Exploring the implications of the USMCA trade deal Exploring the implications of the USMCA trade deal

Exploring the implications of the USMCA trade deal
05 Nov 2018

After more than a year of talks, the USCanada, and Mexico finally managed to agree a new trilateral trade deal, only days before the Trump administration’s self-imposed deadline of 30 September.

The new deal, which updates the 1994 North American Free Trade Agreement (NAFTA), is called USMCA, or the United States-Mexico-Canada Agreement. But the decision to drop ‘free trade’ in the pact’s name is telling. Key concessions made by Mexico and Canada have given into US protectionism, strengthen the country’s position with regard to its escalating trade war with China, and generally mitigate towards an environment based on less free trade.

While negotiators from all three sides have agreed the details of the new arrangement, legislators still have to approve it. If the USMCA is passed though, most of its provisions will not come into effect until 2020.

How different is the USMCA from NAFTA?

The short answer is not really. Renegotiating NAFTA was a key election campaign promise of US President Donald Trump, and the new deal is mostly a mix of the old NAFTA deal and the Trans-Pacific Partnership (TPP) proposals, which Trump pulled out of in January 2017.

But a few changes introduced into the USMCA deal do have huge implications for the automotive sector. There will also be consequences for agriculture, environmental regulation, intellectual property (IP), and digital trade.

The most important thing to grasp though is how upfront the USMCA is in its support of US trade and economic interests over free market principles – a situation that could have repercussions for the country’s trade partners around the world.

US veto power targets China

Most eyes have been on the inclusion of Article 32.10 in the USMCA deal, which lays out the consequences of negotiating an FTA with ‘non-market economies'. Most people are reading this phrase as a code word for China.

What it means is that, if either Canada or Mexico want to negotiate a trade agreement with China, they must inform the US three months in advance. Moreover, if they sign a bilateral FTA with China, any of the three trade partners can terminate the USMCA with just six months’ notice.

As a result, many market watchers are looking at this ‘us or them’ clause as rather more symbolic than substantive. Article 2205 of the previous NAFTA agreement already allowed any signatory to withdraw from the agreement with six months’ notice without needing any justification to do so. The same applies with Article 34.6 of the USMCA.

Another point to note is that neither Canada nor Mexico are anywhere close to signing such an FTA with China. While Canada, in particular, has explored the possibility of doing so, it shares many of the same grievances against the country as the US - as does Mexico, which is keen to strengthen its position as a cheap manufacturing and sourcing base, aka a potential alternative to China.

USMCA tightens country of origin rules and introduces minimum wage regulations

A key focus of the USMCA is on the automotive sector. Under the new deal, 75% of car and truck components must be manufactured in the US, Mexico, or Canada to qualify for zero tariffs. Under NAFTA, the previous limit was 62.5%.

Such a move will require automakers selling to North American consumers to stop sourcing some of their parts from cheaper destinations in Asia, such as China, Vietnam, and India, in order to take advantage of tariff benefits. But this scenario is likely to add significantly to final market costs.

In addition, a minimum wage rule has been imposed on the automotive sector for the first time. The USMCA requires that by 2023, 40% to 45% of vehicles manufactured in the region must be produced by workers who earn at least US$16 an hour. Borrowing from the TPP, the USMCA will also allow each country to sanction the others for any labour violations that impact trade, although the proposed process is quite complex.

Nonetheless, the USMCA’s wage and country of origin rules are likely to act as a disincentive for foreign companies to move investment and production activities to Mexico (or China and Vietnam for that matter), where lower pay and cheap manufacturing have long resulted in the loss of US jobs and plants – something the Trump administration hopes to end.

At the same time, introducing higher wage standards and sourcing constraints will also make North American cars less competitive on the international market. More expensive production will lead directly to price increases for cars and trucks, which could hit exports to the rest of the world as automakers in Asia or Europe are not subject to the same rules of origin.

If such a scenario does materialise, foreign automakers are likely to diversify their investments within non-North American markets. China, for example, is still the largest car market in the world, despite a recent sales slowdown. In fact, market analysts point to China’s maturing consumer tastes, where interest in buying electric, German luxury and Japanese cars continues to mount.

IP protection and digital trade

The USMCA will extend copyright terms from 50 years beyond the life of the author to 70 years.

In the biopharmaceutical sector, the new deal will increase protections from eight years to 10 years, which will safeguard new drugs against competition from generic, cheaper manufacturers.

