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North American Free Trade Agreement (NAFTA)

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

The North American Free Trade Agreement (NAFTA) was implemented to promote trade between the U.S., Canada, and Mexico. The agreement, which eliminated most tariffs on trade between the three countries, went into effect on Jan. 1, 1994. Numerous tariffs—particularly those related to agricultural products, textiles, and automobiles—were gradually phased out between Jan. 1, 1994, and Jan. 1, 2008.

Understanding NAFTA

NAFTA’s purpose was to encourage economic activity among North America’s three major economic powers: Canada, the U. S., and Mexico. Proponents of the agreement believed that it would benefit the three nations involved by promoting freer trade and lower tariffs among Canada, Mexico, and the United States.

On Aug. 27, 2018, President Donald Trump announced a new trade deal with Mexico to replace NAFTA. The U.S.-Mexico Trade Agreement, as it was called, would maintain duty-free access for agricultural goods on both sides of the border and eliminate non-tariff barriers while also encouraging more agricultural trade between Mexico and the United States.

On Sept. 30, 2018, this agreement was modified to include Canada. The United States-Mexico-Canada Agreement (USMCA) took effect on July 1, 2020, completely replacing NAFTA. If not renewed, the USMCA will expire in 16 years.

A Sept. 30, 2018, joint press release from the U.S. and Canada Trade Offices stated:

“USMCA will give our workers, farmers, ranchers, and businesses a high-standard trade agreement that will result in freer markets, fairer trade, and robust economic growth in our region. It will strengthen the middle class and create good, well-paying jobs and new opportunities for the nearly half billion people who call North America home.”

History of NAFTA

About one-fourth of all U.S. imports, such as crude oil, machinery, gold, vehicles, fresh produce, livestock, and processed foods, originate from Mexico and Canada, which are, respectively, the United States’ second- and third-largest suppliers of imported goods, as of 2019.23 In addition, approximately one-third of U.S. exports, particularly machinery, vehicle parts, mineral fuel/oil, and plastics are destined for Canada and Mexico.4

NAFTA legislation was developed during George H. W. Bush’s presidency as the first phase of his Enterprise for the Americas Initiative. The Clinton administration, which signed NAFTA into law in 1993, believed it would create 200,000 U.S. jobs within two years and 1 million within five years because exports play a major role in U.S. economic growth. The administration anticipated a dramatic increase in U.S. imports from Mexico as a result of the lower tariffs.

The next scheduled review of NAICS will take place in 2022.

This classification system allows for more flexibility than the SIC’s four-digit structure by implementing a hierarchical six-digit coding system and classifying all economic activity into 20 industry sectors. Five of these sectors are primarily those that produce goods, and the remaining 15 sectors provide some type of service. Every company receives a primary NAICS code that indicates its main line of business. A company receives its primary code based on the code definition that generates the largest portion of the company’s revenue at a specified location in the past year.

The first two digits of a NAICS code indicate the company’s economic sector. The third digit designates the company’s subsector. The fourth digit indicates the company’s industry group. The fifth digit reflects the company’s NAICS industry, and the sixth designates the company’s specific national industry.

Advantages and Disadvantages of NAFTA

NAFTA’s immediate aim was to increase cross-border commerce in North America, and it did indeed spur trade and investment among its three member countries by limiting or eliminating tariffs. It was especially advantageous to small or mid-size businesses, because it lowered costs and did away with the requirement of a company to have a physical presence in a foreign country to do business there.

Most of the increase came from trade between the U.S and Mexico or between the U.S. and Canada., though Mexico-Canada trade grew as well. Overall, there was $1.0 trillion in trilateral trade from 1993 to 2015, a 258.5% increase in nominal terms (125.2%, when adjusted for inflation). Real per-capita gross domestic product (GDP) also grew slightly in all three countries, primarily Canada and the U.S.

NAFTA protected non-tangible assets like intellectual property, established dispute- resolution mechanisms, and, through the NAAEC NAALC) side agreements implemented labor and environmental safeguards. It increased U.S. competitiveness abroad and “exported” higher U.S. workplace safety and health standards to other nations.

From the beginning, NAFTA critics were concerned that the agreement would result in U.S. jobs relocating to Mexico, despite the supplementary NAALC. In fact, many companies did subsequently move their manufacturing operations to Mexico and other countries with lower labor costs—in particular, thousands of U.S. auto workers and garment-industry workers were affected in this way. However, NAFTA may not have been the reason for all those moves.

