NAFTA Renegotiation and Future Scenarios for North America’s Supply Chains – Part 2

NAFTA Renegotiation and Future Scenarios for North America’s Supply Chains – Part 2

Executive Summary

  • The new NAFTA renegotiation process among the United States, Canada, and Mexico continues this August after it was initiated nearly 12 months earlier, with reason for optimism as Canada has expressed willingness to negotiate, and the U.S. and Mexico near an agreement on the automotive rules of origin components of the accord.
  • Despite progress, there remains considerable uncertainty around a successful conclusion to the talks in a manner that satisfies all parties. For the U.S., this will require concessions for companies already operating in Mexico. For Canada, this will be preservation of its agricultural ‘supply management’ system.
  • A base scenario, where negotiation talks extend beyond 2018 and parties make small concessions, would truly satisfy no one but may prove to be good enough for all parties involved. In this scenario, current NAFTA rules will stay in place through 2019 and all three countries will be able to achieve a respectable USD 13.9 billion in tariff relief on NAFTA members’ products across the automotive, apparel, aerospace, chemical, and technological sectors. Despite progress in negotiations, any air of uncertainty may adversely impact business performance in the aforementioned sectors. Paradoxically, extension of the negotiation time period offers the greatest promise for a favorable and sustainable result.
  • In contrast, a withdrawal scenario offers a net detrimental situation for the NAFTA parties, as a result of tariffs increasing raw material prices, impacting export demand and affecting employment in export-oriented industries. Furthermore, the retaliatory tariffs experienced from May through July have the potential to proliferate in the worst case scenario. Due to each of the countries’ trade reliance on one another, each can expect a degree of loss, as well as an increase in trade deficits, due to the availability of the low-cost Chinese trade option.
  • Finally, a NAFTA modernization scenario can offer several business-friendly enhancements, such as facilitations and protections for e-commerce and intellectual property. While some nationally protective measures would have to be conceded, such as U.S. auto sourcing requirements, others such as enhanced environmental and labor standards offer promise for bloc competitiveness. The likelihood of the most optimistic scenario, however, is slim.

Trade Impact at a Glance

Twenty-four years after NAFTA entered into force, the economies of the U.S., Canada, and Mexico are more interdependent than ever, with trade between the three countries reaching USD 1.3 trillion in 2016 and millions of jobs depending on its rules. In this context, the NAFTA renegotiation represents both a threat to regional supply chain and an opportunity to make necessary changes. The table below illustrates the trade implications for the changes in the NAFTA agreement for different North American industries:

Base Scenarios

Efforts to renegotiate NAFTA, which were on hold after Mexico’s July 1 presidential election, are back on track. The three countries have agreed to speed up talks in order to get a new deal done as soon as possible. However, given the difficult political environment and the sharp escalation in the tit-for-tat trade war among the U.S., Mexico and Canada, it is likely that the NAFTA renegotiation talks will extend through the U.S. midterms on November 6. In support of this idea is the fact that to date, U.S. negotiators remain inflexible on the most controversial proposals, most of which are unacceptable to Canada and Mexico. Such intransigence puts at risk almost USD 570 billion trade flow between the three countries in the automotive, aerospace, technological, chemical and apparel sectors, and a USD 13.9 billion benefit in tariff relief on NAFTA members’ products.

While this outcome is less severe than a complete U.S. withdrawal, the “current” NAFTA would continue to operate under a climate of uncertainty regarding the outcome of the negotiations, leading to stifling of business performance as well as ongoing supply chain disruptions. Under this scenario, it is likely that productive investment will decrease somewhat, especially in Canada and Mexico, and consequently result in slightly slower GDP growth in the region. The uncertainty bears the greatest weight on the automotive and aerospace sectors, where the status quo plus the retaliatory tariffs provide a taste of the brunt that the NAFTA countries will bear if the agreement is not renegotiated.

Various reports suggest delaying the talks is actually good for the NAFTA renegotiation process. After all, an extended timeline means no party has given up on the treaty, making an eventual deal more likely. Moreover, by extending the renegotiation process, NAFTA would allow political and business actors at the federal and state/provincial levels in all three countries to better organize their efforts and to form coalitions designed to protect the gains of the agreement. In this way, dragging out the negotiations for as long as possible could allow for a more favorable result. More specifically, most recent indications reveal that automotive rules will be the first point of agreement in a renegotiation.

