The NAFTA Agreement:
A Canadian Perspective

Leonard Waverman
Centre for International
Studies, University
of Toronto

Introduction

THE NAFTA ANNOUNCED ON August 12, 1992 offers advantages and challenges for Canada. Critics will note the small current trade between Canada and Mexico, Mexico's low labour costs, Mexican competition with Canadian goods in U.S. markets and the supposed failure of the existing FTA as reasons for Canada to spurn the agreement.

In my opinion, to reject NAFTA could be a fundamental long-term error for Canada. My thoughts are based on the following three propositions:

1.The Mexican challenge to Canadian exports to the U.S. would be greater without Canadian participation in NAFTA (the so-called hub-and-spoke model [see Lipsey, Wonnacott]).

2.NAFTA offers a number of significant improvements over the FTA from the Canadian perspective (though it still contains several serious defects).

3.The Americas are changing, Canada's best interests are in working towards a new order in the Americas from North to South.

Canada cannot "escape" Mexican growth and competition by staying out of NAFTA. Whatever the marginal changes induced in Mexico due to NAFTA, these will surely arise because of the large size of the U.S. market. If NAFTA is required to induce Mexican entrepreneurs to invest more at the margin in Mexico, that investment will be almost the same with or without adding Canada to the agreement. Thus by staying out of NAFTA Canada will not affect Mexican growth and exports. Canadian tariffs are already low against Mexico. Even with only a U.S.-Mexico FTA, Mexican producers would become more significant competitors in Canadian markets because improved access to the U.S. market will improve Mexican efficiency through economies of scale, increased production runs, and so forth. Whatever new Mexican competition Canadians will face in U.S. markets will exist even if Canada does not take part in NAFTA. Competition in U.S. markets does not depend on which trade agreements Canadians decide to join.

A U.S.-Mexican free trade agreement, therefore, leads to a certain amount of "pain" for Canada. However, being outside the agreement will lead to fewer "gains" for Canada. Mexican tariffs are triple the Canadian average and imports to many Mexican sectors face formidable barriers. Therefore, preferential access to the Mexican market will be valuable, and NAFTA, by lowering Mexican trade and investment barriers for the U.S. and Canada, will lead to preferential advantages for these two nations or in the parlance of trade economists, "trade diversion" against Asia and Europe.

A major reticence voiced in Canada against joining NAFTA is the feeling that the Canada-U.S. Free Trade Agreement (FTA) has been the major cause of the large number of job losses, especially those in the manufacturing sector, which have occurred since 1989.

I surveyed five recent analyses of the impacts of the FTA on industrial output and employment in Canada. Three of these five studies show the FTA as a potential source for a small but significant number of job losses-45,000 to 53,000 out of the 365,000 manufacturing jobs lost in Canada since January 1, 1989. No one disputes the fact that Canada faces severe problems including high unemployment (and to this point few innovative policies have been put forward), but violent disagreement exists over the source of the problems and of the job losses. These studies all suggest that the major blame is not the FTA but elsewhere. For example, Rodrique Tremblay points to the 55 percent increase in Canadian manufacturing costs relative to the U.S. since 1986 as the major culprit. Adding Mexico to the Free Trade Agreement will add marginally to adjustment pressures but Mexico, as stressed above, will be a more fit competitor (and a richer nation) even without Canada in the Agreement. What is essential economically and politically in Canada, is to alter domestic policies including new transition programs to assist in retraining those who are caught by the new global pressures.

Finally, enormous changes are traversing Latin America. Countries which for generations have looked inward, basing economic policies on state enterprises, protection and import substitution, are opening up and making far reaching basic changes in the structure of their markets. Latin America is integrating into North America. The new vision of the Americas necessitates a reexamination of Canadian strategies and a shift towards the huge market and opportunities of the South.

Mexico and Canada in U.S. Markets

In 1991, Canada exported $96 billion (U.S.) worth of goods and services to the U.S., while Mexico exported $29 billion to the U.S. How will NAFTA affect Canadian sales in U.S. markets? Charts 1a and 1b detail the distribution of Canadian goods exports to the U.S. from 1990 through the first half of 1992. Chart 2 provides basic information on the sectoral distribution of Canadian and Mexican exports to the U.S. in 1990.