During the NAFTA years, U.S. trade deficits (importing more from a nation than you export) did increase, especially with Mexico. So did inflation.

Some critics also cite the rising wave of Mexican immigrants to the U.S. as a result of NAFTA—partly because the expected convergence of U.S. and Mexican wages didn’t happen, thus making the U.S. more attractive to Mexican workers.

Pros

  • A spurred surge in cross-border trade and investment
  • Increased competitiveness of U.S. industry
  • Opened up opportunities for small businesses
  • Implemented universal, higher health, safety, and environmental standards
Cons

  • Caused loss of manufacturing jobs, especially in certain industries
  • Increased inflation in the U.S.
  • Increased U.S. trade deficits
  • May have spurred Mexican immigration

NAFTA vs. USMCA

The U.S.-Mexico-Canada Agreement (USMCA) entered into force on July 1, 2020. Basically, it builds on NAFTA, using the older legislation as a basis for a new agreement. But it does have some differences.

Some are simple updates, expanding the tariff ban on new technologies and industries. Most notably, the USMCA prohibits tariffs on digital music, e-books, and other digital products. The agreement also establishes copyright safe harbor for internet companies, meaning they can’t be held liable for copyright infringements by users.6

Another change moves the labor and environmental protections of the original side agreements into the main agreement, meaning issues like the right to organize are now subject to the pact’s normal procedures for settling disputes.7

In particular, it revised and toughened labor laws relating to Mexico, establishing an independent investigatory panel that can investigate companies accused of violating workers’ rights, and stop shipments from those found to be in violation of labor laws. It also compelled Mexico to enact a wide array of labor reforms, to improve working conditions and increase wages.7

Here are some other distinctions between the two agreements, indicating qualifications for tariff-free status and other rules.

Comparing NAFTA and USMCA
Provision NAFTA USMCA
autos 62.5% of vehicle components must be made in North America 75% of components be North American in origin; 40%-45% of parts be from a factory paying $16/hour
 pharmaceuticals protections for certain drug classes from cheaper alternatives protections eliminated
 dairy protected market in Canada, limiting access allows U.S. farmers access to up to 3.6% of the Canadian market and vice versa
investor-state dispute settlement mechanism allows companies to sue governments for unfair treatment eliminated, except for certain Mexican industries
intellectual-property protections 50 years 70 years
treaty sunset provision  none treaty to be reviewed after 6 years; expires after 16 years unless extended

NAFTA FAQs

What Was the Main Goal of NAFTA?

NAFTA aimed to create a free trade zone between the U.S., Canada, and Mexico. The goal was to make doing business in Mexico and Canada less expensive for U.S. companies (and vice versa), reducing the red tape needed to import or export goods.

How Did NAFTA Work?

Among its three member nations, NAFTA eliminated tariffs and other trade barriers to agricultural and manufactured goods, along with services. It also removed investment restrictions and protected intellectual property rights. Finally, its provisions addressed environmental and labor concerns, attempting to establish a common high standard in each country.

Is NAFTA Still in Effect?

No, NAFTA was effectively replaced by the United States-Mexico-Canada Agreement (USMCA). Signed on Nov. 30, 2018, it went into full effect on July 1, 2020.

Did NAFTA Help the U.S. Economy?

Whether NAFTA helped the U.S. economy is a matter of some debate. Certainly, trade between the United States and its North American neighbors more than tripled, from roughly $290 billion in 1993 to more than $1.1 trillion in 2016. Cross-border investments also surged, and U.S. GDP overall rose slightly.

But economists find it’s been tough to target the deal’s direct effects from other factors, including rapid technological change and expanded trade with countries such as China. Meanwhile, debate persists regarding NAFTA’s effect on employment (which was badly hit in certain industries) and wages (which largely remained stagnant).8

How Did Canada Benefit From NAFTA?

“NAFTA has had an overwhelmingly positive effect on the Canadian economy. It has opened up new export opportunities, acted as a stimulus to build internationally competitive businesses, and helped attract significant foreign investment,” states the Canadian government’s website.9

More specifically, since NAFTA went into full effect, U.S. and Mexican investments in Canada have tripled. U.S. investment alone grew from $70 billion in 1993 to more than $368 billion in 2013.8 Total merchandise trade between Canada and the United States more than doubled since 1993 and grew nine-fold between Canada and Mexico.

