TheImpactofTradeAgreements
Clarke Ricks School of Business,
Liberty University
BUSI 690: Policy and Strategy in Global Competition
Dr. Hicks
May 7, 2022
TheImpactofTradeAgreements
Trade agreements have a major impact on trade and investment worldwide. In fact, they
are responsible for shaping business relationships among companies across the globe. In order
to succeed in the international environment, small business exporters need to be aware of the
impact trade agreements have had and will have on their businesses. Likewise, lenders must be
familiar with trade agreements in order to better understand the needs and financial concerns
of their customers. But why are trade agreements flourishing? The answer lies in their broad
array of benefits.
Some countries have established free trade agreements and are in the process of
expanding them, while other countries have established customs unions and common markets.
This development is having a profound effect on small businesses worldwide.
A free trade area is formed when two or more nations establish preferential trade
liberalization policies by eliminating or substantially reducing trade barriers among themselves.
A customs union surpasses free trade liberalization policies by establishing a common external
tariff for non-members. A common market goes even further. Members eliminate restrictions
on the movement of labor and capital among each other. Additionally, members may
harmonize national policies to some degree, including monetary, fiscal and social policies, and
concede a degree of political and legal control to a single ruling authority.
Michael Porter, a contemporary trade theorist, explains that the principal economic goal of
a nation is to produce a high and rising standard of living for its citizens. Porter contends that
the ability to do so depends on the productivity with which a nation’s resources are employed.
Productivity is defined as the value of the output produced by a unit of labor or capital. It
depends on both quality and features of products and the efficiency with which they are
produced. As such, the ability to export many goods produced with high productivity allows a
nation to import many goods involving lower productivity. This is desirable because it translates
into higher national productivity.
In pursuit of both increased productivity and international competitiveness, governments
must promote trade without barriers — or free trade — without which the economic growth of
a nation will be stunted. Free trade promotes the following:
1. The creation of economies of scale;
2. An increase in efficiency and competitiveness;
3. A reduction of resources used in the production of goods; and
4. A higher standard of living.
Most free trade agreements (FTAs) owe their success, at least in part, to prior reductions in
trade barriers between the parties to the agreement. For example, integration and cooperation
in the iron, steel, coal, and nuclear energy sectors set a precedent for Western Europe to tear
down barriers in other sectors. The U.S.-Canada Free Trade Agreement was preceded in 1965
by the Automotive Products Trade Act (APTA), which allowed duty-free trade between the
United States and Canada in almost all motor vehicles and parts. This resulted in extensive
integration of motor vehicle production between the two countries. Likewise, many U.S. firms
are taking advantage of Mexico’s maquiladora program and U.S. tariff provision 9802.00.80,
demonstrated by the growing use of assembly operations in Mexico by these firms. The
provision allows for the elimination of duty on goods co-manufactured in both countries.
The progeny of this marriage — Mexico’s maquiladora program and U.S. tariff provision
9802.00.80 — has resulted in more internationally competitive industries. This has made
business and government leaders in both countries see that the elimination of remaining
barriers through a U.S.-Mexico FTA would benefit each country even more. Canadian leaders,
too, saw the advantage of access to low-cost Mexican labor for its producers and access to
Mexico’s burgeoning market for its products. Consequently, Canada opted for the North
American Free Trade Agreement (NAFTA).
The benefits of free trade already have been proven through a variety of pacts throughout
the world. In 1983, New Zealand and Australia implemented an accord liberalizing trade
between them. For the three years preceding the accord, Australian exports to New Zealand
grew at an average of 10 percent each year. After implementation, through fiscal year 1985,
exports rose 18 percent annually. New Zealand’s exports to Australia also increased as trade
barriers declined.
