Home The Washington Diplomat August 2017 Prodded by Trump, U.S., Canada and Mexico Prepare to Renegotiate Trade Deal

Prodded by Trump, U.S., Canada and Mexico Prepare to Renegotiate Trade Deal

Prodded by Trump, U.S., Canada and Mexico Prepare to Renegotiate Trade Deal

The North American Free Trade Agreement (NAFTA) came into force in January 1994. It was an unprecedented symbol of cooperation between the U.S., Canada and Mexico and has since set the tone for the amicable relationship between the three neighboring countries, even with lingering, and new, disputes.

Among President Donald Trump’s endless stream of sound bites, he has deemed NAFTA a “disaster” and counts it among the trade agreements he threatened to “rip up.”

Alarmed at his rhetoric, Mexican President Enrique Peña Nieto and Canadian Prime Minister Justin Trudeau called Trump to roll him back from threats that he was going to pull out of the accord, and Trump decided to renegotiate NAFTA instead.

On May 18, U.S. Trade Representative Robert Lighthizer sent a letter to Congress stating that Trump intends to initiate negotiations with Canada and Mexico to modernize NAFTA. Now that the letter has been sent, Congress has 90 days to review the president’s memo and formal negotiations can legally begin after Aug. 16.

a2.nafta.mexico.storyOn July 17, the administration released a broad outline of U.S. negotiating objectives for NAFTA. Among them: reduce trade deficits with Mexico and Canada; maintain existing duty-free access for agricultural, industrial and other goods; eliminate “non-tariff” barriers to U.S. agricultural exports such as price undercutting; establish new rules to govern the trade of services, including telecommunications, financial services and digital goods like e-books; reduce barriers to U.S. investment; promote intellectual property rights; add enforceable labor and environmental provisions; restrict the amount of imported material in goods that qualify under the pact; address the issue of state-owned enterprises; and scrap a dispute settlement mechanism that gives appeals power to a special NAFTA panel.

Canada and Mexico will likely object to some of America’s demands — and come to the table with their own — when negotiations begin after Aug. 16. The intricate deal-making could take months or even years, after which time any revised agreement would be put up for a vote in each country’s respective legislatures.

Negotiations could, of course, fall apart, in which case Trump is only legally required to notify the other two parties six months in advance if he is withdrawing from the accord.

The president may dislike NAFTA, but it is unlikely the U.S. will completely abandon or remake a landmark agreement that has integrated the North American market. Most likely, what has already been agreed upon will stay in place, and negotiations will focus on bringing NAFTA in line with today’s economy, where digital trade has become a major force.

“This is an opportunity to modernize the agreement, and if the three sides approach the agreement with a constructive mindset, this could improve regional competitiveness,” Cathleen Cimino-Isaacs, a research associate at the Peterson Institute for International Economics, told The Diplomat.

The Purpose of NAFTA

When NAFTA was set up, the objective was to integrate the U.S., Mexico and Canada into one giant market to create a competitive regional economic bloc. In the early ’90s, when NAFTA was being negotiated, globalization was starting to become a grand idea on the world’s stage. In 1993, the European Union was established and the post-Cold War era had begun.

“The U.S. had to become part of these broad globalization efforts,” Peter Hakim, president emeritus and a senior fellow at the Inter-American Dialogue, said to The Diplomat. “What was more natural than to take two of its bordering countries, Canada and Mexico, and join together in representing 20 percent of the world’s economy?”

NAFTA was essentially “an attempt by the U.S. to establish a paradigm for how to organize the global economy in the post-Cold War period,” Matthew Rooney, economic growth director at the George W. Bush Institute, told The Diplomat. 

A free trade agreement between the U.S. and Canada already existed, and NAFTA built on that by adding Mexico to the deal.

NAFTA sought to lower trade and investment barriers, and it achieved that by eliminating tariffs on the majority of goods produced by the three parties.

