When NAFTA renegotiations commenced in August, those involved in supply chains began to analyse the possible consequences.
It is clear that NAFTA’s sole emerging market is vulnerable. According to the Financial Times, Spanish bank Santander warns that Mexico’s economy could contract by 2.6% if NAFTA dies and the US goes into full trade war mode. Moody’s Investors Service says the economy could shrink by up to 4%.
Having said that, there is some comfort to be drawn from the fact that even in the event NAFTA dies, about half of what Mexico exports to the US would still cross the border without incurring tariffs. Nevertheless, Santander’s forecasts assert that export and import volumes would fall by 15% and 16% respectively if NAFTA ends and a trade war ensues, implying significant supply chain disruption.
Other trade avenues are already being explored. For instance, Mexico imported more yellow corn from Brazil and Argentina in September than in the whole of 2016. The US is currently its major source. The search for substitute markets does not appear to be extensive yet, but if uncertainty builds or negotiations get ugly, expect the pursuit for alternatives to accelerate.
But even in the event a new accord is reached, there remains plenty of scope for supply chain patterns to shift.
For those hoping for minimal disruption to North American supply chains, the area of renegotiations probably generating the most angst is possible changes to the rules of origin chapter. From a US perspective, these specify that for a good to be imported tariff-free from Canada or Mexico, a certain proportion of its value must be produced within NAFTA. The proportion of regional content required varies by good.
For a car, 62.5% of its value must have been produced within NAFTA to be imported tariff-free to the US from Canada or Mexico.
For firms to prove they have met the necessary share, they are required to document the origin of parts used in production and obtain a certificate of origin. This implies administrative costs and inefficiencies, which increase as the content share rises.
What is the impact of stricter rules of origin on supply chains? The logic goes that as requirements tighten, more trade should take place within NAFTA, given the desire to qualify for free trade. For example, cheaper car parts from Asia or Europe may be rejected in favour of more expensive NAFTA components by a Mexican vehicle manufacturer aiming to meet the 62.5% benchmark. But as the benchmark increases, there comes a point when it becomes cheaper to import parts from outside NAFTA and pay the tariff on the finished vehicle anyway.
What that means is the tariff rate imposed by the US for a vehicle manufactured in Mexico would be the same as for anybody else the US doesn’t have a free trade agreement with. A competitive advantage is lost. At this point, the vehicle manufacturer may start to question whether Mexico is actually the best place for its production.
Toying with rules of origin is therefore a risky business, one which can easily have unintended consequences. All that can be said for sure is that the greater the changes to content shares, the more likely it is that Mexican and NAFTA supply chains will be forced to adjust, one way or the other.
Source: Transport Intelligence, November 14, 2017
Author: David Buckby