Between 1959 - 1969, trade within the European Community (EC), the forerunner to the
European Union (EU), rose by 347 percent. In contrast, trade outside the EC rose by only 130
percent. In this same period, U.S. global trade rose by 124 percent, while Canadian global trade
rose by 130 percent. The value of Spain’s bilateral trade with Portugal increased more than 79
percent the first year the two joined the EC (1986). During the first 10 years of Britain’s
membership in the EC (1973 - 1983), the U.K.’s exports to the other member states grew by 28
percent per year, while its imports increased by 24 percent. Trade with the rest of the world
during this time period went up 19 percent per year.
The best example of free trade is the unobstructed trade among states in the United
States. As a result, the United States is unquestionably the wealthiest single market and an
extremely efficient producer of goods and services.
SmallBusinessBenefitsFromTradeAgreements
Since 1992, trade agreements such as the Tokyo Round and the Uruguay Round of the
GATT, and the North American Free Trade Agreement (NAFTA), as well as 200 other lesser-
known trade agreements, have been negotiated and implemented by the United States. Small
business has benefited from the resulting substantial reduction in foreign trade barriers. But
obstacles still exist. For instance, high foreign duties have prevented many small U.S. firms from
exporting. Large companies, however, often have circumvented these barriers by establishing a
presence in the foreign country, achieving secure and competitive access. Small firms usually do
not have the resources to do this. By the U.S. participating in trade agreements thereby
reducing and eliminating foreign tariffs, small companies’ products can be more price
competitive, enabling them to export more goods and create new jobs.
Foreign red tape or non-tariff barriers, such as import license requirements, also have
prevented small companies from exporting. Large companies often either have the resources to
hire consultants or the existing in-house expertise to work through these sometimes hidden
barriers. Small companies don’t. By eliminating confusing red tape through trade agreements,
small companies are put on a more level playing field and are better positioned to grow
internationally. On the other hand, smaller companies often are able to respond faster to
market changes than large firms. This can give them an edge as the pace of global change
quickens. Importantly, as more “niche” market opportunities present themselves — which may
be considered insignificant in size for large multinationals — small firms likely will find many of
them very profitable and well worth the pursuit.
GATTandtheWorldTradeOrganization
The General Agreement on Tariffs and Trade (GATT), established in 1947 in Geneva,
Switzerland, was responsible for governing approximately 90 percent of world trade. It sought
to liberalize trade and thereby improve the world trading system through a code of rules and a
forum in which negotiations and other trade discussions took place. Importantly, it played a
major role in the settlement of trade disagreements among member countries. The founders of
GATT believed that increased international trade would promote an economic interdependence
between countries, making wars between trading partners unthinkable.
GATT was responsible for reducing the international tariff average from 40 percent in 1947
to 5 percent in 1990. These reductions have permitted international trade to expand
enormously, national incomes to substantially increase, and international competition to
flourish, resulting in higher quality, lower priced goods. The organization was very successful at
reducing international trade barriers. However, many analysts have argued that it was not very
successful at remedying less apparent forms of protection, such as non-tariff barriers. New
protectionist tools, such as abusive uses of dumping legislation and environmental, labor and
other issues, are becoming the new non-tariff barriers.
In the early 1990s, GATT’s inability to eliminate non-tariff barriers had put the organization
in jeopardy. Its incapacity to successfully remedy the U.S.-European Community disagreement
over agricultural subsidies and complete the Uruguay Round on schedule had created doubt as
to the organization’s ability to meet future challenges. Furthermore, the decreasing level of
world confidence in GATT contributed to the speed at which countries have formed trading
blocs. Since the successful conclusion of the GATT Uruguay Round Agreements, the degree of
confidence in its successor organization, the WTO, has risen significantly. In fact, many believe
it will enforce international trade rules and settle disputes among members to a better degree
than its predecessor.
Eight rounds of multilateral trade negotiations were held since 1947 under the auspices of
the GATT. The goal of each round was to reduce or eliminate tariffs, and in some cases, non-
tariff barriers among the contracting parties. In September 1986, trade ministers met in Punta
del Este, Uruguay, to launch a new and final round of trade talks aimed at strengthening the
GATT — and expanding its coverage. This aspect added a different element from the previously
negotiated Kennedy and Tokyo GATT Rounds, which focused primarily on tariff reductions.
