NAFTA – An Uncertain Sunset?
As noted by recent media reports, United States trade negotiators have chosen to introduce a five-year sunset provision to NAFTA as part of the fourth round of negotiations that took place last week in the US capital.
The idea, first suggested last month by US Secretary of Commerce Wilbur Ross and US Trade Representative Robert Lighthizer, would allow for NAFTA to be terminated at the end of each five-year period unless the signatories review the status of the trade deal and formally agree to continue.
Secretary Ross believes a “systematic re-examination” of NAFTA is necessary. He says the 1994 economic forecast impact to the US when NAFTA entered into force was unduly optimistic. Ross believes that although such a sunset (i.e., termination) would likely never occur, the clause is necessary to force discussion and avoid stagnation. In the new NAFTA, there would be an ongoing mechanism in place to get things fixed or adjusted to current conditions.
Meanwhile, Canada and Mexico have been quick to state their strong opposition to the sunset proposal. They say that the degree of uncertainty that this brings to manufacturing decision makers is very harmful. It could discourage investment away from the NAFTA region.
Canadian US Ambassador David MacNaughton has publicly stated the clause is likely to be met with strong resistance by US industry while Mexico’s US Ambassador Gerónimo Gutiérrez Fernández stated the proposal “would have very detrimental consequences to the business sector of the United States, Mexico and Canada.”
Companies that have capitalized on the benefits of NAFTA have done so by making large investments in sophisticated North American supply chains involving the strategic placement of manufacturing facilities, warehouses, distribution centers, and a range of other supply chain elements. Such infrastructure takes years to plan and develop and involve individual corporate investments ranging into the hundreds of millions (if not billions) of dollars. Therefore, any risk to the success of an investment over the planning horizon becomes inherently discouraging.
According to a recent Center for Automotive Research study, total US foreign direct investment (FDI) in 2015 across all industries in Canada was $353 billion and total US FDI in Mexico was $93 billion. Meanwhile Canadian FDI in the US totaled $269 billion and Mexican FDI in the US totaled $17 billion. Much of this FDI comes from the establishment of the aforementioned supply chain elements and return on those investments usually takes nearly a generation to fully recover.
The auto industry — a key focus of the NAFTA renegotiation — is an obvious example of investment at stake if a sunset clause were to be introduced. As it stands today, the components of the average vehicle manufactured in North America could cross national borders within the continent as much as seven times before a finished vehicle is produced. That is because automakers leverage the cost efficiencies associated with having various components manufactured in different geographies and transported to other geographies for partial or complete assembly.
Not much in the way of substantive agreement has been revealed thus far in the renegotiations. With elections coming up in Mexico and the US in 2018, there is a sense of urgency to complete the talks by the end of 2017 or early 2018 to ensure the renegotiation doesn’t become overly politicized.
This is a ambitious timeline considering the original NAFTA negotiation took five years and 20 negotiating rounds. The introduction of a sunset clause is likely to add to the list of contentious issues, including more stringent content requirements, labour and environment standards, and duty reduction schemes for non-NAFTA goods, which were only introduced in the latest round of negotiations.
Notwithstanding the five-year sunset provision, the immediate threat is that the sunset happens now. If the current talks fail, the US could initiate a six-month notice for a full NAFTA withdrawal by next year. That sunset is the far more imminent and threatening one.