Five Flaws in the USMCA and How to Fix Them

August 6, 2019 10:00 AM
Photo Credit: 
REUTERS/Carlos Barria

The stars seem to be aligning for passage in September of President Donald Trump’s heralded and terribly flawed trade pact, the United States–Mexico–Canada Agreement (USMCA).

Republicans want to give Trump a signature victory; Democrats seem willing to accept it if the pact is reinforced by stronger enforcement of the labor and environment provisions. Business groups sent a flaccid letter of support to Congress, and labor leaders have muted their usual condemnations of trade pacts, in part because they like the new trade barriers. All seem to ignore, or worse misrepresent, the economic analysis of the pact issued by the US International Trade Commission (USITC) in April 2019.

Listen to Vice President Mike Pence’s stump speech on the USMCA and you would think that the trade pact will be an economic elixir for US firms, farmers, and workers. Read the USITC assessment and you come to a more downbeat conclusion: that on balance the pact would hurt rather than help the US economy, that US auto companies and workers would lose competitiveness, and that US farmers would be no better off than they are today under the existing trade regime (except for some dairy farmers).

In brief, the USMCA retains a lot of the existing North American Free Trade Agreement (NAFTA), borrows generously from the Trans-Pacific Partnership (TPP) that Trump and many Democrats condemned (mistakenly in my view), and introduces retrograde regulatory mandates and other restrictive measures that will distort North American trade and investment. It does not “ensure” market access for US exporters of farm and industrial goods any more than the existing NAFTA: Each country can still introduce new border restrictions for national security reasons (as Trump threatened to do against Mexico regarding immigration policies) or in retaliation against measures illegal under World Trade Organization rules (as Mexico and Canada did in response to US Section 232 tariffs on steel and aluminum).

Implementing the USMCA in its current form will make the United States worse off than it would be without it. Canada and Mexico also will suffer losses from the pact according to a new study by one of Canada’s top think tanks.

The following summarizes the major flaws of the pact and how to deal with them:

1. The USMCA introduces new trade protectionism that will constrain growth

First, the new protectionist measures the agreement introduces—restrictions on auto trade and investment, government procurement contracts, and textiles—will constrain US growth. Contrary to official US “fact sheets,” the USMCA will hurt the overall US economy unless those restrictions are removed or modified. While politically difficult, Congress should insist on improvements to remedy defects exposed by the USITC study.

Top White House officials misread the USITC report when they tout the USMCA as boosting US growth by 0.3 percent per year. In fact, the study estimates that on balance the market access provisions of the USMCA would restrict trade and cause US growth to decline by 0.12 percent.

Why the discrepancy? Unlike past US trade deals, the USMCA makes almost no changes to tariffs or nontariff barriers; such restrictions were removed years ago under the existing NAFTA. Trade liberalization under the USMCA, including the changes in US access to the Canadian dairy market, is limited and more than offset by the new protectionist measures.

The 0.3 percent growth is entirely due to USITC estimates that the USMCA will induce more US investment by reducing uncertainty in policies on data, ecommerce, and intellectual property rights. That analysis mistakenly credits the USMCA with achieving those gains. But those reforms are already part of Mexican and Canadian policy through the revised TPP that they have joined.[1] And those reforms generally are applied to all countries, so the United States already is a beneficiary.

Furthermore, the USITC cost-benefit analysis did not account for the additional uncertainty created by the “sunset clause,” a major new provision mandating that the pact expire in 16 years unless the three trading partners explicitly extend it. At the very least, North American businesses will have to make contingency plans for changes that could be introduced in the trade pact because of its possible termination. If the sunset clause had been considered by the USITC economists, the increased uncertainty would offset in whole or part the reduced uncertainty attributed to other parts of the agreement.[2]

2. New rules of origin will hurt US auto sector competitiveness

Second, the USMCA will hurt, not help, the US auto sector. The Trump administration argues that by requiring more domestic content and higher average wages at many Mexican facilities, the USMCA will encourage new investment in US auto plants. Pointing to past media releases and anecdotal comments by auto company executives, US trade officials claim the deal will promote $34 billion in new investment in US auto and parts production and increase US auto sector jobs by 7.6 percent.[3] In contrast, the USITC study concluded that the new auto rules of origin would increase US and Mexican production costs, which in turn would reduce US output, lower US auto exports to Canada and Mexico, and increase US imports from non-NAFTA countries (USITC, p. 86). Overall, the USMCA would raise the average price of vehicles in the US market and reduce US sales—hardly compatible with estimates of large increases in investment and employment in the sector.

Because the USMCA would increase the cost of producing vehicles in the United States, foreign suppliers would have an incentive instead to export more cars to the US market and pay the 2.5 percent import tariff. That’s why auto companies opposed the USMCA auto provisions during the trade negotiations, though they accepted the final deal for fear that Trump would implement his oft-repeated threat to pull out of NAFTA. And that’s why Trump needs to raise US tariffs to prevent increased car imports and why he is using the excuse of a threat to national security to impose Section 232 auto measures to block foreign shipments to the US market. Simply put, Trump needs to protect US producers against the damage done by his own trade pact.

