USMCA: Free Trade with Significant Limitations

During the election campaign, U.S. President Donald Trump had already called the North American Free Trade Agreement (NAFTA) the “worst deal ever” and threatened to terminate it. Finally, a new version was negotiated: the U.S.-Mexico-Canada Agreement (USMCA). The agreement became one of the President’s top trade policy priorities.

Canada and Mexico are indispensable trading partners for the United States. In 2018, Canada was the most important export market with 14.6 percent of total exports (goods and services), followed by Mexico with 12 percent (the EU states considered individually). In terms of imports, the shares were 12.1 percent for Mexico and 11.5 percent for Canada. In terms of imports, they ranked second and third behind China (EU states considered individually). In 2018, the United States had a trade deficit with Mexico of 78.6 billion U.S. dollars (goods -86.6 billion US dollars, services +8.0 billion U.S. dollars) and a trade surplus with Canada of 3.6 billion U.S. dollars (goods -24.6 billion U.S. dollars, services +28.2 billion U.S. dollars).

Struggling for an Agreement

After almost one and a half years of difficult negotiations on modernizing NAFTA, the United States, Canada, and Mexico agreed on a treaty text in early October 2018. However, the Democrats in the U.S. Congress called for amendments. In particular, they wanted stronger enforcement mechanisms for occupational safety and environmental protection regulations and changes in rules for the pharmaceutical sector. Having won a majority in the House of Representatives in the midterm elections at the end of 2018, the Democrats had the political leverage to do so. To ratify a trade agreement, both chambers of Congress must approve it. This was followed by months of confrontation between the Democrats, Republicans, and the Trump administration as well as renegotiations with Canada and Mexico.

At the beginning of December 2019, the negotiating partners agreed on a number of changes: in the areas of labour and environmental protection, rules of origin in the automotive sector, and selected provisions in the areas of the dispute settlement mechanism and intellectual property. Mexico ratified the amended treaty in mid-December 2019, and a few days later the U.S. House of Representatives also approved the text of the treaty by a large majority of 385 votes to 41. In mid-January 2020, USMCA was finally ratified by the U.S. Senate by 89 votes to 10. Canada has yet to ratify the treaty. However, the approval is considered politically secure.

Contents of USMCA

With a total population of almost 500 million people and a total economic output of around 23 trillion U.S. dollars, USMCA is one of the world’s largest free trade areas according to the World Bank.

In some areas USMCA is a meaningful modernisation of NAFTA, in other areas the agreement has become significantly more protectionist.

  • For the automotive sector, the rules of origin have been significantly tightened. These determine when a product can be traded under the preferential conditions of a free trade agreement. For example, they specify what proportion of production or value added must have taken place in the contracting states. For passenger cars and light trucks these have been increased to 75 percent, for commercial vehicles to 70 percent. Stricter rules also apply to parts or components, depending on the relevance of the part – 75 percent for so-called core parts in the passenger car sector. In addition, 40 percent of passenger cars and 45 percent of light trucks must be produced with a minimum wage of 16 U.S. dollars. The companies are granted transitional periods – between three and seven years, depending on requirements. Finally, manufacturers must prove that at least 70 percent of the steel and aluminum purchased last year is of North American origin.
  • For sectors such as information technology, pharmaceuticals, medical devices, cosmetics, and chemicals agreements on consensual compatible regulation, alignment of best regulatory practices, and the general development of trade relations could have positive effects. German companies in the region could also benefit from this.
  • The agreement also includes chapters on competition, state-owned enterprises and against currency manipulation.
  • The chapter on “Digital Commerce” prevents restrictions on the cross-border transmission of information – with exceptions that are necessary for legitimate policy objectives. The principle of non-discrimination and the principle of proportionality of the state measure apply.
  • The regulations on data localisation prohibit prescribing the use of local computer facilities or the establishment of such facilities as a prerequisite for doing business in the country. The agreement does not provide for an exception to this rule. Therefore, USMCA severely limits the policy space of state authorities.
  • If one of the three countries is negotiating a Free Trade Agreement (FTA) with a country that one of the partners classifies as a non-market economy or with which none of the USMCA countries has an FTA, consultations are held. The respective other USMCA countries have the right to withdraw from the USMCA after submission of the FTA text. The remaining USMCA partners can then negotiate a bilateral agreement.
  • USMCA is set to run for 16 years. After six years, a review of the agreement will take place, during which identified problems will be discussed and, if necessary, resolved without calling into question the agreement as a whole. During the review, the partners are also to determine in writing whether the agreement should be extended for another 16 years.
  • NAFTA had three separate dispute settlement mechanisms. There are changes in all three of them. The first is the settlement of interstate trade disputes. Here the rules for appointing a dispute settlement panel have been changed. The aim is that the procedure can no longer be blocked by a single party. Proceedings involving anti-dumping and anti-subsidy duties were not changed in essence. They remain part of USMCA, in particular due to pressure from Canada. The procedure for settling disputes between the USMCA states and investors (ISDS) has been significantly adjusted. The new dispute resolution rules stipulate for claims between Canada and the other contracting parties that claims are no longer heard by international arbitration tribunals but by state courts in the signatory states. For investment disputes between the contracting parties, the United States and Mexico, arbitration is possible at least in certain sectors (such as oil, gas, public services) and under certain conditions, but only after domestic legal proceedings have been unsuccessful.

USMCA: Better than Nothing

The USMCA economies are among the most important foreign markets for Germany; together they accounted for almost nine percent of German foreign trade in goods in 2018.  A large part of this is trade in parts and intermediate products, as German companies are strongly integrated in North American value chains and also produce locally. This is where industry faces major challenges with the new restrictions, especially the stricter rules of origin. Nevertheless, the conclusion of USMCA is a welcome development. A complete termination of the NAFTA agreement without any alternative, involving all three North American states, would have been extremely damaging.