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

The North American Free Trade Agreement (NAFTA) was implemented to promote trade between the U.S., Canada, and Mexico. The agreement, which eliminated most tariffs on trade between the three countries, went into effect on Jan. 1, 1994. Numerous tariffs—particularly those related to agriculture, textiles, and automobiles—were gradually phased out between Jan. 1, 1994, and Jan. 1, 2008.

NAFTA’s purpose was to encourage economic activity among North America's three major economic powers.

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What is NAFTA?

Understanding NAFTA

Proponents of NAFTA considered that it would benefit the three nations involved by promoting freer trade and lower tariffs among Canada, Mexico, and the United States. Former President Donald Trump, however, campaigned on a promise to repeal NAFTA and other trade agreements he deemed unfair to the United States.

On Aug. 27, 2018, Trump announced a new trade deal with Mexico to replace NAFTA. The U.S.-Mexico Trade Agreement, as it was called, would maintain duty-free access for agricultural goods on both sides of the border and eliminate non-tariff barriers while also encouraging more agricultural trade between Mexico and the United States.

On Sept. 30, 2018, the United States and Canada agreed to a deal to replace NAFTA, and the United States-Mexico-Canada Agreement (USMCA) took effect on July 1, 2020. If not renewed, the USMCA will expire in 16 years. 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."

Key Takeaways:

  • The North American Free Trade Agreement (NAFTA) was implemented in 1994 to encourage trade between the U.S., Mexico, and Canada.
  • President Trump made a campaign promise to repeal NAFTA, and in August 2018, he announced a new trade deal with Mexico to replace it.
  • In September 2018, Canada joined the deal: the United States-Mexico-Canada Agreement (USMCA), which was signed on Nov. 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.

NAFTA 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 as a result of 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 tangential agreements were intended to prevent businesses from relocating to other countries to exploit lower wages by providing 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 contained 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 NAFTA signatory countries developed a new collaborative business-classification system that facilitates comparison of business activity statistics across North America. The North American Industry Classification System (NAICS) organizes and separates industries according to their production processes.

The NAICS replaced the U.S. Standard Industrial Classification (SIC) 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 system is reviewed every five years.

The three parties responsible for the formation and continued maintenance of the NAICS are the Instituto Nacional de Estadística y Geografía 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, and the remaining 15 sectors 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 a 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, and 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, if at all, U.S. manufacturing, jobs, immigration, and the price of consumer goods. 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. However, NAFTA may not have been the reason for those moves.