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Is there a role for small business in the North American Free Trade Area?

With the United States, Mexico and Canada poised to embrace creation of the world's largest and richest trading bloc, there are concerns that small firms will be left on the sidelines. This author argues the "problem" may be perception and not reality.

The U.S. economy has been characterized as a dual economy, made up of large corporations on the one hand, and many small and medium-size businesses on the other. Although the large corporate sector gets the biggest spotlight of attention in the United States, the small business sector has been been the mighty engine of robust job creation and innovation. Will the growing contributions of small and medium-size firms be diminished by events that develop as a result of ratification of the North American Free Trade Agreement? Or, will U.S. participation in the bloc lead to greater internationalization of U.S. small business and, therefore, to greater U.S. success in the global economy? U.S. small business, although entrepreneurial, has not been adventurous about becoming involved in the global economy in the past, which leaves the sector's future viability in some doubt. If the new trading bloc environment leads to more small businesses entering into the international economy, it would seem that the entire U.S. economy would be helped.

Regional Trading Blocs

There is a movement away from an environment characterized by increased free, open trade between all nations. There are now 23 regional preferential trading agreements of various kinds (free trade area, customs union, common market) inclusive of 119 countries and accounting for 82 percent of goods traded in the world.[1] It is debatable whether such regional agreements lead to more free trade or are protectionist in nature, but the important point here is that such agreements are meant to reduce trade barriers among member nations while maintaining barriers against nonmembers.

The U.S.-Canada Free Trade Agreement (FTA) of 1989 is a recent addition to the regional agreements. The FTA created a "free trade area" between the two nations in which tariffs and nontariff trade barriers are to be nearly eliminated over a ten year period. Because it creates a free trade area, the FTA does not deal with free movement of resources or labor and does not require that the two nations have identical barriers concerning trade with others. An agreement was recently negotiated that would add Mexico to the current FTA, creating the North America Free Trade Area (NAFTA), which would result in the world's largest single market. NAFTA, as with all regional trading blocs, would effectively make trade between the member nations much simpler by removing the complex and differing regulations now in effect at the borders. This simplification should bring about higher levels of trade among the countries and benefit both consumers and producers. An International Trade Commission study of NAFTA found that it would benefit the U.S. economy as a whole, minimally at first but at an increasing rate over time, and that there might be shifts in occupations but little effect on overall employment in the U.S.[2] This means, of course, that although industries could lose production to other member nations, other industries would gain employment as a result of the NAFTA. Would these structural changes have an effect on small business in the U.S.?

Small Business and

International Business

Small and medium-size businesses in the U.S. have tended not to become involved in the international economy to their full potential. The Department of Commerce has estimated that there are many thousands of small businesses that could export but do not, and other studies have found the same.[3] These non-exporting businesses are among those that could gain from the simplified trading environment to be created under NAFTA. Whether they will or not depends a great deal on why these firms are not exporting under conditions of "free trade," and if the reasons given will still hold up under the new NAFTA conditions. It is possible that these potential traders will become active traders and that small businesses that now trade occasionally will become more frequent traders.

There have been numerous studies of small business and exporting, dealing with a range of factors from those involved in the actual export decision,[4] to those necessary for exporting successfully.[5] Although it is difficult to synthesize the literature because of differences in defining small business, there does seem to be some consensus about the reasons small business does not export even when it has an exportable product. Although several factors enter into a decision not to become involved in international trade (factors relating to size such as resource availability, and those relating to competitive advantage such as planning ability), managerial attitudes toward trade are a key element that may, in fact, tie other factors together. U.S. small- business managers have simply not been interested in exporting and thus have resisted attempts to become involved. Reasons for this lack of interest range from cultural attitudes of individualism, to perceived high risks and complexity of exporting, to preoccupation with the domestic market.[6 ] This indifference to exporting is in marked contrast with attitudes of Japanese and European firms. Japanese firms are a part of a cultural ethic that mandates "export or die", and European firms have an historical experience of requiring a larger-than-domestic market to take advantage of scale economies (although even in Germany, a very successful exporting nation, smaller firms tend not to wish to enter into international markets). These cultural experiences have perhaps negated the natural inclination of small-business managers to reduce risk and have made the decision to internationalize somewhat less traumatic by simply allowing for little choice. To succeed, a firm was required to export. For many, if not most, U.S. small firms, there has been no such imperative. The sheer size and variability of the U.S. domestic market are sufficient to allow for any desired expansion. Exporting, when considered at all, is often seen as a temporary expedient to rid the firm of excess capacity on an occasional basis.