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What is NAFTA?

Additions to NAFTA

NAFTA’s provisions were supplemented by two other regulations: the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC). These tangential agreements were intended to prevent businesses from relocating to other countries to exploit lower wages, more lenient worker health and safety regulations, and looser environmental regulations.

NAFTA did not eliminate regulatory requirements on companies wishing to trade internationally, such as rule-of-origin regulations and documentation requirements that determine whether certain goods can be traded under NAFTA. The free-trade agreement also contained administrative, civil, and criminal penalties for businesses that violate any of the three countries’ laws or customs procedures.

North American Industry Classification System

The three NAFTA signatory countries developed a new collaborative business-classification system that facilitates comparison of business activity statistics across North America. The North American Industry Classification System (NAICS) organizes and separates industries according to their production processes.

The NAICS replaced the U.S. Standard Industrial Classification (SIC) system, allowing businesses to be classified systematically in an ever-changing economy. The new system enables easier comparability between all countries in North America. To ensure that the NAICS remains relevant, the system is reviewed every five years.

The three parties responsible for the formation and continued maintenance of the NAICS are the Instituto Nacional de Estadística y Geografía in Mexico, Statistics Canada, and the United States Office of Management and Budget through its Economic Classification Policy Committee, which also includes the Bureau of Economic Analysis, Bureau of Labor Statistics, and the Bureau of Census. The first version of the classification system was released in 1997. A revision in 2002 reflected the substantial changes occurring in the information sector. The most recent revision, in 2017, created 21 new industries by reclassifying, splitting, or combining 29 existing industries.

Economy

Can Industrial Policy Save The American Economy? – Forbes

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As the US continues struggling with Covid-19 and economic recovery, debate is growing about the revival of “industrial policy”—government -led efforts to favor certain industries over others, in contradiction to market fundamentalist approaches.  An important new forum in the Boston Review takes on these issues and is well worth your attention.  For our future prosperity, these issues are more important than just arguing about deficits and taxes. (Disclosure:  I’ve coauthored a piece in the forum.)  

In the battle over President Biden’s economic proposals, most commentary focuses on whether the price tag of over $3.5 trillion is too large. How much should be paid for?  Which taxes should go up or down?  Senator Joe Manchin (D-WV), the key Democratic vote for Senate passage of the Biden plan recently called it “the largest single spending bill in history with no regard to rising inflation, crippling debt or the inevitability of future crises.”

But there’s a second debate hidden behind these budget numbers—how and whether government should deliberately foster some industries and withdraw support from others.  Although simple introductory economics textbooks say government intervention is always “second best” to markets, in the real world government is constantly favoring some industries over others.

So the debate is really about what type of industrial policy we are going to have, not whether it exists.  The Review’s forum centers on an excellent piece by economist Marianna Mazzucato and colleagues—“Industrial Policy’s Comeback.”  They flatly (and correctly) say “market fundamentalism has failed to improve economic and social conditions,” calling for “a mission-oriented approach to the economy that embraces an active role for government in spurring growth and innovation.” 

Mazzucato is one of our best thinkers on the complex relationships between government and the private sector.  Her 2013 landmark book, The Entrepreneurial State: Debunking Public vs. Private Sector Myths showed how government investment undergirded the tech revolution, with Apple and other firms adapting technology developed and paid for by the government, often through military spending.

Economists have long known that industrial policy is central to modern economies.  In 2008, Harvard’s Dani Rodrik asked readers to imagine “a set of policy interventions targeted on a loosely-defined set of market imperfections…implemented by bureaucrats…and overseen by politicians” while subject to “rent-seeking by powerful groups and lobbies.”  

Yikes!  Rodrik says those sound like good reasons that “governments should stay away from industrial policy.”  But he then turns the tables, saying he’s not describing industrial policy.  Rather, those complicated conditions hold for “long-standing areas of government intervention such as education, health, social insurance, and macroeconomic stabilization.” And no one thinks we should stop those policies just because they are complicated and sometimes contentious.

So complexity, political debate, attempts to capture benefits at the costs of general prosperity, and addressing critical problems possessing lots of uncertainty characterize all modern social and economic policy.  Hence Mazzucato’s emphasis on developing clear “missions” for industrial policy, with government setting overall directions and goals while avoiding “excessively top-down planning by an overbearing state.”