Click here to view Chart 1a: Canadian Goods Exports to the U.S. 1990

Click here to view Chart 1b: Canadian Goods Exports to the U.S. First Quarter of 1991

Click here to view Chart 2: Goods Exports to the United States, 1990

Products of the transportation sector make up 35 percent of Canadian goods exports to the U.S. However, these export figures exaggerate the importance of the transport sector since many of the components contained in cars assembled in Canada and shipped to the U.S. are of U.S. origin. The automotive sector accounts for nearly 13 percent of Canadian manufacturing, and overall manufacturing employment in Canada is 15 percent of total Canadian employment. Thus, while automotive exports are important, the direct employment in that sector accounts for some 2 percent of the Canadian labour force. Twenty-two percent of the products of the Canadian manufacturing sector are exported, 80 percent of these to the U.S. Thus, some 3.5 percent to 4.0 percent of the Canadian labour force is directly employed in exports to the U.S. Adding indirect effects (the steel in the cars etc.) and services would expand this figure two- to three-fold. Still, Canada is primarily a service economy with 72 percent of its employees engaged in the provision of services.

The distribution of Canadian and Mexican exports to the U.S. is quite different (see Chart 2). Automobile products represent 30 percent of Canadian exports but only 14.4 percent of Mexican exports; tele-electronics products represent 24.4 percent of Mexican exports to the U.S. but only 4.7 percent of Canadian exports. Forestry product exports are important to Canada (over $12 billion in 1990 and nearly 13 percent of all exports to the U.S.) but an unimportant export item for Mexico.

Within each of these broad product categories the distribution of Canadian and Mexican exports to the U.S. market varies as well. For example, finished vehicles make up half of each of the two countries exports to the U.S., but Mexico ships small cars and Canada large cars and vans. Mexico ships many engines to the U.S. market and Canada few; Canadian exports of trucks to the U.S. are large while Mexican exports of trucks to the U.S. are not.

It is clear that Canada and Mexico do compete in U.S. markets to some degree. However, Mexican competition will surely be greater if Canada is not part of a Mexico-U.S. trade agreement for the reasons given in the introduction. Mexico, or any country for that matter, is free to sign any trade agreement with the U.S. that makes its citizens better off. These trade agreements will provide more competition for Canadian exporters. Canadians cannot retain negotiated preferential access to U.S. markets. The only recipe for longer-term Canadian export success is Canadian excellence.

Were the U.S. to sign separate agreements with Canada, Mexico, and other countries in Latin America or elsewhere, it would be the "hub" in a hub-and-spoke system (see Lipsey, Wonnacott). As the hub, the U.S. would be the only country in this system with duty-free access to all markets. Canada, for example, would have duty-free access only to the U.S. market but not to Mexico or the other countries in the system. As a result of this asymmetric market access, the U.S. would be the natural investment location for any company wanting duty-free access to all countries. Canada and other "spoke" countries would lose out in the long run.

The Experience of the FTA

The Canada-U.S. Free Trade Agreement came into force on January 1 1989. The Canadian and U.S. economies (along with Europe, Japan etc.) have been mired in deep recession since 1990. Some observers blame the FTA for the majority, if not all, the Canadian job losses. The Canadian population at large appears to share this perception. There have been all too few serious unbiased analyses of the effects of the FTA, partly because serious economic analysis requires a number of years of data in order to disentangle the various factors which impact on the economy. The several such studies undertaken differ in their results but none blame the FTA for a major share of the enormous job losses which have occurred since 1990.

A 1991 study by Peter Pauly, for example, finds slight favourable impacts of the FTA. A 1992 study by Rodrique Tremblay attributes three quarters of all manufacturing job losses in the 1986-91 period to two causes-the substantial 55 percent increase in costs relative to U.S. and the recession. In 1992 Aileen Thompson analyzed how the stock market reacted to announcements of FTA events (such as the signing of the Agreement). She finds that significant positive effects occurred for two industries and negative (but statistically insignificant) effects for seven industries. Schwanen's 1992 study finds positive elements of the FTA's impact by investigating the changes in Canadian exports and imports since 1989 identifying those goods and services which were affected the most by tariff reductions in the FTA agreement. Gaston and Trefler, in a preliminary 1992 study using an econometric model of labour supply and demand in Canada (which includes the effects of trade liberalization), find employment losses from the FTA.

Pauly (1991) utilized a linked set of macro-econometric models to isolate the impacts on Canada (and the U.S.) of the FTA. In order to ask econometric models to sort out the variety of impacts on GNP, employment etc., Pauly had to pose a counter-factual path for macroeconomic events in the absence of the FTA. Pauly suggests that these results, obtained in 1991, "must be interpreted with extreme caution" and "provide as good an impression of the macroeconomic effects of the FTA as one is likely to get at this stage."

