. .

. fle
Dick Anney Chairman 26th District, Texas

September

13, 1993

The North American Free Trade Area (NAFT A) agreement, which brings Mexico into the current Free Trade Area (FTA) between the U.S. and Canada and expands its provisions, offers an opportunity for American firms to get in on the ground floor of what promises to be one of the world's major new growing markets. In addition to more employment ancj business opportunities for Americans, NAFT A creates pressure for other countries in this hemisphEtre to seek similar agreements with the U.S. Although some Republicans oppose NAFT A, most Republican Members believe that NAFTA is key to America's future prosperity and competitiveness as well as hemispheric pe.ace and ~)ecurity. Because NAFTA essentially eliminates government controls over trade with Mexico and Canada, it gives individual Americans both the freedom to sell their goods and services to a vastly expanded market as well as the freedom to purchase a wIder variety of goods and services at more competitive prices. This Issue Brief outlines the main provisions of the NAFT A agreement and its side agreements on the environment and labor, and analyzes the likely economic effects of ratification.

Since the mid-1980s, and particularly under current President Carlos Salinas de Gortari, Mexico has implf~mented major free market reforms, including joining the GA TT and liberalizing trade and investment laws as a means of invigorating its depressed, debtridden and overly socialized economy. The Mexicans hope to cap this reform with a free trade area with the U.S.

1818l.ONGWORTH HOUSE OFFICE BUILDING, WASHINGTON, D.C. 20515 {202)22S-5107

Mexico is America's third largest trading partner. Since Mexico initiated itS economic reform program, it has become an even larger importer of much-needed American goods. (See Table 1) American exports have jumped by nearly 350 percent since 1986.
Table 1 --U.S.-Mexico Bilateral Trade

{in $billions)

From the perspective of the U.S., the North American Free Trade Area is at bottom, as its name suggests, an agreement that opens Mexico's market to American exports. Specifically, it brings Mexico into the U.S.'s existing FTA with Canada ar)d expands the provisions of the pact.
.

Tariffs. NAFT A will phase out all tariffs on goods and services traded betweerl the member countries. This Is a significant benefit for the U.S. becauS'8 Mexico's tariffs on American goods average about ten percent while U.S. tariffs on Mexican products average between three and four percent.
If the three governments approve NAFT A. some tariffs will be eliminated immediately when the pact takes effect on January l' 1994. Other tariffs will be pha..c)ed out in five year intervals. with all tariffs elim inated after fifteen years. Most trade will be duty-free after ten years.

Rules of OrlQln. As with the U.S.-Canada FTA, NAFTA contains rules of origin to prevent non-member countries from using one NAFTA country as a way to channel goods into another while avoiding tariff or other trade restrictions. The most notable rule requires most motor vehicles to contain 62.5 percent North American content. Motor vehicle parts constitute America's largest export to Mexico, while parts in addition to vehicles constitute America's largest export to Canada. This rule of origin Is meant primarily to prevent Japanese firms from using assembly plants In

Mexico as a way to Increase sales of vehicles

.

In the U.S

Trade In Services. NAFT A also provides for removal of most barriers to trade in services. This will allow American banks, securities firms and Insurance companies, which generally have been barred from Mexico, to operate south of the border. Barriers to trade in other services will be eliminated or reduced as well. In general, NAFTA mandates .national treatment,. meaning that whatever treatment is extended to domestic service providers must be extended to providers from all NAFTA countries. For example, if domestic Mexican companies are allowed to market securities in that country, American investment houses would enjoy the same freedom and would not be subject to discriminatory regulations issued by the Mexican government.
Aarlculty!!. In a major breakthrough in an historically thorny area, NAFTA provides that Mexico and the U.S. will convert their non-tariff barriers on agricultural trade (for example, quota restrictions) into tariffs and phase them out over fifteen years.

