UPDATE 2-U.S. takes tough lines as NAFTA negotiations begin

(Adds comments, background)

WASHINGTON, Aug 16 (Reuters) - The United States on Wednesday laid down a tough line for modernizing the North American Free Trade Agreement, demanding major changes to the pact that would reduce U.S. trade deficits with Mexico and Canada and increase U.S. content for autos.

Speaking at the start of the talks in Washington, U.S. President Donald Trump's top trade adviser, Robert Lighthizer, said Trump was not interested in "a mere tweaking" of the 23-year-old pact, which he blames for hundreds of thousands of job losses to Mexico.

"We feel that NAFTA has fundamentally failed many, many Americans and needs major improvement," Lighthizer, the U.S. Trade Representative, said in an opening statement.

Canadian and Mexican officials defended NAFTA and said its benefits and structure should be preserved while it is modernized.

Lighthizer said he would demand increased regional and U.S. content in autos produced in the region, the largest source of a $64-billion U.S. goods trade deficit with Mexico last year. He also said the United States would insist on strong provisions governing labor and currency practices.

"We need to ensure that the huge trade deficits do not continue and we have balance and reciprocity. This should be periodically reviewed," said Lighthizer. "The rules of origin, particularly on autos and auto parts, must require higher NAFTA content and substantial U.S. content."

The demand is at odds with auto producers and suppliers in the region, who are concerned that increasing local content requirements will raise their costs and make their factories less competitive with those in Asia and Europe.

Canadian Foreign Minister Chrystia Freeland, who suggested this week her country could walk away if the U.S. insisted on scrapping a NAFTA mechanism to resolve trade disputes, also took a swipe at the U.S. fixation on cutting its trade deficits.

"Canada does not view trade surpluses or deficits as a primary measure of whether a trading relationship works," she said in her opening statement. "Nonetheless, it's worth noting that our trade with the U.S. is balanced and mutually beneficial."

Mexican Economy Minister Ildefonso Guajardo said NAFTA stood as model of North American integration and the talks should aim to strengthen the continent's trade ties. "The issue is not tearing apart what has worked, but rather, how we make our agreement better," he said. "For a deal to be successful, it has to work for all parties involved. Otherwise, it is not a deal." Mexico is keen to maintain preferential access for its goods and services to the United States and Canada, where nearly 85 percent of its exports are shipped. Its NAFTA priorities also include greater integration of the continent's labor markets and energy sectors.

Canadian and Mexican delegations were not surprised by the Lighthizer's tough talk.

Raymond Bachand, the lead trade negotiator for the Canadian province of Quebec, said he was not worried by Lighthizer's remarks that the U.S. would not accept minor changes to the agreement.

"Mr Lighthizers speech was very focused on U.S. domestic policy. President Trump promised to renegotiate NAFTA," Bachand said. "There's a lot of strategizing going on today because it's clear that U.S. business circles have one objective do no harm," he told reporters.

The first round of meetings, which are expected to last until Sunday, will focus on consolidating the proposals from all three countries, a U.S. trade official said ahead of the talks, which are being held at a Washington hotel.

As the NAFTA talks began, Trump faced increasing political heat over his comments that both right-and left-wing extremists were responsible for violence at a white supremacist rally in Virginia on Saturday.

The biggest uncertainty in the NAFTA talks is whether a deal can pass Trump's "America First" test. Trump has constantly blamed NAFTA for shuttering U.S. factories and sending U.S. jobs to low-wage Mexico. The test will be whether NAFTA negotiators can prove to him that a new agreement alters that course.

Business communities from all three countries have called on the sides to "do no harm" amid concerns that a new agreement will unravel a complex North American network of manufacturing suppliers built around NAFTA.

U.S.-Canada-Mexico trade has quadrupled since NAFTA took effect in 1994, surpassing $1 trillion in 2015.

Robert Holleyman, a former deputy U.S. trade representative during the Obama administration, said the "toughest nut to crack" will be whether changes meet Trump's goal of reducing the trade deficit.

"We know where he wants to make changes to NAFTA. Whether those changes lead up to something that actually reduces the trade deficit with Mexico is wholly unclear," Holleyman said.

NAFTA renegotiation will be a major test of Trump's ability to meet his campaign promises to restore U.S. manufacturing jobs. Although he has inherited a strong economy that has added 1.29 million jobs this year, his promises of an ambitious legislative agenda have been derailed by the failure of a healthcare bill and the lack of a detailed plan for tax reform.

Also weighing heavily over the talks is the upcoming 2018 Mexico presidential election. Mexico has urged all sides to complete the negotiations before the campaign ramps up in February to avoid it becoming a political punching bag.

(Additional reporting by Lesley Wroughton, David Lawder and Ginger Gibson; Editing by Leslie Adler and Nick Zieminski)