What counter-factual world has Pauly posed? Pauly assumes what economic theory states-that in the absence of the FTA a) exports and imports from the U.S. would have been lower (Schwanen proves this to be true), b) Canadian productivity would have been lower (there is no corroborating evidence of this), and c) investment in Canada would have been lower (the Government of Canada suggests that this is true). The results of imposing this alternative path and comparing it to the actual path of the Canadian economy are as follows:

1.Actual GNP in 1991 is 0.4 percent above what would have occurred without the FTA

2.Without the FTA, unemployment would have been a little higher

3.Inflation has been reduced (by two-tenths of 1 percent) because of the FTA

4.Imports, exports and business investment would have been slightly lower without the FTA.

Rodrique Tremblay examines the impacts of five effects on job losses in Canada in the 1986-91 period:

1.the real appreciation of the Canadian dollar of 18.1 percent

2.the 10.8 percent lower productivity growth in Canada than in the U.S.

3.the 11.2 percent increase in manufacturing wages in Canada relative to the U.S.

4.the recession

5.the FTA

Tremblay estimates the effects of these factors on manufacturing job losses as follows: [Tremblay utilizes a simple model of labour demand. See his Appendix B.]

1.The increase in Canadian relative costs -146,000
(factors 1,2,and 3 above)

2.Recession - Canada-126,000
- U.S. -12,000
Total 284,000
Total manufacturing job losses 1986-1991 319,000
Manufacturing job losses due to other factors 45,000

Thus, according to Tremblay, the major impact on job losses in Canada in the 1986-91 period was the 55.2 percent relative increase in real costs for Canadian manufacturers in the 1986-1991 period. The recession is the second most important factor. Third is the combination of all other forces (tax changes and free trade).

Thompson (1992) provides an alternative means of investigating the impacts of the FTA by studying the impacts of significant FTA events on the stock valuations of the TSE 300 and a broader index. [The TSE/Western data file including all stocks on the TSE and some stocks on the MSE and VSE.] Did these "events" provide abnormal returns to stock market investors?-the agreement on the FTA, October 3, 1988; the gaining strength of the Liberal party in October 1988 and the vows to abrogate the FTA if elected; and the conservative government election on November 21, 1988. None of these events had statistically significant effects, although the second event was consistent with a negative expected impact of free trade while events one and three had positive expected impacts.

Thompson points out that these aggregate effects mask industrial distributions-the FTA creates winners and losers. Accordingly, industries were grouped according to whether the expected effects were negative, positive or indeterminant according to Litvak (1986) and the MacDonald Commission Report. Industry level effects (stock market prices) are significant for event one but not for events two or three (remember that the aggregate effect of event one was negative but not significantly so). The food and beverage, textile, apparel, furniture, printing, rubber and plastics, and footwear industries had stock market decreases in value when the FTA agreement was reached on October 3, 1988. Positive stock market effects occurred for lumber and wood and paper. Other industries had indeterminate effects. However, the only statistically significant effects were for lumber, wood, and paper (all positive), and electronics (negative effect but indeterminate, a priori); the sum of each of the negative and positive groups was tested and found to be statistically significant. [Thompson also notes that the information contained in each so-called event was not totally new, thus the probabilities of the FTA did not go from zero to one each time new information arrived but changed existing positive probabilities say from .5 to .75. If one uses, as an example, a change in probabilities from .5 to .75, then, the stock market abnormal returns in the paper industry suggest gains from the FTA of 19 percent.] Thompson (1992) states:

It is striking that all of the Canadian cumulative abnormal returns corresponding to industries for which the lobbying and MacDonald Commission information provide consistent predictions have the expected sign. In addition, although only a few of the cumulative abnormal returns are statistically significant, many of them are quite large. During the three trading days of event window four, the values of the paper and industrial machinery portfolios increased by over 4 percent net of market-wide effects, and the values of the lumber and wood products and primary metals portfolios increased by 3.7 percent and 2.4 percent net of market-wide effects. The rubber and plastics products and electronic and electric equipment portfolios experienced abnormal declines greater than 4 percent during these three days and the textile, apparel, furniture and printing portfolios each experienced abnormal declines of over 2.5 percent. (p. 9)

Schwanen (1992) examines how Canada's trade pattern has changed since the FTA began. Economic theory suggests that trade in commodities liberalized under the FTA should expand faster than trade in commodities not affected by the Agreement. The actual data bears this out. Table 1 has been produced from the data compiled by Schwanen 1992. For merchandise, there is a clear trichotomous relationship; goods liberalized in the FTA had rates of growth for U.S./Canada trade (exports and imports) substantially greater than for goods not so liberalized, and Canada/U.S. trade in goods not liberalized grew (or fell less) than trade between Canada and the rest of the world (except for some goods imports (2b and 2c)). Schwanen's work is not definitive however cause and effect are inferred from these statistics. "The facts [these data] so far are more consistent with the optimistic scenario of free trade supporters than with the views of detractors" (Schwanen p. 13). However, would examining these same data for say 1980-1985 show the same patterns? Did the negotiators liberalize where trade was already growing rapidly? Without examining data for periods before the FTA, it is difficult to conclude from examining trade data for 1989-91 alone that the FTA caused trade expansion.