After seven long years, a landmark GATT accord was finalized.
While trade agreements have evolved and have helped small and big business alike gain
secure access to foreign markets, trade blocs have emerged. Today, the major trade blocs
include the European Union, chiefly involving West European countries and spreading
eastward; the North American Free Trade Agreement, among Canada, the United States and
Mexico and spreading south; and an informal bloc in East Asia, currently dominated by Japan,
but soon to be dominated by China. Based on past trade patterns and policies, and anticipated
policies, these blocs will continue to develop, gaining increased strength and influence.
InTheSpotlight
Within each of the world’s trade blocs, small and large, free trade will continue to become
more entrenched. Future trade between blocs is not so clear. Many fear that individual blocs
will become inwardly focused and protectionist. Even if protectionism does not emerge
outright, trade diversion could have a similar effect. Trade diversion occurs when members of a
trade group buy more goods from each other due to the elimination of internal trade barriers,
and displace non-member goods. For manufacturers and distributors, foreign market share may
be at risk. In the dynamic international environment, all tools that offer U.S. firms a competitive
advantage must be employed. And the ability to offer attractive export financing is becoming
essential.
TheEuropeanUnion
The EU has come a long way in its development. On April 18, 1951, the European Coal and
Steel Community was formed. Its success prompted the March 25, 1957 signing of the Treaties
of Rome, creating the European Economic Community (EEC) and the European Atomic Energy
Community. On April 8, 1965, the three organizations merged into the European Communities,
simply referred to as the European Community or EC. On July 8, 1968, the EC formally
established a customs union.
An economic decline in the 1970s, compounded by a recession in 1980, caused EC
economies to stagnate. Declining confidence in EC policy and increased import competition
from members and non-members alike resulted in individual EC countries establishing non-
tariff barriers directed toward competitors, including other EC members. Consequently,
industries became increasingly inefficient and less competitive with the United States, Japan
and the newly industrialized countries of the Far East.
In an attempt to reverse this trend, in 1982, the European Council, composed of EC
member nation heads, agreed that the completion of a unified market was a priority and
requested that the EC Commission propose a timetable for removing all obstacles. In June 1985,
the Commission released its White Paper detailing a timetable ending December 31, 1992, for
the implementation of some 300 directives or measures intended to eliminate all physical,
technical and fiscal barriers to intra-EC trade. Essential to its success was the enactment of the
1987 Single European Act that changed EC voting procedure. This body has matured into a
common market. Policies include the elimination of barriers to labor and capital movements,
coordinated monetary and fiscal policies, a common agricultural policy, use of common
investment funds, and similar rules for wage and welfare payments.
In late 1992, a survey conducted in Germany yielded specific conclusions regarding the
advantages of the single market. Reported by the Journal of Commerce on January 4, 1993, the
advantages are as follows:
1. A decline in unit costs as production runs are lengthened;
2. A single EC-wide registration and protection of intellectual property;
3. The harmonization of taxes, eliminating divergent tax systems that distort competition;
4. Lower research and development costs due to lengthened production runs;
5. Opportunity for longer product life span;
6. Simplified inventory management no longer necessitating that individually tailored
products satisfy different EC country standards;
7. The elimination of border delays;
8. Simplification of formalities, resulting from mutual recognition of approval procedures;
and
9. A reduction in product and service costs, resulting from greater product availability and
competition.
As the EU expands, it will continue to gain greater economic and political strength, in
addition to an enhanced level of global competitiveness. Should it look inward and establish
protectionist measures, U.S. firms could be at a disadvantage. Or through trade diversion, it’s
possible that EU members will purchase more goods from each other at the expense of non-
member firms. On the other hand, a more economically viable Europe can mean more imports.
And further integration among EU members, which creates one set of standards and
regulations, can make the export process less complex.
