NAFTA and the New Trump Administration: Your Top Ten Questions Answered

Introduction

With the recent U.S. election finally reaching its close, the unexpected election of Mr. Trump has left many multinational companies wondering how the change in administration will impact their business operations. One of the chief issues of concern is Mr. Trump’s campaign rhetoric that the United States should withdraw from the North American Free Trade Agreement (NAFTA) or, perhaps, substantially renegotiate it (with Mr. Trump taking both positions at times).

Many multinational companies have structured their operations on the assumption that the free trade of goods within the NAFTA region was a given, and understandably are nervous regarding the future of the agreement. To help deal with this insecurity, this client alert presents the “top ten” questions every company that relies on NAFTA should be thinking about. Future client alerts will deal comprehensively with all international trade and regulatory areas where significant change could occur under the new administration.

The Top 10 NAFTA Questions

1. What has President-elect Trump promised?

2. Is the promised repeal of NAFTA a real possibility or just campaign rhetoric?

3. Can the Trump administration just withdraw from NAFTA on its own?

4. Will Congress have any role in the withdrawal or be able to alter the way in which any withdrawal occurs?

5 .What are the most likely options — withdrawal, amendment, or no change?

6. Are there limits to how high tariffs could go if there is a full withdrawal?

7. If there is a full withdrawal, what will be the consequences in addition to higher tariffs?

8. Are there countries other than Mexico that are potentially a target for major changes in U.S. trade policy?

9. If NAFTA withdrawal is part of a “war on international trade,” what are some other types of international trade issues I should be monitoring?

10. The possibilities sound pretty scary. What can my company do to help mitigate the risk of a NAFTA exit?

The Top Ten NAFTA Questions Answered (or, What to Do If the New Administration Plays the NAFTA Trump Card)

1. What has President-elect Trump promised?

After calling NAFTA “the worst trade deal maybe ever signed anywhere,”¹ Mr. Trump stated that he either would seek a full repeal of the agreement or would seek to renegotiate it to remove incentives to transfer manufacturing and jobs to Mexico. Mr. Trump’s “100-day action plan to Make America Great Again” confirmed that NAFTA would be a focus of the early days of the administration, as it promised that within 100 days of taking office, Mr. Trump would “announce my intention to renegotiate NAFTA or withdraw from the deal under Article 2205.”² Action on NAFTA likely will be a priority of the Trump administration.

2. Is the promised repeal of NAFTA a real possibility or just campaign rhetoric?

The election of Mr. Trump ran straight through such manufacturing states as Wisconsin, Ohio, and Pennsylvania. In each of these states, anger about lost manufacturing jobs, and their often high wages, was a deciding factor for key swing voters. It is fair to say that discontent about the loss of manufacturing jobs in general, and the accompanying anger with NAFTA in particular, likely tipped these closely contested states — and therefore the election — to Mr. Trump.

With the high visibility given to NAFTA, it is highly likely that there will be either a NAFTA withdrawal or at least enough of a renegotiation of its terms that Mr. Trump can claim that his administration has “fixed” NAFTA. Certainly the Mexican and Canadian governments believe Mr. Trump is serious: Leaders of both countries have stated they are open to renegotiating the terms of NAFTA, although Mexico stated its willingness was more along the lines of having a “discussion” of potential changes.³

3. Can the Trump administration just withdraw from NAFTA on its own?

Article 2205 of NAFTA provides that “{a} party may withdraw from this Agreement six months after it provides written notice of withdrawal to the other Parties. If a Party withdraws, the Agreement shall remain in force for the remaining Parties.” Thus, withdrawal could potentially be effective as early as the summer of 2017. In all likelihood, however, there would initially be a period where renegotiation is attempted, thus delaying any unilateral withdrawal. The likelihood of a withdrawal by this summer accordingly is very small. Further, as noted below, duties would not change for likely a year or more after any withdrawal occurs.

4. Will Congress have any role in the withdrawal or be able to alter the way in which any withdrawal occurs?

Although NAFTA was approved by Congress, it is technically not a treaty. Rather, it is a congressional-executive agreement approved by a majority vote of each house of Congress, as are the World Trade Organization (WTO) agreements). NAFTA was put in place pursuant to the Trade Act of 1974, which gives the president authority to negotiate agreements dealing with tariff and non-tariff barriers. Section 125 of the 1974 act gives the right to terminate and withdraw solely to the president, after giving appropriate notice (six months, as specified in NAFTA).⁴

5 .What are the most likely options — withdrawal, amendment, or no change?

