ComercioExterior, Vol. 53, No. 5, Mexico, May 2003

Legal Inequityin the North American Free Trade Agreement

Rafael Sosa Carpenter

Professor in InternationalTrade at the Chapultepec University, and a partner with Consultores en ComercioExterior y Aduanas, S.C., <rafasosa@mailbanamex.com>.

To write about the North American Free Trade Agreement(NAFTA) is a major challenge since it involves addressing a topic that is pivotaland controversial for the country. Because of the interdependence between Mexicoand the United States, it is vital to maintain clear rules that define not only tradeexchange, but also something more. Nevertheless, there are many errors that mustbe corrected, both in NAFTA and in national laws, since they have led to the inequityin the treatment of Mexico by Canada and the United States.

ECONOMIC INTEGRATION: FROMA GEOPOLITICAL TO A GEOECONOMIC VISION

Economic integration1 isthe product of rapid changes in the world economic scene: the fall of the Communistbloc; the internal strengthening of the European Union; the increased importanceof the Pacific Rim in world trade; financial crises in Mexico, Brazil, Argentina,Russia and Japan; the forming of Mercosur; and the creation of the World Trade Organization(WTO). These are events that reflect a recomposition of the world into regional economicblocs—more in geoeconomic terms than in geopolitical-military terms.

Technically, economic integration should be evaluatedin terms of trade creation2 and trade diversion.3 However, economic integration affects other economic and political aspects: it improvesaccess to foreign markets, it promotes economies of scale, it helps to prevent civilwars,4 it generates greater cooperation among parties,and it assures the prevalence of certain economic and democratic reforms that givea country an image as a trustworthy nation for foreign investment.

As in all processes, integration has its advantagesand disadvantages. The benefits can be measured at various levels, depending a greatdeal on the asymmetry of the parties and the long-term plan pursued by the partnerswith an eye toward surviving in a world made up of regional blocs. In theory, economicintegration takes place in stages: from the simplest, as in the preferential trade"club," to a free trade zone, tariff union, and a common market, and tothe most ambitious: economic union.

THE NORTH AMERICAN MARKET:A HISTORICAL ASPIRATION

The idea of creating an integrated economic areain North America is not a new idea. Its antecedents can be traced back to 1860, whenthere was an attempt to ratify the failed McLane-Ocampo Treaty that had been designedto create a free trade zone between the United States and Mexico. For many years,this idea was placed on the back burner, until the Carter administration (1976-1980)and the Reagan administration (1980-1988) presented the idea of creating a NorthAmerica Common Market (NACM) which would include a project for a common energy market,an idea that, despite everything, was not appealing to Mexico. However, years later,in 1988, Canada and the United States signed a free trade agreement that integratedtwo of the world’s most developed economies and formed a North American regionaleconomic area.

Later, President George Bush (1988-1992) announcedthe Initiative for the Americas, aimed at creating a hemispheric free trade zonethat would begin with the signing of free trade agreements with countries in LatinAmerica and the Caribbean. The Initiative clearly defined signing a free trade agreementwith Mexico as the first step toward its crystallization. Thus, in 1992 Mexico signedNAFTA with the United States and Canada, and the agreement went into effect in January1994.

NAFTA’S EVOLUTION: FOREIGNTRADE

The primary topic in negotiations for a free tradeagreement is the elimination of tariffs (used as a mechanism for protecting nationalindustries and industrial development) in order to prioritize the importing of lessexpensive inputs to allow national industries to manufacture products at lower costs.

Tariff reduction was not as important for the UnitedStates and Canada as it was for Mexico. One year before NAFTA went into effect, theUS tariff for Mexican products was 3.3%; in 2001 the average was 0.10%, althoughit was 2.69% for countries with which the United States does not have a trade agreement.The same happened in the case of Canada; in 1993 the average tariff for Mexican productswas 2.4%; in 2000 it was 0.3%, while for other countries it was 3.5%.5 Mexico, for its part, maintained an average tariff of 15% in 1993; and in 2001 theaverage tariff for its NAFTA partners was approximately 2%. What is important hereis that Mexico negotiated tariffs with economies at different levels of development,and at times without considering the risks for certain economic sectors, such asagriculture.

