What would a repeal or reset of the landmark trade deal really mean and entail?
Donald Trump campaigned against the North American Free Trade Agreement as a jobs destroyer that should be renegotiated in America’s favor, or discarded, but potential changes to U.S. policy vis-à-vis trade with Canada and Mexico likely won’t become reality until 2018 or beyond.
Nonetheless, large U.S. and Canadian companies that depend on cross-border commerce are preparing for a possible worst-case scenario: significant amendment of NAFTA and what that would mean to their supply chains.
Others are holding off on new investments until Trump administration trade policies become clearer.
But most firms importing and exporting across the continent are trying not to read too much into the president-elect’s anti-trade campaign rhetoric on the assumption that rolling back NAFTA would undermine the economy and Trump’s stated goal of creating jobs, according to industry officials.
Few believe NAFTA will actually be terminated, largely because the three economies are so intertwined. Still, corporate risk managers are smart to think about how policy changes could influence their bottom line.
Trade between the three NAFTA members exceeded $1.1 trillion last year, nearly a fourfold increase since entering into force in 1994. In the past 22 years, the United States increased exports to its neighbors 265 percent, to $517 billion – a third of its total overseas sales. U.S. manufacturing exports to NAFTA partners have increased 258 percent and the United States maintains a manufacturing trade surplus. American exports of computer and electronic products, furniture, paper and fabricated metals have all more than tripled since NAFTA was implemented.
Several large manufacturers in the auto, pharmaceutical, high-tech, and chemical industries are modeling the business impact from NAFTA changes, Bernie Hart, vice president for global trade management sales at Livingston International, told the Adam Smith Project.
“A number of our clients are doing scenario analyses” on how they could be impacted if NAFTA privileges are revoked, he said. “If the program changes significantly, some companies could lose hundreds of millions of dollars.
“But it’s hard to do. It’s like throwing things at a dart board” at this point, he added.
That hasn’t stopped the Center for Automotive Research (CAR), an industry think tank, from trying to quantify the hardship higher tariffs on automobiles made in Mexico would create.
A 35 percent tariff would result in a sales reduction of 450,000 units in the United States and the loss of 6,700 North American jobs, mostly in Mexico, according to a report from the think tank that is due to be published later in January.
CAR based its estimate on the average cost of the 1.3 million vehicles made in Mexico and sold in the United States in 2015, Bernard Swiecki, a senior automotive analyst, said in an interview.
The cost to produce a car in Mexico – not including shipping, advertising, profit margin and other ancillary costs – is about $18,400. The tariff would raise the cost to $24,800 and scare off many potential buyers, he said.
The auto industry is global and most likely will substitute Mexican vehicles from another location in the world
Swiecki said a 35 percent tariff is unlikely to play out because it would probably be implemented as an emergency measure, and under World Trade Organization rules temporary protectionist steps can only last for 150 days. A more realistic scenario is that the U.S. government grants Mexico “Most Favored Nation” status, which would increase tariffs between 2.5 percent to 3.5 percent from zero today.
Trying to protect U.S. jobs with tariffs may not have the desired result, Swiecki said.
Halting imports from Mexico, where cars are built with about 40 percent U.S. content, doesn’t mean production will be replaced by U.S.-built vehicles, he explained. The auto industry is global and most likely will substitute Mexican vehicles from another location in the world. Ford, for example, soon plans to import a small crossover SUV from India and consumers already can buy certain Volvos made in China and Buicks made in Poland.
“The replacement vehicle won’t have that 40 percent U.S. content and you will have shot yourself in the foot,” Swiecki said. “You will have replaced that 40 percent content vehicle with a 5 percent content vehicle.”
CAR is still early in its analysis and hasn’t crunched the numbers yet on how a 3 percent tariff on Mexican imports would impact U.S. auto sales, he added.
Cautious Optimism. So far, industries in Mexico, Canada and the United States are in the dark since Trump has yet to announce any concrete policy proposals.
Many business leaders say it is too early to make decisions based on the U.S. election because Trump could take a more pragmatic approach to NAFTA once in office.
“Business is still going on. Mexico’s economy is the highest it’s been in a long, long time. The market dynamics aren’t going to change, so I’m not concerned,” said Chris Gutierrez, president of KC SmartPort, a non-profit economic development organization focused on freight-based companies in the Kansas City area.
“Most folks understand that Mr. Trump is a businessman that will do fair trade, not just free trade,” added Hector Cerna, president of International Bank of Commerce’s Eagle Pass, Texas, regional office.
