Trade & Investments

NAFTA’s final clauses were implemented in 2008 and while relative merits continue to be debated, NAFTA has been highly influential in shaping subsequent Free Trade Agreements and affecting the trading patterns of member countries. NAFTA also reached beyond just trade in goods to pioneer measures in respect of intellectual property, foreign investment, dispute resolution and government procurement. It has also helped to facilitate a surge in trading volumes between member countries, and contributed to the creation of regional value chains across North America.

Tariffs

NAFTA provided for the removal of most tariffs on goods traded between member countries. These tariffs were subject to a gradual phase-out period of 15 years, with the last tariffs removed in 2008.

In order to facilitate the removal of tariffs on sensitive goods, the Agreement introduced a variety of transitionary mechanisms. During the phase-out period, member countries were allowed to snap tariffs back to pre-existing levels if a sudden surge of an imported good resulted in deleterious impacts to a domestic market and its producers. It also used an innovative system of tariff rate quotas (TRQs), allowing countries to impose limits on the amount of duty-free goods that could be imported in a given year. NAFTA was the first free trade agreement to use this method.

The removal of tariffs on agricultural goods was a particularly sensitive area of negotiation, and is covered by three separate bilateral agreements – CUSFTA, alongside agreements between Canada and Mexico, and Mexico and the United States.

The agreement between Mexico and the United States is comprehensive, removing tariffs and other restrictions (such as import quotas) on all agricultural products. Reflecting the sensitivities surrounding such broad reaching liberalization, tariffs for products such as Mexican dried beans and corn, and American grain, barley and sugar, were only removed in 2008.

The Canadian agricultural agreements are less expansive and leave TRQ protections in place for dairy, poultry and eggs. Under CUSFTA, the United States also maintains TRQs for Canadian sugar, dairy and peanuts.

Automotive Sector

Building on the provisions of CUSFTA, NAFTA helped to remove multiple barriers to the trade of automotive goods in North America. By the time negotiations for NAFTA were taking place Canada and the United States had already liberalized most of their automotive trade.

The Auto Pact of 1965 removed tariffs on automobiles and parts traded between the two countries provided that that the goods satisfied a 50% national content requirement. While the big three auto producers in the past had relied on expensive branch plants to curtail these restrictions and service the broader market, the Auto Pact allowed them to rationalize their operations and create transnational supply chains.

Capitalising on its cheaper supply of labour, assembly and low-value parts, producers increasingly set up facilities in Canada, while the United States undertook a greater share of research and development, and the manufacturing of high-value parts.3 This development helped to improve productivity and the rate of vehicle production. Between 1964 and 1969, Canada’s automobile production rose by 85% and its productivity by 60%.4

CUSFTA incorporated most of these Auto Pact provisions, however replaced the national content requirement with a regional content requirement to cement the practice of using transnational supply chains. It also introduced restrictions on Canada’s ability to entice foreign auto producers, particularly from Japan and South Korea, with duty drawback schemes. CUSFTA still governs the trade of automotive goods between Canada and the United States.

Through NAFTA, these provisions were extended to include Mexico, which in the past had been reticent to open up its auto market to foreign competition. Under the terms of the Agreement, tariffs on automotive goods were eliminated over a 15-year period. Mexico’s trade balancing requirement, which mandated that $1.75 of goods be exported for every $0.80 of imported goods, was also removed.

The impact of this for Mexico has been large increases in foreign investment from countries such as the United States, Japan and Germany, as well as substantial production growth, with auto trade expanding fivefold between 1993 and 2003, and representing 22% of total exports.5

Energy and Basic Petrochemicals

Negotiations on the Energy and Basic Petrochemicals Chapter were among the most controversial for NAFTA members, with many commentators surprised that provisions in this area were included in the final agreement.6 While some advances were made in respect of removing barriers to energy and basic petrochemical trade, the parties were less successful in eliminating restrictions on foreign investment.

An important backdrop to this Chapter was Mexico’s long history of restrictions on foreign investment in hydrocarbon and basic petrochemical industries, which had a strong political and constitutional basis. While an unwinding of this regime was strongly advocated by the United States, and to a lesser extent Canada, during negotiations, it was largely upheld through a list of reservations on the part of Mexico in an accompanying Annex. These reservations effectively allow Mexico to maintain its restrictions on foreign investment in the aforementioned industries, blocking foreign participation in the production of gas and nuclear energy, and the exploration and refinement of oil. That being said, some liberalization in this area was achieved, with restrictions being eased for some secondary petrochemical products.