Areas where we could see some advancements in the next couple of months are: i) Stronger intellectual property rights and a commitment from Mexico and Canada not to impose customs duties on digital products, ii) Modernization of border measures and trade clearance disciplines to promote digital trade, iii) Strengthening regulatory coherence, including promoting increased transparency and stakeholder dialogue on regulations, iv) Strengthening and aligning a risk- and science-based approach to environmental and labor regulation throughout North America, and v) Concessions from Mexico and Canada to increase their de minimis threshold, which is the value below which goods can be imported without paying duties or without exporters having to fill out time-consuming customs forms. Any modernization with respect to the IT industry would further contribute to the optimistic 5.6% gains to be made across the bloc in trade should renegotiation be successful.

At the end of this extended negotiation process, it is likely that Canada and Mexico will accept some of the U.S. demands. On one hand, U.S. could drop its demands to remove Investor-State Dispute Settlement from the agreement, while Mexico and Canada could offer concessions that not only please the Trump administration, but also make sense to their own economies. Such concessions might include higher wages for the automotive sector by Mexico and fewer dairy import restrictions by Canada. This muddle-through scenario truly satisfies no one but might prove good enough for all parties involved.

IndustriesPotential Effects
AutomotiveA scenario where Mexico and Canada capitulate to higher rules of origin in the automotive industry at somewhere around 70 to 75 percent would moderately disrupt the auto supply chains in the region, prompting some automakers to consider contingency plans. However, with the automotive industry growing at an exponential rate, with both OEMs and Tier 1 suppliers opening new plants and revamping old ones, it is unlikely that this scenario will affect the whole system.
AerospaceAerospace companies will probably take comfort in the idea that NAFTA’s current rules will continue to exist while the agreement is being renegotiated. However, the uncertainty around NAFTA’s future would dramatically decrease the appetite for new FDI among NAFTA countries. Moreover, under this scenario, the Trump administration could use new tariffs and other non-tariff barriers to intensify pressure on Canada and Mexico. The Bombardier-Boeing dispute is a good example of this, where the U.S. Department of Commerce applied a preemptive tariff of 292% on Bombardier’s C-Series jets.
TechnologyUnder this scenario, NAFTA has a high likelihood of being updated and modernized to reflect current supply chains in the technology industry, but also updated to reflect new sectors like the digital economy. A new agreement that would facilitate the flow of technological goods and services is certainly possible because all parties are in favor of modernization.
ChemicalsAs part of the long negotiation process, the Trump administration is likely to extract specific concessions from Mexico and Canada on chemical, oil, gas, and other products, which will most likely be announced with fanfare. Similarly, the U.S. government will likely extract concessions not only from trading partners but also from private firms, including chemical companies. These concessions will likely play an important role in the way the industry evolves in the next couple of years.
ApparelTariffs of up to 20% on textiles and 32% on apparel imported from Canada or Mexico into the U.S., which would likely push more textile and apparel production away from North America, are very unlikely under this scenario. In apparel, the United States had a trade surplus with Canada of USD 1.4 billion and a trade deficit with Mexico of only USD 2.7 billion in 2016. This reality will not make the industry a great matter of contention during the remaining of the NAFTA renegotiation process.

Withdrawal from NAFTA

President Trump has routinely threatened to withdraw from NAFTA if negotiations fall apart. As president, he has the authority to pull out of NAFTA on his own, but he must give Mexico and Canada a six-month notice. If the U.S. decides to withdraw from NAFTA, this could have important implications for the economy and businesses in the region. About 14 million jobs in the U.S. depend on trade with Mexico and Canada, according to the U.S. Chamber of Commerce, and most analysts agree that the demise of NAFTA would raise prices, destroy demand for exports and cause job losses in all three countries. Most recent estimations indicate that withdrawing from NAFTA would cause a net loss of 300,000 jobs in the U.S. over three to five years. Mexico would lose 951,000 jobs and Canada 125,000 during this period.

In addition, the introduction of tariffs into North American supply chains would increase production costs and disrupt regional economic integration, causing exports as well as imports to become more expensive. NAFTA essentially reduced tariffs between the three countries to zero, which has enabled manufacturers in the region to have a competitive advantage globally by extending their supply chains regionally. Without NAFTA, however, tariffs would likely revert to levels under the WTO: an average 7.5 percent tariff on U.S. goods coming into Mexico, and as much as 150 percent for certain products such as meat and poultry. Mexican products, in turn, would have to pay an average of 3.5 percent in tariffs to enter the U.S.

In a worst-case scenario, Canada and Mexico could decide to impose very steep retaliatory tariffs, causing the costs of trade within North America to be raised substantially. Without NAFTA, however, companies in North America would lose out on the FTA movements in the rest of the global economy and supply constraints will become more important as tariffs are levied on manufacturing components, some of which may cross the border many times before a final product is complete.

