Posted before NAFTA Renegotiations started on Aug 15, 2017

Bilateral negotiations between USA, Canada and Mexico are scheduled to start tomorrow to renegotiate NAFTA (North American Free Trade Agreement) which was earlier signed into law in the 1990s. NAFTA was negotiated with the premise that countries in North America had deep relationships and North Americans compete as a block (bound competitiveness).

However, in the intervening two decades, we have seen that the business landscape has undergone a sea change since the original NAFTA was negotiated when internet commerce did not exist. In the guise of an Inclusive Trade Agenda, we have seen that this treaty destroy American Manufacturing, Competitiveness and American Middle Class. Due to unregulated “supply chain integration” or “outsourcing”, large number of well paying middle class jobs have disappeared or “moved south of the border” to Mexico because of unfavorable tariff structure, far lower labor costs, very lax environmental and other regulations. Hence, we believe that the time is right for NAFTA to be renegotiated to level the field for American Manufacturing and Labor.

In these negotiations, we are very fortunate to have President Trump at the helm, who has always spoken out about this unfairness and pronounced NAFTA as a great disaster on numerous occasions. President Trump, in his addresses, has rightly indicated that “Failure is an option” and expressed his preference for Direct Policy Intervention to pull us out of NAFTA if these inequities are not addressed. He has rightly defined current NAFTA as Unfair Trade which in our opinion is unfairly slanted against us and needs to treated as a Zero Sum Game.

Treaties are generally negotiated and reconciled based on one of the following two principles:

• Marginal Reciprocity: Normal modus operandi for trade treaties where all countries cut tarrifs on their imports / exports
• Level Reciprocity: This is not very common but where all countries wind up with same levels of Trade Barriers

In the past, due to our lack of Trade Barriers, we have had had wholesale movement of Manufacturing Infrastructure to lower cost Mexico. This is a very dangerous development since we are now dependent on Mexico and other countries to produce critical components for our defense and other industries and could affect our national security and competitiveness in coming years! Hence, President Trump rightly wants our re-negotiations, to be based on Level Reciprocity, where we have the same level of Trade Barriers as Mexico and Canada

However, there are critics who argue that this could affect US – Mexico relations in the following ways:

• Process of Compartmentalization has always been the cornerstone of US – Mexico Relationship i.e. security cooperation will not be tied to Market Access. Since these renegotiations affect their Trade, Mexico will treat “Market Access” as a “Red-line” and dial back security cooperation in the war on drugs etc.
• Mexico has a bigger Deficit than USA and Mexico is not China with surplus. Hence, Mexico as a deficit country will not be receptive to increasing their deficit

In the meantime, there is significant incentive on all sides to find a way to reach a reasonable outcome. Hence, moderate update to NAFTA is possible and may be ascribed to the following factors:

1. USA, Canada and Mexico are fundamentally aligned for trade and all favor the free market system
2. There is a significant stakeholder group who depend on NAFTA in the three countries
3. Improvements to make the Dispute Resolution Mechanism more Robust are needed in this version of the treaty
4. Massive repurcussions to Mexican Economy will occur if treaty is cancelled and affect around 10 million Jobs there
5. Disruptions in Supply Chains, which are highly Integrated, and it is estimated that 1/2 of this are industrial inputs

However, it is our view, that the likelihood of reaching agreement by ratifying this updated version of NAFTA 2.0 by the end of this year target, looks very unlikely, due to the following possible scenarios:

• US Congress will definitely wait to take it up for consideration possibly after the next mid-terms in 2018 since this has been a very contentious issue for a long time. We believe that Congress may not have an appetite to consider this before more pressing items on the agenda like Comprehensive Tax Reform and Border Security etc.
• Mexico’s next Presidential Election is scheduled for June 2018 and the current incumbent has already started seeing a strong challenge from his Left Wing Rival who is campaigning on an Anti-NAFTA Platform

In closing, it is our belief, that NAFTA 2.0 looks unlikely to pass in the next 18 months. However, since Mexico has more to lose than us should there be a deterioration of relationship between Mexico and the US, we feel that the President is absolutely right in renegotiating this treaty aggressively so that our American Interests are protected resulting in more favorable and fair NAFTA 2.0 for us.