After more than a year in operation, signs of strain are beginning to show in the US–Mexico–Canada Agreement (USMCA) — the free-trade agreement negotiated under former US president Donald Trump to replace the North American Free-Trade Agreement (Nafta).

The USMCA is likely to hold, however. Overall, experts say that the tariff-free trade it enables has benefited all three of the three deeply intertwined economies involved. 

Yet, from potatoes and dairy to energy and procurement, fierce competition has driven politicians in each country to demand greater protection for their own markets or improved access to the others. The US has initiated a dispute settlement panel over Canadian dairy products; Canada has done the same over US tariffs on Canadian solar products.

Playing by different rules

One of the key points of contention is the way the US is interpreting the vital automotive “rules of origin” agreed to in the USMCA. To address this, Mexico demanded a formal consultation with US trade representative, Katherine Tai, who was closely involved in negotiating USMCA, on August 20. It was joined a week later by Canada.

Luz Maria de la Mora Sánchez, Mexico’s undersecretary for foreign trade, emphasised that the disagreement could have a severe impact on the industry’s competitiveness, investments and jobs in North America, especially in Mexico.

USMCA’s rules of origin specify the ‘regional value content’ (RVC) that parts must contain to be considered “originating” in North America, and escape tariffs between the three countries.

The dispute arose after the US decided unilaterally to change the way RVC is calculated. Under the Nafta, if a part contained the required percentage of North American-made content, the entire part would count as originating in the region and ‘roll up’ into the RVC of the finished vehicle. However, under the new standard that the US intends to apply under the USMCA, any foreign content would be deducted from the RVC calculation, jeopardising its tariff-free status.

“As someone who was very close to the negotiations, this was never part of the discussion. Everybody assumed the roll-up under Nafta would apply,” says Daniel Ujczo, senior counsel in law firm Thompson Hine’s Columbus, Ohio office.

In his view, the US believes its interpretation will persuade more companies to supply auto parts from North America. However, Mr Ujczo warns that this is a careful balancing act. “The roll-up created a strong incentive for companies to locate in North America. At some point, it could become too difficult or expensive to comply.” Companies could then decide to move production elsewhere and simply pay the tariff.

“My hope is this is simply a leverage discussion, as opposed to a fundamental rethink of what has already been negotiated,” Mr Ujczo comments. If the parties are unable to resolve their differences through the consultation, the dispute would go through a lengthy arbitration process. 

An analysis by Maria de Lourdes Álvarez Medina, a researcher at the Universidad Nacional Autónoma de México, found that carmakers’ response to the new rule would depend on their product strategies, how ready they are to meet the new RVC requirement and the tariff they could face if they do not. Although vehicles made in Mexico by US companies for US sale already meet the RVC standard, she noted that vehicles made by some German and Asian manufacturers would not, and premium foreign brands — such as BMW, Mercedes Benz and Audi — might choose to pay the tariffs rather than undergo the costs and risks of switching suppliers.

Cost of labour

Another controversial element of the USMCA’s rules of origin is the required ‘labour value content’ — the first such rule in a free-trade agreement. It states that 40% of the cost of a vehicle must be made in a facility that pays an average hourly rate of $16. The aim stated by the US labour department is “to promote more high-wage jobs for the US automobile and auto parts industry” by ensuring the use of high-wage labour.

However, it is unclear if the rule will incentivise foreign investors to shift parts or vehicle assembly plants in Mexico to the US. Many Japanese companies are electing to remain, raise wages — in some cases tripling the average rate — or pay tariffs, according to a Nikkei Asia report. 

Other labour provisions in the USMCA have had a more positive reception. The agreement requires companies in all three countries to observe the International Labour Organization’s (ILO’s) declaration of workers’ rights, including the right to collective bargaining, and provides for independent registration of union elections and independent courts to try disputes. 

USMCA is far more ambitious than Nafta in its scope, coverage and depth of commitment to labour issues, and settlements in labour disputes are now fully enforceable, says Antonio Ortiz-Mena, senior vice president at Albright Stonebridge Group in Washington DC, who worked on Nafta for the Mexican government.

“Wages in Mexico have not kept pace with productivity, especially in export industries. Public policy needs to step in and fill the gap,” Mr Ortiz-Mena says. “The USMCA has built-in mechanisms that foster a level playing field. Nevertheless, he believes unions are more important than specific wage provisions to impact wages in Mexico.

An annex between the US and Mexico has created a rapid-response labour mechanism that allows appointed panels to be deployed when there are accusations that workers at a facility are being denied these rights. 

The mechanism was first invoked following violations of workers’ rights in a vote organised by an existing union at a General Motors facility in Silao, Mexico. A remediation plan resulted in a fresh vote overseen by Mexico’s Labour Ministry, with ILO observers, that rejected the original outcome. The mechanism was successfully used again at a Tridonex automotive parts facility in Matamoros.

ILO involvement is very significant, says Desiree LeClercq, a professor at Cornell University in Ithaca, NY, who previously served as an official in the office of the US trade representative and in the ILO. “The ILO provides an objective participant knowledgeable about these standards rather than an interested party,” she notes.

The emphasis on workers’ rights in Mexico could force US companies with subsidiaries there to agree to the same standards in their US operations, Ms LeClercq adds. Indeed, this is the aim of Thea Lee, head of the US Bureau of International Labor Affairs. “I want every business to ask itself: ‘Am I in compliance with the international labour rights that are put forward in the USMCA?’” she told Politico on June 1. 

Ms LeClerq stresses that it is still too early to judge the success of USMCA, especially given the impact of Covid-19 on the world economy. However, experts say foreign investors need to adjust their labour and operational practices to account for the new reality.

This article first appeared in the October/November print edition of fDi Intelligence.