The North American Free Trade Act or NAFTA, in effect since the 1990’s, has recently been replaced by the United States – Mexico – Canada agreement or USMCA.  The original NAFTA was in place for 24 years bringing major economic activity to and from the U.S. and its North American neighbors.  An enormous amount of political ballyhoo preceded the beginning of the trade talks, and a surprisingly little amount of change to the treaty has taken place since the talks have completed.  The U.S. administration took a reckless approach to the important negotiations by disregarding the major risks that loomed large if no agreement could be reached and the old treaty scrapped without a new one to replace it.  What then was all the commotion about?

Regular Reviews Added:  The new trade agreement is subject to review every six years by representatives from all three countries.  It is further set to expire after a period of 10 years following a review if any of the three countries intends to pull out of the treaty.  The new treaty can thereby put the entire free trade zone at the tender mercies of upstart politicians who can scuttle the agreement for political gain.  Additionally, the new treaty faces termination if any one of the parties decides to make a similar free trade deal with a “non-market” economy such as China.

Automobile Manufacturing Affected:  The most noticeable changes in USMCA pertain to the rules governing the manufacture of motor vehicles and their replacement parts.  By 2023 when the new agreement is fully implemented cars, trucks, and other motor vehicles must have at least 75% (up from 62.5%) of their value created in North America to be sent across any border duty free.  Further, as much as 40% of the production must come from workers who will earn at least $16.00 per hour, taking a number of those jobs away from Mexico where wages are lower.  The U.S. Administration hopes that this will end up creating more good paying jobs in the automobile industry within the U.S.’s borders, but it might instead push those potential jobs up into Canada.  From an economic standpoint the inefficiency this brings to the industry will raise the cost of these vehicles to be paid by all vehicle consumers in the hope of a few extra jobs.

Impact on Investors:  The original NAFTA started a wellspring of investment throughout the region and has provided major economic benefits to all parties involved.  The new agreement does not portend to do the same, however, as investors have a lot of reasons to feel insecure.  The U.S. can restrict production in Canada and Mexico on vehicles that are deemed to impose “national security risks” to the U.S.  Although exemptions are available it places much control into the hands of U.S. politicians.  In the leastways these greater protections and burdensome regulations will wind up creating higher costs per unit of each vehicle manufactured.  These costs will eventually be passed down to the consumer.

Appellate Mechanism:  USMCA retains from NAFTA an appellate mechanism known as “Chapter 19”, which allows an affected party to appeal tariffs from any of the three countries to a five-member panel.  This provision, which does not apply to any vehicles which are ruled as “national security risks”, is deemed as Canada’s main success in the overall negotiations as protection from arbitrary actions on the part of the U.S. Administration.

Opens Canada’s Dairy Markets:  The new agreement gives access to about 3.6% of Canada’s protected dairy markets.  Ironically, this is only very slightly more than the 3.25% mandated by the Trans-Pacific Partnership, or TPP, which all three parties were members of until Donald Trump pulled the U.S. out over a year ago.

Risks of Failure:  The major risks that surrounded the renegotiation of NAFTA were so magnanimous we in this nation should count ourselves lucky that nothing collapsed, especially considering the reckless approach taken by Mr. Trump.  Had NAFTA been scrapped without a replacement agreement, trade rules would have reverted to those provided by the World Trade Organization.  The states of Texas, Iowa, Nebraska, Mississippi, Alabama, Michigan, Arizona, South Dakota, and Kansas would stand to lose the most.  Agricultural products would be the hardest hit, and the great state of Texas with its radically conservative Republican government would get a cut in GDP of about 6%.  In Iowa’s case the yearly $132 billion of exports of high-fructose corn syrup to Mexico would be taxed at a whopping 100%.  Additionally, the entire auto industry in the U.S. would be thrown on its ear with the resulting chaos enough to push the entire economy into a recession.

Conclusions:  The exercise of scrapping NAFTA and replacing it with USMCA was handled recklessly by the U.S. Administration considering the major risks involved.  The gains are nominal at best, and more changes might be in the offing when the deal reaches Congress for ratification.

 

Sources:  “NEWFTA”, The Economist, October 6, 2018.

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