THE FREE TRADE AGREEMENT BETWEEN MEXICO & THE EUROPEAN UNION
Introduction
On July 1, 2000, the Mexico-EU Free Trade Agreement (MEFTA) came into force. This NAFTA-like agreement gradually reduces the existing barriers to trade and investment between Mexico and the European Union and has the potential to provide significant positive opportunities for U.S. and Mexican companies. Both the EU and Mexico expect that this agreement will reverse the significant decrease in the share of Mexico's trade with the European Union as reflected in the following chart. This paper will highlight products where this agreement offers business opportunities for U.S. and Mexican producers.
Free Trade in the Context of Deepened Bilateral Political and Economic Relations
The recently implemented free trade agreement between Europe and Mexico is part of a much broader agreement signed in December 1997 called the Economic Partnership, Political Coordination and Cooperation Agreement. This so-called Global Agreement meets the EU objective to have an agreement to promote greater social equality in Mexico and to promote a political system that is genuinely democratic, pluralist, and respectful of human rights.
This agreement contains a "democratic" clause:
· "Respect for democratic principles and fundamental human rights proclaimed by the Universal Declaration of Human Rights, underpins the domestic and external policies of both Parties and constitutes an essential element of this Agreement."
This Agreement regularizes the political dialogue between the EU and Mexico with broad coverage including cooperation on drug trafficking, money laundering, health, and the environment. The Agreement has just recently been ratified by all the member states of the EU and replaces the Interim Agreement on Trade and Trade Related Matters that was ratified in late 1998 and that provided the legal basis for the free trade negotiations and the entry into force of many of the trade aspects. The Interim Agreement is now subsumed within the Global Agreement.
The MEFTA is a NAFTA-like Agreement
While this agreement provides a path to dramatically liberalize trade in industrial goods, eliminating all tariffs in stages by 2007, it goes far beyond that, establishing a clear framework for a broad spectrum of economic relations between Mexico and the EU.
· Agriculture and Fisheries - liberalizes selected products, taking full advantage of the complementary climates of Europe and Mexico. It also sets up a process for dealing with Sanitary Phytosanitary (SPS) issues.
· Services - Goes beyond the WTO General Agreement on Trade in Services (GATS) negotiated as part of the Uruguay Round, progressively liberalizing trade in services over the next ten years. It immediately provides European service operators NAFTA-equivalent access to Mexico in most areas, including financial, energy, telecom, distribution, and tourism.
· Investment - Provides a stronger legal basis for the investment liberalization already adopted by Mexico.
· Government Procurement - This agreement provides EU providers access to the Mexican procurement market essentially equivalent to those given to U.S. and Canadian producers under NAFTA, including key EU priorities of petrochemicals (PEMEX), electricity (CFE), and construction.
· Intellectual Property - Patent, trademarks, and copyright protection is set at the highest international standards, with a special committee set up to review enforcement.
· Competition - Agreement includes cooperation mechanisms to ensure and facilitate the enforcement of competition laws (to limit monopoly power)
· Dispute Settlement - Agreement includes government-to-government process, compatible with WTO dispute settlement provisions. It does not include any provision for dispute settlement between private parties.
· Rules of Origin - For companies to gain preferential access to the EU for production in Mexico, a certain proportion of the product must be produced in Mexico (or the EU). Most products are subject to the EU standard harmonized rules of origin. However, for some products this was deemed too restrictive due to Mexico's lack of production in certain products. For these goods, a more liberal rule of origin was adopted. Firms operating in Mexico that plan to export to the EU need to examine the product specific rule of origin required by the EU for preferential access under this agreement.
Motivating Factors Supporting this Agreement
Mexico's exports now comprise about 35 percent of its GDP. Since almost 85 percent of Mexico's exports flow to the United States, about 30 percent of Mexico's GDP depends on sales to the U.S. This makes Mexico vulnerable to downturns in the U.S. economy and is a great incentive for Mexico to diversify its exports. In addition, Mexico is running a trade deficit with the EU of about $ 7.4 billion per year. It expects that this agreement will reduce that trade deficit.
