Following Up: Still Lots of Unanswered Questions About that Trump NAFTA Revamp

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auto parts, autos, Canada, domestic content, Following Up, Mexico, NAFTA, national security, North American Free Trade Agreement, rules of origin, Trade, Trump, World Trade Organization, WTO

In recent days, the Trump administration has reached a trade deal with Mexico that either may or may not fundamentally rework the North American Free Trade Agreement (NAFTA). I say “may or may not” because above and beyond the question of whether the third NAFTA signatory, Canada, will actually go along, and whether Congress will agree to consider a bilateral as opposed to a trilateral deal, some of the most important provisions of the bilateral U.S.-Mexico pact remain unknown to the public.

In particular, it’s completely unclear what the United States and Mexico have agreed to regarding the rules of origin for automotive products traded within the NAFTA zone. In fact, it’s completely unclear whether what they reportedly have agreed to is an agreement at all.

To remind: The rules of origin specify how much of a product (in this case, most motor vehicles as well as all automotive parts) needs to be made inside North America in order to qualify for tariff-free treatment when its sold in any of the signatory countries. The idea – totally reasonable, in my opinion – is to make sure that as many of the benefits of a trade deal as possible flow to the signatories (which of course, legally need to incur all of the obligations) and don’t leak out to non-signatories (which of course legally need to incur none of the obligations).

Automotive trade is crucial in this respect because vehicles and parts combined last year made up nearly a third of all U.S. merchandise imports from Mexico, and (revealingly) 9.65 percent of the considerably smaller amount of U.S. goods exports to Mexico.

As I’ve repeatedly observed, the original NAFTA failed to achieve this objective. And the main problem was not the level of North American content required for duty-free treatment (62.5 percent). The main problem was that the penalty for ignoring the rules was so negligible (a 2.5 percent tariff). And it appears that even though the content requirement has been increased (to 75 percent), the meager penalty remains. Reportedly, it’s also the only obstacle to automakers ignoring the new requirement that 40 to 45 percent of a vehicle be made by workers earning at least $16 per hour.

So it’s entirely reasonable to finish most news accounts and conclude that the new U.S.-Mexico treaty will do little to achieve its stated goal of inducing automakers based outside North America to move production and jobs inside North America.

Complicating matters, though, are some wrinkles in the U.S.-Mexico deal that have been reported in the days since the agreement was first announced. Principally, according to some news accounts, much higher 25 percent tariffs will be imposed on vehicles assembled in Mexico and sent to the U.S. market once the number of those vehicles exceeds 2.4 million. Therefore, the actual automotive rules of origin may well have been genuinely toughened.

Nevertheless, for several reasons, this conclusion, too, needs to be qualified. For Mexico exported only 1.8 million passenger cars and sport-utility vehicles to the United States last year. So its sales would need to rise considerably before that genuine toughening kicks in. Second – and again, reportedly – this provision of the agreement is contained in a side letter. The apparent failure to include it in the core text of the agreement raises questions about its enforceability – especially since the same reports indicate that under it, Mexico retains the right to challenge those higher tariffs at the World Trade Organization (WTO). Moreover, I’ve seen absolutely nothing about any quotas for imports of auto parts as such from Mexico – which are currently running at an annual rate topping $16 billion.

That could actually be good news for the United States – because the auto tariffs (again, reportedly) would be based on the U.S. trade law that authorizes Washington to impose levies based on national security considerations. Such trade curbs are legal under WTO rules because the creators of even this sovereignty-impinging arrangement recognized that no major powers would ever surrender their right to assess and act on their national security interests. It’s plausible, therefore, to believe that today’s WTO majority would shy away from challenging this kind of decision by Washington, however damaging it might be to their exports, for fear of provoking a U.S. walkout and thus the organization’s demise.

But there’s no guarantee of this outcome – especially if or when a more WTO-friendly administration replaces Mr. Trump’s in Washington.

It’s true that an eventual Trump decision to impose lofty national security-justified auto tariffs on non-North American auto-makers would render many of these questions moot – because even if Mexico was exempted, and those companies therefore could keep supplying the American market through that channel, they’d quickly run up against the quota (assuming of course that one exists).

Yet this auto tariff decision seems to lie pretty far down the road. In the meantime, the NAFTA decision continues to look pretty confusing. I’m just hoping that this post will make your confusion a little more informed.

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(What’s Left of) Our Economy: The Case that Trump Has Blown a Big NAFTA Opportunity

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autos, Bloomberg.com, Canada, domestic content, Mexico, NAFTA, North American Free Trade Agreement, rules of origin, Trade, Trump, U.S. Transportation Department, World Trade Organization, WTO, {What's Left of) Our Economy

Suppose the U.S. government punished certain types of tax cheating with the financial equivalent of a wrist slap (and no reimbursement requirement), and then announced that some more types of tax cheating would be punished with that same wrist slap. Chances are, unless you had moral qualms about any kind of tax cheating, you’d keep on cheating because even if you were caught every year, your gains would be well worth a marginal fine.

Now let’s suppose that Washington announced that all tax cheating would result in a truly massive and mandatory fine. Chances are you’d become a model taxpayer, or close to it, if your chances of being caught were relatively small.

If this makes sense to you, then you understand one of the main problems that’s plagued the United States since the advent of the North American Free Trade Agreement (NAFTA), and chances are you recognize why what we know of President Trump’s new NAFTA revamp agreement with Mexico leaves that problem almost fully intact.

Although it seems like a big deal that the revised terms require that 75 percent of an automobile be made within the NAFTA free trade zone to qualify for duty-free treatment rather than the current 62.5 percent, as I’ve repeatedly explained, the decision to keep the tariff punishment for noncompliance at 2.5 percent still renders these “rules of origin” toothless. For any automaker whose home base is either inside of outside North America and that’s worth his or her salt should be able to find 2.5 percent cost-savings to offset the levy, or remain plenty profitable even without such offsets. And the high levels of non-North American content that continue to characterize so many vehicles sold inside North America make clear these companies have succeeded in one or both respects.

In other words, because non-compliance is so relatively painless, the existing rules of origin were not stringent or smart enough to achieve their stated aim of luring much automotive production and employment from outside North America to inside North America, and the new rules are no likelier to work any better.

