By Daniel J. Ikenson
President Trump famously called the North American Free Trade Agreement “the worst trade deal ever made.” Bygones. The need to debate that claim has been mooted by the fact that NAFTA’s likely successor—the United States-Mexico-Canada Agreement—now holds that distinction.
There’s a reason that neither “Free” nor “Trade” appears in the agreement’s name. There isn’t much of any new trade liberalization in the deal. Then again, an agreement pursued with import reduction and supply chain repatriation as its main objectives was never going to be an exemplar of enlightened trade policy.
Instead, the deal reflects the shared objectives of the administration’s economic nationalists and Congress’s labor left, which were to strengthen the enforcement provisions and discourage companies from investing and operating factories in Mexico. These inducements come by way of the agreement’s streamlined labor and environmental provisions, onerous “rules of origin” requirements, unorthodox “sunset” provision, and the scaling back of investment and intellectual property protections.
To be sure, free trade and free trade agreements are very different animals. Free trade is an economic ideal and is a condition characterized by the absence of trade barriers. Free trade agreements are political creations built atop mercantilist fallacies and are not about “free trade,” per se. These deals include rules that simultaneously liberalize, divert, and stymie trade, capital, and labor flows. Liberalization is usually the organizing principle, but the specifics tend to constrain the liberalization. Trade barriers are lowered or eliminated in some provisions, while protectionism is baked into the others.
Free trade is about removing impediments that benefit some at the expense of others so that each of us individually has the fullest battery of choices to decide how best to use our own resources. Free trade agreements are about managed trade and labyrinthine rules intended to distribute particular benefits to particular interests.
No agreement illustrates these distinctions as clearly as the USMCA does.
To be fair, USMCA does “modernize” NAFTA to include rules restricting protectionism in digital trade, which wasn’t on our radars back in 1994 before the internet and e-commerce took off. The deal secures better access to the Canadian market for U.S. dairy farmers and winemakers. And, nearly all goods trade within the region will remain tariff-free.
Notably, the deal doesn’t include any significant new U.S. market-opening provisions, which really is unprecedented for a U.S. trade agreement. Despite U.S. consumers spending $9.2 trillion on services in 2017, a mere $550 billion (6%) was spent on imported services. By comparison, over 57 percent of the $4.1 trillion Americans spent on goods in 2017 was imported.
That large disparity betrays some significantly protected U.S. services markets, which USMCA does nothing to address. Instead, the deal reaffirms bans on foreign competition in maritime shipping, commercial air services, and trucking. The absence of foreign competition across our transportation services industries—as well as in our education, health care, and professional services industries—suggests that the USMCA could have been much more liberalizing.
The U.S. market is generally open to foreign investment already, but investment restrictions persist in certain industries, including financial services, commercial air services, communications, and mining. The USMCA provides no significant new access to foreign investors in the United States.
Likewise, it does nothing to open any wider the estimated $1.7 trillion U.S. government procurement market to bids from Canadian and Mexican companies. The absence of competition, of course, raises the cost of every government procurement project and ensures that taxpayer dollars get needlessly wasted.
But worse than the absence of liberalization is the abundance of provisions intended to raise the costs of investing in and importing from Mexico. Let’s start with the streamlined labor and environmental provisions. Opposition, over the years, to enforceable labor and environmental provisions in trade agreements has been predicated on concerns that demands for those kinds of provisions were not motivated by altruism or humanitarian aspirations, but by protectionist desires for access to triggers that could impede trade. The looming threat of an allegation of a labor provision violation against a Mexican factory, which could result in that factory suffering lost or impeded access to the U.S. market, would deter investment and retard the cultivation of business relationships.
That’s not a frivolous concern. Consider that for many U.S. and other western companies that contract out manufacturing, their biggest assets are their brand names. They don’t want to risk being associated with factories that engage in bad labor practices or that have big environmental footprints. Nor do they want to be vulnerable to allegations that the factories they are using are socially irresponsible. Mere allegations can affect the bottom line.
