Will There be a New NAFTA?

Already during the presidential campaign, Donald Trump had announced that the North American Free Trade Agreement will be renegotiated or even suspended under his leadership. After a series of failures in foreign politics – the latest ones being the unilateral termination of the Iran nuclear deal and the suddenly canceled peace talks with North Korea – he now seems to push for a fulfillment of his promises on NAFTA. But are his chances any better in this field? From the looks of it, the two neighboring countries are not up to being bullied, and with the increased isolation and the pressure to achieve something on the field of foreign policies, Trump might actually be forced to follow Canada’s or Mexico’s lead.

Just this past Wednesday, he told reporters at the White House, that NAFTA in general as well as Canada and Mexico in particular had been “difficult”. He described both neighboring countries as “very spoiled,” their requests framed as “unfair”. But beyond the Trump administration’s rhetoric, what is it that the members of NAFTA want? And what will that mean for the economic development in the free trade area?

The Conflicts

There are a variety of conflicts currently debated. Research has shown that all three countries have suffered economically since the agreement came into force. For the US, the loss of jobs in heavy industry is blamed on NAFTA; Mexico has experienced a drop in wages; and for Canada job loss as well as deregulation of environmental protection are most prominently named.  

The problem is that with the agreement in place for 24 years the three economies have become extremely dependent upon each other. The damage that would be done by simply ending the contract is the main reason why the US’s threat to “just leave” does not have the bite that Trump might hopes for.

Therefore, the conflict around the US demand to have an automatic termination clause after five years, in case there is no explicit agreement to extend the contract, seems to be a pretty symbolic battlefield that distracts from the actual problems on the table.

For the US government the talks are all about the auto industry. Trump’s main goal is to increase the percentage of net costs of a car that needs to originate in the NAFTA region in order to be traded tariff free. Currently, 62.5 percent needs to originate from the NAFTA region and the US wants to raise this number to 75. Mexico now offered 70 percent but had said in the past that, in doubt, their industry might choose to pay the relatively low tariffs over disclosing all their sources – a threat that Trump has answered with a threat of his own: he will raise the tariff on car imports to 25 percent, based on the same legal ground he had used to against German imports – national safety.

 

But while Trump is very outspoken on this topic, the actual conflict is smaller that it appears: The US already moved from its original proposal of 85 percent to now 75 and Mexico moved from a flat ‘no’ to increasing the conditions for tariff free cars to 70 percent net value being produced in the NAFTA region. It is likely that Trump will give in at this point, trying to bring home some win. For Mexico, it might become hard to move much below the 70 percent without violating promises the state has made to other countries like Japan. Toyota and Nissan have major productions sites in Mexico, importing parts of their cars into the NAFTA region.

Impossibilities

Another number is the 40 percent of a car’s net value that Trump wants to see produced in “high wage areas”. This demand is less loudly discussed and in our opinion remarkably much harder to achieve. In difference to the question of import percentages that define the ‘made in North America’ label, this demand threatens the whole concept of the Free Trade agreement. With all the complaints about lost jobs in US industries, we tend to forget that moving labor into the cheap production area “Mexico” was no side effect. The Mexican economy has been actively restructured: Small farmers had been forced out of their jobs by the allowance of foreign investment in agricultural industry and a tight protection of agriculture in the US and Canada. The freed labor force further lowered the wages for the now incoming assembling factories, that largely required low skilled labor at low costs. This was the strategy to keep product prices low within the NAFTA region.

If the three partners would now outlaw one of the basic elements of the agreement the way economic structures react would be unpredictable. Higher prices on many everyday products would be needed, but who would be left capable of paying them? It is far more likely that Mexico will push against such reform – most likely supported by Canada and economic experts within the US government – and that this demand of Trump will silently fall off the table.

 

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