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North American free trade agreement.

ONCE SIMPLY A MATTER OF MERCHANTS BARTERING WITH ONE another, trade has become a global affair. Trading in a world economy involves more than a Kansas City company selling bottle caps to a soda manufacturer in Brussels; transactions in the world today include overcoming a complex array of hurdles from language barriers to tariffs to some heavily controlled regulatory systems. While this monumental international effort continues groups of countries all over the world are working to establish "free trade" regions or trading blocs. In these free trade zones, members agree to eliminate border and customs controls and to unify tax and regulatory practices. Ultimately, the outcome may be a world in which there are three or four trading regions corresponding roughly to the areas of Europe, Asia, Africa and the Americas.

CURRENTLY, these trading blocs are in varying stages of development, with the European zone the only concrete reality so far. Following closely behind Europe is North America, under the North American Free Trade Agreement (NAFTA). Signed bilaterally by Canada and the United States in 1988 and proposed to include Mexico only last year, this pact has far to go before the continent is a truly free trade zone.

Although NAFTA negotiations are only in the preliminary stages, representatives from all three countries are sitting down to negotiate the terms of the agreement. It's impossible to visualize what form such an agreement will take. Will there ever be a North American currency? What are the implications for the insurance industry? While Mexico struggles to stabilize its economy - and to catch up with its two northern neighbors - the answers to these questions are still pending. Competition from other parts of the world will certainly demand that North American countries combine resources and open up economic opportunities to one another.

The North American Agreement

WHEN NAFTA IS SIGNED, sealed and delivered, and North America becomes a formal free trading bloc, it will surpass the European Community in both population and market size. The NAFTA bloc, extending from the Yukon to the Yucatan Peninsula, boasts 362 million consumers and a gross national product of $6 trillion.

The movement toward eliminating trade barriers on this continent has already been occurring for a number of years, particularly between Canada and the United States. These two countries, which exchange about $200 billion in goods and services each year - the largest bilateral trading relationship in the world - signed a bilateral agreement that went into effect in 1989.

With fairly free access to each other's markets, there are few current trade barriers of any significance between the two countries. One issue that recently brought negotiators back to the bargaining table concerned the supply of natural gas which Canada makes available to the United States. However, insurance issues have generally been ironed out between the two countries.

"There are no insurance issues with Canada as a major concern," says Gordon Cloney, president of the International Insurance Council. "The situation was addressed several years ago during the Canada-United States agreement. Now the two markets have mutual levels of access across the border either way." The issue of severe limitations that Canada placed on U.S. investment in Canadian life insurance companies was resolved when the limitations were eliminated.

Although negotiations began in 1990 with Mexico as well, that country is a different ball of wax. Until very recently, Mexico was a tightly regulated market. "Virtually everything was controlled by regulatory authority," Mr. Cloney says. The kinds of contracts insurers could write, the prices they could charge and the way foreign establishments could own Mexican companies were among the myriad strands of red tape that had to be cut through before foreigners could do business in Mexico.

The Mexican Economy

MEXICO BEGAN only recently to emerge from decades of state intervention, antagonism toward its neighbors, and resistance to foreign investment. The many ills that existed for so long in the Mexican economy have been slowly healing, particularly since 1989, when Carlos Salinas de Gortari became Mexico's president.

Since then the country has taken major steps toward opening its economy to foreign investment. After years of negative growth, the Mexican economy is now growing at a rate of about 3 percent per year. According to the Office for Free Trade Agreement Negotiations in Washington, D.C., gross domestic product growth in 1990 exceeded population growth for the second year in a row. Inflation was reduced from nearly 160 percent in 1987 to less than 30 percent in 1990. Fueled in the past mainly by government borrowing-which created an enormous debt of more than $100 billion that the country was unable to service-development is now being encouraged by outside investment in such areas as heavy machinery, electronic equipment, high-technology and tourism. Global corporations have invested more than $80 billion in Mexico in the past four years and continue to invest at a growing rate.

In the past few years, many U.S. companies have established wholly owned maquiladora assembly plants, along the American-Mexican border. Legislation has afforded these plants a tariff break in exporting finished goods back to the United States. In addition, a report in the Harvard Business Review stated that of the approximately 1,250 plants that now operate in the northern Mexican tier, many are owned by companies from other countries, particularly Japan.

Since President Salinas took office, Mexico has cut the maximum tariff rate from 100 percent to 20 percent, cut the average trade-weighted tariff from over 25 percent in the mid-1980s to about 9 percent today-, eliminated the import licensing requirement for 98 percent of its import categories, and pledged to further reduce the number of items subject to prior import permits (in 1983, all imports were subject to government approval)-, discontinued the use of official prices for customs valuation purposes; eliminated most of the remaining nontariff barriers to trade, including domestic-content quotas for autos and electronics; and reduced bureaucratic red tape by introducing an expedited system of approvals for foreign investment applications. Now a formal response must be given within 45 days to projects requiring those applications. Automatic approval is given if no response is received from the government within that time. Today, highway freight transportation, container shipping and aquaculture have been deregulated, and tax rates were reduced to levels more in line with international standards.

