USMCA – breakthrough in NAFTA negotiations

Free trade agreement USMCA

After lengthy negotiations, the US and Canada finally achieved a breakthrough in NAFTA. The delegations finally reached an agreement in the previous US-Canada trade dispute in the late afternoon of October 1st 2018 in Washington after many hours of deliberation. The fear that Canada would be left out in a renegotiation of the NAFTA agreement, thus remained unfounded.

The new designation “United States Mexico Canada Agreement” (short: USMCA) is representative for the renewal of the free trade agreement. USMCA has a minimum validity of 16 years.

Duty-free trade between the three states is still guaranteed, provided that the product fulfills the relevant conditions of origin. Nevertheless, the protectionist policies pursued by Donald Trump affect the automotive sector . The Regional Value Content (RVC) will increase from 62.5% to 75% in the future. The goal is to support regional production. Furthermore, the new agreement determines that all automobile manufacturers must aquire at least 70% of their steel and aluminum purchases from high-wage regions, where the average wage in the automotive industry is 16 US Dollar per hour.

President Trump in particular hopes to reduce the trade deficit in the automotive sector by means of the new agreement between Mexico, USA and Canada.

Also other sectors of the US economy are thus expected to reduce their trade deficit. In the agricultural sector, US dairy farmers, for example, should receive better access to the Canadian market in the future, which has been shielding local farmers from high tariffs so far.

What are the next steps? The agreement must be signed by Mexico´s president Peña Nieto before the end of his term until 30.11.2018 in order to become effective. When the agreement officially enters into force is still unclear. The ratification in Mexico is expected in a timely manner for legal reasons, whereas the process of ratification in the US is expected to take until 01.01.2020.

Consequences for German Investors

The new agreement entails difficulties, especially for German carmakers and especially for suppliers. The regulations are particularly affecting European and Asian automobile manufacturers in Mexico, because many companies in this industry regularly buy parts of their home markets outside of North America. According to estimates by the Mexican government, about one third of the cars manufactured in the country do not fulfill the new requirements. These include the Volkswagen models Golf and New Beetle. On the German side, Volkswagen subsidiary Audi is currently heavily affected in Mexico. In the plant in San José Chiapa the Q5 has been produced for the US market since 2016. BMW and Mercedes-Benz (together with Nissan) are also building plants that will be fully operational by 2019. The location of Mexico is attractive for German automobile manufacturers mainly due to its numerous free trade agreements and its low production and labor costs. Therefore the question arises how the requirements of USMCA can be fulfilled in the future.

The current average hourly wage is $ 5 in the Mexican auto industry. Even top wages with $ 10 an hour are still below the required wage. It is unlikely that the wages will be adjusted in the near future.

Administrative effort increases

Another complication is the administrative effort that USMCA brings with it. The new rules, when applied, lead auto manufacturers to more complicated source computations. Significantly more than half of all manufacturers issue the proof of origin of the cars produced for the entire plant. Due to the higher minimum value added, in the future it is possible that the calculation will be made for each individual model to prove that various models already fulfil the requirements. However, this would drastically increase the administrative effort.

Whether the US will provide an alternative location for greater localization in the automotive industry is questionable in the future because of the uncertain political situation, which provides new remissions of duty of foreign imports by Donald Trump.