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The New American Way of Trade

Thought Leader: Robert Lighthizer
September 27, 2023
Source: Foreign Affairs

How the USMCA Does What NAFTA Couldn’t

In December 2019, in the middle of one of the most toxic political environments in U.S. history, the House of Representatives cast the most significant vote on trade matters in decades. By a vote of 385 to 41, the House of Representatives changed the course of trade policy by approving the U.S.-Mexico-Canada Agreement (USMCA), upending the unbridled free trade philosophy that had been conventional wisdom for 70 years. Significantly, more than 90 percent of both Democratic and Republican members supported the agreement. They voted to replace the failed North American Free Trade Agreement, then the biggest trade deal in the world—covering some $1.3 trillion in goods and services—with a new kind of agreement, one designed to bring manufacturing home, to create American jobs, to enforce labor standards in Mexico, to support environmental quality, to open agricultural markets, to write sweeping rules on digital trade, and much more.

The USMCA passed as the United States was heading into an election year. Only days before, the House had voted to impeach U.S. President Donald Trump. Partisan fervor was running high. Yet the trade deal met with broad bipartisan acclaim. The Democratic Speaker of the House, Nancy Pelosi, declared that “there is no question, of course, that this trade agreement is much better than NAFTA.” The AFL-CIO, the federation of trade unions which had not supported a major trade deal since Lyndon Johnson was president, lobbied for a yes vote. Republican leader Kevin McCarthy said that the law “would deliver a much-deserved win for the American worker.” Richard Neal, the Democratic chair of the House Committee on Ways and Means, called the USMCA “a transformative agreement that creates a new high-water mark for U.S. trade deals going forward.”

Fixing the failures of NAFTA was too important to let partisan politics get in the way. “I opposed NAFTA with every bone in my body,” said the Democratic U.S. Representative John Lewis, of Georgia. “I never thought that the day would come where we would have the opportunity to right some of the wrongs in that agreement.… With this vote, we have a chance to reset the clock, to chart a new path, to create a new trade model.”

In the years since Congress voted to approve the USMCA, that new model has taken shape. Even Republicans with a long history of supporting free trade recognize that the way Washington had handled economic relations with other countries for decades had become politically unsustainable. Meanwhile, a new generation of pro-worker Republican leaders has emerged, led by members like Senator Marco Rubio and House Ways and Means Chair Jason Smith, who has called for a “new path forward to put American workers first” in trade negotiations. In some ways, the USMCA negotiations pushed some senior Republican members of Congress to think differently about trade. At the same time, it provided a model for the new generation of pro-worker Republicans to follow. Likewise, some Democrats who have long opposed free trade deals became convinced that such agreements can put workers first. The net result is a new bipartisan consensus on trade policy. For decades, trade policy was dictated principally by large corporations seeking to make more money through globalization. Trade agreements sought to increase profits for companies and decrease prices for consumers. By contrast, the new trade philosophy that the USMCA helped usher in focuses on protecting American workers and expanding the U.S. manufacturing sector.

NAFTA’S FAILURES

To understand how this new consensus emerged and to grasp its contours, one must begin by understanding both the failures of the old free trade regime that NAFTA embodied and the details of the agreement that replaced it. NAFTA was always unpopular in Congress and among voters. It passed the House in 1993 by a vote of 234 to 200. The leadership of both parties had to twist arms to move it forward. A mere 17 members of Congress could have sunk the bill by changing their votes. At the time, the American public also was evenly split in their support for NAFTA: 42 percent of Americans opposed the agreement, 42 percent of Americans supported it, and 16 percent were neutral.

In fairness, NAFTA did help some U.S. producers. Exports expanded for a few agricultural products like corn, soybean, and pork. But on balance, the deal did not serve the United States’ interests and certainly did not help American workers.

