Washington: Protectionist Racket

As if the North American Free Trade Agreement didn't have enough enemies already—Ross Perot, Ralph Nader, the AFL-CIO, Greenpeace, and most congressional Democrats for starters—now some free-traders are turning hostile. Specifically, in late August two free-market organizations—the Competitive Enterprise Institute and the Ludwig von Mises Institute—came out in opposition to NAFTA. The plot thickens: They made their announcement at a NAFTA-bashing press conference starring—are you ready?-protectionist/nativist Pat Buchanan and former Customs commissioner/drug war Dr. Strangelove William von Raab. What's a nice idea like free trade doing in a place like that?

Actually, there's plenty in NAFTA to make a free-trader uneasy. To begin with, the whole idea of negotiated trade agreements is mercantilist in conception. In trade negotiations we will only "give up" our trade barriers (no matter how misguided or harmful to our economy they may be) in exchange for similar "concessions" by other countries. The implication is that opening our markets is the price we pay to gain better access to markets abroad. That "exports good, imports bad" premise is at the heart of the mercantilist worldview; any good free-trader knows that open markets are their own reward, regardless of what is going on in other countries.

I have argued, in these pages (see "Reciprocity for Disaster," August/September 1991) and elsewhere, that for both theoretical and practical reasons a strategy of unilateral liberalization is generally preferable to trade negotiations. Pursuing open markets strictly as a matter of national economic policy is clearly sound in theory. Practically, it has the advantage of putting the focus of policy debate where it belongs: not on whether policies and conditions abroad are to our liking, but on whether the particular U.S. industries receiving or requesting import protection deserve special treatment at the expense of the rest of us. Furthermore, the example of the United States actually taking its own rhetoric seriously and opening its markets would do more to encourage freer trade abroad than any negotiations ever could.

Whatever my druthers, though, unilateral free trade is not exactly a happening political movement in this country. The cause of free trade, for the foreseeable future at least, rests entirely on the fate of trade negotiations: the Uruguay Round of the General Agreement on Tariffs and Trade talks and, of course, NAFTA.

If those initiatives fail, there's quite simply nothing else on the horizon. In evaluating NAFTA, then, the realistic question is not whether the agreement is perfect or even whether it represents the best approach to reform—I think it fails on both counts, but neither count is relevant. The decisive question is whether NAFTA marks a step in the right direction. The answer is a resounding yes, and therefore free-traders ought to be lending the embattled agreement their full support.

Let's look at the original agreement first, and then we'll move on to the more controversial side deals. The original NAFTA certainly has its share of warts and wrinkles: The first clue is that the document is more than 1,000 pages long, though a truly "clean" free-trade agreement could probably be squeezed into a sentence or two. Here are the agreement's main shortcomings:

• Unfair trade laws. Under NAFTA each of the three countries may continue to use its anti-dumping and countervailing-duty (anti-subsidy) laws to impose penalty duties on "unfair" imports from the other two countries. The United States just imposed such sanctions on Canadian and Mexican steel, and Canada and Mexico are in the process of doing the same to U.S. steel. On the bright side, NAFTA establishes a dispute-settlement mechanism (based on the one created for the U.S.-Canada Free Trade Agreement) that allows neutral binational panels to review enforcement of these laws.
• Escape clause. Under Section 201 of the U.S. trade law, also known as the "escape clause," imports that are causing serious injury to a domestic industry can be limited by tariffs and quotas, even without any proof of "unfair trade." Granting relief under Section 201 is discretionary with the president, though, and as a result the law is seldom used. NAFTA allows the three parties to continue using their escape-clause laws against imports from NAFTA countries, subject to various special constraints.
• Rules of origin. These arcane provisions set the criteria for determining whether products are made in North America and thus qualify for duty-free treatment under NAFTA—a highly complex endeavor now that raw materials, components, and subassemblies are sourced from all over the world. The rules negotiated in NAFTA are too often skewed in favor of upstream U.S. raw material and component suppliers and against their non-North American competitors. The most egregious examples are in textiles, automobiles, and electronics. Arbitrary origin rules both restrict the benefits of duty-free treatment and divert trade from other regions.
• Energy. The Mexican Constitution reserves ownership and exploitation of energy resources to the state. Accordingly, NAFTA was severely limited in its liberalization of the energy sector. Pemex retains its monopoly on oil exploration, production, and refining, and U.S. and Canadian producers are excluded from the Mexican retail gasoline market. But NAFTA does eliminate most investment restrictions on petrochemicals, and it also opens up Pemex and CFE (the State Electricity Commission) procurement contracts to foreign participation.

