TTWTO VCCI - PVTM - Trade Trends: NAFTA 2.0

Top priorities and concerns for the United States, Canada and Mexico as they work through the renegotiation of the trilateral North American Free Trade Agreement (NAFTA).

The news cycle surrounding renegotiation of the North American Free Trade Agreement (NAFTA) changes like the weather, and forecasting the outcome is equally challenging. But, increasingly, the picture of what each party to the agreement wants from a NAFTA version 2.0 is coming into focus.

It is important to note that the uncertainty around the discussions is largely by design. U.S. President Donald Trump is known to be an advocate of aggressive negotiation tactics, wherein a first offer is designed to be unacceptable, with the idea that this will lead to concessions by the other party. The risk inherent in this strategy, however, is that the other party may simply shut down negotiations and walk away, as evidenced by the Trump administration’s backpedaling on terminating the U.S. free trade agreement with South Korea.

The challenging timeframe of the renegotiation also accelerates its inherent risk, and in a sense, the one goal all three countries share is to maintain a generally open and liberalized trade environment with one another. Consider the timeline of the original NAFTA negotiations: talks began in 1990; the agreement was signed in December of 1992; and the U.S. Congress ratified it in November of 1993.

But that kind timeframe—three years to negotiate and ratify— simply won’t work for NAFTA 2.0.

In Mexico, for example, President Enrique Peña Nieto cannot run for re-election because of term limits, and officials within his administration have repeatedly warned that they would not be able to garner support for a renegotiated NAFTA once campaigns begin in spring 2018. As a result, the White House has avoided setting a specific date for closing the deal. U.S. officials say that all counterparties aim to come to an agreement by the end of the year, but they caution that this is an aspiration, not a firm deadline.

According to the Peterson Institute for International Economics (PIIE), it takes 18 months on average to negotiate a trade deal involving the United States and more than three and a half years to get to the implementation stage. PIIE looked only at bilateral deals in its analysis, and although NAFTA 2.0 is a trilateral deal, it is reasonable to expect that it will be easier to negotiate than, say, the Trans-Pacific Partnership (TPP), a sweeping 12-nation multilateral deal that took nearly eight years to negotiate. But even with a timeline closely resembling that of the average bilateral deal, it seems that NAFTA 2.0 would fail to receive the necessary support from Mexico.

Given this, many trade practitioners and Washington pundits are skeptical that the NAFTA 2.0 agreement will be renegotiated within the required timeframe.

Even so, the countries do seem to have some common ground when it comes to some of the details of the agreement. The White House in July released a list of objectives for NAFTA 2.0, which includes provisions that closely resemble those contained in the TPP. And remember, the TPP was signed by all 12 member countries, including the U.S., Mexico and Canada, before the Trump administration summarily withdrew from the agreement. These provisions include measures to regulate the treatment of labor, the environment, and state-owned enterprises.

The White House also wants new rules that govern the trade of services and digital goods, updated customs procedures, and a mechanism to deter currency manipulation, and there appears to be common ground in these important areas.

That seems to be where the consensus ends, however. While the U.S. is encouraging Canada to increase imports of agriculture products from the U.S. by cutting tariffs, a concession included in TPP, and raising the threshold of duty-free imports through e-commerce, it seems to be using Canada as leverage against Mexico.

One stated objective of the U.S. is to reduce its trade deficit with Mexico, and renegotiating how rules of origin work under NAFTA 2.0 is a large part of this. Currently, 62 percent of the parts in cars sold in North America must come from the region. The Trump administration wants rules-of-origin criteria that specifically prioritize components sourced in the U.S. in order to meet campaign promises to boost domestic manufacturing employment. But Mexico’s trade representatives say that if the U.S. proposes country-specific rules of origin, it would walk away from the negotiations.

NAFTA’s Chapter 19 is another contentious issue. The Trump administration wants to be able to impose duties on imports it thinks are unfairly subsidized or set at artificially low prices by Mexico or Canada. Chapter 19 established an arbitration process for challenging these anti-dumping and countervailing duties decisions that has consistently ruled against the United States’ efforts to impose these import taxes. And much like Mexico’s stance on country-specific rules of origin, Canada has threatened to quit the talks if the U.S. insists on eliminating Chapter 19.

Broadly, all three economies have become irrevocably interdependent, and the primary objective of both Canada and Mexico seems to be preservation. And both countries have some leverage.

Mexico’s leverage lies largely in the fact that its interests are aligned with those of powerful domestic industries. Mexico imports corn products, such as high-fructose corn syrup, from the U.S., and it is well-known for its “maquiladoras,” assembly factories located close to the border that U.S. companies increasingly use for low-cost assembly of complex goods, particularly in the automotive sector. The agriculture and automotive industries are well-represented in Washington, and they will lobby in favor of trade policy that maintains a market in Mexico for their exports and reduces their costs. Equally importantly, Latin American countries are already significant suppliers of agricultural products such as corn, providing an alternative to U.S. imports.

Mexico also has leverage across the Pacific Ocean. According to a July report from Chinese state-run Xinhua news agency, China is open to a free-trade agreement with Mexico.

“If we negotiate a free trade agreement, this will greatly favor trade exchanges between our two countries,” Qiu Xiaoqi, China’s ambassador to Mexico, said at an academic event in Mexico City.

“There is no difficulty from China’s side.”

Canada’s leverage is more direct. Simply put, it is the largest market for U.S. exports—greater than the United Kingdom, Japan and China combined. Of particular importance is the fact that Canada buys a substantial amount of manufactured goods. President Trump has made it a priority to strengthen the U.S. manufacturing sector, and import restrictions from Canada could create a major obstacle in this area.

So although it is true that Canada and Mexico depend on the U.S. more than the U.S. depends on them, the combination of an ambitious timeframe and the economic power of NAFTA’s current iteration means all three countries share an enormous incentive to do what needs to be done to diffuse what’s becoming a ticking time bomb.

The details around how this renegotiation plays out are of the utmost importance, not only to the automotive and agricultural sectors, but to other industries and the overall U.S. economy as well.