Trump and Trade

Written by Aaron Ari Afilalo and Beata Samel — March 4, 2018

President Trump campaigned, partially, on his overt dislike of international trade treaties, including the Trans-Pacific Partnership Agreement and the North American Free Trade Agreement (NAFTA). He also vowed to restructure various bilateral commercial relationships (such as that with China), and to apply tariffs to adjust our balance of trade. In a series of articles in this forum, we will review and continuously report on the implementation of the Trump Administration’s policies of “economic nationalism.”

In this post, we start with an outline of the principal issues discussed in the course of the attempted overhaul of the NAFTA. Candidate Trump promised to renegotiate the 25-year old trade pact. His Administration is now conducting the seventh round of negotiations with Mexico and Canada. The United States is challenging NAFTA on two fronts: questioning fundamental tenets of trade, and attempting to amend technical provisions of the Agreement. In both cases, the United States is negotiating under the shadow of divorce. We have forced Mexico and Canada to the negotiating table by invoking the threat to trigger the exit and termination of the treaty on six-months prior notice.

One of the fundamental challenges to trade comes in the form of a proposed “sunset clause.” If this provision was added to the treaty, a review of the treaty benefits to each signatory country would be conducted every five years. Each country would have the opportunity to ask for new concessions and to adjust the treaty to be more to its benefit. If the negotiations were not successful, the treaty would not be renewed. Essentially, the United States, as the most powerful party, would use this system to negotiate more favorable terms of trade under the shadow of a divorce.

Trade treaties are entered into precisely to create long-term commitments to cross-border trade. The rationale is that, in the aggregate, trade is beneficial to all participating countries. Committing the governments to stable treaties promotes “good governance.” The treaty framers anticipate the temptation to apply populist policies of protectionism, so as to respond to domestic pressure. A sunset clause undermines this basic feature of trade treaties. It is akin to a family law that would provide that a married couple has to renew their vows every five years, and that each spouse can ask the other at that time for new concessions, failing which a divorce would ensue.

The second major area of renegotiation of the treaty pertains to investment rules. Chapter 11 of the NAFTA was adopted after literally decades of disagreement between Mexico and other emerging economies, on the one hand, and more industrialized countries like the United States. One of the principal innovations of Chapter 11 is that it allows private parties, in particular companies doing business abroad, to bring legal cases when the host jurisdiction does not comply with international investment standards. This goes well beyond the normal trade disputes, that are brought by States only (no individual access), and are therefore much less frequent.

The United States is now retreating from the investment policies reflected by Chapter 11, after promoting them since the end of World War II. We are advocating in the current round of negotiations a wholesale retreat from the investor-to-State system. A hodge-podge of special interests have joined to lobby for this outcome. This includes environmental groups that fear challenges to resource conservation and other laws by heavily regulated companies. On the other side of the spectrum, large corporations, worried that the torts bar might take advantage of the grant of access to court, are supporting the move. Like the sunset clause proposal, these plans go against the historical evolution of trade and, as we will discuss in this series, will likely hurt the United States.

The principal technical points of renegotiation pertain to the “rules of origin” currently in effect in the NAFTA. Rules of origin determine from where a final product is considered to originate. Say that a car has leather seats made in Japan, a battery coming from China, and Belgian wheels. Its other components are American. Is it a NAFTA car? Currently, rules of origin in NAFTA Chapter 4 provide that cars must have at least 50% regional content in order to count as NAFTA products and be sold within NAFTA duty-free. If rules of origin are raised to 85% as the United States is trying to accomplish, then American suppliers may have access to a larger regional market to sell their products. This is an amendment to the treaty that Canada has also advocated.

In our next articles, we will evaluate each point of negotiation and discuss which groups may benefit and how it overall affects the position of the United States. The trade tensions threaten to further upset broader foreign relationships between the three countries, that are already strained. For example, Mexican president Enrique Pena Nieto recently canceled an upcoming trip to the White House after a confrontational phone call with President Donald Trump about the border wall. Also, trade battles between the partners may be waged in other venues. Canada, for instance, is challenging New York State’s use of “Buy American” strategies. These new trade wars will be more sophisticated and complex than the simple mutual increase of tariffs that led to the Great Depression. The consequences could nonetheless be disastrous and it is essential that we understand the issues at stake.