Enerav. NAFT A liberalizes trade in electricity and natural gas, allowing foreign firms to bid on supply and service contracts with Pemex, Mexico's state oil company, and the State Electricity Commission. While under NAFT A some restrictions on foreign ownership in the energy area would remain, it is important to note that in recent years Mexico has allowed foreign involvement in peripheral energy-related operations, and that under President Salinas, the Mexican government is moving slowly towards allowing more foreign involvement in the energy sector .

What
.

NAFT A Doesn't

Do

Unlike the current efforts by the European Community to remove all barriers to the movement of goods, services, capital and labor, NAFT A does not liberalize immigration. It does allow for temporary entry of no more than 5,500 Mexican businessmen, but America can keep its immigration restrictions, tighten enforcement or tighten the laws themselves. Many ~ponents allege that NAFT A will open Mexico to a flood of American firms fleeing south of the border to take advantage of cheap labor. But Mexico ,already has removed most of its restrictions on foreign investment and ownership of manufacturing facilities. The American businesses that want to move to Mexico can do so already --as many have. NAFTA doesn't create incentives to move American businesses south of the border, but, because of the reduced Mexican tariffs, it provides Incentives to service Mexican markets from the U.S. 3

..

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This allegation also depends on the erroneous assumption that businesses necessarily follow low wages. If low wages were the only factor Influencing the migration of businesses, the low wage, less developed countries of the world would have attracted businesses long ago and would no longer be less developed. In reality, many factors, such as transportation costs, energy costs, education and productivity of workforce, and government policies, affect business decisions on where to locate. Several years ago, foreigners were allowed to own only 49 percent of enterprises in Mexico. Over the past decade, Mexico has made more and more exceptions to its ownership restrictions, and has scrapped many of them entirely. The bottom line on business relocation Is that NAFT A will have a minimal Impact compared to Mexico's reform of Its foreign ownership provisions.

When President Clinton assumed stewardship of NAFT A from President Bush, he insisted on negotiating side agreements due to the concerns of labor and environmental groups. Business groups were critical of Clinton's initial description of the purpose of the agreements maintaining that they would subject American business to even more government control. Free market supporters of NAFT A argued that the side agreements would make a free trade agreement into a government managed trade plao, empowering international bureaucrats instead of American businesses and consumers. The political dilemma of the Clinton Administration was that if the side agreements satisfied labor and environmental groups, they would likely alienate businesses and free traders and vice versa. Prior to announcement of the side agreements, some labor groups stated that they would settle for nothing less than side agreements that impose American labor standards and wages on Mexico. The final Clinton Administration side agreements did not appease labor and it probably was not realistic to expect that they would.
Enviroomental groups also feared that under NAFT A, Mexico could radically reduce or fail to enforce its own environmental laws as a means to attract American firms, causing similar policies to be adopted in the U.S. The side agreements have satisfied some but not all of the major environmental groups. Regardless of the content of the side agreements, there probably is little danger of the .competition-through-pollution. scenario that was originally feared, because, as discussed further below, the modernization of the Mexican economy will involve using resources in a less wasteful manner. Nor do the side agreements establish trade and force onerous environmental
4

manage

an international bureaucracy that will and labor regulations on the NAFT A

~ .

countries, as some businesses and free traders feared. The difficulties in getting through the intricate system established by the side agreements ensures that countries will pursue cases only in the face of grievous provocations. There are strong incentives for all par1ies to .settle out of cour1,. that is, to come to informal agreements. The labor and environment side agreements are summarized below

The Environmental
.