Although Mr. Trump has repeatedly criticized NAFTA (as well as other trade agreements, such as the WTO agreements), he did not state that he was against all trade agreements. Instead, he stated his view that many existing free trade agreements (FTAs) were poorly negotiated, and thus were not in the interest of the United States and U.S. manufacturers. This position opens up several possibilities regarding NAFTA, ranging from complete withdrawal to severe or even moderate renegotiation. The criticism of NAFTA thus could be used as a way of creating negotiating leverage to allow for the targeted reopening of the agreement.

Despite the campaign rhetoric, millions of U.S. jobs depend on trade between the United States, Canada, and Mexico. Canada and Mexico are, respectively, the first and second largest export markets for the United States. (Although China is a larger overall trading partner, China trade is heavily weighted towards exports to the United States.)⁵ Much of the trade with Mexico, in particular, involves the shipment of U.S. goods to Mexico for assembly and then the return of the downstream products to the United States. Eliminating NAFTA without any replacement would create tremendous upheaval in these international supply chains. This would lead to significant job losses in the short term and the stranding of significant investments that were made based on the promise of free trade benefits.

As a result, impacted companies likely will exert tremendous pressure on Mr. Trump to amend, rather than repeal, NAFTA. Significant changes to NAFTA would support Mr. Trump’s claim that business negotiators would be able to achieve better FTAs than “career diplomats,” while still allowing him to claim that he has carried through on his NAFTA promises.

There are also strong reasons on the partner side to believe that renegotiation, rather than withdrawal, is most likely to occur. Since Canada shares concerns about the transfer of jobs to Mexico, it would not be surprising if Canada were to align with the United States on certain issues that it would prefer to see amended. As for Mexico, NAFTA is too important to the Mexican economy for Mexico to give up its free trade access to the United States without a fight. Even if Mexico would prefer that the agreement remain as written, giving up trade concessions would be far preferable to risking the likely recession and economic upheaval that would accompany withdrawal and the shift of U.S. multinational companies to other locations.

The effect of NAFTA withdrawal also could have the side effect of increasing illegal immigration — another Trump signature issue. Upheaval in the Mexican economy and any recession as a result would almost certainly lead to an increased desire for Mexican workers to leave Mexico for the much stronger U.S. economy. Avoiding a large increase in illegal immigration from Mexico (which actually has been falling in recent years) may pressure Mr. Trump to amend, rather than eliminate, NAFTA.

6. Are there limits to how high tariffs could go if there is a full withdrawal?

As a general matter, the Trade Act of 1974 provides that after any withdrawal from a covered agreement, impacted tariff rates will remain unchanged for one year. This is to allow businesses time to adjust to any change. The president is allowed to raise tariffs more quickly if there is a need for expeditious action, so long as Congress is notified and a public hearing is held, but this option is unlikely to be triggered.⁶ Thus, for all intents and purposes, there will be no increase in tariffs for at least 18 months (the six-month notice period plus the additional year of frozen duty rates).

Beyond that, if the United States withdraws from NAFTA, there are two sets of default options that come into play. The U.S.-Canada Free Trade Agreement — which preceded NAFTA — is still in effect, as it was only suspended when NAFTA came into force. So withdrawal from NAFTA would likely bring the U.S.-Canada FTA back into play. Although not automatic, reinstatement of that U.S.-Canada FTA likely would be politically acceptable, both because Mr. Trump did not focus any attention on Canada in particular when criticizing NAFTA, and because the trade deficit with Canada itself is quite small when compared to the deficit with Mexico. Further, with Canada often exporting natural resources such as petroleum to the United States, its exports are not viewed as displacing U.S. manufacturing jobs. Indeed, with there being some concern in Canada that its own manufacturing base has been hollowed out in recent years, Canada might even join the United States in seeking certain modifications to NAFTA.

If the U.S.-Canada FTA is brought out of suspension, trade between the two countries may be a lot like it is under NAFTA. The tariff rates under the U.S.-Canada FTA are often the same as the rates under the NAFTA (i.e., often zero). The U.S.-Canada FTA also includes many of the same types of FTA protections as contained in NAFTA, such as providing the means of appealing disputes to special arbitrator panels. Thus, the impact of repeal with regard to dealings with Canada is limited because the fallback position is another FTA.

It is trade with Mexico that could potentially see more changes. NAFTA is the only FTA possibility in place between the United States and Mexico. Without any type of FTA in place, the tariffs between the United States and Mexico would be based on pre-NAFTA levels. The extent of the rise is dictated by two different legal documents:

• Under U.S. law, tariffs are allowed to rise to a level that is between 20 and 50 percent higher than the rates in effect on January 1, 1975.⁷ Because tariff rates were much higher in 1975, this would allow for very large tariff increases.

