The very large and mutual gains from free trade within North America began with the U.S.-Canada Auto Pact of 1965, which created the economic and political momentum for the comprehensive U.S.-Canada free trade agreement of 1988. The path-breaking extension of free trade by these two industrialized nations to a major developing country, Mexico, in the 1994 North America Free Trade Agreement completed the regional economic integration among the three democracies based on private sector–driven free trade and market-based currencies. This report by Ernest H. Preeg, Ph.D. recounts this extraordinary success story, which refutes recent ill-informed adverse commentary, and is in three parts.
The 50-Year, Three-Stage Historical Path
Comprehensive regional free trade among two industrialized and one developing country—the United States, Canada, and Mexico—was a three-stage process of bold and forward-looking initiative by the three governments that began with the U.S.-Canada Auto Pact of 1965, which will be 50 years old in 2015. This agreement for the dominant manufacturing sector of trade was a creative response to strong nationalist pressures in Canada to turn inward and become self-sufficient in automobile production, at considerable cost to U.S. exporters and Canadian consumers. There was growing anti-Americanism in Canada, with concerns that U.S. automotive production would overwhelm Canadian industry, including through special interest actions in Washington at Canadian expense.
To reverse this protectionist path, the two governments acted boldly to create a broadly based sectoral free trade accord, including a safeguard that Canadian automotive production would not fall below the 1964 level. The Canadian government acted in the face of strong protectionist opposition. For the United States, this preferential trade policy initiative was fundamentally at odds with postwar U.S. trade policy based on most-favored-nation nondiscrimination in trade. The 1962 Trade Expansion Act was President Kennedy’s number one legislative priority, designed to cut tariffs across the board by 50 percent in order to reduce protectionism within the preferential European Community. Moreover, free trade limited to one sector was in violation of the GATT system, which only permits free trade agreements that include substantially all of the trade among members.
Nevertheless, to avoid the consequences of a sharp protectionist turn in Canada, the two governments began negotiations in mid-1963 with highly able and experienced negotiators. Deputy Minister of Industry Simon Reisman headed the Canadian delegation with determination and foresight. The Department of State provided the U.S. negotiating team, since the newly created Office of the Special Trade Representative (now USTR) was not yet fully operational, headed by Assistant Secretary for Economic Affairs Philip Trezise and Deputy Trade Director Julius Katz. The negotiations were completed in early 1964 and the agreement received congressional approval for implementation in 1965. Thus the first stage of North American free trade was achieved on a fast track, resolving a serious problem through creative leadership.
The Auto Pact produced rapid and reasonably balanced growth in the largest manufacturing sector of trade, of benefit to both countries, and especially to Canada. As Machiavelli observed 500 years ago, people “do not truly believe in anything new until they have had actual experience of it. Despite continued strong nationalist pressures in Canada against free trade, the Auto Pact experience was striking, and a number of Canadian academic and government studies supported further movement toward free trade, perhaps through additional sectoral agreements. The United States, however, opposed such limited agreements, in part from com- plaints lodged in the GATT over the Auto Pact, and in part from domestic opposition to further safeguards, by sector, for Canadian production.
This set the stage for the big option of a comprehensive free trade agreement, which Canadian Prime Minister Brian Mulroney proposed despite strong opposition from the other two major political parties. President Reagan welcomed the initiative and negotiations began in May 1986. Simon Reisman was called out of retirement to lead the Canadian delegation and the American team was headed by experienced former deputy USTR Patrick Murphy. The negotiations were concluded in August 1987, another fast track accomplishment. The U.S. Congress approved the agreement with a comfortable majority, based on fast track presidential authority, while the 1988 Canadian election, called the “Free Trade Election,” saw Mulroney barely win over the anti–free trade opposition parties, and the agreement promptly entered into force.
The agreement was comprehensive in eliminating barriers to trade and liberalizing cross-border investment, with only a few sensitive sectors excluded by both countries. The growth in bilateral trade from this agreement was again rapid, especially for Canada. Canadian exports to the United States, about 25 percent of GDP through most of the 20th century, surged to almost 50 percent by 2000. The U.S.-Canada free trade agreement also became the first demonstration model, outside the European Union, for the global proliferation of free trade agreements over the ensuing 25 years. And the next major free trade agreement, which also bridged the divide between industrialized and developing nations, was the extension of North American free trade to include Mexico through NAFTA.