In 1998, U.S. exports to Western Europe exceeded $150 billion, up by more than 30
percent from 1990, and far exceeded exports to Eastern Europe, which barely reached $7.5
billion. U.S. direct investment throughout Europe has outpaced exports. In fact, according to an
Arthur Andersen report on international investment, Europe was the world’s largest recipient
of foreign investment in 1995.
The European Union (EU) now encompasses 15 countries: Austria, Belgium, Denmark,
Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain,
Sweden, and the United Kingdom. Many other countries are waiting for full membership.
Turkey applied in 1987; Cyprus and Malta applied in 1990; Switzerland applied in 1992; and
Hungary and Poland applied in 1994. Six countries applied in 1995: Romania, Slovakia, Latvia,
Estonia, Lithuania, and Bulgaria. And the Czech Republic applied for membership in 1996. As
the EU expands, it will continue to gain greater economic and political strength, in addition to
an enhanced level of global competitiveness. Thus, should all Eastern European countries
eventually become members of the EU, its numbers of consumers would swell to approximately
850 to 900 million.
Provided the EU does not look inward and establish protectionist measures, a more
economically viable Europe should result in more imports. Further integration among EU
members, creating one set of standards and regulations, could make the export process less
complex for outsiders.
EastAsia
In recent years, trade among East Asian nations has increased at a much faster pace than
trade outside the region. Through the development of several trade agreements — such as the
Association of Southeast Asian Nations (ASEAN), comprised of Malaysia, the Philippines,
Singapore, Thailand, Brunei, and Indonesia — the region is becoming more trade-cohesive.
However, economic integration is primarily influenced by Japanese investment in the region,
creating an informal trade bloc. Even considering the Asian financial crisis that began in 1997,
which will no doubt have a massive impact on regional developments and world growth, many
predict that Asia will still become the world’s dominant region in the next decade.
Prior to the Asian financial crisis, many Asian economies were growing at the fastest rates
in the world. And, as the region emerges from the crisis, its purchasing power will again
increase at favorable rates and provide a plethora of export and investment opportunities.
According to a report published by the Asian Development Bank, economic recovery in affected
economies to pre-crisis GDP growth rates and per capita income levels will take a number of
years.
Many U.S. companies that have watched Asian economic developments closely over the
last decade do not appear to be dissuaded. Thus, many are positioning themselves to take
advantage of new opportunities, while establishing new strategies to mitigate risks caused by
the economic crisis.
Numerous U.S. firms predict that as Asian trade barriers are reduced, expanding in the
region will be less burdensome. However, many admit successful navigation through Asian
distribution systems will continue to be difficult. Piracy of intellectual property continues to be
an obstacle in many Asian countries, especially China. Numerous executives believe that vast
cultural differences in Asia represent the biggest trade barrier of all. Without a doubt, close
familiarity with Asian markets and a solid understanding of business customs are prerequisites
to doing business there. Companies that take the time to become well-positioned are more
likely to reap the trade and investment opportunities of the 21st century.
TheAmericas
The North American Free Trade Agreement (NAFTA) was implemented on January 1, 1994,
creating a trade area of 360 million consumers and ensuring secure markets for U.S., Canadian
and Mexican products. One of the primary goals of NAFTA is to encourage expansion of
business partnerships among North American firms to promote greater efficiency and to
counter fierce competition from the Far East and Europe. So far, NAFTA appears to be working.
Since the Agreement’s implementation, there has been a proliferation of joint ventures and
strategic alliances between U.S. and Mexican companies. Already strong ties with Canada also
have prospered. The benefits derived from this teamwork will continue to make the United
States, Canada and Mexico more globally competitive at a time when regional trade alliances
are becoming increasingly important in the world economy.
In 1997, for the first time, Mexico followed Canada as the United States’ second largest
export destination, pushing Japan into third place. And the proposed Free Trade Agreement of
the Americas (FTAA) — in which all the benefits given to Mexico and Canada under NAFTA will
be extended to the rest of Central and South America — further would increase cooperation
among nations in the Western Hemisphere. Such an agreement would make the Americas one
of the largest trading areas in the world, with a population of 750 million consumers.