As a result, U.S. trade with its neighbors more than tripled, growing more rapidly than U.S. trade with the rest of the world, according to a Jan. 24 backgrounder by the Council on Foreign Relations (CFR).

In 1993, regional trade amounted to $290 billion. The latest numbers show NAFTA involves over $1 trillion in trilateral trade, according to the Americas Society/Council of the Americas (AS/COA). Twenty-six U.S. states, including eight of the 10 largest state economies, rely on Canada and Mexico as their top two export destinations, and 14 million U.S. jobs depend on NAFTA trade. Today, Canada is the leading market for U.S. exports, while Mexico ranks second.

Mixed Bag

Based on numbers alone, NAFTA is a big success. But economists caution that “it has proven difficult to tease out the deal’s direct effects from other factors, including rapid technological change, expanded trade with other countries such as China, and unrelated domestic developments in each of the countries,” wrote CFR’s James McBride and Mohammed Aly Sergie in their backgrounder.

Determining whether the deal was a net gain or net loss for workers is even more difficult, the authors argue. “Debate persists regarding NAFTA’s legacy on employment and wages, with some workers and industries facing painful disruptions as they lose market share due to increased competition, and others gaining from the new market opportunities that were created.”

The debate is hardly new, mirroring disagreements that surfaced when the idea was first proposed over 25 years ago. NAFTA was controversial when first proposed, mostly because it was the first FTA involving two wealthy, developed countries and a developing country,” said a May 24 Congressional Research Service report, noting that proponents of the deal said it would generate thousands of jobs and reduce income disparity, while opponents warned it would result in enormous American job losses as production shifted to lower-cost Mexican factories.

“NAFTA did not cause the huge job losses feared by the critics or the large economic gains predicted by supporters,” the report concluded.

a2.nafta.trump.storyWhat it did do was usher in a new global trading paradigm. “NAFTA initiated a new generation of trade agreements in the Western Hemisphere and other parts of the world, influencing negotiations in areas such as market access, rules of origin, intellectual property rights, foreign investment, dispute resolution, worker rights, and environmental protection,” the CRS report said, noting that the U.S. now has 14 free trade agreements with 20 countries. “As with NAFTA, these trade agreements have often been supported or criticized on similar arguments related to jobs.” 

The Biggest Winner

NAFTA has yielded undeniable benefits for all three parties, but Mexico has emerged as the one that has gained the most. The U.S. and Canada were already modern economies when NAFTA went into effect, and Mexico, in forging a formal economic relationship with its two developed neighbors, was catapulted into a new playing field. It was forced to abide by new international rules, which created a novel discipline in Mexico’s formerly protectionist, debt-saddled economy, said Hakim.

The result is that Mexico became a modernized, liberalized economy, reducing its public debt, stabilizing inflation and attracting foreign investment (although the deal has not done much to slash poverty or boost wages). Notably, Mexico moved away from a focus on agricultural products to industrialization as a result of NAFTA.

The most conspicuous example of this is in the automotive industry, where supply chains were created by the free flow of goods between borders that now enables the body of a car to be built in Mexico, then sent to the U.S. for its motor to be put in, then sent back to Mexico to be painted, according to Hakim.

There has been a change toward “maquiladora-style manufacturing to provide for the U.S. and Canadian market,” Michael McKeon, project manager of transatlantic relations at the Bertelsmann Foundation, told The Diplomat, referring to factories that import tariff-free goods for assembly and export them as part of the supply-chain process. “There’s been a big move from classical agricultural employment in Mexico to low- and mid-level manufacturing jobs. Those jobs in the U.S. moved to Mexico and China and other parts of the developing world, supplanted by automation.”

Unintended Consequences

The unforeseen consequence of successfully integrating the North American market has been the loss of blue-collar manufacturing jobs in the U.S., which has contributed to Trump’s voter base. The so-called Rust Belt of the U.S. contains a swath of people who have lost their jobs, and some would argue a whole way of life, as the auto industry has evolved.

