Happily ever NAFTA? A new agreement seems imminent

By Chantal Wittman Meier, VP, International Banking

Preparing for the potential of a renegotiated NAFTA

Despite some public rhetoric questioning the benefits of the North American Free Trade Agreement (NAFTA), and threats that the United States might pull out of the trilateral agreement, leaders and negotiators representing all three nations—the U.S., Canada and Mexico—indicate a new agreement could be imminent. They are still targeting mid-May for achieving consensus. 

Why May is so important
The May date is not arbitrary; in the U.S., the preference of the current administration is that the current Congress would be the one reviewing and ratifying it. The risk in not hitting the target date is that the November midterm elections might result in a shift in the control of Congress. The current administration would rather have a re-negotiated NAFTA resolved on its watch.

In addition, elections in Mexico this summer could also endanger the progress made to date. If the agreement needs to be approved by the new administration, it could face opposition depending upon that election’s outcome. Some candidates have indicated they would take a harder stance with the U.S. if they were doing the negotiations. This adds to the incentives the trade partners have for resolving NAFTA this month.

The remaining points of contention
While specifics had not yet been released, there were reportedly five issues still pending as of mid-April, two of which are procedural. Analysts and reporters following the talks speculate that the three nations have already given ground on each of them and aren’t that far apart at this point. These points include:

  1. The sourcing of auto parts. The U.S. initially asked for major increases in the percentage of North American-made components required for a vehicle to qualify for an exemption from tariffs, along with a tiering system for making the calculation. 
  2. Limits on Canadian dairy and Mexican fruit imports. The U.S. has argued for Canada to lower its quotas and tariffs for dairy and poultry and for a reduction in Mexico’s flow of off-season fruit, including avocados, to the U.S. to enable American growers to compete better on pricing. 
  3. Changes to the way grievances are aired, like the “Chapter 19” and the investor-state dispute settlement panels. Canada and Mexico have reportedly dug in on this point. They are joined by many U.S. businesses, which feel the changes being proposed by the U.S. negotiator would disadvantage them in a dispute.
  4. The quid pro quo on public works contracts. The U.S. has proposed different rules regarding the rewarding of government contracts to firms domiciled in NAFTA countries. The points being negotiated could make U.S. firms more competitive when bidding against foreign companies than they are now.
  5. The need for a sunset clause. The U.S. has proposed that sunset provisions be part of NAFTA going forward. Specifically, it wants NAFTA to come up for renewal every five years. Many, however, feel that this would create a permanent element of uncertainty for the business community and make long-term capital planning more complicated. 

Substantial change is unlikely
All three trading partners seemed to agree that modernizing the 24-year-old document is necessary, especially in the areas of e-commerce and technology. The degree to which revisions are needed is what they have been debating since last August. Despite that high-level agreement, the U.S. has repeatedly raised the notion of withdrawal from NAFTA. That action now seems unlikely, given how close agreement on NAFTA appears to be. 

However NAFTA has a mechanism in place allowing any of its members to leave at any time without cause. Quitting the agreement requires six months’ notice. Given that each country’s currency is independent, as are their economies, the U.S. potentially leaving means the current lack of trade tariffs among the three neighbors would revert to the World Trade Organization (WTO) tariff agreements where the U.S. is concerned. Prices on imports to the U.S. from Canada and Mexico would rise; currently, they are free of tariffs. Meanwhile, Canada and Mexico would have the option of continuing trade under a bilateral NAFTA, with zero tariffs between them, which could make U.S. exports to those countries less attractive. In Mexico, where the peso has been falling relative to the U.S. dollar, the addition of tariffs to exports would make U.S. goods even more expensive and could further accelerate the existing trade imbalance.

Finding agreement on NAFTA, therefore, seems like the best scenario for U.S. businesses at this point. It would address some of the inequities that have arisen as technology and globalization have altered the economic landscape. 

What this all could mean for Midwestern businesses
Regardless of how soon the NAFTA negotiations are resolved, it’s clear that whether you run a global company, do business with one, or indirectly are impacted by them, waiting for resolution may not be your best option. It gives events beyond your control too much influence over your operating decisions. For this reason, many companies are focusing on reducing their exposure to these types of risks.

Specifically, they are looking more closely at their global sourcing in order to shift their supply chains as needed to maintain a desired level of cost efficiency and a steady flow. Some exporters, in particular, are making it their policy to regularly review their options for manufacturing. For most, the closer they are to their customers, the lower their costs and the higher their margins can be. Several larger manufacturers are looking to relocate facilities to leverage free-trade agreements of other countries, which makes them less dependent on what the U.S. is doing. 

Best defense is a good offense—consider:

  • Being in more than one market. Diversification can be the best antidote to multiple risk factors.
  • Having multiple supply routes available. Be ready to divert orders to avoid being caught off-guard by a sudden change in tariffs.
  • Continually revisiting opportunities for cost savings to offset tariff-related increases.