NAFTA Renegotiation: Exercise In Protectionism Or Opportunity For Modernization?

Original article here.

On Thursday, May 18, President Trump formally notified Congress of his intent to pursue renegotiation of the North American Free Trade Agreement (NAFTA) triggering a 90-day consultation with Congress and U.S. businesses prior to engagement with trading partners. The 23-year-old multilateral trade agreement between the United States, Canada, and Mexico has been a primary target for a U.S. Administration interested in addressing the offshoring of jobs and trade imbalances.

At the conclusion of the 90-day consultation period, the United States will have the option to notify both Canada and Mexico of its intent to withdraw from the agreement beginning a six-month period of review. Unlike the Brexit’s invocation of Article 50 requiring separation from the European Union, NAFTA Article 2205 indicates that a signatory nation only may withdraw following the six-month notification period. This leaves the United States the opportunity to remain a NAFTA signatory following their notification of intent to leave should the Trump administration determine conditions for remaining in the trade agreement have improved.

Any altering of the agreement will require delicate trilateral negotiation given the dependence of the U.S. economy upon its second and third largest trading partners. An estimated 14 million U.S. jobs are directly dependent upon trade with the Mexican and Canadian markets. Additionally U.S., Canadian, and Mexican companies have invested heavily in their neighboring countries to secure critical international supply chains with the U.S. investing almost $500 billion in Canada and Mexico.  In turn, the U.S. has benefitted from over $350 billion in investment from the other trading partners. Jeopardizing these supply chains will come at a steep cost for each of the three nations involved likely manifest through higher consumer prices, but there are areas in which a NAFTA renegotiation is long overdue and could bear fruit for the US.

Trump Administration renegotiation targets

Canadian agricultural export has long been a point of concern for the United States and slowed negotiation over the Trans-Pacific Partnership (TPP). Of particular concern is Canada’s dairy export. U.S. producers have long expressed concern over the Canadian supply management system which lowered the price of a specific class of milk used in such products as cheese and yoghurt. This was met with harsh criticism from the U.S. agriculture community, and attempts to settle the dispute have gained little traction. Canadian agricultural concerns will certainly take a central role in NAFTA renegotiation, and the Trump administration has already taken the first step recently imposing an up to 24 percent tariff on softwood lumber imports.

These actions will also serve to address one of the primary goals of the Trump administration’s trade policy, the reduction of the U.S. trade deficit. Last year the United States realized a trade deficit with Canada in excess of $11 billion. This falls well behind the U.S. trade deficit with Mexico totaling over $63 billion in 2016. Reducing this imbalance has been a primary concern for the Trump administration in its effort to protect domestic labor.

A final goal of the Trump administration in the forthcoming NAFTA renegotiation will be identifying opportunities to, at least through public perception, extract compensation for U.S.-Mexican border security efforts. A central policy initiative of the campaign, the administration will likely attempt to use NAFTA renegotiations as a medium of engagement with Mexico on border security funding.

Trilateral opportunities for modernization

There are also a number of areas of common growth.  NAFTA, now more than two decades old, would benefit from areas of modernization.  One critical area is in digital trade.  At the time of NAFTA’s enactment, digital commerce and the internet of things was far less mature and were consequently not addressed in the language of the agreement.  To this day, no major trade agreement has developed global digital trade standards.

This issue was, however, addressed in the draft of the Trans-Pacific Partnership (TPP).  Included in TPP is language creating foundational standards for digital trade.  Given the size of the trade agreement as determined by collective GDP of its signatories, its successful enactment would have likely addressed this significant gap in global trade regulation.  As the United States as now withdrawn from the TPP, the digital trade language included in that agreement could be leveraged and even expanded upon to strengthen and modernize NAFTA.

Another area of mutual benefit is in energy market cooperation. Mexico specifically has signaled an interest in deepening this relationship with the United States in any NAFTA renegotiation. North America is rapidly reaching the point of energy independence, and the further opening of U.S. markets to Mexican energy supply could be balanced by a significant increase in U.S. energy and infrastructure investment in Mexican supply.

Finally, regulation of shipping, particularly across the U.S.-Mexico border, has imposed costs which could be addressed by the forthcoming NAFTA renegotiation. Under current regulation, three drivers are required to physically drive a single shipment across the border leading to higher costs per shipment.  Additionally, border shipments face a crossing duty imbalance which may be addressed to reduce shipping cost.

Difficult path to unilateral U.S. withdrawal

With Robert Lighthizer now confirmed as the United States Trade Representative, the chief U.S. trade negotiator, the U.S. will now enter into a 90 day period of consultation with Congress and U.S. industry representatives.  Members of Congress will likely express reservations about a significant disruption of the 23-year-old multilateral agreement given deep economic and global supply chain ties to both Canada and Mexico. Further complicating Congressional support is the timing of the renegotiation period.  Legislative action has been stalled by ongoing investigations into allegations of Russian interference in the 2016 U.S. presidential elections. Further, Congressional primary candidates will begin to announce their intent to run in the 2018 midterm elections in the coming 6 months.  This truncates the timetable during which incumbent members of each chamber might be willing to engage on a potentially tumultuous NAFTA renegotiation.

Without the support of Congress, even if President Trump should ultimately be able to unilaterally disengage from NAFTA, it could be in name only. U.S. law and regulation has been adapted to accommodate the requirements of the NAFTA treaty.  The North American Free Trade Agreement Implementation Act, signed in November 1993, creates the legal infrastructure for the signed agreement and would require a repealing law to fully disengage the United States. It is possible that the Trump administration withdraws from NAFTA, but the legal implications of the agreement remain unchanged.

While Congressional approval is required to alter non-tariff barriers, Mr Trump could unilaterally raise tariff barriers in pursuit of his trade policy aims. This would almost certainly be met with a response from the target trading partner.

In addition to Congressional elections in the United States, Mexican national elections will be held in July of 2018 further complicating the timetable for renegotiation. With Mexican President Peña Nieto weak in the polls, a reopening of NAFTA negotiations with the United States may provide him with an opportunity to gain public support through a show of strength against perceived economic bullying by the U.S. administration.  Mexican officials have already expressed that they view the current NAFTA agreement as a starting point on which to build and will not tolerate a weakening of Mexico’s trade position.  They would like negotiations to conclude no later than December of 2017 to maximize time prior to the scheduled July elections.

In the unlikely event of a full U.S. withdrawal from NAFTA, the country would revert to most favored nation (MFN) status by both Canada and Mexico. Under this World Trade Organization (WTO) designation, tariffs would revert to higher levels.