The Future of NAFTA from Mexico’s perspective

A special to USLAW NETWORK and USLAW DigiKnow

By Fernando Holguín, EC Legal

Introduction

The main objective of this essay is to try to clarify the scenario and visualize the future of NAFTA from the standpoint of Mexico, which by the way seems even more unpredictable than the result of the last Super Bowl between the Patriots and Falcons.

The question everybody is asking during this time of uncertainty is whether NAFTA will be terminated or renegotiated. Without further preamble, our guess is RENEGOTIATED. Either in the form of bilateral agreements or three party agreement, or even with a new name (or a new F), for the almost 25-year-old Free Trade Agreement all signs indicate continuity. Also, a fair renegotiation of NAFTA seems to be in best interest of all its parties.

Mexico’s position

In a nutshell, Mexico wants and needs NAFTA to continue in effect. While the country is beginning to turn its head to other countries and regions to supplement the possible loss of NAFTA; focusing on other strategic areas of economic development like tourism and the creation of domestic technology, and; modernizing its education system, it would still take some years to reduce the significant impact that a sudden termination of NAFTA would create for our country.

In this era of technology and automated processes which is generating a reduction in the need of labor, sooner or later Mexico will have to learn to be less dependent on the foreign investment focused on manufacturing, since the location of these high-tech premises will become geographically irrelevant.

The stronger position that Mexico is taking for the renegotiation of NAFTA, is not based on the lack of convincement on the importance of NAFTA to this country, but on the political pressure from all actors in Mexico, including congress, political parties, people and media, which are all consensually demanding that the country should be treated with dignity and fairness during the renegotiation process, otherwise NAFTA should be terminated.

What could go wrong?

Although the main idea of this essay is that NAFTA will be renegotiated, we have to explore the possibility of termination, in which case, a six-month prior notice to the other parties would be required. Below we analyze some factors which could generate the termination of NAFTA:

• Political Pressure. – (Addressed above).
• Border Tax. – Statements from the Mexican government, specially the Minister of Economy Ildefonso Guajardo and the Minister of Foreign Affairs Luis Videgaray, have made it clear that if a Border Tax (either in the form of a Border Adjustment Tax adversely impacting the income tax of companies importing from Mexico, or a Border Tax imposing additional duties on the import of Mexican goods into the US) is implemented by the US, Mexico would be ready to walk-away from the NAFTA negotiations.
• Long Negotiations. – Mexico will be involved in a presidential election process in the middle of 2018, and unless negotiations of NAFTA are completed within 2017 or the first quarter of 2018, the political scenario may complicate the renegotiation by Mexico, since a negative perspective of NAFTA may become a political flag for one or more presidential candidates in this country. Latest statements from both governments indicate that negotiations should be completed by the end of 2017, although there is some skepticism on the aggressiveness of this target.

Response by Mexico in case of NAFTA termination

The Mexican government, specially through the Minister of Treasury Jose Antonio Meade, and Ildefonso Guajardo, has been very vocal in the sense that ideally NAFTA will be successfully renegotiated, however, in case the agreement is terminated, the response by Mexico would consist among other measures, in a tax reform and the adjustment of duties.

What could we expect from a tax perspective? On the one hand, we would expect Mexico to adopt a tax reform that may absorb to some degree the impact of the termination of NAFTA on foreign investors with a legal presence in Mexico. This tax reform may include among other measures, granting tax incentives to Maquiladora companies, allowing most of the profits of said companies to be allocated in the US side; On the other hand, we would expect the Mexican government to take reciprocal measures to those potentially adopted by it US counterparty, i.e. Border Tax.

From a customs and trade perspective, the duty system would be then governed by the rules of the World Trade Organization, specially the Most Favored Nation clause, which would result in duties ranging from approximately 7% to 15% for US goods entering Mexico, and 2.5% to 2.8% for Mexican goods imported into the US. Additionally, it is important to remark that Mexican goods entering into the US, will no longer be subjected to the provisions of Article 303 of NAFTA, stating that it is mandatory to pay duties in Mexico for those materials originating outside the NAFTA region if they are incorporated into finished goods which ultimate destination is one of the NAFTA parties. Consequently, to reduce the impact of the measures adopted by the US, Mexico could additionally foster its internal programs such as the Sectorial Promotion Program, which allows many materials entering into Mexico duty exempted (or by paying duties ranging from 1% to 5%) without regard of the origin.

