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The Texas economy: making North American Free Trade work.

What is the North American Free Trade Agreement? Like all free trade agreements, this proposed Canada/U.S./Mexico pact is an attempt to improve general living standards in the signatory countries by reducing barriers to the free flow of goods, services, and investment capital. (Unlike common market arrangements, such as the European Community, that anticipate eventual economic and political union, a free trade agreement does not address the free movement of labor.) Such agreements usually are not easily accomplished (their track records during this century have not been inspiring). Among other things, they directly affect people employed in industries protected from foreign competition, people in service sectors strongly linked with protected industry, and powerful domestic and international investment interests.

The main items on the NAFTA negotiating table are: nontariff barriers, the level of tariffs on traded goods, intellectual property rights, and rules governing foreign direct investment. Nontariff barriers include licensing agreements, import quotas, customs procedures, and domestic subsidies, but also frequently extend to health, safety, and environmental standards. Not surprisingly, nontariff barriers pose the trickiest problems in large part because of the difficulties of distinguishing protectionist measures from legitimate attempts to protect the public welfare. In contrast, with tariff barriers, intellectual property rights, and foreign investment rules, it is relatively easy to define relevant categories and to identify and measure the degree of domestic protection.

It is difficult to predict the specific provisions of the negotiated agreement (expected to be subbmitted to Congress in mid-1992). Most people agree, however, that the existing Canada/U.S. free trade agreement provides the effective starting point for negotiations. Effective January 1, 1989, the Canada/U.S. agreement is organized around the following broad topics: * Trade in Goods. This includes the core of tariff-reducing provisions in manufactured goods and the "rules of origin" that define the content levels necessary to qualify for protected free movement. Tariff-reducing provisions establish, among other things, the schedule for reducing tariff rates for specific commodities to zero. The Canada/U.S. FTA limits phase-ins to a maximum of ten years, but rumors have it that phase-ins of up to twenty years are being contemplated for some NAFTA sectors. Strict rules of origin reserve special NAFTA treatment for commodities with a high degree of North American content so that third party countries cannot use one signatory country as a platform for penetrating the markets of another. (A Korean apparel manufacturer, for example, could not enjoy NAFTA treatment for clothing exported to the United States through Mexico if the final product contained little Mexican value added.) The Canada/U.S. FTA generally requires that traded goods contain 50 percent North American content to qualify for tariff-free treatment. There is significant pressure from some sectors (most notably from automobile-related interests) to require North American content of up to 70 percent in the trilateral agreement. * Government Procurement. All levels of government face tremendous pressures to favor domestic goods and services in their procurement practices and can do so with fewer risks than the private sector. However, reducing preferential treatment in the public sector is important symbolically and can produce significant effects in some sectors (e.g., paper and computer equipment). * Services. Unlike goods, services can be difficult to identify and evaluate. It is therefore often more difficult to negotiate terms for services. The Canada/U.S. FTA liberalizes rules and licensing requirements governing trade and investment in construction (not expected to be covered in the NAFTA), tourism, insurance, telecommunications, computer services, and a host of other professional/consulting services. Also included are provisions for streamlining the temporary entry of business persons. Transportation services are not covered in the FTA. * Financial Services. The FTA greatly reduced the discrimination that U.S. banks, savings and loan associations, insurance firms, securities firms, and other financial institutions had faced in Canada. While these same financial institutions would welcome the opportunity to operate in Mexico on equal terms, Mexican negotiators would prefer to delay making significant concessions until their banking sector recovers from almost ten years of stagnation under nationalization. Reinforcing the tendency to go slowly is the fact that Mexican banking makes up only a little more than I percent of North American banking in terms of total assets. Financial services pose special challenges and uncertainties because operations are narrowly circumscribed by government regulation and have been profoundly affected by advances in telecommunications and information technology. Predicting the state of U.S. financial services at the turn of the century is difficult enough without even considering the possible impact of NAFTA. * Foreign Investment. The Canada/U.S. FTA provides for "national treatment" for the establishment, acquisition, sale, and operation of businesses (excluding transportation) in the other country. Historically, the United States had been quite open to Canadian firms; in fact, Canada is the second largest foreign investor in the United States. These provisions had the effect of dramatically opening Canada to U.S. investment and operations. U.S. negotiators have pressed for Mexican commitment to national treatment under NAFTA, but many Mexicans argue that this exceeds their concept of free trade. * Dispute Resolution. The FTA establishes a set of independent binational review panels to replace national courts in resolving disputes arising from the implementation of the agreement, particularly with respect to charges of anti-dumping and the imposition of countervailing duties. In the two years since the FTA was signed, these panels have wrestled with the difficulties of distinguishing barriers to trade from regulations designed to protect health, safety, and the environment. (One illustration is a recent case involving U.S. restrictions on the import of hogs from Canada due to differences in meat inspection requirements.) The observation that the Canadians have made more effective use of the dispute resolution mechanisms has fueled U.S. efforts to overhaul dispute resolution procedures in a trilateral agreement.

