What the Future Holds for NAFTA

NAFTA

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Fordham University's Matt Gold and McGill University's Andrea Bjorklund discuss the renegotiation of NAFTA.

As the latest round of talks between the U.S., Canada and Mexico to renegotiate the North American Free Trade Agreement (NAFTA) ended last week in a stalemate, two issues emerged as the key sticking points.

One is the Trump administration’s demands over the so-called “rules of origin” for automobiles. The Trump administration wants U.S. content in automobiles to be at least 50% to qualify for NAFTA’s zero tariffs. A companion push is to raise the minimum value of automotive components sourced within the three countries from the current 62.5% to 85%. The second issue is the U.S. demand for a so-called “sunset clause,” where the three countries must renew the 23-year-old agreement after five years, or else it would lapse. The demands are intended to help bring automobile manufacturing jobs back to the U.S. and correct the U.S. trade deficit, Robert Lighthizer, the U.S. trade representative, said in a statement after the latest round of talks.

But the U.S. demands threaten to upset the economics that drove decades of planning and investments by automobile companies in the three countries, and the jobs that went overseas aren’t about to come back to the U.S., according to experts at Wharton, Canada’s McGill University and Fordham University.

“Given the United States’ other free trade agreements and given the comparative advantage of labor in other countries — Vietnam is the one that springs to mind first — it’s far from clear that those jobs are ever coming back to the U.S., whether or not NAFTA is renegotiated,” said Andrea Bjorklund, a law professor at McGill University in Montreal. Bjorklund was also formerly a member of the NAFTA arbitration team at the U.S. State Department.

“The sunset clause is an absurd [demand] for a myriad of reasons,” said Matt Gold, an adjunct law professor at Fordham University who served in 2012 as the deputy assistant U.S. Trade Representative for North America, in which he was the country’s lead negotiator and policy advisor focus on North American trade. “Companies need to do medium-term and long-term planning. Nobody can do that if there is a five-year sunset provision that says that the agreement can die in five years unless the countries re-vote to reaffirm it.” American industry and the U.S. trade negotiators involved in the talks were “stunned” when the U.S. made that demand, he added.

Bjorklund and Gold discussed the implications of the U.S. demands on NAFTA and the outlook for future negotiation rounds on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

The U.S. stance reflects two clear goals in renegotiating NAFTA. First, it wants to update the 23-year-old agreement to reflect a modern economy that covers intellectual property, digital trade, anticorruption, technical standards, financial services, and others. Second, NAFTA “has become very lopsided and needs to be rebalanced,” said Lighthizer in his statement, explaining that it has cost the U.S. “a huge trade deficit … and tens of thousands of manufacturing jobs.”

“Nobody can do [medium- or long-term planning] if there is a five-year sunset provision that says that the agreement can die in five years.”–Matt Gold

Costs and Benefits

Mauro Guillen, Wharton management professor and director of the school’s Lauder Institute, noted that no other major trade agreement in the world includes a sunset clause. “If the sunset clause sets an automatic end to NAFTA unless the three countries agree to continue, it will freeze investment by companies to some extent, given that it places a term limit on the agreement,” he said. “There are parts of the U.S. economy that benefit from NAFTA, and they will be opposed to sunset-clause activation or to any disbanding of the agreement.”

Gold said the proposal to require 50% U.S. content in cars coming into the U.S. from Canada or Mexico is “unheard-of in any free trade agreement.” He noted that customarily, North American content would be the only measure to determine whether the product qualifies for duty-free movement across borders.

“Every single American sector came out of the woodwork,” said Gold of how U.S. industry received Trump’s NAFTA position. “They completely panicked about the possibility that Trump would withdraw from NAFTA as a negotiating tactic or that they would change NAFTA in a way that would cost various American sectors markets in Canada and in Mexico and access to the Canadian and Mexican markets.”

The Outlook for Jobs and Investment

If the Trump administration were to have its way with NAFTA, will jobs that have been offshored to Mexico or elsewhere over the past two decades come back to the U.S.? “Unlikely,” said Guillen. “Quite on the contrary, many investments by German, South Korean and Japanese firms in South Carolina, Tennessee, Alabama and elsewhere were triggered by the large market that NAFTA created.”