• This degree of increase would not occur, however, because the extent of any increase in tariffs is limited by the WTO agreements, which are multilateral agreements that are independent of NAFTA. Due to the operation of the most favored nation (MFN) tariff rules, tariffs for Mexico and the United States would be set based upon the average tariff rates in place for each country. The United States has a low MFN rate, which means that even though U.S. law otherwise allows for large increases based on 1975 tariff levels, existing WTO rules would limit the increase to a general maximum of 3.5 percent.

The irony is that the increase in Mexican tariffs would be much greater than 3.5 percent. The Mexico MFN rate is much higher than the U.S. rate, meaning that Mexican duties could increase to as much as 36 percent. This means that the tariff impact of NAFTA withdrawal would actually be felt more acutely on the U.S. side of the border, as the rate levied by Mexico on exports from the United States would rise to a much greater degree than the rate that could be levied by U.S. Customs & Border Patrol on imports from Mexico. Withdrawal, supposedly intended to aid U.S. manufacturing, would asymmetrically result in much higher tariffs for U.S. exports.

7. If there is a full withdrawal, what will be the consequences in addition to higher tariffs?

Including negotiated annexes, NAFTA is more than 2,000 pages long. In addition to a full phase-out of tariffs, NAFTA also eliminated a variety of non-tariff barriers (import licenses, local-content requirements, export-performance requirements, and other non-tariff barriers). NAFTA helped unify customs procedures and regulations, provided uniform investment rules, established fair and open procurement procedures, and gave firms the right to repatriate profits and capital, among other trade and investment provisions. It also provided a mechanism for settlement of many bilateral disputes. All of these investments in trade stability could disappear if NAFTA is no longer in force.

Another wild card is the impact of any withdrawal of the maquiladora rules. The maquiladora rules pre-date NAFTA, and provide for special tariff rates and other advantages for companies in the maquiladora region (generally, within 75 miles of the U.S. border, although they can be located elsewhere). Such industries as the automotive, aerospace, medical devices, and electronics industries have turned the maquiladora region into a sophisticated manufacturing hub, making maquiladora operations essential parts of the complex supply chains established by U.S. companies that operate within this region. There was no discussion of the maquiladora special tariffs during the campaign, and it is unknown whether there will be any changes in these rules. Although it is a program run by Mexico, its growth in use has been spurred by NAFTA, and the United States has cooperated in many aspects of the maquiladora program. It is unknown whether the rules will change in light of any NAFTA modifications or withdrawal.

8. Are there countries other than Mexico that are potentially a target for major changes in U.S. trade policy?

Equal to the criticisms of NAFTA (which are largely criticisms of trade with Mexico, not Canada) were criticisms of China. China is a juicy target for campaign rhetoric, since it not only is a large trade partner, but also is a country that frequently exports while importing far less. Far more manufacturing jobs depend on exports to Mexico than to exports to China.

The 100-day plan states that Mr. Trump will “direct my Secretary of the Treasury to label China a currency manipulator.”⁸ This designation takes advantage of a law passed this year that allows for retaliation against countries that manipulate currencies to give their goods an artificial advantage. Any such designation might be accompanied by other actions against China, such as designating currency manipulation as a countervailable subsidy in countervailing duty investigations and administrative reviews or taking action against Chinese imports in other ways, such as through safeguard actions. Mr. Trump’s 7-Point Plan to Rebuild the American Economy by Fighting for Free Trade also vowed to raise tariffs on Chinese imports and to bring cases against China for any violations of international trade agreements, as well as to incorporate the campaign promise to label China a currency manipulator.⁹

China also is not a member of any FTA with the United States, and thus is reliant on its membership in the WTO to provide what trade protections are available to it. Any attempts to lower the trade deficit have to include China, as trade with China represents more than 40 percent of the overall trade deficit._¹⁰ Yet proposals by Mr. Trump to place high tariffs on imports from China likely would run afoul of WTO rules, which may mean that fights against Chinese imports need to take place using international trade litigation (described below).

Looking past China and Mexico, there are three other countries with significant trade deficits with the United States: Japan, South Korea, and Germany. None of these countries was singled out the way Mexico and China were during the campaign; nonetheless, the trade deficit represented by these countries is also significant. There is a heightened probability that these countries will, at the very least, be singled out through such international trade remedies as antidumping, countervailing duty, and safeguard actions, as discussed below.

9. If NAFTA withdrawal is part of a “war on international trade,” what are some other types of international trade issues I should be monitoring?

