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Trans-Pacific Partnership: Renegotiating NAFTA by the Back Door

For years, trade and justice activists from across North America have proposed renegotiating the North American Free Trade Agreement to address some of the deal’s most damaging features. Top priorities would include removing the anti-democratic investor-state dispute settlement (ISDS) provisions of Chapter 11, linking trade benefits to genuine protections for human and labour rights (crucial given the deteriorating democratic situation in Mexico, with mass disappearances and regular suppression of journalists and organizers), and establishing a continent-wide strategy to fairly allocate investment and production in key industries like auto manufacturing (thus curtailing the race-to-the-bottom the that currently shapes those patterns).

We were always told that renegotiating NAFTA was a pipe dream: it would not be possible to open the text and get all three countries on board with reforms, no matter how legitimate the concerns. So imagine our collective surprise to see that the entire NAFTA is suddenly now being renegotiated on a wholesale basis – but through a back-door method. The Trans-Pacific Partnership talks, as usual behind closed doors, have jumped right into the deep end, opening up the entire text of NAFTA to wholesale reform and renegotiation.

The TPP would include 12 countries, several of which already have free trade agreements with each other.  Originally Canada and Mexico were not included in the talks, but both countries pressed hard to join (worrying that a TPP would erode their supposedly “preferred” access to the U.S. market – although that will occur whether or not Canada and Mexico are part of the deal). The fact that all three members of NAFTA are participating in the TPP talks, however, opens up a significant new Pandora’s box: the TPP would supplant NAFTA’s language. So the TPP is not just “another trade deal.” For the North American participants, it is akin to re-opening all of the language in what is, for each of them, the most important existing trade relationship.

TPP-inspired changes to NAFTA’s rules could thus have major impacts on trade, investment, and employment outcomes across North America – quite separate from the effects of the TPP in facilitating more cross-Pacific trade and investment with countries (such as Japan) which are not yet linked to North America via an FTA.  For this reason, the TPP discussions should be conducted with far more public consultation, dialogue, and caution than has been the case so far.

The most important new bilateral free trade axis under the FTA would be with Japan.  For Canada, bilateral free trade with Japan poses many risks in its own right, similar to the risks of other deals (like the proposed CETA with the EU, and the bilateral FTA with Korea which came into effect on January 1 of this year).  Canada’s bilateral relationship with Japan (and indeed with all of Asia) starts from a position of deep quantitative and qualitative imbalance: Canada incurs chronic trade deficits with Japan, with imports of high-value manufactured goods vastly outweighing exports to Japan (which consist mostly of natural resources).  Bilateral tariff elimination with Japan will undoubtedly boost Canadian imports more than exports (since imports are bigger to start with, and resource-based exports do not face large Japanese tariffs in the first place).  The working of Japan’s state-directed economy, reliant on nuanced and multidimensional interventions to support and protect strategic domestic industries, and boost net exports, will not be fundamentally altered by the restrictions of a trade deal.  Hence, the ongoing, targeted trade surpluses which Japan runs as part of its deliberate export-led growth strategy will be unaffected. So liberalization with Japan can only reinforce Canada’s structural disadvantage as a resource supplier – as is also true of other FTAs.  This point has been made in previous critiques of the Conservative government’s strategy to sign many more FTAs.

A potentially greater risk of the TPP, however, is the impact of changes to the (flawed) rules which currently govern trade and investment within North America. TPP rules would now supplant NAFTA’s practices on all sorts of issues: from rules of origin, to dispute settlement, to intellectual property.

One important example of this back-door renegotiation of NAFTA rules has been the proposal to substantially water down rules-of-origin provisions governing trade in automotive products.  When NAFTA was negotiated in the early 1990s, it included relatively strong regional content rules for this vital industry: to qualify for NAFTA’s tariff-free preferences, an auto part had to include 60% North American content, and a vehicle had to contain 62.5% North American content.  These relatively ambitious regional content rules were intended to reinforce the stability of the continental automotive supply chain.

In July, however, it was reported that Japanese and U.S. negotiators had secretly agreed to reduce those content rules to just 30% for parts, and 45% for vehicles, under a TPP.  Thus a vehicle could be imported tariff-free to North America even if a majority of its content was produced outside of the TPP (say, in China, Thailand, or Indonesia).  Japanese automakers are strongly committed to this watering down, because their own supply chain is heavily oriented around imports of low-cost parts (for installation in Japanese assembly plants) from those low-wage non-TPP countries.  U.S. negotiators accepted the demand, over the objections of U.S. auto parts, steel, and other input industries.  The U.S. government is interested in the TPP mostly for geopolitical reasons, to counter China’s growing influence in the Pacific Rim economy; perhaps that explains the U.S. government’s willingness to make such a painful concession, in order to keep Japan on-side.  (President Obama’s rush to finish the TPP as a “legacy” achievement is another.) America’s NAFTA partners, Canada and Mexico, were not even consulted on that auto deal.  This sparked fury on the part of Mexico, and embarrassment on the part of Canada. (The official Canadian reaction was muted by the strange electoral politics unfolding, as the country heads toward an October 19 federal election. The ruling Conservatives are still keen, despite this betrayal, to sign a TPP before the election, as supposed “proof” of their economic stewardship. In reality, however, since being elected in 2006 the Conservatives have overseen the weakest economic performance in Canada’s postwar history – including the worst growth in exports, despite signing several free trade deals.)

