The Trump administration reached a deal with Mexico today on some bilateral issues in the renegotiation of the North American Free Trade Agreement (NAFTA). Some details of what was agreed are here. Other issues have been reported by the press as having been agreed, but until we see official government announcements, we are skeptical that those issues have been fully resolved.
This is not the conclusion of the NAFTA talks, because there are a number of outstanding issues, and Canada has to be brought back to the table as well. Nevertheless, today’s United States - Mexico deal is in some sense, "progress." In another sense, however, it is a step backwards. To illustrate this, let's look at the example of what was agreed on auto tariffs.
NAFTA eliminates tariffs on trade between Canada, Mexico, and the United States, but only for products that meet specific requirements to qualify as being made in North America. For example, you couldn't make a car in China, ship it to Mexico and put the tires on, and then export it to the United States at the NAFTA zero tariff. Under current NAFTA rules, in order to qualify for duty free treatment, 62.5 percent of the content of a vehicle has to be from the NAFTA countries.
The Trump administration has been opposed to this content threshold, arguing that it needs to be higher. A key part of the bilateral talks between the United States and Mexico was to address this issue, and also add some conditions related to wage levels.
With regard to the content threshold, the United States has asked for this requirement to be raised, and according to the fact sheet released by USTR, the new content requirement will be increased to 75 percent. On the wage levels, the United States has pushed for a provision that requires 40 percent of the content of light trucks and 45 percent of pickup trucks to be made by workers that earn at least $16 an hour, and Mexico appears to have agreed to this as well. These changes make it harder for Mexican producers to satisfy the conditions to get the zero tariffs, while Canada and the United States would not be affected by this change.
So what’s the point of all this? The goal of the Trump administration's negotiators was to make it more difficult for autos to qualify for the zero tariffs. In other words, they are taking some of the free trade out of NAFTA.
Along the same lines, reports suggest there is a provision that would allow the United States to charge tariffs above the normal 2.5 percent tariff rate (which applies to countries that don’t have a trade agreement with the United States) for any new auto factories built in Mexico. It is not clear from today’s announcement whether this is included in the newly agreed provisions.
The impact of these changes, if the NAFTA talks are completed and the new rules go into effect, will vary by producer, so it is hard to give a precise assessment of how much it will raise costs overall. The 25 percent auto tariff that the Trump administration is currently considering -- ostensibly based on national security, but really just protectionism -- is likely to raise auto prices a lot. A recent study estimates that if Trump implements his proposed 25 percent tariff on auto imports, the average price of a compact car would increase by $1,408 to $2,057, while luxury SUVs and crossover vehicle prices could increase by $4,708 to $6,972. No similar study has yet been done for the new NAFTA content requirements, but whatever the final figure may be, it is clear that these stricter content requirements will raise prices to some extent, which will make autos more expensive for consumers and potentially make North American production less competitive.
The NAFTA renegotiation has led to great market uncertainty, and it would be nice to get this all resolved. But before we applaud the completion of any deal, what matters most is in the details. From what we know at the moment, those details suggest that NAFTA may have been made worse, not better. And there are a still a lot of details to work out. A full assessment of the new NAFTA will have to await all of the final terms.
Furthermore, President Trump suggested that while Canada can join soon, it may not be part of the agreement at all, and instead could face a tariff on car exports to the United States. Leaving Canada out of a new NAFTA would be a mistake. On the phone during the announcement, Mexican President Enrique Pena Nieto remarked on more than one occasion that he was looking forward to Canada rejoining the talks. This should be received positively as it suggests Mexico is still committed to a trilateral deal. What happens next is anyone’s guess, but we should keep our eyes open for the return of Canada’s Foreign Minister Chrystia Freeland to Washington to wrap up the discussions soon. Let's hope the other changes still under discussion point us in a more positive direction.