On the trading front, NAFTA removed tariffs and import quotas for most energy products. Article 906 of the Agreement does stipulate, however, that countries are allowed to limit the flow of energy goods from another member country if it affects national security or results in critical scenarios, such as energy shortages or acute price fluctuations. This is effectively an emergency clause, however, and has not been activated during the life of NAFTA.

Textiles and Apparel

NAFTA removed all tariffs on the trade of textiles and apparel between member countries, but introduced strict rules of origin. These rules, known as "Yarn Forward" and "Fibre Forward", mean goods are only eligible for duty-free treatment if the yarn, or in the case of cotton, fibre, originates from a member country.

Financial Services

Chapter 14 of NAFTA outlines a number of clauses relating to the liberalisation of financial services.

NAFTA helped to remove barriers to the provision of financial services in the bloc by easing foreign ownership restrictions and setting standards for the treatment of foreign firms in the domestic market. The legal text extends the principles of national treatment and most favoured nation status to firms from member countries, ensuring they receive “competitive opportunities” and are treated “no less favourably” than domestic players.

Some safeguards continue to allow Mexico to request consultations for remedial measures if aggregate foreign market share of a sector exceeds 25%.

While the Agreement opens up participations for foreign firms, it does not allow for them to establish branches in member countries. Instead, separate subsidiaries or entities must be established.

Non-Tariff Measures

A number of non-tariff barriers to trade were removed through Chapter 3, Section C of the legal text. Customs user fees were phased out over a gradual period of time, while existing fees were completely abolished in 1999. Under the Agreement, performance based customs user fees were also largely eliminated, with the notable exception of Mexico’s Programa de Importacion Temporal por Exportacion.

Government Procurement

NAFTA prescribes that member countries shall receive non-discriminatory treatment when bidding for government procurement contracts. This clause excludes goods related to national security or defence. Another important exception is the fact that NAFTA only covers federal government procurement contracts, as well as agencies listed in the Annex, not those of state or local governments.

An important implication of this Chapter was that it opened up opportunities for Canadian and American firms to bid for supply contracts for Mexican energy and utility giants Petroleos Mexicanos (PEMEX) and Comision Federal de Electricidad (CFE).

Sanitary and Phytosanitary

NAFTA established that countries may only impose sanitary or phytosanitary standards which have a scientific basis and are aimed at providing reasonable protections to the country in question. In a bid to encourage regulatory transparency, new standards and their guiding principles must also be publicised prior to their implementation.

Trade in Services

Service providers benefit from NAFTA through the removal of barriers to cross-border trade and investment. Under the legal text, most favoured nation status is extended to service providers from member countries, ensuring they receive comparable treatment to domestic firms in most aspects of their operations, including in the granting of licences. State and municipal bodies are not bound by the national treatment principle, however, meaning they can maintain restrictive, discriminatory regulations.

Another notable feature of the Agreement is removal of the legal requirement that a provider establish a local presence before offering services. The scope of service providers covered by the Agreement is quite broad, and covers sectors such as accounting, consulting, advertising, construction, legal services and architecture. Sectors excluded from the Chapter include international airlines and maritime shipping.

Telecommunications

NAFTA opened up the telecommunications market in North America by removing restrictions on the flow of equipment and the provision of services. As per Chapter 13, tariffs on telecommunications equipment were gradually phased out over five years, with 80% of tariffs removed upon the implementation of the Agreement.

Canadian and American telecommunication equipment manufacturers particularly benefitted from this provision, as the opening up of the Mexican market coincided with a large-scale modernization of its telecommunications infrastructure.

On the services side, NAFTA liberalised the provision of enhanced, or value-added, telecommunication services. Enhanced telecommunication services involve computer-processing applications during the course of data transmission (rather than the pure transfer of data), such as electronic emails, databases and voice-mail. The legal text extends most favoured nation privileges to these service providers, ensuring they have fair and equitable access to transport networks and suitable equipment. It also ensures non-discrimination in the granting of licences. Pursuant to Chapter 12 of the Agreement, investment restrictions for enhanced service providers are also lifted, which removed Mexico’s former requirement limiting foreign ownership to 49%.

It is important to note, however, that these provisions do not cover basic telecommunications services.