So NAFTA isn't perfect—big surprise. But does that make it a "managed trade" accord, as some critics have alleged? Managed trade means quantitative controls on trade: import quotas, reserved market shares. Our textiles quotas, the semiconductor agreement with Japan, the various deals allocating international airline routes—those are managed trade.

NAFTA is nothing of the sort. The agreement eliminates tariffs and quotas across the board. It substantially liberalizes investment within the region. It opens up the Mexican financial services sector to foreign competition. It allows cross-border access in trucking. Managed trade is about asserting political control over trade and investment flows; NAFTA is about relaxing and eliminating such control. The fact that it doesn't go all the way in that direction doesn't mean it's going in the opposite direction.

The labor and environmental side agreements, on the other hand, do represent an attempt to maintain political control in the face of falling trade barriers. They are repugnant to the liberalizing thrust of the underlying agreement, and they set a very bad precedent for future trade negotiations. They ought to be roundly condemned by free-traders. But as to whether they undo all the good the original NAFTA offers—well, it's not even close.

The side agreements create special supranational bureaucracies to police the enforcement of each nation's labor and environmental laws. If a "persistent pattern of failure to effectively enforce" such laws is found, those bureaucracies can impose fines on governments that refuse to take remedial action and can ultimately impose trade sanctions if the fines aren't paid (or, in the case of Canada, obtain a court order in the Canadian judicial system mandating compliance).

That's the bad news. The good news is that the side deals are concerned only with the enforcement of laws. They do not create any new laws, and they explicitly recognize the authority of the three countries to set their own substantive labor and environmental policies. NAFTA establishes no monolithic regional standards according to which substantive national policies could be judged and found wanting. And while the side deals impose a duty to enforce laws, they contain nothing that would prevent a country from changing or repealing laws if it wanted to.

The more you look at these side agreements, the less there is to them. Only failures to enforce child-labor, workplace-health-and-safety, and minimum-wage laws are sanctionable under the labor side deal; failures to protect the rights to strike and bargain collectively are not covered. And the environmental side deal does not apply to laws governing the use of natural resources.

Moreover, it is not a violation of the side agreements for a government to fail to pursue legal violations if the inaction "reflects a reasonable exercise of the agency's or the official's discretion" or if it "results from bona fide decisions to allocate enforcement resources to violations determined to have higher priorities." That's a fairly gaping loophole. And the maximum fine that can be imposed is limited to 0.007 percent of the value of North American trade, or a whopping $20 million at present.

In sum, the side agreements have absolutely no impact on the substance of labor and environmental regulations and add only slight pressure for more vigorous enforcement. Meanwhile, the economic pressures generated by increased competition under NAFTA will be acting to constrain policy makers from imposing excessive burdens on business. In labor and environmental policy, then, NAFTA—even with the side deals—looks like a wash. In trade policy, on the other hand, NAFTA represents a substantial gain.

And that gain goes far beyond the specific reductions in trade barriers contained in the agreement. NAFTA represents a bold and unprecedented experiment: It marks the first time ever that a rich, industrialized country and a poor, developing country have agreed to open their economies to each other. NAFTA can help to show the world that free trade, even between dramatically different nations, truly does benefit both sides.

In this country, it can help to acclimate people to living in an international economy (which they already do but don't fully realize). Once Americans see that open trade with Mexico doesn't cause the world to end or all the jobs to disappear, they may be less resistant to tearing down other protectionist barriers in the future.

On the flip side, NAFTA's failure would be an enormous setback for the cause of free trade here and abroad. In Mexico and throughout Latin America, the perceived betrayal by the United States could seriously undermine support for free trade and free-market reforms generally. And if NAFTA is voted down in Congress, you can bet that the fallout in this country won't be a sudden turn toward unilateral free trade. On the contrary, politicians are going to run away from free trade as though it's radioactive. Meanwhile, NAFTA's defeat will be seen as a big win for Perot and populist know-nothingism.

Unfortunately, the free-trade opponents of NAFTA are lending credence and rhetorical cover to those reactionary political forces. That is especially true of the ones who have been flirting with the Neanderthal right on the issue. It's bad enough to be wrong, far worse to enthusiastically play the useful idiot.

Contributing Editor Brink Lindsey is director of regulatory studies at the Cato Institute.