What is the expected impact of NAFTA? Most economists agree that the agreement will have a small but positive effect on overall GNP and employment and will place downward pressures on the prices of commodities most affected. Sophisticated economic modeling efforts support this view. Others, most notably organized labor, point to job dislocation, depressed wages, and the wholesale movement of production to Mexico where working conditions do not meet U.S. standards. Almost everyone, however, agrees that Texas will be the primary U.S. beneficiary of NAFTA. About one-third of U.S. exports to Mexico are produced in Texas, and almost half pass through the state. Whatever shape the final agreement takes, its impact across industries will vary, one reason being the phase-in provisions that can call for immediate implementation of negotiated terms in some industries and gradual implementation in others.

The way NAFTA fits into the global trading system and into the General Agreement on Tariffs and Trade (GATT)-the multilateral institution responsible for shaping global trade in the postwar period-is an indicator of what kinds of changes are in store. Leaders of the three signatory countries argue that NAFTA is an effort not to supplant GATT, but rather to move forward with progressive regional arrangements that have proved to be sticking points in the multilateral negotiations that are part of the evolving GATT. Although notably successful in the postwar period in reducing trade and investment barriers in traded manufactured goods, GATT frequently founders on the more challenging issues of agriculture and services.

These three areas also pose the greatest challenges to NAFTA negotiators. It is likely that a trilateral agreement will have only a marginal or gradual

effect on agriculture and services. The Lower Rio Grande Valley probably has fewer reasons for concern about imminent loss of jobs and production in its citrus and leafy vegetable industries than public opinion would otherwise suggest. And, as already mentioned, the realities of and uncertainties in banking make financial institutions an unlikely candidate for radical change. Mexican petroleum resources represent a third area in which only marginal changes in trade regulations can be expected. Basic petroleum is even enshrined in the constitution as part of Mexico's national patrimony, and its exploitation by foreigners is officially not negotiable. This does not preclude some liberalization in trade and investment. Mexico's critical and growing need for investment capital in petroleum-related sectors signals that some concessions should be in the offing, and, in fact, certain forms of joint ventures in oil drilling are already open to foreigners. Another area in which NAFTA negotiations can expect to face obstacles is textiles and apparel. With a complicated array of tariff rates ranging up to nearly 40 percent, these industries produce goods that enjoy greater tariff protection from foreign competition than any other manufactured products in the United States and in Mexico.

Granted that NAFTA will have its greatest or most immediate effects on traded manufactured goods, what kinds of changes can be expected? Generally speaking, Mexico can attract production processes that use proven, well understood, standard technology; are relatively labor intensive; and require relatively low capital investment. Distinct U.S. advantages include high value-added production, relatively capital-intensive operations, innovative technology, sophisticated information and delivery systems, unique local inputs, and innovative and experimental goods. It is a mistake to assume that NAFTA will cause the wholesale movement of entire businesses to Mexico, although some of this will surely occur. Instead, the agreement is more likely to result in an increase in U.S.Mexican joint ventures and other forms of intraindustrial linkages in which the location of the production process will be determined by the comparative advantages of each nation. This prediction is supported by the fact that approximately three-quarters of U.S. commodity trade with Mexico consists of intermediate rather than final consumer goods, with most of this trade occurring within industries.

The changes that win come in the wake of the North American Free Trade Agreement, on the whole, will benefit all parties. Nevertheless, concerns about environmental impacts, better job training programs for displaced workers, and the need to adapt Texas transportation, services, and other infrastructure to the emerging realities are legitimate. The Texas Department of Commerce, which enjoys a direct line to people involved in the negotiations, is in a position to communicate the concerns and insights of business. Now is the time to do so if we are going to maximize the benefits of free trade for Texas. Chandler Stolp, Associate Professor LBJ School of Public Affairs and Institute of Latin American Studies University of Texas at Austin
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Title Annotation:North American Free Trade Agreement
Author:Stolp, Chandler
Publication:Texas Business Review
Date:Dec 1, 1991
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