Joel Kwan is a corporate lawyer based in Los Angeles, California. Currently acting as financial/legal associate for Westwood Group, a specialty finance company, Joel focuses on general regulatory compliance, creditor rights and structured finance. Visit his website to learn more.

Monday, December 9, 2013

Comparing NAFTA and CETA

On October 18 2013 the European Union and Canada reached an agreement in principle concerning the Comprehensive Economic and Trade Agreement (CETA).  The Canadian government has yet to release the text of the agreement, but has released a technical summary upon which this commentary is based.
CETA is seen as the most ambitious and far-reaching agreement since the North American Free Trade Agreement (NAFTA) between Canada, US and Mexico.  NAFTA has been implemented for nearly 20 years so there is much written about its after-effects.
Here is how NAFTA matches up to CETA.

Trade in Goods
A central component of a free trade area (FTA) is the reduction of trade barriers between countries.  Trade barriers can be in the form of quotas, tariffs or non-trade barriers (could be technical standards used as barriers). 

While NAFTA planned for a phasing out of most barriers in a 15 year time frame, CETA sets this phasing out period at seven years for the most sensitive goods.  To have an indication of the speed of the phasing out, over 95% of all goods are to face no tariffs upon entry into force of CETA.  With NAFTA, the process was much slower and haphazard. For example, only 40% of goods faced tariffs of 0% between Mexico and the US when NAFTA came into force.  Further, piece-meal deals between the three countries had to be reached in order to further lessen trade barriers.  CETA on the other hand is more comprehensive and tends to treat the EU as one economic entity (as it should) which eliminates the need for side deals.

CETA also seems to have an upper hand in terms of reducing barriers for agricultural goods, normally an issue of great contention between trade partners.  In fact, World Trade Organization trade talks between member countries have been constantly failing in large part due to failure to arrive at a compromise on agricultural goods.  CETA is set to have most agricultural goods trade freely between the EU and Canada within seven years.   NAFTA was not as successful on this count since the tripartite side deals concerned sensitive agricultural goods.

One interesting aspect of CETA are the rules of origins that favour the use of foreign components.  Rules of origins are used to determine the country of origin of the traded goods.   If a good is deemed to be produced outside the FTA, then tariffs may be levied.  Without getting in the nuts and bolts of rules of origin, suffice it to say that CETA would allow auto components that only have 45% Canadian content to count as a good produced in Canada.  In contrast, NAFTA required a domestic content of 62.5% at entry into force.   Auto manufacturers would claim that this will erode domestic business and jobs while third-party foreign manufacturers could see this as an indirect way of benefiting from CETA.

One important distinction between NAFTA and CETA is the FTA between Canada and US that existed before NAFTA.  Many observers note that Mexico felt the greatest economic effects from the agreement since Canada and US had already extensively reduced trade barriers before NAFTA.  This is not the case with CETA.  Currently, Canada and the European Free Trade Association  (Iceland, Liechtenstein, Norway and Switzerland) have an agreement to reduce the tariffs on goods.  This represents only a fraction of the EU economically and much less comprehensive than a FTA.  Consequently, there are chances that the economic effects of CETA be felt more rapidly and be more important than with NAFTA.

Another important difference is the economic climate of Canada.  When NAFTA came into force, Canada’s manufacturing industry was much more powerful.  Today, the manufacturing sector is sluggish due to a Canadian dollar hovering at parity with the American dollar and NAFTA which lifted the protectionist shield of uncompetitive manufacturers.  Also, Canada’s resource-based economy is stronger now than 20 years ago.  As a result, there is fear that Canada will be exporting natural resources to the EU and in return, high-value finished goods will be imported.  Critics of CETA warn that this could lead to a growing trade deficit.  

Trade in Services
This area of CETA is much less ambitious.  Compared to NAFTA, there is no surprise here with the standard Most Favored Nation provisions and specific exclusions.

Labour Mobility
While CETA boasts a framework that streamlines regulations to allow mobility of professions between member countries, this is merely a voluntary endeavor left at the discretion of the respective governing bodies.  It is unclear how this initiative will boost mutual recognition of qualifications.  NAFTA was slow on this issue, but as of 2008, the three countries had agreed on the core competences of 64 professions in order to issue NAFTA visas that allow workers to work temporarily in a member country for up to three years.   There has already been some initiatives between Canada and the EU prior to CETA  with lawyers and architects.

Trade in Investments
Of interest here is a commitment in CETA to provide a dispute-resolution mechanism that is transparent and in which interested third-parties can part-take in.   This diverges greatly from NAFTA chapter 20 which provides for a closed dispute settlement mechanism for foreign investors.

Intellectual Property Protection
NAFTA based its IP regime on the then TRIPS negotiations.  Canada nonetheless has continued to be viewed as weak in terms of IP protection. CETA contains nothing ground breaking in terms of Copyrights and Trademarks, but there is a commitment to allow pharmaceutical companies to restore up to two years of patent protections that was lost by regulatory processes and also allow innovative pharmaceuticals (as opposed to generic) to have a right of appeal for decisions made under the Patented Medicines Regulations, a right that was only available to generic pharmaceutical companies.  This change is welcomed and had been long awaited by pharmaceutical companies.

The final text of the agreement is set to be agreed upon in 2015.  There will be a ratification and implementation phase afterwards.  Therefore, it might be some time before the agreement comes into force.  Compared to the NAFTA experience, the economic effects of CETA on Canada should be expected to be greater since most of the trade integration had been accomplished between US and Canada prior to the tripartite agreement.  One finding from the NAFTA experience that was negative for Mexico was that the benefits did not help narrow the gap between the rich and the poor.  For CETA,  it will be important to enforce complementary policies on poverty reduction in the hopes that any gains from trade will be equitably distributed, especially given that the EU is composed of 28 member states that vary greatly in terms of economic development.

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