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New trade deal for US-Mexico

30 August 2018 Carlos Cardenas John Raines

US President Donald Trump and Mexican President Enrique Peña Nieto said on 27 August that both countries had reached a preliminary agreement to rebalance their trade relationship under a new United States-Mexico Trade Agreement.

  • The agreement represents a positive turn in respect to Mexican-United States trade disputes, and offers increased investor certainty regarding future relations.
  • Canada will likely not sign onto the agreement by 31 August, but will almost certainly join negotiations over the next month in search of a deal.
  • If approved, the deal is a political win for US President Donald Trump, but the US Congress would strongly prefer a deal that includes Canada.

The announcement was made by US President Donald Trump and Mexican President Enrique Peña Nieto during a telephone conversation, and was made in the context of the North American Free Trade Agreement (NAFTA) renegotiation. NAFTA renegotiations started in August 2017 and until the end of July the parties had only reached agreement on nine out of 30 negotiating chapters. Mexico and the United States opted in July 2018 to negotiate bilaterally to expedite progress in the most controversial subjects, such as rules of origin in the auto industry, leaving Canada out.

The preliminary agreement will include subjects already renegotiated and will redefine the trade relationship between both countries if ratified and implemented. The agreement will last until 2034 and is set to be reviewed and updated every six years without the threat of termination. Primary components of the agreement include:

  • Increasing regional local content in the auto industry from the current 62.5% to 75%.
  • Ensure that 40-45% of auto content is made by workers earning at least USD16 per hour.
  • Strengthen rules of origin enforcement beyond existent NAFTA and Trans-Pacific Partnership requirements in the auto, chemicals, steel, glass, and optical fiber sectors.
  • Implementation of new market access chapter to support trade in manufacture goods, as well as a new textile trade-related provisions.
  • The incorporation of sectoral annexes on information and communication technology, pharmaceuticals, medical devices, cosmetic products, and chemical substances.
  • Maintaining agriculture tariffs between both countries at zero while including agricultural biotechnology in the agreement.
  • Agreement on enhancing science-based sanitary and phytosanitary measures, as well as protections for proprietary food formulas.
  • Agreement on intellectual property chapter, digital trade, financial services, environment, and labor.

The agreement is highly positive for the Mexican economy as it eliminates the uncertainty that had been generated over its relationship with the US. Such uncertainty affected the value of the Mexican peso substantially over the past 12 months and had put the country's economic growth in jeopardy given that over 80% of its exports are US-bound. However, in order to reach an agreement, the Mexicans had to concede to a number of US demands including maintaining existent US tariffs on Mexican steel and aluminum and, particularly, accepting the production of 40-45% of auto content in manufacturing plants paying workers USD16 per hour. The acceptance of such demand will prove costly to Mexico as manufacturing wages in the country, including other industries besides auto, are closer to USD3 per hour according to IHS Markit data. Mexican Secretary of Economy Ildefonso Guajardo believes that 68% of Mexico's auto exports will be able to cope with the new local content requirements, which he estimates will be progressively rolled out from 1 January 2020. However, the remaining 32% of the country's auto exports will need to take measures to adapt to the new requirements, according to Guajardo.

For its part, the US offered several concessions to Mexico to push the agreement through before 1 December 2018 - or in time for outgoing president Peña Nieto to sign the agreement - most importantly by scrapping the five-year sunset provision.

The role of Canada
Peña Nieto and President-elect Andrés Manuel López Obrador - who assumes office on 1 December 2018 - have both welcomed the agreement but emphasized of the need to incorporate Canada in the final agreement. However, US President Donald Trump criticized Canadian Prime Minister Justin Trudeau and his administration's continued imposition of a 300% tariff on US dairy products, and mentioned that he would be willing to leave the country outside the renamed US-Mexico Free Trade Agreement. To pressure Canada, the US administration has said that it is planning on sending the agreement to the US Congress as soon as 31 August and that it also planned to impose tariffs on its auto sector.

A major consideration for Canada to rejoin the negotiations, and for Mexico's ratification of the announced agreement, remains the future of NAFTA's dispute settlement mechanism. Canada wants the existent framework to be modernized. Mexico and the US have given contradictory statements. Mexico has said that the dispute settlement issue has not been addressed. The US has claimed that Mexico had agreed to eliminate it from the new treaty barring for energy, telecoms, power, and infrastructure.

Outlook and implications
The announcement of a deal creates a trust-building measure to other trade partners that Trump can negotiate and conclude trade agreements. Up until now, Trump has generally utilized the threat and deployment of higher tariffs in trade disputes. This agreement, along with the 25 July truce between the European Union and the US over higher tariffs, means Trump and his team can focus their efforts more pointedly on pressuring China to change its policies over technology transfer, government subsidies, and greater US company market entry into the People's Republic of China.

The main sticking point for the future of the agreement will be Canadian acquiescence. Major provisions of the new agreement involving dispute settlement, the oil and gas industries regulation, intellectual property technicalities, and the sunset provision were all ironed out without Canadian negotiators in the room. Accordingly, the odds of Canada officially signing on to the new bilateral agreement by the US - mandated 31 August - appears dim, especially as Trudeau would be reluctant to appear to be kowtowing to US pressure to sign within such a limited timeframe. To accommodate Canada's need for more time, on 31 August the US will likely report to Congress that an agreement has been made only with Mexico, but that Canada is expected to join within the required 90-day waiting period. However, if Canada delays approval for longer than a few weeks the odds will increase that Trump will follow through on his threats to impose new tariffs on Canadian cars.

Without Canada's signature, Congress will be reluctant to sign off on the new agreement prior to the mid-term elections, if at all, as the US business community will lobby congresspersons to protect companies located within their districts that conduct cross border trade. This would raise the chances that Trump would simply annul the NAFTA agreement, as he has threated, submitting the Mexican agreement as a separate agreement, an action that would lead to legal battles on whether Congress would need to approve such a move. At that point, Canada would be left only with its 1987 US bilateral free trade agreement and would be forced to negotiate a new agreement with Mexico separately.

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