Talking Trade blog
What happens if NAFTA collapses?
Published 18 October 2017
The fourth round of negotiations in the North American Free Trade Agreement (NAFTA) finished up this week in Washington. Progress did not go well. Officials agreed to delay the next round to late November to give all parties time to bridge “conceptual gaps” between positions and to start scheduling rounds into early 2018.
The original NAFTA agreement that created an integrated market between Canada, the United States and Mexico is now more than two decades old. Over the years, there has been a heated debate about the costs and benefits of the deal.
Yet until US President Donald Trump came into office, few had been making recent arguments in favor of a wholesale revision. Most of the issues between the three parties, after all, had been largely dealt with in the context of the Trans-Pacific Partnership (TPP) negotiations.
For example, the original NAFTA agreement did not cover digital issues. These were included in the TPP. NAFTA allowed all three members to shelter some products, particularly in agriculture, from full liberalization. This was largely addressed through the TPP as well, where significantly more market access was granted in the context of the larger package of benefits to a bigger set of parties in the agreement.
However, once Trump withdrew the United States from the TPP in January 2017, these benefits—and the implicit update of NAFTA—was lost for the United States.
This left the US demanding changes to NAFTA and negotiations got underway in August.
The original plan was to have seven rounds of talks before the end of the year. The tight timeframe was dictated by the electoral cycles in Mexico and the United States. A new NAFTA deal needed to be put to bed as soon as possible in 2018 before it could be caught up in election politics.
So where are the problems coming from?
The NAFTA negotiations are deeply unusual. Thus far, it appears that there are at least four distinct parties in the talks. The Canadians, the Mexicans, US business, and the US government. Normally, US business and US government are in broad alignment on objectives. In the NAFTA talks, however, this does not appear to be the case.
The US government is trying to pursue several overall objectives in NAFTA that are challenging. The first goal is to reduce the trade deficit in goods. Much has been written about the impossibility of this objective, the futility of the goal, and the ability of any trade agreement to accomplish the task.
US Commerce Secretary Wilbur Ross is obsessed with raising the percentage of local content required in automobiles. Current NAFTA rules require more than 60% of a finished car be made with content sourced from within NAFTA countries. It is part of the reason why so many auto supply chains have been set up within the three partners over the past two decades and why these chains have become so integrated over time across the markets.
Ross, however, is not satisfied. He wants to push the levels even further and require that more is produced in the United States alone. This is likely to be illegal and, even if it were allowed, would eventually rebound against the US as other countries are likely to demand similar rules in their own domestic markets, harming US companies operating overseas in the future.
Furthermore, the MFN tariff rate for autos into the United States is 2.5%. If the rules in NAFTA become too onerous, firms will simply opt to “bite the bullet” and avoid using NAFTA preferences at all. As with any trade agreement, companies always have the option of skipping the FTA benefits and trading on MFN rates.
Third, the US continues to insert provisions that are deeply problematic. For instance, the US wants to include a sunset clause that would void the entire NAFTA deal every 5 years, absent reauthorization and, likely, renegotiation. This would insert entirely too much uncertainty and risk into the process, which is why business groups from all three members have argued against this idea.
So what happens if NAFTA collapses?
The damage would be swift. Businesses, farmers and consumers have become so accustomed to NAFTA over the decades that most have forgotten what benefits actually flow from the agreement.
But focus on just the problems faced by US agriculture. Right now, nearly all agricultural products go duty free into both Canada and Mexico. Most items flow with limited paperwork and little customs hassle.
This will not be the case if NAFTA ends.
US exports of corn into Mexico will suddenly face tariffs of 10-15%. Soybeans, grains and flours jump overnight to 10-15% as well. Mexico is one of the best markets for US red meat exports, especially for many cuts that Americans do not favor. Many of these products could face tariffs as high as 234%.
Dairy into Mexico is extremely complicated, with many cheeses, for instance, facing tariffs of 125% and complex quotas.
American agricultural products will become uncompetitive in Mexico. The damage is compounded by the fact that Mexico has a web of free trade agreements with other trading partners that will still receive duty-free access in many of these products. This includes TPP partners, like Canada, Australia and New Zealand, who are competitive in many of the same categories.
Mexican exporters into the US, by contrast, will also face challenges, but since most US MFN tariffs are relatively low, the price shock will be less.
This, US Commerce Secretary Ross will surely say, is an example of the “unfairness” of the system.
Perhaps. It can also be viewed as the difference between a developed economy that has taken a leadership role in the global system for decades and a developing economy. The United States has benefitted enormously from its position.
USTR Robert Lighthizer complained loudly about Canadian and Mexican “resistance to change” in the last round of NAFTA talks. It is certainly worth reflecting on how much change is really needed in these negotiations, especially for America?
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