P.S. – the national governments of these non-North American auto producers have always been able easily to help their companies cope with the NAFTA content requirements through a variety of policies – e.g., providing them with new or bigger tax breaks or subsidies, or devaluing their currencies. And because the external NAFTA tariff remains so low, these tactics, too, remain as capable as ever of frustrating the intent of the origin rules.

Even more frustrating for those who hoped for a game-changing NAFTA rewrite, the exact same flaw sandbags the Trump administration’s win with Mexico concerning its separate proposal that duty-free treatment inside North America apply only to vehicles containing 40-45 percent content from factories paying hourly wages greater than $16.

A new piece on Bloomberg.com helpfully confirms the general point about the pointlessness of such a low external tariff, but even more helpfully (if less wittingly) underscores what an immense opportunity has been missed by the administration’s failure to boost these levies.

The article uses U.S. Transportation Department data to show that only three vehicle models currently assembled in Mexico of the 39 sold to Americans would be tariff-ed under the new origin rules regime – and that only one of these is a significant seller in the American market. For Canadian-assembled vehicles, the number that would be affected by the new origin rules is higher – but it’s still only six of the 19 total.

But these Transportation Department data also make clear how likely a much higher tariff would be to shift automotive output and employment to North America. The key is how many of those Mexico-and Canada-assembled vehicles exported to the United States would fall below the 75 percent threshold. and therefore would cost lots more to sell to Americans (say, the 25 percent suggested by Mr. Trump for proposed national security-based automotive tariffs). For Mexico, the number would be 25, or some 64 percent of the number of models its assemblers send to the United States. For Canada, it’s twelve of the 19, or 63 percent.

These numbers as such don’t tell us how many actual vehicles exported from both countries would face these much higher tariffs. But according to the authors, although that figure is a significantly lower than the model percentage number would indicate, it would still represent nearly a third of U.S. vehicle imports from Mexico. Therefore, the costs of noncompliance with the origin rules would be far from chump change for the non-North American producers. (This one-third number also counts cars that would be affected by a separate requirement that 40 to 45 percent of the content of an vehicle come from factories paying at least $16 per hour in order to avoid tariffs.) Exact statistics for Canadian exports aren’t provided, but the authors describe it as “likely” to be similar.

None of the above contradicts the observation that NAFTA external tariffs greater than 2.5 percent would violate America’s World Trade Organization (WTO) commitments. But since when has the Trump administration had use for that regime – or for the previous U.S. trade policies that spearheaded its creation? In addition, why has President Trump not recognized that much higher NAFTA external tariffs – applied, along with universal rules of origin – would solve most of the biggest and chronic U.S. trade problems he’s complained about with foreign rivals like China, Germany and the European Union, Japan, and South Korea.

The answers to date remain unclear at best. What’s perfectly clear, though, is that although President Trump is often portrayed as a disrupter, his new NAFTA deal with Mexico is anything but.

(What’s Left of) Our Economy: Is Trump Finally Getting It on NAFTA?

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automotive, Bill Clinton, Canada, Inside U.S. Trade, Mexico, NAFTA, North American Free Trade Agreement, Politico, Ronald Reagan, rules of origin, tariffs, Trade, Trump, World Trade Organization, WTO, {What's Left of) Our Economy

It’s still unconfirmed, but if true, a development reported in the (usually reliable) newsletter Inside U.S. Trade would reveal that the Trump administration is finally recognizing a major weakness in its approach to revising the North American Free Trade Agreement (NAFTA). And special bonus – the proposal in question would also go far toward solving the trade problems with China and most of the rest of the world that have been rightly identified by the administration.

Here’s a good summary of the scoop provided Tuesday by Politico:

“Three sources close to the [NAFTA] talks said the U.S. has demanded that Mexico, and possibly Canada, accept a higher tariff rate for autos that don’t meet the pact’s new content rules. That would essentially force companies that build cars in Mexico to agree to have exports to the U.S. that don’t conform to the rule be subject to a tariff beyond the 2.5 percent rate Washington bound itself to at the World Trade Organization. USTR [the Office of the U.S. Trade Representative] also declined to confirm this development….”

The key here is the point about higher tariffs. The three NAFTA signatories have now come to agree that the treaty’s regional content rules need to be made more strict. So far, in order to qualify for tariff-free treatment anywhere inside North America, autos and light trucks (which comprise an outsized share of intra-North American trade, and have attracted the most attention in the talks) need to be made of 62.5 percent North American parts and components. The aim, at least ostensibly, has been to encourage producers outside North America to relocate production and jobs inside the free trade zone.

The Trump administration has been pressing to raise the content levels needed for such tariff-free treatment to at least 70 percent for passenger vehicles, and reportedly Mexico is now on board in principle (though the exact number has yet to be agreed on). But so far, the administration has not demonstrated much, if any, awareness that higher mandated local content levels alone won’t bring many new factories or jobs to the signatory countries – and have under-performed on this front so far – for a very simple reason. As I’ve noted repeatedly, the penalty that non-North American producers need to pay for non-compliance is only 2.5 percent – an extra cost they can easily absorb.

The Inside U.S. Trade item suggests that this point has been taken, which would be great news for all three NAFTA countries if the eternal tariff is raised high enough to foster North American production and discourage imports. Even better, this proposal – which would essentially turn North America into a genuine trade bloc if extended to all traded goods and services – would by definition limit American imports from all the countries long regarded in Washington as troublesome trade partners (like China, Germany, and Japan). For they would all find it much more difficult to supply the United States – along with Canada and Mexico – with exports, and would face great pressure to serve North American customers instead with products overwhelmingly made in the free trade zone by North American workers.

It’s true that an increase in the external NAFTA tariff would violate WTO rules and would therefore expose all three North American economies to retaliation from outside the continent. But all three countries have run chronic trade deficits with the rest of the world, so they stand to come out ahead if a full-fledged trade conflict actually resulted. And as former President Ronald Reagan emphasized when he originally broached the subject (back in 1979), North America is self-sufficient, or could easily become so, in every significant product or service used by a prosperous economy.