IBC provides services such as currency exchange, trade financing and commercial lending for companies engaged in cross-border trade.
“Our Mexico contacts are skeptical, but they understand…that tweaking NAFTA will benefit all three countries…and that ultimately capitalism will prevail,” Cerna said.
A NAFTA update could also address new trade opportunities such as e-commerce, and oil and gas, he added.
Officials at freight railroad Kansas City Southern remain bullish about their cross-border business in Mexico, which represents 30 percent of revenue. Three weeks after Trump won the election, the company launched a new joint intermodal service with BNSF Railway connecting shippers in the Chicago area, and other major markets along BNSF’s rail lines, to its network in Mexico. KC Southern primarily operates a north-south network from southern Illinois deep into Mexico, while BNSF trains mostly run east-west across the western half of the United States.
“The President-elect’s team has indicated that there will be a process for any reshaping of America’s trade policies, which could include reforming NAFTA,” Donielle Carlson, assistant vice president for corporate communications at KCS, said in an e-mail response to questions. “KCS understands this would include a study on what the ramifications of withdrawing from the agreement might be. While NAFTA allows a member nation to withdraw with 180-day notice to the other member countries, if done, it must be done with both of the member countries and not just one or the other; and, initial withdrawal from NAFTA does not, by itself, raise tariff levels. It is unclear that the President(-elect) could unilaterally set permanent, across-the-board tariffs without Congressional involvement.
“KCS remains optimistic that its premium service between the U.S. and Mexico will continue its long-term growth over time due to the strong, interconnected nature of the North American economy. As demand for products continues to grow across the North American continent, the need to move them between the three countries will continue to grow and KCS is well positioned to service that growth.”
Alan Russell, president and co-founder of Tecma Group, a so-called shelter company that offers a full suite of support services for foreign companies looking to manufacture in Mexico, expressed confidence that Trump will be a trade promoter just like previous presidents who appealed to the anti-trade mood among voters during their campaigns. The difference, he said, is that Trump will likely generate slight changes to NAFTA that he can tout to the American public as following through on his promise to protect American interests.
But even if Trump is willing or able to renegotiate NAFTA, the new terms will take time to go into effect. Once the trade community is notified about the changes, each government will need to update its automated customs systems with the new trade rules, and industry will need time to update trade management systems and compliance software
NAFTA is incredibly important for the U.S. economy and its export capability, Russell said.
“Without the available and lower cost of Mexico production, U.S. companies would be suffering and would have more of their business in China. [A large percent] of the content of those finished products made in Mexico is actually U.S. content,” he said.
Products produced by Tecma clients are made with 80 percent U.S. content, he added.
Shelter companies have local expertise, close relations with governmental organizations, a maquiladora permit, and “shelter” the overseas customer from liabilities and risks associated with manufacturing in Mexico. Tecma handles site selection, human resources, accounting, payroll, reporting to government agencies, environmental, health and safety compliance, customs and logistics, and many other functions. The manufacturer provides the raw materials and machinery, as well as management. The model allows clients to have full control over their operations while ensuring intellectual property protection compared to using a contract manufacturer.
Most of Tecma’s customers are small-to-medium-size enterprises that would have a hard time carrying out all those disciplines in-house. By spreading the overhead costs across a large base of clients, the shelter company creates economies of scale and lower overhead for each account.
Brake on Investment. But policy limbo over U.S. trade will likely have a short-term chilling effect on business expansion in Mexico for U.S. firms, Livingston’s Hart said.
Livingston International, headquartered in Toronto, is a large provider of customs brokerage, global trade management, freight forwarding and trade consulting services, with a concentration on North America.
The logistics services firm has a number of clients that are in the process of building new factories in Mexico, but now may ramp up production lines more slowly than originally planned until the regulatory roadmap becomes clearer, Hart said.
As for companies that rely on contract manufacturers to produce their goods, “I don’t anticipate many multi-year agreements,” Hart said. “I think we’re going to see agreements for a year to 18 months, until they get clarity on what the changes will mean to their business.”
Three-to-five year agreements offer better rates, but “I can’t imagine that will happen that often until there’s a level of certainty out there,” he added.
Many Mexican businesses are having second thoughts about investing until the cloud over trade is lifted, according to Erik Markeset, director general of Tsol, a provider of supply chain consulting and technology services with offices in Mexico City and Houston.