Latin America and the Caribbean have come a long way in their economic and political
development. The so-called “lost decade” of the 1980s is a fading memory. Less than 20 years
ago, most Latin American countries were run by generals or dictators closely aligned to the
military. Today, freely elected governments rule in almost every Latin American and Caribbean
country. These once-closed markets have become dynamic economies that resemble the “Asian
tigers” (Taiwan, Hong Kong, South Korea, and Singapore) during their development in the
1970s. The region’s more severe boom-and-bust cycles are starting to smooth out due to
widespread economic reforms and better leadership. According to the Inter-American
Development Bank, the region’s growth rate is vastly improved since the 1980s, when annual
growth stagnated at 1.1 percent. At the end of 1996, average inflation in the region was
approximately 10 percent, a remarkable turnaround from 550 percent in 1990.
Political and economic reforms in Latin America and the Caribbean are working well, and
the middle class is on the rise. Like East Europeans, Latin Americans have learned that
protectionist policies only result in an inevitable loss in standard of living. As a result, the region
has a great deal more to offer the United States in terms of export markets, investment
opportunities and a low-cost manufacturing base. U.S. exports to Latin America exceeded $142
billion in 1998. And U.S. direct foreign is up considerably. And that’s not all. According to former
U.S. Trade Representative Mickey Kantor, by the year 2010, the United States will export more
goods to Latin America than to Japan and Europe combined.
TheNorthAmericanFreeTradeAgreement
On January 1, 1989, the United States and Canada implemented the U.S.-Canada Free
Trade Agreement. On September 25, 1990, former President Bush notified Congress that the
United States and Mexico intended to initiate free trade negotiations. On February 5, 1991, the
United States, Canada and Mexico issued a joint communiqué formally proposing a North
American pact that “would link our three economies in bold and different ways.” Formal NAFTA
negotiations began on June 12, 1991, and were completed on August 12, 1992. The agreement
was ratified by the U.S. House of Representatives on November 18, 1993, and two days later by
the Senate, with formal implementation taking place on January 1, 1994.
Due to issues concerning wage differences and possible job losses along with
environmental concerns, an unusual coalition of NAFTA opponents emerged that included labor
and environmental activists. Supporters of NAFTA were equally diverse. The successful vote of
234 to 200 in the House of Representatives was primarily due to the support of Republican
members. Former Republican Senator and 1996 presidential candidate Robert Dole played a
vital role in garnering support for NAFTA. Prior to the vote, all former presidents came out to
show bipartisan solidarity for the trade accord. In the final days before the vote in the House,
President Clinton had to bargain hard to put together a majority vote.
The NAFTA agreement was voted on by the legislative bodies in all three participating
countries. The Mexican Parliament readily supported the agreement. Although Canada’s newly
elected Prime Minister Chretien had opposed NAFTA in his campaign, he eventually supported
the agreement, and the Canadian Parliament voted favorably. Although trade with Mexico was
not particularly significant for Canada at the time, the agreement offered long-term potential.
Moreover, the Canadians did not want to be left out of efforts that were expected to lead to far
broader open market agreements in the Western Hemisphere.
At that time, U.S. textile industry leaders, generally opposed to free trade, were out front
campaigning for NAFTA. Except for executives in a few firms, the textile industry saw free trade
with Mexico as the opening of a large market for its business. The textile mill products sector in
Mexico was not well developed. Therefore, Mexico represented a potential 25 percent market
increase for U.S. textile producers. In an effort to offset concerns over possible U.S. job losses,
board members of the American Textile Manufacturers Institute (ATMI) pledged that they
would not move their jobs, plants, or facilities to Mexico. The forceful support of textile leaders
for NAFTA swayed some members of Congress from the major textile-producing states to vote
in favor of the agreement.