Indeed, Reagan subsequently and explicitly contended that NAFTA was needed as a trade bloc to fend off the challenges posed by regional consolidation in Europe and East Asia. (The Wall Street Journal article in which this argument was made is now behind a pay wall, but the quote is found in my Marketwatch.com op-ed linked above.)  So did former President Bill Clinton. Both were known – and rightly so – as free trade supporters. Donald Trump, a decided free trade skeptic, should settle for no less.

(What’s Left of) Our Economy: The Deepening Mystery of Trump’s NAFTA Strategy

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autos, Canada, light trucks, manufacturing, Mexico, NAFTA, Nick Carey, North American Free Trade Agreement, Reuters, ROO, rules of origin, tariffs, Trade, Trump, wages, {What's Left of) Our Economy

The Trump administration’s approach to the North American Free Trade Agreement (NAFTA) keeps getting murkier. And although I agree that keeping the other parties to a negotiation off balance from time to time, and holding cards close to one’s vest, can be excellent tactics, the latest apparent twist in American policy doesn’t appear to be explained by such considerations.

Let’s start with the excellent insight contained in a Reuters article today about one of the centerpieces of NAFTA reform identified by the administration – the rules of origin (ROO) for autos and other light-duty passenger vehicles. These treaty provisions have been rightly targeted by Team Trump negotiators from the standpoint of U.S. interests because motor vehicles and parts comprise such a large percentage of the goods exchanged throughout North America, and because since NAFTA went into effect, contrary to its supporters’ promises, the American automotive sector has become less, not more globally competitive.

The NAFTA ROO are ostensibly aimed at encouraging automotive manufacturing inside North America and currently require that 62.5 percent of a vehicle’s value come from within the free trade zone in order to be exempted from tariffs. The administration’s response is widely described as a toughening of these rules because it would raise this threshold to 75 percent.

But there’s always been one huge catch that I’ve been tweeting about consistently: Unless the tariff penalty imposed on vehicle and parts-makers outside North America is greatly increased, boosting the duty-free content threshold will have little impact on these companies’ production and employment decisions. The reason? The current NAFTA external tariff on these products is only 2.5 percent. (Just FYI, this point was first made during the original NAFTA debate, in this Economic Strategy Institute study to which I contributed modestly.)

(What’s Left of) Our Economy: Why Trump was Still Right to Nix Obama’s TPP Trade Deal

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Asia, Barack Obama, bilateral trade agreements, China, export-led growth, mercantilism, multilateral trade agreements, non-tariff barriers, rules of origin, subsidies, tariffs, tech transfer, TPP, trade surpluses, Trans-Pacific Partnership, Trump, {What's Left of) Our Economy

At first I was irritated with President Trump for his expressions of interest this year in reviving U.S. efforts to join the Trans-Pacific Partnership (TPP) – the Pacific Rim-wide trade agreement that former President Barack Obama couldn’t persuade Congress to ratify, and that Mr. Trump removed from America’s policy agenda during his first week in office.

I still wish the President had kept the TPP consigned to the proverbial ash heap of history. But I do see one silver lining in his apparent about-face: the new opportunity it creates to remind how awful the Obama TPP was, and in particular how cynical the case that it represented a masterful ploy to contain the rise of Chinese power regionally and globally, and even shape it to serve America’s goals of sustaining an open world trading system.

In fact, it’s entirely possible that Mr. Trump’s apparent new openness to TPP results at least partly from widespread claims from mainstream politicians and analysts that its multilateral nature endowed the deal with much more potential to curb China’s trade predation than the unilateral tariffs he’s announced.

Yet this contention is the one that’s most easily refuted. First, the version of the treaty signed by Obama contained a wide open back door for many Chinese exports by allowing goods that contained high levels of content produced outside the TPP zone to be traded freely within the zone. Given how central China is to Asia-wide production chains, these loose rules of origin were bound to enable China to enjoy crucial benefits created by the TPP without incurring any of the obligations.

Second, until the eve of its departure from office, neither the Obama administration nor any TPP supporters in Congress or the mainstream media or the think tank world lifted anything more than the occasional pinky even to protest perhaps the principal source of China’s rising economic and military power – the massive transfer of cutting edge knowhow, along with capital, from U.S. tech companies to Chinese business partners or other institutions, either voluntarily (including through shortsighted training programs and investments in Chinese entities) or involuntarily (due to Beijing’s widespread practice of linking access to the China market to the handover of critical technology).

The sudden transformation of these corporate panda-huggers and their hired American guns into China skeptics and even hawks has demonstrated nothing more than that national security is the last refuge of a trade policy scoundrel – especially since by all accounts, U.S. technology and investment continue pouring into China – including defense-related tech. (See here and here for some evidence.)

Third, there’s no reason to believe that most of the other key TPP members have any interest in turning China into a free-trading economy. Quite the contrary. Whether it’s Japan or Singapore or Vietnam or Malaysia, most of the treaty’s most important countries have followed China-style economic development models (except when they’ve borrowed from Japan’s somewhat different but of course much earlier blueprint). And economic openness emphatically isn’t in the recipe. What’s central to these strategies is amassing trade surpluses with the United States and the rest of the world to help generate adequate levels of growth and employment.

The bottom line: Most TPP countries knew that effective disciplines on the trade predation largely responsible for China’s surpluses could be used against their own subsidies and non-tariff barriers. Conversely, it’s surely the reason that these economies accepted the paper curbs on mercantilism that are mandated by TPP. They’re rightly confident that thanks to the secretive bureaucracies that keep their economies effectively closed – and their barriers difficult for outsiders even to identify, much less litigate – none of these curbs is remotely enforceable.

Even better for TPP’s mercantile majority, the treaty’s dispute-resolution system ensured that the United States would be repeatedly outvoted when it sought to advance or defend its interests.

That’s why the TPP was so likely to supercharge America’s already enormous and economically damaging trade deficits. The TPP mercantilists’ liberalization promises would do nothing substantial to open their markets and increase U.S. export opportunities. But America’s TPP commitments, carried out by a government characterized by transparency, would be very effective guarantees that the American market would remain wide open to the TPP majority’s products.

