NAFTA renegotiations: US protectionism writ large

Five rounds of negotiations concerning the future of the North American Free-Trade Agreement (NAFTA) were met by the end of 2017, with consistent disagreement since the second round. So far, all three countries – consisting of the US, Canada and Mexico – have accepted the need to discuss clauses addressing digital economies, developing a ‘Trilateral Small and Medium Size Enterprise Dialogue’, and new standards tackling the environment, food safety and sanitation.

The topics driving outright disagreement are those presented by Washington. US Trade Representative Robert Lighthizer’s proposals reflect President Donald Trump’s campaign goals. Lighthizer aims include rebuilding the US car manufacturing industry; removing the Investor State Dispute Settlement (ISDS) mechanism; and introducing a “Sunset Clause” which requires the renegotiation of NAFTA every five years or it trigger its expiration. Canada and Mexico have expressed their concern for US demands, and partnered up to rebuke the proposals.

Trump’s ‘America First’ mandate is pressing negotiators to reduce the US trade deficit with its northern and southern neighbours. Mexican and Canadian negotiators have sought to ca[italise on the talks to contemporise NAFTA, with the introduction of a ‘Trade and Gender Chapter’ that Canadian Prime Minister Justin Trudeau suggests will offer protections for women’s rights in the workplace under free-trade.

But a breakthrough for the talks looks shaky and Trump has repeatedly taken to Twitter to threaten to remove the US from NAFTA.

TRADE DEFICITS SUPPORT ‘AMERICA FIRST’ RHETORIC

Since its inception in 1994, NAFTA has quadrupled trade between the US, Canada, and Mexico. Currently, the US has a considerable trade deficit with Canada and Mexico, which has motivated Trump to instruct his trade negotiators to return manufacturing jobs to the US. From January to September 2017, the overall US trade deficit was $34.7 billion higher than 2016’s figure of $370.7 billion. In the first 10 months of 2017, the deficit with Mexico rose 11% from 2016, reaching $59.7 billion, while the US accumulated a deficit of $14.3 billion with Canada. The last time the US recorded a trade surplus with Mexico was September 1994, the first year of NAFTA’s existence.

A trade deficit with Mexico has been a two-decade norm, overlooked by previous administrations as it simply implies that US businesses and consumers buy more goods and services than they send to Mexico, whereby the US is not indebted to Mexico. However, the deficit has irked Trump and inspired his pledge to rebuild the US car manufacturing industry. The president has also suggested that Mexico’s acceptance of US proposals will facilitate their indirect payment for Trump’s border wall expansion.

For Mexico, the car manufacturing industry accounts for nearly one-fifth of all national manufacturing. Mexico earns customs taxes from car-part supplier countries, as it imports parts primarily from China and Taiwan, only to send the finished components into the US for final assembly duty-free. Now, US negotiators are pushing for change to favour their own industry, but their proposals would not only affect Mexican labour markets but also raise costs for US car companies.

Under NAFTA’s current rules of origin, 62.5% of all automobiles traded in NAFTA countries must derive from NAFTA countries. US negotiators have introduced an 85% rule of origin to resist the influx of non-NAFTA components. Trade experts consider the proposal detrimental to NAFTA, as disruptions to an enormous global supply chain would reduce cost efficiencies for US firms invested in cheaper manufacturing destinations.

While the US auto industry faces uncertainty, proposals to remove the ISDS will weaken investor confidence. The ISDS has given corporations a voice in policymaking and legislative processes by allowing foreign companies to sue a host country for introducing regulations or legislation that impact profits. Canada is objecting to the ISDS’s removal despite being sued 39 out of 84 times legal cases have been presented under NAFTA – Canada has lost or settled eight of the cases, paying a total of $215 million to mostly US companies. Meanwhile, the US has never paid compensation or lost any of the 18 concluded cases presented to it. It seems counter-intuitive to US interests to remove the ISDS and replace it with an opt-in system that allows countries to reject cases, which will render it obsolete.

LOOKING EAST AND WEST: THE PRAGMATIC RESPONSE

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Canada and Mexico are now looking to integrate trade outside of NAFTA and without the US. Even though former Mexican President Vicente Fox has warned Trudeau to “not be a Judas” and back-track on rejecting prickly US proposals, expect Canada and Mexico to continue disagreeing with the US on various topics.

A conundrum facing Mexican and Canadian negotiators is their reliance upon trade with and through the US. If Trump rejects NAFTA membership, Canada can rely on a 1987 FTA with the US, enabling tariff-free two-way trade. Mexico does not have a fall-back agreement with the US, and Canada and Mexico are not joined outside of NAFTA. The impending Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which both countries are party to, could be a safeguard if the US withdraws from NAFTA, but its conclusion lies someway off yet.

US withdrawal from NAFTA would hypothetically heighten their trade deficit with Mexico. Countries not party to an FTA generally face an average tariff rate of 4.5% in Mexico compared to the US applied tariff average of 2.8%. If NAFTA collapses, there is the likelihood that US goods and services will face higher taxes entering Mexico than those facing Mexican enterprises selling to US consumers. While businesses may gain confidence from US tax cuts passed in December 2017, the introduction of a “Sunset Clause” in NAFTA will weaken any business confidence across the three countries, as the five-year renegotiations will create uncertainty for many industries that look for long-term investments.

Mexico and Canada are actively seeking alternative arrangements in the event that Trump withdraws the US from NAFTA. Both countries have persevered with multilateral negotiations through the CPTPP and the Pacific Alliance despite the US withdrawal from the original TPP. The CPTPP could set the foundations for increased trade integration between Asia and the Americas, though US recalcitrance will lessen the ability for US companies to enjoy tariff-free trade. Additionally, in September 2017, the Comprehensive Economic and Trade Agreement (CETA) between Canada and the EU partially entered into force. The EU and Mexico are also deep into renegotiations for a bilateral agreement dating back to 1997, and a Mexican official has claimed on January 17 that the deal will be finalised in weeks.

NAFTA’s failure is the worst-case scenario and would severely impact all three countries’ economies. The foresight of Mexico and Canada to increase engagement across the Pacific and the Atlantic could mitigate the substantial risk of economic instability if Trump withdraws, though they would not go unharmed. Additionally, legislative and regulatory mechanisms would need incredible overhaul to address the trade disruption. Nevertheless, Trump will need to battle his biggest stakeholders in the US Chamber of Commerce and agriculture lobbies, among others, which would be his biggest economic test to date.

While trade negotiators may achieve a breakthrough in talks in the final rounds, they will need to look past the idea that a trade deficit defines trade relationships – an unlikely shift under President Trump.