NAFTA to USMECA: What is Gained?

_ Mary E. Burfisher, Frederic Lambert, and Troy Mathesonm IMF. Washington D.C., March 2019.

The North-American Free Trade Agreement (NAFTA) between Canada, Mexico, and the United States has been in force since January 1994. When NAFTA negotiations were concluded in 1992, it was the most comprehensive free trade agreement ever negotiated, creating the world’s largest market for goods and services. The agreement eliminated almost all tariffs between the three countries and incorporated numerous other innovative provisions. NAFTA influenced other free trade agreements that the United States later negotiated and multilateral negotiations. It also initiated a new generation of trade agreements in the Western Hemisphere and other parts of the world, influencing negotiations in areas such as market access, rules of origin, intellectual property rights, foreign investment, dispute resolution, worker rights, and environmental protection. NAFTA fundamentally reshaped North American economic relations, driving unprecedented integration between Canada, the United States and Mexico and encouraging a dramatic increase in regional trade and cross-border investment between the three countries. Since the agreement came into effect, trade between the three NAFTA parties has increased from US$ 290 billion in 1993 to over US$ 1.1 trillion in 2017.

Most economists agree that NAFTA has provided benefits to the North American economy by expanding trade and economic linkages between countries, creating more efficient production processes, increasing the availability of lower-priced consumer goods, and improving living standards. However, it has proven difficult to isolate the agreement’s beneficial effects from other factors, including rapid technological change, expanded trade with other countries such as China, and unrelated domestic developments in each of the countries. Debate also persists regarding NAFTA’s legacy on employment and wages, as some workers and industries have faced painful disruptions amid increased competition while others have gained from new market opportunities.

This debate is evidenced in the fact that, after more than a quarter of a century, the impact of NAFTA remains a perennial topic of discussion in the broader debate over the benefits of free trade.

Against this backdrop, the United States launched new trade negotiations with Canada and Mexico soon after President Trump’s inauguration in 2017, with the aim of supporting higher-paying jobs and growth. Those culminated in a new trilateral United States – Mexico – Canada trade agreement (USMECA) signed by U.S. President Trump, Canadian Prime Minister Trudeau, and Mexican President Peña Nieto, on November 30, 2018. The agreement still needs to be ratified by the three countries before it can be implemented. It includes tighter rules of origin in the automobile, textile, and apparel sectors, a new labor value content requirement in the auto sector, higher U.S. access to Canadian supply-managed markets, further goods trade facilitation, updated provisions related to financial services, as well as a new currency provision and a provision about entering free trade agreements with non-market economies.

The conclusion of USMECA is occurring in a dynamic trade environment for Canada and Mexico. In March 2018, they joined 9 other countries in the Asia Pacific region in signing the Comprehensive and Progressive Agreement for a Trans-Pacific Partnership (CPTPP). This agreement will provide preferential access by Canada, Mexico, Japan and other CPTPP members to each other’s markets.

Also, in May 2018, the United States imposed import tariffs of 25 percent on steel and 10 percent on aluminum due to national security concerns, to which U.S. major trade partners (including Canada and Mexico) responded with surtaxes on imports of selected U.S. products. Finally, in April and August 2018, the United States levied additional tariffs on a combined US$ 50 billion of imports from China, which immediately triggered retaliation by China.2 The impact of USMECA is analyzed within this context.

Summary and conclusions

Using a global, multisector, computable-general-equilibrium model, this paper provides an analytical assessment of the potential effects of five key provisions of USMECA. USMECA is explored within the context of the simultaneous implementation of the CPTPP, the U.S. imposition of tariffs on steel and aluminum imports and retaliation by Canada, Mexico, China and the European Union, and the U.S.-China trade tensions. The analysis also considers the extension of USMECA to include removal of U.S. tariffs on Canadian and Mexican steel and aluminum imports and of the Canadian and Mexican reciprocal surtaxes. The sensitivity analyses examine the effect of alternative rates of trade efficiency gains due to USMECA’s new provisions on customs facilitation.

At the aggregate level, effects of the USMECA are relatively small. According to the analysis of this paper, key provisions in USMECA would lead to diminished economic integration in North America, reducing trade among the three North American partners by more than US$4 billion (0.4 percent) while offering members a combined welfare gain of US$538 million. Effects of the USMECA on real GDP are negligible. Most of the benefits of USMECA would come from trade facilitation measures that modernize and integrate customs procedures to further reduce trade costs and border inefficiencies. Changes in trade flows due to USMECA would also lead to structural changes in the composition of production across North America. Depending on each country’s circumstances, some sectors benefit from greater trade integration while others experience declines in output and job losses. Changes in industrial structure that result from changing trade flows prompt employees to move from contracting to expanding sectors. In the aggregate, real wages for skilled and unskilled workers in Mexico decline slightly due to the new provisions of USMECA, but wages are unaffected in Canada and the United States.

The results show that the tighter rules of origin in the auto sector and the labor value content requirement would not achieve their desired outcomes. The new rules lead to a decline in the production of vehicles and parts in all three North-American countries, with shifts toward greater sourcing of both vehicles and parts from outside of the region. Consumers would face higher vehicle prices and respond with lower demanded quantities. Higher labor costs in Mexico’s vehicle sector would lead to greater-capital intensity as Mexico’s producers substitute capital equipment for higher-cost labor. Some negative results for Mexico and the United States would follow the implementation of tighter rules of origin in the textiles and apparel sectors. (Canada is less affected due to the leeway provided by its low TPL fill rates.) The effects of increased U.S. access to the Canadian supply-managed dairy market would be very small and macroeconomically insignificant.

The three countries would gain much from ending the dispute triggered by the U.S. tariffs on steel and aluminum. USMECA scenario is extended to include the removal of U.S. steel and aluminum tariffs and a reciprocal elimination of Canadian and Mexican retaliatory import surtaxes. The extension would increase the welfare gain for the Canada, Mexico and the United States by $2.5 billion, to a total of $3 billion, generate a small increase in GDP in Canada, and help to offset the negative wage impacts of the RVC and LVC provisions on Mexican workers.

Both the main scenario and the sensitivity analyses highlight the importance of the assumption related to the effects of trade facilitation in determining the magnitude of the overall impact of changes in trade policy. While the empirical literature has made strides in quantifying the effects of non-tariff trade costs on trade flows, assumptions related to these costs remain a key source of uncertainty around model-based estimates of the effects of changes in trade policy. In general, the effects of policy changes in models of the type used in this paper tend to be small when the models describe fixed trade costs and trade efficiency, and a fixed resource base of land, labor and capital. The results show larger aggregate impacts when non-tariff efficiency gains are assumed to be greater than the conservative estimate used in this analysis.

Another important caveat to this analysis is that many aspects of USMECA are not examined due to either modeling limitations or significant uncertainty about their qualitative and quantitative effects. Undoubtedly, these limitations and uncertainties will decline over time following the implementation of USMECA, allowing a more complete analysis of all aspects of the agreement for future work.


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