The hidden gems of the US-Mexico trade deal

Investors cheered Monday’s announcement of a trade deal with Mexico, and appropriately so. A final agreement is not yet in hand, but if maintained, it could alleviate a portion of the significant trade-related uncertainty investors have been dealing with for more than a year.

The agreement would offer a few notable adjustments to the original 1994 North American Free Trade Agreement (NAFTA), which primarily dealt with the trade in goods. The world has changed dramatically since 1994, however, and the value-add of manufacturing skills has been diluted by a proliferation of production capabilities around the world.

A nation’s economic worth, and its standard of living, is now largely dependent on technological proficiency, services expertise and innovation, which is exactly where the proposal could offer its best long-term value.  

A new agreement for a new age

There are new provisions relating to digital content protections, intellectual property (IP) rights, trade secret safeguards and most notably, IP theft by state-sponsored enterprises. The term "state-sponsored enterprises" appears to be a clear reference to China. And it should act as a signal to China.

Trade negotiations with China currently sit in limbo. This agreement suggests that rather than waiting for a change of heart from Chinese leadership or push for updated World Trade Organization (WTO) rules, which would likely take years and are uncertain to succeed, the U.S. could address the unique challenge of the Chinese system indirectly through its own trade-partner agreements.

In a sense, the U.S. could upgrade what is perceived to be the standard for fair dealing in today’s technology-driven world.

It’s fair to wonder why so many countries just go along when the U.S. implements economic sanctions. What’s the main reason? The U.S. dollar is the dominant global currency, and the U.S. controls the financial network through which dollars flow. If organizations want to do business via this network, they’ll have to follow the rules.

The idea here is similar. If a country wants a good trade relationship with the world’s biggest market (the U.S.), it will need to adhere to modernized rules of fair play — particularly as they pertain to intellectual property.

Of course, it would still take many years for updated rules to become widespread enough to matter. It may be more important, however, for China to simply realize that such pressures are only going to grow.

China’s rapid ascension up the global economic ladder has been concurrent with a worldwide revolution in internet-enabled business operations and major advances in technology. Such changes have long necessitated modernized trade rules.

The WTO rule book has simply not kept pace with the competitive landscape in technology or in addressing China’s hybrid economic system and practices.

Does the agreement raise production costs?

Some of the initial evaluations of the trade deal with Mexico have been critical of the higher content rules, as they could result in higher consumer prices or lessen the competitive position of North American manufacturing. Such concerns may be overdone.

The required North American content of vehicles to qualify for zero tariffs would be bumped up to 75.0 percent from a prior 62.5 percent, and there are new requirements on the percentage of content needing to be sourced from high-wage factories.

Such provisions may indeed boost labor costs, and their impact on broader production costs should be closely monitored.

Nevertheless, any incremental increase is likely to be modest and at levels that can be overcome via productivity improvements and operating leverage. Recent corporate tax cuts in the U.S. should also be considered in respect to total production costs.

Labor costs can also be over-emphasized. In 2017, average auto assembly wages in Mexico were less than $8 per hour versus more than $32 per hour in Canada, according to the Center for Automotive Research (CAR). Yet CAR estimates each country accounted for approximately 11 percent of U.S. auto and auto part imports in 2017. (Japan also accounted for 11 percent).  

Separately, higher content rules should come as welcome news for U.S. workers in the manufacturing sector. Economists and business leaders will consistently tout the benefits of free trade, but this is the group that has historically paid the price.

The enhanced purchasing power that often resonates from trade deals is an indisputable economic good, but living standards are also based on income.

Content provisions are most likely to be supportive of wages rather than a sudden boost, and workers may worry less about being outsourced. Economics tends to do a poor job of considering such social implications.

To wit, the term, “capitalism doesn’t work for me” has become a rising refrain in many parts of the developed world, particularly since the financial crisis.

This could be a dangerous trend with long-lasting consequences unless those who are considered the working poor begin to see more tangible benefits of globalization fall their way. Unfortunately, history has shown that people often go too far in the other direction when seeking economic change.

A step in the right direction

This deal, if implemented, would likely have little tangible influence on near-term economic growth, employment, prices or business practices. Trade deals rarely do. Just as was the case with the original NAFTA agreement, it takes years to identify the changes in trade patterns and business decisions that trade deals intend to influence.

There could be hidden promise in the framework of this agreement, however. The world has changed, and it’s time trade agreements caught up.

Russell Price is a senior economist at Ameriprise Financial and member of the firm’s Global Asset Allocation Committee.