In the U.S., the main losers of a potential withdrawal from NAFTA would be small Midwestern farmers, which are large exporters to Mexico, and those exporters in states that share a border with Mexico, including in Texas. U.S. consumers, particularly lower- and middle-class consumers, would be hurt by increased gasoline costs, if trade with Canada is hindered.

For Mexico, the impacts of a potential termination are much worse, since a great deal of inward direct investment in Mexico is oriented to the U.S. market, and since Mexico has no fallback agreement if NAFTA is terminated. Termination of NAFTA would also complicate cooperation with the U.S. on security, immigration and other crucial areas.

For all three members, the key to deriving benefit from a withdrawal scenario would be the ability for each member to attain a non-NAFTA import substitution. Asian countries like China and Vietnam are poised to take advantage of this scenario, since higher-cost U.S. goods would make lower-cost Chinese and Vietnamese goods more attractive to customers in the U.S. and around the world. Automotive-parts and aviation-parts industries that are strong in Mexico would probably shift to China or Vietnam, since the tariff advantage offsetting Asian labor-cost advantages would go away.

Analysts have indicated that the probability of this scenario remains moderate, although no longer as high as last year. Negotiators have expressed their desire to wrap up year-old NAFTA talks in the upcoming months; however, the three nations remain far apart on several issues and time is running out quickly. No agreement has been reached in terms of increased North American content in auto manufacturing, Canada’s supply management policies, and the U.S. proposed ‘sunset clause’. Moreover, given the volatile temperament of President Trump and President-elect López Obrador, either could pull the plug on NAFTA at any time.

IndustriesPotential Effects
AutomotiveA withdrawal scenario could force many automakers to move their plants to the United States, where higher costs would likely force them to sell at higher prices. That being said, most analyst agree that the U.S. auto industry and the North America auto supply chains would continue to be strong even if NAFTA is disbanded, because there is only a 2.5% tariff for cars imported into the United States under rules of the WTO. What remains uncertain is whether U.S. automakers would charge higher prices for the vehicles or move much of their Mexico-made vehicle output to Asia, and not back to the United States.
AerospaceHigher tariffs in North America will most likely deter further investments into Mexico and Canada’s aerospace industries, affecting the medium and smaller suppliers in particular. While the larger aerospace companies may have the staffing and resources to manage these changes, smaller companies will be at a disadvantage.
TechnologyWithdrawing from NAFTA would mean a lost opportunity for U.S. tech firms, as they seek a commitment by NAFTA countries to eliminate tariffs on a broad range of tech products, including computers, smartphones, semiconductors and medical devices. Today, the United States and Canada already subscribe to the idea of zero or near zero tariffs on technology goods, but Mexico does not.
ChemicalsAccording to estimates by the American Chemistry Council, if NAFTA gets wiped away, U.S. chemicals exports to Mexico and Canada could drop by as much as USD 22 billion or 45% of the current export total. Total losses could reach USD 29 billion when lost chemistry exports are combined with direct losses in end-use industries such as automotive, electronics, and appliances.
ApparelIf tariffs suddenly double on clothing, companies in the U.S. could not simply switch production overnight to factories in another part of the world. Changes could also raise prices for consumers, and there are manufacturing jobs in Mexico to consider, as well as related jobs in retailing, shipping and other industries in the U.S. that would be indirectly affected.

A Modernized NAFTA

A third and more-positive scenario is that the NAFTA talks result in a modernized trade deal that not only maintains the zero tariff agreements on most goods, but also includes new provisions for meeting environmental and labor standards, protecting e-commerce and intellectual property and enabling cross- border data flows. In that sense, most analysts agree that renegotiating NAFTA is great opportunity to address issues that were not relevant when the trade agreement was first drafted.

Recent reports indicate that the nations are nearing an accord on content and salaries for auto manufacturing. However, for all three countries to compromise on a modernized NAFTA would require avoiding some of the most controversial U.S. proposals, such as the elimination of the investor-state dispute settlement system, restrictions on Mexican agricultural exports depending on the season, as well as the notorious ‘sunset clause’. In this last point, Mexico is pushing to evaluate the results every five years instead of setting up NAFTA to automatically expire, a position that resonates well with companies on both sides of the border.

If NAFTA ultimately survives these significant hurdles, it will most likely incorporate new pro-business chapters. For instance, most analysts agree that the three countries will likely compromise on slightly more restrictive rules of origin to ensure that the benefits of NAFTA flow only to its members. In the automotive industry, for example, sources indicate that Mexico is willing to increase the threshold for regional content beyond a May proposal of 70%, up from the current level of 62.5%. Furthermore, the four-year phase-in period for many rules of origin requirements would not only provide time to adjust, but would also provide an opportunity for the automotive industry to capitalize.

