What Is the North American Free Trade Agreement?

6 Things NAFTA Does

Canadian, American, and Mexican flags
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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. 

Through NAFTA, the three signatories agree 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. 

Key Takeaways

  • NAFTA is the largest free trade agreement in the world.
  • It was signed by President Clinton and implemented in 1994.
  • NAFTA was created for the United States, Canada, and Mexico in answer to trade competition posed by China and the EU.
  •  In 2018, NAFTA was renegotiated. It emerged under a new name, USMCA.
  • NAFTA is still in effect until the USMCA is brought into force.  

NAFTA Is Now the USMCA

On November 30, 2018, the United States, Mexico, and Canada renegotiated the North American Free Trade Agreement. The new deal is called the United States-Mexico-Canada Agreement. It must be ratified by each country's legislature. The implementation act passed the House in December 2019, the Senate on Jan. 16, 2020, and signed by Trump on Jan. 29, 2020. It was ratified in Mexico in 2019.  Canada ratified the agreement on March 13, 2020.  Until the USMCA is brought into force, NAFTA remains in effect.

The Trump administration wanted to lower the trade deficit between the United States and Mexico.

The new deal changes NAFTA in six areas.  The most important is that auto companies must manufacture at least 75% of the car's components in the USMCA's trade zone.

NAFTA Pros and Cons

NAFTA's pros and cons are hotly debated. Critics point to three main disadvantages of NAFTA. First, some argue that 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. 

Functions of NAFTA

© The Balance, 2018

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.

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 19 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 increases the competitiveness of these three countries in the global marketplace. It allows them to better compete with China and the European Union. By per capita GDP on a purchasing power parity basis, China is now the world's largest economy, having surpassed the United States in 2014. 

It took three U.S. presidents to put NAFTA together. President Ronald Reagan kicked it off during his 1979 announcement of his bid for the 1980 presidential election. He wanted to unify the North American market to better compete.

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 shortly before he left office. It then went back to the legislatures of all three countries for ratification.

In 1993, President Bill Clinton signed it. NAFTA went into effect on January 1, 1994. 

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.

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