What's the holdup?
While we thought the U.S. and the U.K. might strike a trade pact this year, we were doubtful the U.S. and the European Union (EU) could also settle all their differences in time and pretty much dismissed hopes for a Phase 2 deal with China. Now, however, it’s looking increasingly likely that the United States-Mexico-Canada Agreement (USMCA) will be the only one to become official before the calendar turns to 2021. Let’s take a look at where all four stand.
Driven by concerns that the trade deficit with Mexico was costing the U.S. manufacturing jobs, President Trump early on pushed to replace the North American Free Trade Agreement (Nafta), which has been in place since 1994. The USMCA, which went into effect on July 1 and addressed issues like digital trade that weren’t around in the early 1990s, retains much of the original Nafta framework. We view this as a positive as the accord undoubtedly met its original intent—to forge a stronger trading relationship between the three North American countries. Under Nafta, U.S. trade with its border partners more than tripled and in 2019, Mexico and Canada were the two largest trading partners with the U.S., both with a 14.8% share. Among the numerous changes, we believe the most significant additions to the new pact are:
- Country of origin rules Automobiles will now need to have 75% of their components manufactured in the U.S., Mexico or Canada to qualify for zero tariffs (up from 62.5% under Nafta).
- Labor provisions At least 40% of automobile parts must be made by workers paid $16 an hour, on average, by 2023.
- Canadian dairy access U.S.farmers now have access to Canada’s protected dairy market.
USMCA provides greater certainty around the long-term rules applicable to trade in goods, services and investment, and reduces the risks of protectionist measures. As a result, we believe this deal is an incremental positive for all three countries. A United States International Trade Commission study last year concluded the new Nafta would tack on an additional 0.35 percentage point to GDP and create 176,000 new jobs. Exports to Mexico and Canada are expected to increase 6.7% and 5.9%, respectively, while U.S imports would increase 4.8% from Canada and 3.8% from Mexico. We believe Mexico is in a position to use the USMCA to continue promoting itself as a way for the U.S. to diversify trade away from China. Mexico has been taking trade market share from China over the last two years and if it can accelerate these gains and attract more investment, could see a growth tailwind.
Trade deal roundup
U.S.-U.K. We initially thought the U.S. and U.K. were on their way to a trade deal this year and were encouraged by the joint statement two months ago that both sides would work at an accelerated pace. For the U.S., it would give the current administration another feather in its trade cap in an election year and would also give the U.S. leverage in negotiations with the EU. The U.K. would benefit with a flagship trade agreement post Brexit, important for both political and symbolic reasons. Finally, both countries could use the economic boost from a trade deal as their economies are slowly reopening after the Covid-induced shutdown.
While, on paper, there seem to be plenty of incentives for both parties to announce a deal, progress has been slow and U.S. trade representative Robert Lighthizer recently said completing a trade deal with the U.K. before the November election would be “almost impossible.”
U.S.-EU This is a more difficult negotiation as there are two big disputes: EU subsidies to Airbus, which date back to 2004, and France’s proposed tax on digital service providers that could pave the way for a regional digital tax plan in the EU. A few weeks ago, the U.S. announced it’s considering a new round of tariffs on over $3 billion of imported goods from the EU in retaliation over the Airbus dispute. This is in addition to the $7.5 billion worth of tariffs the U.S. imposed last year on EU imports. The current administration has used tariffs as a trade negotiating tactic with China and during USMCA discussions, so this is a familiar playbook. Still, all signs point to talks between the EU and U.S. being at a standstill as the EU is now threatening retaliatory measures and the U.S. continues to threaten tariffs on EU automobiles.
Short-term, Brexit negotiations are the top priority for the U.K. and EU. Until there is more clarity over the future relationship between the two, it’s difficult to see the U.S. agreeing to a trade deal with either. With an election looming in November and countries around the globe dealing with the economic fallout from the coronavirus, the prospects of a trade deal between the U.S. and the U.K. and/or EU have dimmed.
U.S.-China Phase 2 The status of Phase I of the U.S.-China trade deal made headlines recently including confusion over trade advisor Peter Navarro’s comments that the deal was over. Navarro quickly clarified that the deal is still in place and his comments were taken out of context. China has also confirmed that Phase 1 remains in place and they are sticking to their purchase commitments. The fact that the status of this deal is even in question underscores the tension in the current U.S.-China relationship.
The frayed relations are the result of clashes over China’s handling of the coronavirus outbreak, accusations of human rights violations in Xinjiang, disputes over the South China Sea and an ongoing disagreement over China exerting more control over Hong Kong through the passage of a new security law. Regarding the Hong Kong dispute, Congress recently passed the Hong Kong Autonomy Act, which approves sanctions on Chinese officials over Beijing’s crackdown in Hong Kong. President Trump also issued an executive order to end the preferential treatment for Hong Kong. China has vowed to retaliate against the U.S., while President Trump said he’s not interested in starting Phase 2 negotiations.
Phase 2 was always going to be a complex negotiation. Phase 1 essentially was about getting China to buy more U.S. products to reduce the trade deficit between the U.S. and China. Phase 2 will address more contentious issues including cybersecurity and China’s subsidization of its state-owned enterprises. We think it’s unrealistic to expect the two sides to resolve these issues ahead of the election, so any possible Phase 2 agreement won’t happen until 2021.