Many Democrats, including Senator Elizabeth Warren in her recent trade manifesto, support Trump’s protectionist content rules despite the abundant evidence of its negative impact on US workers. That’s a mistake that should not be compounded by accepting additional auto trade protectionism through new Section 232 measures. If the USMCA rules can’t be changed, then Congress should minimize the damage by insisting that auto most-favored nation tariffs not be changed either.

3. Pharmaceutical patent rules need to better balance consumer interests

Third, the USMCA echoes the TPP by including patent terms that greatly benefit pharmaceutical companies (i.e., 10-year data exclusivity for patents on certain pharmaceuticals) and inadequately protect consumers.[4] Former Senate finance chairman Orrin Hatch insisted on measures to protect Big Pharma from generic competition; their inclusion in the TPP was among the reasons why many Democrats opposed that pact. Those concerns carry over to the USMCA.

In brief, the issue is about how to balance consumer and producer interests. Consumers want affordable prices; allowing competition from generic drug producers would reduce prices as well as monopoly profits of pharmaceutical patent holders. But those companies argue that reduced revenues would deprive them of resources for their research and development of new medicines.

Interestingly, other TPP participants also disliked the extended pharmaceutical patent protections and quickly expunged them when they revived the agreement under the banner of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Canada and Mexico accepted the deal without the patent provisions on biologics and presumably would be willing to do the same or accept a shorter term for data protection than in the current pact, if the US Congress asks to revise the USMCA.

4. Improved environmental provisions still fail to address climate change

Fourth, in the environmental area, the USMCA is “best in class” compared to trade agreements signed by other countries, with provisions for the enforcement of multilateral environmental agreements (MEAs), extensive disciplines on fishery subsidies, and new obligations regarding combatting marine litter that are “TPP-plus.” But more is needed.

Critics charge that the USMCA did not make enough progress because it maintains investor-state dispute settlement (ISDS) procedures in the energy sector (which they claim favor industry interests) and does not directly link the pact’s commitments to specific MEAs. The MEA language can be clarified with a few simple edits; the ISDS issue, while more politically charged, also could be recast: Trump officials never seemed committed to retaining it.

Oddly, despite considerable talk about a green new deal, congressional critics of the USMCA have missed one of the pact’s most egregious defects: It does not address global warming (also shunted aside by Obama negotiators for fear of losing Republican support for the TPP). The growing crisis is too critical to ignore any longer. At the very least, the USMCA should promote investment and trade in renewable energy resources and other measures to encourage low-carbon emissions. Officials could draw on specific provisions included in the recent EU-Mercosur trade pact promoting “domestic and international carbon markets” and “energy efficiency, low-emission technology and renewable energy” (EU-Mercosur pact, Article 13.6).

5. Labor improvements still need stronger enforcement provisions

Fifth, Congress should seek revisions to augment the labor provisions to ensure effective monitoring and full compliance with obligations to protect the freedom of association and other core labor rights. Like the environmental area, the labor chapter is far superior to previous US pacts: It builds on the TPP chapter and is subject to the pact’s dispute settlement procedures. But its improvements do not satisfy some US labor union leaders or meet all the demanding requirements of the May 10, 2007 congressional–executive branch trade policy agreement.

What should be done? House Democrats ought to give priority to revisions that ensure the expeditious and comprehensive phase-out of labor protection contracts in Mexico (i.e., collective bargaining agreements biased against worker interests). The new Mexican government of Andrés Manuel López Obrador already passed labor reforms required by the USMCA and should be amenable to additional procedures to strengthen labor rights. Rapid response measures to monitor USMCA obligations, building on constructive proposals by Senators Ron Wyden and Sherrod Brown, should be part of enhanced trilateral enforcement measures.

Conclusion

The USMCA cannot be considered and is not called a “free trade” agreement: It is the first US accord in recent memory to build up rather than break down trade barriers. It updates the 1994 NAFTA, but in most areas the “updated” provisions merely reiterate obligations that Canada and Mexico already apply as members of the CPTPP!

In other words, Mexico and Canada already have updated NAFTA by virtue of their CPTPP membership, providing most of the benefits to the United States for free. That’s the status quo. And it’s better than the current USMCA that distorts North American trade and investment and impairs economic growth in all three countries. Trade officials should get back to work on the five issues outlined above and return with a pact that truly enhances US competitiveness and growth.

Notes

1. The USITC study did not include in its baseline analysis reforms already adopted by Mexico and Canada under the revised TPP; gains from those reforms are attributed instead to similar provisions in the USMCA.

2. The USITC study notes that the authors received differing views on “whether and to what extent” the sunset clause would add uncertainty, and the economics literature did not provide adequate guidance for modeling the potential economic effects (USITC 2019, p. 17).

3. The USTR study, “Estimated Impact of the United States-Mexico-Canada Agreement on the US Automotive Sector,” was issued hours before the public release on April 18, 2019, of the USITC study, which reached quite different conclusions.

4. See the chapter “TPP and the Conflict over Drugs: Incentives for Innovation versus Access to Medicines” by Lee Branstetter in Trans-Pacific Partnership: An Assessment(Cimino-Isaacs and Schott, editors, 2016) and “The Pharma Compromise on TPP Is Good for US Consumers” by Caroline Freund (2015).