Finally, the USMCA will introduce provisions that target the digital economy and amount to a major revision of the two decades-old NAFTA deal. The revisions include policies such as no duty on products, including music downloads and e-books, that are purchased electronically, and protection for internet companies to ensure they are not liable for content produced by users of their platforms.

Protection for governments against investor lawsuits

Chapter 11 in the original NAFTA deal enabled investors to sue governments over policy changes that were considered harmful to their future profits. But this provision will now be eliminated for the US and Canada at least, and in Mexico, it will be restricted to only a few sectors, such as energy. Companies have used this mechanism in the past to challenge health and environmental regulations.

US steel and aluminium tariffs to continue

Section 232 of the NAFTA constitutes a trade loophole that the Trump administration has been using to impose steel and aluminium tariffs on its external competitors, including allies such as Canada, Mexico, and the European Union. This loophole will remain in the USMCA, enabling the US to block imports of any materials that it deems critical for national security and to ensure the country has reliable supplies in the event of war.

Given this logic, the decision to impose tariffs makes little apparent sense as the US obtains much of its steel from allies. But the clause also gives the Trump administration the legal heft to impose tariff protection on domestic industries should it see fit.

Introduction of sunset clause

The USMCA contains a ‘sunset clause’, which indicates that the terms of the agreement will automatically expire after 16 years – rather than the five years desired by the US - unless explicitly extended by all parties concerned. The deal will also be reviewed every six years though, at which point extension decisions can be taken.

USMCA still awaits approval

The USMCA pact must be approved by lawmakers from all three countries in order to come into effect. If there is pushback from any of the signatories, it could end up in an impasse.

For example, mid-term elections are due to take place in the US this month, which could change party representation in Congress. Mexico will also see a new government form when outgoing president, Peña Nieto, leaves office on 1 December.

Meanwhile, Canada’s concessions to the US on agriculture as well as steel and aluminium tariffs are likely to become a key campaign issue as the country heads into its own election in 2019.

 

By Melissa Cyrill, editor.

 

This article was first published on China Briefing

 

Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and ASEAN, we are your reliable partner for business expansion in this region and beyond. For inquiries, please email us at info@dezshira.com. Further information about our firm can be found at: www.dezshira.com.

 

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After more than a year of talks, the USCanada, and Mexico finally managed to agree a new trilateral trade deal, only days before the Trump administration’s self-imposed deadline of 30 September.

The new deal, which updates the 1994 North American Free Trade Agreement (NAFTA), is called USMCA, or the United States-Mexico-Canada Agreement. But the decision to drop ‘free trade’ in the pact’s name is telling. Key concessions made by Mexico and Canada have given into US protectionism, strengthen the country’s position with regard to its escalating trade war with China, and generally mitigate towards an environment based on less free trade.

While negotiators from all three sides have agreed the details of the new arrangement, legislators still have to approve it. If the USMCA is passed though, most of its provisions will not come into effect until 2020.

How different is the USMCA from NAFTA?

The short answer is not really. Renegotiating NAFTA was a key election campaign promise of US President Donald Trump, and the new deal is mostly a mix of the old NAFTA deal and the Trans-Pacific Partnership (TPP) proposals, which Trump pulled out of in January 2017.

But a few changes introduced into the USMCA deal do have huge implications for the automotive sector. There will also be consequences for agriculture, environmental regulation, intellectual property (IP), and digital trade.

The most important thing to grasp though is how upfront the USMCA is in its support of US trade and economic interests over free market principles – a situation that could have repercussions for the country’s trade partners around the world.

US veto power targets China

Most eyes have been on the inclusion of Article 32.10 in the USMCA deal, which lays out the consequences of negotiating an FTA with ‘non-market economies'. Most people are reading this phrase as a code word for China.

What it means is that, if either Canada or Mexico want to negotiate a trade agreement with China, they must inform the US three months in advance. Moreover, if they sign a bilateral FTA with China, any of the three trade partners can terminate the USMCA with just six months’ notice.

As a result, many market watchers are looking at this ‘us or them’ clause as rather more symbolic than substantive. Article 2205 of the previous NAFTA agreement already allowed any signatory to withdraw from the agreement with six months’ notice without needing any justification to do so. The same applies with Article 34.6 of the USMCA.

Another point to note is that neither Canada nor Mexico are anywhere close to signing such an FTA with China. While Canada, in particular, has explored the possibility of doing so, it shares many of the same grievances against the country as the US - as does Mexico, which is keen to strengthen its position as a cheap manufacturing and sourcing base, aka a potential alternative to China.

