NAFTA 2.0 or 0.9?

Predictions vary on whether Trump is intent on ripping apart or revising NAFTA

By: Eric Kulisch
Photo: GrAl/Shutterstock
   Many trade experts and business leaders are optimistic the Trump Administration will ultimately pull back from its hardline position that the North American Free Trade Agreement has been a disaster for middle-class workers and needs to be completely overhauled, or scraped.
   President Trump, they contend, will soon realize withdrawal from NAFTA is counterproductive because it is ingrained in the economic fabric of all three partners, too difficult to undo and has too many stakeholders that would be negatively affected by a seismic shift in trade policy.
   But that is wishful thinking, says Nelson Cunningham, president and co-founder of McLarty Associates, an international global strategy firm with many FORTUNE 200 clients.
   It is becoming increasingly clear that Trump intends to pursue a “two-speed” approach to North American trade that treats Canada and Mexico very differently, the former aide to President Bill Clinton said.
   “I believe he has a deep political project in mind, which is to remake the Republican Party as a populist party and the party of the working man, and to come up with strategies that will bring them over from their typical loyalty to the Democrats,” Cunningham said last week during a panel discussion organized by the Washington International Trade Association. “As he looks to his reelection, he wants to cement his relationship with those voters even more strongly. And that suggests to me that a tepid massaging of NAFTA and announcement of victory may not be what he is going for. He is actually going for something that is more radical, more dramatic, that will speak more directly and meaningfully to this constituency he is trying to attract.”
   Trump signaled such a divide-and-conquer strategy during a press conference with Canadian Prime Minister Justin Trudeau at the White House on Monday.
   “We have a very outstanding trade relationship with Canada,” Trump said. “We’ll be tweaking it. We’ll be doing certain things that are going to benefit both of our countries. It’s a much less severe situation than what’s taking place on the southern border. It’s an extremely unfair transaction. We’re going to work with Mexico, we’re going to make it a fair deal for both parties.”
   Cunningham, who was a special advisor on Western Hemisphere affairs as well as general counsel on administrative matters in the White House during the Clinton years, says it’s easy to envision the United States pursuing a free trade agreement with Canada and reverting back to Most Favored Nation (MFN) trade status with Mexico.
   Such a scenario fits with Trump’s philosophy that multilateral trade deals should be avoided in favor of bilateral agreements with individual nations.
   Under World Trade Organization (WTO) rules, member countries are required to treat all trading partners equally in terms of tariffs, unless they are specifically denied by law from normal trade relations (think North Korea). The lowest tariff offered to one partner has to be offered to others as well, although countries can carve out certain types of products in sensitive areas for higher duties. Conversely, nations can obtain better trade advantages by signing free trade agreements.
   After Trump’s election in November, Canadian officials said they were open to reexamining NAFTA, but made clear that Canada should be given priority in any U.S. policy change given the strong economic ties between the two nations. Canada is the second largest U.S. trade partner, at $545 billion, and its top export market, with $267 billion in sales, according to U.S. government statistics for 2016. Thirty-five states export more to Canada than any other country in the world.
   The United States has a $60 billion trade deficit in goods with Mexico. Imports and exports with Canada are relatively balanced.
   Canada is also in a stronger legal position to hold onto trade benefits with the United States, according to Vanessa Sciarra, vice president for trade and investment policy at the National Foreign Trade Council. When NAFTA entered into force it replaced a U.S.-Canada free trade agreement that had fewer rules on dispute resolution and intellectual property rights protection, and added Mexico to the fold. At Canada’s request, the pre-existing treaty was suspended – not terminated. That means that if something goes wrong with NAFTA, the lower tariffs and other terms of the U.S.-Canada free trade agreement can be implemented and then both sides can work to upgrade the deal.
   “The Canadians know that,” Sciarra said in an interview. “That’s why they are not worried. They have a backup plan so they don’t have to go back to WTO tariff levels.”

If something goes wrong with NAFTA, the lower tariffs and other terms of the U.S.-Canada free trade agreement can be implemented and then both sides can work to upgrade the deal.