The reduction in tariffs has generated significantgrowth in trade. From 1994 to 2001, trade among the NAFTA partners increased by 115%.In only seven years, trilateral trade went from US $339 billion to US $622 billion.However, this trade is centered in the United States, on whose economy Canada andMexico depend a great deal. Data from the WTO indicates that 87% of Canadian exportsare destined for the United States (more than US $241.5 billion), compared with 0.5%destined for Mexico.6 The same is true for Mexican exports:in 1999, 89% were destined for the United States, while only 2% for Canada. The UnitedStates, however, depends to a much lesser degree on Canada and Mexico, since only37% of its total exports are destined for those two countries, and it buys only 19%of its total imports from Canada (its primary supplier) and only 11.2% (US $140.4billion) from Mexico (its fourth most important trade partner, after the EuropeanUnion and Japan). This implies that the United States’ two NAFTA partners barelycover 30% of its imports. In summary, the United States does not depend as radicallyon Canada and Mexico as the latter two on the United States.

The agricultural sector is a particular case. Ingeneral terms, tariffs on agricultural products are being reduced in phases of five,ten and fifteen years. Mexico negotiated some products as "sensitive" andthose tariffs will be completely eliminated after 15 years: sugar, eggs, pork meat,milk products, beans and corn. In fact the non-preference tariffs imposed in a freetrade agreement are among the highest in the list of tariffs for products that Mexicoimports.

NAFTA permits the importing of certain quantitiesof products free from tariffs or with reduced tariffs, while higher tariffs are paidon imported products above these quantities. Mexico applies this type of quantitativemeasure (tariff quotas) to agricultural products. However, with NAFTA the reductionin tariffs is significant even without tariff quotas (which exempts them from payment)since in accordance with rules of origin, these products obtain a considerable discount.Examples are eggs (tariff is reduced from 46% to 9.5%), milk (reduced from 128% to70.8%), potatoes (from 251 to 51.6%), yellow and white corn (from 198 to 70.4%),and beans (from 128 to 70.4%). All of these are vital products for the Mexican population.

According to the theory of economic integration,trade is created when inefficient producers are replaced by efficient producers.However, a producer can be more efficient due to the subsidies granted by the government.7 Subsidies are permitted in NAFTA on the condition that governmentswishing to increase or modify them consider the repercussions on their partners andconsult their partners regarding their application. In this case government consentdoes not signify that subsidies are legitimized, leaving producers exclusively dependenton their own productive efficiency.8 It is evident that Mexico cannot getinvolved in a subsidies "war" with the United States, and the only wayto combat subsidies is to impose compensatory quotas. The problem is that for Mexicothe agricultural sector represents a highly important source of work: 20% of theMexican population works in agriculture, while in its partner countries, this amountis less than 5%.9 Thus, agriculture is more importantfor Mexico than many believe, and even more so, in terms of self-sufficiency in thearea of sensitive food products, since it can be an element that determines a country’sweakness in international politics and the country’s dependence on its suppliers.10

NAFTA’S DANGERS IN THE MEXICAN LEGAL SYSTEM

In any country, a treaty occupies a high positionwithin its legal system, since it is an instrument of international law. Treatiescannot go against the Constitution since, together with treaties, the Constitutionis a nation’s supreme law, above federal or state laws. In the case of treaties,provisions from international law are incorporated into Mexico’s legal system andbecause of their importance, they are signed and approved, by the country’s presidentand the Senate, respectively.

With the objective of regulating the signing oftreaties and interinstitutional agreements, Mexico’s Treaty Law11 was made public in 1992. It establishes two instruments through which provisionsfrom international law are incorporated into the Mexican legal system: 1)treaties, and 2) interinstitutional agreements. According to this law, thesecan be agreed upon in writing between a department or decentralized agency of publicadministration (federal, state or local), and one or various foreign government entitiesor international organizations, whether or not they are derived from a previouslyapproved treaty. Agreements must be exclusively circumscribed to the specific attributionsof government departments and decentralized agencies in the mentioned governmentspheres and the signing of such agreements must be reported to the Foreign RelationsMinistry.

