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The United States-Mexico-Canada Agreement (USMCA) updates the
25-year-old North American Free Trade Agreement (NAFTA), with
modifications including a focus on resolution of disputes at a
local level prior to international arbitration. The USMCA includes
new provisions on intellectual property, digital trade, taxing of
shipment value levels, financial services, currency manipulation,
labor, and the environment. Notably, the USMCA increases local
content requirements in the automotive sector from 62.5% within
member countries to 75%. NAFTA's investor-state dispute mechanism
has also been modified to favor the resolution of US-Mexico
disputes in local courts by delaying for at least 30 months their
potential elevation to international arbitration, although key
sectors such as hydrocarbons, electricity, telecoms, transport, and
infrastructure will be exempt (agribusiness not included).
The USMCA's entry into force increases the stability of the
Mexico-US trade relationship (worth USD614.5 billion in 2019), but
sunset provisions threaten to generate trade regulation uncertainty
every six years. Overall, the USMCA is highly positive for Mexico,
with 83.5% of its exports sold to the US in 2019. Its introduction
also removes the US threat to withdraw unilaterally from NAFTA, and
the business uncertainties generated by USMCA negotiations.
However, the USMCA's sunset provisions state that it will expire
after 16 years unless members agree to an extension, and that joint
committees must review its contents every six years. The latter
feature will create opportunities for members to pursue
modifications of those terms they consider unfavorable, leading to
renewed uncertainty over trade relationships in the periods
preceding such reviews. The extent of this uncertainty will depend
on future administrations' priorities but will be greater if
economic protectionism intensifies in the US following the current
economic recession.
Labor and environmental disputes are likely to increase under
the USMCA. The formation of labor-related dispute settlement panels
is likely to allow US and Canadian unions and firms to claim that
Mexican violations of labor standards equate to the establishment
of trade and investment barriers. The US plans to monitor Mexico's
enforcement of labor-related commitments through an inter-agency
committee and labor-attaché figure. US Trade Representative Robert
Lighthizer said on 17 June that the US would take action "early and
often" to challenge any potential violations of the USMCA.
Mexico's automotive, steel, and aluminium industries are likely
to struggle to meet new USMCA local content requirements. Besides
increasing local content requirements in the automotive industry to
75%, Mexico is committing to generate 40-45% of its automotive and
automotive parts production at hourly wages of USD16 by 2023;
Mexico's average hourly manufacturing wage was USD3.73 in 2019
according to Mexico's National Autoparts Industry chamber
(Industria Nacional Autopartes: INA). Likewise, 70% of steel and
aluminium that is melted and poured must be sourced from North
America. Mexico's failure to further develop its own industries
within the seven-year transition period would imply greater Mexican
reliance on US and Canadian supply
Given this context, Mexico is likely to seek greater flexibility
around the implementation and enforcement of new USMCA chapters.
Some temporary exceptions or extensions for compliance are likely
through mechanisms such as the Alternative Transition Regime
announced in May. Some Mexican automotive industry representatives
have said that where specific requirements have been published only
recently and imply higher costs, companies may choose instead to
pay tariffs. Although the USMCA stabilizes Mexico's external trade
relations during the global recession, its foreign direct
investment inflows are still likely to be limited by a broader
deterioration of the business environment under the current Mexican
administration. US, Canadian, and European companies and diplomatic
officials have raised concerns in recent weeks over Mexican
government actions that are increasing legal uncertainty for
investors, including project cancellations, gas supply contract
renegotiations, and new restrictions for renewable energy
providers. The government is also pursuing an aggressive tax
collection strategy against private firms and thinking about
modifying the privately-run pensions system in Mexico, to grant the
executive greater control
Indicators of changing risk environment
Increasing risk
A continued lack of Mexican government financial stimulus
measures for the private sector in response to the COVID-19 virus
outbreak, particularly for exporting firms, will limit their
ability to adapt to new USMCA regulations and take advantage of
tariff-free trade opportunities.
Any Mexican violation of USMCA labor requirements, including
the need to pay higher wages and eliminate child and forced labor,
would increase the risk of penalties for exporters.
Decreasing risk
A government support program for the Mexican automotive
industry would facilitate its compliance with increased costs and
additional regulation.
Signs of improved collaboration between the government and
national private-sector groups such as Coparmex and Concamin would
increase the likelihood of new government measures to incentivize
foreign investment.
Posted 06 July 2020 by Johanna Marris, Senior Analyst, Latin America, Country Risk, IHS Markit