Commission

The side agreements establish a North American Commission on Environment. At the top is a Council made up of high-Ievel representatives from the three member governments. The Council is assisted by a Secretariat and an Executive Director with a certain degree of independence from the NAFT A governments.
There are two processes that the Commission process and a dispute settlement process.
Inaulrles

can under1ake: a fact-finding

Fact-flndlna

The Complaint. Private parties from the NAFT A countries can bring to the attention of the Secretariat enforcement problems with a NAFT A country's own environmental laws. However, the Secretariat need not act on every nuisanc~ complaint. To go to the next step in the process, the complaint must m"eet certain mandatory criteria. Seeking Explanation from Governments. If the Secretariat finds a complaint to have merit and if it meets the mandated criteria, the Secretariat asks the accused government for information regarding the issue. If that government indicates that there is an ongoing domestic case or legal proceeding concerning the alleged non-enforcement, the Secretariat must drop its inquiry. If the government indicates that the accuser has not sought a remedy through the country's own legal system, the Secretariat could drop the inquiry. Other reasons given by the government might also cause the complaint to be dropped, for example, that enforcement is inadequate due to lack of governmental resources. There are also a number of protections to allow a government to legitimately refuse to turn over information to the Secretariat. The Secretariat does not have subpoena power. . Whether to Fact-flnd. If the Secretariat finds the government's explanation inadequate, then it asks the Council of representatives of the three governments whether a fact-finding study should be undenaken. Two of the three governments must agree in order for such a study to be conducted.
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The Study. Upon Council approval, the Secretariat now undertakes its study of the erlforcement situation. The study is designed to be nonjudgmental, focusing on the facts of the situation, government's explanation and the critics' allegations. presenting both the

Issuing the Report. The members of the Council are given a draft report. Two of the three must agree to make the report public. If two of the three think the report inadequate for any reason or if the governments involved are satisfied that the problem is being dealt with. the report is not issued. After the Report. Once the report is released, the process ends. The report is meant to call attention to failures by a country to enforce its own laws on the belief that public exposure will pressure governments to abide by their own environmental laws.
Dispute Resolution

The Consultation. If one of the member governments believes that another is engaging in: 1) a .persistent pattern of failure to effectively enforce. its own environmental laws; 2) that involves .workplaces. firms, companies. or sectors that produce goods or provide services traded between the parties or that compete with goods produced -or services provided by another party,. it can request consultations with the government in question. Patterns can only be traced beginning with NAFTA implementation. presumably starting January 1, 1994. There is a time limit to these consultations. If the accused government convinces the other government that its complaint is ill-founded or that it is taking steps to reverse the pattern, the case ends here. [)eclslon to Investigate. If a government is not satisfied in the consultative stage, it must secure the agreement of the third NAFT A government (in other words, the non-party to the dispute) to convene an investigative panel.
The Panel Study .If two of the three governments ask for a panel study I the panel members are selected from a pre-chosen roster of experts, some picked by each of the three NAFT A governments. The expert panel prepares the report on the complaint. Finding. of Violation. If a government is found to be engaging in a pattern of failure to enforce its own laws where tradable goods and services are involved, that government has 60 days to offer a remedy to the practice 'which the panel must certify.

The FIne. If no remedy is agreed to, the accusing country can ask the
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panel to fine the accused government up to $20 million and request again a plan to remedy trle offense. No private party or business would be subject to a fine. The dispute is solely between the governments. The fine would go into an enforcement trust fund, not to one of the accusing governments.
Trade sanctions. ~ if a country fails to pay its fine or carry out its remedy plan can another NAFT A country resort to tariffs to collect the value of the fine. If possible, the tariffs are to be levied on goods or services that were subjects of the case.

It is impor1ant to note that the level of the tariff sanction can be no higher than the pre-NAFTA tariff level. This means that in the worst possible case, tariffs on a limited number of goods will go to their pre-NAFTA, that is, their current, levels. Of course, without NAFT A .!! tariffs on American expor1s to Mexico would remain at current levels.
Sanction appeal. If a country believes that the tariffs levied against exceed the value of the fine, it can appeal the fines to the panel. it

The Labor

Commission

The operation of the Labor Commission is in most respects simirar to the operation of the Environmental Commission. As such, it would focus only on the enforcement of laws and not on forcing changes in laws, so that, for example, a U.S. enterprise zone law allowing a sub-minimum wage could not be acted on by the Labor Commission. The differences between the Labor and Environment Commissions are that, under the labor agreement:
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Private parties cannot go to the labor Secretariat with a complaint. They must go to an office established by the member governments, according to its own laws. The structure and procedures of the national office are left to the discretion of each country. Presumably, the national office would then decide whether to seek a fact-finding study. A dispute settlement process cannot be initiated by two of the three Council members without a finding by the experts panel of a failure to enforce its own labor laws where a trade issue is involved. Side Agreements Infringe on U.S. Sovereignty?