Some argue that these jobs have been lost to cheaper labor in Mexico, but others argue that the loss is due to the larger forces of globalization (in particular, China’s accession to the World Trade Organization in 2001) and automation, which has seen technology replace people and increase productivity (also see “Trade, Automation, Cheap Wages Abroad Conspire to Alter U.S. Economic Landscape” in the March 2017 issue of The Diplomat).

Economists differ greatly in their opinions on the merits of sweeping trade accords like NAFTA. Some, such as Dean Baker of the Center for Economic and Policy Research, point out that since NAFTA came into effect, America’s trade deficit with Mexico has ballooned and that numerous studies show a link between unfettered trade and lower wages for workers without a college degree.

But others say increased trade benefits the economy as a whole. A 2014 Peterson Institute for International Economics (PIIE) study, for example, says that claims of NAFTA stealing American jobs were exaggerated. It points out that almost 17 million jobs were added to the U.S. economy in the seven years following enactment of NAFTA, and that the unemployment rate dropped from 6.9 percent to 4 percent. A more recent PIIE study from May estimates the payoff to the United States from trade expansion between 1950 and 2016 to be $2.1 trillion, which translates into an increase of over $7,000 in per-capita GDP, although the study also concedes that over 150,000 manufacturing jobs have been shed annually over the last 13 years.

These figures have “been in keeping with what most economists maintain, that trade liberalization promotes overall economic growth among trading partners, but that there are both winners and losers from adjustments,” according to the Congressional Research Service.

That applies not only to American workers, but also to their counterparts in Mexico and, to a lesser degree, Canada. For instance, the elimination of trade barriers under NAFTA exposed millions of small-scale Mexican farmers to competition from heavily subsidized American agricultural firms, putting many out of business. Meanwhile, annual U.S. farm exports to Canada and Mexico since NAFTA took effect quadrupled. That’s why American farmers are now lobbying against significant changes to NAFTA, fearing a loss of access to their lucrative Canadian and Mexican markets.

a2.nafta.graphic.storyOn the flip side, the U.S. auto sector has lost hundreds of thousands of jobs since 1994, while Mexico became a thriving automotive-export hub. Again, however, economists disagree to what extent this shift was the result of NAFTA versus other factors, such as China’s growth, Mexico’s own efforts to build up its auto industry and the forces of globalization that have connected global supply chains and wiped away traditional divisions.

For example, thanks to NAFTA, carmakers in the U.S., Canada and Mexico effectively operate as one large bloc against competitors such as Germany. Parts and labor have become so closely intertwined that “Mexican-made” cars are often made with American parts that support thousands of American jobs, while some 35 percent of “American-made” cars are made with imported components from Mexico, Canada and other nations.

While globalization has transformed entire industries, most economists agree that automation — the use of machines and robots to replace low-skilled labor — has caused far more manufacturing disruptions than trade agreements. Today, manufacturing accounts for less than 10 percent of the U.S. workforce, as the nation continually evolves toward a more high-tech, service-oriented economy — precisely the areas that a revised NAFTA seeks to address. 

So while Trump blames NAFTA for job losses in the auto industry, even if NAFTA were abolished, “The jobs are not coming back,” said William Reinsch, a fellow at the Stimson Center. Technology is advancing, and so is globalization.

Updating NAFTA

There is a consensus among trade experts that while NAFTA has achieved its original objective of increasing trilateral trade, it could certainly use a refresh to bring it up to date with today’s economy.

“In particular, we note that NAFTA was negotiated 25 years ago, and while our economy and businesses have changed considerably over that period, NAFTA has not,” Lighthizer stated in his letter to Congress. “Many chapters are outdated and do not reflect modern standards. For example, digital trade was in its infancy when NAFTA was enacted…. [O]ur aim is that NAFTA be modernized to include new provisions to address intellectual property rights, regulatory practices, state-owned enterprises, services, customs procedures, sanitary and phytosanitary measures, labor, environment, and small and medium enterprises.”

