Comments to U.S. Trade Representative on Revising NAFTA

Nigel Cory June 12, 2017
June 12, 2017

ITIF filed comments with the U.S. Trade Representative on priority issues during the renegotiation of the North America Free Trade Agreement (NAFTA). In the 25 years since the North America Free Trade Agreement (NAFTA) was concluded, changes in technology and global production networks have fundamentally changed the structure and function of the U.S. economy and how it trades.

Many of the innovative goods and services at the heart of trade between NAFTA partners could not have been foreseen when the agreement was first negotiated. The role of data, technology, and intellectual property (IP) has reshaped how consumers and businesses in North America operate. The movement of data underpins a large and growing digital economy, but also innovation and trade in many traditional sectors. And innovation-based industries have grown significantly over the past quarter of a century. This means that the issues that NAFTA needs to address have also changed. For NAFTA to continue playing its role as a vehicle for shared economic prosperity, it needs to be updated to address modern barriers to trade and investment between its members. Most importantly, while it would be ideal for the U.S. government to get Canada and Mexico to agree to every single desired change in the agreement, the reality is that tradeoffs will have to be made. In this context, the U.S. government should focus its negotiating efforts principally on the significant array of trade policy issues that most affect America’s advanced industries, as detailed in this filing, for these are the industries that are most important to America’s economic future.

In manufacturing, U.S. companies have used NAFTA to become and remain globally competitive by leveraging Canada and Mexico’s respective comparative advantages as part of continental production networks. NAFTA supported the flow of goods and services across borders as part of complex production networks that source intermediate goods and services from wherever is the most competitive, which is trade as it should be. For example, the United States and Mexico form a high-wage/low-wage partnership, bringing complementary labor forces, investments, innovation capacity, and industry strengths together to be able to compete globally. Within this relationship, the United States is the source of much of the research and development, design, innovation, and high-value-added manufacturing, while Mexico provides some of the lower-tech, lower-cost, and less value-added manufacturing activity. This economic relationship makes regional North American manufacturing value chains globally cost competitive with Asian ones. A revised NAFTA, if done right, could therefore make the region more attractive for global manufacturers, attracting global manufacturing value chains—now centered on Asia—to move back to North America. A revised NAFTA that further reduces trade frictions between the three countries can help the United States attract higher-value-added components of industries, further supporting the United States’ comparative advantage as a high-wage, innovation-intensive country.

In services, deeper North American integration is critical as it will enable companies from all three nations to achieve economies of scope and scale gained when serving a much larger market. This will help the U.S. economy as it is highly competitive in services, but it will also help Canada and Mexico as these nations would enjoy lower priced services and help them achieve increased firm size. Indeed, one key reason why Canada and Mexico have lower standards of living than the United States is their smaller average firm size, as 4 smaller firms are less productive than large firms and their firms are smaller in part because of smaller market size.

In line with this, the Trump administration should see a revised NAFTA as a strategic and tactical tool to encourage U.S. companies to move production networks for advanced technology industries from Asia and elsewhere back to North America, whether by “onshoring” production back to the United States or “nearshoring” operations to Canada or Mexico. Such “nearshoring” should be encouraged as the United States stands to gain much more from such nearby operations. For example, 40 percent of the inputs to finished manufactured goods in Mexico come from the United States, compared to just 4 percent in China. This is why the United States loses out on much more of the same production processes when production shifts to other countries, such as China. Such a focus is win-win for all three countries given it also helps provide jobs, investment, and other benefits to Canada and Mexico.

All members of NAFTA have benefited from the agreement. The United States should start by revising the current agreement, rather than starting from scratch by cancelling NAFTA. Such a move would create economic, political, and negotiating problems given the economic activity, time, and issues involved. The United States should view negotiations as a way to improve a deal that is already working well. On some issues, NAFTA negotiators have the benefit of using the details of the Trans-Pacific Partnership (TPP) trade agreement as a guidepost, which could facilitate swifter completion of an updated agreement. But that is not to say that the administration should not push very hard for improvements in the agreement that would benefit the U.S. economy.