Will the New NAFTA Deliver?

NAFTA

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Fordham's Matt Gold and Andrea Bjorklund from the McGill Faculty of Law discuss what the USMCA will mean for the U.S., Mexico and Canada.

President Trump last week claimed victory in clinching a new trade deal with Canada to replace the North American Free Trade Agreement (NAFTA) with the so-called U.S.-Mexico-Canada Agreement (USMCA), a month after Mexico agreed to come on board. According to experts at Wharton and elsewhere, the USMCA is certainly an improvement over NAFTA, although it is too early to conclude which country gains the most. Also, it does not necessarily pave the way to improve the sour trade relations between the U.S. and its other trading partners globally, they said.

Immediate gains will be seen on several fronts with the USMCA. The agreement reflects changes over the years in the economics of trade, and “modernizes” NAFTA with respect to intellectual property, digital trade, financial services and environmental issues. It also brings improved market access for U.S. dairy farmers and provides for a bigger share for North American content in automotive manufacturing – from the existing 62.5% to 75%. The three signatories to the agreement are expected to sign it by the end of November; in the U.S., it will head after that for approval from Congress.

Trump is not right in that claim of victory, according to Wharton management professor Mauro Guillen. “[Trump] has obtained minimal concessions from Mexico and Canada,” said Guillen, who is also director of the Lauder Institute. “He has also made USMCA more protectionist than NAFTA relative to third countries because the local content rule is now 75%, up from 62.5%. He has lost Mexico’s and Canada’s confidence and trust. It is important to note that American automobile firms are against the changes.”

Wharton legal studies and business ethics professor Philip Nichols described the USMCA as “a shockingly reasonable agreement given President Trump’s professed disdain for reasonable trade agreements.” Whether it will bring back jobs to the U.S. or reduce the country’s trade deficit with Mexico is hard to predict, he said. “But it appears to be the sort of agreement that boosts overall trade and can lead to growth.” However, because the agreement still has to be confirmed by the legislatures of the three countries, “it is a little premature to declare victory for anyone.”

“The USMCA deal is a major step forward, and it will help companies to optimize their supply chains through better use of resources in all three countries,” according to Morris Cohen, Wharton professor of operations, information and decisions. “This will eventually lead to more employment and a better balance of trade. It suggests that adjustments to existing trade agreements can be made through negotiation.” Cohen is also co-director of the Fishman-Davidson Center for Service and Operations Management at the school.

“[Trump] has obtained minimal concessions from Mexico and Canada.” – Mauro Guillen

“It’s best to talk about what [USMCA] isn’t,” said Matt Gold, adjunct professor of law at Fordham University. Gold was formerly deputy assistant U.S. Trade Representative for North America. “It’s not going to bring back any manufacturing jobs from Mexico, and it’s not going to eliminate, or even meaningfully reduce, our trade deficit with Mexico. It also doesn’t include almost any of the series of things that President Trump was demanding that involve actual concessions from Mexico and Canada.” For example, the new agreement retains NAFTA’s Chapter 19, a binational panel review mechanism for anti-dumping and countervailing duty investigations. Trump had originally wanted to scrap that.

The updates and improvements contained in the USMCA were needed to ensure consistency with other trade agreements the U.S. has entered into with other countries after NAFTA took effect in 1994, said Gold. “It was a lot of catch-up.”

Mixed Signals for Investors

One significant change that could impact investor appetites relates to their ability to contest government actions, according to Andrea Bjorklund, the chair in international arbitration and international commercial law at McGill Faculty of Law in Montreal. She formerly worked on the U.S. State Department’s NAFTA arbitration team in the Office of the Legal Adviser. “Investor-state dispute settlement under the Chapter 11 of NAFTA would be eliminated in the new agreement,” she noted, although there would be a three-year legacy period to take care of pending claims. “Canadian investors in the U.S. and U.S. investors in Canada, after a three-year implementation period, would not be able to submit those claims.” (Both Gold and Bjorklund shared their views on the Knowledge@Wharton radio show on SiriusXM. Listen to the full podcast at the top of this page.)