There’s a lot of deep thinking and clear argument in the Boston Review forum, from a wide range of viewpoints, and I won’t try to summarize it all here.  Read the forum (and buy the new book the Review is publishing on this topic.)

My contribution to the forum, co-authored with my colleague (and spouse) Teresa Ghilarducci, emphasizes the central role workers and labor unions must play in any successful industrial policy.  We hearken back to the great economist John Kenneth Galbraith, who after World War II focused on how the large firms needed to foster innovation and growth could be kept from purely self-interested behavior.

Galbraith’s answer was in the title of his 1952 book—American Capitalism:  The Concept of Countervailing Power.  Without government and union countervailing power, “private decisions could and presumably would lead to the unhampered exploitation of the public.”

Ghilarducci and I argue that successful industrial policy “promotes unionization and shared economic returns,” not just technical innovation where the gains are captured by a narrow slice of wealthy tech and finance owners.  And the politics of industrial policy mean it won’t be enacted without union and popular support.

So as you follow the twists and turns of Biden’s economic plan, where the cable news and commentary are dominated by spending, taxes, and deficits, spare a thought for what that money will be spent on.  Senator Manchin correctly warns about “the inevitability of future crises,” but those aren’t mainly budgetary issues. They are structural problems that need industrial policy solutions.

Our economy faces a short and long-term crisis of innovation, climate change, and racial, gender, and economic inequality.  Industrial policy is critical to building a long-term, sustainable, and equitable prosperity.  I commend the Boston Review forum and book to you as a way to understand this critical issue.

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Germany's next leader could make or break the economy – CNBC

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Supporters of the German Social Democrats (SPD) party, attend at an election campaign rally on August 27, 2021 in Berlin, Germany.
Maja Hitij | Getty Images News | Getty Images

With Chancellor Angela Merkel due to leave office after Germany’s upcoming federal election on Sunday, the country’s priorities could change dramatically, particularly as power could soon be shared among newer (and more unpredictable) political forces.

It’s practically certain that the next government (like the current one) will be a coalition, but what’s far less certain is which parties will create or dominate a governing alliance.

What form the next coalition takes will undoubtedly have a big impact on Germany’s economy which is Europe’s largest and, arguably, its most important.

In 2019, almost a quarter of the EU’s gross domestic product (24.7%) was generated by Germany, according to Eurostat, and so how the country is governed — at a time of transition in terms of global trade and consumer trends — matters.

The election is still wide open with the latest voter poll on Monday showing that while the left-leaning Social Democratic Party remains in the lead and is seen with 25% of the vote, the ruling conservative alliance of the CDU-CSU (the Christian Democratic Union and Christian Social Union) has closed the gap, and currently stands to gain 22% of the vote. The Green Party, meanwhile, trails with 15% of the vote, according to the Insa poll for the Bild newspaper.

A new coalition will have to be formed after the vote and German economists say certain alliances could have “massive consequences” on the country’s economy.

‘Massive consequences’

Germany’s respected Ifo Institute and newspaper Frankfurter Allgemeine Zeitung surveyed 153 economists at German universities, asking them how different coalition formations could affect Germany’s economic growth, unemployment, public debt, and income inequality.

For each of these measures, respondents were asked under which coalition the highest and lowest levels could be expected at the end of the next legislative period.

The survey results, published Tuesday, found that 83% of the German economists polled believed that the lowest economic growth rate would be the product of a so-called “Red/Red/Green” coalition of the SPD, the Left Party (Die Linke) and the Greens.

Such a coalition of leftist parties “would represent a sea change in policy direction, which would translate into a different economic policy with higher taxes and more government transfers,” Ifo Researcher and Professor Niklas Potrafke noted of the survey results Tuesday, adding “that would also have massive consequences for the real economy.”

A total of 77% of the economists said they expected that, in addition to delivering the lowest economic growth, a “Red/Red/Green” coalition would lead to the highest unemployment rate and 86% believed they would have the highest national debt. However, 55% of the economists also believe that such a leftist alliance would achieve the greatest net reduction in income inequality.

The devil you know

Perhaps unsurprisingly, 44% of the economists believed that a coalition of the ruling CDU-CSU alliance and the pro-business FDP (a “Black/Yellow” coalition) would achieve the highest growth rate for Germany, although this grouping lacks a majority when it comes to current polls.

A “Black/Yellow” coalition would achieve the lowest unemployment rate, according to 43%, and the lowest public debt ratio, according to 73% of the economists.

