New trade agreement preserves 'Fortress North America'

23 Oct 2018

The new trade agreement between the US, Mexico and Canada further strengthens the cross-continental supply chain that has defined the relationship between the three trading partners.

Thierry Wizman, a Macquarie global foreign exchange and rates strategist, says there are some interesting revelations in the US-Mexico-Canada trade agreement (USMCA).

These include higher wage settings for North American car production, the unexpected boost to US-Mexican relations and the broader implications for international trade, with a ban on free trade agreements with 'non-free market' countries such as China.

'Fortress North America' prevails

For US retailers and manufacturers, the greatest benefit of USMCA is that it maintains the trilateral trade structure and cross-continental supply chain that characterised its predecessor, the North American Free Trade Agreement (NAFTA).

“Under USMCA, businesses engaged in cross-border North American trade will continue to benefit from cost savings," Wizman says. “These businesses will still be able to produce in the lowest cost centers in North America and take advantage of tariff-free logistic links."

The main benefit to Canada and Mexico may simply be the continuation of the NAFTA-style framework that encourages trade and foreign direct investment from the US (and from countries selling goods to the US) into Mexico and Canada.

Mexican farm exports to the US have tripled since NAFTA's implementation, as have US and Mexican direct investments in Canada. These commercial and investment flows will be maintained. However, Canada's concession to liberalise its dairy market may pose some domestic political difficulties.

Mexico and Canada will also be spared the expense of invoking contingency plans developed in anticipation of a failure to reach an agreement. In Mexico's case, this would have involved building new logistic routes and ports to service trade with other countries.

Workers in all three countries could benefit from a stipulation that 75 per cent of a car must be produced in North America to avoid tariffs, and that at least 30 per cent of auto manufacturing must be done in factories paying an average wage of $US16 an hour. This rises to 40 per cent by 2023.

US and Mexico strengthen relationship

“An unexpected outcome of the USMCA is that the US and Mexico appear to have emerged from the negotiations on stronger diplomatic terms,” says Wizman.

The two countries reached a bilateral agreement before Canada joined the pact.

The new agreement likely solidifies the relationship between Mexico's president-elect Andres Manuel Lopez Obrador and US President Donald Trump, who hold similar views on issues surrounding national sovereignty and the need to raise industrial wages.

With the agreement in place, Mexico can now direct resources earmarked for contingency plans to other priorities, such as social benefits, while the USMCA will help stabilise Mexico’s currency and potentially ease inflation concerns.

One area still to be addressed is the tariffs imposed by the US on aluminium and steel from Mexico and Canada.

The US administration has a political interest in protecting its steel and aluminium workers, especially in the states that were key to the Republican Presidential election victory in 2016. Wizman says this issue is unlikely to be resolved for the enactment of the USMCA agreement in 2019.

“We had expected that the outcome of the negotiations to replace or modernise NAFTA was likely to be benign, and that has been the case," Wizman notes. "We now expect the US to turn its attention more toward its trade relationship with other partners, including Japan and the EU. The outcome of these are more difficult to forecast as any bilateral trade agreements would be new ones.”

And what of the US-China dispute?

While the agreement largely maintains existing arrangements between the three North American trading partners, Wizman says it has implications for other international trade, particularly the US-China trading relationship.

Wizman says the US may be under less pressure to make concessions to China now that it has strengthened its relationship with its nearest trading partners.

The stipulation that North America auto production must be conducted in a high-wage setting and the ban on USMCA signatories entering into free trade agreements with 'non-free market' countries could also limit the flow of China’s products into North America.

Wizman says while the ban may become a model for other US free trade agreements it negotiates, the US would need to be mindful that such attempts to isolate China could prolong their current trade dispute.

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