June 2018

Is multilateral trade under threat? Economist Rebecca Harding argues that political disaffection with the principles of free trade doesn’t really help anyone

The North American Free Trade Agreement (NAFTA) was signed between the US, Canada and Mexico in 1994 as the full impact of the end of the Cold War was being felt and the Single European Market was becoming a reality. At the time, there was a strong belief in multilateralism, largely on economic grounds.

Strong together

The goal of NAFTA, as with the European Union (EU), was to promote national strength through regional strength: free trade between nations, or blocs of nations, would allow businesses to take advantage of the economies of scale inherent to the larger markets. Like the Single European Market, the remit of NAFTA grew and, by 2008, included government procurement, investment, services, intellectual property and dispute resolution mechanisms.1

Like most of the trade arrangements that exist between nations around the world, NAFTA is a free trade area (FTA) and not a customs union or single market. This means several things:

  1. Each nation within the FTA agrees to trade freely with the others but is free to negotiate its own trade with other nations and regions. This means that Canada has negotiated the Comprehensive Economic and Trade Agreement (CETA) with the EU, while both Canada and Mexico agreed to the new Trans-Pacific Partnership (TPP) of 11 countries from the Asia Pacific and
    North American regions.
  2. There is no external tariff applied to imports from countries outside
    the FTA.
  3. There are no obligations to have free movement of people, capital, goods and services between the FTA members.

US$5.5trn
The combined level of trade between the US, Canada and Mexico

NAFTA is dominated by the US, which, by itself, constitutes 21% of the value of world trade. Mexico and Canada account for 4.6% each, meaning that the region as a whole accounts for around 30% of world trade. This percentage is slightly misleading, as it includes both trade between these three countries and trade between them and non-NAFTA members. Nevertheless, all the trade of these three nations added together comes to US$5.5trn.

FTA and trade agreements

Free trade areas generally, including the EU’s Single Market and Customs Union, are a feature of the global trade landscape that has evolved since the Second World War. The Latin American Free Trade Association (LAFTA), although covering only goods, was established in 1960, while Europe’s Common Market dates back to 1957’s Treaty of Rome, which committed its founding six members to preventing war in the region and creating an economic area where goods, services, people and capital could move freely. This goal was achieved in 1992 with the Single European Act and it is the most developed, and largest, trading bloc in the world (see Figure 1). NAFTA does not approach the degree of integration represented by the agreements between the countries in the EU. However, it is a more comprehensive free trade area than the newly reworked TPP, since it includes intellectual property, government procurement, investment and dispute resolution mechanisms.

Clearly, trade agreements are important for nearly every country in the world. There is some double counting in Figure 1; Mexico and Canada, for example, have recently signed up as members of the TPP, and Mexico is a member of LAFTA. However, the chart clearly shows that what has evolved since 1990 is a global framework of multilateral agreements that aim to enable cross-border trade and financial transactions between businesses and that are characteristic of the globalisation of the last 30 years.

"The US is concerned about its trade surplus with the rest of the world

and has taken the protectionist route to protect the domestic iron and steel industry"

Political disruptors

Politics now has the potential to rebalance the nature of global trade. First, China has taken advantage of the withdrawal of the US from the TPP to promote the Regional Comprehensive Economic Partnership (RECEP). If ratified, this would be a trade bloc of a similar size to the EU. Second, the new US administration was elected to power on the basis of an economic nationalist agenda that would involve renegotiating the terms of NAFTA. The administration has stepped back from renegotiating with Canada and Mexico on a bilateral basis, and the “America First” agenda has put pressure on relations within NAFTA, most recently because of the decision by the US to impose a 25% tariff on iron and steel imports and a 10% import tariff on aluminium, invoking a national security loophole in the General Agreement on Tariffs and Trade (GATT)
that has existed since the 1960s.

There may be some scope for Canada and Mexico to negotiate terms on iron and steel with the US. However, even if the threats remain rhetorical, they serve to weaken the links between members of the bloc. This may in the end be more detrimental to the US: its exports to Canada, for example, are more than 30% of the value of total US exports of iron and steel (See Figure 2).

In a sense, the focus on iron and steel is emblematic of the broader ‘zero sum’ approach that an economic nationalist attitude to trade represents. The US is concerned about its trade surplus with the rest of the world and has taken the protectionist route in order to protect the domestic iron and steel industry rather than to trade more externally.

It regards any resultant trade war as ‘winnable’, but it is worth pointing out that the 300% tariff that was to be imposed on Bombardier aircraft at the end of December 2017 was revoked after a legal challenge by the Canadian company.2 NAFTA has arguably been good for all the countries within it. Trade between them has grown, the only exception being US trade with Canada as a percentage of the US’s total trade (see Figure 3).

Similarly, services trade has also grown as a share of total services trade for the US, although not for Mexico and Canada. Mexico imported fewer services from the US as a percentage of total services imports by 2016 than it had done in 2001 (see Figure 4).

"There are arguments in favour of renegotiating

the relationships within all the world’s trade agreements"

The rationale behind the US’s desire to renegotiate its agreement with NAFTA is only explicable on the grounds of its trade in goods. Here, the country has a long-standing and stubbornly consistent deficit with both of the countries (see Figure 5). Although the deficit with Canada may have narrowed slightly since 2015, the deficit with Mexico has fluctuated, but remained essentially stable at around US$7.5bn since 2010.

However, as Figure 6 shows, the reverse is the case for services. The services surplus with both countries has been dropping since 2012 and, despite a pick-up in 2009 and 2010, has been on a downward trajectory since the financial crisis. However, it is still substantial, at US$12.6bn with Canada and US$6.6bn with Mexico in 2017. A trend projection suggests that the trade surplus with Canada will not shrink further, although with Mexico it may.

Fit for purpose?

There are arguments in favour of renegotiating the relationships within all the world’s trade agreements. Much has changed in trade since they were first conceptualised: digital trade dominates services in particular and services, because of technological change, have become a part of manufacturing. This means that the agreements that were drawn up in the 1990s or earlier are no longer fit for purpose, as they do not cater for the reality of how goods and services are moved across borders in the 21st Century. This is also the case for the EU as much as for NAFTA and there is broad consensus that reforms to multilateral trade institutions are necessary.

However, there is an equal danger of the breakdown in the multilateralism that trade structures such as NAFTA represent, into bilateral agreements at best or trade wars at worst. At present, the ‘trade wars’ are rhetorical but serve to heighten tensions and exacerbate uncertainties for business. NAFTA is a large market, and there are substantial opportunities there for businesses. The current uncertainties, particularly in the US, potentially suggest that there are risks associated with the cost of doing business in the region. While politics dominates the institutions and frameworks of trade in the way it is currently doing, there is a risk that its economic and business benefits are weakened. This is not a price worth paying.

Dr Rebecca Harding is an independent trade economist and former Chief Economist of the BBA (now UK Finance). She is founder and CEO of the TradeTech business Coriolis Technologies, on whose data this article is based

_________________________
Sources

1 See https://bit.ly/2HlDWdm at nafta-sec-alena.org
2
See the Bombardier announcement at https://bit.ly/2GdSuQ5 

Dr Rebecca Harding

Independent trade economist and former Chief Economist of the BBA | Founder and CEO of Coriolis

Dr Rebecca Harding

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