President Donald Trump wants to shrink the U.S.’s half-trillion-dollar trade deficit in goods and services in part by rewriting the North American Free Trade Agreement’s "rules of origin." Those rules dictate how much of a product must be made in the three Nafta countries -- Canada, Mexico and the U.S. -- to qualify for the treaty’s free-trade benefits. Trump is asking Canada and Mexico to tighten considerably the regulations for autos. He hopes this will bring car manufacturing jobs back to the U.S., though such a step also could backfire.
1. What are the rules of origin now?
Generally speaking, a car is subject to Nafta’s preferential trade terms if at least 62.5 percent of it comes from the U.S., Canada or Mexico. (The threshold is generally 60 percent for individual parts not yet attached to a vehicle.) Automakers must specifically prove where some parts come from; that amounts to red tape, they say. And yet there’s something of a loophole: Not all parts and components are on the so-called tracing list, which determines which products’ origins must be tracked. Anything not on the list isn’t tracked, so it’s effectively treated as domestic content, even if was made abroad.
2. Why aren’t all car parts counted?
As time goes by, the original Nafta accord becomes less and less comprehensive in what parts it accounts for. While still considered restrictive, the list is now outdated, opening the door to foreign parts that weren’t in cars built in 1994, such as complex computer systems. In other words, under the existing tracing list, a Nafta car can get more and more of its pieces from overseas and still get the pact’s preferential treatment.
3. How does Trump want to change this?
- bump the auto minimum threshold from Nafta countries to 85 percent from 62.5 percent.
- add a U.S.-specific requirement of 50 percent -- unprecedented under the current pact.
- expand the tracing list to include nearly everything.
- strengthen verification of where parts came from, rather than deeming some to be from North America.
Trump’s proposal would mean tougher rules and more legwork for companies to comply, and a complete disruption of existing production systems. He also wants swift implementation of the new rules, giving automakers as little as one year to adapt.
4. Wouldn’t that make it more expensive to make cars?
Yes, for companies doing business under a revised Nafta. While cheaper parts and Mexican labor have caused U.S. job losses under Nafta, they also have made U.S. cars more affordable to consumers, who could suffer from sticker shock if Trump gets his way. There could also be substantial costs for automakers to re-orient supply chains to comply with Trump’s rules-of-origin changes. In the end, automakers may not bother with the new rules.
5. What else could they do?
Automakers might abandon Nafta altogether, choosing instead to build abroad and pay an import tariff to bring vehicles into the U.S. For cars, the tariff is just 2.5 percent -- likely far cheaper than contorting an existing supply chain on short notice. For trucks and SUVs, the tariff is higher, 25 percent, so there’s more incentive for Nafta compliance in those categories. Automakers could also avoid Nafta rules by manufacturing and selling exclusively within the U.S. -- but that, too, would raise the price of a vehicle.
6. Have carmakers indicated how they’d respond?
The Motor and Equipment Manufacturers Association has warned that Trump proposals would lead to higher costs and ultimately risk jobs. Flavio Volpe, who represents Canadian parts makers, said of the proposed new rules, "At some point, with the layering of all these things in it, you’d say, ‘I’m not going to try.’" Then there’s the example of what Ford Motor Co. did. After being criticized by Trump for planning to move production of its second-best-selling U.S. car to Mexico, Ford instead is moving it to China.
7. Why is Trump doing this?
For him, Nafta talks are all about trade deficits. The U.S. trade deficit with Mexico is fueled in part by manufacturers moving plants south of the border, and automakers are a poster child for that. U.S. Commerce Secretary Wilbur Ross has argued that the share of U.S.-produced content in goods imported from Mexico was only 16 percent in 2011, down from 26 percent in 1995, while Chinese content is rising. He partially blames the rules of origin.
8. Will Mexico and Canada agree to this?
Not so far. Along with a U.S.-requested sunset clause and changes in dispute settlement, dairy trade and government procurement, the proposed revisions to rules of origin were flatly rejected during the fourth negotiating round, which ended Oct. 17.
9. Would Trump’s changes narrow the U.S. trade deficit?
Maybe. They also could raise it. That’s because the tougher standards would give companies an incentive to import cars to the U.S., rather than make them in the U.S. Ross, for one, has downplayed that scenario. "I don’t think it’s that hard at all," he said during a discussion of the Nafta proposals in Washington on Oct. 11. "I think you will find we will get increased percentages in the rules of origin and I think you’ll find the car companies will adapt themselves to it."
The Reference Shelf
- QuickTake explainers on the issues in the Nafta talks, the complicating role of Trump’s desire for a border wall and free trade’s foes.
- A Bloomberg View editorial argues that Nafta is working just fine.
- A U.S. Department of Commerce study of U.S. content in imports under Nafta.
- A Bloomberg News article on the auto sector and Nafta talks, and another on why auto companies oppose revamping Nafta.
- An explanation of the "auto alley" that employs more than 1.5 million people in three countries.