President Trump has demonstrated that he recognizes many of these fatal flaws in the Obama TPP. His stated preference for bilateral over multilateral trade deals suggests an understanding that the former give the United States much more legal authority in dispute resolution. Moreover, he has explicitly tweeted that he’d only back rejoining the TPP if major fixes were made.

Precisely because he’s the only American President in recent memory to show any interest in changing the nation’s ill-considered trade status quo, and any awareness that the United States retains ample leverage to achieve its trade objectives unilaterally, I can’t rule out the possibility that Mr. Trump might turn TPP into a winner for the U.S. domestic economy (as opposed to the importing and offshoring lobbies).

But the main lesson that should be taken from decades of American trade diplomacy with Asia is that economies structured to promote exports and limit imports are going to stay substantially closed no matter what promises they make. Therefore the best course for the United States to make is to expend its energy and resources on reducing its economic engagement with Asia, rather than trying to remake the region in anything like its own image.

(What’s Left of) Our Economy: Flunking the NAFTA Laugh Test

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American Automobile Labeling Act, American Automotive Policy Council, auto parts, autos, Canada, domestic content, GDP, ImpactEcon, Jobs, light trucks, Mexico, Motor & Equipment Manufacturers Association, NAFTA, North American Free Trade Agreement, rules of origin, tariffs, Trade, Trump, {What's Left of) Our Economy

Remember the wonderful David Letterman show feature “Stupid Pet Tricks”? I couldn’t help but think of it while reading various news reports and analyses claiming that the demise of the North American Free Trade Agreement (NAFTA) will bring apocalyptic consequences to three signatory countries: the United States, Canada, and Mexico. But my parents always told me never to use the (needlessly harsh) word “stupid.” So instead, I’ll call them, “Silly NAFTA Studies.” Examining two that have attracted major attention will make clear why.

First, let’s look at findings released in August by a Colorado consulting firm called ImpactEcon, and revised in October, that was mindlessly written up by The New York Times, The Wall Street Journal, CNN.com, The Los Angeles Times, and many other big news organizations. According to this report:

“Overall, the results show that the US’s reversal of NAFTA leads to a decline in real GDP, trade and investment in the US, Canada and Mexico, with most of the losses resulting from Canada and Mexico’s reciprocation. The losses in low skilled employment are most significant, with employment declining by 256,000, 125,000, and 951,000 in the US, Canada and Mexico respectively. Production and specialization of production across the NAFTA region declines, particularly in those sectors with the highest levels of vertical specialization across NAFTA. The motor vehicles and services sectors in all three NAFTA countries decline, along with production of US meat, food, and textiles; Canadian chemicals and metals; and Mexican textiles, wearing apparel, electronics and machinery.”

Sounds awful, right? And especially dumb for President Trump, who won the votes of many American workers without glitzy high tech skills.

But buried here – glossed over in the press accounts – are results that should be screamingly obvious to anyone knowing anything about intra-NAFTA trade balances, the Canadian and Mexican economies, and in particular their heavy dependence on exporting to the United States: Canada and Mexico take much greater growth and employment hits from NAFTA’s termination than does America.

The passage quoted above shows a major gulf between the projected job impacts.  But the differential effects on real growth rates are even greater – and more threatening to Mexico and Canada. (The researchers assume that all three countries return their tariffs to pre-NAFTA levels.)

Real GDP:

U.S.: -0.09 percent

Canada: -0.48 percent

Mexico: -0.88 percent

And keep in mind two other considerations: The Canadian and Mexican economies are much smaller than the U.S.’ So the jobs losses are much more important for them, relatively speaking. Moreover, Mexico is still a developing country with real political stability problems. Growth and employment shocks like this would spell big, and possibly fatal, trouble for its ruling classes.

In fact, the damage to Canada and Mexico is so great that the (closely related) policy conclusions couldn’t be clearer (except to economics reporters). First, America’s NAFTA partners simply can’t afford to retaliate against the United States if the treaty is terminated; and second, as a result, a walk-out by them is wildly improbable unless Washington’s demands are positively draconian.

The second silly study (and related press coverage) comes from the Motor & Equipment Manufacturers Association (MEMA) – the trade association of an industry that has moved massive amounts of production and jobs to Mexico (much of it from the United States), largely to serve the American market, not the Mexican market or third country markets.

So obviously, the group’s findings should be viewed skeptically. Additionally, however, MEMA assumes (along with the ImpactEcon findings and another study – from another offshorers’ organization – the American Automotive Policy Council), that higher NAFTA requirements for origin rules will leave external tariffs low enough to enable auto manufacturers to ignore the standards and keep shipping product with lots of content from outside the hemisphere all around the free trade zone. Worse, without higher enforcement tariffs, the auto industry might also supply American customers to an even greater extent from even lower-cost economies, like those in Asia.

It’s true that the Trump administration hasn’t discussed raising those tariffs to levels that would bite. It’s also true that these moves would violate all three NAFTA countries’ World Trade Organization commitments on bound tariffs, and similar promises they’ve made in their other trade deals. But the folly of preserving that status quo is so clear cut that it’s entirely reasonable to expect a Trump-ian learning curve. And the President does prize his reputation as a disrupter.

Moreover, all he needs to do is look at the situation for sport utility vehicles and other so-called “light trucks.” Since their non-NAFTA U.S. tariff remains at 25 percent, even staunch opponents of a major treaty rewrite conceded that factories will return stateside if this status quo ante comes back. And P.S.: These products are increasingly dominating American passenger vehicle markets.

A second substantive reason for discounting this study concerns the auto parts makers’ claim that “Raising the automotive content thresholds and forcing automakers to verify the North American origin of more electronics and other parts now sourced from Asia would cause some parts manufacturers to forego NAFTA benefits.”

As just mentioned, the second fear is warranted if tariffs for the origin rules stay where they are. But the point about forcing the companies to verify where their inputs come from? Vehicle makers have already required to provide exactly this information for NAFTA’s entire life by the American Automobile Labeling Act. And they clearly view NAFTA as a huge success. Many companies in the parts supply chain are much smaller, and detailed reporting could indeed become an unreasonable burden for them. But many parts makers are plenty big enough to assume this responsibility easily (unless they don’t know where they themselves manufacture?). Much more important: The information would greatly aid policymakers and the public in (finally!) evaluating the impact of trade agreements and related policy decisions with a critical mass of precision.

