Trade Policy Free Trade Agreements

Trade Policy

Introduction

An FTA (Free Trade Agreement) refers to a deal between at least two countries for reducing obstacles to exports and imports between them. Under free trade policies (FTP), services and products may be purchased and sold over international borders without any (or, at least, with scant) governmental tariffs, subsidies, prohibitions, or quotas for hampering their exchange (Amadeo, 2021). The free trade principle is contrary to economic isolationism or trade protectionism. In the contemporary era, FTP is typically implemented via an official, mutual agreement between involved countries. But an FTP might merely be a lack of restrictions to trade. Governments do not have to take any particular action to support free trade – a hands-off stand that is termed as trade liberalization or “laissez-faire trade” (Barone, 2020). Governments that have put FTPs or such agreements into practice don’t always have to give up total control over exports and imports or do away with every protectionist policy. In the contemporary global trade domain, a small number of FTAs lead to totally free trade.

The NAFTA (North American Free Trade Agreement) is one of the examples of FTAs. Although it was concluded, owing to its replacement (the updated USMCA (U.S.-Mexico-Canada Agreement)) on July 1, 2020, it continues to be of interest when discussing the subject of FTAs as it represented the world’s biggest free trade area created in the year 1994 (Alvarez, 1996). This treaty between the three nations mentioned above did away with the majority of tariffs between these nations. Before NAFTA, never had any developed countries entered into any trade pact with an emergent market nation. Through this Agreement, the three nations agreed upon eliminating obstacles to trade between them. By eliminating tariffs, NAFTA gave rise to more investment opportunities; hence, this paper considers NAFTA as its referral FTA.

FTA Benefits to the trade

Global trade constitutes the contemporary basis of affluence. FTPs have opened up novel areas to invention and competition. Free trade has resulted in improved jobs, greater investment, and fresh market areas. Besides services and products, it also disseminates beliefs and values. As international trade is dependent on traders sticking to agreements, firms and nations are more answerable and, thus, more stable now.

Increased Production

Trade aims at providing access to a larger number and diversity of services and products. The Heritage Foundation claims that free trade promotes competition, encouraging organizations to be creative and develop improved products while maintaining superior quality and low prices (Froning, 2000). It enables firms and regions to concentrate on services or products that they are best at producing. International trade helps companies acquire a larger market share, lower costs, and enhance productivity, thereby resulting in higher production rates.

Economic Development

In free trade, risk-taking is rewarded in the form of greater market share and sales. When America and other large nations make the most of it, they witness economic growth, which overflows into economically unstable, poverty-ridden, small nations open to trade. The Heritage Foundation states that poorer nations trade for capital profit because their private sector payoffs are more instantaneous (Froning, 2000).

International Cooperation

Free trade coerces organizations into standing by the rule of law. All WTO member nations are required to honor every agreement and follow every WTO law. Nations failing to enforce agreements end up losing business, with investors investing elsewhere. For a nation to benefit from free trade, it has to stick to the rules. Further, the Heritage Foundation claims free-trade transmits values and ideas (Froning, 2000) that facilitate the creation of more stable and robust governments within smaller nations.

Resource Allocation

Free trade enhances global resource allotment. If individuals or nations can trade for necessary services/ products, they may concentrate on producing those best. Imports usually suppress inflation as individual services and products spring from their best source of supply. The CATO Institute claims that Americans profit from lower imported goods prices; the money saved may be utilized to buy local services/ products (Glassman, 1998).

Business Incentives

Trade agreements help open markets, in addition to providing protection and business incentives. They cover commitment to safeguarding labor and intellectual property rig and as open areas to the competition. Moreover, they regulate environmental standards as well as enhance customs facilitation. Typically, exporters are more technologically advanced and facilitate increased, improved job creation (Drozdz & Miškinis, 2011). Finance and trade are mutually supportive. Lastly, global investment facilitates increased risk-sharing and diversification.

How FTAs violate the rules of the GATT

“Substantially All Trade”

The above phrase’s meaning is among Article XXIV’s most tricky elements, especially concerning economic sector exclusion from FTAs (Grimmett & Tatelman, 2004). This phrase hasn’t been defined by joint GATT Parties or working GATT parties that have provided inconclusive reports (Davey, 1998). The 1994 Understanding doesn’t clearly describe the term. But the preamble asserts that trade expansions that regional agreements promote are increased with the elimination of restrictive business rules such as obligations between constituent territories extending to total trade; further, exclusion of any key sector diminishes them. In analyzing whether FTAs are compliant with the above responsibility, working parties consider qualitative and quantitative factors (Davey, 1998). Working parties displayed concerns concerning specific agrarian trade exclusion under American FTAs with Canada and Israel; however, neither panel suggested FTA disapproval, which resulted in both reports being adopted.

