Economic Development / Tradewinds

Do Trade Agreements Deliver?

Free trade agreements are getting bigger, more complex — and more important to extended supply chains

August 1, 2014
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Free trade agreements are often announced and signed with much promise and some degree of fanfare, but do they deliver over time?

On a high level, U.S. exports to those markets where the U.S. has earlier free trade agreements (FTAs) have gone up on the order of 20 percent, so these have definitely been catalysts for more export growth. But on more recent FTAs, some of the phase-ins of the tariff cuts and other market-opening provisions come in over time, says Leslie Griffin, SVP international public policy for UPS. The underlying economics of the current recovery are also a factor that may be slowing the progress with the more recent FTAs, she adds.

“We are confident in the work [the FTAs] do to remove tariffs and non-tariff barriers to allow freer flow of goods across the borders through some of the customs modernization provisions, and the general transparency they promote — all of these things collectively are very good for exports,” says Griffin.

The business community watches closely during the negotiation stage but also during implementation and enforcement of the FTA provisions, assures Griffin. This is true not only on the clear-cut elements but especially in areas that may be open to interpretation. “You want to be sure that interpretation goes in the most market-opening way,” says Griffin.

The dialogue continues after the agreements are signed and begin implementation. Either of the parties in the negotiation would put issues on the table where they might see shortcomings in implementation. At that point, much of the information about where bumps or road blocks might exist comes from the private sector companies directly involved.

The first step for a company or industry group that sees a problem is to raise the issue and “put a spotlight on it.” And the scope of the resolution may go all the way out to the dispute resolution terms that are part of the agreement.

NAFTA’s Progress

As an example, the North American Free Trade Agreement (NAFTA) was designed to promote increased trade among the negotiating parties, says Griffin. It really has succeeded in that. In 1993, before NAFTA, trade between the U.S., Canada and Mexico was about $337 billion, she points out. When you look at 2012, it was over $1 trillion. And in the U.S., 37 out of the 50 states have both Mexico and Canada in their top five export markets. And 31 out of the 50 states have Mexico and Canada in their top three.

The other thing NAFTA was designed to do was promote North American integration and develop supply chains within the Western Hemisphere in a way that would position the NAFTA countries to compete well with Europe and Asia. “I think on that score it’s been successful as well. You can see supply chains that have developed among the three nations,” continues Griffin.

“We see now that for every dollar of U.S. imports from Mexico, 40 cents of that is U.S. content, U.S. value,” she adds. “Today we have an opportunity to deepen that integration and remove choke points that still exist through the TransPacific Partnership (TPP) talks.”

Mexico, Canada and the U.S. are among the parties to the TPP talks. The talks will allow the U.S. and other negotiating countries to push for customs modernization and better technology. “That will be the next live opportunity to advance the NAFTA partnership.”

NAFTA may have been a U.S. response to the European Union to keep North America competitive with the developing trading powerhouse of the original 12 European partners. It was, in many ways, less complex because it did not seek to create a North American federation with a governing body such as the European Union has. NAFTA also involved fewer sovereign nations.

As Purolator International’s John Costanzo points out, “It’s not the U.S. fighting for market share or Canada fighting for market share, it’s North America.” Costanzo feels where the NAFTA partners need to be looking is not where they might be losing ground as a country but “where we might be losing ground as a region.” One thing he suggests is going back to the agreement and looking at the areas where NAFTA lowered trade barriers and seeing if they can be enhanced even further. “I’m not sure there has been as much discussion on that as there has been on the environmental side of things or other aspects of the agreement.”

The president of Purolator International notes that his company has benefitted from NAFTA since entering the U.S. market 15 years ago and especially over the last 10 years. As trade barriers have dropped, it was a boon to Purolator’s business and also to many of its retail customers. He draws a parallel between his own company’s experience and that of the U.S. in the NAFTA agreement. If Purolator had not expanded into the U.S. and taken advantage of NAFTA opportunities, it would likely have seen some deterioration of its Canadian business. Similarly, the U.S. may not be completely satisfied with its trade balance relative to NAFTA, but it may have been worse without the agreement, and much more business may have been lost to Europe and Asia.

When you look at the economics of North America, and specifically the northeast quadrant of the U.S. extending as far Minnesota to the East Coast, that part of the U.S. has much more in common with the eastern part of Canada. If that quadrant of the U.S. and Canada were a country, Costanzo postulates it would be among the top five or six GDPs of the world. He sees similar links and strengths with the southwest U.S. and Mexico. “We need to strengthen that,” he says.

Speaking from a market competition perspective, Costanzo says, “The enemy’s not us; it’s maybe Asia, to a degree Europe, and maybe in the future Africa.” He continues, “Our leadership needs to take a more global view because that is going to drive policy, and policy is going to drive business.”

