Trade bill unwittingly incentivizes U.S. car makers to locate their production facilities in Mexico
NAFTA, the North American Free Trade Agreement, was the brainchild of Ronald Reagan when he first ran for president. Following years of negotiation, an agreement between Canada, Mexico, and the United States was signed (by President Clinton for the United States) in December 1993 and finally took effect on January 1, 1994. The trade deal reduced tariffs or taxes on goods shipped within the continent, promoting trade and economic growth in North America. For these reasons, most economists generally support the NAFTA framework—plus or minus concerns over human rights and environmental protection.
But trade agreements are not just about trade; they are also about building relationships between nations so they are less likely to go to war and more likely to support each other when required by geopolitical considerations.
NAFTA certainly has flaws, and not everyone is a NAFTA fan. When running for president, Donald Trump called NAFTA “the worst trade deal ever approved in the United States.” He blamed the U.S. trade deficit on NAFTA, even though the large majority of the U.S. trade deficit is with China, and the U.S. has run an $8 billion trade surplus with Canada for years. And he vowed to negotiate a better deal for the United States if elected.
On August 27, the president announced his new agreement—a deal with Mexico; then Canada came aboard on September 30. Trump calls the new agreement USMCA (for the U.S., Mexico and Canada); actually it is an only slightly modified NAFTA, or NAFTA 2. Remarkably, it is a worse bargain for the United States than the NAFTA it proposes to replace. Nevertheless, with his finely tuned sense of modesty, the president called USMCA “the most important trade deal we’ve ever made, by far.”
There are only three new provisions in USMCA—one primarily concerning dairy, one concerning cars, and one concerning future trade agreements. Otherwise, it is NAFTA.
First, dairy. USMCA gives American dairy farmers greater access to the Canadian market, so more Wisconsin cheese will get sold in Canada. In return, the United States gives Canadian dairy producers greater access to the United States, so that more Quebec cheese can be sold here. This will reduce domestic sales by Wisconsin dairy manufacturers. Overall, it is not clear who will come out ahead. Likely it will be a wash.
The second change, the one trumpeted by the president, is the feature of the proposed treaty that is least favorable to the United States. Trump wants to increase the fraction of each car that gets produced in the United States. USMCA won’t accomplish this. Although the new rules are complicated, here is how it’s supposed to work.
To encourage auto production in the United States, USCMA stipulates that at least 75 percent of a vehicle (up from 62.5 percent today) must be produced in North America to qualify for duty-free treatment. This encourages automakers to produce auto parts in North America rather than elsewhere. To encourage production in the United States, USMCA requires that more and more parts (reaching 40 percent in 2023) comprising each automobile be made by workers earning at least $16 an hour—a low figure for the U.S. economy but far higher than Mexico’s average wage of $4 per hour. Vehicles that fail to meet these two conditions are subject to a 2.5 percent tariff.
However, instead of leading to greater production in the United States, this provision will encourage firms to outsource more car production to Mexico in order to remain competitive. Here’s why.
Consider a car that costs $25,000 to manufacture (close to the average cost), with more than 40 percent of production (the Trump threshold) taking place in low-wage Mexican factories. A 2.5 percent tariff means car dealerships will pay $625 more to get each car, an increase that will be passed on to consumers. In order to avoid having to charge this premium, President Trump thinks that auto manufacturers will move production back to the United States.
But there is another possibility. Once we reach the tariff threshold, more jobs may be shifted to Mexico to compensate for higher costs due to the tariff. U.S. auto workers on average make $20 per hour more than Mexican auto workers. Given this wage differential, moving 30–35 hours of production per car from the United States to Mexico saves $625, or the cost of the USMCA tariff. There will be no additional tax penalty for doing this, since the 2.5 percent tariff is imposed because more than 40 percent of parts are already made in low-wage Mexican factories. There are no further costs of moving production to Mexico, yet there are gains from lower production costs.
It should be clear why Mexico readily agreed to USMCA.
Unlike our president, President Obrador understood that once we hit the 40 percent threshold, U.S. firms have incentives to
shift more auto production and more jobs to Mexico.
Understandably, Canada was reluctant to go along with a deal that would hurt it as much as it hurts the United States because its wages are close. It finally caved in under the threat of larger tariffs and losing access to the U.S. market.
Another problem with USMCA is that it doesn’t address our real trade problem right now—Trump’s tariffs.
Aluminum and steel tariffs work against creating jobs in the United States. They make it more expensive to manufacture cars in the United States and harder to sell them abroad or at home (since foreign cars are not subject to the tariff). Not only is the U.S. auto industry hurt; any firm manufacturing goods in the United States using aluminum or steel loses its competitive advantage because the tariffs raise its production costs.
Moreover, other countries have retaliated by placing tariffs on U.S. motor vehicles, so cars manufactured in foreign countries are relatively cheaper. To remain competitive, manufacturing plants located in the United States have to move abroad. Ironically, some production is already going to China. BMW announced it will move SUV production from South Carolina to China; other firms will follow. And what goes to China will stay in China.
It is unclear why President Trump would make such a poor deal. Probably he wanted to brag about ending NAFTA; and any deal he can put his name on is better than nothing.
Alternatively, this may be his negotiating strategy. The third major provision of USMCA keeps Mexico and Canada from negotiating an independent trade deal with China because they can lose their favored access to the U.S. markets if they do so. President Trump may want to do all the negotiating, either convinced that only he can get the United States the best deal, or determined to get all the credit, or both.
The problem is that rather than gaining the trust and cooperation of U.S. allies when negotiating with China, Trump is assembling a coalition of the unwilling and the bullied. This won’t strengthen Trump’s negotiating position. And because USMCA is already such a bad deal for the United States, it shows China that if you simply let Trump have the bragging rights you will come out way ahead.
There is still hope. Before becoming law, USMCA must be passed by Congress. And Congress may recognize USMCA for what it is—a worse trade deal than NAFTA and a bad deal for the United States—and then have the courage to vote it down.
Taken From: https://washingtonspectator.org/pressman-usmca/