“The USMCA deal is a major step forward, and it will help companies to optimize their supply chains through better use of resources in all three countries.” –Morris Cohen

“The U.S. has put these investor-state chapters in all of our recent free trade agreements,” said Gold. “This is the first time we’re scaling back on that and going in the other direction, which is a bad thing. I think it is being driven by the fact that people don’t understand how the investor-state rules work.” Guillen, too, described the removal of the investor-state dispute settlement feature “a bad move,” adding that it is premature to quantify the negative effect it would have.

The U.S. wanted to get rid of the investor dispute panel, but Canada and Mexico stood firm. Most multilateral trade agreements include a dispute resolution mechanism, so “the U.S. position was difficult to begin with,” said Nichols. Now that the investor-state dispute mechanism is still in place in the USMCA, that aspect of the agreement should have no effect on investments, he added.

However, the USMCA does remove a provision that allowed businesses to protest and block government action that negatively affected their businesses, Nichols pointed out. “Progressives in the U.S. did not like that [provision] at all, because it gave businesses standing to complain about environmental regulations, consumer protection, labor protection, and actions like that. So, with almost no fanfare and without explanation, this agreement gives a nice gift to progressives.”

Autos: Higher Prices Down the Road?

Although the USMCA increases the North American content to 75% in automobiles, that increase would be only up to 70% because of how they are calculated. “From what we understand, there is certain content that they’re allowed to count in those numbers that they weren’t allowed to count before,” Gold explained.

According to Gold, the requirement of a $16 minimum wage in the provisions relating to automotive manufacturing is “groundbreaking.” However, he said it is not clear if that minimum-wage requirement would mean Mexican workers get paid more, or if more parts would be sourced from the U.S. or Canada, where auto workers are already getting paid more than $16 an hour.

The deal’s clauses on automotive rules of origin and the $16 minimum wage requirement would hurt U.S. auto consumers, according to Nichols. The U.S. currently levies a 2.5% tariff on cars imported from the European Union. In June, Trump had threatened to increase that to 20%, after launching an investigation into whether auto imports presented a threat to national security. Nichols explained how auto prices could go up after the USMCA for U.S. consumers. “The 2.5% general tariff on automobiles will become much less onerous, which might drive demand for cars produced outside the region. That makes it likely that President Trump will raise tariffs on automobiles from outside the region, which will cost consumers even more.”

“The USMCA is a shockingly reasonable agreement given President Trump’s professed disdain for reasonable trade agreements.” –Philip Nichols

Ultimately, it isn’t clear which country benefits the most from the revised rules of origin for the auto industry, Nichols noted. “It is hard to disentangle the auto industry by country in terms of which workers will benefit since it has become so integrated across the three countries.”

Guillen drew the bottom line for automobile buyers: “Cars will be more expensive. Period.”

Relief for Agriculture

The USMCA is “a huge sigh of relief” for the U.S. agriculture generally, said Gold. “The uncertainty of the [U.S.] threat to pull out of NAFTA was very worrisome to U.S. agriculture. [Also], President Trump’s illegal tariffs on Canadian and Mexican steel and aluminum brought retaliation from [those two countries], some of which was on U.S. agriculture. So, [U.S. farmers] had lost a little bit of their markets in Mexico and Canada and they were worried about losing more. They’re [also] worried about losing markets in China.”

The win-lose equation is less severe for the dairy industry in either country. “The U.S. dairy sector got very little and Canada lost very little,” according to Gold.

Montreal-based Bjorklund offered the view from Canada. “The dairy industry here is not at all pleased that there were concessions made on supply management and opening of the market to U.S. dairy products,” she said. “Any opening here is not viewed favorably. At least on a local level, I don’t think the new agreement has been welcomed.”

The gains to the U.S. dairy industry may not extend significantly to the rest of the economy. “Dairy is not a huge contributor to the U.S. economy, but it is to some local economies,” said Nichols. “They could be better off, as will to some extent Canadian consumers.”

Wood and Metal

Lumber trade is one area where Canada is a clear winner under the USMCA, notably with the retention of NAFTA’s binational panel review process. “This permits Canada to have non-U.S. courts review the decisions of an American administrative agency on imposing countervailing duties on softwood lumber,” said Bjorklund. “For Canada, that’s politically extremely important.”

