Author’s Note: I originally wrote this article in the Summer of 2019 before the U.S. Congress passed legislation by a large bipartisan majority implementing the United States-Mexico-Canada agreement (USMCA). As often occurs, the negotiators were put back to work recasting parts of the agreement to satisfy concerns of members of Congress before the trade pact was put to a vote. Two of the five flaws cited in this article were remedied; three were left untouched.
The USMCA now represents the basic template for future U.S. trade pacts. Its terms will likely guide potential revisions and updates to existing U.S. free trade agreements (FTAs) with Latin American countries as well as the possible (and desired) U.S. re-engagement in the Trans-Pacific Partnership (TPP) that President Donald Trump walked away from at the start of his term.
The USMCA is the successor to the North American Free Trade Agreement (NAFTA); it retains a lot of the previous pact, borrows generously from the TPP that Trump and many Democrats condemned, and introduces retrograde regulatory mandates and other restrictive measures that will distort North American trade and investment. It does not “ensure” market access for U.S. exporters of farm and industrial goods any more than NAFTA did: Each country can still introduce new border restrictions for national security reasons (as Trump did on imported steel and aluminum from Mexico and Canada) or in retaliation against measures illegal under World Trade Organization rules (as Mexico and Canada did in response to the U.S. tariffs on steel and aluminum).
Despite the retention of much of the original pact, Republicans and Democrats alike praised the USMCA for fixing NAFTA. For Republicans, it gave the President a signature victory and fulfilled a campaign promise. Democrats liked the stronger labor and environment provisions, though they wanted tougher enforcement authorities. Support from business lobbies was flaccid; in contrast, labor leaders muted their usual condemnation of trade pacts, in part because they liked the new trade barriers. Not surprisingly, proponents promised that the trade pact will be an economic elixir for American firms, farmers, and workers.
Flawed but Politically Popular
Read the economic analysis of the pact issued by the US International Trade Commission (USITC) in April 2019 and you come to a more downbeat conclusion: that on balance the pact would hurt rather than help the economy, that auto companies and workers would lose competitiveness, and that farmers would be no better off than they are today under the existing trade regime (except for some dairy farmers). Canada and Mexico also will suffer losses from the pact according to a study by one of Canada’s top think tanks.
In short, the USMCA is flawed but now politically popular. The following summarizes five major flaws of the original pact and what was done and not done to fix them.
New Trade Protectionism Constrains Growth
First, the new protectionist measures the agreement introduces—restrictions on auto trade and investment, government procurement contracts, and textiles—will constrain U.S. growth. Contrary to official U.S. “fact sheets,” the USMCA will hurt the overall economy unless those restrictions are removed or modified. Congress should insist on improvements to remedy defects exposed by the USITC study but the odds of doing so are slim to none.
Trump administration officials misread the USITC report when they touted the USMCA as boosting US growth by 0.3 percent per year. In fact, the study estimates that on balance the market access provisions of the USMCA would restrict trade and cause US growth to decline by 0.12 percent.
Why the discrepancy? Unlike past US trade deals, the USMCA makes almost no changes to tariffs or non tariff barriers; such restrictions were removed years ago under NAFTA. Trade liberalization under the USMCA, including the changes in U.S. access to the Canadian dairy market, is limited and more than offset by the new protectionist measures.
The 0.3 percent growth is entirely due to USITC estimates that the USMCA will induce more American investment by reducing uncertainty in policies on data, e-commerce, and intellectual property rights. That analysis mistakenly credits the USMCA with achieving those gains. But those reforms are already part of Mexican and Canadian policy through the revised TPP that they have joined. And those reforms generally are applied to all countries, so the United States already is a beneficiary.
Furthermore, the USITC cost-benefit analysis did not account for the additional uncertainty created by the “sunset clause,” a major new provision mandating that the pact expire in 16 years unless the three trading partners explicitly extend it. At the very least, North American businesses will have to make contingency plans for changes that could be introduced in the trade pact because of its possible termination. If the sunset clause had been considered by the USITC economists, the increased uncertainty would offset in whole or part the reduced uncertainty attributed to other parts of the agreement.
New Rules of Origin Hurt U.S. Auto Sector
Second, the USMCA will hurt, not help, the U.S. auto sector. The Trump administration argued that by requiring more domestic content and higher average wages at many Mexican facilities, the USMCA will encourage new investment in U.S. auto plants. Pointing to past media releases and anecdotal comments by auto company executives, U.S. trade officials claimed the deal will promote $34 billion in new investment in U.S. auto and parts production, and increase U.S. auto sector jobs by 7.6 percent. In contrast, the USITC study concluded that the new auto rules of origin would increase U.S. and Mexican production costs, which in turn would reduce U.S. output, lower U.S. auto exports to Canada and Mexico, and increase U.S. imports from non-NAFTA countries. Overall, the USMCA would raise the average price of vehicles in the U.S. market and reduce U.S. sales—hardly compatible with estimates of large increases in investment and employment in the sector.
