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The Free-Trade Case Against NAFTA

By James M. SheehanJames M. Sheehan is a research associate at the Competitive Enterprise Institute in Washington. / September 11, 1992



PRESIDENT George Bush is celebrating the recent formation of a trade bloc between the United States, Mexico, and Canada as a milestone in foreign relations.

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According to Mr. Bush, the new arrangement will greatly enhance our economic competitiveness and prosperity by uniting 360 million consumers and $6 trillion in annual output. While progress was made in reducing trade-stifling tariffs, which were 250 percent higher in Mexico than the US, the North American Free Trade Agreement (NAFTA) is actually a misnomer for this treaty. When the final text of the treaty is implemented, "free trade" will still be encumbered by significant government management and regu lation.

The Bush administration cites numerous economic benefits it expects from NAFTA. Joblessness should subside as employment rises by up to 2.5 percent. By 1995, NAFTA will create more than 400,000 jobs in export related fields which pay 17 percent more than jobs in the overall economy. The administration admits, however, that these benefits are somewhat exaggerated.

At the request of US Trade Representative Carla Hills, the US International Trade Commission conducted a survey of numerous independent studies done on the aggregate economic effects of NAFTA. The results of that survey were proudly featured on the day of NAFTA's announcement at a White House briefing, which cautiously claimed that the agreement "would increase US real GDP by up to 0.5 percent per year once it is fully implemented." (Emphasis added.)

In truth, NAFTA will not be fully implemented for 15 years. Several tariffs on manufactured products and insurance services are scheduled to remain in place for 10 to 15 years. At best, the benefits touted by the Bush administration cannot be fully realized until those tariffs are phased out, thus phasing the economic benefits in.

As it postpones tariff phaseouts, the agreement introduces several new "rules of origin" that restrict trade in certain products not assembled in North America, including automobiles, textiles, and computer circuitry. The rule of origin for autos dictates that only those produced with 62.5 percent or more of North American-manufactured content can be sold duty-free under NAFTA, which will expressly benefit the Big Three at the expense of Japanese manufacturers.

Ambassador Hills defends such provisions, arguing that "rule of origin is not a protectionist device. [It] is just a way in which we assure that the benefits negotiated within the region are for the region." If true, the argument could be used to justify higher tariffs across the board.

RULES of origin are certain to inflame trade tensions with the European Community, Japan, and other countries, which could result in more protectionist measures against the US. Andreas Van Agt, the EC's ambassador to the US, recently complained that NAFTA rules of origin would discourage European investment in the US, raising the question of whether economic gains from NAFTA would be partially offset by losses elsewhere.

The trade agreement also establishes a North American Trade Commission, which will appoint conflict resolution panels to mediate disputes over trade barriers created by environmental regulations. Mrs. Hills has indicated that the panels will lean heavily in favor of the regulations, as long as they have an identifiable scientific basis.

According to Hills, "we won't quarrel with the science so long as a scientific methodology has been used to develop the standards." Unfortunately, US standards have long been set to avoid risks that even modern science must strain to detect. The commission will likely bestow advantages on larger firms with the resources to master its arcane rules, while small businesses are likely to lose out.

Moreover, the watering down of free trade in NAFTA will have a particularly counterproductive effect on Mexico's environment, as evidenced by a recent study by Princeton economists Gene Grossman and Alan Krueger. Heightened commercial activity in Mexico would be concentrated in its heavily labor-intensive and agricultural sectors, which "require less energy input and generate less hazardous waste per unit of output." Furthermore, relaxed restrictions on foreign investment would facilitate the transfer of

modern technologies, which are cleaner and more efficient than the ones they replace. Yet these benefits are foregone in the absence of truly free trade.

The intent of government management of North American trade is to prevent the easing of any nation's environmental laws or other trade restrictions in order to attract foreign investment. An essential purpose of free trade, however, is to foster competition between nations in maintaining a favorable investment climate.

By creating an EC-style bureaucracy to manage our trade, NAFTA contradicts the rationale behind reducing barriers to trade between nations. More menacing, though, is the potential that a NAFTA bureaucracy could expand its reach into even more areas of our economic life.