Status of Safeguard Measures

The GATT’s article XIX, expanded on within the WTO’s Safeguards Agreement, permits parties to levy short-term import restrictions should imports surge. The Safeguards Agreement’s Article 2.1 presents a general rule: WTO Members are eligible to apply safeguard measures to goods only in case they find the goods being imported in such great quantities, relative or absolute to local manufacturing, and under situations that injure or are at risk of gravely injuring the local industry which manufactures directly competitive or similar goods (Oza, 1995).

Paragraph 8(b) of Article XXIV doesn’t list article XIX as an exception to FTA; further, the previously mentioned Safeguards Agreement gives rise to the issue of safeguards’ link to FTAs. Member states of the WTO have voiced divergent opinions on this topic, contending that (1) safeguards aren’t imposable against FTA allies as paragraph 8(b) doesn’t exempt these measures; (2) safeguards are applicable based on MFN, partly owing to the Safeguards Agreement, Article 2.2 requirement that safeguards “be applied to a product being imported irrespective of source”; and (3) safeguards between FTA parties are permitted as long there is no third-party right infringement (Davey, 1998, p.22 -23).

Though not deciding on Article XXIV’s link to safeguards imposition, the Appellate Body and WTO panels have determined a “parallelism” requirement within the Safeguards Agreement which dictates that in the event a grave injury is grounded on every import, including imports from FTAs, safeguards apply to those imports. For instance, in WTO’s challenge to an erstwhile steel import safeguard that the U.S. levied in March of 2002, the WTO panel, as the Appellate Body upheld, censured America for the inclusion of affected product imports from American FTA partners while investigating whether or not greater imports were behind the serious injury while excluding those nations’ imports from remedial safeguards, and failing to offer a sufficient, acceptable reason for safeguard-covered imports alone satisfying the requirements for measure imposition (Grossman & Sykes, 2007).

Dispute Settlement

Paragraph 12 of Article XXIV’s 1994 Understanding has the following provision: WTO conflict resolution procedures can be invoked relative to matters that spring under the Article’s provisions concerning interim agreements and free-trade regions. The provision elucidates that Article XXIV’s review provisions don’t form the sole means of examining FTAs’ compatibility with GATT rules (Grimmett & Tatelman, 2004). Additionally, WTO conflict resolution is available concerning every GATS obligation.

Case of the NAFTA

How it was formed

President Reagan passed the TTA (Trade and Tariff Act) in 1984, giving him special powers to swiftly negotiate FTAs. Going off this initiative, Mulroney, the then-Prime Minister of Canada, supported him, leading to the signing of the 1988 U.S.-Canada FTA, which was implemented the next year (Sraders, 2019).

After President Bush took the nation’s helm, he started negotiating with the then-President of Mexico, Salinas, for developing a trade pact between the two countries. This pact was a part of the former’s three-part strategy – the Enterprise for the Americas Initiative – that also encompassed debt relief initiatives (Sraders, 2019). Mexico’s 1991 demand for a trilateral trade pact gave birth to NAFTA as a free trade means between three North American superpowers. H.W. Bush, Salinas, and Brian Mulroney signed the NAFTA the next year. It came into effect on December 8, 1993, when Bill Clinton had already taken over the nation’s presidency. By January 1994, it was fully in effect.

Benefits of NAFTA to all parties

NAFTA’s influence on actual welfare and GDP, measured using ex-post research, is appreciably lower than that anticipated by ex-ante estimates, despite the absence of extensive literature. Parro and Caliendo (2014) projected effects on welfare from 1993 to 2005 because NAFTA tariff decreases to 0.08 percent for America, -0.06 percent for Canada, and 1.31 percent for Mexico. Up until now, this represents the most positive estimate, which is still well below the majority of ex-ante predictions. A Congressional Budget Office (2003) research estimates yearly NAFTA effect on America’s GDP to lie from 0.001 to 0.005 percent in 1994, and from 0.006 to 0.041 percent in the year 2001. Meanwhile, the World Bank research quantifies Mexico’s greater per capita GDP due to NAFTA at 4 to 5 percent until 2002 (Lederman/ Maloney/ Serven 2003). Rosnick, Baker, and Weisbrot (2004) claim the World Bank’s model utilizes biased data. Employing this very model using reasonable data, the researchers discovered that NAFTA decreased Mexico’s growth rate. Likewise, Romalis (2007) doesn’t find any impact of the Agreement on Canada’s and America’s GDP, although Mexico’s GDP does suffer by 0.3 percent.