(What’s Left of) Our Economy: Trump’s NAFTA Rewrite Blueprint is an Encouraging Start

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bubbles, Buy American, Canada, dispute resolution, environmental standards, GATT, General Agreement on Tariffs and Trade, government procurement, labor standards, manufacturing, Mexico, NAFTA, national treatment, non-discrimination, North American Free Trade Agreement, reciprocity, rules of origin, tariffs, TPP, Trade, trade deficit, trade enforcement, trade laws, Trans-Pacific Partnership, Trump, value-added taxes, VATs, World Trade Organization, WTO, {What's Left of) Our Economy

The Trump administration is out with its detailed statement of renegotiation objectives for the North American Free Trade Agreement (NAFTA), and if you’ve favored turning U.S. trade policy from an engine of debt-creation and offshoring into one of production-fueled growth and domestic job creation, you should be pretty pleased.

As critics have noted, yesterday’s statement does lack numerous important details about how the administration intends to achieve its goals, and some of these omissions (as will be explained) raise legitimate questions about the depth of the president’s commitment to these changes. But the statute requiring the release of such statements doesn’t mandate disclosure of every – or any – specific strategy for reaching these goals. Moreover, the talks haven’t even started, and these tactics naturally tend to change with circumstances. So those accusing the administration of excessive vagueness should start holding their fire.

As indicated in yesterday’s post, the most important change needed in NAFTA is the addition of teeth to the agreement’s existing rules of origin – the requirements that goods sold within the NAFTA free trade zone comprised of the United States, Mexico, and Canada be made overwhelmingly of parts, components, and materials made inside the zone.

After all, manufacturing dominates trade not only inside NAFTA, but between the NAFTA countries and the rest of the world. Without imposing teeth, non-NAFTA countries will have no meaningful incentive to invest in new NAFTA-area facilities to produce the intermediate goods that comprise the content of final products, like automobiles. And the economies, businesses, and workers in the three countries will be denied immense opportunities to boost production and employment. Indeed, this is precisely this opportunity that’s been missed under the current NAFTA.

It’s difficult to imagine these teeth taking a form other than steep tariffs on goods imports from outside NAFTA, and the Trump blueprint never mentions that “t” word. But it does contain a call to “Update and strengthen the rules of origin, as necessary, to ensure that the benefits of NAFTA go to products genuinely made in the United States and North America.” And it specifies that these improved origin rules must “incentivize the sourcing of goods and materials from the United States and North America.” How could anyone supporting more U.S. manufacturing production and employment not be heartened?

Also impressive – as widely reported, the administration has prioritized preserving America’s ability to “enforce rigorously its trade laws, including the antidumping, countervailing duty, and safeguard laws” chiefly by eliminating the NAFTA provisions that established international tribunals as the last word in resolving trade complaints among the signatories, rather than the U.S. trade law system. The Trump administration is also seeking to reestablish America’s unfettered authority to impose “safeguard” tariffs on imports from Mexico and Canada when they begin to surge into the United States. So if you’re worried that NAFTA and other recent U.S. trade agreements have needlessly undermined American sovereignty, this blueprint is for you.

Similarly, critics have long complained about NAFTA’s overriding of the Buy America provisions of U.S. public procurement regulations aimed at maximizing the American taxpayer dollars used to purchase goods and services for government agencies. The Trump strategy laid out in the blueprint seeks to preserve these and other key domestic preference programs.

It’s true, as is being contended, that in areas ranging from promoting high labor rights and environmental standards, to dealing more effectively with the trade distortions created by state-owned enterprises (SOEs), the Trump NAFTA blueprint looks a lot like the Trans-Pacific Partnership (TPP) trade deal that the president condemned as a candidate and withdrew from on his first day in office.

It’s just as true, however, that formidable obstacles were bound to prevent effective enforcement of those proposed TPP rules. These loom as large as ever – notably, the huge numbers of U.S. government officials that would be needed to monitor the even huge-er Mexican manufacturing sector on anything close to an ongoing basis. But the final TPP text demonstrated beyond reasonable doubt that the Obama administration failed to address these concerns adequately. Maybe the Trump administration will come up with viable answers.

Finally, the Trump NAFTA blueprint contains two conceptual objectives that have never been prioritized since the current world trading system was created shortly after World War II, and that trade policy critics should be applauding vigorously. The first is the endorsement of reciprocity as a lodestar of American trade strategy. The second is an emphasis on reducing America’s mammoth trade deficits.

Although reciprocity (i.e., America opens its markets to certain trade partners only to the extent that their markets are open to U.S.-origin goods and services) seems like an uncontroversial trade goal for Washington to seek, and is often presumed to be the goal, nothing until now could be further from the truth. In particular, the foundational principles of the world trade system under the General Agreement on Tariffs and Trade (GATT), and the World Trade Organization (WTO) are national treatment and non-discrimination.

National treatment simply insists that countries deal with foreign enterprises the same way they deal with their own domestic enterprises. Non-discrimination simply mandates that countries treat imports from all trade partners’ identically. The big problems? They enable closed economies to maintain way too many trade barriers. For instance, countries that favor certain companies over others for either political reasons (as with China’s state-owned sector) or reasons of national economic strategy (as with Japan’s efforts to limit entrants into certain industries to prevent excessive domestic competition) can continue discriminating in similar ways against foreign competitors. And countries can maintain high trade barriers as long as they apply equally to all imports.

As for trade deficit reduction, it’s a great way to promote healthy, production-led American growth, rather than the kind of debt-led, bubble-ized growth that’s been engineered arguably going back to the 1990s. But here’s where the Trump blueprint can be faulted. Especially if the new NAFTA contains better rules of origin, it’s likeliest to reduce the U.S. trade deficit with non-NAFTA countries, not with the treaty signatories that the blueprint targets. And nothing would be wrong with that result at all.

Two other aspects of the NAFTA objectives deserve comment – and merit genuine concern. First, although it’s good that the administration has included on the list currency manipulation, critics are right to note that specifics are urgently needed. Their development, moreover, is important not mainly because Canada and Mexico have been important culprits (they haven’t been) but because this is a challenge that President Trump needs to meet in connection with countries that clearly have manipulated in the past and could well do so again.