All three parties say they are ready to come to the table to update NAFTA. Experts say that while the administration hasn’t fleshed out its position in great detail, the main issues will likely be e-commerce, rules of origin and intellectual property. Between the U.S. and Canada, softwood lumber will be a sticking point, and between the U.S. and Mexico, sugar and citrus will be the big points of contention.

 Any negotiations will be fraught with difficulty and arcane details, however, and just like Trump will be pushing for a better deal, Canada and Mexico will expect concessions from him as well. For instance, Canada will be reluctant to open up its protected dairy industry. Mexico will want more favorable treatment for its truckers crossing the U.S. border. And both countries will want to preserve the dispute mechanism that largely prevents the U.S. from imposing anti-dumping duties on them.

Canada and Mexico are gearing up for a fight, launching an aggressive charm offensive to woo American lawmakers and businesses. Canadian Prime Minister Trudeau, for example, delivered the keynote address at the 2017 U.S. National Governors Association’s summer meeting, touting the benefits of U.S.-Canada trade. Among other things, he noted that the two countries share the largest trading relationship in the world, with bilateral trade totaling over $880 billion last year.

 The goal, wrote Megan Cassella of Politico, is to “build groundswell of local support in the United States to pressure the Trump administration not to do anything radical to the 23-year-old trade agreement.”

Do No Harm

Indeed, many economists say the U.S. should approach negotiations with a “do-no-harm” mentality. Opponents of wholesale change argue that U.S. trade with Canada and Mexico is already fairly well-balanced, particularly compared to America’s gaping trade deficits with nations such as China.

The Peterson Institute for International Economics has created a guide to renegotiating NAFTA, by Melina Kolb and Cimino-Isaacs. For e-commerce, the recommendation is to raise North American limits for imports that count as duty-free, ensure an open market for digital goods and services, and protect proprietary technologies, intellectual property and consumer privacy. The recommendation for rules of origin is to simplify them into a regional content rule that can be used for all products. The guide also recommends the enforcement of labor rights and laws; encouraging renewable energy and infrastructure investment; enhancing dispute resolution mechanisms, such as narrowing the scope for frivolous cases; and improving safeguards for the government’s right to regulate in the public interest.

 The Peterson guide also contains a section on what not to do at the negotiation, such as revising rules of origin to require more content from U.S. factories. The White House argues that increasing the required share of North American parts in determining what counts as originating from the NAFTA trade area will help American manufacturers and reduce competition from low-wage countries in Asia. But the Peterson Institute argues that such a revision could erode NAFTA trade preferences that make it cheaper for importers to buy products from the region as a whole, making the free trade zone less competitive. The guide also cautions against promoting “Buy America” policies because this will likely result in retaliation from Canada and Mexico, which could restrict the ability of U.S. firms to bid on their government contracts, meaning businesses in all three countries could be left hurting.  

On that note, economists stress that the U.S. should not adopt protectionist policies that violate World Trade Organization rules, which could spark a raft of lawsuits, tit-for-tat tariffs and a trade war that hurts U.S. exporters and raises costs for consumers.

TPP Template?

Trade experts point to the Trans-Pacific Partnership (TPP), which was to have been outgoing President Barack Obama’s economic legacy, as a good template for renegotiating NAFTA, given that the U.S., Canada and Mexico have already agreed to major concessions in the 12-nation TPP.

a2.nafta.honda.storyObama saw TPP as a way to improve NAFTA, according to Politico Magazine, which reported that the Obama administration spent three years working on upgrading NAFTA under the umbrella of TPP. Under TPP, Canada gave U.S. farmers access to its dairy industry, and Mexico said yes to labor reforms. U.S. service sectors such as insurance, accounting and delivery services were also brought into the agreement, as well as digital commerce. The U.S. was also able to include more protections for intellectual property and the environment, Politico’s Michael Grunwald reported.

