not because they are the cheapest source of supply, but because their
tariff-free prices under NAFTA are lower than the tariff-burdened prices
of imports from other countries. This effect is a gain to U.S. firms and
Canadian consumers of the product. U.S. firms get new business and
therefore they clearly gain. Canadian consumers buy the product at a
lower, tariff-free price from the U.S. producer than they used to pay to the
third-country producer (with a tariff), and so they are also better off. But
Canada as a whole is worse off as a result of the trade diversion. Canada
is now buying the product from a U.S. producer at a higher price with no
tariff. Before the agreement, it was buying from a third-country producer
at a lower price (and also collecting tariff revenue).
From the global perspective, trade diversion represents an inefficient use of resources.The main argument against regional trade agreements is that the costs of
trade diversion may outweigh the benefits of trade creation. While
recognizing this possibility, many economists believe that regional
agreements, especially among only a few countries, are much easier to
negotiate than multilateral agreements through the WTO. In addition,
regional agreements may represent effective incremental progress in what
is a very lengthy process of achieving global free trade.