With this law, agreements take on the level of aninternational treaty—something ridiculous since this incorporates international provisionsnegotiated by a government official and without Senate approval into the nationallegal system, and the country can be subjected to commitments that are not in nationalinterest. The clearest example can be found in the parallel letters signed in 1993by the Mexican and US Secretaries of Trade and approved by the US Congress. Throughthese agreements, the Mexican government limited itself to exporting a smaller amountof sugar and orange juice than what was negotiated in NAFTA, generating problemsin placing these products on the market.

INVESTMENT

Another successful area within NAFTA is investment.From 1994 to 2000 US and Canadian corporations invested US $43 billion and US $2.9billion, respectively, in Mexico.12 NAFTA has generated incentives forattracting investment, not only due to access to the US market, but also due to alegal framework that offers legal certainty, while respecting the principles of nationaltreatment and most-favored-nation treatment.13 However, NAFTA generates differencesbetween foreigners and Mexicans.

Expropriation

Given past experiences with the railroad debt14 and oil expropriation, the US government proposed certainprinciples for expropriation: only when cause of public utility exists, without discriminationon the basis of nationality, through compensation without delay, liquidatable inone of the G-7 currencies,15 and including interest payments.

This provision extends far beyond what is stipulatedin Mexico’s own Expropriation Law, which states in Article 20: "Compensationmust be paid within the term of a year beginning on the date the expropriation isdeclared, in national currency and without excluding the possibility that paymentin kind is deemed appropriate."16 These provisions do not include theobligation for interest payment, and even less so, for payment in foreign currency,and the possibility of payment in kind is maintained. Furthermore, this proceedingwould only be applied to Canadian and US investors and not to Mexican investors,thus discriminating in favor of foreign investors.

Resolution of Differences Between the Contracting Party and an Investor

With NAFTA an investor from the United States orCanada may file a legal complaint against the Mexican government for violations inthe area of investment, using one of three options: presenting an appeal before nationalcourts, requesting a panel for resolving controversies, or resorting to arbitration.17

This constitutes a change in relation to the Mexicantradition of applying the Calvo doctrine, through which a foreigner must "renouncediplomatic protection from his/her State of origin and resort exclusively to thecourts and legislation of the receiving State. Foreigners may receive treatment equalto that given to nationals, but not more favorable treatment."18 It is clear that foreign investors have preference over Mexican investors since thelatter only have the possibility of resorting to national courts that interpret nationallaws (for example, the Expropriation Law), while Canadian and US investors can choosebetween three legal channels.

OIL

While Canada and the United States agreed on freetrade in the case of oil, in NAFTA the topic is barely touched upon. Until the endof the 1980s Mexico’s oil policy attempted to prevent one country from absorbingmore than 50% of energy exports. In 1990 this posture changed, with 56% destinedfor the United States, and only 0.4% to Canada. In 1993, one year before the Agreementwent into effect, Mexico sent 66% of its oil exports to the United States and 1.9%to Canada. By 1994 this position had radically changed: 73% of Mexico’s oil exportswent to the United States, and 1.4% to Canada. And by 2000, these figures were 75%and 1.7%, respectively. 19

With these figures, NAFTA could be blamed for thedrastic change in Mexico’s posture regarding the diversification of its oil trade.But this was not the case. The renegotiation of the foreign debt in 1989, the PersianGulf War in 1991, the European economic recession in 1992-93,20 and the Asian crisis of 1997,21 were the factors that led to directingoil exports to the US market—which was experiencing years of strong economic growthand a need for greater amounts of energy. Nonetheless, especially outstanding wasthe crisis caused by the devaluation of the Mexican peso in 1994-95, when the Mexicangovernment agreed to a financial emergency package of more than US $51.6 billion22 to save the country from bankruptcy. One of the conditionsof this loan was that in the case of incompliance with payment, 29% of the incomefrom Petróleos Mexicanos (Pemex) would go directly to an exclusiveaccount in the United States. Curiously, with this condition, there was a returnto past schemes for payments and guarantees, when customs income was committed topaying debt. 23