   Refresh, Not Replace. Companies of all sizes in agriculture, manufacturing and services rely on zero tariffs and other preferential trade rules that exist between the United States, Canada and Mexico under NAFTA. The free-trade agreement has enabled the integration of the three economies into a common manufacturing platform that allows companies to take advantage of economies of scale among suppliers. Millions of dollars worth of parts and supplies are shipped back and forth across the borders that become part of finished products in one nation or another.
   “If U.S. manufacturers could not get access to Mexican and Canadian value-added inputs, it would have severe disruptions and make U.S. manufacturers much less competitive,” said Ralph Carter, FedEx’s top government affairs official in Washington, noting that a simple car seat has components made in four states and four locations in Canada.
   “So our view is, the bedrock principles of NAFTA should be maintained,” he said. “There should be no new barriers.”
   Since the election trade advocates have acknowledged that NAFTA should be modernized to address digital commerce, liberalize telecommunications, and foster energy collaboration as new fossil fuel resources are discovered – dynamics that weren’t present when its rules were drafted nearly a quarter century ago. In addition, it could be strengthened by borrowing from the Trans-Pacific Partnership agreement (recently jettisoned by Trump) better safeguards for intellectual property rights, and labor and environmental safeguards, as well as provisions reducing the influence of state-operated enterprises.
   FedEx is also interested in developing a more efficient truck drayage system on the southern border that enables fewer handoffs of cargo as well as raising of de minimus levels in Canada ($15 threshold for duty payments) and Mexico ($50 threshold) to the same level as in the United States ($800), Carter said.
   Appliance manufacturer Whirlpool would also like a trade deal to include mutual recognition of regulatory and security standards, as well as testing bodies for products, and rules that improve labor mobility, Sarah Bovim, vice president for government relations and international trade policy, said.
   But Trump isn’t interested in tinkering around the edges of the deal, Cunningham told the Adam Smith Project after the event. The President wants to deter foreign investment in Mexico that could be made in America, encourage on-shoring and make it look like Mexico is paying for a border wall to stop illegal immigration – another campaign promise.
   “I don’t think a simple renegotiation is what he’s looking for,” Cunningham said. “He’s looking for a dramatically different trading relationship that will bring jobs home and erase the trade deficit. And a digital chapter will not do that.”
   Corporations, most notably Ford Motor Co., are already under pressure to change their sourcing practices. After Trump publicly shamed Ford for moving some production to Mexico, the automaker canceled plans to build a factory there and announced a major investment to expand a plant in Michigan. Ford’s response, however, likely had as much to do with normal market forces as Trump’s influence.
   Trump is “about transforming our trading relationships – not listening to the Chamber of Commerce,” Cunningham said.
   “NAFTA 0.9” is what economist Uri Dadush calls a modified NAFTA agreement that adds some features and closes down others – an outcome that assumes Trump is willing to compromise.
   Trump’s freedom to achieve his objectives will be circumscribed in such a scenario by WTO rules and the fact that the negotiations will not be one-sided, Dadush, a non-resident scholar at the European economic think tank Bruegel and a senior fellow at the OCP Policy Center in Rabat, Morocco, said during the roundtable discussion.
   The administration’s main option would probably be tightening the rules of origin to limit imports of parts from Asia, while also allowing quicker triggers for certain safeguard actions.