In addition to managerial attitudes, other factors that enter into a decision not to export include perceptions of risk associated with geographic and cultural distance and the strain on small firm resources that can result from trying to locate, distribute to, and promote in foreign markets. Some studies have associated these factors with firm size - with small firm managers seeing risks and costs as great, or greater than, larger firm managers might.

The NAFTA Environment

Can these attitudes and perceptions be overcome in the milieu of a U.S.-Canada-Mexico free trade area? When complete, NAFTA would create the world's largest free trade area, consisting of more than 360 million people and a combined annual output of $6 trillion.[7] In 1990, Canada was the top U.S. trade partner, with Mexico third in importance. In 1992, Mexico moved to the position of the number two market for U.S. exports, after Canada. U.S. exports to Canada and Mexico in 1992 were expected to reach a record of $124 billion for the year.[8]

Larger markets give firms opportunities to take advantage of economies of scale resulting from size, so one result of a free trade area might well be increased size of firms as industries rationalize their production. However, many smaller firms tend to be niche players and will remain somewhat unaffected by such effects. Other smaller firms, however, may find that joint ventures or partnerships, or other forms of alliance, may increase their effective size to the point that some of the exporting constraints caused by size may disappear. Figure One lists some of the perceived barriers to exporting by small businesses and the provisions of the NAFTA agreement that could mitigate those perceived barriers. Not listed in the figure are the provisions relating to investment, which will make joint ventures and other cross-border alliances much easier to enter into.

Small businesses do not always have financial and managerial resources to enter export markets. The NAFTA will reduce these kinds of barriers by eliminating tariffs (over a 15-year period) and allowing U.S. truckers to take cargo across the border. Currently, truckers are required to hand off their cargo to Mexican truckers at the border. These two provisions of NAFTA will reduce the costs involved in exporting within the FTA. In addition, rules for customs documentation and accounting are greatly simplified under the NAFTA, which should enable small business to expend fewer resources to comply with those rules than would be necessary now.

Perceptions of increased risk in exporting because of geographic and cultural distance may become less important under the NAFTA. Although such distance has likely not been felt too strongly about Canada (compared with Mexico), the proximity of the two nations, when combined with the elimination of the complex of rules that now apply to trade, may lessen it further. This reduction in rules will also reduce the direct costs of exporting and may help in profitability perceptions. Also helping to reduce perceived risk are the provisions that guarantee equal treatment of domestic and "foreign" businesses in the Canadian and Mexican markets - particularly provisions that allow cross-border services. These will allow U.S. small businesses to deal with their own banks and insurers, who will, under the NAFTA, be able to operate in Mexico without relocating operations and employees to Mexico.

Many small businesses, especially in high-technology industries, fear the loss of control over product that can occur when exporting. Many small businesses refuse to even use export intermediaries for this reason. The NAFTA will ease some of these fears by providing greatly strengthened protection of intellectual property rights. Software, as an example, is treated as a literary product and protected by strong copyright rules under the NAFTA.

One Market, Not Three

It is the lack of interest in exporting that may be most affected by creation of the NAFTA. With all of the publicity surrounding the negotiations between Mexico and the U.S., more small businesses will become aware of the expansion of market opportunity, not only to Mexico, but also to Canada. If the new NAFTA is perceived as simply an extension of the U.S. domestic market, rather than as three separate markets, which is the current perception, then more small businesses are likely to take advantage of the situation and discover niches in the new areas. It will, in other words, not really seem like exporting! The NAFTA's elimination of both tariff and nontariff barriers (such as domestic content laws and use of standards and technical regulations as barriers) will allow small businesses to treat the Canadian and Mexican markets as if they were a part of the U.S. market. Although immigration laws will not be changed under the NAFTA, there are rules that allow easier temporary business movement across the borders, which may serve to reduce the geographic distances between the business and the expanded markets.

For small and medium-size firms that already export on an infrequent basis, the creation of the NAFTA might take the place of former sales to the European markets. With Europe 1992, the single market created of 12 nations, more U.S. and other foreign firms are choosing to locate production within the European Community rather than face what are expected to be tough barriers to trade from outside the Community. Fears of "Fortress Europe" may discourage some small businesses from continuing their exporting to European nations. They will be looking at other markets, instead, closer to home. With creation of the NAFTA, and with possible connections of NAFTA with one or more of the Latin American free trade areas, the North-South American regional bloc will be a formidable market.

Many large U.S. corporations are strongly in favor of creating the NAFTA.[9] They are poised to shift production to Mexico as investment restrictions are relaxed. Although these shifts will cause labor problems in the affected industries, they may also create opportunities for the smaller businesses that supply the inputs to the larger companies. This movement may force many small support businesses to begin exporting simply to keep their customers. Indeed, the Department of Commerce's International Trade Administration has reported that as investment in production shifts to Mexico, U.S. exports also increase because U.S. producers in Mexico get 51 percent of their inputs from U.S. exports, compared with U.S. offshore ventures, which get only 13 percent of their inputs from the U.S.[10]

Services are included in the U.S.-Canada FTA, and because the service sector is made up largely of small businesses, this also may result in increased internationalization of service businesses under NAFTA.

