Business Ethos Blog

The Threat to Blow Up NAFTA

Dr. David Mielke, Retired Dean of the College of Business at EMU

Nine months after President Trump won election and threatened to blow up the North American Free Trade Agreement if he couldn’t win better terms from Mexico, negotiations to update the agreement started last week.  The agreement has been labeled a disaster for US factory workers while border states and the agricultural states have been big NAFTA winners.  US negotiators have pledged to do no harm to the large number of industries and communities that have benefited.  There are a number of issues and concerns to be renegotiated with Canada and Mexico, who are primarily playing defense.  The auto industry will be at the center of many of the discussions. Should NAFTA be updated?  Can the US extract enough concessions from Canada and Mexico so that President Trump can declare victory to his factory worker base without upsetting business backers who have lobbied to preserve the agreement?  Does it make sense to try to update the agreement by February?  If no substantive changes can be made, should the US pull out or just continue as is?  What is the “Right Thing to do?”  Let’s look at some issues:

  1. The NAFTA agreement took effect in 1994.  Since then complex systems of commerce have taken root integrating the three economies and many multinational companies.  The introductory 5 days of meetings in Washington concluded last Sunday and will start up again in September in Mexico City.
  2. Trump aides say the president wants to move quickly, aiming to wrap up negotiations by early next year, to avoid having talks getting caught up in 2018 election campaigns in Mexico and the US.  This is an unusually rapid timetable, as major trade negotiations are measured in years not months.  The NAFTA agreement took 3 years to complete and any new agreement must be ratified by all three governments.
  3. One US objective is to stem and possibly reverse the shift of manufacturing from the US to Mexico and to reduce the bi-lateral trade deficit.  The US has gone from a small trade surplus of about $2 billion with Mexico at the start of NAFTA to a deficit of $63.2 billion last year.  Michigan’s total trade with Mexico and Canada was equal to 27% of its GDP in 2016, primarily auto related.
  4. The trade talks started with an early dispute over how to settle disputes.  The US wants to do away with dispute resolution panels while Canada is digging in on maintaining this critical tool for Canadian firms to fight tariffs imposed by the US.  Mexico also wants to retain the mechanism.  Known as Chapter 19, disputes that allow one country in the bloc to challenge tariffs imposed by another due to alleged dumping or subsidies.  Without the dispute resolution panels any issues would end up in national courts or before the World Trade Organization.
  5. The panels have been used primarily to overturn tariffs imposed by the US Department of Commerce on Canadian or Mexican products.  There have been 100 cases filed against the US and 23 each against Mexico and Canada.
  6. The big US agricultural industries, corn, beef and pork are happy with the current version of NAFTA and are focused on preserving their duty free, quota free access to Mexico and Canada.  US dairy farmers want Canada which tightly controls dairy prices and imports to open its market.  At the same time, the US is considering tariffs or quotas on the importation of Canadian lumber.
  7. Free trade agreements eliminate duties on products made in the trade block, but only if produced according to certain rules.  The Trump administration wants to tighten the rules for the auto industry to bring supplier and assembly jobs to the US.  The US is upset with the use of foreign steel to make parts in Mexico and that are then shipped to the US duty free.  The current content requirement is 62.5% for cars and 60% for light trucks.  Mexico is willing to go to 70%, the UAW wants 90%.
  8. The US is also seeking to negotiate some sort of currency rules to avoid trade benefits from a country artificially holding down their exchange rates.  Low exchange rates effectively make exports less expensive and imports more expensive.  Mexico and Canada haven’t faced serious charges of currency manipulation, but the rules could serve as a template for future trade deals.
  9. A high priority for President Trump has been reducing legal and illegal immigration, especially from Mexico.  But Mexico would like to use NAFTA to further ease the flow of workers between the 2 countries.  The US has faced severe shortages of guest workers this year and could benefit from revisions in this area.
  10. A key question is how hard President Trump will push his team’s first objective to improve the trade balance and reduce the trade deficit with the NAFTA countries, especially Mexico.
  11. When the administration released its official negotiating objectives, Canada, Mexico and big business said there was much they could accept.  They had already accepted many of the objectives last year as part of the 12 nation Trans-Pacific Partnership negotiations which were killed by President Trump.  Those provisions covered digital commerce, which didn’t exist when NAFTA was created and stricter labor and environmental standards.

Should the US be pushing hard to reduce the trade imbalance, especially the $62 billion with Mexico when the imbalance with China is well over $300 billion?  Does it make sense to eliminate Chapter 19, eliminating the dispute resolution, turning it instead to the US, Canadian or Mexican court systems—or the World Trade Organization?  Should immigration be part of the agreement? Is it realistic to push for an agreement by February?  If the negotiations are unsuccessful or hit an impasse, should the US withdraw or merely let NAFTA continue as is?  What is the “Right Thing to do?”  It makes sense to negotiate an increase in content to 70%, as Mexico has already signaled they would accept.  The auto industry is well integrated among all 3 countries and it is important that this critical industry continues to do well—especially for Michigan.  It does not make sense to try to use a treaty to bring down a trade imbalance, unless it means opening additional markets for US products.  Free markets that are not hindered by quotas and duties determine trade balances.  The US is sending more and more natural gas to Mexico and has 8 new pipelines under construction.  That will definitely help the trade balance.  Chapter 19 should be maintained.  It makes sense to have arbitration rather than tie up cases, more than likely for years, in a court system.  There may be some work on immigration, but the US hasn’t really addressed immigration and it remains a very hot issue.  I am not sure a new NAFTA agreement can fix the problems—other than allow more guest workers.  If the negotiations are unsuccessful or hit an impasse, the US should definitely not pull out of NAFTA.  The current agreement may not be perfect, but without it we will have economic turmoil that the US economy, and those of Canada and Mexico can ill afford.  The Blow Up would eventually be the US economy without a NAFTA agreement.