Also, there is a broad consensus in all three nations that NAFTA needs to be updated with emerging standards for digital trade facilitation processes and electronic commerce. This means simplifying customs requirements and processing of e-shipments as well as raising the dollar amount at which goods may enter duty-free. This is particularly important for small and mid-sized companies that benefit the most from e-commerce platforms, like Amazon and eBay. Tech companies would also like to see provisions that ensure open access to the internet and ban any future government requirements that force online service providers to store data in a particular country. If most of these conditions materialize, the technology industry could stand to gain 5.6% with a new NAFTA text.

A stronger NAFTA would also include environmental and labor standards which would make U.S. and Canadian companies more competitive, thus averting any race to the bottom. One of the main reasons why it is cheaper for companies to operate in Mexico is that the country has lower labor and environmental standards. While all three countries have enacted numerous standards, Mexico has notoriously fallen short in their implementation. Moreover, NAFTA’s current provisions on labor are also unenforceable and are therefore seen as little more than symbolic. A modernized NAFTA would need to establish a mechanism to allow member states to impose trade sanctions on countries that do not honor their labor and environmental commitments.

Finally, a strengthened NAFTA would also include provisions that make it easier for service providers to do business across borders, such as lowering heavy licensing and registration requirements that are particularly burdensome for foreign businesses. This would benefit both professional companies in the U.S. and Canada as well as consumers in Mexico.

However, most analysts remain skeptical about the likelihood of a modernized NAFTA text, given a fundamental disparity in the goals between all three countries. While the Trump administration’s concern is its trade deficit with Mexico, aiming to bring back manufacturing jobs to the United States, Mexico and Canada’s goals are to deepen international trade, attract more investments, and modernize the agreement for the twenty-first century.

IndustriesPotential Effects
AutomotiveSlightly more restrictive rules of origin in the automotive industry, somewhere between 65% and 70% would not severely disrupt the auto supply chains in the region, while ensuring that a larger percentage of the benefits of NAFTA go to its members.
AerospaceLike the auto industry, slightly more restrictive rules of origin in the aerospace industry would not deter further investment into Mexico and Canada, especially as both countries continue to expand and diversify their supplier and customer base away from the U.S. market.
TechnologyNew electronic commerce provisions would open new opportunities for U.S. e-commerce firms elsewhere in NAFTA, while strengthening export prospects for U.S. and Canadian firms that sell high-tech goods, such as sophisticated software. Leading the way would be services for travel, transportation, computer software, and industrial processes.
ChemicalsTighter environmental and labor standards will raise the costs of production, affecting all chemical companies with operations in Mexico. In the medium-term, however, tougher standards will increase the competitiveness of the North American chemical supply chains as the industry continues to promote tougher labor and environmental regulations worldwide.
ApparelOpening the doors for Canadians and Mexicans to affordably purchase more international products online would benefit the American retail industry. A boom in online sales from these countries would open up new markets for small and medium size retailers that typically lack the scale to reach international


Whether NAFTA is renegotiated or scrapped, businesses in North America will have to adapt to a new trade environment. The effects of a modernized NAFTA (or a NAFTA demise) will not be homogenous across the three countries. Therefore, it is important for companies to put together a contingency plan, using the following guiding points, over the coming months to prepare for an uncertain outcome:

  • Understand your supply chains and sourcing arrangements: Understanding the implications of higher U.S. tariffs on each part of your supply chain is the first step in any risk mitigation process. Companies should enhance transparencies in their supply chain using multi-tier visualization tools to understand the interdependencies of the network entities and to prioritize risk mitigation efforts.
  • Initiate supplier identification processes: In the event that there are ambiguities around sourcing locations and product parts affected by the NAFTA renegotiations, companies are advised to initiate supplier identification processes early on to determine potential impacts of the three scenarios outlined in this report.
  • Implement operational hedging strategies: Companies with a regional footprint should speak to economic and tax advisors, as well as their partners, customers, and suppliers to understand the effects of relocating parts of the supply chain. Local teams should weigh the pros and cons of implementing operational hedging strategies to protect business from liquidity, credit and translation risk.
  • Familiarize yourself with available federal and state resources: Each state (or province) and federal government has an office responsible for trade and private sector issues, and can advise on trade and procurement issues affecting your business. Customers are advised to make use of these resources to better understand impacts of the NAFTA renegotiation and use any available information as inputs for contingency planning.
  • Consult internal government/corporate affairs teams: Finally, with the exact outcome of the negotiation unknown, supply chain managers should consult their government/corporate affairs teams to learn what different companies, industry associations and other stakeholders are doing to influence the policy debate as well as to voice concerns and carry out assessments of the practical implications on your business.

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