Click here to view Table 1: Trade Patterns, 1989-91

Gaston and Trefler in a preliminary 1992 analysis estimate the impacts that the tariff reductions in the FTA will have on Canadian employment and wages. The authors begin with an interesting survey of the existing literature, summarizing the expected impacts that protection and trade will have on employment and wages. The main conclusions of the survey are

•changes in exports have large and positive effects on employment

•changes in imports have large and negative effects on employment

•export oriented industries are associated with higher wages

•protected industries are associated with lower wages

•"in response to tariffs and imports, union workers make much greater wage adjustments than their non-union counterparts" (p. 8)

•employment is much more sensitive to imports than are wages

•"a worker who is forced to switch industries because of trade displacement faces a cut in wages with the loss of industry-and firm-specific human capital" (p. 15)

•"low-paid workers will be the group of workers that is most affected by trade liberalization" (p. 17)

•"in the long run, trade liberalization would induce a reallocation of workers out of low-paid manufacturing jobs and into high-paid manufacturing jobs which in turn would increase manufacturing wages" (p. 7)

•liberalization of trade forces adjustment of workers from protected, low-wage industries to higher wage jobs. This "will mostly benefit the low-skilled union members...the ones who find it most difficult to find a new job" (p. 20)

Gaston and Trefler then examine the potential impacts of the FTA on employment in Canada and the U.S. by estimating econometrically a model of labour supply and labour demand over the 1979-1991 period. The FTA is represented in the model only by its impact on tariffs. The effects of exchange rates, GNP changes and interest rate differentials are also incorporated as these clearly impact employment. Table 2 attached here (Table 5 in Gaston and Trefler, 1992) shows actual employment losses in the two countries between 1988 and 1991. There are two essential points to raise about this Table. First, note the magnitude of job losses in Canada relative to those in the U.S. In a number of industries Canadian job losses are three to five times as great as job losses in the U.S. Second, in only three industries were there job losses in Canada and job gains in the U.S.-food and beverages, metal mines and paper.

Click here to view Table 2: Employment and Wage Growth, 1988-1991

Gaston and Trefler note that the correlation between employment changes across the 22 industries for Canada and the U.S. over the 1988-91 period is .58-similar factors are affecting employment in both countries. [Gaston and Trefler conclude that these high correlations suggest job flight to the U.S. This is incorrect; in my view correlation is not causation.] Even after accounting for the host of independent influences-tariffs, imports, exports, domestic GNP, exchange rate and the interest spread-changes in Canadian employment on an industry by industry basis are still highly correlated with U.S. employment changes. The elasticity of employment changes in Canada with respect to employment changes in the U.S. is .865. A 10 percent increase (or decrease) in U.S. employment is associated with an 8.65 percent change in Canadian employment. [There is no effect of changes in Canadian employment rates on U.S. employment rates.]

Table 3 provides summary data on job losses from Gaston and Trefler in column one; the second and third columns are the rates of productivity advance in the sector in the 1980-85 period for Canada and the 1980-86 period for the U.S. taken from Denny et al. 1991. I have calculated the correlation between changes in total factor productivity (TFP) across these industries to be 0.29 (a 10 percent increase in TFP in the U.S. (or Canada) is associated with a 2.9 percent increase in TFP in the other country). Thus both employment and productivity changes in Canada are significantly correlated with those in the U.S. Similar forces are at work. One might suppose that employment losses were concentrated in the industries where productivity growth was the lowest. This is not evident in Table 3. Productivity growth over the 1980-85 period however might not say a lot about relative efficiency and costs. Column 5 in Table 3 provides estimates of the relative level of absolute efficiency for these industries as between Canada and the U.S. The correlation between the relative efficiency of Canadian industries (relative to the U.S.) and job losses in Canada is .43 for the eleven industries for which data exist. There is then evidence that lower total factor productivity in Canada does cost jobs.