NAFTAExpectations
Former President Bush and former Mexican President Salinas defined a U.S.-Mexican free
trade agreement as a process of gradual and comprehensive elimination of trade barriers
between the United States and Mexico, including: the full, phased elimination of import tariffs;
the elimination or fullest possible reduction on non-tariff trade barriers, such as import quotas,
licenses, and technical barriers to trade; the establishment of clear, binding protection for
intellectual property rights; fair and expeditious dispute settlement procedures; and other
means to improve and expand the flow of goods, services, and investment between the United
States and Mexico.
The United States had several fundamental objectives in pursuing a free trade agreement
with Canada and Mexico. These included the promotion of the following:
1. U.S. exports to Mexico, designed to increase the number of well-paying U.S. jobs;
2. Ongoing Mexican trade and investment reforms, especially intellectual property rights
which would generate substantial new opportunities for U.S. firms;
3. More efficient uses of natural and human resources in North America, structured to
promote U.S. world competitiveness; and
4. Mexican economic growth and prosperity, an increase in the Mexican standard of living
and a reduction of the number of undocumented Mexican immigrants in the United States.
Both Mexico and Canada wished to initiate a free trade agreement (FTA) with the United
States for several reasons. In January 1990, Mexican President Salinas visited Europe to
promote foreign investment that would support the Mexican trade liberalization process. He
found the Europeans preoccupied with Eastern Europe. It became apparent that Europe would
not be a sufficient source of investment and exports. Mexico would have to depend upon U.S.
investment and markets to increase productivity, exports and wages. Through a U.S.-Mexico
FTA, President Salinas hoped to stimulate Mexican economic growth through increased trade
and investment. President Salinas also saw that an FTA likely would prevent future Mexican
presidents from deviating from his economic policies, which he believed were essential to
provide the stability necessary to promote long-term economic growth.
The expected benefits to Mexico of economic integration included the following:
1. Greater and secure access to U.S. and Canadian markets;
2. Achievement of international credibility and increased foreign investment;
3. Improved domestic confidence in Mexico’s economic future and the return of flight
capital;
4. Access to U.S. and Canadian technology and expertise;
5. The development of economies of scale to achieve greater productivity;
6. A movement toward greater specialization;
7. An increase in jobs and wages, resulting in a higher standard of living with a more equal
income distribution;
8. Improvement of working conditions; and
9. A reduction in the so-called brain drain or the loss of educated workers through
migration.
Canada expected to benefit in ways very similar to the United States, including:
1. Better access to Mexico’s large and growing market;
2. Establishment of guarantees protecting intellectual property rights;
3. Enhanced competitiveness at home and abroad;
4. Establishment of long-term guarantees protecting Canadian direct foreign investment;
5. The development of economies of scale to achieve greater productivity;
6. A movement toward greater specialization; and
7. Availability of less-expensive products.
EliminationofTradeBarriers
NAFTA provides for the progressive elimination of all tariffs on North American goods
through four staging categories defined as A through D. Duties on goods in category A, which
had the fastest tariff phase-out, were eliminated entirely on January 1, 1994. According to the
U.S. International Trade Commission, this represents 31 percent of U.S. goods exported to
Mexico (based on goods traded in 1990). Duties on goods in category B were removed in five
equal annual stages beginning on January 1, 1994. This represents 17.4 percent of goods
exported to Mexico. Duties on goods in category C are phased out in 10 equal annual stages —
representing 31.8 percent. Duties on goods in category C+ are eliminated in 15 equal annual
stages — representing 1.4 percent of U.S. goods exported to Mexico. And duties on goods in
category D will continue to be duty free. This represents 17.9 percent of U.S. exports to Mexico.
Thus, approximately 50 percent of all U.S. exports to Mexico were completely duty-free on
the day NAFTA entered into force and approximately 66 percent were made duty-free within
five years. Products included in this category include: aerospace equipment; semiconductors;
computers and parts; telecommunications and electronic equipment; medical devices; rail
locomotives; many auto parts; machine tools; and paper products. Pre-NAFTA Mexican duties
on these products ranged from 10 to 20 percent. All Mexican duties will be eliminated on U.S.
goods within 10 years with the exception of corn and beans, which will become duty-free
within 15 years. Duty rates will be phased out based on the applied rates in effect on July 1,
1993.
