Trilateral tribulations: unpacking the new NAFTA

January 2019  |  FEATURE  |  GLOBAL TRADE

Financier Worldwide Magazine

January 2019 Issue

Widely agreed to have been long-overdue for an overhaul, the North American Free Trade Agreement (NAFTA) between the US, Canada and Mexico has been repurposed and refined – the result of much-needed modernisation and president Trump’s desire to revamp what he considered “the worst trade deal ever”.

Designated the US-Mexico-Canada Agreement (USMCA), or NAFTA 2.0 according to some, updates to the 25-year-old trilateral North American accord – signed by US president Donald Trump, Canadian prime minister Justin Trudeau and Mexican president Enrique Peña Nieto (shortly before leaving office) in November 2018 – include new digital economy protocols, as well as a number of substantive changes, as well as tweaks, to pre-existing provisions.

Although the inclusion of a section on the digital economy does much to bring the recently signed agreement into the 21st century, many commentators feel that replacing NAFTA with USMCA is less to do with modernisation and everything to do with the Trump administration’s belief that the original NAFTA was a deal that needed to be undone.

“The political impetus for updating NAFTA came from president Trump who denounced the original deal as not in the interest of the US,” says William Reinsch, senior adviser at Kelley, Drye & Warren LLP. “While most stakeholders disagreed with that assessment and did not support his rhetoric, there was widespread agreement that the 1994 document needed to be revised.”

Veronique de Rugy, a senior research fellow at George Mason University’s Mercatus Center, also dismisses the president’s denunciation. “Falsely portraying successful trade agreements as failures fuels the public's fear that trade resulting in increased US imports – as successful agreements will – is to be lamented, criticised and changed,” she suggests. “The expectation is that ‘better’ deals in future will result in the US exporting more relative to what it imports – a very bad outcome portrayed as a 'win'.”

Following initial consent on 1 October 2018, the USMCA was signed by the three partners at the G20 Summit in Argentina in November/December, with ratification expected to follow sometime in 2019.

Reheated or reinvented?

Although there are some who view USMCA as little more than a reheated version of NAFTA, others consider the legislation as containing updates and modernisations which, above all, make sense. Elements of the agreement have certainly been divisive.

Among the key changes in the USMCA are: (i) more restrictive rules of origin for automobiles; (ii) the imposition of a 16-year sunset clause indicating when the agreement expires; (iii) the phasing out of an investor-state dispute settlement (ISDS) clause for Canada; (iv) increasing access to Canada’s dairy market by US farmers; (v) a requirement to provide a data protection term for biologics of at least 10 years; and (vi) the inclusion of digital economy, and stronger labour and environmental provisions.

“There appears to be broad support for the ‘upgrade’ portions of the agreement, such as digital trade, intellectual property (IP) and state-owned enterprises,” observes Mr Reinsch. “However, there is great disappointment over the removal of the ISDS provision for Canada, its truncation for Mexico and unhappiness over the sunset provision. The most significant change is probably the new auto rules of origin which are intended to force companies to alter their supply chains and move more production to the US.”

For her part, Ms de Rugy has a somewhat more critical view of many of the new agreement’s provisions. “Here we need to set the record straight,” she says. “For all president Trump’s complaints about how NAFTA brought about tariffs that were unfair to US exporters, data shows that this does not hold water.”

Citing World Trade Organization (WTO) data, Ms de Rugy notes that, under NAFTA, all US exports to Mexico faced tariffs of 0 percent. In addition, all non-agricultural US exports to Canada entered the country duty-free. Furthermore, despite all the talk about a 270 percent Canadian tariff on US dairy products, 97 percent of US agricultural exports to Canada were duty-free.

“This means that on the tariff front, there was not much room for progress,” she continues. “Even though the deal leaves in place many of the existing protectionist policies that are part of the original NAFTA, there is in this new deal some trade liberalisation. These concessions, such as Canada agreeing to open its hitherto restricted dairy market, are small, but real.”