Almost all the animus toward NAFTA focused on the impact of adding Mexico to the trade arrangements that the United States already had with Canada. Under NAFTA, multinational corporations seeking to increase their profit margins could easily move their factories to Mexico, where they could take advantage of the country’s low-cost labor and near-abysmal regulatory standards. Unsurprisingly then, in the years after NAFTA passed, the United States lost over four million manufacturing jobs. To be sure, factors beyond NAFTA—such as rising automation and normalizing trade with China—played a large role in the decline of U.S. manufacturing employment. But according to data collected by the Trade Adjustment Assistance program, at least 950,000 U.S. workers lost their jobs because of imports from Canada and Mexico. The trade balance fared no better. In 1993, the United States had a $7.5 billion surplus in its goods and services trade balance with Mexico, but by 2017 the United States had a $119.4 billion goods and services trade deficit with Mexico.

NAFTA by 2017 had become hopelessly out of date.

A major source of the trouble was the automobile industry. In the NAFTA years, international auto companies were manufacturing in Mexico to sell cars in the United States, and their parts suppliers were following suit. Auto companies were taking advantage of Mexico’s labor laws, which prevented workers from organizing genuine unions. The Clinton administration had projected that wages in the two countries would converge just a few years after the agreement came into effect. In fact, the opposite happened, thanks to Mexico’s antiworker labor laws and a substantial devaluation of the peso that took place soon after NAFTA was signed. By 2016, the difference between the lower wages in Mexico and the higher wages in the United States was even greater than it had been in 1993. One effect of this profound shift was that by the time Donald Trump became U.S. president, nine of the previous 11 car plants built in North America were located in Mexico, as manufacturers sought to take advantage of lower labor costs south of the border.

In addition to being a poor agreement for U.S. workers from its inception, NAFTA by 2017 had become hopelessly out of date. It was negotiated before even dial-up Internet was invented. It had no enforceable labor or environmental rules. It did not address digital trade at all. And its provisions on auto trade were poorly drafted and full of loopholes. For example, NAFTA essentially provided that all auto parts that were not found in cars in 1993 but became common in subsequent years were “deemed” to have been made in North America—regardless of whether they were or not. As a result, many foreign parts could qualify a car for duty-free treatment. Since much of the value of cars comes from parts that have been added in the last 20 years (such as electronics, GPS, and advanced safety systems), this method of enforcement had become wildly outmoded only a decade after NAFTA came into effect. So, too, had many other elements of the agreement, including its rules pertaining to intellectual property and dispute settlement.

Over time, NAFTA became increasingly unpopular. In 2008, the Democratic presidential candidates Barack Obama and Hillary Clinton both pledged to renegotiate the deal or terminate it. But as president, Obama did not overhaul NAFTA. By 2017, polls indicated that around 46 percent of Americans believed that NAFTA had a negative impact on the U.S. economy, and only 30 percent believed that the United States should continue being part of NAFTA. This dissatisfaction with NAFTA and with trade policy more generally was essential to Trump’s victory in 2016.

IF IT’S BROKE, FIX IT

The Trump administration designed the USMCA to fix much of what was wrong with NAFTA, and it won widespread bipartisan acclaim and support. A few examples of the fundamental changes are worthy of particular note.

The rules of origin dictate what proportion of a car’s contents must come from member countries in order to qualify the car for tariff elimination. Under NAFTA, these rules were very weak. In theory, they required that 62.5 percent of the car had to come from the region. But in practice by 2016, owing to loopholes and changes unforeseen by NAFTA, even a car that was made mostly of foreign parts could qualify. To address this, the American side in the USMCA negotiations insisted on increasing the minimum regional content to 75 percent. But the USMCA also rewrote the rules to ensure that there would be an honest calculation of this percentage by closing the “deemed originating” loophole that allowed foreign-made parts—including those made in China—to be counted as regional content. That loophole would have become much larger over time, as electric vehicles and other next-generation car models continued to come online. Indeed, if not for the USMCA, China today would likely be using Mexico as a staging ground for an assault on the U.S. auto market.

The USMCA also added a novel provision requiring that 40 percent of car content (and 45 percent of truck content) be produced in high-wage factories—which effectively means factories in the United States and Canada. This “labor value content” rule was the first of its kind, and it is already helping to bring manufacturing back to the United States. The USMCA also requires that 70 percent of the steel and aluminum used in cars come from North America, and it mandates that certain core auto parts—such as engines and chassis—meet regional content valuation requirements. These changes took into account the trend toward electric vehicles. In practice, the USMCA rules on regional and labor value content essentially compel companies to locate the vast majority of their electric battery production in the United States.

