US-Mexico-Canada Deal is a Conceptual Breakthrough But Details Will Be Critical

October 03, 2018

By Jeff Ferry, CPA Research Director

The three magic numbers for understanding the new US-Mexico-Canada trade agreement (USMCA) negotiated by the Trump administration are 16, 16, and 6.

Those numbers provide insight into a trade agreement that is conceptually revolutionary in the context of previous US trade agreements.  Donald Trump was elected president by voters who wanted him to shake up the bureaucratic world of trade and take unilateral US action where necessary for the betterment of US citizens, and he is doing just that.  He has corralled Canada and Mexico into accepting major modifications in concepts and goal that neither of those nations wanted.

However, it is still unclear how many details will play out. Provisions on the auto industry, currency rates, and dispute settlement are not yet fully understood. For that reason, the USMCA is best viewed as the beginning of a process. This is the first step in what will hopefully turn out to be a persistent campaign of improvement to make international trade work better for US workers, farmers, and domestic businesses. For that to happen, many further steps need to happen.

A New Target: $16/hour

The first 16 refers to the $16 an hour figure contained in the USMCA’s labour value content rule. This rule states that 40% of the value of an automobile must be produced by workers earning at least $16 an hour to meet the USMCA free trade criteria. This is the first time in any trade agreement anywhere that the parties agree that higher wages are a target for a trade agreement.(Mexican auto wages are about 75% below this level.) Previous trade agreements (when they were made public) droned on and on about trade and investment as if those were absolute benefits when in fact they are merely intermediate steps towards economic progress. David Ricardo, to cite one well-known economist was categorical that companies should invest in their home country. Now, 201 years after Ricardo published his magnum opus, this is acknowledged in a trade agreement. Companies should invest at home and governments should work to have workers’ incomes rise. And the further good news is that in two months a new populist Mexican president takes office. Let us hope he embraces these goals and uses his powers to work towards them.

My second 16 refers to the 16 year lifespan of this trade agreement.  The agreement states specifically (Ch. 34): “This Agreement shall terminate 16 years after the date of its entry into force, unless each Party confirms it wishes to continue the Agreement for a new 16-year term.”Previous trade agreements were designed to last forever. By putting a 16-year lifespan on the agreement, it’s clear that it is the duty of the US government to determine as that deadline approaches whether this agreement has been good for the American people or not. In fact, a review is required after the first six years. With NAFTA, it was abundantly clear after 24 years that the agreement had failed, with economists agreeing that it caused some one million lost jobs and irretrievably damaged many communities across the country. This is not as good as the US government’s original negotiating position of a five-year lifespan, but it’s still a big step in the right direction. Those free-trade economists who praise the free movement of investment and are criticizing this agreement because it will make investors think twice before investing outside the US are right about one thing: we want investors to think twice about exporting capital. We want them to invest in US industry. That’s the only durable way we can get our productivity, wages, and incomes to rise.

Finally, the number 6 refers to the 6 month notice that any USMCA party is required to give to the others should it begin trade agreement negotiations with a “non-market economy.” This is of course aimed directly at China, and reveals that the Trump administration sees the USMCA agreement as a stepping stone towards the ongoing, and intensifying, confrontation with the gorilla in the trade room. Only a few days ago, President Trump and Japanese prime minister Abe agreed to work together “to address unfair trading practices including intellectual property theft, forced technology transfer, trade-distorting industrial subsidies, distortions created by state-owned enterprises, and overcapacity.”By now signing a deal with Canada and Mexico, Trump is pulling our two North American partners closer to us as we work to change China’s trade behavior—or exclude it from a significant amount of trade with those nations that do respect international rules and norms.

Now, About Those Details….

Here is where assessment of the USMCA gets tricky. While the section on the auto industry rightly focuses on the need to rebuild US auto production, it’s not clear if the details of the agreement will deliver that end. The 75% rule of origin (ROO) on vehicle value created in the USMCA nations is a big step in the right direction. But it’s not clear if that will shift much production back into the US, because most US and Japanese companies already meet that standard with their production facilities in the three countries. It might encourage those foreign producers (mainly German) who are assembling cars in Mexico out of components manufactured in Europe to shift some production back to the US, and that would be a good thing. But the Mexican auto parts industry is already hailing the agreement for being likely to add a potential $10 billion to their top line and with it 80,000 new jobs. So the best we can say at this point is that the agreement should throw sand in the works of what once looked like an irresistible shift of manufacturing south of the border.

Next is the issue of currency. The USMCA spells out in some detail (Ch. 33) a new system for monitoring and reporting currency manipulation. A committee will be set up including members from all three nations to report annually on currency practices of the three members.  This is a new level of transparency for trade agreements, which have previously been carefully stage-managed by multinational corporations to keep the details well out of public view.

However, the core problem for US trade impacting both our manufacturing and our agricultural sector is that the US dollar is overvalued not because of manipulation but because of misalignment, in other words because the free market forces of the international capital markets have kept the dollar well above a trade-balancing level for four decades.  Indeed, in December 1994, eleven months after NAFTA came into force, the Mexican peso suddenly plummeted 50%, rendering all previous estimations of Mexico’s competitive advantage woeful underestimates. Few people saw that as manipulation—it was instead the result of capital markets reversing their opinion on the Mexican economy following rising imports and a minor guerrilla revolt in Chiapas. The USMCA simply repeats the language favored by the US Treasury and Wall Street about following “market-determined” exchange rates when those markets can be highly volatile and unpredictable. The US may need to take action to bring the dollar back to counter capital market forces that keep the dollar at an overvalued level. The language in the USMCA could potentially be interpreted to block such action and may need to be modified.

Finally, the agreement lacks any mention of country of origin labeling as a way to keep US consumers informed and help US farmers benefit from their hard work.  In 2013, following a World Trade Organization ruling, the US Congress abolished country of origin labeling for beef and pork. Cattle farmers subsequently suffered from rising imports and reduced incomes.

All of these shortcomings can be rectified over time. The Trump administration has broken with the past shameful record of trade agreements that prioritize multinational and Wall Street profits instead of US productive capacity and the earning power of the middle class. But more steps will need to be taken.

Showing 3 reactions

  • John R Hansen
    Excellent summary. Particularly important is your section on currency misalignment and the market forces that drive the dollar to such high levels that America’s producers cannot compete profitably at home or abroad.
    As you note, the current language totally fails to fix this problem. At a minimum the final agreement must not present any barriers to implementing the MAC in the near future. Even better would be language that endorses the MAC immediately.
  • Dave McMahan
    The Trump Administration, I believe, wants to stop the bleeding of job’s to Mexico, balanced with a desire for Mexico to be built up, economically. I think the Trump Administration (rightfully) is WAY more concerned about cutting down on our practices which have been greatly empowering to China and damaging to the USA. I think this reboot of NAFTA is a good step in the right direction.
  • James Crawford
    These are, indeed, positive conceptual breakthroughs in an international trade agreement. But the caveats and concerns identified above are enormously troubling. It is not enough, for example, to hope one has “thrown sand in the gears” of outsourcing.

    Businesses thrive and business plans become financible when their markets are growing and uncertainty is mitigated. Sound, industry specific industrial policy is the most direct and sure way to create these market conditions.

    The CPA’s focus on macroeconomics and trade agreements has prevented it from organizing its own members to engage in political action, form coalitions, and impact the elections of legislators.

    Following the progress of the CPA is like watching a man with one hand trying to clap, and being satisfied with having at least created a bit of a breeze.