Because the USMCA would increase the cost of producing vehicles in the United States, foreign suppliers would have an incentive instead to export more cars to the U.S. market and pay the 2.5 percent import tariff. That is why auto companies opposed the USMCA auto provisions during the trade negotiations, though they accepted the final deal for fear that Trump would implement his oft-repeated threat to pull out of NAFTA. And that’s why Trump also threatened to raise U.S. tariffs to prevent increased car imports, citing the bogus excuse of a threat to national security to impose Section 232 auto measures. Simply put, Trump needed to protect U.S. producers against the damage done by his own trade pact.
Many Democrats support Trump’s protectionist content rules despite the abundant evidence of its negative impact on American workers. That is a mistake that should not be compounded by accepting additional auto trade protectionism through new Section 232 measures. If the USMCA rules cannot be changed, then Congress should minimize the damage by insisting that auto most-favored nation tariffs not be changed either.
The Biden administration will not change USMCA content rules. But they will likely spur development of new electric vehicles, which could help offset the damage to U.S. production.
Pharmaceutical Patent Rules Need Consumer Interests
Third, the USMCA echoes the TPP by including patent terms that greatly benefit pharmaceutical companies (i.e., 10-year data exclusivity for patents on certain pharmaceuticals), and inadequately protect consumers. Former Senate finance chairman Orrin Hatch insisted on measures to protect Big Pharma from generic competition; their inclusion in the TPP was among the reasons that many Democrats opposed that pact. Those concerns carried over to the original USMCA.
In brief, the issue is how to balance consumer and producer interests. Consumers want affordable prices; allowing competition from generic drug producers would reduce prices as well as monopoly profits of pharmaceutical patent holders. But those companies argue that reduced revenues would deprive them of resources for their research and development of new medicines.
Interestingly, other TPP participants also disliked the extended pharmaceutical patent protections and quickly expunged them when they revived the agreement under the banner of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Canada and Mexico accepted the deal without the patent provisions on biologics and presumably would be willing to do the same or accept a shorter term for data protection than in the current pact. In the event, Democrats in Congress demanded these changes and the USMCA was thus aligned closely with the CPTPP in this area.
Environmental Provisions Fail To Address Climate Change
Fourth, in the environmental area, the USMCA is “best in class” compared to trade agreements signed by other countries, with provisions for the enforcement of multilateral environmental agreements (MEAs), extensive disciplines on fishery subsidies, and new obligations regarding combating marine litter that are “TPP-plus.” But the deal still was criticized by environmental groups.
Critics charged that the USMCA did not make enough progress because it maintains investor-state dispute settlement (ISDS) procedures in the energy sector (which they claim favor industry interests) and does not directly link the pact’s commitments to specific MEAs. The MEA language can be clarified with a few simple edits (subsequently added in the revisions to the USMCA); the ISDS issue, while more politically charged, also could be recast: Trump officials never seemed committed to retaining it.
Oddly, despite considerable talk about a “Green New Deal,” congressional critics of the USMCA missed one of the pact’s most egregious defects: It does not address climate change – indeed, the very words were banned from the text (also shunted aside by Obama negotiators for fear of losing Republican support for the TPP). At the very least, the USMCA should have promoted investment and trade in renewable energy resources and other measures to encourage low-carbon emissions. Officials could draw on specific provisions included in the recent EU-Mercosur trade pact promoting “domestic and international carbon markets,” and “energy efficiency, low-emission technology and renewable energy.”
Labor Improvements Need Better Enforcement Provisions
Fifth, as with the environmental area, the labor chapter is far superior to previous American pacts. It builds on the TPP chapter and is subject to the pact’s dispute settlement procedures. But its improvements did not fully satisfy some US labor union leaders, who sought revisions to augment the labor chapter and ensure effective monitoring and full compliance with obligations to protect the freedom of association and other core labor rights.
What should be done? House Democrats ought to give priority to revisions that ensure the expeditious and comprehensive phase-out of labor protection contracts in Mexico (i.e., collective bargaining agreements biased against worker interests). The new Mexican government of Andrés Manuel López Obrador already passed labor reforms required by the USMCA and should be amenable to additional procedures to strengthen labor rights.
Subsequently, negotiators added a rapid response mechanism, building on constructive proposals by Senators Ron Wyden and Sherrod Brown, to monitor and resolve abusive labor practices at the firm level. The Biden administration will likely require comparable enforcement procedures in future trade deals with developing countries.
The USMCA cannot be considered and is not called a “free trade” agreement. It is the first U.S. accord in recent memory to build up rather than break down trade barriers. It updates the 1994 NAFTA, but in most areas the “updated” provisions merely reiterate obligations that Canada and Mexico already apply under the CPTPP. Before the USMCA, Mexico and Canada already had substantially updated NAFTA by virtue of their CPTPP membership!
The USMCA passed Congress with strong bipartisan support and will set the baseline for future trade negotiations – both bilaterally and in the WTO. Several of its flaws, particularly those related to the automobile content rules, the sunset clause, and the new restrictions on government procurement, seem likely to be defended by the Biden administration and extended to its future trade accords. But one of the most important omissions seems ripe for resolution: new provisions and initiatives aimed at mitigating the adverse effects of climate change should be added. Indeed, adding a new chapter on trade and climate change could become a hallmark of trade accords in the next administration.
Jeffrey J. Schott is a senior fellow at the Peterson Institute for International Economics.