The labor and environmental provisions in the USMCA seem to be designed to be easily accessible. The burden of proof is reversed so that the factories accused of violations have to demonstrate how they have not breached commitments or, if they have breached, how that breach doesn’t significantly affect trade. Among other things, this reversal of the burden of proof reduces the cost to U.S. labor unions, for example, to render accusations that could lead to trade restrictions. This makes those accusations more likely. And that, in turn, makes more fraught, more uncertain, and more expensive any decisions by U.S. businesses (or business from other countries) to set up operations in Mexico.
The same is true for the USMCA’s “rules of origin,” especially with respect to trade in automobiles. Under current NAFTA rules, in order to qualify for duty-free treatment, at least 62.5 percent of the cost of the automobile must come from regional (U.S., Canada, Mexico) labor, material, and overhead. Cars that don’t meet this requirement are assessed a tariff of 2.5 percent of the total cost.
Under the new rules in USMCA, the benchmarks are much higher—75 percent of the cost must originate in the region. Moreover, 40 percent of that 75 percent (a total of 30 percent) must be made with labor earning at least $16 per hour. For reference, Mexican wages in auto assembly and production average in the single digits per hour. Furthermore, under USMCA, an additional rule to qualify is that 70 percent of the steel used in the automobile must come from the region.
In aggregate, these rules—contrary to expectations of a trade agreement—encourage less efficient production processes and virtually ensure higher costs and higher-priced products. And that, perversely, could result in more producers shifting North American production to Asia and elsewhere, and relying more on imports from outside the region. Paying a 2.5 percent tariff instead of zero-tariffs with much higher production and compliance costs might be the profit maximizing alternative.
The USMCA also includes an unorthodox provision that calls for the agreement to automatically terminate, unless the parties affirmatively agree to continue the deal. Agreement to continue can come as early as year 6, when discussion is open to air concerns and possibly negotiate changes to the provisions. If agreement is not reached, the parties will go through the process again, annually, through year 16 (if agreement to continue isn’t reached before then). If no agreement is reached after year 16, the deal terminates.
This provision needlessly injects a great deal of uncertainty into the agreement. How will investors and businesses that may be considering trans-national production evaluate their expected costs and projected revenues over a multiyear horizon if, one, the terms are subject to revision and, two, the whole deal could be terminated. This provision seems intended to discourage investment outside of the United States.
Finally, although I find investor and intellectual property protections to be unnecessary or at least “too protectionist” in typical U.S. trade and investment agreements, the considerable scaling back of these protections is also intended to raise the costs of investing in Mexico vis-à-vis the United States. There are greater risks to investing abroad than in the United States, and these kinds of provisions tend to mitigate those costs. Ambassador Lighthizer considers these rules to be subsidies for outsourcing, which the USMCA seems designed to snuff out.
Several editorials and articles, recently, expressed surprise and delight, and marveled at the fact that Lighthizer was deft enough to actually produce a trade agreement that not only attracts bipartisan support, but also the affirmative endorsement of organized labor. Labor hasn’t supported a major trade deal since the legislation implementing the Kennedy Round of GATT negotiations in 1967, and a Democratic majority hasn’t voted in favor of a trade agreement since the legislation implementing the Uruguay Round of GATT negotiations in 1994. So, this is, indeed, pretty rare.
But this outcome should not be viewed through the typical partisan prism. It’s not your traditional anti-trade Democrat vs. pro-trade Republican situation. It’s labor left and economic nationalist right, who strongly agree on managed trade outcomes and rules that keep investment and all jobs in the United States.
It wasn’t very difficult for Robert Lighthizer and AFL-CIO Chairman Richard Trumka (through his proxy, House Speaker Nancy Pelosi), two peas in a pod in their skepticism about trade, to agree on major provisions in a deal that has very little to do about liberalizing trade, but quite a lot to do about enforcement, protection, and other inducements aimed at muting an imaginary “giant sucking sound.”
There should be little doubt that the USMCA will win the approval of Congress. The Democrats are on board. And while the old Republican party would object to this deal, Trump’s GOP will not. The only remaining question is when.