The North American Free Trade Agreement was enacted in 1994. Not to put too fine a point on it, NAFTA was a means by which companies — such as vehicle manufacturers and suppliers — could manufacture products — cars and SUVs or sensors and subsystems — in the U.S., Canada or Mexico and not have to worry about tariffs. (Yes, there are all manner of minutia involved, but that's the big picture.)
An objective was to create a large bloc that would be competitive with other global chunks that are either political — like the European Union — or geographic — like China.
On Aug. 27, President Donald Trump stated that the "ripoff" known as NAFTA was done. In its place would be what he called the "U.S. Mexico Trade Agreement" (USMTA), which is certainly less catchy. Be that as it may, one thing particularly unusual in the press release describing the agreement is that it is repeatedly referred to as a "deal," which is not exactly a noun that is characteristic of major agreements between countries.
As in: "The deal encourages United States manufacturing and regional economic growth by requiring that 75 percent of auto content be made in the United States and Mexico" (this is known in economic parlance as Regional Value Content, which currently stands at 62.5 percent, so that 12.5 percent is non-trivial). And, "This deal uses trade rules to drive higher wages by requiring that 40-45 percent of auto content be made by workers earning at least $16 per hour." (According to Trading Economics, using data from Instituto Nacional De Estadística y Geografía, the "Wages in Manufacturing in Mexico averaged 2.48 USD/Hour from 2007 until 2018," which is a long way from $16 per hour).
Those vehicles that don't meet the elements of the deal will have a 2.5 percent tariff charged against them.
So what are the implications?
Maybe little to no changeAs you may recall, in May Trump applied tariffs on imported steel — 25 percent — and aluminum — 10 percent. What are most vehicles made with? But here's the thing: While the president has the authority to impose tariffs, he can't go it alone on USMTA. That has to be approved by the Senate. And at this point there is concern regarding whether Canada will be included, and given what happened at the end of the G7 summit between President Trump and Canadian Prime Minister Justin Trudeau, maybe Canada won't want to play along in quite the same way that Mexico has.
This is not to suggest the Canadians won't make concessions, but their hand is somewhat stronger than Mexico's: Given that there is a tremendous amount of trade between U.S. states and Canada, members of Congress have more than passing interest in making sure that their states are not penalized. (And remember that Canada responded to the materials tariffs by applying their own on steel and aluminum being sent to Canada, as well as on items ranging from whiskey to ballpoint pens. Trump's tariff game cuts both ways.) Given that wages in Canada are not low, this whole thing could be much ado about little. There are, of course, still the materials tariffs.
Or maybe a lotThe Center for Automotive Research notes that according to the U.S. Bureau of Labor Statistics, in the period since NAFTA was enacted through 2017, the Consumer Price Index (CPI) for all goods except for food, energy and new vehicles has increased 86 percent. But the CPI for new vehicles in the U.S. has increased just 7 percent. So presumably NAFTA has managed to keep prices of cars and trucks rather moderate in the U.S.
Realize that when it comes to complete vehicles, the U.S. imports from Mexico 11 percent of the cars it buys (and the same from Canada). So what happens to the CPI for vehicles post-NAFTA?
Or maybe a whole, whole lotRealize that there are a number of vehicles from U.S., Asian and European manufacturers that are produced in Mexico. So let's say for the sake of argument that the OEMs decide there is no way that they can fulfill that 75 percent RVC if they have their assembly plants — which generally also means their suppliers' assembly plants — in Mexico. Does that mean that they'll build plants in the U.S.? Look at it this way: It costs about $1.5 billion to build an assembly plant, and then there is all of the money associated with finding and hiring workers (isn't the U.S. unemployment rate essentially "full employment"?). And let's not overlook the fact that it takes about three years to build the plant. So:
(1) Who is going to pay for the new factory? U.S. vehicle buyers.
(2) Who is going to pay for the new higher-wage employees? U.S. vehicle buyers.
Look: Vehicle manufacturers strategically have located their plants on a global basis where it makes the most economic sense. For example, small cars provide little in the way of margins for OEMs, so their production is performed in lower-wage countries so that the cars can be affordable. Larger vehicles like trucks and SUVs bring higher margins, so they can be profitably produced in the U.S. So while the Ford Fiesta is made in Cuautitián, the Ford F-150 is made at places like Dearborn Truck, which is even a tourist attraction. And realize that while the industry has been growing post-recession, it is well accepted that the number of vehicle sales in the U.S. is going decrease for a number of reasons, ranging from increased interest rates to the increased number of vehicles coming in off lease. So how is it going to work out when the OEMs are faced with increased costs to produce vehicles? They're not going to eat the cost, so the numbers on the window sticker are going to be higher — which means the likelihood that consumers are going to buy more of them is not that good.
Arguably, this is a form of a regressive tax in that even small cars could be priced high, which will have a disproportionate effect on those of modest incomes.
With the U.S. automakers (1) looking at a weakening U.S. market that could further be affected and (2) having to invest a whole lot of money in developing autonomous capabilities and consequently not necessarily being inclined to invest in new factories, this "deal" doesn't look all that great.