Click here to view Table 3: Canada - Changes in Employment, 1988-1991; Productivity Growth, 1980-85

Several other issues suggest that the correlations between job losses in Canada and the FTA may be misleading. [It is important to point out that the Gaston and Trefler work is a preliminary analysis, and one which ignores the impacts of a number of other crucial factors on employment. Primarily, global forces which are creating structural change in a number of countries are ignored.] First, the high level of aggregation in Gaston and Trefler masks opposing effects. The job losses in Canadian mining and job gains in that aggregate sector in the U.S. are in different actual industries. Second, note that trade between the two countries has fallen in a number of industries. This occurred in leather, wood products, non-metallic mines, primary metals and transport equipment. It is hard to argue that the FTA decreased employment in both countries by decreasing trade. Third, there are an important number of industries where tariff changes are close to zero-wood products (Canadian employment loss 12.6 percent); non-metallic minerals (employment loss 9 percent); primary metals (employment loss 6.5 percent); food and beverages (employment loss 5.2 percent); metal mines (employment loss 4.5 percent); printing (employment loss 4.5 percent); mining non-metals (employment loss 1.3 percent); manufacturing petroleum and coal (employment gain 0.3 percent), and mining-mineral fuels (employment gain 0.5 percent). To relate employment losses to tariff reductions, given this range of job losses across industries with little tariff reductions, shows that significant other factors are at work.

Gaston and Trefler compute the marginal effects of tariff reductions on employment and wage levels in Canada, given import levels, trade changes and the effects of the recession. They find a negative effect on employment in Canada of the tariff reductions in the FTA. Why do they find this when the literature surveyed shows net gains from trade liberalization? The answer is twofold. First, Canadian tariffs are higher than U.S. tariffs so that U.S. import penetration into Canada generated by the FTA is greater than increased Canadian import penetration into the U.S. Second, they cannot model the benefits of more assured access.

The FTA also affected exports and imports as Schwanen (1992) and Pauly (1991) demonstrate. Thus, a more accurate measure of the short-run impact of the FTA would incorporate these effects as well. I estimate, from the Gaston and Trefler model, that the effect of the phase out of tariffs between Canada and the U.S. in the 1989-1992 period was a reduction in Canadian employment of some 42,000-63,000 employees (or 53,000 for an average estimate) [Estimated as follows (using coefficients from Gaston and Trefler, Table 7): Canadian tariffs on U.S. goods averaged 3.2 percent in 1989; I assume the tariffs have fallen by one third in the three years. The impact of a 1 percent reduction in Canadian tariffs is estimated to be an employment loss of .748 x 1.0 percent or .75 percent. U.S. tariffs averaged 2 percent in 1989. A .66 percent fall in U.S. tariffs increased Canadian employment by .142 x .66 or 0.09 percent. Assume that Schwanen is correct and the FTA caused export and import changes. Canadian exports to the U.S. rose 9.3 percent in the three years 1989-91. This increased Canadian employment by .37 percent (0.04 x 9.3 percent); the impact of imports has a marginally positive impact on Canadian employment, 0.05 percent (.005 x 10.5 percent). The aggregate impact is a fall in employment of 0.42 percent. Employment in 1988 averaged 10.1 million (Statistics Canada-72.002, this is a consistent base with the Gaston-Trefler study which excludes agriculture, professionals, etc.); 0.42 percent of this is 42,400. Using short-run elasticities estimated over 1988-91, employment loss would be .62 percent or 62,600.]. I think this exaggerates job losses because of the omissions in the model.

While there have been, in my view, more dislocations to this point than economists predicted, it is short sighted, I think, to concentrate on the FTA as the source of Canada's economic problems. Four of the five studies I examine here do show some job losses. However, unemployment in Canada since 1989 has risen by 880,000, 365,000 of this in the manufacturing sector (see Tremblay, 1992, p. 18-19). Job losses attributable to this point to the FTA might account for 15 percent of Canadian manufacturing job losses since 1989. [This does not mean that in the longer term there will not be job gains because of the FTA. Restructuring takes time, especially in today's unfortunate economic climate.] Many respected researchers have been warning for years of the loss of Canadian competitiveness (see Daly or Porter for two examples). Dismembering the FTA will not improve Canadian productivity, reduce costs or improve access to the U.S. and other markets. The majority of current Canadian problems require real and serious solutions to fundamental issues of education, training, labour markets, entrepreneurship, etc. Canadian firms are adjusting to the realities of a North American economic space (see Blank and Waverman, 1992). Forcing the costs of adjustment once again, this time to a market of 26 million Canadians at the northern edge of the Western Hemisphere as the whole Hemisphere (a market of 445 million people) is beginning to form would be, in my opinion, unwise

In the remainder of the paper, I highlight some of the key changes in the NAFTA agreement which are an improvement over the FTA.

Autos

In another chapter in this book, Jon Johnson provides an important substantive analysis of the changes in NAFTA for the auto sector. Clearly the important issue in the auto sector is the rules of origin. [See the paper by Peter Morici elsewhere in this volume for details on the rules of origin.]

