The U.S.-Mexico-Canada Agreement (USMCA) went into effect on July 1st, replacing NAFTA and modernizing the trade guidelines between the three North American countries.
Major changes have been made to the automotive industry, while new policies also have ramifications for labor practices, environmental standards and e-commerce.
The framework for the agreement largely comes from NAFTA, which already eliminated most tariffs between the U.S., Mexico and Canada, while also borrowing from the Trans-Pacific Partnership that the U.S. declined to join.
Small Businesses Receive Boost
Often neglected in major trade deals, much of the focus of the USMCA has been for the benefit of U.S. small businesses. It is the first trade agreement to include a full chapter dedicated to small business interests, targeted at redressing the U.S. trade deficit with both Mexico and Canada.
The Cross-Border Trade in Services chapter allows for companies to have greater market access, with small businesses now not required to have a foreign office or representative in order to do business in either of the other two countries.
The chapter also establishes a committee on small and medium-sized enterprise (SME) issues comprised of government officials from each country. This is aimed at improving business planning resources, the creation of advisory networks and increased access to financing.
The automotive industry will have to adjust the most, with automobiles requiring 75% of their components manufactured within the three countries, up from 62.5% under NAFTA. The changes to rules of origin (ROO) requirements will require significant examinations of supply chains in order to ensure compliance.
The added level of complexity means that supply chain managers will likely need to onboard new suppliers and in some cases re-shore production.
The deal went into effect in the middle of the Covid-19 pandemic, at a time that businesses are facing significant supply chain disruption. The Motor & Equipment Manufacturers Association says companies will be stretched to respond to the new rules due to the timing, as the U.S. economy suffers its sharpest recession on record.
However, depending on the type of vehicle, a grace period of up to seven years is being offered before penalties are introduced.
40-45% of automobile parts must also be made by workers earning at least $16 an hour by 2023, a move designed to reduce labor cost arbitrage. Greater labor protections have also been granted to Mexican workers, notably the ability to unionize.
The enforced wage hikes have also created concerns around vehicle costs which could damage sector growth at an already difficult time.
For the first time in decades both Canada and Mexico will raise de minimis shipment thresholds, meaning U.S. SMEs will be able to benefit from reduced customs duties and taxes, increasing their ability to reach new consumers.
“Implementation of USMCA will bring greater certainty to importers and exporters of all sizes throughout North America, which will facilitate their ability to invest for future growth and provide goods and services more efficiently,” says Tod Burwell, CEO and president of the Bankers Association for Finance and Trade.
American farmers will gain access to foreign markets as a result of the deal. Most notably Canada’s highly sought-after dairy and sugar sector, following the elimination of a program that protected domestic sellers.
USMCA also creates new origin rules and requirements for “secondary” textile components, such as sewing threads, narrowing elastics, and pocketing fabrics. These measures are aimed to encourage the use of these components in North American goods.
Sunset clause creates uncertainty
With businesses facing sweeping changes, the addition of a sunset clause has done little to ease minds. Unlike NAFTA, which had no expiry, USMCA will come to an end after 16 years, while also being subject to a review every six years, at which point the three countries can decide to extend its lifespan.
Restructuring supply chains and incurring costs in the short-term will need to be balanced against the potential termination of the agreement.
Though it will likely come with higher costs, the prospect of nearshoring to Mexico and Canada is already in the minds of business owners, as trade tensions with China intensify.
The deal will have vast ramifications for those doing business in China. New ROO requirements will create issues for manufacturers relying on China. Businesses will need to make important decisions on whether to absorb tariff costs or restructure through nearshoring.
The deal also dictates that China is not a market economy and both Canada and Mexico will have to provide three-months’ notice if they are planning on negotiating a trade agreement with a non-market economy.
Overall, the net benefits to U.S. GDP is muted, with the International Trade Commission estimating it results in just a 0.35% increase after six years. Contrasted against the possibility of a breakdown of NAFTA it protects against a strong negative outcome.
Much uncertainty remains over how the deal will play out, with many regulations not being enforced for years. Though significant decisions will need to be taking to restructure supply chains, USMCA has created a positive outlook for U.S. SMEs.