NAFTA’s Dead? Long Live NAFTA?

May 22, 2017

The Trump administration started the clock on renegotiation of the North American Free Trade Agreement (NAFTA) in its official notice to Congress on Thursday. Robert Lighthizer, Trump’s newly confirmed trade czar, said in a statement that this made good on Trump’s campaign critiques of the pact.

Is this just more bluster, or can we expect meaningful change? It’s hard to say at this point. It will be mid-July before the administration is required to get specific about its renegotiation priorities, and mid-August before negotiations can formally start. Moreover, his mandate may limit major changes. Lighthizer has indicated that he will follow the priorities congressional Republicans laid out in the 2015 “Congressional Trade Priorities and Accountability Act” (also known as Fast Track or trade promotion authority). While these include some loose encouragement of labor and environmental progress, the binding and high-bar standards are focused on getting more market access for U.S. investors and producers — fairly traditional trade diplomacy concerns.

The potential renegotiation agenda can be put in at least four buckets. First, there’s the stuff the Mexican and Canadian governments might want to change that the U.S. government probably doesn’t. Lighthizer has signaled contentment with NAFTA’s agricultural and investment rules, areas where Mexico and Canada have respectively been hit by waves of U.S. commodities and lawsuits. Second, there are areas like country of origin labeling for beef and higher Buy America requirements that Trump might want to change that Canada and Mexico won’t. I wouldn’t expect much movement in either of the first two buckets — unless Trump could threaten to credibly shred all of NAFTA. Canada and Mexico read the U.S. newspapers, and know he would lack support for anything so audacious as his poll numbers plummet and impeachment talk looms.

Third, there’s the stuff where there was already consensus at the governmental level. Lighthizer has flagged digital trade, state-owned enterprises, and labor rights as areas where improvements are needed. Yet all three are areas where Trump’s maligned Trans-Pacific Partnership (which also included Canada and Mexico) went further than NAFTA.* The ironic outcome of Lighthizer’s agenda may be that we end up with the same agenda that Trump canned his first week in office — but with fewer countries bound by it. And while the case for TPP disciplining non-member China’s policy stance always seemed dubious to me, there seems to be even less reason to think that China would feel cowed by a North America-only initiative.

Finally, there are new directions on old issues where inter-governmental consensus seems possible. For instance, Lighthizer has privately told Senate Democrats that he will explore a model currency provision in NAFTA. The only problem: neither Canada nor Mexico would be found “guilty” under such rules. On the one hand, this means they might agree to inclusion of currency disciplines. On the other hand, this could be hard to sell as impactful policy, since no jobs would be brought back by enforcing rules no one is breaking. (As I wrote in an earlier post, the focus on currency has largely punted the bigger issue — which is a lack of a mechanism to tax persistent multilateral trade surpluses, as Keynes proposed in his proto-version of what became the IMF.)

Another issue Lighthizer is known to have interest in is increasing NAFTA’s rules of origin, telling Congress: “I believe the objectives of rules of origin for automotive goods are to provide incentives for producers to source goods and materials here in the United States. These rules should support good jobs in the United States, rather than provide benefits for producers to outsource production and send jobs to other countries.”

This policy area is arcane but fundamental in an era of supply chain complexity: how much of a product has to be made in a NAFTA country to get the pact’s lower tariff rates? A higher rule of origin encourages backward linkages — economist Albert Hirschman’s phrase for when a policy to promote an industry also incentivizes production of the inputs that industry uses. A lower rule of origin encourages offshore-outsourcing to China and other non-pact members.

This may be one of the few areas where Team Trump may be able to shift the content and orientation of policy. As analyst Sarah Oliver noted in a recent book chapter, the Obama administration was poised to lower auto rules of origin from 62.5 percent in NAFTA to 45 percent under TPP. For auto parts, the administration was willing to go as low as 30 percent, before Canada and Mexico insisted on raising it back up. Thus, our North American neighbors could be expected to go along with a reorientation from Obama-era precedents.

Yet just because it is doable doesn’t make it a great use of political and negotiating capital. Say the U.S. was going to raise its regional value content in the rules of origin to close to 100 percent. The theory behind doing so would be that the NAFTA tariff benefits are so attractive that it makes up for using more expensive locally made parts. Yet, from the would-be importer-into-the-US perspective, this is only true if the costs of the non-NAFTA tariff are higher than the higher bill on the parts. Depending on the product line, some importers may choose to forego NAFTA rates and pay the higher WTO tariffs on their imports from Mexico and retain flexibility over their supply chains under looser WTO origin rules. The U.S. has also committed to relatively low tariffs in the WTO, so the math still may favor using Chinese parts, depending on which of the over 14,000 tariff lines a given product falls on. For some, a higher rule of origin could be pushed because the alternative WTO tariff would be high (e.g. SUVs and transport vehicles, which have 25 percent tariffs at the WTO). For others, maybe not (e.g. air conditioning for cars, where the WTO tariff is only 1.3 percent). Because there is so much variance by product, Trump will invite intense industry lobbying on thousands of different rules of origin.

Opening up rules of origin may or may not be a good idea, but it will undoubtedly unleash a torrent of industry transacting with the administration. If we’re going to go down that road, it seems like a good moment to extract something more broadly beneficial else in return. This could include industry-level commitments to fight climate change and deunionization, and the other new agenda items we included in our Sustainable Equitable Trade Doctrine report.

In sum, the politics of renegotiation are daunting and heavily biased against meaningful change.

* “Further” did not always translate to “of broad use to the public.” For example as an illustration of the virtues of digital commerce rules, ANALYST LEE BRANSTETTER cites the example of an architecture firm in Milwaukee that could give e-tours to rich Emiratis buying up U.S. real estate. And the promise of the TPP’s core commitment in the area — no tariffs on digital goods — is weakened by the fact that no TPP countries had any.