Transport

NAFTA outlines a number of mechanisms to liberalize the transport sector, particularly in relation to bus and trucking services. Extending most favoured nation status to foreign companies and calling for a harmonization of safety standards, the legal text aims for the creation of a truly competitive transport market, allowing American, Canadian and Mexican bus and trucking companies to compete in the provision of cross-border services. Implementation of this Chapter, however, has been subject to extensive delays.

The United States implemented a moratorium on cross-border trucking in 1982, through the Bus Regulatory Reform Act. Prior to this, foreign buses and trucks operated freely in the United States so long as they conformed to licencing and safety requirements. Shortly after its introduction, a decree was given which exempted Canadian providers from the moratorium. Mexican trucks were only permitted to deliver goods within a 25-mile zone of the border, so as to allow them to transfer their cargo to an American provider.

When negotiations for NAFTA commenced, the removal of the moratorium as it applied to Mexico was deemed a priority. Negotiators agreed to a gradual winding back of the restrictions in an attempt to allay community concerns regarding asymmetrical safety standards. The first tranche of changes was due to come into effect in 1996, and would allow Mexican trucks to operate on all roadways in American border states. By 2000, these trucks would then be able to operate freely on all American roadways.

A day before the first phase of liberalization was due to come into effect, however, the United States rescinded its commitment to the provision. This move was largely due to political pressure from lobbying groups, which cited safety and job loss concerns. Mexico retaliated by blocking the movement of US trucks in its territory. Under the terms of Chapter 20 of the Agreement, Mexico also took the issue to an arbitration panel, claiming the US had violated its obligations under the text. The arbitration panel ruled in Mexico’s favour, allowing it to impose retaliatory tariffs on a range of US products. As of the 2014, it is believed these tariffs totalled $2 billion dollars.7

After a series of pilot programs from the early 2000s onwards, the Federal Motor Carrier Safety Administration of the United States announced on January 9, 2015 that the provisions of NAFTA will soon be implemented. Many see this announcement as an important part of finalising NAFTA’s liberalisation efforts vis-à-vis transport, particularly since roughly two-thirds of American and Mexican trade is transported via the road.

Intellectual Property

NAFTA codifies high standards for the protection of intellectual property, and was the first trade agreement to incorporate provisions in this area.

Chapter 17 of the legal text makes it incumbent upon member countries to harmonize their baseline requirements vis-à-vis intellectual property rights by signing key international conventions. These conventions include the 1971 Geneva Phonogram Convention (covering sound recordings), the 1971 Berne Convention (covering literary and artistic works) and the 1967 Paris Convention (covering industrial property).

In general, these Conventions prescribe that intellectual property must be protected for the life of an author (if the product is an artistic work), plus an additional 50 years. NAFTA also expands the scope of some of these conventions, including computer programs and datasets under the framework of the Berne Convention, for example. Previously uncovered areas, such as semiconductor integrated circuits, trade secrets and encrypted satellite signal are also afforded protection.

Regarding enforcement, NAFTA stipulates that companies from member countries must receive the same spectrum of rights and opportunities for redress as would domestic firms. Companies also have access to arbitration and compensation pursuant to the dispute resolution provisions of the Agreement.

Moreover, the Agreement directs the customs agencies of member countries to screen and halt the flow of counterfeit or pirated goods which are in violation of the intellectual property of member countries or investors.

Dispute Resolution

The NAFTA legal text creates a strong framework for the resolution of trade disputes. These mechanisms cover unfair trade practices, under Chapter 19 on Anti-dumping and Countervailing Duties, and the implementation and application of the legal text more generally, pursuant to Chapter 20.

Resolution mechanisms for both chapters vary slightly, however both rely upon arbitration panels as a last resort to make rulings and recommend remedial action. Cases regarding unfair trade practices, covered under Chapter 19 of the legal text, will normally be referred to an arbitration panel after a national investigation finds clear instances of unfair behaviour. Administered by the Permanent Secretariat, these panels are typically constituted of international lawyers and have the power to recommend remedial action. If these recommendations are not followed, then the affected country can impose retaliatory measures.

The Agreement also creates a framework for disputes regarding the implementation and application of the legal text itself, as described in Chapter 20. The process for resolution is similar to that prescribed for Chapter 19, however involves a more extensive consultative and mediation process. After negotiations between member countries are deemed unsuccessful, the NAFTA Free Trade Commission will typically be called upon to investigate the matter and recommend remedial action. As it is unlikely that disputes will be resolved by mutual consent at this stage of the process, the NAFTA also provides that the arbitration panel process used for Chapter 19 can be used if the issue is not resolved by the Commission. As with Chapter 19, retaliatory measures can be imposed as a last resort.