These new auto content rules would make it easier for Japanese automakers to import vehicles tariff-free to North America, even if they contain a majority of non-TPP content.  This alone would damage North American auto production for various reasons: giving Japanese brands fiscal space to squeeze North American market share from their North American competitors, and reducing the incentive for Japanese manufacturers to invest in North American plants.

However, the new watered-down content rules would also apply to the existing North American auto supply chain, not just to imports from Asia – since the former NAFTA thresholds, which have underpinned the geography of auto production for a quarter-century, will disappear.  Any auto company could now outsource a substantial portion of its existing parts and input purchasing to non-TPP countries, thus gaining more access to the same low-wage labour (in China, Thailand, Indonesia, etc.) that is already tapped by Japanese automakers.  (Those cost savings for Japanese automakers, until now, have been offset by the fact they must face modest tariffs to bring those products to North America.  But that countervailing factor would disappear under a TPP.)

The weakening of auto content rules would facilitate the offshore outsourcing of about one-quarter of the total value of a finished vehicle by North America’s auto industry.  The parts content rule would be reduced by 30 percentage points (from 60% to 30%), and the finished vehicle rule by 17.5 points (from 62.5 to 45).  Given that the auto parts industry employs about two-thirds more workers than the assembly sector, this works out to a weighted-average content reduction of 25 percentage points. In other words, the TPP rules would allow North American automakers to offshore production of an additional one-quarter of each vehicle they produce!

Another way of calculating the proportional reduction in the content rule, is to consider the combined effect of the two thresholds.  An auto part can qualify as TPP-made with just 30% TPP content.  A vehicle can qualify as TPP-made if 45% of its content originate within the TPP — including auto parts which only had minority TPP content in the first place.  This “double jeopardy” effect means that the theoretical minimum regional content for a finished vehicle to qualify for TPP trade preferences would be only 13.5% (equal to 30% of 45%).  That is a theoretical minimum; in practice, true content will be higher than that (in part because the deal would require final assembly within the TPP to qualify for tariff-free status).  The equivalent value for NAFTA is 37.5% (60% of 62.5%), hence the weighted average reduction in the regional content threshold is 24 percentage points.

By either method, the industry could outsource approximately one-quarter of the value of its existing value-added activity to jurisdictions outside of the TPP, yet still preserve its made-in-the-TPP trade preferences.  Applying the lower of these two weighted-average calculations (24 percentage points) to Canada’s existing automotive manufacturing footprint (and assuming that the dislocation for Canada’s industry is only proportional to the overall North American shrinkage, an assumption which is probably optimistic), provides an estimate of the potential scale of economic loss if the U.S.-Japan deal was implemented.  Canada could lose 24,600 jobs (ie. 24% of existing automotive manufacturing employment), $6 billion in parts shipments, and a large chunk of its assembly footprint as well.  This loss would be experienced over several years, as automakers and suppliers alike adjusted their investment and location decisions to take advantage of the new freedom afforded them under the watered-down content rules.

These seem like large predicted changes, but the methodology seems reasonable, and they are consistent with equally alarming predictions made by auto parts officials in Mexico and the U.S.  For example, Oscar Albin, Executive President of Mexico’s National Auto Parts Industry Association, has estimated his sector would lose $23 billion (U.S.) in shipments over ten years if the U.S.-Japan rules were implemented (Inside U.S. Trade, August 26, 2015).  We have already seen in North America how the geography of auto production can experience tectonic shifts in response to trade policy and other determinants (with the migration of investment to Mexico in the wake of the NAFTA and Mexico’s attainment of critical mass in this sector).  The dramatic change in NAFTA’s content rules could certainly unleash equally dramatic effects.

There are several other concerns relating to the auto industry under a TPP: including the need for protections to ensure that automotive trade with Japan and other TPP countries becomes meaningfully two-way (right now it is a one-way street, with no meaningful flow of automotive products from North America back across the Pacific). North American automakers have also proposed measures limiting the use of active currency manipulation as a means of achieving advantage in trade competition.  (I would favour more direct limitations on trade imbalances, instead of assuming that trade would be mutual and balanced “if only” other countries played “by the rules.”)

And of course there are many other fundamental problems with the TPP: including its likely acceptance of ISDS, its further tightening of intellectual property rules (with many consequences, including higher pharmaceutical prices), and the lack of democratic rights in several TPP countries (such as Brunei, Malaysia, and Vietnam) which can clearly distort investment and competition. Feisty efforts are underway in several countries to draw attention to these concerns; the anti-TPP campaign in New Zealand has been especially ambitious (perhaps because it would be the first time that country becomes entrapped in the noose of the ISDS kangaroo courts).

The auto content issue, however, has captured some mainstream attention because of the concerns expressed by an important North American business constituency. It seems their concerns about renegotiating NAFTA in this manner are far more politically influential than the long-standing concerns of trade justice and human rights activists. Perhaps this debate will spark greater attention and concern across North America to these trade talks, which — by renegotiating the NAFTA — would have a much bigger impact on the continental economy than “just another trade agreement.”

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