On 30 November, the leaders of the U.S., Mexico and Canada signed the USMCA trade pact – an updated version of the Nafta agreement. The new deal has important implications for various sectors, particularly manufacturing and agriculture.
Case Study: USMCA likely to help U.S. industries
On 1 October 2018, negotiators from the U.S., Mexico and Canada formally reached agreement on updated terms for North America’s free trading zone. Previously known as the North American Free Trade Agreement (Nafta), the new deal has been rebranded as the United States-Mexico-Canada Agreement (USMCA). On 30 November 2018, the three countries’ leaders gathered in the Argentine capital, Buenos Aires, for the annual summit of the G20 – an international forum of 20 major economies – where they approved the deal.
The signing ceremony marked the culmination of 14 months of tense negotiations, which frayed U.S.-Canada relations at the highest level and spilled over into Mexico’s divisive presidential election. In reaching an agreement, the three sides have avoided U.S. President Donald Trump making good on his repeated threats to cancel Nafta, which he has labelled ‘the worst trade deal…ever signed in [the U.S.]’, ensuring that closely integrated supply chains continue to function smoothly. Trump’s criticism of the deal mainly focused on its supposed detrimental effect on U.S. manufacturing. In spite of Trump hinting at terminating the deal, its importance to the U.S. economy widely, and to certain ‘swing states’ won by Trump in the 2016 presidential election in particular – including Michigan, Iowa and Pennsylvania – meant that cancelling the agreement would have damaged the U.S. economy and harmed the interests of electoral constituencies who brought Trump to office.
Importantly for businesses operating in North America, the USMCA contains numerous new or modified provisions, particularly those related to rules of origin and market access, which will change how business is conducted in the region. Sectors most affected by the new provisions include the manufacturing and automotive industries, as well as agriculture and timber.
Source: United States Census Bureau
Manufacturing and automotive sectors
The USMCA seeks to address U.S. concerns that Nafta’s provisions were leading to the offshoring of production, particularly in the manufacturing and automotive sectors, to jurisdictions with lower wages and operating costs, such as Mexico and China. To counter this, the USMCA includes new, stricter provisions on rules of origin, which determine the amount of auto content that must be made in the USMCA region for an automobile to qualify for the agreement’s terms. Under Nafta, this figure was set at 62.5 per cent for the automotive sector, meaning that vehicles made in the U.S., Mexico and Canada needed to be made up of at least that percentage of U.S., Mexican or Canadian content to qualify for the agreement’s terms. In the USMCA, this figure will gradually rise to 75 per cent over five years once the deal is ratified by the countries’ legislatures, which should take place by mid-2019. By increasing the automotive sector’s rules of origin requirements, the deal incentivises manufacturers to produce a greater share of a vehicle in the region. In turn, the three countries anticipate that this will boost employment in the sector, particularly for key parts such as engines and transmissions. Additionally, the new agreement heightens the rules of origin requirements for U.S., Mexican or Canadian steel and aluminium in car production to 70 per cent. This will assist North American steel and aluminium industries, many of which have also been protected by recent U.S. tariffs on the import of steel and aluminium products.
Another significant change in the USMCA relates to automotive sector wages. According to the new agreement, at least 40 per cent of the value of most vehicles, or 45 per cent in the case of trucks and vans, must be produced by workers earning a minimum of USD16.00 per hour (p/h) for the vehicle to qualify for the deal’s terms. This provision seeks to address the considerable variance in auto sector wages across North America. In Mexico in 2017, average wages varied from USD3.41 p/h for automotive parts workers to USD7.34 p/h for auto assembly workers. In the U.S. and Canada, however, wages for auto assembly and parts workers in 2017 were both above USD20 p/h. By stipulating that a large proportion of a vehicle’s content must be produced by high-wage workers, the USMCA encourages automakers to produce in the U.S. and Canada, where most of the North America region’s vehicles are sold, rather than Mexico, where operational costs are lower. Such a move is designed to halt the long-term decline of U.S. automotive production, whose output has fallen from 600,000 units per month in 1993 to less than 250,000 per month in 2018, largely as a result of increased competition from overseas, including Mexico and Japan. For Mexico, however, the new terms reduce the commercial advantage of its low labour costs.
Source: Economic Research Division, Federal Reserve Bank of St. Louis
Agriculture and timber sectors
The USMCA contains several important provisions which impact the agriculture and timber sectors, all of which became thorny political issues during the negotiations for national leaders sensitive to the demands of their constituents. In particular, throughout the negotiations the U.S. and Canada were locked in a long-running dispute over access to the latter’s dairy market, which under Nafta was protected by import quotas, tariffs and guaranteed prices for Canadian farmers. Under the USMCA, the U.S. will receive increased access to Canada’s dairy market, calculated at approximately 3.5 per cent of the total size of Canada’s domestic dairy industry. Canada has also agreed to remove the so-called ‘Class 7’ milk classification, a cheap form of protein-rich milk which has priced out U.S. competitors. Furthermore, the U.S. has gained exclusive tariff rate quotas, which allow for low tariff trade for a fixed amount of dairy exports, including fluid milk, cheese and cream.
Another source of contention in the negotiations was Nafta’s Chapter 19 dispute-settlement system, which allows firms to challenge countries’ emergency antidumping and antisubsidy tariffs at a special panel. Under Nafta, the system had frequently been used by Canadian timber producers to counter restrictive U.S. measures. Despite a U.S. desire to remove the system from the USMCA – U.S. trade representative Robert Lighthizer had criticised it as an infringement upon U.S. sovereignty – the dispute-settlement system has been retained. This aids Canadian timber companies against future U.S. protectionist measures. Mexico also managed to avoid U.S. demands for seasonal restrictions on imports, which would have damaged Mexico’s farming sector.