Many government-owned businesses in Mexico are being privatized. Out of 1,155 stateowned companies, 801 have been divested or authorized for divestiture. According to the Office for Free Trade Agreement Negotiations in Washington, D.C., by early 1990, the privatization process was finalized for 619 companies. The national telephone company, airlines, hotel chains, the state steel and mining industries, banking and the state insurance company, among others, have been sold or are in the process of being sold to private interests. The sale of government-owned companies has produced about $2.5 billion and represents a significant cost savings since many of those companies were operating at a loss.

President Salinas also substantially relaxed Mexico's restrictions on foreign direct investment. Up to 100 percent foreign ownership is now permitted in most sectors, and up to 49 percent in petrochemicals, mining, fishing and insurance sectors that were previously reserved exclusively for Mexican nationals.

Bigger Opportunities

IT IS EXPECTED that NAFTA will further increase Mexican development, and spur growth in both the United States and Canada. Expanded trade opportunities, job growth, an increase in the export of goods and services, increased efficiency and productivity, enhanced competitiveness and reduced prices are among the benefits predicted for the North American bloc. A study conducted by Peat Marwick shows that both the United States and Mexico will benefit from a free trade agreement. Real U.S. income should rise by an additional $1 billion; exports to Mexico will increase by 2.5 percent.

A study by the U.S. International Trade Commission shows that real income for unskilled and skilled American workers is likely to rise, and that employment levels in the United States -an issue many Americans have been concerned about-is not likely to be affected. Another study, undertaken by the Federal Reserve Bank of Dallas, shows that if all the maquiladoras were shut down tomorrow, many jobs would not return to the United States; instead they would go to Taiwan, Hong Kong, Singapore or Korea.

A study conducted by Rudiger Dombusch at the Massachusetts Institute of Technology shows that a shift in Mexico's trade deficit could result in 150,000 more jobs in the United States. However, it also points out that most jobs lost in the United States over the last decade have gone to Asia. The question becomes that when jobs do go abroad, would the United States prefer them to go to Mexico rather than to Asia?

Risk Implications

WHILE NO ONE DISPUTES that free trade will bestow distinct advantages on all three countries of the North American bloc, many problems will have to be ironed out over the next few decades. How will the formation of this North American trading bloc, whatever the terms of the agreement may be, affect the insurance industry in all three countries and the risk managers in various sectors?

One insurance expert expressed concern that barriers on this continent may be coming down too quickly. "In the European Common Market, the coming together of people and countries in free trade association has taken place over many years-, preparations have been very intensive and protracted," says Ron Poole, senior vice president at Reed Stenhouse Ltd. in Canada. "In free trade with Canada and the United States, there was no such equivalent period of preparation."

To expedite free trade, the three countries will have to work toward what Mr. Poole called "harmonization," and smooth out various kinds of inequities in the three economies. The effects of this equalization of risk exposures for such things as environmental impairment and product liability can only be guessed at; One concern in both Canada and Mexico is the possibility of a rise in the number of lawsuits.

"One risk in management issue is, what will be the effect on risk exposure as a result of the effort to harmonize environmental impairment and product liability," Mr. Poole says. "In the United States you can bring suit against a manufacturer and pay a lawyer only if you win. Not in Canada. If we harmonize with the United States, it would have an enormous impact on risk. There would be a lot more lawsuits."

Capacity is another insurance issue. Earthquakes, in particular, are a concern in Mexico, as well as in some parts of the United States. "If a major earthquake hits California or Mexico, will there be enough capacity to cover it all?" asks Doug Smith, vice president, in the international department at Johnson & Higgins in New York. "It could be a real problem. How can we build capacity for such a contingency in all three countries?" As negotiations among the three countries, especially the United States and Mexico, proceed the effects of change will have to be carefully weighed. For example, an issue of concern to the insurance industry is the possible increased relaxation of foreign ownership restrictions in Mexico. The insurance industry in the United States would like Mexico to grant 100 percent ownership although some industry observers say such a move could be disastrous.

"We'd like to see Mexico permit more generous rules for U.S. access," says Mr. Cloney. "We can't argue against the need for approvals, only that the United States should be able to own up to 100 percent."

But one consultant to the insurance industry, who asked not to be identified, said Mexico is not likely to grant such an increase in ownership right away. "Why would Mexico open its markets 100 percent? It's not an even equation. The United States has tremendous economic power and an insurance industry that is overwhelming. It would be unfair. "

The world certainly will not shrink to three or four trade zones overnight, say the experts. In Asia and Africa, as well as on the North American continent, even as negotiations between the parties progress, the shrinking of the planet is a lumbering, slow, yet inexorable process. And that, says one insurance consultant, is how it should be. "Whatever opening occurs [in Mexico] must by and large be slow and scaled in, and that is a fair approach for all parties," he says. "It can't happen overnight. Suddenly opening the doors would create cross currents of change that could devastate Mexican industry and throw too many people on the street."