Do the
.

Fre&Market and Environmental Reform Concerns. Now that the side agreements have been announced, it is clear that many of the fears of the side agreements skeptics have not been realized. Judging from the text of the agreement, free market advocates need not fear that environmental 7

groups will use the side agreements as a means to impose even ~ regulation on the American economy as private parties do not have a right of action In U.S. courts based on a Commission panel finding. The issue is solely between the governments.
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Free market advocates have also expressed concern that the side agreements would prevent the U.S. from changing unsound environmental or labor laws. The side agreements only deal with failures of a country to enforce Its own laws already on the books. They do not deal with changes In a country's laws. NAFT A itself does state that .it is inappropriate to encourage investment by relaxing domestic health, safety or environmental standards. (Article 1114) and allows for consultations if one country believes another is engaged in such a practice. But NAFT A does not provide a mechanism by which member governments can act against an alleged violator. The hortatory language of NAFT A does not confer upon any international body legal authority over U.S. domestic affairs. The environmental agreement makes clear that, while NAFT A countries are urged not to reduce environmental protection, they still retain the right to make their own policies. Beginning the side agreement is a Preamble .Reaffirming the sovereign right of States to exploit their own resources pursuant to their own environmental and development policies And Article 10 of the side agreement, while stating .each Party shall insure that its laws provide high levels of environmental protection and shall 'strive to improve these laws,. does so while .Recognizing the right of each Party to establish its own levels of domestic environmental protection and environmental development policies and priorities and to adopt or: modify accordingly its environmental statutes and regulations .0. NAFT A In no way would prevent a country from adopting free marketoriented reforms of Its environmental laws. In fact, if laws on the books provide little or no protection of the environment while imposing huge economic burdens on the economy, a NAFTA country will have an even greater incentive to replace it with a property-rights, market-based environmental protection law because inefficient environmental laws could no longer be .subsidized,. or otherwise compensated for, by erecting trade barriers.

Do the Side Agreements

.

Help the Environment?

With or without the side agreements, environmentalists need not fear a wholesale reduction in U.S or Mexican environmental standards or reduced enforcement of environmental laws. The side agreements, ~ile establishing
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the .environmental Commission, make it very difficult for the Commission to issue a critical repo!'t or impose a fine, and virtually impossible to impose sanctions. At best. the Commission is a mechanism that can expose to public criticism serious enforcement failures. In any case, the Mexican government is already moving toward Improving the quality of its environmental law enforcement.
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Thus, regardless of the impact of the side agreement on the environment. NAFTA as a whole should be of considerable benefit to the North American environment. Economic development allows countries to better deal with their environmental problems. A recent Princeton study, for example, found that as per capita Incomes grow above about $4,000, the environment tends to be better cared for and pollution levels go down. This fact makes conceptual sense. Development means using resources more efficiently. A Mexico modernizing its economy, for example, will purchase more efficient industrial equipment, primarily from the U.S., which will be more energy efficient and pollute less. Pollution In socialistic countries Is In part the result of a lack of private property rights. When, for example, the government of Mexico allows farmers to cut down rain forests, over-plant for a few years, destroy the land, and then hand over another free parcel of government land to destroy; .it is ttle lack of an owner that causes the problems. There are numerous, similar examples from the former Soviet bloc.

