It has been 13 months since US President Donald Trump initiated the renegotiation of the North American Free Trade Agreement (NAFTA). During that time, officials under Canadian Prime Minister Justin Trudeau and Mexican President Enrique Peña Nieto have engaged in intensive negotiations, while managing rapidly-evolving political challenges. Despite these challenges, the US and Mexico finalized an Agreement in Principle on August 27, 2018, and just a day before President Trump's October 1, 2018 deadline, all three countries settled on what is now known as the US-Mexico-Canada Agreement (USMCA).1
We anticipate the three leaders will sign the USMCA at the G20 Summit in Buenos Aires, Argentina (taking place from November 30 to December 1, 2018). While the USMCA is a major milestone that strengthens confidence and integration in the North American market, the legislatures of each country will be required to ratify the deal. Until this time, the possibility that the US withdraws from NAFTA remains a risk.
Ratification of the agreement will not likely begin until 2019 due to the US midterm elections held in early November, which may pose unforeseen challenges should a new Democratic majority in Congress challenge the agreement. Leadership in Canada and Mexico will have to determine their own legislative timetable against the lead of their American counterpart. As this process could take months, the USMCA will likely not come into full force until early 2020.
The USMCA includes a number of significant changes in areas that will affect businesses across North America and beyond. The following brief explores these changes, and provides political perspectives from the US, Canada and Mexico.
This high-level overview will be the first in a series in which Dentons examines how different industries will be impacted by the USMCA.
The US–Mexico–Canada Agreement: Key takeaways
US officials signalled early on in the NAFTA negotiations that they wanted to include a 'sunset clause' in the modernized agreement, which would require a full renegotiation every five years. Both Mexico and Canada rejected this outright, publically signalling it a 'red line' due to concerns that the inclusion of a sunset clause would significantly limit the certainty required for businesses to make mid-to-long-term investment decisions, and that the agreement would fall subject to political machinations of the day.
The compromise agreed upon in the USMCA, with noteworthy support from Mexican negotiators, is a review of the agreement every six years to determine whether it should be extended beyond its now 16-year lifespan.
Autos: Rules of origin
The US opened with a tough posture on autos, seeking a 50 percent US content requirement in all cars; though this demand was later dropped. What was agreed to in the USMCA is higher levels of North American components in cars writ large. The new North American content threshold is now 75 percent, up from 62.5 percent under NAFTA. A 70 percent North American steel and aluminum requirement is now also required for tariff free import. Governments anticipate these changes will further incentivize auto production and auto parts sourcing in North America.
Of significant importance in the USMCA is the new labour value content provision, which requires that 40-45 percent of car manufacturers' "labour activities" be undertaken by workers who earn at minimum US$16 per hour. This will significantly affect Mexico, where the average auto-sector salary is reportedly US$2.04 per hour. This move to equalize the wage rate across North America may well serve to disincentives auto / parts manufacturers from moving their facilities to Mexico—a clear win for Southern Ontario and Detroit.
New USMCA labour standards seek to 'level the playing field' in North America, by ensuring that national laws provide for the rights of workers, including stronger provisions for the establishment of unions (such as freedom of association and collective bargaining), migrant worker rights, protection against gender-based discrimination, and a ban on the importation of goods made using forced labour. These labour and working condition standards will be subject to the dispute settlement regime in the USMCA, which will empower states to address any violations of these standards head on.
Agriculture / Dairy (supply management)
In the end, Canada conceded to increase US market access in the form of tariff quotas for dairy, poultry, and egg products; eliminate milk classes 6 and 7; and monitor / control trade in skim milk powder, milk protein concentrates and infant formula. While politically valuable in both the US and Canada, this concession only accounts for less than a percentage more market share than what was already agreed upon between the US and Canada in the original the Trans-Pacific Partnership under the Obama Administration.
Canada did have some wins in this area, including a modernized and empowered Committee on Agricultural Trade, which will address trade barriers, increased market access for refined sugar and sugar products, and obligations for biotechnology that seek to increase investment, transparency and predictability.
Biologics: Patent protection for biologic drugs (drugs manufactured from biological sources, rather than chemical compounds) was extended from eight years in Canada and Mexico to 10 years, reflecting the US patent life. The USMCA states that this and other terms must be implemented within five years of the agreement coming into force. This is a significant win for the manufacturers of biologic drugs.
Copyright: Under the USMCA, copyright protection will be extended by 20 years. This means that current duration of protection (which is the life of the author plus 50 years) will increase to the life of the author plus 70 years.
The exemption related to Canadian cultural industries has been largely preserved, but Canada is undertaking to modify certain CRTC rules regarding retransmission of programming, and provide greater access to US home shopping networks.
Early in negotiations, the US called for the elimination of Chapter 19, which establishes the independent mechanism to solve trade disputes outside of the courts. Mexico and Canada had deemed this another 'red line', as it has—and remains—a vital tool to protect against any illegitimate barriers to trade. Given the arguably protectionist trade posture that the US adopted under the Trump Administration, and the long-standing importance of Chapter 19, it would have been extremely difficult for Canada or Mexico to concede to its elimination from the modernized agreement. Although the level of compliance by the US on rulings by the Chapter 19 dispute resolution panel has historically been low, all parties - but particularly Canada and Mexico - have done well to maintain it.
US negotiators had opened with a hardline position on government procurement, which would have curtailed the ability for Canadian and Mexican firms to bid on lucrative US government projects, including major infrastructure. The US backed away from this position and countries will retain access to each other's procurement markets in accordance with existing obligations under the WTO Agreement on Government Procurement (GPA). Government procurement requirements between Canada and Mexico will be covered under the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).