The NAFTA negotiations were far more complex, involving comprehensive free trade with a newly industrializing Mexican economy. The Mexican state oil monopoly, Pemex, was excluded, and the agricultural sector involved three separate bilateral agreements, including a 15-year phasing out of Mexican import restrictions. The initiative for NAFTA came from Mexican President Carlos Salinas, with the aim of integrating the Mexican market-oriented economic reforms of the 1980s within a broader regional free trade framework. President Bush responded positively, and in June 1990 the two presidents announced the intent to open negotiations. Canada was at first not interested, fearful of losing trade preferences from the U.S.-Canada agreement, but once it was clear that the United States and Mexico would begin negotiations, Canada was obliged to join in. Such is the economic dynamic of expanding regional free trade.
After 14 months of intense negotiations, including 100 pages of rules of origin for trade, the three presidents signed the agreement in December 1992, following the election of Bill Clinton to succeed George Bush. Clinton approved of the agreement provided there were strengthened consultative provisions for environmental and labor cooperation, which were incorporated. The agreement was approved by the Congress in late 1993 and came into force on January 1, 1994.
Much has been written about the NAFTA negotiations, the final agreement, and the initial years of implementation and no attempt is made here to summarize them. Without question, however, NAFTA brought to a successful conclusion the three-stage, 50-year process of North American free trade and investment, including the historic breach of the north/south divide with the inclusion of Mexico. It was characterized throughout by bold and creative leadership by all three governments. It also created the basic framework for the next decisive phase of regional economic challenges addressed in the final section. But first, a look at the rapid and balanced recent growth of NAFTA trade.
The Rapid and Balanced Growth of NAFTA Trade, 2009-2013
Recent U.S. trade with Canada and Mexico is presented in the following six tables. The first three present U.S. merchandise trade, by principal sector, for NAFTA partners together and then separately for Canada and Mexico, from 2009 to 2013. Tables 4 through 6 present trade in services in the same format, although available statistics are limited to 2009 to 2011.
Total U.S. merchandise exports to NAFTA partners, as shown in Table 1, grew by 58 percent from 2009 to 2013, to $526.4 billion, while imports were up by 52 percent to $612.6 billion. The $86.2 billion deficit in 2013 was more than accounted for by the $94.6 billion deficit in energy, offsetting the $22.7 billion surplus in manufacturing. Agricultural trade was close to balance, with a $2.6 billion deficit in 2013.
The most important feature of this trade is the dominant role of manufacturers. In 2013, U.S. exports by manufacturers of $406.6 billion accounted for 77 percent of total exports and the $383.9 billion imports were 63 percent of total imports. Manufactured exports grew by 52 percent from 2009 to 2013, much faster than the 34 percent export growth with the rest of the world, rising to 35 percent of global exports, and with NAFTA manufactured exports more than five times larger than the $76 billion of exports to China. Even more striking, the 2013 NAFTA surplus of $22.7 billion stood in dramatic contrast with the $524 billion deficit with the rest of the world, of which $351 billion was with China. Moreover, this strong U.S.-NAFTA export performance for manufacturers is likely to continue.
The other large sector of trade presented is energy, which accounted for 9 percent of total exports and 23 percent of imports in 2013. The large 2013 deficit of $94.6 billion reflected imports three times larger than exports. It is difficult to identify trends in energy trade because of wide swings in energy prices, but the steady rise in U.S. exports reflects, at least in part, the increase in domestic production and a corresponding decrease in import dependence. This should continue and perhaps accelerate in coming years, further reducing the NAFTA energy deficit. It could also reduce the energy share of NAFTA trade and further increase the manufacturing share.
Agriculture is always a troubled sector for trade negotiations, especially within a free trade agreement, because of high and varied forms of import protection for farmers. But as shown in Table 1, the agricultural share of U.S.-NAFTA trade in 2013 was only 8 percent for exports and 7 percent for imports, at $39.6 billion and $42.2 billion, respectively, with a small deficit of $2.6 billion. The outlook for agricultural trade is uncertain, but trade restrictions and consequent disputes will almost certainly continue, and agricultural trade will likely remain relatively small.
