Business Chaos

A No-USMCA, No-NAFTA Scenario: How Bad Is It?

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“Congress Will Have a Choice”

Hours after signing the United States-Mexico-Canada Agreement (USMCA) in December last year, President Trump said, “Congress will have a choice of the USMCA or pre-NAFTA, which worked very well.”

What if Congress fails to approve the USMCA and President Trump withdraws from NAFTA nonetheless? Evaluating the economic effect of this action is difficult. NAFTA does not operate in a vacuum. The existence of other multilateral, regional, and bilateral agreements defines the relative advantages and disadvantages for U.S. businesses of operating under NAFTA or the new USMCA.

A no-USMCA, no-NAFTA scenario carries economic implications for the United States in key areas including market access for trade in goods and agriculture, autos, intellectual property rights, digital trade and e-commerce, investment disputes, and labor standards.

A World Without NAFTA

Tariffs: Mexico and Canada both have a vast network of free trade agreements with countries other than the United States. Mexico has 10 free trade agreements with 45 countries. Canada has free trade agreements with all G7 countries, South Korea, the European Union, Mexico, and the other 10 countries in the Trans-Pacific Partnership (TPP), among others. Exports from all of these other countries to Canada and Mexico would receive preferential market access (lower tariffs or zero tariffs and the riddance of non-tariff barriers), while U.S. exports would be subject to higher tariffs and other trade barriers.

Specifically, without NAFTA, Mexico would apply the same tariff to U.S. products that it applies to any other WTO member with whom it does not have a free trade agreement. (That tariff rate is called the Most Favored Nation or MFN tariff rate.) U.S.-Canada trade would presumably go back to the type of bilateral market access treatment that existed before NAFTA under the U.S.-Canada Free Trade Agreement which eliminated virtually all tariffs in goods but not agriculture.

Non-Tariff Rules: In January 2017, the United States withdrew from the TPP, but Canada and Mexico are still members and would remain bound to their commitments with regard to other non-tariff rules governing intellectual property, digital trade, and e-commerce. Industry observers view the new USMCA rules in these areas as marginally better than TPP, though some sectors would benefit from the USMCA more than others.

Strain on U.S. Agriculture

Twenty-nine percent of all U.S. agricultural exports are sold to customers in Mexico and Canada, today with zero tariffs. A no-NAFTA, no-USMCA scenario could be devastating for American farmers who would now face an average applied MFN tariff of 13.5 percent. Adding to their business uncertainty, Mexico’s “bound” tariff rate averages around 45 percent for agriculture, although it reaches over 60 percent on a range of agriculture and dairy products. Canada’s average MFN applied rate for agricultural products is 15.7 percent for agriculture. For dairy in particular, Canada’s bound rates reach over 200 percent, and for animal products over 25 percent.

Freer Trade in Cars?

With no USMCA and no NAFTA, there would be no rules of origin for autos, light trucks, and auto parts; and Mexico would not be bound by the USMCA to enact new minimum wage requirements. If the current rules of origin are more constraining than the cost of MFN tariffs, then trade in autos and auto parts may actually become freer with no agreement. Auto prices could even decline for U.S. consumers.

Here is why.

Existing NAFTA rules of origin require that 62.5 percent of a vehicle’s content come from North America in order to enter the United States duty free. Under the USMCA, the total required North American content of a vehicle would increase to 75 percent; and 70 percent of all steel, aluminum, and glass used in the production would be required to come from North America.

In practice, the U.S. auto sector has relied on imports for content beyond the 62.5 percent minimum required under NAFTA, suggesting that without such rules, automakers may source even more from outside the region depending on existing tariffs.

The USMCA also requires that 40 percent of an automobile and 45 percent of a light truck be produced using an average labor wage of $16 per hour. Without the USMCA, Mexico would not be bound to these wage requirements.