Without NAFTA, Mexico would have the right under international law to raise most of its
duties to 50 percent. Under NAFTA, Mexico is prevented from raising its duties above current
rates. In addition, should the United States and Mexico agree, tariffs on U.S. exports to Mexico
may be eliminated at an accelerated pace. This has been successfully accomplished several
times between the United States and Canada under the U.S.- Canada FTA and NAFTA.
Mexico eliminated many of its import licenses upon NAFTA’s implementation date. Other
licenses will be eliminated over a 10 year period. These include items such as pharmaceutical
inputs and used equipment, including computers, tractors and industrial machinery. In addition,
enhanced intellectual property rights under NAFTA have better protected American technology.
Consequently, U.S. exporters of R&D-intensive goods that require a high level of patent
protection have benefited because, in the past, inadequate protection has held back U.S. sales
to Mexico.
RulesofOrigin
In an attempt to confine NAFTA benefits to North America, rules of origin have been
devised to define the origin of a particular product. Only products that originate in North
America are accorded free trade status — allowing them to enter the United States, Mexico or
Canada at a reduced duty or duty-free. Under these rules, as duties are phased out, the
incentive to use North American goods increases. NAFTA rules strengthen, clarify, and simplify
rules contained in the U.S.-Canada FTA.
Most NAFTA rules are based on simple, predictable tariff classification principles. New U.S.
Customs provisions set out documentation, record keeping, and origin verification procedures,
and provide for advance rulings, review and appeal of customs origin determinations. U.S.-
Canada FTA rules are superseded by NAFTA and are compatible with the General Agreement on
Tariffs and Trade.
Concerns that non-North American companies will use Mexico as an export platform are
addressed in NAFTA. For example, if two Japanese components are shipped to Mexico,
undergoing “simple assembly” there, and then are exported to the United States, under the
NAFTA rules of origin, the finished product would not be classified as a Mexican product.
Instead, it would be classified as a Japanese product because the value added in the assembly
was too small to cause the required transformation. As a result, U.S. Customs would assess the
same duty as if the product were shipped directly from Japan to the United States.
Under these origin requirements, products wholly obtained in North America, such as
minerals extracted from the ground, undeniably satisfy these rules. However, products that
embody overseas parts or materials must be substantially transformed in North America in
order to satisfy the transformation requirements stipulated in NAFTA.
For example, live chickens imported from Europe into the United States enter under a
particular U.S. harmonized code, HS 0105. If processed in the United States into chicken cutlets,
the product then takes on an entirely different tariff code classification, HS 0207. Thus, the
cutlets would have been sufficiently transformed to be considered a U.S. product. If exported to
Mexico, the cutlets would then qualify for duty-free treatment.
In some cases, a product must satisfy both transformation and content requirements. For
example, hairdryer parts imported into Mexico from Japan and South Korea will arrive under
parts classifications. When assembled with North American parts, the sum of the parts
becomes a hand-held hairdryer. At this point, tariff transformation rules have been satisfied,
but percentage content requirements must now be met.
Value content may be calculated using either the transaction value, based on the selling
price, or the net cost method, based on the cost of goods. In general, if the North American
value content is less than 60 percent using the transaction value, or 50 percent using the net
cost method, the product will not be considered a North American product.
NAFTA rules of origin improve upon current requirements in U.S.-Mexican trade and
requirements under the United States-Canada Free Trade Agreement. NAFTA implements
stricter transformation requirements and content requirements not previously imposed on U.S.
imports from Mexico. Consequently, NAFTA origin requirements encourage more North
American components to be used in North American trade, while discouraging use of non-
North American components.
