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  August 13th, 2018 | Written by

A critical juncture for US trade policy

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The “when,” not just the “what,” can make all the difference. It has been widely reported that the Trump Administration is in the process of renegotiating the North American Free Trade Agreement (NAFTA) with Canada and Mexico and may be close to agreement. It is a matter of common knowledge that the United States has pulled out of the Trans-Pacific Partnership Agreement (TPP), although there have been some signals that the United States might try to get back in; meanwhile, key elements of TPP live on for Canada, Mexico, and nine other countries in the Comprehensive Progressive Trans-Pacific Partnership Agreement (“CPTPP”). And potential national security trade restrictions on automobile imports under Section 232 of the Trade Expansion Act of 1962 have received a great deal of attention in the wake of reports that the EU may obtain an exemption from any such action. But how these trade moves interact with each other, especially in light of their timing, is in need of greater public discussion.

In this article, using rules of origin for automobiles as a window into that dynamic, I maintain that concluding an agreement on NAFTA in the near future is likely to put off US re-engagement with TPP/CPTPP but accelerate one or more bilateral negotiations.

Rules of origin in trade agreements have a major impact on the pattern of imports and exports. A trade agreement typically establishes preferential tariffs (or tariff-free entry) for goods moving between the countries that are parties to the agreement. The preferences are intended, among other things, to give companies an incentive to source their inputs from within the region of the agreement, thereby creating regionally integrated value chains that support regional cooperation and prosperity. If a tradable good contains value both from inside and outside of the region, there have to be rules governing whether it is entitled to this special treatment.

If the rules are too strict—say they require 100-percent content from the region in order to qualify for trade preferences—they will be ignored by producers, because as a practical matter producers must source some components from other countries. If the rules are too lax, on the other hand, non-parties would enjoy the same benefits as parties, and there would be no reason for countries to commit to the obligations set forth in the agreement. Even if they do nevertheless commit to the obligations, the goal of regional integration of supply chains would be thwarted by the ability of so-called third countries to benefit from the preferences.

The rules of origin applicable to automobiles generally center on a minimum percentage for the content that must come from within the region, the so-called regional value content. Although there is more than one method for calculating regional value content, the net-cost method is the most widely cited. The current NAFTA threshold is that a vehicle is considered to be from within the NAFTA region if its regional value based on net cost is at least 62.5 percent of its total value, but the United States is seeking to raise that percentage as well as to impose a US content requirement. The threshold in the CPTPP is 45 percent, and CPTPP relies on its own approach to calculating net cost (which is simpler than the NAFTA approach). As the 45-percent figure suggests, CPTPP’s overall treatment of rules of origin for automobiles is considered to be more permissive than NAFTA’s.

If the US, Canada, and Mexico were to conclude a revised NAFTA agreement with strengthened rules of origin for automobiles, much stronger than those in CPTPP, there are at least four foreseeable consequences. First, the United States would be less likely in the short-to-medium term to re-engage on TPP/CPTPP, as otherwise Canada and Mexico may well prefer the rules of origin in TPP/CPTPP to the new NAFTA rules and threaten to render them commercially irrelevant. Second, any Section 232 tariffs on automobiles that apply to Canada and Mexico, but not to the EU, could undermine the NAFTA bargain if the new tariffs are greater than the difference between tariff-free access to the United States under NAFTA and the existing 2.5 percent tariff on automobiles from the EU (note also the 25 percent tariff on light trucks), and it would thus be logical to exempt Canada and Mexico from any such Section 232 tariffs. Third, Japan, which is one of the eleven CPTPP countries and a major automotive exporter to the United States, would likely make a concerted effort to achieve a US-Japan bilateral deal on trade in this sector, so that it would not be disadvantaged in the US market relative to Canada, Mexico, and the EU. Finally, in the longer-term, there could be a renewed US focus on TPP/CPTPP at such time as the United States might be prepared to liberalize the rules of origin agreed to under NAFTA.

Complicating matters further, the United States may find that CPTPP’s rules of origin afford it some advantages, even while it remains out of that deal. After all, 55 percent of the value content of automobiles eligible for CPTPP preferences can come from outside of the region, and that means US companies can participate in the development of CPTPP regional value chains. In the long term, however, much of the impact of CPTPP on the United States will depend on whether CPTPP markets for automobile imports continue to grow and how that influences decisions by manufacturers on where to locate production.

Thus, if the US, Canada, and Mexico are close to an agreement on NAFTA, companies will have to evaluate what that means for US involvement in TPP/CPTPP as well as for the potential imposition of new Section 232 trade restrictions and for the negotiation of new bilateral trade arrangements.

Dean Pinkert is a former commissioner at the US International Trade Commission and a partner at Hughes Hubbard & Reed. This article expresses his views, and not the views of the firm or its clients.