Trump's New Trade Deal: the Good, the Bad, and the Ugly

A U.S. flag is pictured on a truck loaded with merchandise at the freight shipping company Sotelo, which transports goods between Mexico and the United States, in Ciudad Juarez, Mexico, December 10, 2019. REUTERS/Jose Luis Gonzalez
December 14, 2019 Topic: Politics Region: Americas Blog Brand: The Buzz Tags: U.S.-Mexico-Canada AgreementFree TradeTrade WarDonald TrumpTarrifs

Trump's New Trade Deal: the Good, the Bad, and the Ugly

There's a lot of all three in the U.S.-Mexico-Canada Agreement.

However, the principle is an awful one -- applying these tariffs and then establishing export quotas is bad policy and undermines the rule of law. Democrats should have pushed for a guarantee that our closest trading partners would not be impacted by future 232 action on autos. At this point, the whole issue may be moot, as the deadline has, arguably, now passed for the imposition of these tariffs.

The Bad:

FTAs with China: The agreement discourages the NAFTA parties from negotiating trade deals with non-market economies, which means China and a few others. (Canada and China were talking about negotiating an FTA, but those discussion were derailed by non-trade issues.) Generally speaking, a limitation in one FTA on negotiating another FTA is a bad idea. We are skeptical that the provision will have much impact, but it is nonetheless a bad precedent to set.

The Ugly:

North American auto trade: The new rules of origin are likely to be extremely restrictive, raising costs for auto production in North America. This could lead to more production being done outside of North America, or higher costs for consumers. This is the most negative part of the new agreement. In order to qualify for duty free entry, regional value content (that is the amount of production that happens in North America) was increased from 62.5% to 75% (starting at 66%, to be increased over three years) for passenger vehicles. In addition, there are rules requiring that a portion of that content has to come from workers making at least $16/hr, a provision that is entirely targeted at Mexico. Finally, there is an additional Buy America provision that requires producers to source 70% of the steel and aluminum used in their production to originate in North America.

The 2019 update made this final provision even worse by making the requirements for use of North American steel even more strict. Beginning at year seven after entry into force of the agreement “for steel to be considered as originating…all steel manufacturing processes must occur in one or more of the Parties,” including “the initial melting and mixing and continues through the coating stage.” This was a request not made by Democrats, but by USTR. It also includes the possibility to extend these restrictions to aluminum in ten years’ time.

This is the part of the USMCA that takes a lot of the free trade out of the North American Free Trade Agreement. The specific impact will depend on how the provisions are implemented, which is likely to involve a big fight among various interest groups. It could also lead to the auto supply chain being significantly scaled back, with companies retaining the option of simply paying the 2.5% most-favored-nation tariff for cars instead of complying with the more stringent USMCA rules. At any rate, we can expect auto production costs to increase.

Labor rights: The labor rights provisions go further than past U.S. trade agreements. For some people on the left, this could offer a reason to support the agreement. If you are skeptical about including labor provisions in trade agreements, as we are, this is a negative aspect to the agreement. During the 2019 update, the House Democrats pushed for stricter enforcement of these provisions. What they wanted was for U.S. labor inspectors to have access to Mexican factories in order to evaluate whether they were meeting their obligations. Mexico resisted, however, and in the end what the parties agreed to was a new annex to the labor chapter (Annex 31-A), which sets up specialized expert panels who can hear complaints about these practices.

There are a number of concerning elements regarding how the labor provisions and a new “facility-specific rapid response labor mechanism” will operate. First, the burden of proof has shifted to the defendant in demonstrating that the alleged violation is not in a manner affecting trade or investment between the Parties. Second, inspections are not eliminated, but rather incorporated into the panel process, to serve as a fact-finding exercise. This will ultimately put a heavier burden on Mexico in future labor disputes. Third, the use of remedies appears similar to U.S. antidumping petitions and is ripe for abuse. Finally, it is notable that there is not one, but two annexes, one between the U.S. and Mexico and another between Canada and Mexico. In theory, Mexico could bring a complaint against the United States, but Canada and the United States have no recourse to these panels between them. Such an action locks in symbolic asymmetry among the North American partners.

Sunset clause (no change): We have raised concerns about this issue before, because it triggers a renegotiation and possible termination after only six years in force. After six years, the governments will have to make a decision about whether to extend the agreement. If they do not extend, they have to make that same choice in years 7 through 16, after which the agreement will terminate if it has not been extended. The revised provision may end up being harmless if the parties decide to extend, but there are risks, and it would be better to take it out. As we noted here, one aspect of the problem with the provision is the transfer of power over trade agreements from Congress to the Executive branch. This unnecessarily politicizes the process as well, and leaves the future of the agreement to the whims of whoever is in the White House. Some of the negative impact of this clause could be alleviated by giving Congress a role in the process. Unfortunately, Democrats did not push for clarification on the role of Congress. Ideally, the implementing legislation could spell this out, but at this point it is hard to tell if this baked in uncertainty can be resolved.

Overall, the package agreed to here looks like a mixed bag. There are some good things, some bad things, and many unknowns. The biggest loss might be unseen, however. If only the Trump administration had just implemented the TPP, or had begun negotiating with countries with whom the U.S. did not already have a trade agreement, it could have achieved a great deal more trade liberalization. On the other hand, people may feel that the biggest gain was preserving most of the zero tariffs under the NAFTA. But somehow, just keeping what you already had does not seem like that big of a win to us. NAFTA needed an update, but it would have been better if that update had been carried out by a president who was a free trader.

The next step for ratification is to draft the implementing legislation and put it to a vote in Congress. The House seems ready to act right away, while the Senate may not act until January. In our view, the USMCA is a significant change from the status quo, and should not be rushed. It sets out the U.S. relationship with two of its main trading partners and allies, and also has an impact on a wide range of domestic policy. At this point, what we need is careful and deliberate consideration of this major new international economic arrangement.

This article by Inu Manak and Simon Lester first appeared at CATO on December 11, 2019.

Image: Reuters.