Second, the Trump blueprint makes no mention of value-added taxes (VATS). Mexico’s is 16 percent, Canada’s is five percent at the federal level and eight percent at the provincial level. As with all other VATs, these levies act as barriers to imports and subsidies for exports. Candidate Trump rightly called for American countermeasures in order to level the trade playing field inside NAFTA. President Trump should take heed.   

(What’s Left of) Our Economy: It’s “Big Week” on Trade

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100-day China plan, Canada, China, environmental standards, G20, Gary Cohn, H.R. McMaster, James Mathis, labor standards, Mar-a-Lago summit, Mexico, NAFTA, North American Free Trade Agreement, North Korea, Robert Lighthizer, rules of origin, steel, Steve Mnuchin, tairffs, Trade, Trump, Wilbur Ross, Xi JInPing, {What's Left of) Our Economy

During World War II, the United States and the United Kingdom launched a massive multi-day strategic bombing campaign against Nazi Germany called “Big Week.” The stakes are considerably less apocalyptic, but yesterday began a period for U.S. trade policy that qualifies as a big week, too. Here’s why, and what to look for.

First, yesterday marked the deadline for the 100-day plan announced at the summit between President Trump and his Chinese counterpart Xi Jinping to start bringing down America’s immense trade deficit with the People’s Republic. Some near-term deals were announced in May, and the Chinese seem to be playing along, to at least some extent. But even the American offshoring lobby, which has greatly soured on China since its full-court-press lobbying campaign convinced Washington to expand U.S.-China trade exponentially, has been complaining that agreements of this scope are way too small to solve their own problems with Beijing in the Chinese market. These deals have even less potential to stop most of the damage still being inflicted on the American domestic economy from wide-ranging predatory Chinese economic practices.

The results are due to be announced this week – and may be delayed to take into account whatever can be accomplished by a new high-level economics dialogue that will hold its first session in Washington this week. Will they produce some big wins for the administration and the domestic economy? As I see it, reasons for pessimism outweigh reasons for optimism.

The former include the president’s continuing statements about the threat posed by China’s imports (in this case, of steel), and the awareness demonstrated by his campaign of how varied and unconventional (meaning they went far beyond tariffs and quotas) China’s trade and trade-related transgressions have been. Among the reasons for pessimism, though, are intra-administration divisions that entail both economic issues (with the administration’s economic populists arrayed against what’s been called the pro-free trade “Goldman Sachs” gang comprised of top economic adviser Gary Cohn and Treasury Secretary Steven Mnuchin) and security issues (pitting the populists against traditional foreign policy thinkers like national security adviser H.R. McMaster and Defense Secretary James Mattis, who would sympathize with notions like the claim that China should be courted to enlist its help in sitting on North Korea). In addition, the kinds of staffing woes still dogging the administration typically make sharp departures from a policy status quo difficult to engineer.

In fairness, Commerce Secretary Wilbur Ross, who has forthrightly described the China economic challenge, acknowledged when announcing the 100-day trade plan’s first results that three months worth of talks couldn’t possibly be a game-changer precisely because China’s mercantilism was so pervasive. But in so doing, he unintentionally made the argument – which I support for U.S. trade policy generally – for dispensing with talks altogether and capitalizing on China’s urgent need to export to the United States by addressing this issue unilaterally.

Certainly, this kind of course change would be much more consistent with the president’s numerous campaign statements emphasizing the destructive effect of Chinese predation on America’s economy and working class. It’s also the kind of strategy you’d expect from a chief executive whose non-trade agenda is almost completely stalled in Congress, who’s under intense political pressure, and who could badly use a big economic win in order to prevent major Congressional losses in the next off-year elections – whose campaign cycle will be here before he knows it.

Another big (self-imposed) administration deadline falls today. It marks the date by which the White House said it would submit its detailed plan to renegotiate NAFTA – the North American Free Trade Agreement. In May, U.S. Trade Representative Robert Lighthizer sent Congressional leaders a brief letter alluding generally to some objectives, but by tomorrow he needs to fill in critical details. Many might have been contained in a draft letter released March 30, and that plan looked pretty impressive. The big question of course is which ones will wind up surviving – and whether the administration is open to other ideas.

As I’ve written, the most important issue concerns the treatment of “rules of origin” – the provisions of NAFTA aimed at ensuring that any goods sold in the three signatory countries (the United States, Canada, and Mexico) are overwhelmingly made in some combination of those countries. The deal that’s currently in place specifies North American content levels that need to be met to qualify for duty-free treatment inside the free trade zone. But the tariff penalties for goods not meeting these standards aren’t nearly high enough to achieve the goal of increasing the entire region’s competitiveness.

The March 30 letter suggested that the administration would seek origin rules that promote U.S. production and jobs more effectively, but it didn’t say how. If much higher external tariffs aren’t proposed in the plan due today, it’s doubtful that any reforms will result in non-NAFTA countries to make more of their products in any of the countries inside the NAFTA zone. Moreover, it’s of course going to be easier for Washington to persuade Canada and Mexico to go along if it re-emphasizes what President Trump has been saying since his meeting last summer, before the election, with his Mexican counterpart: NAFTA should aim to boost the competitiveness of all three countries.

The brief May 18 Lighthizer letter also suggested obliquely the need to change NAFTA’s dispute-resolution procedures, and the March 30 draft discussed the issue at greater length. But even its recommendations to strengthen America’s authority both to respond to import surges from its NAFTA partners (called “safeguards”) and to apply its own Buy American government procurement rules to intra-NAFTA trade may not go far enough.

As I’ve explained, the fundamental problem is that the current dispute-resolution process treats the three NAFTA countries as legal equals, even though the U.S. market is nearly 90 percent of the total NAFTA market, and clearly remains the most valuable prize for all three signatories. Without closing or somehow changing acceptably, the yawning gap between the NAFTA legal regime and the economic facts on the ground, it’s hard to imagine the system serving U.S. interest on net.

