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Analysis

NAFTA: Renegotiating Key Trade Deal

Sat, 09/01/2018 - 10:40

After the implementation of NAFTA on Jan. 1, 1994, the elimination of tariffs gave way to better opportunities and a greater integration between Mexico, Canada and the US that strengthened many industries, automotive among them. “The Mexican automotive industry was the real winner after NAFTA was enforced,” says Óscar Albin, Executive President of INA. “Our industry has grown the most thanks to this trade agreement and there is still a great deal of room for more.” Yet, not everyone is happy with the results of the agreement.
Beginning with his campaign for office, President Trump has attacked NAFTA as the “worst trade deal ever made” by the US. He says it had led to an enormous trade deficit with Mexico and the loss of countless manufacturing jobs for US citizens. It is true that once NAFTA was implemented, it was easier for companies to establish manufacturing operations in Mexico, where it was cheaper to produce components and assemble vehicles but at the same time, many jobs were lost due to the increasing automation that the industry implemented to remain competitive and deliver the production volumes the global market demanded.
This, however, was not good enough for Trump who stated that once he entered office, the first thing he would do was to renegotiate the agreement or pull the US out altogether should he find it unsuitable for the country’s new America-first policy.
At first, industry leaders thought this was just a bluff, akin to Trump’s promise to make Mexico pay for a border wall to prevent immigration. But Trump followed through with his promise and announced a revision of the agreement that led to a start in negotiations on Aug. 16, 2017 in Washington, D.C. Trade representatives expected seven rounds of negotiations, which were scheduled every three weeks starting in August, to be finalized before the end of 2017. According to El Financiero, one of the Mexican negotiators stated that this was planned to avoid an overlap with Mexico’s presidential elections in 2018.
Among Trump’s demands regarding NAFTA was the implementation of a 35-percent tariff on automotive exports entering the US, which was later transformed into a border adjustment tax that would favor US exporters while charging companies importing products to the US. Both of these initiatives found resistance from investors and members of the Democratic and Republican parties, as well as industry representatives that urged Trump to reconsider his position to avoid messing with an agreement that had brought so many benefits to the industry.
Rules of origin were also to be revised even though AMIA and its counterparts in Canada and the US lobbied to keep regulations unchanged. “NAFTA represents a success story and we should not be messing around with important topics such as rules of origin,” stated Eduardo Solís, Executive President of AMIA. “Our members feel very strongly that rules of origin are not the tools to use to reshore jobs to the US,” said Ann Wilson, Senior Vice President of Government Affairs for the Motor and Equipment Manufacturers Association in an interview with Reuters on Aug. 14, 2017.
Although the border adjustment tax issue was dropped, the revision of rules of origin was kept with the objective of decreasing the US$74 billion trade deficit the US had with Mexico and to limit the entrance of Chinese auto parts to the region.
The US government’s requirements changed but America First was still the connecting thread in its rhetoric. Trump demanded a more stringent rule of origin that required 80 percent of the components used to manufacture a vehicle to be sourced in North America, while 50 percent of this content should come from the US. This was an equally negative alternative for an industry that for over 20 years had worked to raise its local content sourcing strategies to NAFTA’s current standpoint of 62.5 percent.
“A more stringent limit than the 62.5 percent local content regulation already in place would force automakers to go straight to paying the added tariff,” said Charles Uthus, Vice President for International Policy of the American Automotive Policy Council in an interview with Reuters on Aug. 14, 2017. “If stricter rules of origin led to tariffs higher than 3 percent, thus threatening competitiveness, companies would have to choose to operate under WTO standards to maintain solid operations,” added Rogelio Garza, Mexico’s Deputy Minister of Industry and Commerce.
FOCUS ON WAGES
This was a major concern that prevented the negotiations from advancing but in March, it was announced that Trump had dropped his demands regarding local content in what seemed like a rare concession. “(The proposal) was completely unfeasible and unreasonable in a free trade agreement,” Albin said in an interview with El Economista on March 23, 2018. For a moment, it seemed the NAFTA stalemate could be broken. Salaries, however, became a new threat for Mexican production, along with Trump’s views on Latin American immigration.
After the domestic content proposal was dropped, US trade negotiators started working on an idea to integrate wages into the discussion. The idea was to determine a percentage of component production that should be completed in higher-salary regions, which was later set at 40 percent, as well as a wage floor for all other manufacturing activities.
Reuters reported on March 30, 2018 a wage floor of US$15 per hour, which would translate to a daily wage of approximately US$120 considering an eight-hour shift. The 2014 research by Alex Covarrubias for the Friedrich Ebert Foundation in Mexico, Explosión de la Industria Auomotriz en México: De sus encadenamientos actuales a su potencial transformador, outlined an average daily salary in the Mexican auto industry of MX$305.90. When considering the yearly increase in salaries related to inflation, that average would translate to approximately MX$358.84 (US$19.72). This would mean that if the US proposal was accepted, salaries in automotive manufacturing operations would have to increase by 508 percent.
Since skilled, low-cost labor availability has long been regarded as one of Mexico’s greatest advantages as an investment destination, a decision of this kind could have significant repercussions on the country’s role as an automotive manufacturer. That being said, Reuters sources indicate that even though Mexico and Canada were analyzing the proposal, the wage floor would be much lower for a deal to be viable.