SO FAR, EUROPE LEADS THE WAY IN FORMing a free trade zone. The European Common Market (EC), long looming as a dream (or a threat, depending on which prime minister you talk to), is already a reality, making its formal debut this year. The EC is eliminating five types of barriers to free trade among members: customs and border controls, protectionist procurement policies as well as different product regulations and standards, business laws, and tax laws. With 12 nations joining at the start, and more waiting in the wings including Austria, Sweden, Turkey, and several eastern European countries, the EC is presently the largest trading bloc in the world. This burgeoning market, with a population of more than 324 million people, surpasses $4.8 trillion ! Apart from NAFTA and the EC, two other trading zones have been proposed. Negotiations have begun for the Preferential Trade Area for Eastern and Southern Africa (PTA) and the East Asian Economic Grouping (EAEG) in the Asia-Pacific region.

In the works for the past 10 years, the 18-member PTA already has a financial clearing house, a tribunal for disputes, a chamber of commerce and standard customs documents. It is also planning trade liberalization, common tariffs and agricultural policy agreements. Predictions are that this trading bloc may be solidified within five to seven years. Extending from the Sudan in the north to Mozambique in the south, the population of this region is about 220 million with a total gross national product in 1988 of $70 billion.

The possible formation of an AsiaPacific trading bloc was discussed in july when foreign ministers from South Korea, Taiwan, Hong Kong, China and Japan met in Kuala Lumpur for an annual conference. With the EC a reality, the PTA in the works, and a North American bloc looming in the near future, some Asian ministers are uneasy that their loosely affiliated trading network no longer can serve their countries' needs. The idea of establishing the EAEG as an open trading bloc, possibly with Tokyo as its center, was proposed as an insurance policy to protect existing markets. Some have argued that forming such a bloc-one that could well become the largest in the world-might threaten both the EC and the United States and create unnecessary trading tensions. While East Asia's total market is presently estimated to be about $1 trillion, the Asian Pacific rim is already the fastest growing economy in the world.

Currently, it is difficult to predict the outcome of this discussion; the accepted view being that, if Japan opts to join such a group, others will inevitably follow. A recent article in the Far Eastern Economic Review stated that Japan's post-World War II prosperity has been so dependent upon access to North American and European markets that Tokyo would never espouse the cause of Asian economic regionalism."

Yet the same article also quotes Noburo Hatakeyama, the vice-minister for international affairs at the Japanese Ministry of Trade and Industry, supports the Malaysian prime minister's proposal for an EAEG: "We can understand his desire for stronger ties with East Asian nations. With regard to economic interdependence in Asia, systematic talks at a more profound level would be of significance to Asia because this would provide us with a broader range of options in our trade relations."

As TRADE INCREASES BETWEEN CANADA, the United States and Mexico, the Colgate -Palmolive Co. may close some of its plants on either side of the border. For instance, it may not be necessary for the company to continue operating all of its plants in Canada. However, the result of this kind of streamlining may not be an across-the-board reduction of costs; insurance costs, at least, could go up.

"At one time, we built plants in another country and those plants sold only

to that country; now we won't need to do that," says Jim Noble, director of risk management and insurance at Colgate-Palmolive. "If it turns out to be true that Colgate would have fewer operations, we'd have higher insurable values at the remaining locations. Direct damage and business interruption costs would go up because of a higher concentration of risk,' As each facility appreciates in value, fire protection might have to be upgraded thereby creating a sharp increase in cost. Capacity, too, could become a problem, Mr. Noble says.

While the Mexican economy is engaged in a fierce struggle to catch up with its North American neighbors, it has made operating there attractive to some companies. Along with lower labor costs and cheaper supplies, insurance costs have decreased and more coverage has become available. It might encourage a company like ColgatePalmolive to consider opening more plants south of the U.S. border.

While insurance prices in Mexico may be softening right now, there may not be enough coverage. "If we have more values in Mexico, then earthquakes might be the major risk," he says. "That could increase the cost of insurance there, making it difficult to provide coverage elsewhere."

Mr. Noble is also concerned about how Colgate-Palmolive will back up its manufacturing capability if it should have fewer facilities operating. Presently, its locations are interdependent, each providing backup for the other. Closing plants in less important locations could create a curious paradox.

"We could end up with only our more important facilities operating and less backup for them," he says. Mr, Noble's job managing risk would become a more demanding one if fewer plants operate. As the flow of trade opens up on this continent and, indeed, globally, occurrences in different parts of the world could have greater impact on particular operations than they do now.
COPYRIGHT 1992 Risk Management Society Publishing, Inc.
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Title Annotation:includes related articles on the European Common Market and Colgate-Palmolive
Author:Moss, Vicki
Publication:Risk Management
Date:Mar 1, 1992
Words:3023
Previous Article:Understanding Canadian health care.
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