Canada, Mexico, and the United States are about to start the so-called “fourth round” of negotiations to revise the North American Free Trade Agreement (“NAFTA”) starting from October 11, 2017, when the four-day long negotiation calendar starts in Washington D.C. The negotiations are expected to be contentious, and possibly at times fierce, particularly given the negotiation style of the current U.S. administration.
The primary focus of the United States, the country with the largest economy and strongest negotiation power at the table, will be to discuss changes in NAFTA that will reduce U.S. trade deficit with Mexico, and overall increase U.S. exports to the NAFTA region. Domestic policies and politics of the Trump administration have had a tremendous focus on revival of U.S. manufacturing, and the NAFTA discussions will manifest that desire. To increase U.S. manufacturing and export, one of the key new ideas likely to be placed by the U.S. during the negotiation is U.S. content requirement, where it will be made mandatory that any goods benefiting from NAFTA have at least 50% or more U.S. originated content.
Domestic policies and politics of the Trump administration have had a tremendous focus on revival of U.S. manufacturing, and the NAFTA discussions will manifest that desire. To increase U.S. manufacturing and export, one of the key new ideas likely to be placed by the U.S. during the negotiation is U.S. content requirement, where it will be made mandatory that any goods benefiting from NAFTA have at least 50% or more U.S. originated content.
The United States may also demand increase of the “Regional Content Requirements” from 62% to 85%. Regional Content Requirement stipulates what portion of any good’s value addition should come from the three countries within NAFTA. The increase in regional content requirement will be targeted towards reducing Chinese and European imports for goods produced within the NAFTA region.
The primary focus of the United States, the country with the largest economy and strongest negotiation power at the table, will be to discuss changes in NAFTA that will reduce its trade deficit with Mexico, and overall increase U.S. exports to the NAFTA signatory countries.
The United States is likely to zoom in on the automotive sector with large trade deficits for the U.S. However, given the highly complex supply chains of the auto-manufacturing process, the regional and U.S. content requirements are not popular among the auto-manufacturers due to operational and financial complexities. The benefit of the U.S. content requirement in the auto manufacturing process may also be doubtful, particularly given that U.S. auto parts are often expensive, and the auto manufacturers may simply choose to pay higher tariffs rather than manufacturing autos using a higher portion of U.S. made parts. U.S. currently imposes 2.5% tariff on light-duty vehicles that fail the content requirement thresholds. Paying this 2.5% may make more sense for the auto-manufacturers rather than revising their sourcing practices.
About a month ago U.S. Commerce Secretary Wilbur Ross had said that the U.S. would like to incorporate a so-called sunset clause during the NAFTA negotiations. The “sunset clause” would mean automatic termination of the NAFTA deal after five years absent any re-negotiation/extension mutually agreed by the three countries.
The Sunset Clause idea remains controversial among the Canadians and Mexicans, and it is likely that they would vehemently oppose any such move, just like they did when the idea was first floated.
Another novel idea floated by the U.S. has to do with “Seasonal Trade Barriers” for agricultural crops during their harvest seasons. The key idea here is to restrict the flow of certain agricultural products during their time of harvest in the United States. Canada and Mexico are certain to object to such seasonal barriers given that their own harvests for specific crops coincide with that of the United States.
Canada and Mexico are certain to object to any seasonal barriers for agro-products given that their harvests for specific crops may coincide with that of the United States.
Another contentious sector within agriculture will be Canada’s closely protected dairy sector. The dairy sector was not part of the original NAFTA signed in 1994, and the United States has long contended that the Canadian government provides subsidies to about 12,000 Canadian dairy producers enabling them to compete against cheaper dairy exported from the United States.
Hard Negotiations will be Mostly Between Mexico vs. the U.S.
At the negotiation table, it is expected that it will be trade issues between Mexico and the United States where the majority of the heat will be exchanged. Canada’s trade with the United States is largely balanced, with the exception of few contentious sectors like dairy. From the Canadian side, it will fight to preserve the current mechanism for dispute resolution (i.e., Chapter 19), where countries can avoid domestic courts in their dispute resolution around dumping, non-tariff trade barriers, and trade duties.
Mexico, on the other hand, is expected to present a much more direct and contentious posture against any significant changes to the existing NAFTA. Mexico has already identified a number of items they will certainly refuse to agree. Mexico has shown strong resistance towards the “Sunset Clause”, increase in “Regional Content Requirement”, “Seasonal Restrictions” on agro-products, and changes to the “Chapter 19” dispute resolution mechanism. It is likely that Mexico will vote against all of these measures leaving not much room for negotiation.
Mexico knows the Trump administration is hungry for a successful re-negotiation of NAFTA, so that he can deliver to his voters something concrete. A collapsed NAFTA may not be an ideal delivery for sure. However, playing too hard against the United States has its own risks for Mexico. There is about 30% decline in Mexican Peso against the U.S. dollars since Donald Trump became the president. One can only imagine what would happen to Mexican currency or economy if NAFTA were to be abolished or materially altered.
The bilateral trade surplus with Mexico against the United States is a real issue and fixing it to America’s favor was a crucial part of the Trump campaign’s electoral promise. Any attempt by the Trump administration to reduce Mexico’s trade surplus in a meaningful way is bound to hurt Mexico, and there are only a limited number of tit-for-tat trade measures for Mexico to counter the United States. One of those limited options floated by Mexico is to impose trade barriers for U.S. export of corn and ethanol into Mexico – a business where various southern states of the U.S. with strong support for Donald Trump play a major role.
Mexico will rehash its official argument that about six million American jobs depend on U.S. exports to Mexico, without of course stating the obvious that many more million Mexican jobs rely on the continuation of NAFTA, which clearly leaves more leverage for the U.S. negotiators. To embolden Mexico’s leverage over the United States, however, it is expected that Mexico will bring into the table non-trade related items as negotiation chips. Mexico may deploy as bargaining chips its cooperation with the U.S. on cross-border drugs trade, illegal migration, border security, anti-terror campaigns, illegal weapons trade, and money laundering.
Despite all the tough talks, bombasts, and posturing, one common thing that all of the three parties in NAFTA secretly recognize is that they all largely benefited from the treaty. Particularly after the collapse of the TPP agreement floated by the former U.S. administration, the importance of NAFTA has enhanced for the combined industries of the three nations. Therefore, it is expected that the three parties on the table will not do anything that damages the NAFTA treaty which may render it beyond repair, causing its unnecessary collapse.