I will not repeat Johnson's analysis. The bottom line is that the 50 percent rule-of-origin in the FTA becomes 62.5 percent for passenger cars and engines in 2002, rising from 56 percent in 1998. These increased domestic content provisions are a trade-off for improved definitions.

Therefore, simply for Canada-U.S. trade, what effects do the new rules have? Under the FTA rules as they were being interpreted, uncertainty was raised for producers as to whether particular direct costs would be challenged. NAFTA reduces that uncertainty. However, there is now a "certain" higher rule-of-origin and a regional value content for three countries (RVC) instead of the either "in or out" rules before for two countries (a part was either a qualified import-thus duty free-or not). An exact comparison could only be done by a company or a government official. Johnson argues (and I concur) that the effective content requirement likely has been raised after incorporating the changes in calculations.

Will an increase (assume hypothetically by 15 percent or 7 percentage points) in required content hurt Canadian producers? That is, are auto producers in Canada importing some 40 to 45 percent of net cost from outside the U.S., Canada and Mexico? Chrysler utilizes a number of Asian-sourced parts, as does Ford to a lesser degree. Both of these companies use Asian-made capital goods as well. If one considered the capital equipment used by some Big Three auto plants as foreign, these plants might not meet the new content rules. However, all capital equipment is considered as originating, no matter the origin. [Capital equipment is classified as "indirect material" in NAFTA (Article 415). Article 408 states "An indirect material shall be considered to be an originating material without regard to where it is produced."] Only the imports of original equipment parts count against RVC. RVC can be averaged over a model line (say Honda Civic) in a class (minis, subcompacts, compacts, midsize, large) in one plant; over a class in a plant, or over a model line (Article 403.4). Thus, larger producers with more models in a plant or a greater number of plants have more room to average. Asian producers tend to have fewer plants and fewer models and more parts imports. Who then is the rule aimed at?

An important issue is why 62.5 percent. Some have suggested that this was an average between the 60 percent desired by Canada and the 65 percent wanted by the U.S. (see the Globe and Mail, August 15, 1992, p. B2). I am unimpressed by this rationalization. After all, why is 62.5 percent more desirable than 60 percent? Is this just a shift at the margin for more local North American produced parts? One suggestion (Globe and Mail, August 15, 1992, p. B2) is that "achieving more than 60 percent North American content requires significant investments in power train manufacturing-the engines and transmissions that rank high in value in any car." This point must be carefully considered since autos are products which cannot have RVC continually changed at the margin; at some point (but is it 62.5 percent?) a big lump of net costs must be added-say an engine. Thus, 62.5 percent or 65 percent RVC may be equivalent to 80 percent RVC if the component made RVC by the change in rules is 15 percent to 20 percent of the costs of a car.

It is evident that Mexico's present Auto Decrees limit imports of parts and vehicles and promote exports. These decrees must be phased out by January 1, 2004 (see Johnson's chapter).

Adding Mexico complicates the calculations in two ways. First, Mexico is part of RVC, therefore out-sourcing to Mexico assists Canadian assemblers allowing them lower costs but retaining RVC. Second, Mexico becomes an alternative to Canada to earn RVC. Which effect will win out in the long-run? Recent research by Markusen et al. suggests that the elimination of Mexican controls will favour Canada in the long run. This study suggests that the NAFTA rules will lead to an increase in employment in parts and engine production in Canada offsetting a loss of Canadian employment in assembly. This study's conclusions rest on a number of key assumptions and the gains to Canada may be exaggerated. It is however important to emphasize that the interrelationships of the domestic content provisions are complex and it is not evident to a number of researchers that Mexico will become the preferred site for all forms of automotive manufacturing.

Textiles and Apparel

Trade in textiles and apparel (T&A) is not "free" in most developed countries. The U.S. and a number of other importers and exporters utilize the multi-fibre agreement to govern trade in T&A through a series of product and country specific quotas and tariffs.

There have been a number of complaints that the changes in NAFTA will lead to serious harm for the Canadian apparel industry (see articles in Le Devoir, August 13 and 14, 1992). This is likely exaggerated. [See the paper by Barry and Siwicki elsewhere in this book.] Canadian apparel manufacturers have been able to practice trade diversion to a substantial degree in the U.S. since 1989. Canada's share of the U.S. woolen suit market has gone from 1 percent in 1989 to nearly 7 percent today because only Canadian producers' exports can use third country fabrics and enter U.S. markets duty free-a saving of some 40 percent over exporters from outside North America (see Smith, 1992). It is true that the "fibre forward" rule and low growth rates for quotas in men's woolen suits are not to Canada's benefit. Textiles (where NAFTA gives significant increased quotas to Canadian producers) and apparel are clearly sectors where, with managed trade and under-managed trade, big wins and big losses can occur.