The EU, on the other hand, saw its exports to Mexico rising very slowly due to the fact that the Mexican tariff structure discriminated against the EU (and much of the rest of the world) in favor of imports from the other NAFTA countries and selected countries in Latin America. EU trade with Mexico has been falling not in absolute terms but in relative terms. Exports to Mexico from the EU have doubled since 1990 but because of the extraordinary growth of Mexico's trade within NAFTA and its other free trade agreements, the EU trade share (exports and imports) with Mexico has fallen from 13 percent in 1990 to 6.4 percent in 1999.
Both the EU and Mexican negotiators saw a benefit in Mexico becoming an export hub within the Americas. The EU hopes that its exports to Mexico will rise, due in part to sales of goods being consumed within Mexico and due in part to being included in products being exported from Mexico.
Timing of Tariff Reductions
This FTA relatively quickly reduces and then eliminates tariffs currently faced by Mexican and EU exporters. While the EU already had zero duties on 60 percent of industrial exports from Mexico, this figure rose to 82 percent as of July 1, 2000. Also, as of July 1, 2000, 48 percent of EU industrial exports have duty-free access to the Mexican market. This is the most ambitious tariff elimination schedule ever negotiated by either party. The EU has agreed to eliminate its tariffs on Mexican industrial products somewhat faster than Mexico is doing for EU products.
· By 2003, the year that NAFTA tariffs are to be reduced to zero, the EU will have reduced all of its industrial tariffs to zero on imports from Mexico while the highest tariff being levied by Mexico on EU imports will be 5 percent.
· By 2007, all industrial tariffs will disappear.
Automotive
The auto and auto parts industries are winners in the EU-Mexico FTA. Mexico has been exporting about 1 million cars a year, primarily to the North American market, since tariffs to the EU have been 7 percent. This duty fell July 1, 2000 under the FTA to 3.3 percent and will fall to zero by 2003 as long as Mexican content is adequate.
· For the first three years of this agreement, local content must be at least 50 percent based on the value added by Mexican producers. This is a bit stricter than NAFTA as NAFTA assigns all the value of an auto part to Mexico if the imported components for that part have been significantly transformed in Mexico.
· After the third year, the local content requirement will rise to 60 percent.
· This was one of the more difficult issues in the negotiation, as Mexico had wanted a requirement for 30 percent local content.
But Mexico is also opening up its market to European automobiles. Prior to the FTA, Mexico levied a duty of 20 percent. Under this FTA, Mexico has established a tariff rate quota (TRQ) for automobiles being imported from Europe.
· This means that for the first two and one-half years, Mexico will permit up to 14 percent of its automobile imports to come from the EU with special low tariffs (the in-quota tariff). Mexico will allocate up to 10 per cent of its imports to EU firms already established in Mexico and the remaining 4 percent to EU firms new to Mexico.
· The tariffs on these "in-quota" cars from the EU will be identical to tariffs under NAFTA: 3.3 percent for 2000, 2.2 percent for 2001 and 1.1 percent for 2002. After 2002 there will be a zero duty. From 2003 to 2006 there will be a single 15 percent quota for established or new firms.
· Mexico will still accept car imports from the EU above this quota level but they will be subject to a 10 percent duty.
· This TRQ will be abolished by 2007.
Other Manufacturing
The EU is dramatically reducing its tariffs on appliances from Mexico. For example, the EU tariff on TVs will fall from 13.6 percent to zero within three years.
Export Opportunities Leading to Projected Investment Increases
Investment in Mexico has averaged about $11 billion per year since the start of NAFTA. The new trade opportunities due to the FTA with Europe should significantly increase this level.
As automobile manufacturers chose Mexico as an export platform for their vehicles, look for investment in Mexico to skyrocket.
· Already, Volkswagen, which produces the popular Beetle for export to the U.S. and the EU in Mexico, will increase its investment in Mexico by $1 billion having decided to earmark a third of its worldwide investment budget to Mexico over the next 5 years. VW exports 300 New Beetles to the EU daily and imports one third of its vehicle parts from Germany. Tariffs on these parts are due to be cut by more than half to 4 percent by 2005 reducing significantly the cost of production.
· DaimlerChrysler is also planning to invest $1.2 billion to solidify its production of its successful PT Cruiser, which is manufactured exclusively in Mexico.
· Renault is planning a return to Mexico after a 15-year hiatus with an investment of $ 0.4 billion in conjunction with its merger partner Nissan. Peugeot is also considering an investment in Mexico.