Section 232: US steel and aluminum tariffs / Canadian countervailing tariffs
On May 31, 2018, during the midst of NAFTA negotiations, President Trump issued proclamations under Section 232 of the Trade Expansion Act of 1962, which reinstated tariffs on steel and aluminum imported from Canada, Mexico and the EU (25 percent duty on steel products and 10 percent duty on aluminum products). Canada responded to these tariffs with its own countervailing measures on US steel, aluminum and a roster of other items worth more than CA$16.7 billion, which is an equivalent, dollar-for-dollar response. Both the US 232 and Canadian countervailing tariffs remain in place outside of the USMCA.
What has been agreed to in a side letter to the USMCA is an exemption from the imposition of any future 232 measures by the US for at least 60 days. It is presumed the US and Canada would negotiate an appropriate path forward during this period. Canada has also secured an exemption on autos and auto parts, which will serve to protect Canada's sector should the US seek to apply 232 tariffs on autos. Canada has maintained it will continue to respond to any escalation of 232 measures with equal countermeasure.
Non-market economy clause
This provision in the USMCA requires that any of the trilateral partners that seek to engage in free trade talks with a 'non-market economy' must provide the other members three months' notice of these negotiations, as well as the full text of a proposed agreement in advance of final sign-off. Further, this section empowers counterparts to withdraw from the USMCA with only six months' notice, should they deem the trade agreement is adverse to the terms of the USMCA. Observers correctly note that China is the target of this clause. The US sees this provision as a safeguard to prevent Canada or Mexico from becoming a 'backdoor' to the US market.
Canada has done well to land a deal that is better than what many had anticipated, given the hardline strategy employed by the Trump Administration. Canada's full-court press in Washington D.C., and at the state level, proved effective in directing influential players in the business community, the US Congress and Senate, to compel the White House to close a deal. Canadian advocacy in the US should remain a fixture of its approach throughout the ratification process and beyond.
Despite agreement on the USMCA, the NAFTA 2.0 odyssey is far from over, as the agreement has yet to be approved by Parliament. Canada's next federal election is slated for October 2019, and while there has generally existed all-party support for the Liberal-led negotiation, partisanship may slightly challenge the ratification process. More pressing is the sword-hanging overhead in the form of the existing 232 actions on steel and aluminum, and the threat of the 25 percent auto tariffs by the US. Canada has stated it will respond to any escalation with a dollar-for-dollar response. This X-factor is a significant liability for the business community, which should well figure into decision-making and lobbying efforts.
Canada will continue to support global free trade through a rules-based multilateral order, including through the establishment of the CPTPP. This approach stands somewhat in contrast to the Trump's 'America First' strategy, in which a clear willingness to challenge multilateralism and test the contours of American power are being exercised. Given this global shift, North American business must remain expertly informed and stand prepared to act responsively to new trade actions.
The USMCA is widely perceived to be a great success for Mexico, which will provide a boost to the economy and government legitimacy. It came just at the moment when Mexico is undergoing one of the most important political changes of its modern history. The USMCA was the result of very hard discussions lead by a team of talented Mexican negotiators with great experience in trade and investment policy dated back to the original 1994 NAFTA talks. After the July 2018 elections, the current team of negotiators were joined by representatives of the new president elect, Lopez Obrador, in what is widely regarded as a very successful strategy.
The challenge was enormous for the administration of current president Enrique Peña Nieto because of the conditions initially expressed by the Trump Administration and the timing of the negotiations, which coincided with the Mexican federal election. The new USMCA will bring new trade and investment opportunities for Mexico in key sectors of the economy, including automobile manufacturing, agriculture and energy. In addition, it introduces new provisions in areas that will certainly represent a challenge, such as labour standards, anticorruption, small- and medium-sized businesses, and e-commerce.
Under the Mexican Constitution, the USMCA will have to be ratified by the Mexican Senate after its signature by the President. While the ratification is still a challenge, it will not represent a problem since the new majority party Morena will certainly support the USMCA.
The USMCA represents a continuation of a Trump campaign promise to "get better deals for America." Whether or not the USMCA is, in fact, a better deal remains to be seen and will only be fully realized once implemented. As highlighted, implementation is not a forgone conclusion and will depend upon what US legislative timeline is adopted. Assuming the current Congress does not have enough time to consider the new agreement before the new class takes office in January, a fresh cohort of legislators will have an opportunity, if they choose, to deliver President Trump a major defeat by voting down the USMCA.
The primary benefit of the USMCA (even before it is ratified), is that it removes the economic uncertainty associated with the US threat to withdraw from NAFTA. That said, the fact that the US steel and aluminum tariffs, and resulting Canadian countervailing tariffs are unresolved, means that the two governments need to return to the negotiating table. The question becomes "when." When will the US return to the table with Canada, given President Trump's desire to escalate its trade confrontation with China?
The outcome of these intense negotiations launched last year is less a revolution than an incremental modernization of the NAFTA. As a result, the essential principles of free trade on the North American continent have been preserved. If implemented by the three legislatures, the agreement will have varying impacts on different industries. New winners and losers will emerge, and the agreement will have far-reaching effects on commerce and trade policy for years to come. As the impacts emerge, Dentons will continue to work with its clients to help them mitigate the risks, moderate negative impacts and leverage the opportunities.
1 The full text of the agreement is available here.
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