Competition Policy, Monopolies and State Enterprises

NAFTA prescribes that member countries will uphold or adopt rules against anticompetitive business practices, and will enforce domestic competition law. While the legal text calls for a harmonization of competition policy, it provides no clear mechanisms or mandate for doing so.

Chapter 15 also outlines certain standards for the behaviour of state enterprises and monopolies. While not forbidding the formation of monopolies (instead only requiring notification of an entity’s intention to create one), NAFTA requires that they, along with state enterprises, operate according to the principle of national treatment.

Rules of Origin

NAFTA establishes a comprehensive rules of origin regime, providing detailed formulas and guidelines to determine whether a good originates from a NAFTA member country. As the Agreement only extends concessions and preferential treatment to goods originating from countries in the bloc, the rules are used to identify which goods meet this classification standard. The rules were also implemented to block the practice of using member countries as platforms for the export of goods which had not undergone significant transformation in a member country.

Different methods are used to determine whether a good is NAFTA originating depending on its inputs, place of production and level of transformation. Wholly obtained or produced goods, that is, goods produced in or consisting solely of inputs from member countries, are deemed automatically originating. Goods that typically fall under this classification are either agricultural or resource products, such as minerals, animals, vegetables and seafood.

The second classification system is used for goods that are composed of inputs from one or more non-NAFTA member countries. In order to qualify for origin status, these goods must be significantly "transformed". Annex 401 provides detailed outlines of how this is to be calculated. The difficulty associated with this process is compounded by the fact that the mechanism provided in the Annex is not homogenous, and variously relies upon tariff switch and regional value added methodologies.

In order to cater for goods which are predominantly composed of originating goods, but nonetheless do not qualify under the tariff switch provision, the NAFTA outlines a de minimis rule. This rule stipulates that goods with less than 7% of non-NAFTA originating goods are eligible.

Regional valued added formulas are also used for the determination of origin for some goods. While varying depending on the product, this rule typically stipulates that 50 to 60% of the value of the good's content must have its provenance in a member country. This provision typically covers non-assembled goods, such as components and parts.

Investment

NAFTA’s chapter on investment extends a number of basic rights to foreign investors from member countries, and introduces stringent enforcement mechanisms.

The basic premise of the Agreement is the understanding that foreign investors should receive Most Favoured Nation (MFN) status, meaning they and their investments should receive no less favourable treatment than domestic firms. This provision protects foreign investors from discriminatory treatment and state expropriation, and entitles them to due process. An important caveat, however, is the fact that this principle does not have uniform applicability.

The accompanying annexes in the legal text outline a number of reservations and exceptions on the part of member countries. While some of these reservations were subject to gradual phase out periods, many are permanent, meaning there are still cumbersome investment restrictions in some sectors. For example, as per Canada and the United States’ listed reservations, industries such as social services, fishing, agriculture and aero transport are exempt from investment liberalization.

Similarly, pursuant to the Annex, Mexico is able to maintain a 49% foreign ownership threshold in the areas of construction, livestock, agriculture, petrochemicals and petroleum. The Annex also provides for “tit for tat” measures, meaning that in a number of listed sectors, discriminatory treatment can be implemented in retaliation for commensurate treatment in another country.

One of the key features of NAFTA’s investment chapter is that it provides dispute resolution mechanisms when investor rights have been infringed. While controversial, many consider this provision to be one of the most important provisions in the Agreement. On a basic level, Chapter 11 allows foreign investors to take states to arbitration and seek compensation if they have been treated contrary to standards outlined in the chapter. This mostly applies to instances when a government expropriates assets without providing due compensation. If negotiations between the affected party and the government in question do not result in a satisfactory resolution, then the affected party can then resort to binding arbitration, delivered through either the International Centre for the Settlement of Investment Disputes or the United Nations Commission on International Trade Law.

The appointed arbitrator is able to investigate the claim brought before it, and where appropriate, award monetary compensation. It does not have the power to force a government to reverse its act of expropriation, however. Chapter 11 was included in the Agreement on the understanding that extending hypothetical rights and privileges to foreign investors, without proper means of enforcement, would not prove as substantial an incentive for the flow of investments across borders.

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