Regardless of whether NAFTA is terminated, there is a wide variety of international trade actions that can be taken to limit the amount of imports from Canada, Mexico, and other countries that are not parties to NAFTA. These include:

• Section 301 proceedings. Section 301 of the Trade Act of 1974 gives the U.S. trade representative, at the direction of the president, the ability to impose tariffs based on “an act, policy, or practice of a foreign country that is unreasonable or discriminatory and burdens or restricts U.S. commerce.” One of the remedies that can be imposed is higher tariffs on imports from a chosen country.

• Section 122 balance-of-payment proceedings. Section 122 of the Trade Act of 1974 authorizes the president to deal with “large and serious United States balance-of-payments deficits” by imposing temporary import surcharges or temporary quotas or a combination of both. This relief is limited and temporary, however, as it can only last 150 days, and the charge cannot exceed 15 percent of the ad valorem value of the imported goods.

• Section 232(b) national security actions. Where there is a deemed threat to national security, Section 232(b) of the Trade Expansion Act of 1962 authorizes the secretary of commerce to investigate imports and then take actions to limit or restrict them, or to “take such other actions as the president deems necessary to adjust the imports of such articles so that such imports will not threaten to impair the national security.”

• International trade remedies (safeguard proceedings and antidumping/countervailing duty investigations). These forms of international trade remedies focus on relief for individual products, types of products, or industries. They do not provide the same type of general relief as afforded by a wholesale increase in customs duties, but can offer powerful relief in a more targeted fashion. Duties in antidumping and countervailing duty proceedings often exceed 10 – 20 percent of the entered value of subject merchandise (depending upon the information submitted in lengthy and detailed questionnaire submissions). If non-U.S. companies do not respond to the detailed requests for information, the duties imposed are based upon “facts available,” which is intended to be punitive and can result in duties that exceed the value of the goods themselves by more than 100 percent. Safeguard proceedings can result in targeted duties on entire industries as well.

• Section 337 unfair trade practices proceedings. These proceedings target unfair trade practices, including the abuse of patent and trademark rights. In some recent cases, U.S. companies have created novel theories that would allow the International Trade Commission to reach a wide variety of conduct, thereby expanding the use of the section 337 process to address perceived unfair trade practices.

The potential increase in international trade remedies is a complicated subject in and of itself. This is especially true for certain industries of concern to Mexico and Canada, such as the steel and softwood lumber industries. (In this regard, antidumping and countervailing duty petitions on softwood lumber from Canada were filed on November 25, 2016.) This topic will be explored in a future client alert devoted to international trade remedies under the Trump administration.

10. The possibilities sound pretty scary. What can my company do to help mitigate the risk of a NAFTA exit?

As noted above, there is a wide set of possibilities, ranging from moderate (or even no) change to complete revocation of the agreement. Predicting the exact impact of any change to NAFTA can be difficult. Multinational corporations with operations in Mexico should, however, consider the following topics when determining how best to cope with the uncertainty of a potential NAFTA exit:

• Customs Issues

  • Assess which party is the importer of record. Because of the absence of duties, many companies in the NAFTA region paid little attention to which company acts as the importer of record. Because the importer of record is responsible for the payment of duties, a review of the entity that is acting as the importer of record, and assessing whether this arrangement makes sense in a post-NAFTA world, could help avoid unpleasant surprises.

  • Assess whether processing outside the customs territory can be used. Depending on which way the trade is occurring and the form of the transaction, there are various types of warehousing and manufacturing options that are deemed to be outside the customs territory of the country at issue, such as through the use of foreign trade zones (FTZs). Goods that are in an FTZ are considered not to have entered into the customs territory of the country, thus delaying any payment of duties. If the goods are later shipped to a different country — even the originating country — then no duties are ever paid, even if the goods were further manufactured while in the FTZ. This is a valid option to consider for goods that require processing before they are shipped to another country or back to the originating country.

  • Assess whether other customs options exist. In addition to FTZs, there are additional options for goods that can delay or eliminate duties, including the use of customs bonded warehouses or Temporary Importation Under Bond. Such options become more valuable if NAFTA tariff relief is eliminated.

  • Assess whether refunds of duties are possible. For goods that are involved in a round trip, there can be options where duty refunds can occur, including the use of the American Goods Returned program (where the goods are not further improved while abroad), Mexican and U.S. duty drawback procedures, and other refund programs. Eligibility can vary and depends upon the exact form of the importation pattern.

  • Determine if all customs valuation options are being used. When the tariff rate is zero, the precise value of the goods entered is of little moment. But in a tariff environment, strategies such as the first-sale doctrine (which allows for value to be entered based on the first sale to a middle man, rather than the final price) become more valuable as a means of minimizing duties.