   Ripple Effects. If negotiations break down, then it’s likely the United States will trade at arms’ length with Mexico as it does with the vast majority of countries with MFN status, Dadush predicted. That means the United States would introduce tariffs of about 3 percent on Mexican imports (up from zero percent), while Mexico would raise tariffs on U.S. goods to 8 percent on average, and 20 percent on agricultural products.
   “I think it’s clear that Mexico hurts the United States at least as much as the United States hurts Mexico” if NAFTA is terminated, Dadush said.
ALT Source: Eric Kulisch/Adam Smith Project
   One other scenario still in the mix is if Republicans in the House of Representatives convince the Senate and the White House to go along with corporate tax reform that includes a border adjustment tax. The border tax would effectively represent a 20 percent tariff on imports from all countries and a subsidy for U.S. exports, potentially negating the need to change NAFTA, Dadush said. However, border adjustability could have profound economic effects that are not fully understood and the concept is vehemently opposed by importers who say they could suffer severe harm. It is hard to gauge so far how much political support there is for the border tax proposal.
   Matt Gold, an adjunct professor of law at Fordham University and former negotiator in the Office of the U.S. Trade Representative responsible for North America, said Trump is bluffing about rewriting NAFTA and will back down in the face of too many stabilizing forces.
   “You have to ask yourself, if it were that easy, why hasn’t it been done already?” he asked rhetorically. “All three countries have wanted to change things in NAFTA, but no American administration has been prepared to give them [Canada and Mexico] those concessions, and as a consequence they’ve not been prepared to give us ours. That’s why there’s never been any negotiations to renegotiate NAFTA.”
   One of Trump’s challenges is that NAFTA can only be renegotiated in a trilateral setting and the Canadian and Mexican governments don’t appear ready to put any NAFTA provisions on the agenda.
   The supply chain disruptions for American companies resulting from a NAFTA reversal will create a huge public outcry that will also galvanize Congress, Gold predicted.
   Trump’s antagonistic tone toward Mexico is jeopardizing the bilateral relationship across all issues, such as organized crime, and making it increasingly difficult for the Mexican government to achieve a constructive, negotiated solution on trade, said Antonio Ortiz-Mena, a senior advisor at the Albright Stonebridge Group who served eight years as the head of economic affairs at the Embassy of Mexico in Washington.

I don’t think a simple renegotiation is what (Trump's) looking for. He's looking for a dramatically different trading relationship that will bring jobs home and erase the trade deficit. And a digital chapter will not do that.

   “I haven’t seen Mexicans united to such a degree since maybe the nationalization of the oil industry in 1938,” he said. “The set of acceptable solutions for the Mexican president is getting fairly small.”
   And if leftist candidate Lopez Obrador wins the presidential election in 2018 relations with the United States will get worse, he warned.
   Mexican President Enrique Pena Nieto needs to stand up to Trump, the former Mexican official insisted.
   “I don’t see why Mexico should accept anything less than tariff-free, quota-free access, and then build upon it,” he said. “What I don’t see viable is a full renegotiation of NAFTA, starting from scratch, having Mexico accept less than it already has. If that’s the scenario, a better alternative could be to say ‘OK, we’ll go down the MFN route.’ ”
   With Mexican elections fast approaching, the Trump administration needs to move quickly on negotiations, Ortiz-Mena added.
   Mexico is poised to become the sixth largest economy in the world by 2050, according to PricewaterhouseCoopers. “I don’t understand why the United States would want to make trade and investment more difficult with the nation that could be its main destination for exports,” he said.
   There are three risks associated with raising tariffs on Mexican imports: retaliation, imitation and taxation, Michael Froman, President Obama’s trade representative and now an analyst at the Council on Foreign Relations, said in an interview last week on MSNBC.
   “Retaliation, because if we violate our obligations to Mexico or other trading partners, we give them license to raise tariffs on our products,” he said. “There are 11 million Americans who owe their jobs to exports. We have an integrated production platform across North America. Forty percent of what we import from Mexico is actually U.S. product that’s gone down to Mexico to be incorporated in some other product.
   “By disrupting that trade, we’re going to affect jobs here in the United States. Similarly, if we violate our international obligations, we give license to other countries to do the same. How easy is it going to be to hold China’s feet to the fire if we say we’re willing to ignore our international obligations?
   “And finally, when you raise tariffs on imports it’s a tax. It’s a tax on the consumers of those products. And in the United States it’s low-income Americans who spend a higher proportion of their income on tradable goods like food, footwear and clothing. So you’re imposing a tax on the parts of the American society that are least able to afford it. A very regressive approach.”

   Presidential Authority? Meanwhile, there also remains a great deal of confusion among legal experts about what authority the President has to actually carry out a withdrawal from NAFTA.
   That’s because Congress also passed legislation to implement U.S. obligations under the agreement. Many provisions of NAFTA don’t automatically go away unless Congress votes to change U.S. laws allowing the executive branch to follow through on terms of the deal.
   The National Foreign Trade Council’s Sciarra noted that NAFTA doesn’t have a snap-back provision stipulating that if the deal is terminated the legislation reverts to its status prior to the implementing bill, as is the case in subsequent free trade agreements.
   Without congressional action, the tariffs, rules of origin, import quotas and other rules will remain in place, Gold added. The President has some delegated authorities that might allow him to eventually re-impose tariffs, but the law is complex and not clear on the matter.