In addition to improving upon current origin requirements, NAFTA ensures that non-North
American countries will not use Mexico as an export platform to achieve preferential access to
U.S. markets. In fact, in order to qualify for NAFTA tariff treatment, automotive goods and
vehicles entering the United States from Mexico must contain at least 62.5 percent North
American content, based on the net cost formula. This encourages the usage of North American
auto parts. According to the U.S. International Trade Commission, the resulting increase in U.S.
production of auto parts will increase U.S. competitiveness.
NAFTAUpdate
On January 1, 1994, the day NAFTA was implemented, approximately 50 percent of all U.S.
exports to Mexico became duty free, accelerating trade flows. During that year, U.S.-Mexican
bilateral trade rose 22 percent, up from $81.5 billion to $100 billion. U.S. exports to Mexico
increased at about the same rate — and almost four times faster than U.S. exports to the rest
of the world. Mexico even edged up on Japan, competing for the United States’ second largest
trade partner status.
Since NAFTA was implemented, there has been a proliferation of joint ventures and
strategic alliances between U.S. and Mexican companies. According to a survey conducted in
May 1994 by KPMG/Peat Marwick, a leading consulting firm, nearly 40 percent of 1,000 U.S.
companies said their industry has already benefited in some way by the Agreement’s passage.
The American Chamber of Commerce in Mexico conducted a survey of its members in spring
1994. Of the 224 executive officers who responded, most expressed confidence that NAFTA
would be beneficial to their company’s productivity and profitability.
Coopers and Lybrand, another leading consulting firm, interviewed executive officers of
410 of the fastest-growing U.S. product and service companies. According to the report issued,
for growth companies, NAFTA has meant export opportunities, not job relocations. NAFTA
opponents who predicted a mass exodus of U.S. jobs south of the border have been proven
wrong by the facts. NAFTA contributed significantly to the success that U.S. manufacturers
encountered in Mexico in 1994. In the auto industry, for example, the value of U.S. car exports
to Mexico decreased 6 percent from 1992 to 1993. With the implementation of NAFTA,
however, car exports increased a whopping 685 percent in 1994 to over $437 million, according
to the U.S. Department of Commerce. From January 1 to October 5, 1994, Ford Motor Company
exported 18,000 cars to Mexico. This represented a huge increase from its 1,700 cars and trucks
exported there in 1993. U.S. exporters of textiles and apparel also performed well. The increase
in U.S. textile exports to Mexico from 1993 to 1994, the first full year of NAFTA, was 130
percent more than the increase from 1992 to 1993.
The question often arises: how can Mexican consumers buy U.S. products when their
incomes are so low? The answer is simple. In general, Mexican consumers feel that U.S. goods
are superior in quality, not only to European or Japanese goods, but to Mexican goods as well.
As a result, Mexican consumers have a strong demand for U.S. goods. For example, in 1992,
two years prior to the implementation of NAFTA, production workers in manufacturing
industries in the European Community (referred to as the European Union since 1993) received
748 percent more in hourly compensation than manufacturing production workers in Mexico;
Japanese workers received 588 percent more. Nevertheless, on a per capita basis, Mexicans
bought more goods from the United States than from the European Community or Japan. In
1992, Mexicans spent $440, or 44 percent more, per capita, than European Community citizens
($305) and almost 15 percent more than the Japanese ($384) on U.S. goods.
Even when calculations omit the amount of exports to Mexico that were re-exported back
to the United States or to other countries, Mexicans still consumed more than Europeans.
According to the U.S. International Trade Commission, in 1992, about 21 percent of U.S. exports
to Mexico were re-exported back to the United States. Many of these goods were components
shipped back to the United States after being assembled or improved in some manner. If 21
percent of U.S. exports to Mexico were omitted from calculations, Mexicans still consumed
$335 worth of U.S. goods per capita, 10 percent more than Europeans.
The numbers today are even higher. Thus, despite much lower income by comparison, in
1998, Mexican consumers bought more goods from the United States, on a per capita basis,
than did German consumers. That year Mexicans consumed about 2.5 times more than the
Germans. As purchasing power continues to increase in similar developing markets, and the
perception of American products continues to improve, the demand for U.S. exports will
continue to rise.