Also provoking Ms de Rugy’s ire is the automotive-related sections of USMCA. “The automotive aspect may be the worst part of the deal,” she suggests. “For automobiles to enter the US duty-free from North America, at least 75 percent of their content must originate in the US, Mexico and Canada, up from the current 62.5 percent. This requirement will increase the price that automakers pay for producing cars and Americans pay for automobiles.”

Deal thinking

While there is no doubt as to how president Trump views the USMCA – described by the president as “a wonderful new trade deal” and “a historic transaction” – less clear is the extent to which the deal similarly enthuses Canada and Mexico.

Dean Elliott, a managing partner at BDO Canada, believes the USMCA will impact Canada across three key industries: agriculture, automotive and retail. “Canada has opened up a part of its agricultural market to the US,” he notes. “US dairy farmers will be given market access of 3.59 percent to the domestic dairy market. Farmers who recently expanded will face some challenges. This is not positive for the industry. Canada will also provide new access for US-produced chicken, turkey and eggs.”

In terms of the Canadian automotive industry, the USMCA stipulates that Canada will not be subject to tariffs on automobiles or parts as long as they stay below specified quotas. “The quota of 2.6 million passenger vehicles annually far exceeds the current production level of about 1.8 million vehicles,” says Mr Elliott. “Also, Canada agreed to increasing North American content requirements of 75 percent – up from 62.5 percent – and that 40 to 45 percent of a vehicle is made by workers earning at least $16 an hour.”

As far as the Mexican automotive industry is concerned, while it thrived under the flexible NAFTA regime, the more restrictive USMCA is expected to create a much more challenging environment. “The requirement that at least 40 percent of each vehicle be produced by workers paid at least $16 per hour adds insult to injury,” says Ms de Rugy. “This requirement imposes yet another cost hike on car manufacturers.”

Generally speaking though, Mexico’s reaction to the USMCA has been positive, with economists hopeful that the revised trilateral agreement will strengthen Mexico’s hand on trade issues and end investor uncertainty. Mexico’s new president, Andrés Manuel López Obrador (who took office on 1 December 2018), believes the new trade deal gives Mexico “peace of mind and confidence”.

For his part, Canadian prime minister Trudeau, despite the often frantic negotiations between Canada and the US, not to mention the threat of being sidelined, has described the signing of the deal as a “good day for Canada”.

Congressional review

The result of the US mid-term elections in November – which saw the Republicans retain control of the Senate and the Democrats gain control of the House of Representatives – could prove pivotal when Congress convenes to review the USMCA in January 2019.

“We are hopeful that the trade deal will pass Congress,” states Mr Elliott. “There will be a newly-elected Congress, so it will be a potentially different group of lawmakers that will decide on the USMCA, which is expected to go into effect at the beginning of 2020.”

That said, with the Democrats taking control of the House of Representatives, the path to approval is not necessarily a smooth one. “The most likely scenario is demands from the Democrats for further improvements in the agreement, most likely related to the labour provisions and Mexico, and then approval if the administration is successful in obtaining additional concessions,” suggests Mr Reinsch.

In terms of ratification of the trade deal in the Canadian and Mexican legislatures, little opposition is expected. “We are optimistic that USMCA will be ratified in due course, thereby maintaining the essential principal of free trade in North America,” says Michael T Agosti, a senior business advisor at Dentons Canada LLP.

Trilateral future

The fact that the US, Canada and Mexico have signed their trilateral trade agreement is surely no small achievement – especially when it appeared possible, if not probable, that the entire deal would collapse amid often rancorous negotiations.

“The short-term impact should be a positive one because of the improvements in USMCA over NAFTA,” says Mr Reinsch. “Long-term, however, if you look at the automotive provisions, particularly the side letters, it portends a move in the direction of managed trade, at least in some sectors, which could be unsettling to many.”

Also far from certain about the deal’s worth is Ms de Rugy. “The fact that the three partners stayed in the deal, in spite of the agreement being clearly worth less than the original NAFTA, brings certainty to the market and to manufacturers,” she suggests. “In fact, this is the best thing about this deal: it is done.”

Time will of course tell whether the updates and modifications made to the trade deal formerly known as NAFTA will have the desired effect of maintaining the essential principal of free trade in North America.

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Fraser Tennant