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

The North American Free Trade Agreement (NAFTA) was implemented in order to promote trade between the U.S., Canada, and Mexico. The agreement, which聽eliminated most tariffs on trade between the three countries, went into effect on January 1, 1994. Numerous tariffs鈥損articularly聽those related to agriculture, textiles, and automobiles鈥搘ere gradually phased out between January 1, 1994 and January 1, 2008.

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


What is NAFTA?

President Donald Trump campaigned on a promise to repeal NAFTA and other trade agreements he deemed unfair to the U.S. On August 27, 2018, he a new trade deal with Mexico to replace it. 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聽more agricultural trade between Mexico and the U.S., and would effectively replace NAFTA.

On September 30, 2018, the U.S. and Canada agreed to a deal to replace NAFTA, which will now be called the USMCA鈥擳he United States-Mexico-Canada Agreement. In afrom the U.S. and Canada Trade Offices, representatives said the following:

鈥淯SMCA聽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.聽It will strengthen the middle class, and聽create good, well-paying聽jobs and聽new opportunities for the nearly half billion people who call North America home."

On January 29, 2020, President Donald Trump signed the United States-Mexico-Canada Agreement. Canada has yet to pass it in its parliamentary body as of January 2020. Mexico was the first country to ratify the agreement in 2019.

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 U.S.'s second- and third-largest suppliers of imported goods. In addition, approximately聽one-third of U.S. exports, particularly machinery, vehicle parts, mineral fuel/oil, and plastics are destined for Canada and Mexico.

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 into effect on November 30, 2018.

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聽into law in 1993, believed it聽would create 200,000 U.S. jobs within two years and 1 million within five years because exports play聽a major role in U.S. economic growth. The administration聽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聽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,聽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鈥 laws or customs procedures.

North American Industry Classification System

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

The NAICS replaced the U.S. Standard Industrial Classification (SIC)聽system, allowing businesses to be classified systematically in聽an ever-changing economy. The new system enables easier comparability between all countries in North America. To ensure that the NAICS remains聽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聽Bureau of Economic Analysis, Bureau of Labor Statistics,聽and the Bureau of聽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聽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聽classifying all economic activity into 20聽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聽indicates聽its main line of business. A company receives its聽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聽NAICS code indicate the company's economic sector. The third digit designates the company鈥檚 subsector. The fourth digit indicates the company's聽industry group. The fifth digit聽reflects the company鈥檚 NAICS industry. The sixth designates the company鈥檚 specific national industry.

NAFTA's Impact

Debate continues surrounding NAFTA's impact on its聽signatory countries. While the United States, Canada, and Mexico have all experienced economic growth, higher wages, and increased trade since NAFTA鈥檚 implementation, experts disagree on how much the agreement actually contributed to these gains, if at all, on U.S. manufacturing jobs, immigration, and the price of consumer goods. The results are hard to isolate, and聽other significant developments have occurred on the continent and globally in the past quarter-century.

From the beginning, NAFTA critics聽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 have moved their manufacturing to Mexico and other countries with lower labor costs. However, NAFTA may not have been the reason for those moves. President Donald Trump's USMCA was meant to address these concerns. The White House estimates that the USMCA will create 600,000 jobs and add $235 billion to the economy.