Most labor union leaders sought a labor side agreement that would somehow impose U.S. wages and bulrdensome labor laws in Mexico. The NAFT A governments did not negotiate such an agreement, and subseq~Jently these union leaders are (jisappointed with NAFT A. They point out that. for all practical purposes, at best the Labor Commission can publicize persistent failures by a government to enforce its own laws. But American workers should not be disappointed. NAFT A will create hundreds of thousands, and perhaps millIons, of new jobs for Americans. Just as important, real w,ages in all NAFT A countries will rise. Wages --real purchasing power --irlcrease only when labor productivity rises. In other words, workers must produce goods and services more efficiently in order to be able to trade their labor for higher real wages, that
a

is,

greater

purchasing

power.

Free trade, by removing tariffs that reduce trade and raise prices, encourages greater production. Division of labor allows individual firms to specialize in the production of goods and services at which they are most efficient. This means higher output, greater wealth In a country, and consequently higher real purchasing power for workers. Freer trade between two countries, as between two states within a country, makes possible greater economic output and thus higher wages overall.

The

Economics

of NAFT A

The economic benefits of NAFTA have been well-documented by independent, scholarly studies. The unanimous conclusion of reputable economists Is that both the U.S. and Mexico will gain jobs and add to economic growth. Among the benefits to America:
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The u.s. is guaranteed access for its exports to a market of 80 millIon people and $300 billion In GDP . The u .s. will be in on the ground floor of a what prom ises to be one of the fast-growing .Latin Lions. of the future. If the U.S. had established a FT A 30 years ago with Japan, it would today have a far larger share of that market and would not be spending years trying to force Japan to reduce its trade barriers. The U.S. can avoid a similar problem with Mexico through NAFT A. . American firms will see exports to Mexico rise even higher than the record $40 billion in exports in 1992. In anticipation of NAFTA, numerous American enterprises are poised to sell more of their products In Mexico when trade barriers are dropped. More jobs will be created for Americans. Specifically. the International Trade Commission estimates that between 35,000 and 93,000 Jobs will be created over five years. Independent economists Gary Clyde Hufbauer and Jeffrey J. Schott of the non-partisan Institute for International Economics estimate the number of new Jobs at 170,000. Mexico also stands to gain from NAFT A. The benefits to Mexico include:

The Mexican government sees N AFT A as a means of making permanent the free market reforms it has implemented. The more integrated the Mexican economy is with the U.S., the more difficult it will be for a future

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Mexican economy.
.

governments

to repeal market

freedoms

without

destroying

their

The confidence in the Mexican economy and reform program that will come with passage of NAFT A will prevent current investors and lenders from pulling their funds out of Mexico, which would seriously harm that economy and perhaps create a new debt crisis.

Some NAFT A proponents consider the strategic international political advantages of the agreement to be more important than the immediate economic benefits.
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U.S.-Mexlco Relations. NAFTA places U.S.-Mexico economic and political relations on a solid, friendly basis. Historically, U.S.-Mexican relations have been turbulent, permeated by distrust and punctuated by wars and military interventions. A key aim of Mexico's 1910 revolution was to drive out American investors and to distance the country economically from its powerful northern neighbor. More recently, Mexico has served as a base of operations for agents of both Nazi Germany and the Soviet Union in this hemisphere. Political and economic instability in Mexico has led America to send in troops and has caused waves of Mexicans to flee to the U.S. A prosperous, stable Mexico, like a prosperous, stable Canada, will head off a potential future foreign policy nightmare very close to ho",e.

Comeetltlon for Free Markets. A second strategic benefit of NAFJ A is that it creates an incentive for non-NAFTA countries to seek similar arrangemerits. Rather than a .beggar-thy-neighborcompetition to close markets, NAFT A creates a competition for more free trade. A non-NAFT A member is at disadvantage trying to sell its goods, for example, in Mexico competing against American products. Only by participating in a similar market liberalization agreement, will a non-NAFT A country be on an equal free market footing. Leading to a Free Trade Hemisphere. Building on this incentive, a third strategic benefit of NAFT A is that it may lead to a free trade hemisphere, Which will strengthen immensely America's global economic and political position. Over the past decade many countries in this hemisphere have, like Mexico, been confronted with the failure of their overly socialized economies and non-democratic political systems. Chile has been the most successful so far in establishing a free market economy and placing democratic institutions on a firm footing. It has a liberal trade agreement with Mexico

