Monthly Article

July 2017 Monthly Article – NAFTA Renegotiation Points

In a July 17 press release, U.S. Trade Representative Robert Lighthizer announced that the first rounds for the renegotiation of the twenty-three-year-old North American Free Trade Agreement (NAFTA) will take place in Washington, D.C., from August 16 to 20, 2017. According to the communiqué, “John Melle, Assistant U.S. Trade Representative for the Western Hemisphere, will serve as Chief Negotiator for the NAFTA negotiations. In his role as Chief Negotiator, Melle will be responsible for the day-to-day negotiations at the staff level.”

After the renegotiation date was announced, it was hoped that the Trump administration would shed light on the details of what parts of NAFTA it intends to renegotiate. On July 19, the U.S. Trade Representative’s website stated that, “The new NAFTA must continue to break down barriers to American exports. This includes the elimination of unfair subsidies, market disorienting practices by state-owned enterprises, and burdensome restrictions of intellectual property. The new NAFTA will be modernized to reflect twenty-first century standards and will reflect a fairer deal, addressing America’s persistent trade imbalances in North America.”

Looking at this statement, the first two sentences could have been co-opted from 1994 pro- NAFTA propaganda, when the agreement was implemented between the U.S., Mexico, and Canada. Further information released from the website indicates that the U.S. intends to negotiate an update to NAFTA’s Rules of Origin, which require products traded between the North American partners to have a specific percentage of North American content in order to enjoy reduced tariff and barriers under NAFTA. Most industry experts agree that this element of NAFTA needs to be reexamined and tightened up.

The website also mentions that the Trump team wants to do away with the current NAFTA dispute settlement process in which a panel comprising members of the countries in dispute makes a final ruling. Trump wants total control for the U.S. to remediate and make trade decisions as pertains to disputes with its NAFTA partners. Other areas proposed for negotiation include digital trade and government procurement.

All of these areas, though still lacking in detail, appear to be reasonable areas of discussion. However, the issue involving the U.S. trade imbalance is somewhat puzzling. The U.S. runs the largest trade deficit with China, at approximately $347 billion per year, followed by Japan ($69 billion), Germany ($65 billion), and Mexico ($63 billion). Canada, the other partner of the U.S., is responsible for another $11 billion of the U.S. trade deficit.

As a percentage, China is responsible for about 40 percent of the U.S. trade deficit. Yet when touting the recently crafted U.S.-China trade agreement announced on May 11, and which relies heavily on opening up U.S. beef and natural gas sales to China, Trump did not put as much focus on the U.S.’s trade deficit with China. In announcing the NAFTA areas to be renegotiated, he specifically highlights U.S. “trade imbalances in North America.” Because the U.S. runs a much larger trade deficit with Mexico compared to Canada, it appears that this statement is directed at our neighbor to the south.

It is estimated that each Mexican product imported by the U.S. has approximately 40 percent U.S. content, meaning that production inputs such as plastic, steel, electronics, paint, and adhesives are made in the U.S. and shipped to Mexico, which then incorporates them into products for export. This is the nature of the heavily integrated U.S.-Mexico trade relationship. It would seem logical to assume then that the trade deficit that the U.S. runs with Mexico is overstated by 40 percent, and the real trade deficit would be $37.8 billion. However, economists whom I have talked to who follow the U.S.-Mexico trade relationship have told me that the math is more complicated due to factors such as product valuation, transformation of goods, and intra-company accounting practices. Whatever the real trade deficit figure with Mexico is, it very likely is lower than the official figure being reported.

From a practical standpoint, it remains to be seen how the U.S. can incorporate a trade deficit clause into a new NAFTA, especially with two countries with which the U.S. trades billions per day, and whose American citizens’ strong appetite for items such as cheap electronics, automobiles, and avocados help to create the deficit. Would trigger points be negotiated into the agreement? Would the U.S. impose limits on cross-border trade if the U.S. trade deficit swells with our neighbors? The mechanics of doing this would smack of socialism and would cause distortions in the economy.

The obvious solution would be to have U.S. firms produce more products at prices that would entice American buyers to buy locally. However, based on the theory of comparative advantage, there are products that our two North American neighbors can make more efficiently and economically. The U.S. has its own comparative advantages in areas such as high-tech and pharmaceuticals. Going forward, we need to focus on industries of the future and develop a trained and capable workforce. Compared to China, Mexico and Canada are not the major trade deficit problem. As the NAFTA renegotiation commences, U.S. negotiators must keep this in mind and not put billions of dollars of U.S. inputs used in Mexican products at risk.