What is the North American Free Trade Agreement (NAFTA)?

The North American Free Trade Agreement, which eliminated most tariffs on trade between Mexico, Canada and the United States, went into effect on January 1, 1994. NAFTA’s purpose is to encourage economic activity between North America's three major economic powers. Numerous tariffs, particularly those related to agriculture, textiles and automobiles, were gradually phased out between Jan. 1, 1994 and January 1, 2008.

President Trump campaigned on a promise to repeal NAFTA and other trade agreements he deemed unfair to the United States, and on August 27, 2018, he announced a new trade deal with Mexico to replace it. The U.S. - Mexico Trade Agreement, as it is called, will maintain duty-free access for agricultural goods on both sides of the border and eliminate non-tariff barriers while encouraging more agricultural trade between Mexico and the United States and will effectively replace NAFTA. On September 30, 2018, the United States and Canada agreed to a deal to replace NAFTA, which will now be called the USMCA - The United States Mexico Canada Agreement. In a joint press release from the U.S. and Canada Trade Offices, representatives said the following:

“USMCA will give our workers, farmers, ranchers and businesses a high-standard trade agreement that will result in freer markets, fairer trade and robust economic growth in our region.  It will strengthen the middle class, and create good, well-paying jobs and new opportunities for the nearly half billion people who call North America home."

The three countries signed the agreement on November 30, 2018.

Why NAFTA was Formed

About one-fourth of all U.S. imports, such as crude oil, machinery, gold, vehicles, fresh produce, livestock and processed foods, originate from Canada and Mexico, which are the United States’ second- and third-largest suppliers of imported goods. In addition, approximately one-third of U.S. exports, particularly machinery, vehicle parts, mineral fuel/oil and plastics, are destined for Canada and Mexico.

The legislation was developed during George H. W. Bush's presidency as the first phase of his Enterprise for the Americas Initiative. The Clinton administration, which signed NAFTA into law in 1993, believed it would create 200,000 U.S. jobs within two years and 1 million within five years because exports play a major role in U.S. economic growth. The administration anticipated a dramatic increase in U.S. imports from Mexico under the lower tariffs.

Additions to NAFTA

NAFTA was supplemented by two other regulations: the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC). These side agreements were intended to prevent businesses from relocating to other countries to exploit lower wages, more lenient worker health and safety regulations, and looser environmental regulations.

NAFTA did not eliminate regulatory requirements on companies wishing to trade internationally, such as rule of origin regulations and documentation requirements that determine whether certain goods can be traded under NAFTA. The free-trade agreement also contains administrative, civil and criminal penalties for businesses that violate any of the three countries’ laws or customs procedures.

North American Industry Classification System

The three signatory countries developed a new collaborative business-classification system that allows for the comparison of business activity statistics across North America. The North American Industry Classification System organizes and separates industries according to their production processes.

The NAICS replaced the U.S. Standard Industrial Classification system, allowing businesses to be classified systematically in an ever-changing economy. The new system enables easier comparability between all countries in North America. To ensure that the NAICS remains relevant, the intention is to review the system every five years.

The three parties responsible for the formation and continued maintenance of the NAICS are the Instituto Nacional de Estadistica y Geografia in Mexico, Statistics Canada and the United States Office of Management and Budget through its Economic Classification Policy Committee, which also includes the Bureau of Economic Analysis, Bureau of Labor Statistics and the Bureau of Census. The first version of the classification system was released in 1997. A revision in 2002 reflected the substantial changes occurring in the information sector. The most recent revision, in 2017, created 21 new industries by reclassifying, splitting or combining 29 existing industries.

This classification system allows for more flexibility than the SIC's four-digit structure by implementing a hierarchical six-digit coding system and classifying all economic activity into 20 industry sectors. Five of these sectors are primarily those that produce goods, with the remaining 15 sectors being strictly those that provide some type of service. Every company receives a primary NAICS code that indicates its main line of business. A company receives its primary code based on the code definition that generates the largest portion of the company's revenue at a specified location in the past year.

The first two digits of an NAICS code indicate the company's economic sector. The third digit designates the company’s subsector. The fourth digit indicates the company's industry group. The fifth digit reflects the company’s NAICS industry. The sixth designates the company’s specific national industry.

NAFTA's Impact

Debate continues surrounding NAFTA's impact on its signatory countries. While the United States, Canada and Mexico have all experienced economic growth, higher wages and increased trade since NAFTA’s implementation, experts disagree on how much the agreement actually contributed to these gains, if at all (for more details, see NAFTA's Winners and Losers). The results are hard to isolate, and other significant developments have occurred on the continent and globally in the past quarter-century.

From the beginning, NAFTA critics were concerned that the agreement would result in U.S. jobs relocating to Mexico, despite the supplementary NAALC. NAFTA affected thousands of U.S. auto workers in this way, for example. Many companies moved their manufacturing to Mexico and other countries with lower labor costs, although NAFTA may not have been the reason for those moves. Under the USMCA, those concerns, like NAFTA, may be history.