Economist: Coming soon: NAFTA II

For months, President Donald Trump has veered between threatening to terminate the North American Free Trade Agreement and merely proposing to bring it “up to date.” On Monday, in a letter to Congress, Robert Lighthizer, the U.S. trade representative, made the administration's intentions clearer.

They are closer to revision than destruction, which is a relief for Canada and Mexico, the United States' NAFTA partners. Alongside conventional-sounding negotiating objectives, however, are flashes of Trumpian aggression and hints that the United States will demand painful changes to the deal.

The stakes are high. A quarter of American trade in goods and services is with Mexico and Canada. The three economies tend to grow or shrink together and have integrated supply chains. Fears that the United States would abandon NAFTA have caused volatility in the markets for the Mexican peso and the Canadian dollar, as well as talk of possible recessions.

Lighthizer's letter, published at the start of what Trump billed as “Made in America Week,” calmed those fears. The administration has been tamed by working through Congress. The smaller NAFTA partners made Herculean lobbying efforts to defend the agreement. Canadian ministers bombarded American governors with visits. On July 14, Prime Minister Justin Trudeau of Canada appealed to governors in a speech to protect “our shared North American home.”

A path to a renegotiated agreement is in sight, but it will be rocky. The new deal Lighthizer has in mind borrows from the Trans-Pacific Partnership, the Obama administration's deal with 11 Latin American and Asian countries, which in effect updated NAFTA. One of Trump's first acts in office was to withdraw from that deal. Nonetheless, like the TPP, the proposed NAFTA 2 would bring protections for workers and the environment “into the core of the agreement.”

The letter drops some of the most contentious items from an earlier American wish list. There is no mention, for example, of addressing the Trump administration's grievance that Mexico charges value-added tax on imports.

Some of Lighthizer's ideas are potentially ambitious but vague. He wants to “strengthen the rules of origin” that set out how much North American content a product needs to cross borders duty-free. That could be a tweak, or it could be a big disruption to trade among members of NAFTA. There is talk of ensuring, through an “appropriate mechanism,” that NAFTA countries do not manipulate their currencies - which could impinge on American monetary policy.

Where Lighthizer's goals are the most Trumpian, they will face the fiercest resistance. Reflecting the president's obsession with the United States' trade deficit, the document's first objective is to reduce deficits with other NAFTA countries. This is absurd - trade deals do not determine deficits.

The Mexican government's response has been to argue that the standard numbers neither reflect flows in the value each country sends across borders nor the billions of dollars that Mexicans spend when they shop in the United States. Canada, whose trade surplus with the United States in goods is smaller than Mexico's, is waiting to see how the Trump administration proposes to reduce it. If the United States insists, for example, on allowing countries to block trade if their deficits get too large, the talks could take an angry turn.

Another worry is the administration's approach to trade remedies, i.e., the duties that governments can apply if an industry is “injured” by imports. Under NAFTA, Mexico and Canada get special treatment. The United States has to cross a higher legal threshold to apply defensive safeguards on their exports than it does on those of other countries. In addition, under Chapter 19 of the agreement, disputes between NAFTA partners over other remedies go to a NAFTA court. The Trump administration, which regards the authority of foreign judges as an infringement of sovereignty, has both provisions in its sights.

This will provoke a battle. Negotiations on a free trade agreement between Canada and the United States, which came before NAFTA, nearly broke down in 1987 because the United States refused to relinquish the option to impose retaliatory duties. A clause resembling Chapter 19 was a compromise that saved the deal: “You can have your goddamn dispute-settlement mechanism,” Treasury Secretary James Baker reportedly grumbled.

Canada, and now Mexico, want it more than ever. The United States is threatening to impose trade barriers against other countries to protect such industries as steel. It is fighting with Canada about softwood lumber, aerospace and paper. Without a panel to rule speedily on disputes, and to ensure protection against trade remedies, NAFTA's smaller members would be more vulnerable to the punishment that the United States metes out to other trading partners.

While seeking more protection for the United States, Lighthizer is pushing Canada and Mexico to lower their trade barriers. His letter aims at protected Canadian sectors such as telecommunications and financial services-and, less explicitly, dairy and poultry farming. Mexico, the target of Trump's abuse on the campaign trail, seems to get off more lightly.

Negotiations are due to begin on Aug. 16. The United States' partners are preparing defenses and counter-demands. Mexico's businesses are thinking about how to change their supply chains in case the deal blows up. Canada is pushing for access to contracts awarded by American states and cities, which Lighthizer wants to keep out of NAFTA 2.

Expect plenty of squabbling in the North American home.

From the Economist magazine.