Analyzing the New NAFTA: A Review of the USMCA and its Impact on Site Selection Strategies

by Bob Cook, on Oct 22, 2018 2:46:16 PM

The Trump Administration recently released the text of a new trade agreement between the U.S., Canada and Mexico. Canada signed onto the agreement just hours before the Oct. 1 deadline. Site Selection Group has been reading through aspects of the new agreement as well as scouring media and other reports in an attempt to determine how the new NAFTA (referred to as USMCA) may impact site selection – particularly for our industrial clients. 

The almost 1,600-page agreement has been publicly available for less than two weeks, so these are preliminary impressions.   

Eliminating some uncertainty

Perhaps the most important aspect of the new agreement is that it finally removes a certain level of uncertainty about where trade between the three countries is headed.  Companies with a significant manufacturing footprint in North America can now do a certain amount of planning.  We should caution, however, that the language is still under legal review and each country must ratify the agreement.

The formal ratification process is anticipated to begin by the end of November and could take several months as the administration works on implementation legislation. Once the final implementation bill is presented to Congress, it will have 90 days to take action. Our initial bottom-line assessment is that USMCA represents tweaks in some areas of NAFTA and clear modernization in other areas, as opposed to a wholesale replacement of the prior agreement.  

Following are our preliminary thoughts as they relate to site selection. 

Significant focus on the automotive industry but muted impact

From a manufacturing perspective, the automotive industry is the most greatly impacted by the agreement, although reviews from auto industry experts are mixed as to how significant the changes really are. 

In order for a passenger vehicle or light truck to qualify for duty-free treatment, automobile producers must document that an average of 75% of the value of each class of light passenger vehicle or truck consists of North American content. The 75% target takes effect within three years of the agreement’s implementation (or Jan. 1, 2023, whichever is later) and will increase from its current level of 62.5% by approximately 3% annually until it reaches 75%. 

There is also a provision that 40% of the value of automobiles must be produced by companies that pay a minimum of $16 per hour (applicable only to employees directly related to production and apparently not indexed to inflation).  This ramps up from 30% in the first year (or by Jan. 1, 2020, whichever is later) reaching 40% by the fourth year or Jan. 1, 2023, whichever is later. These provisions also apply to automotive parts that are traded between the three countries. 

It should be noted that 64% of the automobiles made in North America are currently assembled in the U.S., so some analysts believe that it may not be a significant challenge to meet the wage requirement.

As mentioned previously, the wage rule also applies to automotive parts. Over the past three years, the average value of U.S. auto production has topped $682 billion while our nation imported approximately $45 billion annually in automotive parts from Mexico and nearly $13 billion from Canada. This leads some analysts to conclude that the requirement is perhaps already being met. Having said that, any producer’s class of vehicles that do not comply will incur a tariff of only 2.5%. 

Lastly, the USMCA limits duty-free imports of autos from Canada and Mexico to 5.2 million units per year (2.6 million from each country)—but they still must meet content requirements. There are only 6.2 million vehicles produced between those two countries at present, so it is unclear how this may result in any significant impact.  Overall, these provisions should drive an increase in automotive parts production in North America, although the impact may be small.   

No substantial changes for medical device manufacturers

For medical device manufacturers, there does not appear to be any substantial changes that will directly impact costs. In an addendum dedicated specifically to this sector, the agreement attempts to standardize how medical devices are approved and regulated in the three countries. The rules of origin in place during NAFTA remain in place for these products. Medical devices can qualify for duty-free treatment if the North American content is at least 50% using the “net cost” method or 60% using the “transaction value” method. The U.S. has traditionally had a significant trade deficit with Mexico in this sector, last year exporting $2.7 billion in medical devices to Mexico while importing $5.9 billion. 

Manufacturers express concerns over wage pressures in Mexico

The aforementioned wage requirements for the automotive sector have caused concern for some industry leaders, thinking that this will cause upward pressure on wages for other manufacturers operating in Mexico. Given that the penalty for noncompliance is only a 2.5% tariff, many expect that this provision will have a limited impact. 

There are two other wage-related issues in Mexico, however, that businesses should keep a close watch on. In response to the trade negotiations, Mexico appears to be moving toward greater transparency in union negotiations with manufacturers (and presumably other employers). The new approach would require contracts to be ratified by at least 30% of hourly workers. Today, it is common that union leaders negotiate contracts directly with company leaders without approval from the rank and file.  Most significantly, we believe, is that the incoming president of Mexico, Andres Manuel Lopez Obrador (AMLO) has vowed to increase minimum wages in border states by as much as 100%. Most non-Mexican manufacturing operations already pay more than two times the minimum wage, but there will still likely be some upward pressure on border wages if this provision goes through. AMLO takes office on Dec. 1 and his new Morena party will have a majority in the Mexican Congress, likely making it easier to push through reforms that he supports.   

Specific tariffs remain

The agreement does not remove the current tariffs on steel (25%) and aluminum (10%) for Canada and Mexico so this will still impact manufacturers and construction companies that incorporate those commodities into their products.

It is unclear how long the Administration intends to leave these tariffs in place.  The 4-year tariffs on solar panel imports also do not appear to be addressed in the agreement.  These tariffs are currently at 30% and reduce 5% per year until they reach 15% in year 4. Similar to steel and aluminum, it is not clear what will happen the year after tariffs fall to 15%.   

Modernization and increased protections

The agreement addresses specific issues that were either not in the mainstream or simply not addressed when NAFTA was first put in place in the mid-1990s. It specifically addresses digital trade, financial services and telecommunications.  The U.S. also pushed for and received greater intellectual property protection and restrictions against currency manipulation. We think these provisions are more likely to serve as a template for future trade negotiations—specifically with China. There do not appear to be meaningful changes for resolving trade disputes. 

Review and sunset provisions

The agreement automatically terminates in 16 years, unless each country elects to extend the agreement beyond the original 16-year term. To accomplish this, the three countries have agreed to review the pact every six years. If, after six years, there is not unanimous agreement among the countries to extend the USMCA then an annual review is triggered until such time that the agreement either terminates or the 16-year extension is ratified. 

Topics:ManufacturingEconomic DevelopmentSite Selection GroupSite SelectionLocation Advisory



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