Energy and Petrochemicals

The Mexican constitution makes energy and basic energy products the prerogative of the state. Foreign investment is not allowed. However, the definition of what constitutes a "basic" product has changed over time and shifts markedly in NAFTA. [Energy provisions are dealt with in the paper by Campbell Watkins in this volume.] Mexico retains control for domestic investors (the state, largely) over crude oil, natural gas and five petrochemical products (butane, ethane, heptane, hexane and pentane). Foreign investment in other areas (such as ammonia and methane) are allowed. The government procurement section does open up the potential for Canadian and U.S. firms bidding on energy developments. Article 605 of NAFTA repeats Article 904 of FTA preventing government restrictions from reducing the proportion of energy exports below a 36 month moving average. However, Annex 605 states that this Article shall not apply as between the other parties and Mexico.

Canadians have paid too little attention to energy and petrochemicals assuming that the Mexican government's control over PEMEX would eliminate increased competition. This majority view may be in error. Crucial for oil supplies are new developments, reserve additions and replacements. The finding costs for oil and natural gas are likely significantly lower in Mexico than in the U.S. or Canada. Thus NAFTA, by increasing confidence in the Mexican economy, by opening up the Mexican government procurement market, and by explicitly allowing Canadian and U.S. firms to be used for exploration and development in Mexico, will lead to more emphasis on finding Mexican oil and gas. While this may lead to lower finds in Canada in the short to medium term, Canadian expertise could play an important role in the expansion of the Mexican energy sector.

Services

NAFTA applies the general principles of National Treatment and MFN to the service sector but without a great liberalization of cross-border trade. In addition, most existing impediments to trade are grandfathered. Thus most air services, most maritime services, basic telecommunications, and social services, are exempt. Road transport in Mexico is liberalized, as it needs to be for Mexican competitiveness.

Financial services [Financial services are discussed in the paper by John Chant.] are liberalized, allowing financial institutions established in the U.S. or Canada [These need not be Canadian or U.S. majority owned, simply corporations duly registered (i.e. meeting the tests of Canada and of the U.S.).] to expand in Mexico under a set of safeguard mechanisms limiting total market share and individual firm size until the year 2000. After 2000 there are no limits on Canadian and U.S. presence but non-Mexican bank acquisitions may be subject to a 4 percent cap. [Aggregate limits may be put in place between 2000 and 2004 for a duration of three years if foreign financial affiliates reach 25 percent of the commercial banking sector or 30 percent of the securities industries (measured by aggregate capital) (See Annex VIIIB).] The Agreement allows people in one country to purchase financial services located in another country, within limits. National Treatment means that any new service which domestic firms are allowed to offer can be offered by firms from the other countries. Article 1409, however, allows the continuation of certain existing non-conforming measures at the federal or state/provincial levels. A Financial Services Committee is established to supervise the implementation of this section of the Agreement, to examine technical issues, and to participate in dispute resolution.

Agriculture

Two bilateral agreements are proposed: U.S.-Mexico, and Canada-Mexico, within an overall trilateral framework which establishes tariff reductions and overall "rules of the game." Canada and Mexico will eliminate all tariffs or NTBs except in the dairy, poultry, egg and sugar sectors. In these other sectors, Mexico replaces its quotas with "tariff rate quotas," tariffs which yield the same imports as the quotas, or with ordinary tariffs. These tariffs fall to zero over a ten-year period (except for corn and dried beans which have fifteen years). Opening up Mexican field grains and cattle markets to Canadian exporters is a plus, as is the opportunity for Canadians to have Mexican vegetables and fruits at times when the Canadian climate is not conducive to production.

The ability of Canadians to take advantage of agricultural markets in Mexico depends on a host of other factors. Transport links are crucial. Since transport is largely exempt from NAFTA, will rail and truck links allow Canadian grain and cattle to move expeditiously to Mexico? How will trade credits and export financing react? Trade in goods and services are interlinked and it will be necessary for Canadian services to facilitate increased trade in agriculture (and the other liberalized goods).

