NAFTA’s successor is about to take effect. Here’s why it will be good for North America—and bad for the WTO

Flags of Mexico, United States and Canada are pictured at a security booth at Zaragoza-Ysleta border crossing bridge for commercial and private transport, in Ciudad Juarez, Mexico January 16, 2020. REUTERS/Jose Luis Gonzalez

The United States-Mexico-Canada Agreement (USMCA) will take effect on July 1, 2020, replacing the North America Free Trade Agreement (NAFTA). The USMCA features several important changes while maintaining trade flows worth $1.2 trillion among the three-member countries.

It is the latest of the 303 regional trade agreements (RTAs) currently in force—whose rank is likely to increase in the foreseeable future. The RTAs have hollowed out the World Trade Organization (WTO), and this process is likely to accelerate going forward. About half of world trade is now covered by the RTAs, reducing the scope and relevance of WTO rules and tariff schedules, as well as its dispute settlement and appeal mechanism.

If the USMCA is used as a template for future US trade negotiations, that would hasten the regionalization of world trade, fragmenting the global trading system based on the WTO and marginalizing the organization.

Below are key features of the USMCA, most of which are new in a US trade agreement.

  • Auto parts rules of origin: raising the threshold from 62.5 percent to 75 percent (and 70 percent for steel and aluminum used in making parts).
  • Use of quota: while being frowned upon by the WTO, the USMCA contains side letters to exempt 2.6 million passenger vehicles each from Canada and Mexico from potential Section 232 tariffs (of the US Trade Expansion Act of 1962, threatened by the United States on national security ground) on an annual basis, and roughly current annual volumes of auto parts.
  • New labor requirements: 40 to 45 percent of auto parts must be made by workers earning at least $16 per hour by 2023—to be more comparable to the US average wage levels in this sector. Mexico has also passed labor reform law promoting the unionization and collective bargaining rights of their workers.
  • Agricultural markets: US farmers can have better access to Canada which has agreed to raise its tariff-free quotas on dairy, poultry, and egg products under its supply management regime.
  • Digital trade: for the first time, there is a full chapter on free digital trade in an FTA. The chapter prohibits import duties and other charges on electronically transmitted digital products; discriminatory treatment of cross-border data transfers; and forced data localization.
  • Dispute settlement: state-to-state disputes regarding a matter which arises under this agreement, or under another international agreement, including the WTO agreement, to which the disputing parties are party, are to be settled in a forum selected by the complaining party—giving it a choice of forum most favorable to its position, instead of automatically referring WTO disputes to the WTO dispute settlement system. Furthermore, if the formation of the arbitration panel (in a chosen forum) is being blocked by noncooperative responding parties, the USMCA Implementation Act (US Public Law 116-113) allows the United States to use its domestic laws to impose safeguards on any surges in imports from Canada and Mexico.
  • Dealing with state-owned enterprises (SOEs) and subsidies: requiring SOEs to compete on commercial basis and that any advantages such as subsidies enjoyed by the SOEs do not have adverse effects on US companies and workers. These provisions are more comprehensive than the WTO’s rules on subsidies and countervailing duties.
  • Dealing with a non-market economy: any member wanting to negotiate a free trade agreement with a non-market economy (as defined by a member—primarily aiming at China) has to keep other members informed; and upon conclusion of such agreement, the other members can withdraw from the USMCA with a six month notice.
  • Including a chapter on currency manipulation: this is the first time currency manipulation is included in a trade agreement. Traditionally, currency issues are dealt with by the US Treasury, normally in consultation with the International Monetary Fund (IMF) and its members.

Potential impacts of the USMCA

Several features of the USMCA can be viewed as representing the US template in future trade negotiations. Many of those features enjoy bipartisan political support and therefore are likely to stay beyond US President Donald J. Trump’s presidency. Specifically, US emphases on free digital trade, reducing tariff and non-tariff barriers to its agricultural exports, dealing with SOEs and subsidies, dealing with a non-market economy, preserving the US ability to enforce its trade laws in trade remedies—including the anti-dumping, countervailing duties and safeguards laws, and currency manipulation can be found in the US Trade Representative’s negotiating objectives vis-a-vis the United Kingdom and the European Union (EU).

In addition to agriculture, there are new areas of frictions concerning the upcoming trade negotiations with the United Kingdom and the EU. The free digital trade emphasis in the USMCA would be at odds with the plan of many European countries (Austria, France, Hungary, Poland, Turkey, the United Kingdom, and others) to proceed with their national versions of a digital services tax after the United States pulled out of the multilateral negotiations sponsored by the Organization for Economic Co-operation and Development (OECD). The United States has threatened retaliatory tariffs on any country imposing digital taxes.

In addition, the USMCA emphasis on free cross-border flows of data would need to be reconciled with the EU General Data Privacy Regulation (GDPR). Obviously, the difference between the US position and China’s security-driven restrictions on cross-border flows of data is much more glaring.

Also problematic is the USMCA chapter dealing with non-market economies—this would complicate the EU’s effort to negotiate a Comprehensive Agreement in Investment with China as well as the United Kingdom’s desire to seek a trade deal with China. On top of those issues, the US threat of imposing Section 232 tariffs on automobiles and auto parts remains a major irritant in the negotiations.

For developing countries, in the context of its effort to tighten the self-designation as “developing countries,” if the United States makes regular use of its demands contained in the automobiles chapter, for example the requirement that 40 to 45 percent of auto parts have to be made by workers earning at least $16 per hour, that would dilute the comparative advantages enjoyed by developing countries in their efforts to promote foreign trade to industrialize their economies.

More generally, the emphasis on tightening rules of origin for auto parts will strengthen emerging trends toward regionalization. Many companies have taken advantage of technological advances, especially in automation, and followed a desire to be close to their customers by setting up local production facilities to supply large national or regional markets such as North America. Recently, this regionalization trend has received strong impetus from the US-China trade war and from efforts to diversify and streamline complex global supply chains due to disruptions caused by the COVID-19 pandemic.

Finally, quite detrimental to the integrity of the WTO is the USMCA use of quota in side letters (exempting current volumes of automobiles and parts imports from Canada and Mexico fro potential future tariffs); provisions for a complaining party to select the forum to settle disputes even if the matters arise under the WTO agreement; and preserving the US ability to use its domestic laws to remedy trade complaints. These will lead to a further marginalization of the WTO dispute settlement mechanism. Already the WTO Appellate Body has been rendered inoperative due to lack of the necessary quorum to hear cases since the beginning of the year. Furthermore, the United States has signaled its opposition to using WTO resources to support the alternative trade dispute appeal system recently launched by the EU, China, and eighteen other countries. The US opposition to the use of WTO resources to support activities benefiting a subset of the membership can also have a detrimental effect on the plurilateral approach—increasingly used by many WTO members trying to make headway in new trade negotiations with like-minded countries since the global multilateral approach has failed over the past decades.

In short, while the USMCA preserves free-trade flows among the three member countries, its use by the United States as a template for future trade negotiations, starting with the EU and the United Kingdom, would have a far-reaching effect on future developments of world trade. The global trading regime based on the WTO would shift more and more toward regional trading arrangements, in the process further fragmenting world trade and marginalizing the role of the WTO. This is all happening at a vulnerable moment for the WTO, which is going through a process of selecting a new director-general.

Hung Tran is a nonresident senior fellow at the Atlantic Council and former Executive Managing Director at the Institute of International Finance.

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