“Many investments by German, South Korean and Japanese firms in South Carolina, Tennessee, Alabama and elsewhere were triggered by the large market that NAFTA created.”–Mauro Guillen

Within NAFTA’s current 62.5% rule for North American content, each partner country has no specific rule for local content, and it could come from any of the three countries, Guillen pointed out. “If the U.S. successfully asks for a 50% rule of U.S. content, then auto suppliers and assemblers will need to change their sourcing to meet that requirement,” he said. “In the short run, I do not think they will shut down their production facilities. But in the long run, the U.S. should expect less investment or new facilities.”

Gold pointed out that the history of the auto sector straddles the U.S.-Canadian border and that it goes back to the pre-NAFTA days. He pointed to the 1965 Canada-U.S. Automotive Parts Agreement that removed tariffs on cars, trucks, buses, tires and other automotive parts. Another, “special mini agreement” between the two countries covered just cars and car parts. “There is no way to untangle that; the cost of untangling that to the U.S. auto sector and to the Canadian automotive sector would be staggering,” he said.

If NAFTA were to be unwound, Gold expected big shifts in employment as some companies lose export jobs while others would gain. Shareholders would be affected, especially pension funds and mutual funds that have investments in the auto industry, he said. In the long run, he expected the effects to be recessionary in the U.S., although he predicted it would be “a lot worse in the short run.”

Although the current impasse centers around the automobile industry, NAFTA impacts agriculture the most, followed by a host of other industries that benefit from zero-tariff trade, said Gold, Between 1993, the year before NAFTA went into effect, and 2016, U.S. agricultural exports to Canada and Mexico rose by more than 400%, from $8.9­ billion to $38.1 billion, according to a Washington Post report. Mexico and Canada are now the most important overseas markets for U.S.-grown commodities including corn and soybeans, apples and high-fructose corn syrup, the report said.

Without NAFTA’s tariff-free protection, prices of imported products would go up across the board because they would attract duties, said Gold. Canada was the United States’ second-largest single trading partner last year (after China,) while Mexico is the third largest.

The Next Move

All sides will meet for the next round of negotiations in Mexico on November 17, three weeks later than originally scheduled, and the entire process is likely to continue well into 2018. In the next round, Bjorklund expected Mexico and Canada to have an opportunity to respond more thoroughly to the U.S. demands and to consider what is worth fighting for and their respective negotiating tactics. “[Also,] I wonder how much you can trust the U.S. to stick by its world; it pains me to say that, and that’s going to have an effect on the negotiations,” she said. She expected the coming round of negotiations to focus on clarifications and not much by way of real progress.

“It’s not that the [U.S. Trade Representative] is the lead trade negotiator in the way that we have traditionally seen it. You’ve got these other centers of power jockeying for positions.”–Andrea Bjorklund

Gold noted that the stated position in putting off the next round of talks was to give time to the professional negotiators on the ground to come up with creative solutions to the impasses. “We should all take the time between now and our next round to realistically assess what can be done to arrive at a balanced, modern agreement,” Lighthizer stated. However, Gold wasn’t as hopeful. “Many of these impasses don’t have creative solutions because there are complete conceptual gaps in what is and is not appropriate and what does and does not make sense,” he said.

Broadly, Mexico and Canada have “a few asks, but much fewer than the U.S. asks,” said Gold. Mexico wants to improve customs procedures, Bjorklund said. At the same time, Mexico is pushing back on incorporating environmental and labor rules into the main agreement and making them enforceable, she added.

Bjorklund noted that the U.S. demand to get “50% of the pie” in terms of locally-made automobile content is unrealistic considering it would leave Mexico and Canada to split the remaining half. While she noted that Lighthizer has to follow guidelines for the negotiations set by the White House, she said his instincts may ultimately lead him in a different direction. Bjorklund also pointed to “the odd dynamic in this particular White House” with two other voices in the trade negotiations. One is U.S. Secretary of Commerce Wilbur Ross, whom she saw as an influential advisor to Trump. The other is Peter Navarro, an economist who leads the White House Office of Trade and Industrial Policy, she noted. “It’s not that the [U.S. Trade Representative] is the lead trade negotiator in the way that we have traditionally seen it. You’ve got these other centers of power jockeying for positions.”

According to Guillen, the U.S. assumes that the size of the American market gives it more leverage in its negotiations with Canada and Mexico. “A large market always is a strong bargaining chip — no question about it,” he said. “Mexico and Canada care about access to the U.S. market more than the U.S. cares about access to their markets.”

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