“Update Available for Download”: NAFTA Rules for Digital Age

As the United States, Canada, and Mexico prepare to rethink NAFTA in the context of current – and future – ways of doing business, they have an opportunity to write rules for digital trade that could blaze a trail for the rest of the world while protecting North America’s lead.

A Digital Economy is Born

With the ubiquity of modern Internet-connected devices, it can be easy to forget just how far we’ve come. In 1994 – the year NAFTA went into effect – the Internet was still accessed through dial-up. Amazon, Google, and eBay were years away, while Facebook and the iPhone were a decade off. Today, the digital economy is a thriving growth sector in the United States and worldwide. According to a recent report from the Congressional Research Service, the Internet enabled a $4.2 trillion contribution to the global economy last year alone.

Why get out front on digital rules? Because Americans are digital pioneers and early adopters of information and communications technologies or ICTs. As of 2010, American firms held a 26 percent share of the global IT industry and produced more ICT goods and services than any other country in the world. In 2016, 51 of the Fortune 500 companies were in the ICT sector. Competition will intensify worldwide, and as it does, trade barriers could keep American companies from getting the foothold they are capable of reaching. Those barriers affect not just the ICT providers, but all the American industries that are seizing on the Internet of Things in what’s being called the next industrial revolution.

Technology Unlocks New Forms of International Trade

Digital technologies and services are changing what’s traded and how it’s traded. Online sales platforms like Amazon help connect customers and sellers from around the world, while GPS-tracking and third-party online payment systems like PayPal create unprecedented trust in these transactions. Video conferencing and file-sharing services shrink distances and allow collaboration on projects from anywhere, as well as enabling trade in services ranging from personal email to web design and accounting, and even remote medical prognosis. The Internet has also given rise to “digital goods” – book, movies, music and more – once limited by fragile or bulky physical media but now digitized and traded globally.

While the World Has Changed, the Trade Rules Lag

Despite the importance of the Internet to the modern economy, the rules of international trade aren’t upgraded as quickly. NAFTA’s provisions focus mostly on trade in physical goods. Barriers to digital trade are not addressed in any form. The Trans-Pacific Partnership – negotiations in which the United States, Mexico, and Canada all participated – includes provisions on e-commerce and digital trade, but with the U.S. withdrawal from the agreement, it will be up to the NAFTA renegotiations to update the rules governing North American trade. Below are some of the digital trade barriers that could be addressed.

Customs Duties on Virtual Products

Prior to the modern era of trade liberalization, the largest trade barrier most exporters faced was the customs duty or “tariff.” Duties paid at the border raised the cost of exports, making them less price-competitive and limiting the cross-border flow of goods. Free trade agreements like NAFTA drop these rates to zero or near zero, allowing exporters to compete in foreign markets. But the agreement predates the advent of “digital goods,” like e-books, mp3s, and video streaming services. Members of the World Trade Organization have been renewing a “temporary” moratorium on e-commerce customs duties since 1998. NAFTA could make it permanent for North America.

Lack of Information in the Information Age

Countries have a legitimate right to control what enters their borders. But confusing or opaque customs procedures can discourage trade flows. The biggest losers are smaller and medium enterprises who lack the resources to navigate these challenges, ceding the benefits of trade to large multinational corporations. As the great information equalizer, the Internet offers a simple solution to this problem. NAFTA currently has no provisions regarding publishing customs rules, paperwork requirements, and other vital trade information online, and does not include measures encouraging digitizing customs documentation. Updating the agreement to standardize these practices would help simplify cross-border trade.

Data Localization and “Internet Balkanization”

The Internet has allowed people around the world to connect and access information on an incredible scale. Innovations like cloud computing have also utilized the Internet to improve efficiency; rather than everyone needing to house data on their own personal computers or servers, huge data centers now host these services and are accessible anywhere, across devices. Without the limitations of physical distance, the Internet allows for trade in services through the cross-border flow of data. And, as goods and services move across borders, enormous amounts of data move with them.

However, there are some challenges to the open global Internet. Some countries seek to limit access through restrictions on the free flow of data, and may even require that companies build new data centers locally to house data on domestic users. Governments often justify these requirements as necessary for security or privacy concerns, but industry argues that’s a red herring – geography matters little. It’s how cybersecurity is addressed and privacy protected, not where, that matters. In practice these requirements typically serve to raise costs and protect domestic firms from competition, or worse, to stamp out political dissent and control information. Requirements that foreign companies use locally produced hardware or software are similarly unjustified.

Data localization requirements and other restrictions on cross-border data flows could fragment the Internet. China serves as an example, with its own “Chinanet” largely cut off from the global Internet, which the European Centre for International Political Economy estimates has cost its economy about 1.1% in annual lost growth. Preventing data localization has real economic significance, and an updated NAFTA could serve as the model for maintaining an open Internet by prohibiting barriers to data flows across borders and prohibiting requirements that force companies to use or locate computing facilities in one country or another.

Protecting the Source

The digital economy deals largely with “virtual” products, such as software and creative works. While this offers advantages in trade, the ease and relative low cost of replication makes issues of piracy and intellectual property theft particularly difficult. Encryption and Digital Rights Management (DRM) technologies are getting more sophisticated at blocking unauthorized access to digital goods, services, and consumer transactions. They use proprietary lines of computer code – source code – to achieve those levels of security.

It’s research and development at which Americans excel, but some countries have required companies to release their source code for inspection, with proprietary information making its way into the hands of local competitors. NAFTA negotiators have an opportunity to set appropriate boundaries around this practice by largely prohibiting members from requiring the transfer of, or access to software source code and encryption as a condition for the import, distribution, sale or use of commercial software, with any exceptions clearly and narrowly defined.

There’s no turning back the clock – the digital economy will only continue to grow more important to international trade. Forward-looking negotiators have a chance to update NAFTA’s rules to ensure North America remains a leader in the economy of tomorrow.