A Mexican lubricant manufacturing client that imports raw materials from the United States is so concerned about the falling exchange rate and direction of the economy that it is postponing implementation of an Oracle transportation management software system it has already purchased because it doesn’t want to spend about $100,000 for the project. That’s despite projections that the system will allow the company to consolidate freight and save money in the long run, he said.
And a tool manufacturer has put a consulting project with Tsol on the backburner until it sees how the Trump effect plays out.
Foreign direct investment in Mexico will also be shelved for the time being.
“You can bet any company that was thinking about (new greenfield) investing in Mexico in 2017 is probably going to put that that on hold until we know what the new administration is going to do,” Markeset said.
But even if Trump is willing or able to renegotiate NAFTA, the new terms will take time to go into effect. Once the trade community is notified about the changes, each government will need to update its automated customs systems with the new trade rules, and industry will need time to update trade management systems and compliance software.
Companies have developed their operations around rules of origin and other aspects of trade agreements, “so if there were to be changes around them they still need to be done in a way that is possible for our companies to comply with, and, secondly, they can’t be put in place overnight,” Rufus Yerxa, president of the National Foreign Trade Council, said during a briefing for a small group of reporters. “They need to be done gradually . . . to give everyone in the trade time to adjust,” just as tariff cuts and other rules were phased in over time when the deals took effect, he said.
In the worst case scenario under Trump, the trajectory of NAFTA trade will not be significantly altered, Russell predicted.
A number of companies, to this day, especially in the textile sector, still choose to take advantage of the Harmonized Tariff provision over NAFTA trade preferences
If Congress, for example, repealed NAFTA, companies would simply revert to claiming duty exemptions for unaltered U.S. components in imported finished goods under the 9802 provision of the Harmonized Tariff Schedule. Duty is only paid on the value-added Mexican labor, overhead and materials. A number of companies, to this day, especially in the textile sector, still choose to take advantage of the 9802 provision over NAFTA trade preferences, Russell said.
Similarly, if the Trump administration somehow imposed a 35 percent tariff on Mexican imports, the impact would be modest, he added.
By Tecma’s calculation, the retail cost for a $5,000 air conditioner made in Mexico with 40 percent U.S. parts would increase $367.50, or 7.35 percent, if the Trump administration somehow imposed such a tariff.
And a broad import tax would actually precipitate even greater corporate flight to Mexico, according to a blog post on Tecma’s website. Other countries would retaliate with higher tariffs on U.S. goods, depressing exports and hurting U.S. manufacturers. Mexico, however, has trade agreements with 45 countries that give Mexican products preferential tariff treatment. U.S. companies manufacturing in Mexico will be better positioned to export to the rest of the world, Tecma said.
Business groups say American companies need flexibility to move some manufacturing to Mexico, depending on the product, because domestic costs are often too high to make a decent profit.
The incoming Trump administration should realize that manufacturers establish supply chains and select plant sites based on a multitude of factors, including speed to market and product value, Hart said.
Domestic and foreign automakers, for example, want assembly lines in the United States to directly service the market. They also have plants in Canada and Mexico that make large sections that are then transported to U.S. plants for final assembly. But a high-volume factory that will export cars to multiple countries makes more sense to be located in Mexico, Hart said, because workers there are paid about much less (about $30,000 per year) than a unionized employee in the United States.
“You wouldn’t put in a huge manufacturing location in the United States to export because the labor costs are too high,” unless there is unique intellectual capital or resources in the United States, he added.
Some finished vehicles made in the United States are exported to help meet demand in some regions, but plants aren’t built here that are dedicated to exports, Hart explained.
“A huge amount of U.S. manufacturing depends on Mexican inputs, and if you raise the tariff you’ve eroded the business case that put that manufacturing in the United States in the first place,” Swiecki said.
Calls to Action
- Get the message to politicians on Capitol Hill and the Trump transition/administration that NAFTA is an economic lynchpin for U.S. industry success. Work through trade associations, or others who can get the ear of policymakers, that NAFTA has been a net job creator and give specific examples from your company about how NAFTA has made a difference in the bottom line, employment, exports, product quality, etc.
- Closely monitor mainstream media and trade journals for Trump administration pronouncements on how it plans to change trade policy in general, or NAFTA specifically. Stay in touch with trade associations that may have the inside track on picking up what Trump officials are thinking behind closed doors.
- Make sure your trade compliance department has automated tools and is ready to apply changes to trade rules if, and when, they go into effect.
- Conduct a fresh analysis of total-landed cost and your supply chain network for importing from Mexican and Canadian sources once Trump trade policies become clearer.
