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NAFTA IS Dead; Long Live the USMCA!

Borrowing liberally from Shakespeare, I come not to praise NAFTA, but to bury it. NAFTA is the most comprehensive and successful trade agreement ever, if only because it saved the North American auto industry by rationalizing production of vehicles and parts throughout the North American region. Yet throughout its entire history, NAFTA has been known as “a giant sucking sound” and the “worst deal ever”, the destroyer of jobs and communities. Like a scarlet letter, NAFTA’s reputation with the general public has been as a pernicious and inerasable stain blotting out the many benefits NAFTA has bestowed.

Why the disconnect? What caused NAFTA’s epic failure to capture the approval of American Main Street? The answer lies in NAFTA’s weedy details, the process by which goods are certified as qualifying for NAFTA duty-free benefits: the rules of origin.

Rules of origin are critical to the workings of any trade agreement but, by their very nature, they are both complex and arcane. And for reasons no longer relevant or applicable, NAFTA’s origin rules are devilishly so. To know whether something qualifies for NAFTA, its rules of origin require only what does not qualify to be counted. That’s right; NAFTA’s origin rules require that to show what is needed, only what isn’t needed is reported! So, when a certificate of origin shows that a car has the required 62.5% of NAFTA content, what’s actually documented is that the car has no more than 37.5% of non-qualifying content. Even those numbers are questionable, however, because of a rule, specific to the auto sector, called “tracing”, which allows some content, such as nuts and bolts from China, to be “deemed originating”, while other truly qualifying content, like door assemblies and instrument panels made in the same plant as the finished vehicle, cannot be counted as NAFTA content.

That’s how NAFTA works. NAFTA’s origin rules with their negative focus have all but obliterated the proof of NAFTA’s tremendous good. Seemingly impenetrable to 24+ years of economists building models to tell NAFTA’s story, its origin rules work to hide the many and varied jobs and other economic contributions involved in making a car or pickup: from hourly factory workers to highly skilled engineers, not to mention those who make the equipment and tools used in the assembly plants or the truckdrivers or railroad personnel that move everything from here to there. All these contributions and others, such as the value of the R&D that occurs within NAFTA, the billions in investment, and the positive effect all these contributions have on the towns and communities where they happen are neither counted nor recognized because the NAFTA origin rules expressly exclude them. The result has been much like that of effective negative political ads: we have no idea of NAFTA’s positive economic impact or how it could be improved, all we see is a dark cloud of loss and uncertainty.

The new trade agreement replacing NAFTA, awkwardly dubbed the USMCA, goes a long way to fix NAFTA’s near-fatal flaws by taking a new tack on the rules of origin. Focusing on the positive, the new origin rules count all the content that makes a product qualify, instead of what doesn’t. By counting up, not down, more of the economic contributions (jobs, investment, capital equipment) from North American manufacturers will be visible to the public. At last, contributions from the three-person gasket maker to the plant worker who installs the grille on a brand-new car with a few truck drivers in-between will be recognized.

Yet, the reaction to the new NAFTA from those who have been making the old NAFTA work, the automakers and parts suppliers, has been wary and critical. Understandably. The new agreement significantly increases the required content percentages: cars and pick-ups will need 70% qualifying content, up from 62.5%; while the threshold for some parts jumps all the way to 75%. And there are more reporting requirements, such as showing those manufacturers who pay their workers $16 an hour or more and that at least 70% of the steel and aluminum comes from North American mills. The cost and complexity of the new origin rules, the auto industry fears, will cancel out any improvements in the new agreement,

But, has the auto industry and other USMCA critics missed the silver lining? By turning the effort and emphasis to documenting what is in and not what is out, the new agreement’s rules will reveal contributions that have been there all along and establish a more intuitive qualification process with inputs from more contributors. Since a great many parts suppliers are located in the U.S. and Canada, where high wages are prevalent, and the auto industry already sources more than 95% of its steel and aluminum requirements from U.S. and Canadian mills, those reporting requirements shouldn’t be too difficult.

Qualifying goods for USMCA will be a snowball process: starting at the top, each producer will show its contribution and then pass that down to the next one, who will add their contribution and pass it along. Add in some manufacturing processes NAFTA currently prohibits: “intermediate goods”, those door assemblies and instrument panels made in the same plant as the vehicles, and “roll-up”, which in transforming parts and materials into something new and different is the essence of manufacturing; we all may well find the new origin rules to be more attainable than NAFTA’s, not less.

The reformed origin rules alone call for the auto industry’s strong support for the entire USMCA. Congress should approve it. Bringing to light the positive contributions from North American producers will allow at last the American public the chance to understand, and maybe even celebrate, international trade rather than flinch from and scorn it.

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NAFTA: 3 Tips for Car Origin Rules

The Trump trade team has made jaw-dropping demands in the NAFTA renegotiations, but has yet to offer any specifics how to achieve them. If the Americans don’t come up with something concrete, the talks and NAFTA could collapse. On autos, I have three tips; take them for what they’re worth. Trump wants the NAFTA content threshold for cars to increase from 62.5% to 85%, with no less than 50% to come from the US alone. My suggestions would provide a more accurate measure of how much NAFTA content is in a car; use origin rules already in NAFTA for most other manufactured goods; and modernize NAFTA to conform to most of the rest of US FTAs. (1) Eliminate “tracing” and restore cumulation so that all NAFTA originating inputs: materials and jobs get proper credit.

(2) Allow “intermediate processing”, so that the contribution of parts and subassemblies made in the same factory as the finished vehicle and all the associated jobs get their rightful due.

(3) Finally, allow “transaction value”, which looks at prices paid for inputs, to be used in addition to the more cumbersome Net Cost method, which relies on analysis of production costs from accounting records. Adopting these changes may seem cosmetic, but they are consequential. Yet, by going to already extant rules that are familiar and tested, they stand a good chance of being accepted by the Canadians and Mexicans, who have been anxiously waiting for the Americans to put some skin into the game.

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