All you need to know about NAFTA

U.S. Secretary of State Rex Tillerson greets Canadian Foreign Minister Chrystia Freeland at the State Department in Washington, U.S., August 16, 2017. REUTERS/Aaron P. Bernstein - RTS1C2UZ

Talks to renegotiate the North American Free Trade Agreement (NAFTA) have begun and US President Donald Trump is not favor of "a mere tweaking" of the deal.

The trade deal, which came into effect more than two decades ago, is between three countries - US, Canada, and Mexico. The US is facing major trade deficits because of the prevalent terms of the deal.

The renegotiation of the agreement revolves around Canada and Mexico granting concessions to the US for automobile components. Under the current agreement, a car assembled in Mexico can be imported into the United States without paying an import tax if a minimum 62.5 percent of the car, in terms of value, was made in North America.

Trump believes that NAFTA has caused many job losses, particularly in the manufacturing sector, and has resulted on scores of businesses shutting down. The US aims to seek higher paying jobs and in turn, boost the US economy by improving trading opportunities with the NAFTA countries.

On the other hand, major tech firms such as Microsoft and Cisco, have ramped up lobbying with the hope of eliminating technology goods tariffs and to avoid future trade restrictions on cloud storage.

What is NAFTA?

NAFTA is a trade agreement between the US, Canada, and Mexico which has been in effect since January 1, 1994.

NAFTA supersedes the earlier US-Canada bilateral free trade agreement, signed in 1988. The two countries had been in a bilateral agreement between 1989 and 1994, before Mexico joined the fray and NAFTA was born.

As the name suggests, NAFTA is a trilateral free trade agreement. This means there are no tariff barriers when these three countries are trading among each other.

However, the 'no tariff' rule is not applicable for all commodities. Automobiles and their components, textile, and apparel, are among the commodities which come with a minimum tariff.

NAFTA has two 'supplemental agreements' -- North American Agreement on Environmental Cooperation (NAAEC) and North American Agreement on Labor Cooperation (NAALC) -- which address important issues like low wages in Mexico and pollution caused by industrialization.

The treaty aims at establishing commissions to handle labor and environmental issues.

Here's a glimpse of pros and cons of free trade

Pros

Free trade has many advantages. One of the many is comparative advantage, where the countries are able to enjoy the benefit of using specialized goods from other countries without paying anything extra for them.

Even though it is possible for the importing country to produce those goods by itself, it will lack the edge in making the goods.

The removal of tariff barriers gives the countries the opportunity to create a platform for efficiency in trade. High tariffs tend to demotivate countries from engaging in trade, leading to the possibility of stagnant growth.

Cons

On the flip side, removal of tariffs is highly demotivating for the exporting country's local businesses. These businesses tend to lose out on a major chunk of their earnings because of free trade. Because there is no driving force to incentivize them, this effect can manifest into lost job opportunities, stagnant economic growth and low wages for the exporting country.

The exporting country also loses out on tax, which is a major source of government revenue.