Overall, for the past 25 years, the NAFTA rules of origin have driven production location decisions for auto and auto parts makers and global automakers seeking access to the U.S. and North American markets. Without these rules and restrictions, producers may be more willing to produce outside the United States and have their shipments subject to the 2.5 percent duty on automobiles (less so or not at all for light trucks, where the duty is 25 percent).

Small businesses that sell directly to customers across the border lose out

With USMCA, Canada and Mexico agreed to higher thresholds for duty-free imports and simpler customs forms. That would be especially helpful to small U.S. firms that sell directly to customers across the border, including online and e-commerce sales.

Without the USMCA, Canada and Mexico would keep their low thresholds for duty-free imports at C$20 and US$50, respectively. With the USMCA, Canada would raise its threshold from C$20 to C$40 for tax-free treatment and C$150 for duty-free treatment and simple customs forms. Mexico agreed to US$50 tax-free treatment and US$117 for duty-free and simple customs forms.

Duller “Cutting Edge” Provisions in Intellectual Property, Digital Trade, and E-Commerce

Since NAFTA did not include modern provisions on intellectual property rights, digital trade, and e-commerce, these areas would revert to the “next best” set of provisions that Canada and Mexico committed to as part of the new TPP (called CPTPP by the remaining parties). Actually, CPTPP and USMCA provisions are pretty close, but there are some key differences.

Intellectual Property Rights: The United States championed some provisions in TPP that were “suspended” when the United States withdrew, but which USMCA would restore. Without USMCA, Mexico and Canada are not required to provide additional time for patent periods even if parties experience delays during the patent application process, or to provide new protections to prevent trade secret theft or allow for civil penalties. Mexico could declare a national public health emergency and suspend patent protections without discussing it first with the United States or Canada to try to find a better solution.

Mexico and Canada could also exclude inventions from plants to be eligible to be patented that would otherwise be covered under USMCA. Legal improvements in Mexico could be lost without USMCA. For example, USMCA offers greater transparency in the damages assessment from infringement and greater scope for damages. Mexico and Canada would not be required to offer longer data exclusivity periods for biologic drugs and would not be required to increase the copyright term to 70 years (the CPTPP requires 50 years). There is no consensus among legal or economic scholars on the optimal length for copyright terms. Longer copyright terms benefit rights holders while the costs are diffuse. Shorter copyright periods might well be a benefit to consumers and innovation.

Digital Trade and E-Commerce: Digital trade includes not only online shopping and software, but also internet-powered professional services emerging in a wide range of areas, such as cybersecurity, medical care and healthcare, and professional services. Any information that moves across borders in a manufacturing value chain could fall under this umbrella.

USMCA states that “no party shall prohibit or restrict the cross border transfer of information by electronic means.” In comparison, the CPTPP recognizes that each party may have its own regulatory requirements concerning this area and that each party shall allow the cross-border transfer of information by electronic means.

E-commerce, online privacy, journalism standards, and free speech are all issues that are likely to be addressed across the region in the coming years. The USMCA establishes the framework for countries to achieve their public interest goals as long as it is done in the least trade-restrictive way. In the digital trade area, that means that if new laws or rules affect cross-border transfers, they must not alter the conditions of competition between domestic and foreign suppliers. Under the CPTPP, Canada and Mexico are not committed to such principles.

How to Measure Uncertainty?

New rules, regulations, and laws can inject uncertainty and costs into the economy as the private sector, enforcement agencies, and the courts adjust to the new regime – even if they are the rules businesses want, such as in the new USMCA. (In the case of USMCA, there are a number of new rules that businesses do not even want, such as weaker investor protections and a more restrictive automotive and auto parts regime.) With no USMCA and no NAFTA, businesses face a new realm of uncertainty they haven’t known in 25 years. At least with CPTPP in place as a backstop on non-tariff commitments, the policy environment in those areas may not significantly worsen. The net effects, however, are not clear.

What seems clearer is that tariffs will rise for U.S. exports in a no-USMCA, no-NAFTA scenario and that the tariffs are likely to hurt American farmers the most.

Dive deeper into two economy-wide analyses of USMCA: