NAFTA: Rock, Paper, Scissors

The North American Free Trade Agreement is more than 20 years old and should be updated.  This has been clear for several years.  It
was anticipated that the upgrade would be
part of the Trans-Pacific Partnership, which had entered its final stages of
negotiations before President Trump pulled the US out of the effort that it had
previously sponsored as part of the pivot to Asia. 

Trump is no fan of NAFTA, and it seemed that he was prepared to pull out of it as well.  However, he
apparently was persuaded, some say by Canada’s Prime Minister Trudeau, not to
abandon the agreement.  The new negotiations will begin tomorrow. 
The US and Mexico are particularly eager
for a fairly quick resolution.  Mexico holds elections in the middle of
next year, and although the US mid-term election in not until November 2018, there is concern that trade could be an
issue in the primaries.  In addition,
it is thought that the White House would
like a success in what has otherwise proved to be a lot of thunder with little
rain. 

The US runs a trade deficit with both Canada and Mexico. 
However, it does not appear to be a generalized lack of US competitiveness, as
some suggest.  Nor does it appear to be a function of some macroeconomic
imbalance.  The proper level of analysis is industry specific.  If it
weren’t for auto and auto parts, the US would run a trade surplus with
Mexico.  If it weren’t for energy, the US would record a trade surplus
with Canada. 

The US seeks to address the auto trade deficit with Mexico by adjusting
the rules of origin. 
The US will also try to grow its own exports in agriculture, telecom, internet-based transactions.  There is a
large discrepancy in labor relations in Mexico compared with the US and
Canada.  The initial agreement included a sidebar on labor rights, but was
never formally integrated.   Mexico has a weak legal environment for
workers and a large informal economy.    The concessions Mexico
made in the TPP negotiations may serve as a starting line, according to some
press reports, but it is a low bar.  The TPP agreement was simply to
enforce domestic labor laws. 

Addressing Canada’s bilateral
surplus will also prove difficult
. Canada has long been exempt from the
previous ban on US oil exports. There was a period earlier this year that China
imported more US oil than Canada. The US Commerce Department has recently
escalated longer-term simmering disputes over lumber and dairy.  It was hoped that the lumber dispute could be resolved before the NAFTA negotiations, but
this has not been the case.  

The Trump Administration’s trade strategy was part of a broader agenda
that included tax reform at home.
To the extent that globalization has come
to mean offshoring and extensive supply chains, Trump argued that it hurt
America.  To address this, he flirted with a border tax, that was pushed
by the Republican leadership in the House, until being dropped last month.
  Corporate tax cuts were also advocated to create disincentives to
offshore production.  Mexico, and to a less extent, Canada are not eager
to alter the extensive supply chains.   The global supply chains,
after all, were an important part of the economic development experienced in
Mexico and Asia in the last quarter of a century. 

The negotiations will begin off fairly easily and smoothly.  The
initial issues will be largely administrative: meetings’ agendas, the number of negotiating groups, and the process that leads to the compilation of a new
agreement.   Later in the negotiations more difficult issues will be
addressed, and of courses, the thorniest is not
resolved
if at all until the very end.    

The Trump Administration wants to include in the new agreement guidelines
on currency market manipulation. 
The Bank of Canada is now and
traditionally one of the most laissez faire central banks when it comes to exchange
rates.  Mexico is more interventionist, but
as the currency tends to depreciate over time, its intervention is mostly to
strengthen the currency.
  This
is what happened recently.  

Trump’s campaign rhetoric helped fuel sharp peso losses, and the central bank responded by changing its intervention
tactics to husband its reserves and
raised interest rates to address the inflation fed through from currency
depreciation.
  The function of the clause may be more about setting a
precedent, but the US needs to tread carefully
because it could find that such a clause hampers its degrees of freedom in the
future. 

One of the most difficult issues with the new NAFTA negotiations is the
Chapter 19 dispute resolution mechanism.
  Simply put, the rulings
often go against the US, and it is not
surprising that the Trump Administration wants to scrap them.  However,
Canada, and to a lesser extent Mexico, find protection against the US, which is
of course so much larger than Canada or Mexico.  Indeed, Canada appears to
have made this a critical issue.   This
warns of the risk of protracted negotiations, and possible brinkmanship
tactics.    NAFTA may not be
loved by any of the participants
, but there would be no winners if the
NAFTA were to collapse.  

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