NAFTA: What next?

Senator Barack Obama has said that he would renegotiate the North American Free-Trade Agreement if elected President. But what would that mean in practical terms? By Jon E. Huenemann.

In the Ohio primary in the Democratic Presidential race, Senator Barak Obama raised the prospect that he would seek to renegotiate the North American Free Trade Agreement (NAFTA) if elected President.

Although NAFTA does not require a renegotiation, Obama – who went on to win the Democratic Party’s nomination – said that NAFTA’s labour and environmental provisions are insufficient and that he would be prepared to pursue re-negotiation. Furthermore, he suggested he would support withdrawal from NAFTA if renegotiation failed. Senator John McCain, the Republican Party candidate, has indicated he would not renegotiate NAFTA.

Of course, what candidates say before they are elected and what they do after are frequently very different. But not, it seems, in the case of NAFTA. Before its implementation in 1994, the-then Democratic Presidential nominee Bill Clinton promised that he would not implement NAFTA without labour, environment and import-safeguard accords. When he was elected, he kept that promise.

The lesson from this is that some Presidential campaign promises should not be taken lightly, especially if they figure prominently in an election in which a significant portion of the body politic is raising questions about trade agreements. Furthermore, it will be important to observe whether NAFTA renegotiation is highlighted again as the race for the Presidency between Obama and McCain heats up.

What follows is some historical context, a brief discussion of what to expect and avoid if the US does pursue re-negotiation, and a suggestion on the way forward.

Sobering context

Trade growth between Canada, Mexico and the US is a key objective of NAFTA and North American trade is the single most important trading relationship for the US. Between them, Canada and Mexico account for one-third of US exports and more than one-quarter of its imports.

Furthermore, since NAFTA, trilateral trade has more than tripled and is expected to hit $1trn in value in 2008. But despite the big numbers, the cold hard truth is that NAFTA is neither the solution to poverty in Mexico, nor the cause of the US manufacturing sector’s decline as a percentage of gross domestic product (GDP).

In addition, thanks to the way in which the debate has been framed by supporters and critics alike, the general public probably does not grasp many of the essential considerations of NAFTA.

One factor to understand is that diving into the renegotiation of two decades of trilateral work that legally frames these massive trade and investment relationships brings a high risk of upsetting a complex and difficult balancing act of compromises. In other words, the implications of renegotiation are profound and the difficulty of such a project should not be underestimated.

Cost consideration

Before looking ahead, let’s look back: the Uruguay Round that formed the current World Trade Organization (WTO) agreements was a central focus of US policymakers when the NAFTA negotiation was launched. NAFTA was controversial outside and – surprising to some – inside the administration. In the end, President George Bush senior decided to go ahead despite a number of negative considerations.

Strategically, integrating Mexico into the North American trading space was regarded as politically vital. During the subsequent years of negotiations, each country made dozens of painful political decisions that reflected the nature of the significant opportunities for trade and economic integration that were being created, as well as the enhancement of competition that would ensue.

Given this, one should not be surprised if Canada and Mexico do not warmly embrace the idea of re-opening NAFTA over labour and environment. Canada and Mexico may argue that there is little, if any, substantive basis to take on additional dispute settlement obligations pertaining to labour and environment.

Why? They would say that their laws are sufficient and, in some cases, go further than those in the US. Compared to the US, both Canada and Mexico have ratified more of the core conventions of the International Labour Organization (ILO), which is the indicator that many in Congress and the US union movement use to determine the degree to which countries uphold worker rights.

Similarly, both Mexico and Canada have ratified nearly all of the relevant multilateral environment agreements that the US has ratified and that were inserted as benchmarks in the most recent US free-trade agreements (FTAs), and have made commitments beyond those of the US.

On top of the initial hurdle of convincing Canada and Mexico that they need to undertake what would amount to an additional labour and environmental enforcement agenda, both countries likely would charge a high price to conclude any negotiation.

The Prime Minister of Canada has already said as much. For example, Canada might seek:

(i) Modifications to US countervailing duty and anti-dumping laws;

(ii) Significant changes to US homeland security related ‘border thickening’ policies that have slowed trade; or

(iii) More market access for Canadian softwood lumber.

Mexico, ironically, might ask that the US finally implement the NAFTA land-transportation provisions that the Teamsters union loathes or seek to limit market access for US agriculture products, thus restricting the largest export market for many US producers. Mexico might also seek US acquiescence to its immigration agenda. These and other issues would bring major resistance in the US. They would also threaten to undermine the political balance that was sewn together over many years.

NAFTA withdrawal

If the US were to deem the asking price too high after announcing its intention to re-negotiate, the next President could find himself boxed-in, having to consider a withdrawal from NAFTA instead. Withdrawal would carry enormous consequences. The tariff inequity that NAFTA corrected – all countries now pay a zero tariff (with a few exceptions between Canada and the US) – would be lost.

US exports of nearly $400bn would face billions of dollars in new taxes with the average applied tariff in Mexico at 12.6% and the average applied tariff in Canada at 5.5%, while imports from Mexico and Canada would face an average applied US tariff of just 3.5%. WTO membership would not correct this imbalance.

In addition, NAFTA goes beyond the WTO in opening-up the Canadian and Mexico markets to US service providers and investors and in protecting US intellectual property rights. These protections would be lost if NAFTA was tossed aside.

To put it in a nutshell, not only would privileged access to the Canadian and Mexican markets be lost but, unlike prior to NAFTA, US industries and workers would now have to compete in both these markets – its two largest export markets – at a serious disadvantage. Why? Because both Canada and Mexico have negotiated FTAs with other countries since NAFTA. For example, Mexico has FTAs with the European Union, Japan and most of Latin America. The US, in other words, could face a real growth hit.

Way forward

Defining how to move forward is critical. Approaching Canada and Mexico as part of an effort to build on NAFTA’s success and use its built-in mechanisms would limit opposition from Canada and Mexico and substantially reduce the risk to US interests.

Furthermore, pursuing this as a limited ‘incremental’ effort and being especially careful in defining progress in labour and environment is key, as is remaining open to reasonable ‘balancing’ proposals from Canada and Mexico in return.

The existing labour and environment agreements uphold much of the substance that is reflected in the latest FTAs and the so-called 10 May deal articulated by leading congressional Democrats. The main differences lie in the scope of what can be subject to dispute settlement in relation to labour and the use of multilateral environment agreements as a benchmark for enforcement purposes, along with what are largely procedural differences in dispute settlement.

NAFTA’s existing labour and environmental accords have created a strong foundation for even more robust trilateral efforts on labour and environmental cooperation. Also, the Mexicans have even indicated that they want a stronger North American Development Bank focused on the border’s environment, which may be one part of a potential deal.

While the US will want to show progress should it pursue this risky route, it should be careful to avoid a prescription that, in the end, will preclude progress and create a terrible dilemma. Mexico and Canada care deeply about their access to the US market, but assuming they will act as if a wish of the US is their command is reckless and wrong-headed.

Furthermore, Mexico and Canada will have their own agenda. The trick will be to keep the trilateral agenda circumscribed, consistent with deeper economic integration, while advancing the green and blue agenda and, at the same time, avoiding major opportunity costs by allowing such an effort to crowd out other key trade efforts.

No one should underestimate the trickiness in this trick.

Jon E. Huenemann, is a Principal in the International Department of law firm Miller & Chevalier Chartered and a former Assistant United States Trade Representative responsible for coordinating the NAFTA work effort.