Why the USMCA is More Than a Rebranded NAFTA

19 Oct 2018

  • From the US perspective, a main objective of the USMCA is to incentivize investment and production within the United States at the expense of USMCA’s other two members.
  • This objective is evident in new auto rules of origin, wage requirements for auto workers, a sunset provision and watered-down investor protections.
  • The provisions related to the auto sector will raise car prices and could lead to less auto production within North America. This possibility makes protectionist measures against European and Japanese auto imports more likely.
  • Another component of the agreement is aimed at a separate US objective – limiting further Chinese inroads into North American markets.

Shrugging off the United State-Mexico-Canada Agreement (USMCA) on trade as simply a rebranded NAFTA misses a few key differences that highlight the strategic direction of US trade policy – namely, a desire to support US manufacturing by incentivizing investment and production within the United States, and a longer-term objective of limiting further Chinese inroads into North American markets. The former is seen in a number of USMCA provisions, but perhaps most clearly in new labor requirements mandating that at least 40 percent of auto content must be made by workers who earn at least $16 per hour. Over time, this provision will reduce the incentive for car manufacturers to produce autos for the North American market in Mexico, where average auto sector wages remain quite low.  Further, stricter rules of origin for car components are intended to create demand for parts produced within North America. Finally, two provisions of the USMCA introduce uncertainty into the post-NAFTA investment environment and could encourage global firms to invest in the US rather than in Mexico or Canada. First, while the USMCA’s sunset provisions are not nearly as strict as the US trade representative’s opening negotiating position, the provisions still create some uncertainty about the long-term durability of specific USMCA provisions and of the overall agreement. And second, USMCA waters down a NAFTA provision, the investor-state dispute settlement provision (ISDS), that enjoyed significant support in the US business community and increased comfort investing in Mexico and Canada. Businesses considering capital investments in North America may logically respond to the uncertainty associated with the sunset  provision and a watered-down ISDS provision by choosing to invest in the largest consumer market in the region – the United States.

 

Receiving less attention than the US objective of reorienting global business investment away from its North American partners is the objective of creating future barriers to Chinese inroads into regional markets. The USMCA contains a provision that introduces impediments for any USMCA signatory seeking to conclude a free trade agreement with a “non-market” economy, which is implicitly a reference to China. This provision may make ratification of USMCA more challenging in Ottawa and Mexico City, but the Trump administration might not support the agreement without it.

 

Finally, it is worth considering some of the broader implications of USMCA. With this agreement concluded and negotiations under way with both Japan and the European Union on outstanding trade issues, the Trump administration will feel even more comfortable pursuing an aggressive line in any future negotiations with China. Second, the new content and labor requirements for the auto sector will have the effect of raising the cost of vehicles produced in North America for sale to North American consumers. Current producers in North America may thus have an incentive to move production outside of NAFTA signatory countries, and export back to those markets at a low 2.5 percent tariff rate. Knowing this, the Trump administration will likely pursue tariffs against European and Japanese vehicles or request adoption of voluntary export quotas during trade negotiations.

 

Make no mistake, from the Trump administration’s perspective, USMCA is not at all about expanding upon the traditional US commitment to free trade. Instead, it is part of a more mercantilist approach that prioritizes encouraging manufacturing production and employment within the United States. If this can be accomplished while also creating barriers to Chinese firms, all the better from the administration’s perspective.