U.S. Merchandise Trade With Canada and Mexico (Table 1)
U.S.-NAFTA trade is evenly balanced between Canada and Mexico. As shown in Table 2, U.S. exports to Canada in 2013 of $300.2 billion were 57 percent of total NAFTA exports, and imports of $332.1 billion were 54 percent of total imports. The Mexican shares, as shown in Table 3, were thus 43 percent and 46 percent, respectively. Looking ahead, however, U.S. trade with Mexico has been growing much faster than trade with Canada. U.S. exports to Mexico grew by 75 percent from 2009 to 2013, from $128.9 billion to $226.2 billion, while exports to Canada were up by only 47 percent, from $204.7 billion to $300.2 billion. The differential growth was even larger for exports of manufacturing. U.S. exports by manufacturers to Mexico grew by 69 percent to $173.3 billion in 2013, compared with growth of 41 percent to $233.3 billion for exports to Canada. If these differential growth paths continue, U.S. trade with Mexico will soon equal if not surpass trade with Canada.
As for the energy sector, the large deficit with Canada of $82.8 billion in 2013, and the smaller $11.8 billion deficit with Mexico, should decline as U.S. energy production increases and dependence on imports falls, but probably by less than the decline in U.S. imports from other sources, as discussed below. And agriculture will likely remain a small share of total NAFTA trade, with exports to and imports from both Canada and Mexico remaining less than 10 percent of total trade.
U.S. Merchandise Trade With Canada (Table 2)
U.S. Merchandise Trade With Mexico (Table 3)
Statistics for U.S. trade in services by trading partner are much more limited. There are few available U.S. statistics, and the most recent year for WTO statistics is 2011. Nevertheless, the WTO figures for 2009 to 2011, broken down into the three categories of transportation, travel, and other commercial services, do give a broad picture of trade in services, including its size relative to merchandise trade. It is also important to note that the WTO category “other commercial services,” as applied to global U.S. exports, breaks down to roughly 70 percent business services and 30 percent financial and insurance services, and is thus deeply integrated with the manufacturing sector.
U.S. trade in services with NAFTA partners, presented in Table 4, is in large surplus, at $39.6 billion in 2011, with more than half of the surplus, $23.6 billion, in other commercial services. The smaller $11.1 billion surplus for travel is predominantly from NAFTA students in American universities and vacation travel. Transportation services were much smaller, only 15 percent of total services, with a $4.9 billion surplus, reflecting the relatively smaller use of maritime and air freight services for U.S.-NAFTA trade compared with more distant trading partners. U.S.-NAFTA trade in services is growing steadily in all sectors, but remains relatively small compared with merchandise trade. The $81.4 billion of U.S. services exports in 2011 were only 17 percent as large as the $479.3 billion of merchandise exports shown in Table 1.
U.S. Trade in Services With Canada and Mexico (Table 4)
U.S. trade in services with Canada and Mexico, as shown in Tables 5 and 6, is generally in surplus, with the exception of the 2011 $2.0 billion deficit with Mexico for travel, reflecting the American tourist flow south of the border. The most important dimension of services trade with Mexico is the highly favorable trade balance for other commercial services, predominantly business services, with U.S. exports in 2011 of $14.3 billion more than four times larger than the $3.3 billion of imports. U.S. services trade with Canada is far larger than with Mexico. U.S. exports to Canada of $56.1 billion in 2011 compare with $25.3 billion of exports to Mexico, and includes surpluses in all three sectors.
U.S. Trade in Services With Canada (Table 5)
U.S. Trade in Services With Mexico (Table 6)
The overall assessment for U.S.-NAFTA trade in services is that it is flourishing in all directions, with an almost totally positive trade balance for the United States. What is more important for all three NAFTA members is the vital international role for the services sector, both through trade and subsidiary-provided services, for the deepening and broadening of economic integration within North America. Indeed, this integrating role is likely to become even larger for the NAFTA course ahead.
Three Decisive Challenges Ahead
The 50-year history of free trade within North America has been an ever-deepening success story for all three nations. The economic integration process is far from complete, however, especially for Mexico as it rises to become an export-oriented, industrialized economy. In fact, there are three decisive and interacting challenges now facing NAFTA that should be a high priority for the three governments and be given greater action-oriented attention than they have received over the past several years. Each of the challenges is presented in brief and pointed terms to stimulate such attention, with a concluding comment on how NAFTA strategy should be a bedrock for U.S. global trade and financial strategy:
1) The Mexican economic reform program under way.