Trump cut off TPP before it could make its way to Congress for review, but the agreements made under TPP could be a good basis for the upcoming NAFTA negotiations (also see “After U.S. Withdrawal from Trans-Pacific Partnership, Now What?” in the April 2017 issue). Indeed, some of the objectives outlined by the administration with regards to updating NAFTA’s labor and environmental protections appear pulled straight from the TPP playbook.

“The TPP could be a baseline for NAFTA for certain issues, and indeed Trump officials have said they’d like to use TPP as a starting point,” wrote Cimino-Isaacs in an email.In particular, in areas like digital trade and e-commerce, disciplines on state-owned enterprises, labor standards and environment, TPP has been touted as setting new precedents for U.S. trade deals. However, it’s not going to be as simple as moving over what was done exactly in the TPP to NAFTA because the agreement was based on a balance of concessions between 12 countries.”

The Consequences of Exiting

No one but Trump knows what he will do next. His team seems divided between economic moderates such as Lighthizer and National Economic Council Director Gary Cohn on the one hand, and protectionists such as chief strategist Steve Bannon and trade advisor Peter Navarro, who have advocated policies such as restricting steel imports and tariffing Canadian lumber — in line with Trump’s “America first” agenda.

It’s not inconceivable for the president to walk away from NAFTA, as he did from the Paris climate agreement. But the consequences of doing so would be immediate.  

Scrapping NAFTA would mean disrupting the supply chains that have developed as part of the integration of the North American market. The region has become tightly lashed together, and if NAFTA is eliminated, then all bets are off with regards to tariffs.

“If tariffs were to rise to pre-NAFTA levels and investment rules were different, it would really upend the North American economy because so much of it depends on supply chains created by NAFTA,” said McKeon of the Bertelsmann Foundation. “A lot of industries would really suffer.”

For instance, the auto industry would have to rethink the entire way it does business because the cost of vehicle components would change with changing tariffs. The virtually nonexistent tariffs for most goods circulating through North America could easily morph into walls of rising tariffs, which would hinder cross-border trade and hurt industries and consumers in all three countries.

The business community is a staunch supporter of NAFTA. The Business Roundtable, an association of CEOs of leading U.S. companies, co-hosted a meeting with the Business Council of Canada and the Consejo Mexicano de Negocios in June to discuss NAFTA. Business leaders from all three countries issued a statement upholding the trade agreement: “NAFTA drives significant economic growth and job creation in each of our countries. Hundreds of thousands of businesses in our three countries trade with one another, and millions of jobs are supported by trade in goods and services among our countries…. Negotiators must take care not to erect new barriers to the $1.3 trillion in trade across our borders. Equally, they must avoid disrupting supply chains that enable our companies and workers to produce globally competitive goods and services.”

While Trump works to fulfill his vision of putting “America first,” other nations are not standing still. Canada recently completed a major free trade agreement with the European Union. Japan is now looking to forge a trade deal with the EU that would rival NAFTA, while also taking up the TPP mantle. And China has touted itself as an advocate for free trade and open markets in contrast to Trump’s isolationist policies.

Trump may be playing to his base when he rails against the loss of manufacturing jobs, but he’s also a businessman and the head of the Republican Party, which generally champions free trade.

Mexico’s presidential election and America’s congressional midterm elections both loom in 2018, so there has been pressure for Trump to finish negotiations by the start of next year. It’s doubtful NAFTA will be completely renegotiated in the span of a few months, experts say. It’s the trade deal that rules the region, and it will govern the future of the North American market, if it survives.

“NAFTA’s created a market. Let it grow and prosper,” Reinsch of the Stimson Center said. Withdrawing from NAFTA “would be a disaster. The economic consequences would be devastating.”

About the Author

Aileen Torres-Bennett is a freelance writer in Washington, D.C.