When President Trump’s trade negotiators struck a last-minute deal to revise NAFTA last weekend, critics scrambled to reassess the President’s broader approach to trade. Perhaps he really did know what he was doing. Perhaps this new NAFTA demonstrated a promising path forward, away from looming trade wars.
U.S. Trade Representative Robert Lighthizer touted the new agreement as a “paradigm-shifting model” for how to deal with other nations. The Wall Street Journal reported that the strategy could lead the Trump administration to seek new deals with Japan, the European Union, the United Kingdom, and the Philippines.
In fact, the Trump administration’s trade strategy has fundamental, insuperable contradictions. Even if the new NAFTA deal goes through – and it has been neither signed nor passed by Congress yet – the administration will have to choose between the novelty and the viability of its trade approach.
As for novelty, Ambassador Lighthizer’s “paradigm shifting” claim presumes a degree of novelty that is not really there. Sen. Chuck Grassley (R-IA) said of the new deal this week, “You know 95 percent of what we will be voting on is the same as NAFTA.”
There is one part of the new deal, though, that is both important and distinctly different from the existing NAFTA: its treatment of auto trade. The automotive sector accounts for hundreds of billions of dollars in U.S. trade and is highly integrated across North America. If a car qualifies as “North American,” it does not face any tariff under NAFTA. The Trump administration wants to promote U.S. auto jobs by changing the definition of a “North American” car. Currently, a car must have 62.5 percent North American parts to qualify; under the new deal, that “rules of origin” cutoff rises to 75 percent, with additional requirements for the wages paid to auto workers. The Trump administration’s theory is that these requirements will compel auto producers to do more work in North America and, given the wage requirements, more of that in the United States or Canada.
Here we come to the Car Conundrum. The administration will have to pick between two of its principal stated objectives. It will either have binding new rules of origin that rework supply chains, or it will have a model for future deals with major trading partners. It cannot have both. At the crux of the matter are proposed U.S. national security tariffs on auto imports.
Through its experience with steel and aluminum protection this summer, the Trump administration discovered that it could freely set tariffs if only it claimed a national security motivation under “Section 232.” The President then launched just such a 232 investigation into autos trade, which could provide the justification for tariffs similar to the 25 percent ones imposed widely on steel imports.
Now we return to the question of whether the Trump administration has found a model for future deals with the European Union or Japan. Those countries’ transparent motivation in agreeing to deal with the prickly Trump administration on trade was to avoid new auto tariffs. Yet, on the way to a European meeting to discuss US-EU relations this week, Politico quoted one European official on the subject:
‘Everybody is expecting car tariffs’ to come after the midterm elections. Trump will have 90 days to decide on tariff action after the Section 232 report is published. The 232 auto investigation led by Commerce Secretary Wilbur Ross appears to be ‘as good as finished or already lying in the drawer, so that it can be pulled out right after the midterms.’”
Here’s the conundrum: if the administration does go ahead with extensive new auto tariffs, it will not have trade deals with the European Union or Japan. The NAFTA rewrite will lead to nothing but additional costs in North American auto production while the administration dramatically expands its trade war. On the other hand, if the administration does not impose auto tariffs, then the one really novel aspect of the new NAFTA deal will have little or no effect.
To see why the NAFTA rules are linked to the auto tariffs, it is important to remember what happens when a North American car does not meet the rules of origin set out under NAFTA: it then needs to pay the (MFN) tariff faced by the rest of the world. At the moment, that tariff is 2.5 percent. This puts a very low ceilingon the costs that auto companies will be willing to incur to accommodate administration schemes. If the total cost of meeting the rules of origin requirement exceed the cost of a 2.5 percent tariff, expect companies to opt out of the NAFTA preference and just source however they please. Note that the costs of meeting the requirement would include the administrative costs, such as keeping tabs on how much workers are paid at different stages of auto production, something most companies are not currently set up to do.
In this second scenario, in which auto companies just opt out of the rules of origin requirement, Sen. Grassley’s 95 percent familiarity estimate starts to sound low; there would not be much novelty at all. But in the first, alternate scenario, in which 25 percent auto tariffs provide a real incentive to produce locally, the administration would kill any chance of a new, peaceful approach to resolving trade concerns.
No matter how vigorously the Trump administration congratulates itself for reworking NAFTA, it still faces the inherent contradiction between liking trade deals and disliking trade. The rapidly-approaching “national security” decision on car tariffs will force the President to choose.