The persistence of U.S. import tariffs of 25% on steel and 10% on aluminum – which were illegal under NAFTA — remains a major sticking point, according to Gold. He expected the USMCA to help address that. “One would have thought that Canada and Mexico would not have agreed to anything unless elimination of the steel and aluminum tariffs was part of the deal,” he noted. “But they tolerated not doing that, and I think they reached the conclusion that resolving NAFTA would tamp down the animosity on all three sides and maybe open the door to resolve the steel and aluminum tariffs.”

“One would have thought that Canada and Mexico would not have agreed to anything unless elimination of the steel and aluminum tariffs was part of the deal.” –Matt Gold

Cohen said the persistence of the steel and aluminum tariffs will affect costs and competitiveness “to some extent,” especially in industries which are major consumers of these materials, such as automobiles, construction, and aerospace and defense.

The steel and aluminum tariffs are “bad for low-income Americans,” said Guillen “They hurt consumers, especially poor consumers, because they spend a greater percentage of their income on imported goods.” Aluminum goes into a lot of products, including packaging for food, he added.

Digital Trade and Drugs

The updates in the USMCA relating to digital trade represent “a classic example of things that are mutually beneficial to all three countries,” said Gold. He pointed to aspects such as the three countries agreeing “not to impede cross-border data flows, agreeing not to have customs duties on software, and agreeing not to have local data storage requirements.”

Under USMCA, U.S. manufacturers of biologic drugs swill get two more years of protection against generic drugs from Canada. According to Gold, there exists strong support for either side of the argument among consumers and political parties. “Literally every person in the United States and every person in Canada and Mexico is on both sides of that issue,” he said. “The longer you provide protection for a new drug for a drug company, the greater incentive they have to invest money in research and development of new drugs. The downside of course is that drugs are then more expensive for a longer period of time before they become generic.”

The End of Trade Wars?

The USMCA has calmed tensions between the three NAFTA partners, and some analysts are wondering if ultimately that could have a positive effect on U.S.-China relations. “The USMCA deal would have a positive effect on the trade dispute with China,” said Cohen. “It demonstrates that it is possible to reach an agreement even in large-stake, publicized situations.”

“The dairy industry [in Canada] is not at all pleased that there were concessions made on supply management and opening of the market to U.S. dairy products.” –Andrea Bjorklund

However, Nichols did not see the USMCA as an indicator that trade wars between the U.S. and its partners will decrease. “President Trump claims that this agreement is the result of his aggressive use of tariffs,” he said. “There is no indication that he will back down on the aggressive use of tariffs elsewhere — or even on metal [aluminum and steel] within the region.”

Guillen said the U.S. deficit with China is only half of what official statistics show. That is because many goods assembled in China contain components made in Japan, South Korea, Taiwan, Germany, etc., he explained. In any event, he said it would be “a mistake” to try to cut bilateral trade deficits. “What matters is the overall deficit,” he said. “In any case, it’s wrong to alienate China. China is a powerful country, and it will be even more so in the future.”

China is not optimistic about improved ties with the U.S. in the near term, according to Gold. He has done much analysis on this issue to get a clearer picture of China’s stance. “I think China has made a decision that they are going to wait for the next American president. The U.S. and China have gone into a downward spiral — all the way to the basement.”

Gold noted that after a series of tariff moves by the two countries, the U.S. has retaliatory tariffs on $250 billion worth of Chinese goods, or half of everything imported in the U.S., and China has put in place, or is about to put in place, retaliatory tariffs on $110 billion worth of American goods. The stalemate seems tough to resolve. “Now no one has a way out. No one has an exit ramp.”

“The one ray of hope is that after all of the fire and fury, President Trump settled for a reasonable agreement that for the most part updates NAFTA and makes it a bit more equitable,” Nichols said. “Maybe this administration will do the same elsewhere. On the other hand, there is nothing to indicate that this administration will stop attacking its international allies and business partners. So who knows? Trying to figure out this administration’s business policy is like trying to decipher the old Soviet Politburo.”

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