Following NAFTA’s adoption, actual wages in the three-member nations were either not improving or, in Mexico’s case (because of its peso-crisis), were falling (Polaski 2006). The above development, although occurring post-NAFTA, isn’t attributable to NAFTA. According to Parro and Caliendo (2014), NAFTA’s tariff drop effects on an actual wage from 1993 to 2005 were positive in the case of America (0.11 percent), Canada (0.32 percent), and Mexico (1.72 percent). Once again, the research is fairly optimistic. Decoupled productivity increase from wages within Mexico and America has been ascribed by Polaski (2006) to labor unions’ reduced bargaining power owing to FTAs. Bronfenbrenner’s (2000) research on factory-closing threats linked to NAFTA corroborates the above idea. Hakobyan and McLaren (2016) indicate that wage rise for American industrial employees impacted by NAFTA was considerably lower. According to Waldkirch (2008), greater FDI inflows due to NAFTA improved Mexican productivity, though FDI’s “[…] effect on average compensation per worker is negative or zero at best” (p.3).

Further, Hanson (2003) suggests that NAFTA increased Mexican income inequality; the impact on overall wage level isn’t known. Wage growth in Northern and high skilled employees exposed to FDI and foreign markets was considerably higher when compared with Southern and unskilled employees. In general, the association between NAFTA and mounting income inequality is, apparently, broadly accepted (Grumiller, 2014). In sum, the majority of ex-post-assessments unearth no major positive NAFTA impact on actual wages. The small number of research works that find positive effects can still fulfill the huge promises ex-ante evaluations have made.

As the political debate before NAFTA adoption revolved specifically around employment, the debate on NAFTA’s actual effect has remained quite heated. Nevertheless, the consensus is unconfirmed expectations. Even Schott and Hufbauer (2007), avid supporters of free trade whose findings were popular before 1994, state that “[…] NAFTA is no more than a blip on U.S. employment picture” (p.85). What’s more, the overall debate moved from ex-ante estimations attempting to evaluate NAFTA-induced job gains to ex-post-assessments concentrating on net losses. According to Scott (2011), as many as 682,900 jobs were displaced in America from 1994 to 2010 owing to NAFTA-connected trade deficits with its southern neighbor, Mexico. His simple computation hints at creating 791,900 jobs by American exports to Mexico, with 1,474,800 jobs lost from its imports from Mexico. Estimations by Kletzer (2002) reveal a loss of 1,238,593 American jobs from NAFTA-linked imports, making up 24 to 27 percent of production job losses from 1993 to 1999; further, overall job losses this same period amount to 10.7 percent. Hinojosa-Ojeda and colleagues (2000) found that 94,000 American jobs were threatened annually from NAFTA-connected imports, based on information between 1990 and 1997. A well-recognized U.S. job loss estimate is put forward by the TAA (Trade Adjustment Assistance) institution, created for absorbing negative impacts of free-trade connected job displacement. NAFTA-TAA information indicates that no less than 845,000 American employees were displaced based on greater Mexican and Canadian imports from 1994 onwards (Public Citizen 2014). More positive figures are anticipated in Mexico’s case due to its lengthy trade surplus with America; however, this isn’t the case. According to Polaski (2006), NAFTA has generated a very small net job gain: “Data limitations preclude an exact tally, but it is clear that jobs created in export manufacturing have barely kept pace with jobs lost in agriculture due to imports” (p.1). The author claims productivity growth is one of the key job killers in Mexico.

Further, Salas (2006) finds that roughly one-sixth of Mexican agrarian sector workers were displaced from the start of the 90s decade, partly due to NAFTA. Corn producers suffered the most, with 1,013,000 displaced jobs (Data: 1991 -2000). Additionally, Salas (2006: 49) records that Mexican FDI inflows have greatly expanded following NAFTA implementation, though these were largely employed in buying extant assets and, hence, didn’t impact the actual economy as anticipated. This is especially interesting as the very optimistic Mexican ex-ante estimations were chiefly a result of FDI flows.