Mexico has reached the takeoff stage to become a private sector–driven and export-oriented industrialized democracy, as seen with South Korea and Taiwan two decades ago. This has been the Mexican reform strategy since the 1980s, but the dynamic free trade path also has had adverse shortcomings now being addressed in President Peña Nieto’s reform program, all of which are deeply connected with the U.S. relationship. The opening of Mexico to more competitive and productive private investment, including the end of the Pemex state oil monopoly, is critical for the rapid expansion of the modern sector of the Mexican economy and the creation of more productive and higher- paying jobs compared with small-scale subsistence employment. Related infrastructure investments and rapid growth of education for engineers, managers, and vocational skills are essential for this transition. And the longstanding tragic costs from Mexican organized crime and public sector corruption remain debilitating for the overall economy.
These issues are being addressed by the Mexican reform program, but they face strong vested interests to weaken or resist change. The Mexican government needs to maintain firm leadership for these reforms, but the United States also needs to play its part by publicly supporting the reforms and providing technical and financial assistance. There can also be binational expert analysis of the large and potentially positive results involved for both nations. In economic terms, a more productive, higher-growth Mexican economy, with a higher-paid labor force, can bring much larger mutual gains from trade. In broader policy terms, the serious adverse consequences for both nations from organized crime in Mexico are a mutual interest that needs to be dealt with more forcefully by both governments, acting together.
2) A North American energy strategy to become a large net exporter of fossil fuels.
This prospect has received much public attention, but little action, especially by the United States. Increased competitive investment in the Mexican energy sector, which would include lead technology American companies, has already been noted. For the United States, a number of important decisions blocked by special interests remain at a virtual standstill: the end of the oil export embargo from the 1930s; the construction of the Keystone oil pipeline to bring Canadian oil to Gulf refineries; license approval for LNG exports; and greater use of public lands for oil and natural gas production. For Canada, the five-year pipeline impasse has caused adverse impact on the Canadian economy, as a result creating bitter, anti-American feelings, similar to what occurred in 1963, when the situation came close to shutting down bilateral automotive trade. The difference, however, as recounted earlier, was that in 1963 the two governments reacted quickly and positively, whereas over the past five years the American government has been sitting on its hands.
The response by all three governments should be to support an action-oriented, integrated energy strategy to make North America a large net exporter of fossil fuels. Globally, this would undermine OPEC and Russian oil and natural gas monopoly pricing, establish higher safety and environmental standards for production, and reduce CO2 emissions by accelerating the transition to natural gas. For the North American economies, it would create jobs, improve fiscal accounts, and reduce the protracted large current account deficits facing all three NAFTA members. These global and national economic goals, moreover, lead to the third, broadest challenge.
3) An active NAFTA role for restoring the multilateral trade and financial systems.
The multilateral trade and financial systems, which are deeply connected, have deteriorated greatly since 2000, and face collapse on current course. The nondiscriminatory multilateral trading system since the 1940s has been transformed into an expanding network of preferential trading blocs. The 1971 agreement for market-based exchange rates by industrialized trading nations, embedded in the IMF Article IV obligation not to manipulate currencies to gain an unfair competitive advantage in trade, has been grossly violated by a number of newly industrialized nations, most importantly China, converting the financial system largely into a mercantilist currency war. There are ways to restore an open-ended, nondiscriminatory trading system with market-based exchange rates, but this will require a strong U.S. leadership role in concert with like-minded trading partners.
Within this like-minded grouping, the three NAFTA partners can provide the demonstration model for free trade and market-based exchange rates, including between the advanced and newly industrialized groupings of nations. And to this end, the three partners should concert their strategies to respond to the protectionist trade policies and manipulated exchange rates that currently confront all three NAFTA members, and which have led to their large and undesirable current account deficits.
Annual Meeting Needed
The NAFTA relationship is of growing importance for U.S. international trade and investment and provides the free trade, market-based currency model for restoring a fair and balanced trading system. U.S. manufactured exports to Canada and Mexico of $407 billion in 2013 have risen to 35 percent of global exports, while the surplus of $23 billion stands in dramatic contrast with the $524 billion deficit with the rest of the world. These basic facts go a long way for understanding the policy course ahead.
Work remains, however, to consolidate and improve the North American free trade relationship, and the three nations can and should act together to pursue their global economic interests, the most important of which have been presented here. One specific proposal is necessary to get the NAFTA ball rolling on a more productive path. Occasionally the three heads of government meet, but the result has been bland speeches ignored by the media. What is proposed here is an annual meeting centered on an action agenda, to be developed during the course of the year, with the results announced at the meeting. And the initial action agenda should consist of the three principal challenges addressed in this article.