This prosperity could come at a price to many with 70% of economists believing that such a coalition would lead to the highest net income inequality and 56% seeing it as leading to the highest carbon emissions of all the alliances.

The cokery plant of German industrial conglomerate ThyssenKrupp on Rhine river in Duisburg, western Germany in 2019.
INA FASSBENDER | AFP | Getty Images

In joint second place, 18% of the economists believed that the highest economic growth could come out of a coalition of the SPD, Greens, and FDP (widely called a “traffic light” coalition) and 18% felt the same about an alliance of the CDU-CSU, Greens, and FDP (known as a “Jamaica” coalition).

“Should either a so-called traffic light or a Jamaica coalition be formed, respondents believe the effects on growth, inequality, the public debt ratio, the unemployment rate, and carbon emissions would be more restrained,” Potrafke noted.

Polls wide open

Currently, there are a variety of possible coalition options, with most facing stumbling blocks to formation, meaning that there are likely to be protracted negotiations after the election due to policy differences between the parties in areas ranging from economics to climate targets.

“Coalition formation might take some time,” macro analysts from Teneo Intelligence said in a note Monday.

“Less than one week ahead of the 26 September federal election, the Social Democrats continue to lead in the polls. However, the Christian alliance appears to have recovered some ground. But even if the SPD wins, this does not necessarily mean that Finance Minister Olaf Scholz will become the next chancellor; CDU/CSU candidate Armin Laschet could still try to outmaneuver Scholz, for instance by trying to form an alternative government with the Greens and the center-right Liberals (the FDP).”

Journalists and party members watch on a screen from the press centre (L-R) Olaf Scholz, German Finance Minister, Vice-Chancellor and the Social Democrats (SPD) candidate for Chancellor and Armin Laschet, North Rhine-Westphalia’s State Premier and the Christian Democratic Union (CDU) candidate for Chancellor as they attend an election TV debate in Berlin on September 12.
JOHN MACDOUGALL | AFP | Getty Images

The CDU-CSU is used to being in power, but that could all change after next Sunday’s vote; both the SPD and Greens’ candidates for chancellor, Olaf Scholz and Annalena Baerbock, have suggested that neither of them has much appetite for a coalition with the CDU-CSU.

“I think that, after 16 years, many voters would like for the CDU to finally go into opposition again,” Scholz said during the last TV debate between the main contenders for the chancellery on Sunday.

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Canadian dollar, TSX slide ahead of uncertain election outcome

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Canadian dollar

The Canadian dollar fell to a one-month low against its U.S. counterpart on Monday and the Toronto stock market posted its biggest decline since January as Canadians headed to the polls and worries about China roiled global financial markets.

The loonie was trading 0.3% lower at 1.2810 to the greenback, or 78.06 U.S. cents, after touching its weakest intraday level since Aug. 20 at 1.2895.

Prime Minister Justin Trudeau may cling to power after the dust has settled from Monday’s election, but he is likely to lose his bid for a parliamentary majority.

Foreign investors have worried that the election could result in a deadlock that hampers Ottawa’s response to the COVID-19 pandemic and further slows the economic recovery from the crisis.

“No matter the result of the Canadian election, the winner may soon have to face the prospect of a sharp slowdown in China,” said Adam Button, chief currency analyst at ForexLive.

World stocks skidded and oil, one of Canada‘s major exports, settled 2.3% lower, as troubles at property group China Evergrande sparked concerns about spillover risks to the economy.

“It’s a very confusing time and that’s impacting the marketplace,” said Irwin Michael, portfolio manager at ABC Funds in Toronto.

Investors in equities are casting a nervous eye over some of the campaign promises made by Canadian political parties, including Trudeau’s vow to raise corporate taxes on the most profitable banks and insurers.

The Toronto Stock Exchange’s S&P/TSX composite index ended down 335.82 points, or 1.6%, at 20,154.54, its lowest closing level since July 22.

Financials, which account for about 30% of the TSX’s valuation, fell 1.8%, while energy was down 2.8%.

Canadian government bond yields were lower across a flatter curve, tracking the move in U.S. Treasuries. The 10-year fell 6.6 basis points to 1.216%.

 

(Reporting by Fergal Smith; Additional reporting by Gertrude Chavez-Dreyfuss in New York and Sagarika Jaisinghani and Medha Singh in Bengaluru; Editing by Peter Cooney)

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