Where is NAFTA headed?

The pace of the renegotiation of the North American Free Trade Agreement (NAFTA) appears to be quickening, with ministers for the United States, Mexico, and Canada possibly meeting again in Washington next week (May 7). Teams of negotiators have already been working for months, but important roadblocks to a final deal remain, including around the questions of car manufacturing and settling future disputes. The talks have been held in the context of President Donald Trump’s protective trade policies, which have also included withdrawal from the Trans-Pacific Partnership, imposition of tariffs on trade and steel, renegotiation of a trade pact with South Korea, and what many fear are the opening salvos in a trade war with China. We ask Robert Lawrence, Albert L. Williams Professor of International Trade and Investment, about the NAFTA negotiations and the road ahead for the agreement.

Q: Why does the Trump administration dislike NAFTA?

President Trump was elected in part by using a narrative that gave international trade a central role in America’s economic problems. He argued that the United States has signed bad trade agreements, which opened the U.S. market and encouraged U.S. firms to invest abroad, while allowing foreigners to maintain high trade barriers and engage in unfair trade practices. According to Trump, this deeply flawed approach resulted in the loss of millions of manufacturing jobs due to offshoring and the flooding of the domestic market by imports. 

Despite the lack of support for his position among economists, Trump believes that trade balances are a key measure of a nation’s commercial success and that U.S. trade deficits provide compelling proof of the flawed trade policies. Using the trade deficit between the United States and Mexico as a metric, the president called NAFTA “the worst trade deal ever.”

The president and some of his trade advisors therefore believe that the aim of U.S. trade policy should be to reduce these trade deficits and, ideally, turn them into surpluses. They view multi-country trade agreements such as the WTO and the Trans-Pacific Partnership with great suspicion and instead prefer an approach in which America can maximize its leverage to obtain concessions from the countries, such as Mexico, with which the United States runs merchandise trade deficits deemed too large.

Q: What does the United States want?

The Trump administration has approached NAFTA renegotiations with the dual objectives of reducing the trade deficit and the offshoring of American jobs. They’ve offered a number of proposals designed to increase the U.S. value that is added to produce automobiles that qualify for duty-free access under NAFTA. One (completely at odds with “free trade”) was that at least 50 percent of the total value of the car should be American; a second was to increase the North American content required for autos from 62.5 percent to 85 percent; and a third was to require that only the value added by workers paid wages of at least $16 an hour be counted. Obviously, this last proposal would mean that most value-added in Mexico, where wages are much lower, could not count towards qualifying for NAFTA treatment. A second strategy has been to weaken foreign investors’ confidence in the permanence of NAFTA by proposing that NAFTA expire and be renegotiated after five years. And a third strategy has been to undermine the security American firms enjoy when investing in other NAFTA countries by weakening the dispute settlement that is included in the agreement and/or specifically eliminating the Investor-State Dispute System. (ISDS). The ISDS provision gives foreign investors the right to appeal to a foreign arbitration panel if they believe government actions undermine their property rights.

Q: What about Canada and Mexico?

Canada and Mexico see NAFTA as an economic and political success and point to the thick supply chains that now make North America a far more integrated economy, especially for industries like automobiles, clothing, and aerospace. They ascribe this success not only to the removal of trade and investment barriers, but also to NAFTA’s impact in providing greater security and policy stability to foreign investors and operators of supply chains. More fundamentally, unlike the United States, both countries still believe in the current rules-based trading system and both have shown their willingness to commit to deeper trade and investment integration by going ahead with the multi-country Trans-Pacific Partnership despite the United States’ withdrawal. It is not surprising, therefore, that they have not been at all receptive to the proposals for a weaker NAFTA, despite threats by the Trump Administration that absent their cooperation, they could be subject to steel and aluminum tariffs. Mexico and Canada have been willing to negotiate a new NAFTA with the Trump administration, but only because they believe it should be strengthened, revised, and updated to include additional liberalization and rules for digital trade and data storage for example, which have only become relevant since NAFTA was signed.

Q: What is likely to happen and what is the timeline for a renegotiated agreement?

A: It is difficult to predict. The procedures for ratifying trade agreements by the Congress, known as fast track, require a 90-day period for Congress to consider agreements before voting and thus the administration is eager to complete an agreement by mid-May in order to have a vote prior to the midterm elections in November. It is highly unlikely that Canada and Mexico are going to be stampeded to sign a NAFTA that skews the trade balance towards the United States and undermines investor confidence, especially since Mexico has presidential elections coming up in July. Thus it is more likely that, as in the case of the recently renegotiated United States-Korea Free Trade Agreement, the updated new NAFTA could strongly resemble the old one, but with enough changes and uncontroversial additions that both sides could claim victory.

Q: Would such a renegotiated NAFTA be able to pass the Congress?

Even if agreement can be obtained, the devil will lie in the details. Republicans have generally provided most of the votes for free trade agreements, and their support would be crucial in getting NAFTA 2.0 approved. But many Republicans in Congress, most notably the chairs of the key trade policymaking committees are opposed to several of the Trump administration’s proposals, especially those weakening or eliminating ISDS. Indeed 100 legislators, all Republicans, have written a letter saying that dropping ISDS would be a deal breaker. But even if they do not like all its provisions, other members of Congress could approve it. Ironically, many who once opposed NAFTA are now opposed to its dissolution since eliminating NAFTA could have adverse effects on U.S. farmers dependent on Mexican markets, workers in factories dependent on Mexican parts, and the many people who benefit from the thriving trade in the states that border both Canada and Mexico. Members from affected districts could therefore find themselves having to swallow hard since some version of NAFTA could be better for them than no NAFTA. Nonetheless, the Trump administration has taken the process into uncharted waters, and there is considerable uncertainty over the content of a new NAFTA and whether or not we will have one at all.