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Luis Videgaray Caso: a Mexican take on Nafta

The North American Free Trade Agreement is ripe for an update that benefits all parties. But if the US decides to pull out, Mexico is confident that its network of agreements and many enacted reforms will enable it to thrive, says the country’s secretary of foreign affairs, Luis Videgaray Caso.
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Luis Videgaray Caso

The launch of the North American Free Trade Agreement (Nafta) renegotiation process in August 2017 represents an important opportunity for Mexico, the US and Canada. There is ample room to improve and update a 23-year-old agreement to consolidate North America’s position as one of the most competitive manufacturing powerhouses in the world.

First of all, sectors that were not part of the original agreement can be incorporated, and current provisions for sectors that experienced significant transformations, taking advantage of technological and regulatory changes, need to be modernised. These sectors include digital trade (which has become an increasingly important part of the global economy), energy and telecommunications – which, thanks to Mexico’s structural reforms, are now open to private investment and competition.

A win-win scenario

Deepening regional integration in energy and telecommunications, which are productive inputs used across the board, would increase competitiveness in all industries.

There is also an opportunity to strengthen the region’s institutional framework by including labour protection, environmental and anti-corruption provisions into the agreement. The latter is a priority for Mexico, given the importance of enhancing the rule of law to promote certainty and investment, and guarantee a level playing field for firms to compete.

Mexico’s objective for Nafta 2.0 is to reach an agreement that results in a win-win-win arrangement for Mexicans, Canadians and Americans. Mexico is seeking to strengthen the competitiveness of North America through a tighter integration of regional value chains, which is only possible if we maintain and enhance rules-based free trade within the region.

Another priority for Mexico is to ensure the benefits of trade reach more people. This can be achieved by increasing the protection of labour rights and improving working conditions and wages. The latter crucially depends on investment promotion, so strengthening investor protection within the region is key.

Alternatives to Nafta 2.0

While Mexico remains committed to reaching an agreement for Nafta 2.0 that is beneficial to all parties, we are also prepared for a scenario in which the US withdraws from the agreement. In this scenario, Nafta would still govern trade and investment relations between Mexico and Canada (and Mexico would look forward to work on a bilateral updating of Nafta with Canada), and the US would be welcome back in the future. In the meantime, the framework of the World Trade Organization (WTO) would govern the Mexico-US trade relationship.

It is useful to provide some perspective as to how Mexico’s relationship with the US would change under this scenario, especially regarding trade and investment. A potential US withdrawal from Nafta would not entail a significant disruption of bilateral trade. On one hand, there are structural reasons, such as geographical proximity and demographic complementarities, which explain the tight integration between Mexico and the US. On the other hand, most favoured nation (MFN) applied tariffs – which would prevail in US-Mexico trade without Nafta – are low both in the US (3.5% on average) and in Mexico (7% on average).

In fact, low MFN tariffs largely explain why, currently, 44% of US imports from Mexico enter without using Nafta’s preferential tariff treatment (this figure is 51% in the case of Mexico’s imports from the US). Moreover, under a US withdrawal from Nafta, only about 8% of Mexico’s total trade volume and about 12% of Mexico’s trade volume with the US would be affected by tariff increases higher than 5 percentage points.

It is also important to note that many of Nafta’s non-tariff benefits have already been incorporated into the WTO framework. For instance, most of the aspects related to customs procedures in Nafta have been superseded by the Bali Trade Facilitation Agreement (that came into force in February 2017), whose provisions are already in the process of being implemented by both the US and Mexico.

Tariff-free network

Since Nafta was signed, Mexico has developed a network of 11 free-trade agreements (FTAs) with 44 countries, excluding Nafta. Thanks to these, Mexico has tariff-free access to some of the largest markets in the world, including the EU and Japan. The current concentration of Mexican trade towards the US may lead observers to underestimate the potential importance of Mexico’s network of FTAs.

Indeed, in the unlikely scenario in which US trade barriers increased enough to overcome the advantage provided by the geographical proximity, Mexican trade patterns could quickly shift towards other FTA partners, mitigating the potential adverse effects of a US withdrawal.

Furthermore, Mexico’s institutional framework has evolved through international treaties and domestic legislation, making investor protection no longer dependent on Nafta. Mexico’s 32 investment promotion and protection agreements with 33 countries are the best proof of its commitment of granting protection and certainty to foreign investment.

Mexico’s domestic institutional and legal frameworks have also been improved since Nafta was signed, through the liberalisation of most of the economy’s sectors and the strengthening of the rule of law. In particular, in 1994 Mexico implemented a foreign investment act (Ley de Inversión Extranjera), which is consistent with the related provisions set forth in Nafta. Under this law, Mexico provides a non-discriminatory national treatment to foreign investments and eliminates export requirements prohibited under Nafta (for example, national content percentages).

At the time Nafta was signed, important sectors of the Mexican economy (energy and telecommunications) were not fully open to foreign investment. The local legal framework was deemed insufficient, and investors enhanced their legal certainty through the provisions contained in Nafta. Today, Mexico has successfully enacted reforms on energy and telecommunications that go beyond the current Nafta provisions and grant legal certainty to investors at a domestic level.

Mexico can consider further legal amendments that could expressly encode Nafta’s investor protections into domestic legislation in 2018, such as establishing a specific legal framework for the investor-state dispute settlement mechanism.

Mexico’s backbone

Under the leadership of president Enrique Peña Nieto, Mexico is in the implementation phase of a package of structural reforms aimed at increasing the competitiveness and resilience of the whole economy.

The first results are already starting to show. For instance, since the implementation of the telecommunications reform, mobile and long-distance rates have decreased by more than 40%. Electricity rates have also decreased significantly, especially industrial service rates, which have experienced a 16% reduction in real terms since the energy reform was enacted in 2013. The financial reform has expanded access to financing at better interest rates. As a result, internal financing for the private sector has increased from 26.7% of gross domestic product (GDP) in 2012 to 33.2% of GDP as of June 2017.

These are all essential inputs that are used by all industries, so these changes have a direct impact on competitiveness across the board. Lower prices and more financial access have also benefited consumers. For example, during the current administration, 6.4 million vehicles have been sold in Mexico, 45% more than in the same period of the previous administration.

A new strength

In summary, the structural reforms have strengthened the domestic market and increased the resilience of the Mexican economy, enabling it to perform well in an adverse international environment. Indeed, despite negative shocks that include a 47% depreciation of the peso against the US dollar, a reduction of almost 50% in oil prices and a reduction of more than 25% in Mexican oil production, Mr Peña Nieto’s term has enjoyed the largest average annual growth rate of GDP since Ernesto Zedillo’s term in the late 1990s. At the same time, more than 3 million formal jobs have been added to the economy and the unemployment rate has remained at one of the lowest levels in countries that are part of the Organisation for Economic Co-operation and Development.

We have an important opportunity to improve and modernise Nafta, and Mexico is looking forward to an outcome that benefits all parties. However, we are also in a strong position to withstand a potential US withdrawal.

Mexico has come a long way since Nafta was signed. Today, the country has a stronger institutional framework, a wide network of FTAs that will help accommodate shifts in trade patterns derived from a potential increase of US trade barriers, and a dynamic domestic market that has shown remarkable strength against adverse international conditions.

Luis Videgaray Caso is Mexico's secretary of foreign affairs.

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Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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