Mexico and Canada are now the United States’ top trading partners, surpassing China.

One of the reasons that NAFTA had become unpopular was that labor laws in Mexico were so antiworker that Mexican wages stayed low and stagnant. To address this, the USMCA has the most comprehensive and high standard labor provisions ever included in a trade agreement. It requires all signatories—including Mexico—to assure labor representation, collective bargaining, and procedural fairness for workers. These commitments are enforceable under the agreement. In addition, a “rapid response” mechanism provides for monitoring by the U.S. government and sets out specific procedures to challenge unfair actions by employers in Mexico and to obtain a quick resolution or the imposition of severe penalties. No trade agreement had ever included such provisions. Under the leadership of my successor as United States Trade Representative, Katherine Tai, the Office of the U.S. Trade Representative already has brought several successful cases using that mechanism, resulting in wins for both Mexican and American workers.

The USMCA also includes the strongest and most comprehensive set of environmental obligations of any trade agreement, including commitments to limit vessel-source pollution, combat illegal fishing, and stop wildlife trafficking. Unlike NAFTA, the USMCA incorporates such obligations into the core of the agreement and makes them fully enforceable through a dispute-resolution process.

NAFTA was decades old, so it contained no obligations for the modern digital economy. The USMCA, on the other hand, contains a groundbreaking chapter on digital trade. It prohibits the application of custom duties to digital trade, it ensures that data can cross borders, it encourages the adoption of electronic authorization, and it assures cybersecurity collaboration. This chapter is the model for future trade negotiations.

The leadership of both parties had to twist arms to pass NAFTA.

The USMCA also effectively eliminates the “investor-state dispute settlement” requirement that marred NAFTA by allowing corporations to avoid local legal systems and instead sue countries in arbitration. This abuse gave unelected, foreign arbitrators the power to impose new obligations and liabilities on the United States. It also unfairly encouraged U.S. investors to put their money in Mexico instead of in the United States by eliminating the risks generally associated with the Mexican legal system, such as the arbitrary nature of judicial proceedings there.

For the first time in any trade agreement the USMCA directly addresses the practices of nonmarket countries, such as China. The deal expands the definition of “state-owned enterprises,” increases cooperation between countries in North America to fight foreign corruption, and requires additional coordination on tax evasion. And most important, the USMCA stipulates that if any of the three North American countries enters a free trade agreement with China, the others can withdraw from the USMCA.

The USMCA goes far beyond manufacturing, as well. For example, the agreement requires unprecedented access to the Canadian market for U.S. dairy farmers, prohibits Canadian protectionist practices in many agricultural sectors including wheat, and resolves several other long-standing irritants in the U.S.-Canadian trade relationship over issues such as television streaming rights and animal feed.

Finally, the USMCA is the first major trade agreement to include a sunset provision. The terms of the agreement must be reviewed every six years. If the Unites States is not satisfied with the way the agreement is working, it can insist on changes. If the agreement is not changed to Washington’s satisfaction, the agreement would automatically end ten years after the review. This assures that the United States will not wind up back in the position in which it found itself in 2017—23 years of suffering under a trade agreement that was riddled with loopholes, unresponsive to economic change, and terribly unfair to American workers.

SUCCESS STORY

The USMCA entered into force on July 1, 2020, barely three years ago. Many of its key provisions, such as the auto rules of origin, are not yet completely phased in, so it is early to fairly judge it. But in the words of one Brookings Institute report, “USMCA is off to a strong start bolstering prosperity across North America.”

Last year the total value of North American trade was $1.5 trillion. Both Mexico and Canada are now the United States’ top trading partners, surpassing China. The three countries of North America now account for a third of global GDP, and trade among them accounts for 9.5 million jobs.