Other consequences in case of termination of NAFTA

In case NAFTA is terminated, most probably there would a significant relocation of manufacturing companies from Mexico to the United States, notwithstanding the foregoing, the aforesaid adjustments, the response by Mexico to NAFTA´s termination, and the historical background of Maquiladoras, which existence goes far beyond the enactment of NAFTA, makes us think that many companies will continue manufacturing  and having presence in Mexico, specially those labor intensive  industries, and those less sensitive to the termination of NAFTA.

We would also expect of course a more hostile commercial relation between both countries, and possibly constant obstacles for the import of goods from Mexico or the United States depending on the case.

Finally, in case of Termination of NAFTA, from the foreign investors standpoint, it is important to recall that aside from domestic law, Chapter 11 of NAFTA is the only effective mechanism between the two countries to protect investors from arbitrary or discriminatory actions, or illegal expropriations.

Most signs indicate renegotiation

As indicated below, most of recent signs from governments of Mexico and the United States indicate renegotiation:

• Statements by main actors. – Most recent statements from the main officers of both countries indicate in connection to NAFTA that the best-case scenario is a fair renegotiation.
• Reference to specific aspects of renegotiation. – There is coincidence from both countries indicating that NAFTA requires modernization, increase in the percentage of Regional Value Content stated in the rules of origin and some additional chapters addressing new subjects like e-commerce.
• Informal Meetings. – Although formal negotiations have not yet initiated, the main Secretaries of both countries have been meeting periodically, and based on their statements, the outcome of such reunions is currently very positive.
• Silence by Presidents of both countries on unconformable subjects. – In the last weeks, both Presidents have moderated their comments on difficult topics (i.e. who is or who isn’t going to pay for the wall.
• Inconvenience for both countries to become hostile neighbors. – As expressly stated by both countries, NAFTA is just a piece of the complete renegotiation of the bilateral relation between the United States and Mexico. Security, immigration, energy, are only some of the subjects that will be revisited by these nations, and the last thing each of them expects, is to end up with a hostile neighbor.
• Global Support to International Trade. – China, Germany and many other relevant nations in the trade scenario have step up to defend trade, and to express their intent to file the necessary legal remedies before the WTO, against a potential Border Tax that may directly or indirectly affect their investments and exports to the United States.
• New announced investments in Mexico.- One of the most revealing indications on the continuity of NAFTA, are some of the announcements and comments by the main US automakers after their meeting with the President of the United States on January 2017. Although Ford cancelled the project of a new facility in San Luis Potosi Mexico, it also announced the transfer of new production lines to Mexico which are related to the manufacture of compact cars.
• Postponement of actions by US government against Mexico. – As a sign of good faith for the NAFTA negotiations, the United States decided to postpone their dumping claim to Mexico on the subject of sugar exports.

Scenario in case of renegotiation of NAFTA

In the event of renegotiation of NAFTA, and the expected increase in the requirements of regional value content for the rules of origin, NAFTA will bring opportunities for the NAFTA region suppliers which eventually would have to substitute part of the Non-NAFTA region suppliers (specially from Asia) to be able to comply with such RVC requirements. The electronic industry is a clear example of these opportunities.

The United States has also been firm on the need to reduce the deficit of the trade balance between them and Mexico, so eventually, as a result of the renegotiation we would expect an important increase in the preferential access to US goods.

Finally, we would also expect after a potential renegotiation of NAFTA, and the new policies by the US government, a moderate relocation of manufacturing projects from Mexico to the US. A good example for this situation could be the facilities devoted to the manufacturing of large vehicles (with a higher profit margin), and high-tech facilities which are less reliant on labor.

Conclusion

Our projection for the future of NAFTA is renegotiation, however, at the end of the day, there could always be a Tom Brady changing the whole game in the last minute.