US and Mexico Reach NAFTA Deal

US and Mexican negotiators have reached a “preliminary agreement in principle” on NAFTA. The deal is not yet final, since some details still appear in flux and because Congress would need to approve any replacement. We do not expect the revised terms to have substantial macroeconomic effects in the US if they do take effect.

Few details are clear but the agreement appears to be somewhat more restrictive than expected regarding the auto sector.

One of the most important aspects of the negotiations has been the rules of origin for the auto sector. According to USTR, the agreement would increase required regional auto content to 75% and high-wage (at least $16/hr) content to 40-45%. This is much closer to the US position than Mexico’s position, which had been in the 20% range for the high-wage share. By contrast, the US-proposed “sunset” clause appears to have been substantially watered down, and now calls for a review process once every six years that would extend the agreement for 16 years. Compared to the original proposal, which called for termination after 5-years unless all parties agreed to extend the agreement, this should create much less uncertainty.

President Trump has announced his intent to terminate the existing NAFTA.

We believe this is intended to accomplish two goals. First, the President has long discussed the potential termination of NAFTA and doing so would allow for a sharper break with the prior agreement from a political perspective. Second, it presents Canada with a “take it or leave it” choice. While the legal issues are not entirely clear, most observers believe that the President can terminate NAFTA without congressional support. However, under the original NAFTA agreement, the US would need to give Canada and Mexico at least 6 months notice before withdrawal could take effect.

The situation creates some uncertainty for US-Canada trade, but the odds are very high that US-Canada free trade will continue in some form.

On its face, the US negotiating stance appears to create some risk for Canada, as it leaves Canada with three choices: 1) sign on to the just-announced agreement with Mexico, 2) negotiate a separate bilateral agreement, or 3) revert back to pre-NAFTA trade policies. However, the risk that US-Canada trade will be left without any trade deal appears low, in our view, for two reasons. First, Canada’s 1988 trade agreement with the US precedes NAFTA and trade policy might revert back to that agreement in the event that NAFTA terminates. Second, while we have long viewed a NAFTA termination announcement to be possible, we do not believe that termination would take effect without a replacement policy. Congress is unlikely, we believe, to approve a US-Mexico agreement unless Canada is party to that deal or something similar, which would leave the White House with a choice between a revised pact among the US, Canada, and Mexico, or no trade agreement at all.

The final decisions are unlikely until 2019 at the earliest. Under US the Trade Promotion Authority (TPA) law, also known as “fast track”, the President must wait to 90 days to sign the agreement after sending Congress notice of the intent to sign .US Trade Representative Lighthizer indicated today that notice is expected to be sent to Congress on Friday. Once the agreement is signed, a number of additional requirements would come into play that are very likely to push a final vote in Congress into 2019. At that point, as we recently noted, there is a good chance that control of the House majority might have flipped to the Democrats, who could have different views on some aspects of the agreement than the Administration, making ultimate passage somewhat more difficult.