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NAFTA talks are a major trade test for Trump

  • Talks to revamp the North American Free Trade Agreement begin Wednesday and could set the tone for other trade efforts by the Trump administration.
  • Analysts expect a new modern deal to emerge to replace NAFTA, but there are risks and points of disagreement.
  • U.S. proposals mimic the Trans-Pacific Partnership trade deal, which President Trump dropped.

Employees work on the body shell of an automobile on the production line inside the Suzuki Motor Corp. plant in Esztergom, Hungary
Akos Stiller | Bloomberg | Getty Images
Employees work on the body shell of an automobile on the production line inside the Suzuki Motor Corp. plant in Esztergom, Hungary

Talks that could set the tone for every other trade deal during the Trump administration start Wednesday, when Mexican and Canadian officials sit down in Washington to discuss the 23-year-old North American Free Trade Agreement that President Donald Trump had one time vowed to tear up.

Analysts say the odds are good the three sides will successfully update NAFTA by next year. Just resolving the technology issues alone will be a huge undertaking, since the agreement was written when cellphones were close to the size of a brick and there was no digital economy.

At the crux of the talks, initiated by the U.S., is Trump's concern that the U.S. has not been fairly treated under NAFTA, and China has been able to use the agreement as a backdoor to slip its goods into North America. One sore point for Trump has been that Mexico is running a more than $60 billion trade surplus with the U.S.

"For Mexico and Canada, a lot of their trade really is dependent on the U.S. Canada is the U.S. top trading partner, and after that it would be China. There's a lot at stake here. We've seen how the Trump administration negotiates. They kind of present the stick first and the carrot later," said Dana Peterson, U.S. and Canada economist at Citigroup. The U.S. had a $12.5 billion surplus with Canada in 2016, and it traded $628 billion in goods and services with the U.S. last year, compared with Mexico's $580 billion.

The negotiations are also a major test for the Trump administration, which has failed so far to win a legislative victory at home.

"I think as the administration struggle to put points on the political scoreboard, there's going to be a lot of focus on the renegotiation of NAFTA as a key indicator to move their agenda forward," said Jonathan Lieber, head of Eurasia Group's U.S. practice.

Lieber said the problem for the Trump administration is it will be hard to look like a winner on a new NAFTA deal. "If they put barriers on Mexican exports, they're going to have members of Congress condemning what they've done. It's going to be hard for them to spin it into a political victory," he said.

Analysts say the U.S. wish list for NAFTA looks a lot like the Trans-Pacific Partnership, which was a trade agreement that Trump opposed as a candidate and then threw out once he became president. The 12-nation deal included countries in the Western Hemisphere but also partners in Asia like Japan and Singapore.

"I think the likely outcome based on the body language so far is they get a minor rewrite of NAFTA to include some of the TPP-like rules," said Lieber.

The sectors that benefited the most from NAFTA are the automotive, agricultural and energy industries and they stand to lose the most of it falls apart. The automotive industry supply chain spans the three countries, with Mexico now a huge producer of both cars and parts. Peterson said the best case is that the negotiations wind up in six to eight sessions by December, and then be fast tracked so that it would be adopted before both the U.S. and Mexican elections next year.

"The worst-case scenario, which we assign a 10 percent probability, is someone exits, or the U.S. backs out," Peterson said.

Timing is also critical since the Mexican election next year could result in a different party in control that might decide to scuttle the talks, and there's also congressional elections in the U.S. "For Mexico, the main objective is to continue guaranteeing that Mexico has market access to the United States," said Juan Carlos Hartasanchez, senior director at Albright Stonebridge. He said Mexico wants to protect what is now in place in terms of no tarrifs, quotas or managed trade.

There are a few potential hurdles to a deal. One is a U.S. demand to change the way disputes are resolved. Instead of going to a panel made up of representatives of the three countries, U.S. negotiators are seeking to change the rule and open the door for resolution elsewhere, including U.S. courts. Canada and Mexico disagree.

"The Trump administration wants to have all options to protect U.S. trade," said Peterson. If the rule is changed, countries might then slap tariffs on offenders even before the cases are resolved.

The U.S. would also like to raise the level of duty-free import limits for e-commerce to the U.S. level of $800. Current threshold for Mexico is $50 and for Canada, just $20. Canadian retailers worry that e-commerce vendors will offer cheaper prices, and Mexicans are concerned such a move would open the door for cheap imports from Asia. This would be favorable for eBay and Amazon if adopted.

Another concern for Mexico and Canada is the U.S. push to put America first, and buy American.

"[Canada] wants greater access to government procurement contracts while the U.S. wants to restrict it and focus more on producing goods and services within the U.S. with people in the U.S.," Peterson said.

Canada also opposes U.S. efforts to limit the free flow of workers across borders, and the U.S. is complicating its relationship with Mexico by moving ahead with efforts to build a wall on the border, to help bar immigrants from entering.

The U.S. would also like to refocus the country of origin rules, which now require 40 percent content to be made in the country. "If you look at the U.S. objections in detail, they discuss rules of origin by stating that the new rules of origin should be reviewed to guarantee U.S. and North American products. They focus first on the U.S. which would be first thing for bilateral but you're trying to strengthen the region. If they push toward U.S. rules of origin that might complicate the negotiations," said Hartasanchez.

"If the conversation from the U.S. focuses on trying to reduce that trade deficit, through limiting, or high and unrealistic rules of origination, then we could be in a pretty bad situation. Mexico will have no other alternative than to walk away from the negotiations altogether," Hartasanchez said.

As part of the TPP, Mexico had agreed to environmental and labor changes that could put it more on par with the U.S., and Lieber said this could be a positive opening.

In Mexico, "The infrastructure has improved but the wages haven't so you still have employees in Michigan making $30 an hour with health-care benefits competing against someone making $5 in Mexico without health care," Lieber said. "If you can upscale some of the environmental rules you have in Canada and the United States, in Mexico, then suddenly you have a more level playing field for workers in the three countries."

There is also friction between the U.S. and Canada over dairy products and soft lumber, which the U.S. is now taxing at the border. "The U.S. objects to Canada having subsidies for dairy. Canada's argument has been the amount of U.S. exports to Canada are five times what Canada is shipping to the U.S.," Peterson said.

Update: Clarifies that the U.S. ran a trade surplus with Canada