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Perspectives

US-Mexico trade deal puts pressure on Canada

Jorge Amato

By Jorge Amato

Head - Latin America Investment Strategy

September 3, 2018Posted InInvestments and Investment Strategy

The US and Mexico announced that the two countries have reached a bilateral trade agreement, resolving several thorny issues that had hampered NAFTA negotiations for months. President Trump said in a press conference that he will now begin negotiations with Canada on what he sees as a replacement to NAFTA. We view this “termination” of the existing deal as merely an optical tactic, as the basic contours of NAFTA would remain in any new deal.

President Trump floated the possibility that Canada could be excluded from a final deal, threatening to impose tariffs on every car imported from Canada if the two sides cannot come to an agreement. We expect Canada to accept many of the details agreed upon bilaterally between the US and Mexico, though Canada-specific agriculture and metals trade issues remain sticking points. Mexican leaders have insisted that this deal must be finalized on a trilateral basis. US Trade Representative Lighthizer also noted during the press conference that a notice of an updated NAFTA could be sent to Congress later this week if an agreement with Canada is reached.

Both the Mexican peso and Canadian dollar strengthened on Monday when reports of the deal were confirmed by government officials. CAD traded back below 1.30, 0.5% stronger, with investors discounting the higher probability that an eventual deal involving Canada will be reached. Global financial markets also rallied more broadly as this trade agreement is new evidence that US trade disputes can ultimately be resolved.

In order for the new trade deal to be approved before newly elected Mexican President Lopez Obrador takes office in December, the US Trade Representative must notify the US Congress by the end of this week to trigger the necessary procedures that precede final Congressional approval.

While the final text of a deal won’t be released while negotiations with Canada are ongoing, some details of the agreement have been reported:

  • Sunset clause: The US backed off its initial demand that NAFTA expire if it is not renegotiated every 5 years. In the agreed framework, a lack of renegotiation among the parties every 6 years would trigger a sunset 10 years into the future. 
  • Auto rules of origin: The two sides agreed on a requirement that at least 75% of auto parts be sourced from within North America, up from 62.5%. However, the agreement alters the calculation of how to measure “origin”, which will make reaching 75% less onerous than the original NAFTA required. 
  • $16 minimum wage: 40-45% of auto content must be produced by workers earning an average base wage of $16 per hour. While improving labor standards is a priority for the incoming Lopez Obrador administration, a higher minimum wage could reduce the economic incentive for US auto companies to shift business to Mexico. 
  • Labor standards: The deal also requires that all parties adhere to the International Labor Organization's standards.
  • Dispute settlement: The current NAFTA agreement includes a dispute settlement process that allows companies to resolve issues in front of an unelected, non-government tribunal, a system that US negotiators regard as a limit to US sovereignty over its own businesses. A new agreed approach would keep the dispute settlement process for companies with government contracts, but would limit the ability of other US companies to file disputes. The agreement also limits a country’s ability to dispute anti-dumping measures, a provision that could draw opposition from Canada, which has faced escalating anti-dumping penalties from the Trump administration.