Evaluating trade deals like NAFTA 2.0

Not all trade agreements are equally helpful.  All need to be judged against something—compared to no deal, even a not terribly effective agreement might have some useful provisions.  

As with any free trade agreement (FTA), having a deal done on paper is one thing.  How it gets implemented and used in practice is much more critical.  A stunning document that gets left in a drawer is useless.

The revised North American Free Trade Agreement (NAFTA) deal therefore presents a challenge to assess.  If the benchmark is a total collapse of the three-way agreement between Canada, Mexico and the United States, the presence of an agreement to structure trade is very helpful indeed.  If the yardstick is the original NAFTA, there are certainly some things to like.  The deal was several decades old and missing rules, such as anything to cover the entire digital economy.

But if the assessment is made against the Trans-Pacific Partnership (TPP), the picture is considerably more mixed.  

Early commentators have focused on a few key issues in the revised NAFTA, including the name change to USMCA (anyone else stuck humming the tune to YMCA in your head?).

Starting with the more useful elements, NAFTA 2.0 brings across large chunks of the TPP, including most of the digital economy provisions.  As noted, these were not present in the original deal and were needed once the United States opted to withdraw from TPP.

Other parts of the TPP were also brought over nearly intact, including state-owned enterprises, regulatory coherence, many of the sectoral annexes, commitments in financial services, telecommunications and so forth.  Some of these chapters have been renamed, but are otherwise nearly identical to TPP rules.

Throughout the NAFTA 2.0, there are similar provisions that have been lifted from TPP, such as patent protections for biologics (which are now on hold in CPTPP but were part of TPP), nearly all of the environment chapter, most of the labor chapter, and more.   

Of course, our assessment is that it would have been easier and better for the United States to simply remain in the TPP rather than embark on a year-long renegotiation of NAFTA to get these outcomes.  But, given US President Donald Trump’s personal distaste for TPP, moving across identical, or nearly the same, provisions into NAFTA is better than jettisoning the work entirely.

Since NAFTA 2.0 builds on the base of the original NAFTA, the new deal had some advantages over the TPP.  For example, tariffs between the parties are already set at zero.  This remains, although do note that there are very complicated tariff rate quotas in place in NAFTA 2.0 that were not scrapped.  Indeed, the level of genuinely new market access granted to partners that have known and worked with one another for decades is vanishingly small. 

While much focus, as an example, has been on Canada’s new market access for dairy, the total amount given amounts to barely 0.4%.  And the United States, in return, has an equally complex system of barriers in place to protect its own dairy industry from competition (as well as sugar, oranges, and others).

Deeply problematic bits of the agreement can be found buried in the texts.  For instance, the rules of origin (ROO) are incredibly complicated.  Given that tariffs are zero, the only way to keep out goods is to craft ROOs that are impossible to follow.   Clearly, for many products, this objective has been met. 

The level of NAFTA content required in fairly large swaths of products is extremely high.  Commentators keep focusing on the insane requirements for auto production, but note that for a wide range of goods, new NAFTA content rules require 50% or more content.  To make matters worse, in many products, these rules tighten after 3 years, rising to as much as 70% local (ie NAFTA) content.

This will make production for many products very expensive, as the ability to use imported raw materials, parts and components will be increasingly limited.  It will also make NAFTA less and less attractive as an export platform.  The costs of NAFTA-produced goods are likely to be uncompetitive, compared to anywhere else in the world. 

Firms will have to think even harder about whether they wish to use NAFTA, and particularly the United States, as a base for manufacturing.  To sell in the local NAFTA markets, it will be difficult to create low cost goods for many items.   But to sell overseas, remanufacturing is likely to be needed to stay competitive.  Having dual lines and sourcing is difficult and expensive to manage.  For small firms, it is impossible.

In addition to unnecessarily complicated rules of origin, the new NAFTA has deeply problematic rules for autos.  It is not just the high NAFTA ROO content that is a challenge.  It is the newly-introduced idea of the Labor Value Content (LVC) in Article 4:B7 which now requires that passenger vehicles and trucks include something called LVC into the mix. 

The specifics are even more complicated than the term implies.  Here is just the first line of what applies on the first year of the agreement:

In addition to the Product-Specific Rules of Origin in Annex 4-B or other requirements in this Appendix, each Party shall provide that a passenger vehicle is originating only if the vehicle producer certifies, on an annual basis, that its production meets a Labor Value Content (LVC) of 30 percent, consisting of at least 15 percentage points of high-wage material and manufacturing expenditures, no more than 10 percentage points of high-wage technology expenditures, and no more than 5 percentage points of high-wage assembly expenditures,

This is going to be impossible to enforce and monitor. 

To compound problems for auto makers, a provision in Article 4:B6 also requires the use of at least 70% domestic steel and aluminum.  And, just to make the point perfectly clear—steel and aluminum products have their own complicated ROOs with domestic content requirements that rise to 70% domestic (ie NAFTA) production.

In short, NAFTA 2.0 has elements that represent an improvement off the original agreement.  But this trade agreement also has rules that could be difficult or impossible for firms to use.  This will severely limit its utility. 

The original NAFTA turned out to be an excellent tool—shaping and adjusting trade policies in all three countries in generally more liberalizing and transparent directions.  It set rules that have broadly stood up for decades.  The revised version was never going to be able to deliver significant new economic gains, as there was not much left to uncover between these three parties. 

What is new is mostly a mix of TPP rules, which are broadly helpful, and some deeply problematic new protectionist policies that are now embedded into NAFTA 2.0.