By: Miguel del Villar Volkers
Miguel del Villar Volkersz is the Founder of Promoting Good Trade (PGT), a consulting firm that provides strategic advice to domestic and foreign enterprises operating in Mexico. Prior to establishing PGT, he was Mexico’s Senior Counsellor for Commercial Affairs in Korea and Deputy Director of Mexico’s Customs Administration Office.
There is no doubt that the North American Free Trade Agreement (“NAFTA”) has generated an enormous amount of economic activity in North America. Regional trade increased 128% since NAFTA came into effect. The figures for the bilateral trade relationship between the United States and Mexico (which triggered the current renegotiation process) reflect a gross increase in the exports from the United States into Mexico of 455%. The exports from Mexico to the United States increased 637% since the commencement of NAFTA. The daily trade under NAFTA is approximately US$1.8 billion. We know that wages in Mexico (which is another source of major contention among the NAFTA partners) for firms that export products to the United States and Canada are 30% higher on average than the wages of Mexican non-exporting firms. We also know that companies with foreign direct investment in Mexico pay 25% more to their employees than Mexican owned firms. Will all this come to an end if NAFTA terminates? The answer is no. Trade in North America will continue with or without NAFTA. North America will continue to be a very dynamic region in terms of international trade and investment. The United States, Canada and Mexico will continue to be key trading partners, sharing borders and many political, economic and cultural ties. Trade among the United States, Canada and Mexico will continue regardless of the outcome of the NAFTA negotiations.
It is also well established that trade among the NAFTA partners will be governed by the rules of the World Trade Organization (WTO) if NAFTA collapses. Under the WTO, tariffs on trade are already very low (for many products they are zero) and there is a highly developed set of rules for non-tariff barriers. Therefore, one would not expect major changes in the trade patterns in the region if NAFTA were to come to an end.
It is also false that foreign investment will cease to be directed to the NAFTA countries if the agreement disappears. As many commentators have pointed out, there seems to be very little evidence supporting a direct, positive and well-connected causal relationship between investment treaties and foreign direct investment.
One loss is a path to internal reform
So, if there will be very little impact on international trade flows and foreign investment, what would the NAFTA countries lose if the agreement terminates? One thing the United States, Canada and Mexico would lose is the benefit of further internal reform. NAFTA triggered very significant changes in the domestic legislation of the three member countries. In the case of the United States, the implementing legislation incorporated everything that was agreed in NAFTA. The provisions of the implementing legislation would have never been adopted unilaterally by the United States. It is inconceivable that the US would have adopted, on its own, the alternative dispute resolution mechanism set forth in NAFTA Chapter XIX which allows international tribunals to review domestic determinations on anti-dumping margins and injury. Similarly, NAFTA had a substantial impact on Mexico’s internal laws. When NAFTA came into effect, Mexico amended more than 25 federal laws to give effect to the provisions of the treaty, including rules for international trade, insurance, foreign investment, financial institutions and many others. Mexico implemented many long term unpopular changes that otherwise would have been politically unviable. What we really lose without NAFTA is the possibility of utilizing the treaty as an instrument to achieve internal reform.
What should we do then if there is no NAFTA? One thing the NAFTA parties could do is start fighting some of the bureaucratic inefficiencies that affect the productivity of firms and that in the aggregate affect the competitiveness of the region.
For example, UNCTAD’s 2017 report on trade and investment ranks Mexico as number 13 in the index for attracting investment. However, it is a reality that both foreign investors and national firms that establish operations in Mexico are often affected by administrative practices that are inefficient and harmful for firms. This is a very common complaint by firms against the government. These inefficiencies affect all of the procedures that the firm needs to undertake in order to operate in Mexico as an enterprise (e.g., constitution of the firm, licenses and permits, inspections, labor regime, etc.), and have a very important negative effect on businesses.
There is still much that governments and the private sector can do without NAFTA
Regardless of whether NAFTA remains, the United States, Mexico and Canada should work on their trade facilitation agenda, including simplifying administrative procedures. This may sound like a minor item but it is incredible that Mexico City (to name an example) is ranked 31 out of 32 Mexican provinces in the competitiveness score of The World Bank’s Doing Business 2018 report. To open an enterprise in Mexico, firms need to process administrative permits and licenses in more than 12 governmental agencies. It takes an average of 62 administrative days to register property in Mexico, such as real estate property, in the public registry. The licensing of urban development projects takes 100 days on average to be issued and more than 20 federal, local and municipal agencies are involved. This is an issue that Mexico can improve to advance its competitiveness standards, attract more foreign investment and facilitate the production and exportation of goods outside the NAFTA framework. The United States and Canada could take a similar approach and address their administrative barriers (many of which have been discussed in NAFTA trilateral committees).
But, the competitiveness agenda is not only with the government and its administrative processes. It is also the responsibility of private sector firms. It is true that governmental agencies are slow and bureaucratic and they often have excessive and expensive procedural requirements affecting trade and investment, but it is also true that many times companies are unsuccessful in obtaining the required permits due to their own failure to maintain adequate housekeeping procedures and have their documentation in order. There are numerous examples that illustrate the foregoing. Mexico’s tax authorities often state that tax returns are not paid to companies due to the companies’ own flaws and procedural mistakes. There are also many stories of US and Canadian firms that are unsuccessful in the Mexican market because they do not carry out proper due diligence procedures regarding labor laws or maintain corporate books, environmental permits and other basic items such as adequate notarized powers of attorney and translations of operative agreements. Many enterprises do not have the appropriate procedures to insert themselves in the local market efficiently. They maintain international managers with no real connection with the host country. They do not participate in local associations and chambers and sometimes carry out their business assuming that things in the host country work in the same manner as they do in their home country. In every international investment process, there is a cultural element that affects competitiveness. Foreign firms must be capable of inserting themselves in the local market and operate as if they were a domestic company. Many firms have learned this the hard way in the last two decades and others such as a number of Canadian firms, including Scotiabank and Four Seasons, have learned this principle very quickly. In short, an adequate business strategy bridges the cultural gap and makes the firm more competitive. The sum of all these efforts by foreign firms would add up and create a more competitive region in North America. When we think North America would be less competitive without NAFTA, we should think that there are a number of things the three member countries could do internally to offset the termination of NAFTA. Improving administrative procedures and having firms work on their establishment strategies will have a much more significant impact in the region’s overall competitiveness than a small increase in tariffs due to the termination of a 25-year old agreement.