free Trade Agreement?

What Does NAFTA Do?

NAFTA definition
NAFTA lowers grocery prices. Photo: Getty Images

The North American Free Trade Agreement is a treaty between Canada, Mexico and the United States. That makes NAFTA the world’s largest free trade agreement. The gross domestic product of its three members is more than $20 trillion. NAFTA is the first time two developed nations signed a trade agreement with an emerging market country. 

The three signatories agreed to remove trade barriers between them.

 By eliminating tariffs, NAFTA increases investment opportunities. The NAFTA agreement is 2,000 pages, with eight sections and 22 chapters. 

On January 23, 2017, President Donald Trump signed an executive order to renegotiate NAFTA. He wants Mexico to cut its value-added tax and end the maquiladora program. Trump prefers bilateral trade agreements to multilateral ones

NAFTA's pros and cons are hotly debated. Critics point to three main disadvantages of NAFTA. First, it sent many U.S. manufacturing jobs to lower-cost Mexico. Second, workers who kept jobs in those industries had to accept lower wages. Third, Mexico's workers suffered exploitation in its maquiladora programs.

But NAFTA  also has three significant advantages. U.S. grocery prices would be higher without tariff-free imports from Mexico. Imported oil from both Canada and Mexico has prevented higher gas prices. NAFTA has also increased trade and economic growth for all three countries.

 

What Does NAFTA Do?

First, NAFTA grants the most-favored-nation status to all co-signers. That means countries must give all parties equal treatment. That includes foreign direct investment. They cannot give better treatment to domestic investors than foreign ones. They can't offer a better deal to investors from non-NAFTA countries.

 Governments must also offer federal contracts to businesses in all three NAFTA countries. 

Second, NAFTA eliminates tariffs on imports and exports between the three countries. Tariffs are taxes used to make foreign goods more expensive. NAFTA created specific rules to regulate trade in farm products, automobiles and clothing. These also apply to some services, such as telecommunications and finance.

Third, exporters must get Certificates of Origin to waive tariffs. That means the export must originate in the United States, Canada or Mexico. A product made in Peru but shipped from Mexico will still pay a duty when it enters the United States or Canada. 

Fourth, NAFTA establishes procedures to resolve trade disputes. Chapter 52 protects businesses from unfair practices. The NAFTA Secretariat facilitates an informal resolution between the parties. If this doesn't work, it establishes a panel to review the dispute. That helps all parties to avoid costly lawsuits in local courts. It helps the parties interpret NAFTA’s complex rules and procedures. These trade dispute protections apply to investors as well. 

Fifth, all NAFTA countries must respect patents, trademarks, and copyrights. At the same time, the agreement ensures that these intellectual property rights don’t interfere with trade.

Sixth, the agreement allows business travelers easy access throughout all three countries. 

NAFTA has two other agreements that update the original. The North American Agreement on Environmental Cooperation supports the enforcement of environmental laws. The North American Agreement on Labor Cooperation protects working conditions.

How NAFTA Affects the U.S. Economy

NAFTA increased the competitiveness of the these three countries in the global marketplace. It allows them to better compete with China and the European Union. In 2007, the EU replaced the United States as the world's largest economy. In 2015, China replaced both.

It took three U.S. presidents to put NAFTA together. President Ronald Reagan kicked it off during his campaign in 1980. He wanted to unify the North American market to better compete with the EU.

 

In 1984, Congress passed the Trade and Tariff Act. That gave the president "fast-track" authority to negotiate free trade agreements. It permits Congress only the ability to approve or disapprove. Congress can't change negotiating points. Otherwise, countries would never concede valuable trade privileges.

In 1992, President George H.W. Bush signed NAFTA after he took office. It then went back to the legislatures of all three countries for ratification.

In 1993, President Bill Clinton signed it. NAFTA became law January 1, 1994. For more, see History and Purpose of NAFTA.

NAFTA would have been smaller than two other agreements. But the Trump administration pulled out of the Trans-Pacific Partnership. It has not pursued the Transatlantic Trade and Investment Partnership.