Renegotiating NAFTA: “fair” or foul?

In Blog by Marta Bengoa0 Comments

By Marta Bengoa

Amid all the controversies surrounding President Donald Trump, the renegotiation of the North American Free Trade Agreement (NAFTA) between the US, Canada and Mexico – which starts tomorrow – may seem relatively unimportant. But think again. The US’s NAFTA partners spend some $600 billion a year on American goods and services, making them its biggest export market. As the US’s neighbours, the future of their trade relations doesn’t just matter for American jobs and prosperity, it impinges on everything from migration to security. And the renegotiation will be closely watched across the world for indications of how far Trump’s fiercely protectionist America First rhetoric translates into actual policy changes.

The economic benefits of NAFTA are clear. In the 23 years since it came into force, trade among its three members has nearly quadrupled. Americans enjoy duty-free imports of Mexican avocados and much else, while Mexicans can likewise buy American combine harvesters unimpeded. Businesses (and their employees) benefit from a combined $21 trillion market ­– a quarter bigger than the EU single market. US direct investment in Mexico has soared as cross-border supply chains have proliferated, notably in the auto sector, where US parts and components are often assembled into finished vehicles south of the border. While some jobs may have been lost due to NAFTA, mutual trade has made all three countries richer. Indeed, integration with Mexico has helped US firms, notably in the auto sector, to compete more effectively with China, thereby preserving American jobs.

Scrapping NAFTA, as Trump previously threatened to do, would cause huge disruption and damage. The renegotiation could yet do a lot of harm too, if America seeks to impose new trade barriers to reduce its deficit with Mexico and to encourage production to relocate from Canada. But while they fear the worst, Mexico and Canada are entering the negotiations constructively, seeking the upsides to modernising NAFTA. Mexico’s economy minister, Ildefonso Guajardo, likened the renegotiation to a rollercoaster ride: “there will be good, bad and terrible days”.

Starting on 16 August, the opening rounds of the negotiations will focus on the agenda, the composition of the negotiating teams and the negotiation priorities. Ahead of the talks, the US Trade Representative office (USTR) has already published its negotiating objectives. While Mexican officials insist that they are “not as bad” as feared, they are troubling.

The biggest bone of contention is the US’s trade deficit with Mexico. Reducing it is a key US objective, while Mexico rightly rejects any suggestion of imposing tariffs or quotas on its exports to America. Such protectionism would harm Mexican exporters, tax American consumers, likely lead to retaliation by Mexico – and wouldn’t reduce the US’s overall trade deficit.

While USTR believes that a “fair” agreement must achieve balanced bilateral trade, there is nothing unfair about the fact that the US bought $55.6 billion more from Mexico last year than vice versa and it would be perverse to try to force exports and imports to balance.

The bigger picture is that the US has a huge current-account deficit with the rest of the world because it saves less than it invests; in other words, it spends more than it earns and borrows the difference from the rest of the world. As long as that macroeconomic situation doesn’t change, the US will run trade deficits with many countries and overall. Trying to reduce the trade deficit with Mexico by impeding its exports would make both sides worse off and likely cause the US deficit with other countries to widen instead.

Most of America’s trade deficit with Mexico is in cars and car parts. If the US made it costlier to import cars from Mexico, the bilateral deficit might fall, but the US would likely import more cars from other countries instead. American consumers would be worse off, and so would US producers of car parts, since vehicles assembled in Mexico contain lots of US content.

That brings us to a second battleground: rules of origin. These stipulate how much of the value of a good needs to be produced within NAFTA for it to be considered made there and traded duty-free; the US wants more of that content to be “made in America”. In the case of cars, the NAFTA local content requirement is 62.5%, which is already high by global standards. Raising it would disrupt cross-border supply chains and might lead the US to import cars from elsewhere instead. Indeed, if the cost of complying with the rules of origin is greater than the import tariff that applies to countries that trade with US according to World Trade Organisation rules, it would be cheaper to pay that most-favoured-nation (MFN) tariff, which averages only 1% for vehicle parts, but is as high as 25% for trucks.

A third thorny issue is public procurement. The US proposal unfairly wants “Buy America” requirements at home, while pushing Mexico and Canada to open their government procurement markets. That is a non-starter.

Mexico and Canada are also fighting to preserve NAFTA’s current Chapter 19 arbitration system for judging whether one government’s imposition of anti-dumping duties on products that it deems too cheap and countervailing duties on those that it deems subsidised is acceptable or not. Contrary to Trump’s claims that NAFTA panel decisions are biased against the US, they have ruled both for and against the US, and a fair dispute-settlement system is vital to enforcing NAFTA rules effectively and impartially.

More positively, the renegotiation provides an opportunity to update and expand NAFTA, notably on digital trade and the movement of people. The US proposal to increase duty-free import limits for online trade will surely face industry resistance in Canada and Mexico, even though it would undoubtedly benefit their consumers. Canada requires that foreign firms use local servers to operate in its territory, a big restriction on e-commerce. Eliminating it ought to be part of the updated deal.

Better still, a modernised NAFTA ought to facilitate cross-border movement of labour. While the Trump administration wants to cut immigration, US and Canadian firms are lobbying for a freer flow of labour. American farms in particular are short of agricultural workers. Contrary to popular and political perception, more people now move south across the US-Mexican border each year than north.

Canada and Mexico ought to join forces in seeking to expand and update the list of eligible professions that have preference for US visas. The current list includes only sixty occupations and excludes those, notably in the tech sector, that didn’t exist in the early 1990s. It would be perverse to include a digital chapter that boosts cross-border investment while restricting the movement of people who work for those foreign investors. But regrettably, prospects for freer mobility seem dim.

Trade negotiations are extremely complex; the art of the deal requires nuance, not presidential bluster. While Mexico and Canada have little choice but to engage with US demands, the renegotiation seems unlikely to be particularly productive. For all that modernising NAFTA would make sense; with a protectionist president in the White House, Mexico and Canada are likely to end up fighting to preserve its existing benefits instead. Even then, the danger that Trump will ultimately pull the US out of NAFTA is real – although some legal scholars believe that this would also require the approval of the US Congress.

Marta Bengoa is a senior fellow at OPEN, as well as the Director of the Graduate Program in Economics at the Colin Powell School and an Associate Professor of International Economics at City University of New York.