NAFTA interaction with the GATT and other WTO member states

NAFTA explicitly fulfills the conditions the WTO Agreement sets under Article XXIV of the GATT (for a free trade region) and Article V of GATS (for a regional service arrangement). By all reasonable measures, it does away with every major restrictive regulation, including tariffs, trade/ commerce between the US, Canada, and Mexico, and obstacles to the trade of services in innumerable sectors (Abbott, 2000).

NAFTA article 103(1)’s express text upholds extant duties among NAFTA members under GATT, besides stating that the former outweighs the latter in case of inconsistencies. Further, Article 103(2) doesn’t explicitly state that the former outweighs all subsequent agreements. In contrast, for instance, article 301(1) mentions GATT’s “successor agreement” (Abbott, 2000). If the negotiators of NAFTA had aimed for NAFTA overriding all agreements arising out of Uruguay Round negotiations, on the whole (in other words, the WTO Agreement as well as other related agreements), these “successor agreement(s)” would have been referenced in NAFTA’s Article 103.

But, say, the mention of GATT’s “successor agreement(s)” might have a more general meaning as compared to the mention of GATT alone. The GATT Agreement of 1994 has been incorporated in the form of a Multilateral Trade Agreement that applies to every WTO agreement signatory. It is the same as its 1947 version that came into being between NAFTA signatories following NAFTA’s conclusion. The WTO Agreement, in particular, integrates the “acquis” of understandings and interpretations relative to GATT 1947 within its legal system, hinting at the intent for some degree of continuity to exist between the 1947 and 1994 editions of GATT (Abbott, 2000). As integrated into the WTO Agreement, the latter edition effectively functions as a pact that NAFTA signatories signed upon entering the NAFTA agreement. The forms the foundation for the conclusion that NAFTA predominates over GATT’s 1994 version within NAFTA Article 103’s meaning.

But the above conclusion might be challenged by certain terminology used within the WTO Agreement that asserts that the 1947 and 1994 versions of GATT are, in fact, “legally distinct” (Abbott, 2000). If the latter version constitutes a fresh pact only regarded as having been brought into effect from January 1, 1995, onwards (under the WTO Agreement), it wouldn’t be covered by NAFTA Article 103’s exclusive priority rule concerning extant agreements. Nevertheless, the reason for the WTO Agreement’s creation of a legal division between the 1947 and 1994 versions of GATT wasn’t to break the continuity between parties’ responsibilities and rights. This division’s specific goal was to facilitate the institutional transition from the older GATT to the new WTO, employing permitting certain parties of the former deferred entry into the latter agreement concerning the former’s remaining parties for, at least, a certain transition period (Abbott, 1998). Besides this facilitation, the negotiators explicitly conveyed their intent of not breaking continuity from GATT’s 1947 version to its 1994 one.

Whether the GATT referenced in Article 103 of the NAFTA’s priority rule is restricted to GATT’s 1947 edition, or even covers the newer one, isn’t prone to any definite answer. Should the article’s GATT reference be taken to cover both editions, the resultant priority rule proves to be inelegant because the WTO Agreement encompasses considerably more as compared to GATT 1994 (which includes novel area agreements of TRIPS and GATS, as well as numerous supplemental pacts in technical standards, agriculture, and other areas) (Abbott, 2000). NAFTA may outweigh GATT’s 1994 version, in addition to a small share of supplemental deals, while still not prevailing over any other WTO Agreement. The entire array of WTO’s Agreements may make up the GATT “successor agreement(s)” referenced in other areas of the NAFTA Agreement.

Employing the word GATT “successor agreement(s)” in contexts that fall outside of Article 103’s priority rules fails to do away with the ambiguity cleanly. Consider the example of NAFTA, Article 301(1). The article mentioned above encompasses GATT’s Article III as well as relevant interpretative notes. Such exclusive incorporation covers the comparable GATT “successor agreement” provision. Still, if NAFTA negotiators believed the Uruguay Round’s outcome would take precedence over NAFTA via Article 103, the GATT mentioned above successor agreement reference within Article 301(1) of the NAFTA would simply be unnecessary (Abbott, 2000). The novel WTO article or GATT would, through international law, prevail over the previous GATT rule and the NAFTA. Hence, it may be concluded that the “successor agreement” mentioned in NAFTA’s Article 301(1) was because the drafters presumed that, otherwise, NAFTA would outweigh GATT following the Uruguay Round. NAFTA’s Article 301(1) might be aiming to make a specific NAFTA portion clearer, though it still fails to eliminate the ambiguity that revolves around NAFTA Article 103’s meaning.