Opportunity slips away as disagreements over NAFTA continue

Opportunity slips away as disagreements over NAFTA continue

President Donald Trump will face major decisions around trade in 2018, especially with regard to the 24-year old North American Free Trade Act (NAFTA) between Canada, Mexico and the United States. Trump will be forced to balance pressure from two directions of seemingly equal importance to his long-term political capital.

From a personal standpoint, Trump most certainly wants to exit the agreement. He has repeatedly claimed that the deal “rips off” American workers and has called the trade deficit with Mexico unfair. Consequently, he will first face pressure from his political base to fulfill a campaign promise to either exit the agreement altogether or rework it in a way that eliminates the US trade deficit with Mexico and quells additional losses of US jobs. Second, he will face pressure from many workers in red states that voted overwhelmingly for him and have benefited tremendously from NAFTA, as well as industry associations and Republican politicians from these states critical to maintaining his legislative agenda and reelection prospects.

Trump administration’s heavy demands

Since renegotiation activities began in summer 2017, progress has been tenuous at best. Negotiations recently concluded a brief sixth round of talks in Washington, D.C. and will continue with a seventh round in Montreal in late January. Complicating the advancement of a revised agreement are a series of heavy demands from the Trump administration that Canada and Mexico’s leaders describe as virtual non-starters.

These demands center on three categories:

1) raising the rules of origin component of NAFTA, or the percentage of a product that must be sourced within the NAFTA countries to receive free trade benefits, from the current 62.5 percent to 85 percent;

2) eliminating NAFTA’s Chapter 19 ISDS dispute settlement mechanism, which allows companies to appeal trade decisions by domestic courts through an independent panel; and

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

Each of these requests carry some legitimacy, especially the e-commerce proposal, as this technically creates a form of protectionism for the retail industry within a free trade agreement meant to open competition in markets, not close it. However, Canada and Mexico continue to express resistance to these demands, most strongly the ISDS mechanism and auto parts percentage. The ‘rules of origin’ proposal has become particularly contentious due to a US sub-proposal for the auto industry; the US wants NAFTA to mandate that 50 percent of every car sold within NAFTA be built in the United States. The US fixation on the auto rules of origin likely stems from the automobile industry, accounting for approximately 76 percent of the combined $83.3 billion US trade deficit with Canada and Mexico.

Despite Trump’s stance and growing pessimism due to the lack of actual progress, the negotiating parties from all continue to express support for NAFTA and optimism that it will survive. Leaders such as US Secretary of State, Rex Tillerson, and Canadian Foreign Minister, Chrystia Freeland, likely understand the potential unintended consequences to North American consumers and traditionally warm relations between the three countries if NAFTA disappears.  

NAFTA now faced with greater urgency

However, opportunity seems to be slipping as each month passes. Negotiators face urgency to reach a consensus on the future of NAFTA by this spring. The unofficial deadline can be largely attributed to the rapidly approaching Mexico presidential elections in July. Recent polls showed an 11 point lead for Andres Manuel Lopez Obrador (AMLO), a leftist populist and critic of NAFTA, in the race for the presidency.  

President Trump has capitalized on the lack of progress, and perceived inflexibility by Canada and Mexico, to reinforce his long-standing position that the deal rips off America and is not worth sustaining. According to a GRI source, during a luncheon in December, political scientist and President of the Eurasia Group Ian Bremmer stated that he expects Trump to invoke the NAFTA Article 2205 withdrawal clause following the Mexican elections. Many experts believe that if a revised deal cannot be reached prior to the Mexican elections, an AMLO victory, combined with Trump’s lack of faith in the deal, would almost certainly deal a death blow to NAFTA.

Even if the three countries do reach an agreement this spring, AMLO could still win the Mexican presidency this summer and choose not to honor any agreement made by his predecessor. However, Donald Trump remains the most likely near-term threat to any unilateral withdrawal from NAFTA. Based on NAFTA’s rules, if he chose to invoke Article 2205, he would provide formal written notice to Canada and Mexico, thereby allowing the US to fully exit the agreement six months later. Once the US formally left NAFTA, export rules with Canada and Mexico would revert to those of the World Trade Organization (WTO). This would mandate drastic increases in tariffs, especially for agricultural products.

Given the likely timeline for these actions to play out, even if Trump invokes Article 2205, American farmers and other workers dependent on NAFTA would unlikely see a major impact on their business until 2019. However, invoking Article 2205 on its own could send currency markets into chaos and cause a massive pullout of foreign direct investment and cross-border joint ventures, even in the six months while NAFTA remains technically alive. Furthermore, legal scholars emphasize that the president has the authority to terminate US obligations in international agreements, but many statutory provisions within NAFTA related to commerce are tied directly to legislation and must be terminated by Congress.

Many lawmakers on both sides of the political aisle support NAFTA and continue to lobby heavily for constituencies from their states that would be hurt from a NAFTA exit. Consequently, any NAFTA exit proposed by President Trump could lead to battles in Congress and lawsuits from industry and labor associations, prolonging the exit well beyond six months. What a protracted exit would do to the North American markets is uncertain, but it would not be positive.

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.