At this point, you might be wondering why I haven’t mentioned NAFTA’s labor and environmental provisions. The reason? Although they’ve been major objectives of Democratic party and other left-of-center NAFTA and broader trade policy critics, as with their counterparts in the Trans-Pacific Partnership (TPP) deal, they’re largely unenforceable. As I’ve asked before, how many American bureaucrats will be needed to run around how many factories in a signatory country (in this case, Mexico) to ensure that companies aren’t abusing workers or dumping sewage into nearby streams? With more effective rules of origin, however, producers in Mexico will feel less pressure to remain competitive versus rivals in China and elsewhere in Asia by offering the worst possible working conditions and ignoring environmental considerations completely.

Finally, there’s the steel tariff issue. The administration has delayed announcing its decision to impose national security-related tariffs on U.S. steel imports, but is expected to reveal its intentions this week. For what it’s worth, the president sounds determined to approve some levies on some countries’ steel. The main question is who the main targets will be. It will also be crucial to see whether and how prominently the announcement emphasizes the need to deal decisively with the underlying problem – the ocean of subsidized steel from China that has flooded and distorted world markets in recent years.

At the same time, there’s a reason for Mr. Trump to punt – or to punt for the most part: At their summit earlier this month in Hamburg, Germany, the leaders of the world’s twenty largest economies (the “G20”) agreed to require an international commission on the subject to deliver a report by November containing “concrete policy solutions that reduce excess steel capacity.” Postponing unilateral action until this mandate is fulfilled could prove a tempting option for a president who doesn’t exactly need to come under fire from new fronts.

Moreover, if the commission’s ideas don’t pass U.S. muster, Mr. Trump would be in a much stronger position to slap the tariffs on everyone, and vow to maintain or even increase them until meaningful, concrete agreements are reached.

President Trump has been sending surprisingly (at least to me) mixed signals on trade since his Inauguration Day two-step – killing the TPP but refraining from labeling China a currency manipulator. Big Week in trade isn’t likely to clarify the picture fully, but we’re bound to know more at its end than we do here at the beginning.

(What’s Left of) Our Economy: Which Democrats are Serious and Un-Serious About Trade Overhaul?

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AFL-CIO, Bernie Sanders, Canada, Charles Schumer, currency manipulation, Debbie Dingell, Democrats, dispute resolution, Elizabeth Warren, environmental standards, labor standards, Mexico, NAFTA, North American Free Trade Agreement, Politico, Richard Neal, Robert Lighthizer, Rosa deLauro, rules of origin, Thea Lee, Trade, Trump, U.S. Trade Representative, unions, Wilbur Ross, William Pascrell, {What's Left of) Our Economy

Usually, paying attention to instances of politicians and other public figures getting up on their soapboxes is a waste of time. Yesterday served up an exception: a press conference held by House Democrats in reaction to President Trump’s official decision to open talks to renegotiate the North American Free Trade Agreement (NAFTA). The statements recorded in this Politico account offer some evidence as to which leaders on America’s Left are willing to work with the administration on trade policies that can help the working class voters Democrats still profess to champion, and those who will remain content to sit on the sidelines and take partisan potshots.

Reportedly, all of the House members who spoke at the event “said…they feared Trump would make only modest changes to NAFTA after blasting it as an economic disaster throughout last year’s presidential campaign.” The basis for these worries? The letter sent yesterday by new U.S. Trade Representative Robert Lighthizer to Congressional leaders announcing the administration’s intention to open NAFTA talks with the two other signatories, Canada and Mexico. According to these House Democrats and some other trade critics, the document apparently was “short on details,” which many claimed indicated Trump’s intention simply to “tweak” rather than comprehensively overhaul the agreement.

All else equal, wondering about the president’s real intentions is anything but unreasonable. His personality, after all, is mercurial, and one of his major trade initiatives to date – the negotiations begun with Beijing following February’s summit with Chinese leader XiJinping – has legitimately disappointed advocates of the major course change he pledged during the campaign. (The other major trade initiative, scrapping the Trans-Pacific Partnership trade agreement, kept a leading campaign promise to the letter.) Moreover, the Lighthizer letter is indeed short on specifics.

But none of the participants in the press conference seems to have noticed that in previous statements –including reportedly to leading Democratic lawmakers, top Trump officials have emphasized the need for dramatic NAFTA changes.

For example, Commerce Secretary Wilbur Ross has described as high NAFTA-related priorities greatly tightening the pact’s rules of origin in order to incentivize more non-NAFTA manufacturing investment inside the free trade zone, and restructuring a dispute-resolution system that gives each signatory an equal vote even though the United States represents more than 85 percent of North America’s total economic output. Reinforcing this point was the Lighthizer letter’s contention that “establishing effective implementation and aggressive enforcement of the commitments made by our trading partners under our trade agreements is vital to the success of these agreements and should be improved in the context of NAFTA.”

Meanwhile, Lighthizer reportedly has told Senators that the administration is thinking of adding to NAFTA rules that would prohibit currency manipulation – a move that would set a valuable precedent for future trade deals. In addition, his letter mentioned the need to improve NAFTA’s labor and environmental protections. In my view, they’re largely unenforceable. But they’ve been a prime focus of Democratic Party trade policy positions for decades.

So given that background, it seems fair at this point to finger Connecticut’s Rosa deLauro, New Jersey’s Bill Pascrell, and Massachusetts’ Richard Neal as grandstanders. The former stressed the “tweaking” allegation. The latter two charged that “It was clear from the start that the administration was only interested in working with the Congressional Republican leadership in drafting this notice [the Lighthizer letter].”

I’d also include in this group several key Senate Democrats, including Leader Charles Schumer of New York, former presidential candidate Bernie Sanders of New York, and Elizabeth Warren of Massachusetts. They voted against Lighthizer’s confirmation despite his decades-long record of fighting predatory foreign trade practices both as Deputy U.S. Trade Representative during the Reagan administration, and as a trade lawyer representing domestic American producers.

More temperate in their judgments were Michigan’s Debbie Dingell, and the AFL-CIO’s Thea Lee. The former stated that she was “investing the time to understand where the consensus is.” The latter said, “We enter every negotiation in a good faith state of mind and we expect a lot from our government. Certainly candidate Trump made a lot of promises about fixing flawed trade agreements and looking out for American workers and good jobs, so we will hold him and his administration to that promise.”

