NAFTA Deal With Mexico Seen as Nearly Done, but Landing Canada Could Be Tough

President Donald Trump said in a tweet on Aug. 10 that a deal with Mexico is nearly in hand. Canada will have to wait, and he plans to put heavy pressure on Canadian officials to make concessions, because "their Tariffs and Trade Barriers are far too high," he said. "Will tax cars if we can’t make a deal!"

It's that last bit that makes Dan Ujczo, chairman of the U.S.-Canadian practice at Dickinson Wright, blanch a bit. "The view out there that auto tariffs were just a threat to gain leverage in negotiations, that may have been a fantasy," said Ujczo, who once worked for Canada's foreign ministry on ports of entry and border issues. He said he is hearing from Mexican industry sources briefed on NAFTA negotiations, and said the U.S. is asking for at least 15 percent tariffs on autos that don't meet a revised rule of origin standard. Currently, cars assembled in Canada or Mexico that don't meet rules of origin are taxed at 2.5 percent. For auto manufacturers -- though not necessarily for suppliers -- a tougher rules of origin standard wasn't too scary, because they could just swallow the 2.5 percent tariff. So in order for the U.S. trade representative to achieve his goal of moving more production to the U.S., the tariff on cars has to be at least 10 percent.

Mexico has not yet agreed to a higher tariff on non-conforming cars, Ujczo said. But he believes they will, in order to get other things they want -- the end of tariffs on steel and aluminum, preserving the state-to-state dispute chapter and preventing seasonal antidumping cases for produce.

So he expects the U.S. will raise tariffs on autos and auto parts on the rest of the world, either through a worldwide application of Section 232 tariffs or by raising the most favored nation bound tariff rate. "And the only way to escape that will be to have a free trade agreement with the United States," he said. "It looks like Mexico will be first in line."

Former World Trade Organization Appellate Body Member Jennifer Hillman said raising MFN is not so easy. Every country that sells autos or auto parts to the U.S. (if both tariffs are raised) must agree to the change, and will ask for compensating higher tariffs in return.

Ujczo said the U.S. has agreed to a five-year phase-in for tighter rules of origin, and the higher tax on imported cars that don't meet that standard may have an even longer delay. But he thinks the auto tariffs won't remain just a threat for five or six years.

He predicted Trump will get a report from Commerce sometime in September recommending higher auto tariffs on national security grounds. He won't take action in the fall, because a Mexico agreement in principle and a threat of higher tariffs on autos will be enough to campaign on. As he noted, once the U.S. lifts tariffs on Mexican steel and aluminum, Mexico will drop its retaliatory tariffs, including on U.S. pork and cheese. That's great for farm country, he said. Meanwhile, the U.S. will be telling Europe, Canada and Japan if they want to escape auto tariffs, they have to reach a free trade deal by the end of the year.

As long as no one is actually hit with tariffs, Ujczo said, Congress won't act. And he said Trump won't implement tariffs until it's too late for the current Congress to vote. Next year, there will be more Democrats and more protectionist Republicans in Congress, Ujczo predicted, so he's not sure Congress would act as a brake on the tariffs -- unless there's an outcry from voters paying more for new cars. "I think that question extends beyond autos," he said. "The question in the trade war [is]: Has the administration sold it to the public where everyone is going to wrap themselves up in the Stars and Stripes?"

Canada has a lot of reasons to agree on NAFTA in September, Ujczo believes. Canada is getting upgrades on customs and digital trade it wanted. "I’ve heard de minimis is going to land at $100," Ujczo said -- a compromise far closer to Canada than to the current U.S. standard. A source close to the talks said that level has been discussed but is not yet agreed to. "Canada’s agreed to punt on government procurement," he said.

Trump will give in on a sunset clause, he predicted -- that's a deal breaker for both Mexico and Canada. But there are still a couple of other problems to resolve -- Chapter 19, which addresses antidumping remedies, and, of course, dairy.

Ujczo thinks a phase-out of Chapter 19 could be acceptable to Canada. While antidumping is a touchy issue for both sides with regard to softwood lumber, he said it's not like Chapter 19 has helped Canada in that battle over the years. "It was a compromise solution that never worked," he said of the chapter.

Even on dairy he thinks there could be a way for Canada to give a little on diafiltered milk, a protein that used to be outside the quota system, but the amount of pressure Trump is applying could backfire, he fears. "I’m worried this is going to get out of control. I think one, the first step, is if we lift on the 232 on Mexico but not Canada, that is going to solidify the negative sentiment toward the Trump administration in Canada. You’re going to make it more difficult to negotiate," he said.

If Canada cannot accept U.S. proposals in even one or two areas, and the U.S. implements auto tariffs on Canada but not Mexico, he thinks, a chance of a trilateral NAFTA is vanishingly small. That's the trade equivalent of nuclear war, he said.