While this was discussed, Trump seemed to be adamant of finding a way to push Mexico to agree to his conditions for a new NAFTA. In one of his Twitter rants, Trump accused Mexico of failing to act to stop illegal immigration and appeared to be willing to hold NAFTA hostage in order for US Congress to approve the budget to build his infamous wall. On April 1, 2018, Trump tweeted: “Mexico is doing very little, if not NOTHING, at stopping people from flowing into Mexico through their Southern Border, and then into the U.S. They laugh at our dumb immigration laws. They must stop the big drug and people flows, or I will stop their cash cow, NAFTA. NEED WALL!”
MIGRATION AS LEVERAGE
Migration has been a sore topic in Trump’s government for a while, especially after Democrats in Congress fought to keep the Deferred Action for Childhood Arrivals (DACA) alive. Trump had already used immigration before as leverage for Congress to approve his wall budget but at the moment he seemed to be using it as a way to influence both the wall discussions and NAFTA negotiations. After a convoy of migrants coming from Honduras and headed for the US entered Mexico, Trump once again threatened Mexico over NAFTA.
“The big Caravan of People from Honduras, now coming across Mexico and heading to our ‘Weak Laws’ Border, had better be stopped before it gets there. Cash cow NAFTA is in play, as is foreign aid to Honduras and the countries that allow this to happen. Congress MUST ACT NOW!” he tweeted on April 2, 2018.
Trump addressed the issue one more time saying Mexico should do things his way regarding immigration or he would not sign a renewed NAFTA agreement. “NAFTA has been fantastic for Mexico, bad for us,” he said in an official speech. “We have had our car plants move to Mexico, many of them. We make tremendous numbers, millions of cars in Mexico that years ago did not exist. They closed in Michigan, they closed in Ohio, they closed in other places. Now they are starting to move back because of what we have done with regulation and with taxes. They are starting to come back into our country in a big way.”
Unfortunately, immigration was not the only tool Trump used to try to coerce the Mexican government into seeing things his way. While negotiations on NAFTA were under way, Trump also started revising the US’ position in terms of trade tariffs with other countries. On March 8, 2018, under the banner of a national security threat following Section 232 of the US Trade Expansion Act of 1962, Trump slapped a 25 percent tariff on steel imports and another one of 10 percent on aluminum. Mexico and Canada were exempt from these tariffs along with the EU but eventually, the US President decided to lift this exemption starting on June 1, 2018 as a way to pressure Mexico and Canada to move the NAFTA negotiations along since his view was that both countries were not collaborating to finalize the agreement.
Canada was adamant in seeking support from the industry to counter US protectionist measures not only regarding NAFTA but also related to the steel and aluminum tariffs imposed by Trump. “You cannot say that Canada is a national security risk to the United States when we are so partnered on so many different issues,” said Prime Minister Justin Trudeau in an interview with Bloomberg on May 31, 2018. Yet, the tariffs remain even though Trudeau and other members of the G7 urged Trump to rethink his position regarding global trade.
Not only did Trump not change his position, he launched a second national security probe on May 23, 2017, this time toward vehicle imports to the US. The investigation can last up to 270 days, plus 90 more when Trump can decide whether to act on the results or not. However, if the investigation returns a negative result, the US President has threatened to slap a 25 percent tariff on all vehicle imports. Industry representatives had already spoken against this initiative, saying they are willing to challenge Trump’s decision in court to support the interest of the American consumers and even though this has not been directly linked to the NAFTA negotiation, it is still an issue that will impact trade relationships among Mexico, Canada and the US.
NAFTA negotiations stopped in June before the Mexican presidential elections but they resumed shortly after Andrés Manuel López Obrador was designated the new president-elect. López Obrador has already designated Jesús Seade as the chief negotiator for his administration but he has shown openness to keep talks moving. Minister of Economy Ildefonso Guajardo and US Trade Representative Robert Lighthizer met again in August and they said they were close to finalizing an agreement, possibly by the end of the month.
Guajardo informed the media on Aug. 2, 2018 that Mexico and the US were finding common ground in their proposals regarding rules of origin and that an agreement might come soon. This, however, was later dismissed by Fausto Cuevas, Director of AMIA, at a press conference, saying “nothing has been accepted and nothing has been confirmed.”
Still, the industry remains positive as well regarding the possible outcome of the negotiation since all industry leaders agree a successful treaty would be the best bet to continue driving the industry forward. That being said, the industry is still not willing to give in to the US’ demands regarding rules of origin that could be detrimental for the development of the supply chain.
“A key element (for investment attraction) was establishing the right conditions to do business in our sector,” says Solís. “Investment in the automotive industry demands long-term certainty.” This vision is supported by the document Dialogue With the Automotive Industry 2018-2024 where all associations in Mexico categorized NAFTA negotiations as fundamental for the industry’s development.
Key Sticking Points in the NAFTA Negotiation
Determination of an adequate rule of origin to substitute the current 62.5 percent
Determination of a percentage of content to be manufactured in areas with a high-paying salary rate
Discussion regarding a sunset clause that would terminate the deal every five years unless all parties agree to maintain it
Discussion regarding Chapter 20 related to conflict resolution between members