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The United States–Mexico–Canada Agreement (USMCA) officially replaces the North American Free Trade Agreement (NAFTA) on July 1, 2020. This is almost two years after the tri-national negotiations wrapped up on September 30, 2018. In outlining USMCA’s “entry into force,” the United States Trade Representative (USTR) looked forward to a “more balanced, reciprocal trade, leading to freer markets, fairer trade, and robust economic growth in North America.” Statements like these certainly show that trade blocs are much more about politics than economics. The tell-tale is to look for the contradictions. For example, freer markets and fairer trade is a very tough balance to strike. Why? The former simply requires removing trade barriers while the latter is in the eye of the beholder. One is objective and the other is subjective.
(Photo: USMCA)
USMCA is not about “free trade” and neither was NAFTA. No traditional free trade agreement is ever so literal. USMCA, like NAFTA, systematically keeps standard trade tariffs at zero for most tangible items. However, a tangle of non-tariff trade barriers (NTBs) remain. From a supply chain management perspective, tariffs are much easier to factor into cost calculations than are NTBs. Indeed, USMCA is more about what economists call “trade diversion.” This means setting up rules to get the trade bloc partners to do more business with each other than with non-members. There is nothing inherently wrong with trade partners doing more business except, however, when any rules of origin requirements lead to inefficient adjustments in supply chains.
Rules of origin, like the concept of “fairer trade,” is a subjective term. They are designed to ensure that a “fair” amount of supply chain value-add takes place in North America instead of outside. The North American content of passenger vehicles, for example, must rise from 62.5% under NAFTA to 75% under USMCA. Thus, all auto parts and raw materials used in them (e.g., steel and aluminum) will require supply chains to adjust accordingly in order to maintain that threshold.
(Photo: U.S. Customs and Border Protection)
Suppose a vendor in a non-member country offered a more cost-effective option to a Canada-based producer. If using the input in production meant that the finished item or sub-assembly from Canada did not meet sufficient North American content, the item could not be exported duty-free to the United States or Mexico. In other words, the item is less expensive in production but more expensive in terms of export landed-cost due to USMCA regulations. This forces companies to balance outside interests against trade bloc interests. This is also why the USTR’s view of “fairer trade” means less trade outside of North America.
To comply with USMCA’s rules of origin, the importer must calculate the regional value content of the item. In this case, “regional” means North America. Two options are to show either the transaction value or the net cost of the item. Sometimes the customs agency will limit the importer to only one of the two. Iron and steel, for example, have transaction value and net cost thresholds that are 75% and 65%, respectively. These new standards must be in place by the start of 2023. In some cases, however, the new standard is graduated. For example, finished passenger vehicles require that only the net cost method be used to calculate regional value content. The threshold starts at 66% in 2020, 69% in 2021, 72% in 2022 before reaching 75% in 2023. For automobile parts, the thresholds are about the same except that the transaction value method is allowed as well.
On top of this, USMCA adds a novel twist with a concept called labor value content. Basically, passenger vehicle parts manufacturing and assembly must include labor that is earning wages of at least US$16 per hour when calculating net cost. One can argue that this standard eliminates non-member sources of automobile parts (i.e., Asia and possibly even Mexico sources) when striving for the 75% magic number by 2023.
(Photo: FreightWaves staff)
As a creature of its time, USMCA does include innovations that were not available when NAFTA came into force in 1994. Consider the “single window” entry point for electronic document submissions as outlined in USMCA Article 7.10. Using the World Customs Organization Data Model as a basis for gathering data elements, the idea is for importers to have a more streamlined system for tracking the status of an item moving within the trade bloc. The intent is to increase transparency and speed the release time from the respective customs agency. If this works according to plan it should lower compliance costs and increase trade flows. Of course, this is only harmonization regarding an e-portal. It is not harmonization of customs procedures themselves as noted in USMCA Article 7.11. Such a thing would move the agreement along the lines of a customs union which would not be to the taste of either Canada or Mexico.
USMCA was a reaction to the Trump Administration wishing to renegotiate NAFTA or, failing that, leaving the trade bloc altogether. If politics is the art of compromise, USMCA is certainly a good example of it. But it is further removed from the theory of comparative advantage, which makes the objective case for true free trade. Creating an assembly line to increase productivity based on different departments’ skills and talents is not controversial. But use the word countries instead of departments and the controversy begins.
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