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Cars block the road to a renegotiated NAFTA

Cars block the road to a renegotiated NAFTA

Agreeing new rules on cars will be crucial to the deal’s success

February 1, 2018

ROBERT LIGHTHIZER, the United States Trade Representative, wants renegotiation of the North-American Free Trade Agreement (NAFTA) to speed up. When the sixth round of talks ended on January 29th with only three chapters agreed, he griped: “We owe it to our citizens, who are operating in a state of uncertainty, to move much faster.” But given the changes he wants, any more speed risks a crash.

One of the biggest fights is over Mr Lighthizer’s desire to rewrite NAFTA’s rules about cars. Seen one way, the deal has been a boon for the industry. Trade in vehicles and their parts accounts for a quarter of America’s two-way trade with Mexico and Canada. But NAFTA’s critics see it as a big reason for America’s trade deficit with Mexico, and for its falling share of car assembly (see chart). Rules riddled with holes should be rewritten, they think, to yank back American jobs.
Any amendments would be to NAFTA’s rules of origin, which define what counts as a North American car—ie, one that can take advantage of zero tariffs. If the rules are too strict, car companies face a nasty choice between overhauling supply chains or absorbing the non-NAFTA tariffs of 2.5% for cars and 25% for light trucks. Too lenient, and foreign parts-producers will sneak their wares into North American cars, benefiting from tariff-free access that their governments did not negotiate.

The current rules specify that at least 62.5% of a car must come from within the region, excluding costs such as marketing or shipping. Tougher standards apply to parts on a special “tracing” list, such as axles, brakes and tyres. For them, only the regional value-added can contribute to the 62.5%. Items left off this list are easier to count as North American, as only minor processing will be enough for them to be deemed as originating from the region.

The Trump administration wants three big changes: a higher regional-content requirement of 85%; a new requirement that 50% of content is American; and a vast expansion of the tracing list to include everything. The higher content requirements should shelter local component-makers from foreign competition, and could encourage companies like Toyota, Nissan and Volkswagen to source more of their parts regionally. Updating the tracing list to include steel and electronic components, which are mostly made in Asia, should also encourage regional sourcing. The American-content requirement is supposed to ensure that any returning jobs do not flow to Mexico, where wages are lower.

Canada and Mexico have greeted these proposals with derision. An America-specific content requirement is politically impossible. And including all of a car’s thousands of components in the tracing list would be a bureaucratic nightmare and is “absolutely unrealistic”, says Eduardo Solis, president of the Mexican Association of the Automotive Industry. For components where the car industry makes up only part of overall demand, as with lithium-ion batteries, extracting the necessary information from suppliers could be tough. Flavio Volpe, president of the Canadian Automotive Parts Manufacturers’ Association, an industry group, points out that it could lead to “absurd” questions. “Is the raw material petroleum? Or do you have to know where the dinosaurs died?”

Ramping up regional-content requirements quickly would wreak havoc on the industry’s supply chains, especially given how tight the existing rules are. The costs of compliance already mean that 20% of drive-axles and 25% of radiators by value of imports move within the region without NAFTA benefits they are in theory entitled to. A severe tightening would make it harder for North American carmakers to compete with Asian exporters, who were responsible for 15% of American car sales in 2014. American-negotiated deals since NAFTA have involved less stringent rules.

Keen to keep the talks moving, the Canadian side at the sixth round suggested the “creative” solution of expanding the scope of regional content to include things like research and development. By drawing high-value-added investments to the region (and probably to America) that could entice good jobs. But Mr Lighthizer rejected this gear shift as “the opposite of what we are trying to do”. He warned that by allowing new things to count towards the regional-content requirement, the old criteria could become less onerous, making it easier for Chinese exporters to suck away North American jobs. He later added that he was “always one to talk”. With such high-level disagreements remaining, progress towards sealing a deal this year is, in effect, parked.

This article appeared in the Finance and economics section of the print edition under the headline “Rule brakers”

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