NAFTA: MORE THAN A FREE TRADEZONE

The provisions in NAFTA formally establish a freetrade zone between the three member countries. In a free trade zone, according totheory, trade obstacles (especially tariffs and non-tariff regulations) that limitthe free transit of goods and services are gradually eliminated through negotiations—eventhough each member country maintains its own trade policy and its own particulartariff system with respect to other countries. At this stage it is not necessaryto create supranational institutions, but there is an administrative apparatus thatcoordinates the mechanisms of trade reductions and evaluates compliance of commitmentsobtained by the parties.24 Nonetheless, NAFTA extends beyondtariffs, since it includes the promotion of fair competition and investment, theprotection of intellectual property rights and proceedings for conflict resolution,as well as labor and environmental issues. It is not a free trade zone, and evenless so, a common market,25 but rather, something more. For MexicoNAFTA regulates the interdependent relations existing with the United States, andopens up a new market: Canada. It is with Canada that Mexico must cooperate as atrade and political partner, with the aim of creating a counterbalance in relationto decisions made by the United States.

In December 1994 Mexico was practically withoutany international reserves, and the deficit in the current balance registered a seriousdeterioration. Given this situation, consideration was given to imposing limits onimports and establishing controls over capital flight in order to maintain reserves,or it would become necessary to devaluate the national currency. However, NAFTA limitedthe options available, and since restrictions on imports and controls over exchangeswere contrary to the Agreement, the only possibility was to devaluate the nationalcurrency. This illustrated how limited the margin for maneuvering in the economyhad become. At the same time, it was also demonstrated that NAFTA helped to passthrough the crisis more quickly, with the increase in exports and the financial packageof more than US $50.6 billion—something Argentina was not able to obtain.

It is clear that integration into a regional blocinvolves coordinating regional policies. Mexico does not have the capacity on itsown to confront the inertia of integration. The strategy should be to cooperate andparticipate in the discussions around this trade bloc, and defend to the degree possibleits privileged trade niche (in relation to its Latin American and Asian competitors)of providing inputs and manufactured products to the United States and Canada. Thekey is to improve the conditions for competitiveness in Mexico, through investmentin technology, education, infrastructure, government efficiency, security, etcetera.

It should be remembered that many in the world thinkof Mexico as part of the NAFTA bloc, and not as an independent country. This is therisk with trade integration. France and Germany are part of the European Union, howeverthey have not, for this reason, ceased to be proudly French or German. This impliesthat the concept of sovereignty is being transformed in a world of regionalisms.However "sovereignty does not lie in the defense of a poor State, but ratherin the promotion of development, justice and dignity for Mexicans." 26

Mexico’s foreign policy should tend toward multilateralism,presenting the country as independent (especially from the United States) and atthe same time, as a country that cooperates with the international community. Thisexplains why Mexico became a member of the UN Security Council, and became the sitefor the UN Summit on Financing for Development (in Monterrey), and for the Asia-PacificEconomic Cooperation (APEC) Summit in October 2002, and will be the site for theupcoming WTO Ministerial Meeting in 2003 and the site for negotiation meetings forthe Free Trade Area of the Americas (FTAA) in 2005.

Finally, bilateral negotiations with the UnitedStates in the area of trade, migration and support for development within the frameworkof NAFTA should be maintained as a priority. It is true that it is complicated toachieve these goals, especially given what the United States may ask for in return(support for the war in Iraq and against drug trafficking and terrorism, etcetera).However, the vortical changes in the world, plus Asian and European competition,have gradually caused government officials in both countries to understand that theyshould cooperate and create a common agenda for presenting themselves as a unitedregional bloc that is more than simply an association of independent countries withdifferent interests. This is the real challenge for Mexico.