Driving Infrastructure

Expanding on Costanzo’s description of the commonality in regions, the infrastructure needs are also driven by commerce, and where a region is largely engaged in mining, energy exploration and agriculture, there is a greater need for bulk transportation. Where the region is more urbanized, the focus may be more on consumer goods and quick deliveries in congested metropolitan areas. In that sense, Calgary and Texas may have more in common with each other than Calgary might have in common with Ontario or Texas has with Illinois.

This regional/sector link is becoming more apparent as some supply chains are able to take advantage of more transparent borders. One example is the automotive cluster around Detroit and Windsor where parts and components move back and forth across the border.

U.S. and Canadian companies have been good at looking at their costs, says Costanzo, and this has led to manufacturing moving south and then to Mexico, followed by moving to Asia and now, to some degree, back to North America. “We’re seeing companies looking at their landed cost, and not just their landed cost, but also their fill rates,” he notes. When you have inventory in both the U.S. and Canada, you have higher costs to carry inventory in both places, he continues. Your fill rates are sometimes worse than fulfilling orders from your U.S. DCs. Many U.S. companies that establish inventory in Canada do so in Toronto, he says. That makes sense because that is where most of the population is. But there is a lot of growth in the West, he adds.

Enter NAFTA. “You might be better off serving the western provinces and even the central part of the country from your U.S. DCs,” Constanzo explains. The order fill rates are better because there is typically more stock in the U.S. DC, so the ability of a company to fill an order on the first attempt and complete the order is improved. He is seeing growth in places like Nevada and Salt Lake City, not only to fill orders to the western U.S., but also up into Canada.

Another driver is e-commerce. Two or three days of transit is an expectation, he continues. “Right now 40 percent of our shipments are generated through e-commerce companies.” That has changed the distribution patterns, and where Purolator International had been seeing roughly 10 percent of its shipments going into the central and western regions of Canada, that has increased to 18 to 20 percent.

One issue for cross-border e-fulfillment is that the borders are still there. And though NAFTA, in the case of the U.S., Canada and Mexico, streamlines the process, border clearance still must be built into the process in a regional strategy that might use a U.S. DC to fulfill Canadian orders, Constanzo points out. The problem can be multiplied when it comes to returns — which tend to be much higher on e-commerce orders, says Constanzo.

When NAFTA was negotiated, e-commerce was not an issue. It is an area in which current and proposed trade agreements may need some attention. But as strong as e-commerce has become, Constanzo notes, it is still important to focus attention on the industrial sector and manufacturing. “If we are going to continue to be competitive as a region, we’re going to have to retain more of those manufacturing and logistics operations here. Some policy thinking about how we become more competitive is important.”

Content and Value

Extended supply chains have introduced more variety in sourcing, which can come into play with reshoring or nearshoring. How would NAFTA content rules address a product that is assembled in a NAFTA country with content which may be largely sourced offshore?

The nearshoring issues are interesting apart from the trade agreements, comments Griffin. There are the traditional “rule of law” and intellectual property protection advantages, she continues, adding other recent developments to the list. “The landscape here has gotten more attractive, and it’s not purely a labor arbitrage play. Mexico has gotten more competitive and upped its production capabilities.”

TPP may become part of the mechanism for modifying the NAFTA, even the content rules, but as Griffin points out, the TPP agreement with 12 parties makes the content rules that much more complicated to negotiate.

Echoing Constanzo’s comments about the need for more global thinking, Griffin says the trend of things being made by the world for the world means countries are looking to find out what their piece of the value chain is going to be. “What that has meant is that we’ve seen different kinds of trade barriers than we did in the past. Tariffs are no longer the main barrier we face. Today we see things like localization barriers where countries are trying to do things like require your IT infrastructure to be in that country if you want to serve that country. Or they are increasing local content requirements where if you want to be in that country, X percent of your production has to be goods from that country. We see the promotion of national champions or state-owned or state-supported enterprises getting preferential treatment.”

“All of the trade agreements will have to reflect this new reality,” Griffin continues. “They will have to combat efforts by countries to try to get in the way of the most natural and efficient flow of supply chains.”

 Companies have learned to evaluate risk and weigh those risks against opportunities to optimize their extended supply chains. Along with their industry sector partners, they tend to monitor and respond to issues as they develop. And, to some degree, those industry sector partners — including major logistics providers — are actively involved in the early stages of trade agreements as they are developing. The key appears to be maintaining that vigilance throughout the process, from initial trade discussions through the development of any pertinent trade agreements, and then through the implementation and enforcement of terms of the agreement.  

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