I can’t think of a more reasonable position for politicians and other supporters of a movement that still styles itself as the “party of the common man [and woman].”

(What’s Left of) Our Economy: Laughable NAFTA Defenses from the New York Fed

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Canada, competitiveness, Federal Reserve, intermediate goods, intra-industry trade, Mexico, NAFTA, New York Fed, North America, North American Free Trade Agreement, rules of origin, supply chains, tariffs, The Race to the Bottom, Trade, Trump, {What's Left of) Our Economy

Although the Federal Reserve Bank of New York says that posts on its Liberty Street Economics blog “do not necessarily reflect the position” of either this branch of the federal reserve system or the system itself, it’s hard to avoid the conclusion that the bank has gone to war against President Trump’s announced plans to renegotiate NAFTA (the North American Free Trade Agreement). Why else would it have run items critical of these plans on consecutive days last week?

Even more important, it’s hard to avoid the conclusion that these posts aren’t vetted seriously for basic knowledge of America’s international trade situation, or even common sense. Key examples from each of these posts should suffice to establish the New York Fed’s combination of bias and ineptitude here.

The first post, by a New York Fed official and an economist from the offshoring interests-funded Institute for International Economics, purported to show that “An underappreciated benefit of … (NAFTA) is the protection it offers U.S. exporters from extreme tariff uncertainty in Mexico….Without NAFTA, there is a risk that tariffs on U.S. exports to Mexico could reach their bound rates, which average 35 percent. In contrast, U.S. bound rates average only 4 percent. At the very least, U.S. exporters would be subject to a higher level of policy uncertainty without the trade agreement.”

But it quickly becomes clear that even the authors are skeptical about this outcome. Their main stated reason hints at one main reason: “”Given the large and well-documented benefits from low trade barriers, particularly those stemming from access to a wider variety of imported intermediate inputs and lower prices of intermediate inputs, it would not be in Mexico’s interest to raise all of its MFN tariffs to their bound rates.”

This argument is only a hint, however, because it jaw-droppingly softpedals some of the main characteristics of U.S.-Mexico trade – specifically, the hugely outsized role played in this commerce by intra-industry trade. As I first described at length in The Race to the Bottom, a large share of U.S.-Mexico trade has little to do with the exchange of finished goods that dominates the textbook models. Instead, it consists of parts and components and other inputs of finished goods that travel through international production chains until they’re turned into final products.

And because there’s so little consumer purchasing power in Mexico, and so much in the United States, the lion’s share of this bilateral intra-industry trade in turn consists of intermediates being sent from U.S. factories to Mexican facilities, where they’re assembled into final products for export back to America.

Sure, in principle, a U.S. scrapping of NAFTA (which of course is not the Trump administration’s stated intention) could enable Mexico to substitute non-U.S. parts and components etc for the American-made intermediates that current make up so many of its exports. But without NAFTA, Mexico would also lose much and probably most of its current, unconditional access to the U.S. market. And since that market currently buys nearly 80 percent of Mexico’s exports, and since Mexico’s economy relies so heavily on those exports, it should quickly becomes obvious how self-defeating such a Mexican effort at hardball playing would be.

How bizarre that neither the article’s authors, nor anyone else involved in producing Liberty Street Economics, recognized these longstanding realities. Even weirder: The importance of this intra-industry trade in U.S.-Mexico trade was the major theme of another post from the same authors (plus a third) on this same blog that appeared the very next day.

Yet the NAFTA-related follies of the authors and of Liberty Street Economics hardly end there. In that second post, readers are warned that stricter rules of origin (ROO) for NAFTA could “disrupt supply chains” and in particular backfire on U.S.-based businesses by increasing the costs of their imported inputs and undermining the competitiveness of their exports outside North America.

To which someone who actually knows something current U.S. NAFTA renegotiating plans can only reply, “Seriously?”

For what the authors and the rest of the Liberty Street crowd seem to miss is that the only ROO revamping that would make any sense from a U.S. standpoint is also precisely the kind of revamping that the Trump administration seems to be considering: not only tightening the ROO (to confine duty-free treatment for goods traded inside the NAFTA zone to goods with higher levels of content produced inside the zone), but increasing the tariff penalties imposed on goods with relatively low levels of non-North American content.

In other words, the North American supply chains created by NAFTA wouldn’t be weakened. They’d be strengthened and greatly expanded.

Now the authors could still be right in arguing that such measures would raise the prices of goods made inside North America and thereby undermine their competitiveness outside North America. But they completely neglect two counter-arguments.

First, because the (U.S.-dominated) North American market is already so vast, and because intermediate goods industries in the three NAFTA countries are already so enormous, external tariffs that encourage North American businesses to use even more North American content could well bring gains inside the NAFTA zone that exceed whatever non-NAFTA losses are incurred.

Second, NAFTA as it currently exists was touted as a major boost to U.S. and North American global competitiveness, but there’s no evidence that this goal was achieved. Quite the contrary, at least according to World Trade Organization data.

They show that in 1993, the year before NAFTA went into effect, North America’s share of global goods exports was 17.9 percent. By 2015, it had shrunk to 14.4 percent. The U.S. share during this period fell from 12.6 percent to 9.4 percent, and the Canadian share decreased even faster – from 3.9 percent to 2.6 percent (no doubt, however, largely due to falling prices for the oil it exports so abundantly).

Mexico’s share of global exports did increase – from 1.4 percent to 2.4 percent. But surely that improvement stemmed mainly from selling to the United States, not to any non-North American customers.

The North American share of world merchandise imports did decrease during this period as well. But the decline was much smaller, and one quick look at the U.S. trend makes clear that the lion’s share of this improvement has resulted from the recent, dramatic turnaround in American energy trade patterns – which have nothing to do with NAFTA or any other supply chains.

The Federal Reserve system, and especially its crucially important New York branch, have long been renowned for employing premier economists and sponsoring first-rate economic analysis. But these Liberty Street Economics posts indicate that, at least when it comes to NAFTA, the New York Fed is better described as the Gang that Can’t Shoot Straight.