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and has expressed an interest in joining NAFTA. As a long-term policy strategy, !he lJ.S. should foster a prosperous hemisphere.
.

foreign

Strenathens U.S. Hand at GATT. Finally, ratification strengthen the l_' S. in its dealings with the EC, Japan because of the new power of the NAFT A trading bloc.

of NAFTA would and in the GA TT

In sum, just as individuals are better off as prosperous people in a prosperous neighborhood, so are prosperous countries better off in a prosperous hemisphere. This common sense notion leads to the conclusion that not only will NAFTA help all three countries economically, but it will also help avoid future U.S. foreign policy and national security problems.

A growing, prosperous Mexican economy will offer greater job opportunities for Mexicans. This will help remove the major Impetus for Illegal Immigration to the U.S. Mexico has a young and fast-growing population. That country's economy must grow by at least three percent annually simply to absorb the new workers entering the labor market. By boosting economic growth in Mexico, NAFT A makes it more likely that unemployed Mexicans will not seek economic refuge in the U.S.

CIEMEX, part of Wharton Econometric Forecasting Ass;ociafes, conservatively estimates that passage of NAFT A would reduce Illegal Immlgrsltlon by 326,000 between 1994 and 2002. Some critics fear that NAFTA will increase economic activity on the U.S.Mexico border, thus giving more Mexicans an opportunity to slip into the U.S. illegally. In fact, border economic activity currently is associated with the maquiladora factories, which re-export most of their goods back to America. NAFT A will foster development In Mexico's Interior, away from the border . The Mexican government fears that rejection of NAFT A would cause current investors to pull out of Mexico. slowing down the economy. This would almost guarantee thousands of additional unemployed Mexicans fleeing to the U.S.

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With NAFT A negotiated and the side agreements soon to be signed by the three NAFTA governments, the Administration and Congress must consult closely to devejop legislation .necessary ana appropriate. to implement the NAFTA agreement in U.S. law. This process will occur in several stages.
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Currently, Administration representatives are briefing Hill staff on the general concepts contained in the final Agreement and the changes in U.S. law they have identified are necessary to implement NAFT A. Late in September, congressional committees --coordinated by the House Ways and Means Committee and the Senate Finance Committee along with six or seven other committees in each house --will likely begin the so-called .mock mark-up. process. In these mock mark-ups, Members w.ill work with Administration representatives to develop the legislation needed to implement NAFT A. Administration representatives, for example, will advise Members .whether proposed amendments are consistent with the NAFT A agreement as negotiated. The committees will ultimately vote on the proposals offered in the mark-up. When the committees in both houses have worked out their versions of the legislation, a mock conference between the House Ways and Means Committee and the Senate Finance Committee will reconcile differences in tt1e two versions. The resulting .consolidated text. will be given to the Administration. T~ Administration will review this text, make any changes it thinks nQCessary, and then officially submit to Congress: 1) the NAFTA agreement; 2) the implementing legislation for NAFT A; and 3) a Statement of Administrative Intent informing Congress of the actions the Administration will take under its own authority to implement NAFT A. This communication is expected in November. Under the .fast-track. legislative authority, NAFT A must be voted on within 90 legislative days of official submission. The House Ways and Means Committee and Senate Finance Committee may hold hearings on the implementing legislation as transmitted by the President. But since most of the battles over NAFT A will have been fought out in the informal mock mark-up sessions, these hearings are not expected to be lengthy. Finally, the full House and Senate will vote on NAFTA, with House preceding Senate consideration. Under the .fast-track. authority, no amendments to the implementing legislation will be in order on the floor meaning that the Agreement will be voted up or down.

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At this point, the timing of the final vote is uncertain, with estimates ranging from late November or early December to early 1994. As negotiated by the NAFT A countries. the Agreement was intended to take effect on January 1I 1994.

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