New Opportunities

Both threats and opportunities are being presented to U.S. small business from the regional trade blocs being created all over the world. The U.S.-Canada FTA, and ultimately, the NAFTA, will provide new and less risky opportunities for small businesses to enter the international economy through exporting, an opportunity that small business in the U.S. has not felt any urgency about in the past. If the ease of exporting under the less complex rules of the NAFTA attracts small business to the exporting field, it is likely that they will continue their involvement in the global economy on a wider basis in the future. Most studies agree that international involvement occurs in stages, with the first stage being exporting, either directly or through an intermediary. The second stage is the multinational one in which direct investment in a foreign country is made. The third stage is the transnational company which is characterized by integration of sourcing and distribution on a global basis.[11] As familiarity with the global economy improves, companies move through these stages, but without that first step, the process cannot happen.

The global economy is here to stay, in spite of its seeming disintegration with the rise of regional blocs. U.S. companies will be required to be comfortable in that global economy to remain viable in the future. It is possible that the creation of the U.S.-Canada FTA, and most definitely the NAFTA, will give a kick to the many U.S. small businesses that now are not involved in the environment of the future. It can help these companies overcome their indifference, or fear of "going international," helping the U.S. economy now through job creation and innovation, and in the future by ensuring that the U.S. has firms at each level of its dual economy that can function effectively in the globalized environment of the future.

[1] Feileke, Norman S., "One Trading World, or Many: The Issue of Regional Trading Blocs," New England Economic Review, May/June 1992, 3-20. [2] "North American Free Trade Agreement," Congressional Digest, February, 1992, 37-38. Quoting U.S. Department of Commerce, International Trade Commission report of February 1991. [3] U.S. Department of Commerce, A Survey of Business Needs Export Marketing - Federal and Nonfederal Sources of Assistance, Washington, DC, Office of Market Planning, International Division, 1978. Edfelt, Ralph, "U.S. Business in International Competitive Perspective," Issues in International Business, 3 (1), 1986, 17-24. [4] Ali, Abbas & Swiercz, Paul M, "Firm Size and Export Behavior: Lessons From the Midwest," Journal of Small Business Management 29(2), 71-78, April 1991. Vozikis, George S., and Mescon, Timothy S., "Small Exporters and Stages of Development: An Empirical Study," American Journal of Small Business, Summer 1989, 49-64. [5] Czinkota, Michael R., and Michael Ursic, "Classification of Exporting Firms According to Sales and Growth into a Share Matrix," Journal of Business Research, 22, 1991, 243-253. Dichtl, Erwin, Hans-GeorgeKoeglmayr and Stefan Mueller, "International Orientation as a Precondition for Export Success," Journal of International Business Studies, 21, 1990, 23-40. Kathawala, Yunus, Richard Judd, Matthew Monipallil and Melinda Weinrich, "Exporting Practices and Problems of Illinois Firms," Journal of Small Business Management, 27 (l), January 1989, 53-59. Walters, Peter G.P. and Saeed Samiee, "A Model For Assessing Performance in Small U.S. Exporting Firms," Entrepreneurship Theory and Practice, 15 (2), Winter 1990, 33-50. [6] Christensen, Sandra L., "The Export Trading Company Act of 1982: An Effectiveness Analysis." Ph.D. dissertation, University of Washington, 1989. U.S. Government Accounting Office, "Efforts to Promote Exports by Small, Nonexporting Manufacturers," Washington, D.C., 1983. [7] "U.S. Mexico Free Trade Agreement," Congressional Digest, 34, February 1992. [8] Driscoll, Anne M., "Key Provisions of the North American Free Trade Agreement," Business America, October 19, 1992, 3. [9] Masur, Sandra, "The North America Free Trade Agreement; Why It's in the Interest of U.S. Business," Columbia Journal of World Business, 26, Summer 1991, 99-103. [10] Driscoll, Anne M., "Key Provisions," 5. [11] Miller, William F., "Europe 1992: Regionalism and Globalism," The International Executive, 33 (2), September/October 1991, 28-35.

Sandra L. Christensen, Ph.D., is an assistant professor in the Department of Management at Eastern Washington University, Cheney, Washington. Her research interests are in trade policy and business regulation and ethics.
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Author:Christensen, Sandra L.
Publication:Business Forum
Date:Jan 1, 1993
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