NAFTA 2.0 negotiations: Why Trump may back off

NAFTA 2.0 negotiations: Why Trump may back off

After six rounds of talks between Canada, Mexico and the United States to renegotiate the 24-year old North American Free Trade Act (NAFTA), parties still appear far from consensus. Meanwhile, President Trump continues to call the deal unfair and threatens to exit the agreement if Canada and Mexico cannot meet U.S. demands. However, strong support of NAFTA by industry groups and his cabinet could soften his position.

Trump has railed against NAFTA as ‘ripping off’ U.S. workers. He has maintained an obsession with the current U.S. trade deficit with Mexico, which stands at around $64 billion. As a result, the US negotiating team, led by US Trade Representative Robert Lightizer, have approached negotiations with three weighty demands:

1) Increase the rules of origin component. This raises the percentage of a product that must be sourced within NAFTA countries to receive benefits.

2) Eliminate NAFTA’s Chapter 19 ISDS dispute settlement mechanism. Currently, Chapter 19 provides dispute resolution through panels made up of trade representatives from each country involved in the particular case, rather than members being from a single country.

3) Persuade Canada and Mexico to raise their tax-free rates on e-commerce purchases from current levels of $16 and $50, respectively, to closer to the US $800 rate. Canada and Mexico strongly oppose these changes.  

Negotiations will enter a seventh round of talks in late-January, though prospects for reconciling differences by the unofficial deadline of this spring appear increasingly slim. This deadline was made mainly in anticipation of both Trump’s impatience and the Mexican presidential elections in July.

Recent polls show an 11-point lead for Andres Manuel Lopez Obrador (AMLO), a leftist populist and critic of NAFTA. Although on different ends of the political spectrum, both Trump and AMLO are populists with protectionist tendencies. Negotiators hope to propose a modernized revamp of NAFTA that convinces both leaders to avoid unilaterally exiting the agreement. Ironically, what could stop Trump’s quest to exit NAFTA, or at least delay a withdrawal, are many of the constituencies that propelled him to the presidency and have supported his economic policies in office.

Red state industries, members of congress and cabinet at odds with Trump

Trump’s claims that NAFTA has hurt U.S. manufacturing and small businesses holds some validity, but overall the net benefits provided to the US economy and workers have been quite positive. Since its inception, estimates indicate that NAFTA has created around 14 million jobs due to trade with Canada and Mexico, and has created nearly 200,000 export-focused jobs that pay, on average, 15-20% more than U.S. jobs lost by NAFTA.    

Conversely, the U.S. auto sector has lost approximately 350,000 jobs since 1994, a third of the industry’s jobs. However, research from 2016 also found that the elimination of tariffs and enablement of cross-border supply chains under NAFTA likely averted further losses in the industry. This is because it has made the U.S. auto sector more competitive by lowering costs and improving productivity and efficiency, thereby allowing the sector to compete with rising productivity and cheap labor from China.

Additionally, seven of the top ten US states most dependent on NAFTA for commerce voted for Donald Trump. As the graphics below demonstrate, many of the states that voted for Trump in the 2016 election send the majority of their exports to Canada and Mexico. North Dakota sends 82 percent of its exports to Canada;Texas and Arizona send 30% of their exports to Mexico. This would change significantly following any termination of NAFTA, as tariffs would increase and make exports cost-prohibitive for many companies.

Source: New York Times

The U.S. agriculture industry, concentrated heavily in red states that voted for Trump, has also benefited greatly from NAFTA. Reducing tariffs close to zero under NAFTA eliminated traditional barriers to exports of U.S. agricultural products such as beef and corn, the latter of which could not access the Mexican market pre-NAFTA. As a result, since 1994, U.S. farm exports to Mexico have increased more than 450%. Total farm exports to both Mexico and Canada were also expected to quadruple to $40 billion in 2017 under NAFTA.

Concerned about potential losses to a 125,000-person industry, U.S. Senators such as Chuck Grassley from Iowa and Pat Roberts from Kansas, generally supporters of Trump’s policies, have lobbied to promote the benefits of NAFTA to agriculture. Secretary of Agriculture Sonny Perdue has also expressed optimism that the agreement will be preserved. A recent quarterly trade forecast from the USDA shows strong potential for agricultural exports in Fiscal Year 2018, predicting an increase in the agricultural trade surplus from $21.3 billion to $23 billion.

Perdue likely understands that a NAFTA exit would stifle this growth and force him to implement a subsidy program to protect the industry. If the United States withdrew from NAFTA, export rules would revert to those of the World Trade Organization (WTO), which would mandate drastic increases in tariffs for many agricultural products. Further, the ability for the United States to negotiate more favorable bilateral trade deals is in doubt, putting U.S. agriculture at a further disadvantage. 

The United States may be able to fend off such significant tariff increases with Canada by reenacting a pre-existing US-Canada free trade agreement. However, under WTO rules, US farmers exporting to Mexico would face a 15 percent tariff on wheat, 25 percent on beef, and 75 percent on chicken.

New tax cuts could exacerbate trade deficit

In another ironic twist, the recent passage of a sweeping tax reform bill in the U.S. Congress could also complicate Trump’s positions on NAFTA. In the short-term, the tax bill will undoubtedly lower annual federal taxes for a majority of Americans, in addition to a predicted three percent GDP growth from the reduction of corporate taxes.

In additon, tax savings and economic growth will also likely allow Americans to spend more money on cheap, foreign-made goods, including those from Mexico. This will boost the trade deficit with Mexico. However, if Trump left NAFTA and tackled the deficit through increased import tariffs, most imported consumer goods would become significantly more expensive for Americans, thereby erasing many of the gains from the tax reform. The latter scenario would surely hurt Trump politically much more than an increased deficit with Mexico.  

In the end, Donald Trump may still choose to invoke NAFTA Article 2205, the six-month withdrawal clause, in an effort to fulfill his campaign promise.. Negotiating parties also could reach a compromise to sustain the deal, with a new mandate to review the deal every five years. However, significant bipartisan support for NAFTA in Congress and key industries could ultimately dissuade Trump from making any explosive decisions on NAFTA in 2018.

Categories: Economics, North America

About Author

Samuel Schofield

Sam works as a strategy and operations consultant for Deloitte Consulting LLP in its federal services practice in Washington D.C. As a contributing analyst for GRI, Sam writes on political, economic and security risks in Latin America that influence US trade and diplomatic posture toward the region. He has an MBA from American University's Kogod School of Business and a BA in International Affairs from the University of New Hampshire. He previously worked at the US Department of State as a budget analyst and as a program officer at an NGO focused on rural development projects in Mexico and Central America. He also has led a consulting engagement supporting a Colombian aquaculture company with expanding to US markets. The views expressed here are those of the analyst and do not necessarily reflect the views of his current, former, or future employers or any organization with which he is associated.