The USMCA and Mexico’s Prospects under the New North American Trade Regime

Abstract

After 26 years of trading under the North American Free Trade agreement (NAFTA), Mexico and its North American partners enter a new phase with the entry into force of United States-Mexico-Canada Agreement (USMCA) on 1 July 2020. This note quantifies the potential impact of the agreement on Mexico and assesses its implications for Mexico’s economic development in the context of the evolving knowledge-based and data-driven economy, the restructuring of global supply chains in response to the risks that were highlighted by the pandemic-driven economic crisis, and the changes to global trade and investment patterns driven by the trade and technology friction between the United States and China. The USMCA provides a major overhaul of the NAFTA based largely on the text of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). It introduces some minor improvements to market access but its main effect for the industrial sectors of the economy is to intensify trade and investment diversion through more restrictive rules of origin, including onerous new requirements for labour value content in the automotive sector that impose significant adjustments on Mexico’s auto sector producers. The agreement builds on the institutional framework of the NAFTA, retaining the binational panel review mechanism for trade remedies – now Chapter 30 – intact, preserving the investor-state-dispute-settlement (ISDS) mechanism for Mexico-US investments only, improving state-to-state dispute settlement mechanism by addressing procedural weaknesses in the NAFTA version that had undermined its use, and introducing a new rapid-response mechanism for challenges to Mexico’s compliance with the labour market measures newly incorporated in the USMCA. The agreement, however, leaves open the use of US Section 232 “national security” tariffs and thus does not address the main new source of uncertainty concerning assured access to the US market for its North American partners. The analysis concludes that the net impact on Mexico is to reduce real gross domestic product (GDP) by about -0.8% compared to the NAFTA, once the economic adjustments are fully in place. Since Mexico had already signed onto disciplines on data localization and cross-border data flows under the CPTPP, the digital economy measures have little direct impact; however, how Mexico engages in the digital economy, both to tap the economic potential and to develop regulatory safeguards will be an important determinant of how well it fares under the new USMCA trade regime.