Footnotes

1. Economic integration is definedas a process through which two or more national markets are united to form a singlemarket of a more ideal size, and which involves a change from national sovereigntyto common, supranational institutions. Backto 1

2. This occurs when the competitiveadvantages enjoyed by nations are taken advantage of, to manufacture products atlower costs, and the members of the bloc are supplied with products which are well-madeand lower-priced, optimizing production in the region and favoring lower prices tothe benefit of the population. Backto 2

3. This occurs when the trade blocdiscriminates against products from the rest of the world, giving priority to productsfrom countries which are trade partners, even when those products are inefficientand expensive. Back to 3

4. One example is when Spain’s entryinto the European Community helped to reduce tensions inherited from the Civil Warthat potentially surfaced after Franco’s death. Another example could be establishedin the case of Mexico with the transition in power resulting from the July 2, 2000elections, in which the political party that had been in power for 71 years peacefullyturned over the government to the opposition. It is difficult to imagine that thiswould have happened in the way that it did, without NAFTA or the trade agreementwith the European Union, which includes a democratic clause. Back to 4

5. Secretaría de Economía,El TLCAN y México, electronic presentation, April 2002. Back to 5

6. World Trade Organization, AnuarioEstadístico 2001, Geneva, 2002, p. 125. Back to 6

7. On May 14, 2002, US PresidentGeorge W. Bush signed agricultural legislation authorizing new subsidies for theagricultural sector, and involving the payment of US $173.5 billion over the nextten years. Back to 7

8. Eduardo Alcaraz Ortiz and GabrielaAlcázar Prous, "TLCAN, sector agropecuario mexicano y comercio desleal,"Comercio Exterior, Vol. 51, No. 6, Mexico, June 2001, p. 512. Back to 8

9. Data from OECD, Anuario Estadístico2001. Back to 9

10. Morgentau Hans, El podernacional, Fondo de Cultura Económica, Mexico, 1991, p. 146. Back to 10

11. Published in the DiarioOficial de la Federación, January 12, 1992. Back to 11

12. Secretarìa de Economìa,El TLCAN y México, electronic presentation, April 2002. Back to 12

13. Principles based upon whicheach party must concede treatment no less favorable than that conceded to nationalinvestors. Back to 13

14. A debt for which US investorsdemanded post-revolutionary governments to pay US $50 million in mortgage bonds ondomestic debt issued in 1908 and 1909 by the Porfìrio Díaz government,in exchange for the railroad concessions they had possessed at the time. This actionmade it possible to create Mexico’s first public company known as FerrocarrilesNacionales. The debt was not paid until the foreign debt was renegotiated in1942 and 1946 with the Montes de Oca-Lamont conventions. Back to 14

15. The currencies of G-7 countriesare: the yen (Japan), euro (Germany, Italy, France), US dollar (US), Canadian dollar(Canada), and pound sterling (United Kingdom, until 2003). Back to 15

16. The Expropriation Law, reformedin the Diario Oficial de la Federación on December 22, 1993 and December4, 1997. Back to 16

17. Through the Convention on Resolutionof Differences Relative to Investments between States and Nationals from other States.Back to 17

18. Jon R. Johnson, The NorthAmerican Free Trade Agreement: A Comprehensive Guide, Canada Law Book, Aurora,Ontario, 1994, p. 280. Backto 18

19. Pemex Internacional, AnuarioEstadístico 2001, Pemex Internacional, Mexico, p. 51. Back to 19

20. Particularly in Spain, thesecond largest buyer of Mexico oil. Backto 20

21. Particularly in Japan, thethird largest buyer of Mexico oil. Backto 21

22. Agreed upon in February 1995by financial authorities in the United States (20 billion), the Bank of Canada (1.1billion), the International Monetary Fund (17.75 billion), the Bank of InternationalPayments (10 billion), the Inter-American Development Bank and the World Bank (2.787billion). Back to 22

23. Cited in Milenio Diario,February 1, 2001. Back to23

24. Chacholiades Miltiades, Economíainternacional, McGraw Hill, Madrid, 1994, p. 191. Back to 24

25. A common market is the stagein which trade restrictions on the movement of production factors (capital, laborforce, organization and technology) are suppressed. Back to 25

26. Canet Gutiérrez, "Necesaria,una nueva política exterior," Página Uno, Sunday supplementin Unomásuno, November 5, 2000, p. 28. Back to 26