Antidump and Countervail Procedures

A serious omission from NAFTA is the absence of a significant new impediment to the use of antidump and countervail procedures against free trade partners. The FTA made the same error. Adding Mexico clearly complicates Canada-U.S. agreement on a subsidies code. In this area, it is suggested that we are waiting for Godot, spelled G-A-T-T. However, within the EC, firms cannot accuse foreign firms of pricing below cost using costing formulae that no domestic competitor has to meet. This is the reality of antidump law. In the private-interests driven and micro-trade policy domain of the U.S. International Trade Commission, antidump is at best harassment and at worst offensive protectionism. NAFTA does little that is new to remove these protectionist elements. While Dispute Resolution is an important counter to pure protectionism (see Horlick 1991), [Also see the Gilbert Winham paper in this volume.] the ultimate aim must be to have National Treatment for predation rules under Competition Policy in NAFTA, as a replacement for the current domestic procedures. Trade cases levied against Canada by U.S. producers since 1989 account for a small percentage of actual Canadian exports. However, the threat of trade actions must inhibit pricing decisions in other industries, thus protecting U.S. firms. Some investment decisions would also be affected by these very public trade disputes. U.S. unilateralism is a reality but further steps must be taken to reduce protectionism within the free trade area.

Conclusion

NAFTA reduces trade barriers against Mexican goods in U.S. and Canadian markets. For most manufactured products, these barriers were already low. Thus, the new competition that Mexico will offer Canadian and U.S. producers will come largely from increased future production in Mexico that results from NAFTA. By staying out of NAFTA, Canada will not affect to any significant degree increased Mexican penetration of Canadian markets. To prevent this penetration, Canada would have to raise its barriers against Mexico, but GATT prevents this, in large measure. In addition, NAFTA is superior to the FTA in a number of ways.

NAFTA offers Canadian investors and exporters privileged access to the Mexican market. Privileged access to a large and growing market is an asset for Canada. Another issue is the increased competition that Canada will have with Mexico for the U.S. market. Is this detrimental and would staying out of NAFTA have been beneficial for Canada? In fact, Canada cannot prevent Mexico from succeeding in the U.S. market (although the U.S. could do so by increasing barriers to Mexican goods). So, staying out of NAFTA yields no positive effects for Canada.

Thus, my message is fairly simple. Mexico will succeed or not whether Canada is in NAFTA or not. We cannot affect Mexican growth by ignoring Mexico. Since the rise of Mexico as a competitive player, like the rise of Korea or Taiwan, is outside Canadian influence, the key to Canadian success is to concentrate on internal matters-job training, the extent of intra-provincial barriers, venture capital, the building of the "Canadian diamond" (see Porter, 1992), the set of interrelated goods and services production which leads to enhanced productivity, exports and higher incomes. Canada is facing new challenges; Mexico is but one of these. However, greater competition from Mexico will be felt by low-skilled employees, Canadians already hurt by increased global competition. Innovative transition and retraining programs are needed.

Bibliography

Blank, Steven and Leonard Waverman, 1992, "The Changing Infrastructure of North America and Its impact on Canada's Relations with North America: A Concept Paper," North-South Center, University of Miami.

Denny, Michael, J. Bernstein, M. Fuss, S. Nakamura, and L. Waverman, 1991, "Productivity in Manufacturing Industries-Canada, Japan and the United States, 1953-1986: Was the `Productivity Slowdown' Reversed?" CJE 1991.

Gaston, Noel and Daniel Trefler, 1992, "The Labour Market Consequences of the Canada-U.S. Free Trade Agreement: A Preliminary Assessment," October, University of Toronto, mimeo.

Horlick, Gary, and F. Amanda DeBusk, 1992, "The Functioning of the FTA Dispute Resolution Panels," in Waverman (ed.): Negotiating and Implementing a North American Free Trade Agreement, Fraser Institute/Centre for International Studies.

Lipsey, Richard G., 1990, "Canada at the U.S.-Mexico Free Trade Dance: Wallflower or Partner?" Commentary, No. 20, August: C.D. Howe Institute.

Litvak, Isaiah A., 1986, "Freer Trade with the U.S.: The Conflicting Views of Canadian Business," Business Quarterly, Spring.

Pauly, Peter, 1991, "Macroeconomic Effects of the Canada-U.S. Free Trade Agreement," paper in the Studies on the Economic Future of North America series, Fraser Institute/Centre for International Studies.

Porter, Michael, Canada at the Crossroads, BCNI and Minister of Supply and Services, 1991.

Schwanen, Daniel, 1992, "Were the Optimists Wrong on Free Trade? A Canadian Perspective," Commentary, No. 37, October: C.D. Howe Institute.

Trembley, Rodrique, 1992, "L'mergence d'un Bloc conomique et Commercial Nord-Américain: la Compétitivité de l'conomie Canadienne et la Politique du Taux de Change," Université de Montréal, Départment de Sciences conomiques, Cahier 9212.

Thompson, Aileen J., 1992, "The Canada-United States Free Trade Agreement and Stock Prices," mimeo, October 10.

Wonnacott, Ron, 1990, "U.S. Hub-and-Spoke Bilaterals and the Multilateral Trading System," Commentary, No. 23, October: C.D. Howe Institute.

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