NAFTA Definition: North American Free Trade Agreement

6 Ways NAFTA Works. Why It's Important.

NAFTA definition
NAFTA lowers grocery prices. Photo: Getty Images

​​​Definition: The North American Free Trade Agreement is a treaty between Canada, the United States and Mexico. These three countries have 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. 

NAFTA is the world’s largest free trade agreement. Its members contribute more than $20 trillion as measured by gross domestic product.

The Trans-Pacific Partnership or the Transatlantic Trade and Investment Partnership would have been larger if Congress had ratified them. As of the beginning of 2017, all three agreements are in jeopardy.

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. He will withdraw the United States from the Trans-Pacific Partnership. Trump prefers bilateral trade agreements to multilateral ones. For more, see What Happens If Trump Dumps NAFTA?

NAFTA's pros and cons are hotly debated. First, it caused the United States to lose many 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. For more, see NAFTA's Disadvantages

But U.S. grocery prices would be higher without tariff-free imports from Mexico.

It's also clear that importing oil from both Canada and Mexico prevent high gas prices. For updated figures, see Advantages of NAFTA.

Six Ways NAFTA Works

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. (Source: "Certificate of Origin," U.S. Customs and Border Protection.)

Fourth, NAFTA establishes procedures to resolve trade disputes. These protect 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. (Source: "Dispute Settlement," NAFTANow.org)

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. (Source: "NAFTA Summary," NAFTANow.org.)

Why NAFTA Is Important

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.

NAFTA is the first time two powerful, developed economies signed a trade agreement with an emerging market country.

 

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.