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A critical juncture for US trade policy

New NAFTA would govern North American shipments of export cargo and import cargo in international trade.

A critical juncture for US trade policy

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.

New NAFTA would govern North American shipments of export cargo and import cargo in international trade.

Anti-Manipulation or Currency Alignment?

The Trump administration has indicated that it is seeking a currency provision in a revised NAFTA agreement. In itself, this is not particularly controversial. The three NAFTA countries maintain floating exchange rates that are not subject to significant intervention, and all of them run sizable current account deficits. They may well wish to use NAFTA to establish a model currency provision that can be used in agreements with other countries.

The devil, however, is in the details. A simple agreement to refrain from currency manipulation, which establishes a mechanism for remedying such manipulation, would represent an important step forward in the battle against trade-distortive practices.

The background here is China’s massive intervention to devalue its currency on global markets from 2003 to 2013. The Peterson Institute for International Economics has estimated that excessive intervention during that period averaged over $600 billion per year. This had a very substantial impact on trade, and consequently on jobs, just as the United States and other countries with current account deficits were struggling to emerge from the Great Recession.

More than one million US jobs were lost, and we know from recent academic studies that communities were disrupted as well. Especially when demand is slack in the overall economy, there is little reason not to think of massive devaluation as a zero-sum game—there are clear winners and losers. Even when overall demand is not slack, such devaluation by a US trading partner can impose substantial costs on import-sensitive industries in the United States.

China is not devaluing its currency at present, but it is prudent for the NAFTA countries to take a proactive approach to address any use of devaluation to obtain a competitive advantage, whether by China or other trading partners. The Mexican Economy Minister indicated recently that Mexico has no objection to a pledge with its NAFTA partners aimed at preventing currency manipulation, provided that it does not affect monetary policy.

It is not clear, however, that US objectives with regard to currency are limited to establishing a mechanism for identifying and remedying currency manipulation. The administration may be looking for currency misalignment to be taken into account in trade agreements regardless of whether it is due to manipulation. If that is indeed the goal, consensus with Canada and Mexico would be more difficult to achieve.

It is true that an undervalued currency promotes exports and inhibits imports, thus affording the country with such a currency a trade advantage. But how would one measure currency misalignment in situations where there is no indication of currency manipulation? Would one first determine “equilibrium” capital flows and then derive benchmark currency values from those flows? The very first step in that process would likely get bogged down in debates about the role of the dollar in the international political economy as well as whether capital flows in the past have, or have not, been in equilibrium.

It is far more straightforward to identify currency manipulation, and its impact, than it is to define optimal currency relationships. The analysis of currency manipulation is less an economic modeling exercise than it is one of reviewing specific practices and determining their immediate effects. The analysis of currency misalignment where there is no manipulation, on the other hand, is essentially an economic modeling exercise, and there would likely be extensive, ongoing debate about the assumptions to be employed in generating appropriate models.

Moreover, to the extent that a currency misalignment provision would cause monetary policy to be subjected to greater scrutiny as a potential cause of trade frictions, the stakes would be raised and the circle of affected stakeholders enlarged, making negotiations significantly more complex. Given the recent statement by the Mexican Economy Minister cited above, as well as the fact that the United States itself resorted to unconventional, and expansive, monetary policy in the aftermath of the Great Recession, one would think US trade negotiators would seek to avoid getting entangled in those kinds of issues.

By maintaining a focus on addressing currency manipulation, the administration would make the US position less susceptible to the argument that its underlying objective is managed trade. One can imagine a scenario in which a trade imbalance is treated under a currency provision as a per se indication that there is currency misalignment; such a provision would be, in effect, an agreement to eliminate trade imbalances. A proposal along those lines would provoke vigorous debate among US trading partners.

Assuming the policy objective is simply to target currency manipulation, it seems a way forward can be found. A renegotiated NAFTA might include: (1) a ban on specific currency interventions known to have been used historically in the global trading system to obtain trade advantage, with quantitative thresholds to ensure that only massive interventions are prohibited; (2) a formula for determining the trade impact of each banned intervention; and (3) an expeditious dispute resolution mechanism, that would be triggered by substantiated allegations that a banned intervention has occurred and which would include provisions specifying the remedies that could be imposed to offset the trade impact of the intervention. Such a mechanism could even be embedded within existing procedures used to address foreign unfair trade practices.

The steps I have outlined are admittedly not intended to address the overall US trade deficit. They would, however, represent a measured approach to a problem that has bedeviled US trade policy in the past and could reemerge as countries seek to adjust to changing conditions in the international economic system. And they have the advantage that they are not likely to provoke sharp disagreement among the United States, Canada, and Mexico as they renegotiate NAFTA.

Dean A. Pinkert is a partner in the Washington, D.C., office of Hughes Hubbard & Reed LLP and a former commissioner and vice chairman at the US International Trade Commission. The opinions expressed are those of the author and do not necessarily reflect the views of the firm or its clients. This article is for general information purposes and is not intended to be and should not be taken as legal advice.