What Is the North American Free Trade Agreement (NAFTA)?

Definition & Examples of the North American Free Trade Agreement (NAFTA)

things NAFTA does: grants the most-favored nation status to all co-signers, eliminates tariffs on imports and exports between the three countries, all NAFTA countries must respect patents trademarks and copyrights, established procedures to resolve trade disputes, and according to NAFTA expoerters must get certificates of origin to waive tariffs

The Balance 2020

The North American Free Trade Agreement (NAFTA) was a treaty between Canada, Mexico, and the United States that eliminated most tariffs between the counties. It was replaced by the United States-Mexico-Canada Agreement (USMCA) on July 1, 2020.

Learn more about NAFTA and its impact on trade.

What Is the North American Free Trade Agreement (NAFTA)?

NAFTA was the world’s largest free trade agreement when it was established on Jan. 1, 1994. NAFTA was the first time two developed nations signed a trade agreement with an emerging market country. 

Through NAFTA, the three signatories agreed to remove trade barriers between them. By eliminating tariffs, NAFTA increased investment opportunities. 

  • Acronym: NAFTA

How the North American Free Trade Agreement (NAFTA) Worked

NAFTA accomplished six things for the participating countries. First, NAFTA granted most-favored-nation status to all co-signers. That means each country treated the other two fairly and couldn't give better treatment to domestic investors than foreign ones. They also couldn't offer a better deal to investors from non-NAFTA countries and they had to offer federal contracts to businesses in all three NAFTA countries. 

Second, NAFTA eliminated many 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 were required to get Certificates of Origin to waive tariffs. That meant the export had to originate in the United States, Canada, or Mexico. A product made in Peru but shipped from Mexico would still pay a duty when it entered the United States or Canada. 

Fourth, NAFTA established procedures to resolve trade disputes. Parties would start with a formal discussion, followed by a discussion at a Free Trade Commission meeting if needed. If the disagreement wasn't resolved, a panel reviewed the dispute. The process helped all parties avoid costly lawsuits in local courts and helped them interpret NAFTA’s complex rules and procedures. These trade dispute protections applied to investors as well. 

Fifth, all NAFTA countries were required to respect patents, trademarks, and copyrights. At the same time, the agreement ensured that these intellectual property rights didn't interfere with trade.

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

Pros and Cons of the North American Free Trade Agreement (NAFTA)

  • Lower grocery prices

  • Lower gas prices

  • Increased trade and growth

  • Manufacturing jobs moved to Mexico

  • U.S. workers saw lower wages

  • Worker exploitation in Mexico

Pros Explained

NAFTA had three significant advantages. U.S. grocery prices were lower due to tariff-free imports from Mexico. Imported oil from both Canada and Mexico has prevented higher gas prices. NAFTA also increased trade and economic growth for all three countries. 

NAFTA increased the competitiveness of these three countries in the global marketplace. It allowed 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.

Cons Explained

Critics point to three main disadvantages of NAFTA. First, some argue that it sent many U.S. manufacturing jobs to lower-cost Mexico. Second, U.S. workers who kept jobs in those industries had to accept lower wages. Third, Mexico's workers suffered exploitation in its maquiladora programs. A maquiladora is a low-cost, U.S.-owned manufacturing operation or factory operating in Mexico, typically near the Mexico-U.S. border.

The History of the North American Free Trade Agreement (NAFTA)

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 presidency. He wanted to unify the North American market to better compete.

In 1984, Congress passed the Trade and Tariff Act, which gave the president fast-track authority to negotiate free trade agreements. It permitted Congress only the ability to approve or disapprove and it couldn't change negotiating points.

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. 

Notable Happenings

On November 30, 2018, the United States, Mexico, and Canada renegotiated NAFTA. The new deal is called the United States-Mexico-Canada Agreement (USMCA). The implementation act passed the House in December 2019, the Senate in January 2020, and signed by President Trump on Jan. 29, 2020. It was ratified in Mexico in June 2019 and in Canada in March 2020. The USMCA went into force on July 1, 2020.

Key Takeaways

  • The North American Free Trade Agreement (NAFTA) was a treaty between Canada, Mexico, and the United States that eliminated most tariffs between the counties.
  • It was the world’s largest free trade agreement when it was established on January 1, 1994.
  • NAFTA accomplished several things, including granting most-favored-nation status to all countries involved and eliminating many tariffs. 
  • While it increased trade, critics argued that many U.S. manufacturing jobs moved to Mexico. 
  • USMCA replaced NAFTA on July 1, 2020.