• Supply Chain Options

  • Assess the supply base and what alternatives exist. Companies that have the option of using NAFTA generally have found Mexico to be the cheapest option, due not only to NAFTA regional preferences, but also due to inexpensive transportation options between the two countries. Companies should assess whether Mexico-sourcing still makes sense in a post-NAFTA world, and be prepared with a contingency plan if NAFTA exit becomes a reality. Options would include taking advantage of other FTAs, reshoring manufacturing options, or some of the other customs alternatives outlined above.

  • Assess maquiladora manufacturing options. NAFTA withdrawal might not impact all operations equally, due to the fact that the maquiladora benefits (which are granted by Mexico) will likely remain. The benefits of the maquiladora program include the ability to temporarily import goods and services that will be manufactured, transformed, or repaired, and then re-exported back to the United States, without paying taxes, being subject to compensatory quotas, and other designated benefits. For companies whose operations qualify, these benefits may make continuing Mexican operations profitable, even if duties increase. Companies that are not taking advantage of these cost-saving opportunities might want to consider them as a means of potentially offsetting some measure of any increased tariffs.

• Political Options

  • Consider seeking miscellaneous tariff bill options. From time to time, Congress passes a Miscellaneous Tariff Bill (MTB), which allows for the grant of customs duty forbearance for specific products. Companies that operate in Mexico have not needed to pay attention to this repeated Washington rite, because their products already enjoyed duty-free status. In a post-NAFTA world, the MTB might become an option worth monitoring and pursuing for products that meet the requirements for consideration.¹¹

  • Consider options for political pressure. NAFTA represents a trillion dollars of annual bilateral trade. Any actions to up-end that arrangement are going to be contentious, heavily lobbied, and feature winners and losers. Companies that are part of well-connected industries and trade associations will be able to enhance their ability to come out on top if the agreement is renegotiated.

• International Trade Litigation Issues

  • Assess if trade litigation is likely to impact important products and inputs. Regardless of how NAFTA changes, the likelihood of increased trade frictions in the form of international trade litigation is highly likely. Antidumping and countervailing duty actions are likely to increase in the new administration, as potentially will Section 337 and safeguard actions. To deal with this possibility, companies that deal with goods from other countries, including Canada and Mexico, should consider monitoring rumors of potential filings, assessing whether important goods are in industries where trade actions are common (steel products, chemicals), products where there are rumors regarding potential filings (various steel products, softwood lumber from Canada, and so forth), and monitoring whether imports are of products where imports have been sharply rising, especially if at low prices. Import trends can be monitored for any Harmonized Tariff System number on the website of the International Trade Commission.¹²

  • Consider going on offense. It is widely anticipated that the new administration will be more receptive to the filing of antidumping and countervailing duty actions, safeguard proceedings, and other forms of international trade remedies. If a case can be made that products are being sold at low prices in the United States by foreign producers or are receiving subsidies, and these imports are causing material injury to the U.S. industry producing the same product, it may make sense to consider filing a petition to seek import relief. Questionnaires to help assess whether such an action has a potential basis are available by contacting the author at the contact information listed at the end of this alert.

The issues outlined in this alert are only the tip of the international trade iceberg. Companies that have significant operations that could be impacted by the potential NAFTA changes should consider lining up counsel to monitor ongoing developments in the area, suggest coping strategies, and take other measures to mitigate the risk of a NAFTA exit. Billions of dollars of exports, and millions of manufacturing jobs, will be impacted based on how the NAFTA withdrawal/renegotiation is handled. With that much money at stake, it behooves companies with operations, sales, imports, and exports that depend on or are impacted by NAFTA to closely monitor any changes in the Agreement.

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NOTE: The international climate for U.S.-based multinational companies and non-U.S. based companies that sell into the United States has never been more uncertain. This client alert is the first in a series that will cover topics of intense interest to multinational corporations that operate from or within the United States. The Foley Export Controls & National Security Group will be issuing a series of “ten question” alerts related to the transition to a new administration, including with regard to such international regulatory topics as International Trade (antidumping and countervailing duty) actions, the Office of Foreign Asset Controls (OFAC) economic sanctions, export controls, the Foreign Corrupt Practices Act, changes to Committee of Foreign Investment in the United States (CFIUS) filings, likely changes in the regulatory and enforcement environment, and general regulatory compliance concerns. If you would like to be put on a mailing list for these and other alerts related to the international regulatory environment, please contact the Greg Husisian, head of Foley’s Export Controls & National Security Group, at [email protected] or 202.945.6149.

¹¹ See The International Trade Commission, Miscellaneous Tariff Bill Petition System (MTBPS) (available at https://mtbps.usitc.gov/external/).

¹² See https://dataweb.usitc.gov/.