Major Hurdles Remain in NAFTA Renegotiation

by WILLIAM R. HAWKINS September 20, 2017

On September 5, the second round of talks to renegotiate the North American Free Trade Agreement (NAFTA) came to an end without a conclusion. The round lasted five days with discussions divided among 25 working groups. U.S. Trade Representative Robert Lighthizer claimed, as is usual in diplomacy, that progress has been made, "Our work continues at a record pace. By the end of this round, we will have tabled text for over two dozen chapters. These chapters represent a new modern agreement which, once concluded, will support robust economic growth in North America for decades to come. As you know, these negotiations are a very important priority for President Trump." Then he added, "But, as I alluded to in my opening round, we also must address the needs of those harmed by the current NAFTA, especially our manufacturing workers." And it is in the fulfillment of these goals, that were central to Donald Trumps election campaign, that the stumbling blocks remain. Mexico, obviously, does not want to lose the millions of jobs that have been outsourced across the border, nor do the corporations who sent those jobs south, in order to substitute cheap foreign labor for expensive American workers, want to reverse course.

            Having worked on this issue on Capitol Hill and elsewhere in Washington during the time NAFTA was originally being negotiated and implemented, I know the difference between how lobbyists portrayed the agreement and what was really intended by those business "advisers" who helped craft the deal. The public argument was that the U.S. trade surplus with Mexico was declining (which was true) and a "free trade" agreement was needed to open the Mexican market for more American-made exports. In reality, what American firms wanted was to combine their capital with Mexican labor to become more competitive with Asian rivals who had access to cheap labor in China and Southeast Asia. The idea was to import from Mexico rather than from Japan or China. They were driven to this strategy because the U.S. market was open to Asian rivals. Without domestic protection, the question was only to whom would American production and jobs be lost? One policy failure was prompting another.

            In August 1992, NAFTA was announced as completed by President George H. W. Bush, but it was not implemented by Congress until November of the following year and only after intense lobbying by President Bill Clinton and the transnational business community. In 1993, the U.S. still had a $1.6 billion trade surplus in goods with Mexico. By 2003, this had become a $40.6 billion deficit and last year the deficit was $64.4 billion. What is interesting is that Mexico's overall trade is in deficit, which means it is using the trade surplus with the U.S. to finance imports from other countries rather than conduct reciprocal trade within the NAFTA "partnership." In other words, Mexico has the money to buy American goods, but chooses not to. Mexico sells 81 percent of its merchandise exports in America, but buys only 46 percent of such imports from the U.S. 

            Some companies have benefited from this cross-border shift in production, but the U.S. as a country has not. And for those who argued that Mexico would become an export platform for hybrid Mex-American goods to go to world markets, the truth is that the only boost in Mexican-made exports has been to the U.S. Of Mexico's goods exports in 2015, $291 billion went to the U.S., $23 billion went to Canada (making $314 billion within NAFTA) and only $7 billion went to China. Yet, it imported $64 billion in goods from China. If Mexico cannot hold its own market against China, it is not going to be an export platform to compete with China elsewhere. Indeed, Mexico has been overrun by Chinese exports not only at home but in competition with its own exports to the U.S. The network of roads and railways (often called the NAFTA Highway) built to move goods from Mexico into the U.S. is now flooded with trucks and trains filled with Chinese products landed at Mexican ports that have been expanded to carry the traffic.  

            As economist Chen Jiang has argued, "Mexico and China have very similar exporting baskets, meaning the two countries ship similar products overseas every year. Since China's induction to the WTO in 2001, it has surpassed Mexico and has become the second largest exporter to U.S. market. In 2006, China also surpassed Mexico and became the U.S's second biggest business partner after Canada. With the rise of cheap Chinese products, Mexico has suffered greatly. Mexico is still heavily dependent on the U.S. market, but its share in the U.S. market has decreased." It is not that Mexico did not see this coming. It was the last country to give approval to China joining the WTO.

            Tighter rules of origin (or "regional content") would help stem the use of NAFTA benefits by non-NAFTA parties such as China and others. The Trump administration wants to do this, but Mexico is resisting. Goods only have to have 60 percent "regional value" or 50 percent "net cost" within the NAFTA area to qualify for duty free access to the U.S. market. This provides a huge hole through which third parties can bring "parts" into Mexico and use cheap labor to "assemble" them (with the use of arbitrary cost accounting) to essentially become part of NAFTA. Mexico liked this idea, so it could benefit from foreign investment from places other than the U.S. and Canada. It was a blunder by American trade diplomats to allow such low limits in their rush to get an agreement before the end of the Bush administration.

            President Donald Trump particularly wants to raise content requirements in the auto industry because numerous Japanese and German automakers have set up shop in Mexico to use NAFTA to further undermine this core U.S. industry. There are 19 auto manufacturing complexes in Mexico. Ten are American (4 for Ford, 3 each for GM and Chrysler) but 7 are Japanese and 2 are German. These transplants have made Mexico the fourth largest auto exporter in the world, but with only one real customer, the U.S. And much of the auto parts supply chain has also moved to Mexico. Expansion into other areas is also occurring south of the border, including components and assemblies for such strategic sectors as the medical industry, electronics, aviation and aerospace. These are industries the U.S. needs to control for its own security. 

            Canada also presents rules of origin problems centered mainly on China. Drugs imported from Asia are transformed into "Canadian" products that Americans assume are safe (or what to believe are safe because they are cheaper). Too often, however,  they are really just unhealthy Chinese concoctions flying under false colors. The rules of origin will only get worse as China seeks new areas of expansion focusing on massive investments across the region and especially in Mexican infrastructure. Reports indicate, however, that no progress has been made on this vital issue during the talks so far.

            U.S. negotiators want to raise wages in Mexico, but Mexican officials and American business lobbyists want labor issues kept out of the talks. Both want to keep jobs south of the border. Mexican autoworkers earn about $3.95 an hour, which is about ten percent of average wages in the United States and Canada sectors. And benefit packages are not even that comparable. If no progress is made on narrowing the wage gap that so undermines U.S. workers, the talks may collapse; as they should.  Only three days after the second round ended, Commerce Secretary Wilbur Ross said of the talks, "The president has made clear if they don't work, he's going to pull out." And he did not mean just from future talks, but from NAFTA itself.

            There probably is only one way to close the wage gap so that American workers do not have to compete with what amounts to slave labor and that is tariffs. President Trump has reportedly told his aides that he wants tariffs to protect U.S.-based industry and bring jobs back to the country.

            Protective tariffs were long part of The American System (a term coined by Whig Sen. Henry Clay in the 19th century and revived by President Trump as The American Model). They supported the nation's rise to global industrial leadership. Dealing with the wage gap with Mexico (and by extension with China and others) could entail a lesser version of trade restriction known as a "social tariff." This would impose duties on imports meant to equalize labor costs, but still allow other, positive forms of competition to continue, such as technological improvements in products or manufacturing processes. Competition should propel business upwards, not reward a "race to the bottom" based on who can treat their workers the worst. The trend is particularly acute when it is our fellow citizens whose job opportunities are being limited and incomes dragged down by pressures emanating from foreign lands. Government should not allow a business model to prosper that wants middle-class customers, but will not pay its own people middle-class incomes. That model weakens both the economy and society; and is incompatible with national strength and security.

            The next round of NAFTA talks opens September 23 and a fourth round is reportedly planned to start October 11. The Trump administration has hinted that an acceptable agreement must be drafted by the end of the year, or else. 

William R. Hawkins is a consultant specializing in international economic and national security issues. He is a former economics professor and Republican Congressional staff member.

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