Scenarios for Concluding the NAFTA Talks

Gary Clyde Hufbauer (PIIE) and Euijin Jung (PIIE)

July 24, 2017 3:00 PM

Canada and Mexico want to conclude the renegotiation of the North American Free Trade Agreement (NAFTA) by December 2017, but their hopes are likely to be frustrated. A main reason is that the US negotiating objectives, announced by the US Trade Representative (USTR) on July 17, are bound to trigger strong opposition in Ottawa and Mexico City, a recipe for impasse and lengthy negotiations to resolve it.

The only development that would speed negotiations would be the highly improbable capitulation by Canada and Mexico—or by the United States—to each other's demands. A converse outcome would be for the United States to drop the objectives opposed by Canada and Mexico and instead focus on "modernizing" NAFTA. A third possibility, also unlikely, would be an impasse leading to the US abrogation of NAFTA. But there is one way NAFTA talks might be concluded positively, which we outline below.

The three partners have announced an opening round of talks in Washington from August 16 to 20, followed in quick succession by six more rounds before the end of 2017. Canada and Mexico are hoping for a quick timetable to ensure minimal damage to the NAFTA fabric. But Commerce Secretary Wilbur Ross and US Ambassador Robert Lighthizer seek major changes, whatever the timetable. Considering the ambitious US objectives, it's very unlikely that agreement can be reached in four months. No significant US trade agreement has been concluded in such a short period.1 The task is particularly daunting for NAFTA: North American three-way merchandise trade of $1.1 trillion annually creates significant stakes for nearly every US and Mexican state and all the Canadian provinces.

Moreover, President Trump's penchant for restricting US imports in selected sectors—steel, aluminum, solar panels, semiconductors, washing machines, civil aircraft, and softwood lumber—may compel Canada and Mexico to insist that these disputes be considered in parallel to NAFTA talks, if not at the same table, which would be an additional burden.

At least five aggressive US objectives will trigger strong opposition in Ottawa and Mexico City:

  • the demand that trade in goods should be "balanced," implying that Mexico should unilaterally reduce its merchandise trade surplus with the United States, perhaps by voluntarily reducing exports or purchasing more American goods under pressure from Washington;
  • the call for tighter US and North American rules of origin—i.e., limits on the level of inputs made outside North America to qualify for lower tariffs when entering the United States—with the strong implication that changes should promote more US production, especially of autos and parts.
  • the suggestion that Canada and Mexico should open federal, state, and provincial procurement to US firms, coupled with the suggestion that US federal and state governments (and private pipeline companies) should "Buy American";
  • the proposal for asymmetrical investor-protection rules: US firms should be protected by an independent arbitration system operating under international jurisprudence when they invest in Canada or Mexico, but firms based in those countries should have sole recourse to US law; and
  • the demand to abolish both the special NAFTA Chapter 19 arbitration system for antidumping and countervailing duty cases, and the NAFTA exclusion for most US global safeguard cases.

Four possible outcomes can be envisaged from this mix of aggressive US objectives and fierce Canadian and Mexican resistance.

First, and most unlikely, Canada and Mexico might capitulate to these US demands. The leading candidate for the Mexican presidential election in July 2018, Andrés Manuel Lopez Obrador (AMLO), would surely reject this outcome given his lifelong populist credentials. Concessions offered by the sitting Mexican president, Enrique Pena Nieto, would very likely be renounced by his successor, whether AMLO or another candidate, just as President Trump renounced the Trans-Pacific Partnership (TPP). Nor could Canadian Prime Minister Justin Trudeau accept the US demands and retain a strong hold on his Liberal Party.

A converse outcome is that the United States might abandon the objectives opposed by Canada and Mexico and instead concentrate on "modernizing" NAFTA. That scenario would entail stronger enforcement of labor and environmental rules, disciplines that hold state-owned enterprises to private commercial standards, commitments that ensure the free flow of digital commerce, and fresh liberalization of services trade. Since Trump has condemned NAFTA as a "disaster," he could hardly applaud a "modernized" NAFTA that skirts the issues raised by Washington in the negotiations.

A third possible outcome is a deadlock that leads to termination of NAFTA, as Trump threatened during the campaign and most recently on April 27, 2017. For Mexico especially, but also for Canada, termination would disrupt supply chains that integrate the three North American economies and discourage inward investment to Canada and Mexico, dampening the region's future economic prospects. Without NAFTA, Canada could still rely on the Canada-US Free Trade Agreement (CUSFTA) of 1989, which was suspended when NAFTA entered into force in 1994 but never revoked. Even so, investment in Canada would suffer, since firms would wonder whether Trump's next step, after terminating NAFTA, might be terminating CUSFTA. In 2015, foreign firms, including US firms, held direct investment stocks of $756 billion in Canada and added another $49 billion that year.

For Mexico, the prospect of termination is much worse, since a great deal of inward direct investment in Mexico is oriented to the US market, and since Mexico has no fallback agreement if NAFTA is terminated. Mexico's inward direct investment stock from US and other foreign firms totaled $420 billion in 2015, and the inward flow was $30 billion. A termination would put these arrangements at risk and also jeopardize cooperation with the United States on security, drugs, immigration and other crucial areas.

Moreover, within the United States, NAFTA termination would disrupt the commercial lifeblood of numerous firms and communities dependent on the flow of imports and exports to and from Canada and Mexico. The "Do No Harm" pledge by Ambassador Lighthizer and Commerce Secretary Ross would become a dead letter, angering many Congress members from affected districts and states.

Is there a way out of these unlikely and damaging scenarios? Between these extreme scenarios is a fourth—"muddle through"—scenario that could paper over differences and avoid a confrontation or a surrender. Such a scenario finds precedent in trade battles with Japan during the 1980s and early 1990s. In that era, Presidents Ronald Reagan and George H.W. Bush extracted specific concessions from Japan on autos, semiconductors, steel, and other products, which were announced with fanfare. President Trump is similarly keen to trumpet concessions not only from trading partners but also from private firms—illustrated by China's partial liberalization of beef and rice and declarations of US investment by Carrier, Ford, Foxconn, and GM.

Mexico and Canada could offer concessions that not only please the Trump team but also make sense to their own economies—for example, greater natural gas purchases by Mexico and fewer dairy restrictions by Canada. Combining such "deliverables" with "modernization" themes, and making announcements from time to time in the months ahead, might ensure patience in the Trump team for NAFTA talks that will last far beyond December 2017. This "muddle through" scenario truly satisfies no one but in the end might prove barely acceptable to everyone. And of the four scenarios, it is the one most likely to occur.

Note

1. The US-Jordan FTA (2000) took five months from the start of FTA negotiations to signing, which is the shortest time for concluding a US free trade agreement.

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Gary Clyde Hufbauer Senior Research Staff
Euijin Jung Senior Research Staff

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