For more than two decades, trade between the United States, Canada and Mexico has been guided by the North American Free Trade Agreement (NAFTA).
The trilateral framework, which came into force on January 1, 1994, created one of the world’s largest free trade zones. While most analysts concede that NAFTA has been beneficial for all countries involved, U.S. President Donald Trump has sought to overhaul the legislation.
After months of rhetoric, negotiations to rewrite NAFTA are formally set to begin in Washington.
NAFTA: Its Benefits and Discontents
Although NAFTA was initiated in 1994, it would take another 12 years for it to be fully implemented. Over that period, the agreement eliminated most tariffs on products traded between the U.S., Canada and Mexico. In addition to cutting tariffs and supporting trilateral trade, the deal sought to protect intellectual property, create a dispute-resolution mechanism and introduce labor and environmental safeguards.
Over the past two decades, NAFTA has completely reshaped North American trade relations. Regional trade surged from around $330 billion in 1993 to more than $1.2 trillion in 2016. Trade with Canada and Mexico has supported nearly 14 million U.S. jobs, with nearly 5 million jobs supported directly by NAFTA, according to the U.S. Chamber of Commerce.
Cross-border investment has also increased sharply, with U.S. foreign direct investment (FDI) in Mexico rising to $100 billion from just $15 billion. Real GDP per capita has increased for all three countries, with the United States and Canada witnessing the largest percentage gains, according to World Bank data. NAFTA has also increased U.S. exports to both countries. Canada and Mexico purchase roughly one-third of U.S merchandise exports, leading to increased earnings for U.S. businesses and also higher consumption on the back of jobs and wage growth.
Like most free trade agreements, NAFTA has been subject to a great deal of scrutiny over its perceived impact on wages and employment. A 2015 report by the Congressional Research Service found that NAFTA “did not cause the huge job losses feared by the critics.” At the same time, its implementation coincided with a 30% drop in U.S. manufacturing employment. Critics also argue that NAFTA has contributed to wage stagnation in both the United States and Mexico.
U.S. Manufacturing Jobs (1993-2016)
Although NAFTA likely isn’t solely responsible for this decline, the automotive sector has been hit especially hard. At the same time, U.S. telecommunications companies and financial service providers have had limited-to-no access to Canada or Mexico during the lifespan of the agreement.
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The Need for Renegotiation
Although President Trump has complained about Washington’s trade deficit with Mexico and its negative merchandise trade balance with Canada, these aren’t the only reasons why NAFTA needs a facelift. Rules regarding digital trade – which barely existed in the early 1990s – could provide greater clarity around how data is transmitted and stored across national boundaries. Canada will also use the renegotiation as an opportunity to push for more stringent labor and environmental standards.
With the exception of digital trade, negotiations are expected to face roadblocks stemming from U.S. demands for changing government procurement, rules of origin and the goal of eliminating Washington’s trade deficit. Negotiations over new labor provisions will also face roadblocks. Trump’s vow to do away with NAFTA’s existing dispute resolution mechanism is also likely to cause friction with Ottawa. President Trump has already played hardball with his northern neighbor by slapping a hefty tariff on Canadian softwood lumber and announcing plans to look more closely at the country’s dairy industry.
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The softwood lumber debate will be a focal point of NAFTA negotiations. Click here to learn how investors can capitalize on the Canada-U.S. lumber rift.
On the Mexican side of the border, the Trump administration is seeking more concessions that will boost U.S. exports and ensure that fewer manufacturing jobs are lost. Talks with Mexico will take place against a backdrop of political turmoil stemming from Trump’s plan for a new border wall, which he says Mexico will pay for.
The first round of NAFTA renegotiations is set to begin August 16-20 in Washington. Investors are hoping for a swift renegotiation, but analysts warn they should brace for a drawn-out discussion that could incite volatility in the market.
The Bottom Line
NAFTA’s underlying goal was to integrate Mexico with the highly advanced economies of the United States and Canada. While the agreement has certainly accomplished that, a lot has changed since 1994. A do-over is probably in everyone’s best interest, provided it can be completed expeditiously.
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