Moulinex, a brand name producer of small appliances, has decided to close its plant in France and consolidate all of its production of irons to the state of Guanajuato in Mexico.
But Trade in Agriculture will also increase
Agriculture has only represented 6 percent of Mexico's trade with the EU. Even though a significant number of important agricultural products were excluded from the Mexico-EU FTA, there will be ample opportunity for investment in Mexican agriculture due to increase of exports to the EU. These investments will be located throughout Mexico.
· The states of Nuevo Leon, Veracruz, Tamaulipas, and San Luis Potosi will benefit from the large quota negotiated for orange juice concentrate. The Mexican states of Michoacan and Guerrero will see their avocado exports increased.
· Exports of coffee will rise considerably from the states of Veracruz and Chiapas. The flowers from the states of Morelos and Mexico as well as the Federal District, are now on an equal footing with flowers from Colombia and various countries from Africa.
· Finally, the highly efficient tomato production from Baja California, Sonora, Sinaloa, and Yucatan now can enter the EU duty free.
One estimate has Mexican agricultural exports to the EU increasing 10-fold over the next decade.
But Mexico has opened its economy to selected agricultural exports which were high on the EU priority list, including beer, certain vegetables, fruits and fruit juices, liquors and spirits (vodka, cognac, certain whisky, gin) cut flowers, tomatoes, and tobacco. Tariffs on certain wines have been reduced from 20 percent to 15 percent although the agreement has quality wines (above $5 in value) becoming duty-free by 2003.
Mexico's Efficient Textile and Apparel Production Gets Good Access to the EU
Production of textiles and apparel for export to the United States has skyrocketed under NAFTA. While much of that involves U.S. fabric, the EU has offered Mexico good access to its market as long as the fabric is of Mexican or EU origin. This should be a significant plus for the growing Mexican textile industry.
· The EU's tariff on Mexican clothing of 11.5 percent is being phased out over 4 years, with duty free exports in 2003.
· Meanwhile, Mexico is opening its market to EU apparel. As of July 1, 2000, the Mexican tariff of 35 percent was lowered to 20 percent. This will be reduced to 5 percent by 2003 and then phased out by 2007.
Impact on U.S. Business
U.S. firms should not lose sales to Mexico. What is likely, however, is that the U.S. share of imports into Mexico might fall, as a growing Mexico buys more products from the now cheaper EU.
· The U.S. Department of Commerce is developing a list of the few instances where the EU has negotiated tariffs lower than exist within NAFTA.
· While the government of Mexico is under no obligation to accelerate tariff reductions under NAFTA to match these lower levels, one could expect that this will happen with pressure from the U.S. business community.
The bigger question is what will happen to U.S. sales to the EU. The reality is that the EU MFN tariff is already zero for about 60 percent of current Mexican exports to the EU. However, Mexico will have a tariff advantage on several important products, including motor vehicles, as listed in the following table. It is too early to tell how much trade diversion will take place because of these tariff preferences. See Table
From the point of view of U.S. firms, particularly the automotive firms that already have significant operations in Mexico, their share of overall sales to the EU is not likely to fall. What might change is the location of certain production. U.S. firms might move some production to Mexico to meet the EU rules of origin. Of course, if the sales to the EU rise fast enough from Mexico, the sales from the U.S to Mexico of U.S. made components for this production might increase more than the loss of sales directly to the EU.
Conclusion
The Mexico-EU Free Trade Agreement offers U.S. and Mexican firms the opportunity of increasing sales into the large EU market. Indeed, one could expect joint ventures of U.S. and Mexican companies developing production within Mexico meeting the EU rules of origin for preferential access. These products would have content from both Mexico and the U.S. but would have a tariff advantage compared with products either coming directly from the U.S. or from other parts of the world. The key to benefiting from this free trade agreement is a careful assessment of the rules of origin as they apply to specific products.
--August 2000
The preceding paper is part of the United State-Mexico Chamber of Commerce's NAFTA Forum series, which considers general trade issues and sector-specific concerns between the two nations. The information contained herein is for informational and educational purposes only.
CONTACT INFORMATION:
Albert C. Zapanta, President
John Harrington, Senior Economist and author of NAFTA Forum series
United States-Mexico Chamber of Commerce
1300 Pennsylvania Avenue NW, Suite 270
Washington, DC 20004-3021
Tel: 202-371-8680 Fax: 202-371-8686
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