The results on the investment front are just as impressive. The United States is now the largest destination for investment from Mexico and Canada and, according to Brookings, capital investment in the region grew 134 percent since the implementation of the USMCA and now stands at $219 billion. U.S. exports to Mexico and Canada are up 45 percent since 2020. Some of that increase likely reflects pent-up demand from the era of COVID-19 restrictions. But a great deal of it results from the USMCA. The U.S. trade deficits with Canada and Mexico must bothbe monitored, but the flood of auto jobs leaving the United States for Mexico has stopped. According to a recent study by the International Trade Commission, the USMCA’s automobile-related rules of origin have already directly created thousands of new American jobs in manufacturing auto parts and vehicles, leading to almost $240 million in new wages for U.S. autoworkers. Those numbers will only increase as the agreement comes fully into force.

Perhaps more important, the past three years have seen a dramatic increase in factories being built in the United States. This year manufacturing investment is on track to surpass $180 billion, more than triple the annual average in the 2010s. Many factors have contributed to this trend, including the long-term effects of the Trump administration’s tariffs on China (which the Biden administration has kept in place) and some legislation, such as the CHIPS Act. But the impact of the USMCA’s changes to the rules of origin is playing a major role, too. A number of auto executives have told me that the USMCA was a major factor in convincing them to build the next generation of electric vehicles in North America rather than in China. The combination of the Trump China tariffs and the USMCA has also led American companies and consumers to import far more goods from Mexico instead of China, reducing the United States’ dependence on a global adversary and contributing to the prosperity of an important next-door neighbor.

NEXT STEPS

The USMCA ushered in a new era in trade policy, one focused on bringing jobs back to the United States as well as helping the North American region. The USMCA’s new, worker-focused approach contained innovative provisions that should be the core of any future trade agreement and should be incorporated into existing free trade agreements with other countries. There are still, however, important issues in North American trade left to be resolved. Fortunately, the sunset provision provides the U.S. government with an opportunity to correct problems soon after they emerge. Negotiations to renew the USMCA should begin in a year or two.

In the meantime, Washington should be more aggressive in bringing cases before USMCA panels, especially when it comes to Canadian and Mexican practices on issues such as energy sector nationalization and the import treatment of genetically modified corn. On matters such as these, instead of engaging in long consultations that rarely ever resolve trade conflicts, the United States should first file cases and then negotiate.

Washington must also use current USMCA provisions and, if necessary, create new tools to stop the importation of Chinese goods through Mexico. In recent years, Chinese imports into Mexico have increased, as has Chinese investment in the country. Much of this activity is intended to increase the export of Chinese content to the U.S. market. Mexico needs to choose whether it wants access to the U.S. market or to serve China’s interests.

The United States should also correct a flaw that resulted from a ruling on automobiles. In 2022, a USMCA dispute panel ruled in favor of Canada and Mexico, allowing for increased flexibility when it comes to defining which auto parts have been made in the region. The impact of the decision is that more content of Chinese origin will find its way into cars in the North American market. It is unfortunate that the governments of Canada and Mexico brought the case, which will reduce employment in their countries. But it serves as a reminder of the enduring influence of massive corporations, which are trying to get around the tough rules that the USMCA created. Washington should announce immediately that it will demand a reversal of this decision during the sunset review, so that car companies taking advantage of the erroneous decision will understand that any advantage they have gained will be short-lived.

NAFTA was a bad deal for the American people. The USMCA is the beginning of a new bipartisan trade consensus—one that is focused on workers and U.S. manufacturing. The process of renegotiating NAFTA and overwhelmingly passing the USMCA represents a great achievement for the Trump administration. It is also a wonderful example of Republicans and Democrats working together to correct a historic wrong and to help U.S. citizens. Both political parties deserve credit for this paradigm shift in trade policy and for the USMCA, which is already doing so much for the United States. The key now is to hold steady, mindful that powerful interests at home and overseas will diligently seek to undermine the agreement. Washington must be equally diligent in sticking to its new course on trade.

ROBERT E. LIGHTHIZER served as U.S. Trade Representative from 2017 to 2021 and as Deputy United States Trade Representative from 1983 to 1985. He is the author of No Trade Is Free.

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