USMCA tightens country of origin rules and introduces minimum wage regulations

A key focus of the USMCA is on the automotive sector. Under the new deal, 75% of car and truck components must be manufactured in the US, Mexico, or Canada to qualify for zero tariffs. Under NAFTA, the previous limit was 62.5%.

Such a move will require automakers selling to North American consumers to stop sourcing some of their parts from cheaper destinations in Asia, such as China, Vietnam, and India, in order to take advantage of tariff benefits. But this scenario is likely to add significantly to final market costs.

In addition, a minimum wage rule has been imposed on the automotive sector for the first time. The USMCA requires that by 2023, 40% to 45% of vehicles manufactured in the region must be produced by workers who earn at least US$16 an hour. Borrowing from the TPP, the USMCA will also allow each country to sanction the others for any labour violations that impact trade, although the proposed process is quite complex.

Nonetheless, the USMCA’s wage and country of origin rules are likely to act as a disincentive for foreign companies to move investment and production activities to Mexico (or China and Vietnam for that matter), where lower pay and cheap manufacturing have long resulted in the loss of US jobs and plants – something the Trump administration hopes to end.

At the same time, introducing higher wage standards and sourcing constraints will also make North American cars less competitive on the international market. More expensive production will lead directly to price increases for cars and trucks, which could hit exports to the rest of the world as automakers in Asia or Europe are not subject to the same rules of origin.

If such a scenario does materialise, foreign automakers are likely to diversify their investments within non-North American markets. China, for example, is still the largest car market in the world, despite a recent sales slowdown. In fact, market analysts point to China’s maturing consumer tastes, where interest in buying electric, German luxury and Japanese cars continues to mount.

IP protection and digital trade

The USMCA will extend copyright terms from 50 years beyond the life of the author to 70 years.

In the biopharmaceutical sector, the new deal will increase protections from eight years to 10 years, which will safeguard new drugs against competition from generic, cheaper manufacturers.

Finally, the USMCA will introduce provisions that target the digital economy and amount to a major revision of the two decades-old NAFTA deal. The revisions include policies such as no duty on products, including music downloads and e-books, that are purchased electronically, and protection for internet companies to ensure they are not liable for content produced by users of their platforms.

Protection for governments against investor lawsuits

Chapter 11 in the original NAFTA deal enabled investors to sue governments over policy changes that were considered harmful to their future profits. But this provision will now be eliminated for the US and Canada at least, and in Mexico, it will be restricted to only a few sectors, such as energy. Companies have used this mechanism in the past to challenge health and environmental regulations.

US steel and aluminium tariffs to continue

Section 232 of the NAFTA constitutes a trade loophole that the Trump administration has been using to impose steel and aluminium tariffs on its external competitors, including allies such as Canada, Mexico, and the European Union. This loophole will remain in the USMCA, enabling the US to block imports of any materials that it deems critical for national security and to ensure the country has reliable supplies in the event of war.

Given this logic, the decision to impose tariffs makes little apparent sense as the US obtains much of its steel from allies. But the clause also gives the Trump administration the legal heft to impose tariff protection on domestic industries should it see fit.

Introduction of sunset clause

The USMCA contains a ‘sunset clause’, which indicates that the terms of the agreement will automatically expire after 16 years – rather than the five years desired by the US - unless explicitly extended by all parties concerned. The deal will also be reviewed every six years though, at which point extension decisions can be taken.

USMCA still awaits approval

The USMCA pact must be approved by lawmakers from all three countries in order to come into effect. If there is pushback from any of the signatories, it could end up in an impasse.

For example, mid-term elections are due to take place in the US this month, which could change party representation in Congress. Mexico will also see a new government form when outgoing president, Peña Nieto, leaves office on 1 December.

Meanwhile, Canada’s concessions to the US on agriculture as well as steel and aluminium tariffs are likely to become a key campaign issue as the country heads into its own election in 2019.

 

By Melissa Cyrill, editor.

 

This article was first published on China Briefing

 

Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and ASEAN, we are your reliable partner for business expansion in this region and beyond. For inquiries, please email us at info@dezshira.com. Further information about our firm can be found at: www.dezshira.com.

 

OTHER ARTICLES THAT MAY INTEREST YOU

East Asia expected to agree RCEP free trade zone by year end

Guangdong attempts to reposition as high-tech manufacturing base

What will a no-deal Brexit mean for UK business?

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