WASHINGTON — The structure of North America's manufacturing networks will be on the line when the first round of negotiations to rewrite the North American Free Trade Agreement begins here this week.
The central showdown is expected to revolve around the amount of regional content products must contain to qualify for duty-free status, the so-called rules of origin. How that contest plays out will have profound implications for the auto industry.
Administration officials have pointed to stricter rules of origin as one way to address reducing the $60 billion bilateral trade deficit with Mexico and shifting more production to U.S. factories.
In the auto sector, 62.5 percent of a car's content value must come from the U.S., Canada and Mexico to avoid duties when shipped across the border for final sale. The White House has signaled it wants to raise the regional-content threshold, and possibly even carve out a minimum requirement for U.S. content, to keep more local work and protect against greater use of imported Asian parts.
Automakers and free-trade proponents acknowledge that NAFTA deserves to be updated after a quarter century to reflect new economic realities, but warn that even minor adjustments to the rules of origin could upset the carefully constructed balance of economic interests among the U.S., Mexico and Canada.
"We are a seamless manufacturing platform, and it would be extremely difficult to unwind that," Association of Global Automakers CEO John Bozzella said during a forum here last week. "You will create a big advantage for other manufacturing platforms around the world. We have to be very careful that we don't upset that balance between global competitiveness and supporting U.S. production."
NAFTA has the highest regional-content threshold of any automotive trade agreement in the world, industry representatives say, but manufacturers have many options for tallying the value-added content of vehicles produced in Mexico, Canada and the U.S. Under the "roll up" method, each component is evaluated for the amount of material and labor supplied within the trading bloc or sourced outside the region. Parts determined to be 70 percent NAFTA origin, for example, get rounded up to 100 percent, while parts that fall below the content threshold are counted as zero.
The "roll up" method exists to reduce the administrative burden of crunching the added-value numbers for thousands of parts in a vehicle. In practical terms, this pass/fail approach means many vehicles that qualify for duty-free status actually have less NAFTA content than advertised.
But the rules as they are have helped NAFTA generate massive U.S. investment by foreign automakers, tens of thousands of new jobs and record high auto sales, according to industry officials. Domestic car companies and suppliers have also been able to rely on lower-cost Mexican labor as part of their production mix to compete with Germany and Japan, which have access to cheap labor in Eastern Europe and Asia, respectively, experts say.
If companies are forced to buy more expensive parts and supplies in North America, they would spend resources re-engineering their supply chains, which ultimately could become less efficient and make vehicles more expensive. Higher vehicle costs would depress vehicle sales in North America and make U.S., Canadian and Mexican exports to third markets less competitive, trade experts predict.