The United States-Mexico-Canada Agreement (USMCA) updates the 25-year-old North American Free Trade Agreement (NAFTA), with modifications including a focus on resolution of disputes at a local level prior to international arbitration. The USMCA includes new provisions on intellectual property, digital trade, taxing of shipment value levels, financial services, currency manipulation, labor, and the environment. Notably, the USMCA increases local content requirements in the automotive sector from 62.5% within member countries to 75%. NAFTA's investor-state dispute mechanism has also been modified to favor the resolution of US-Mexico disputes in local courts by delaying for at least 30 months their potential elevation to international arbitration, although key sectors such as hydrocarbons, electricity, telecoms, transport, and infrastructure will be exempt (agribusiness not included).

The USMCA's entry into force increases the stability of the Mexico-US trade relationship (worth USD614.5 billion in 2019), but sunset provisions threaten to generate trade regulation uncertainty every six years. Overall, the USMCA is highly positive for Mexico, with 83.5% of its exports sold to the US in 2019. Its introduction also removes the US threat to withdraw unilaterally from NAFTA, and the business uncertainties generated by USMCA negotiations. However, the USMCA's sunset provisions state that it will expire after 16 years unless members agree to an extension, and that joint committees must review its contents every six years. The latter feature will create opportunities for members to pursue modifications of those terms they consider unfavorable, leading to renewed uncertainty over trade relationships in the periods preceding such reviews. The extent of this uncertainty will depend on future administrations' priorities but will be greater if economic protectionism intensifies in the US following the current economic recession.

Labor and environmental disputes are likely to increase under the USMCA. The formation of labor-related dispute settlement panels is likely to allow US and Canadian unions and firms to claim that Mexican violations of labor standards equate to the establishment of trade and investment barriers. The US plans to monitor Mexico's enforcement of labor-related commitments through an inter-agency committee and labor-attaché figure. US Trade Representative Robert Lighthizer said on 17 June that the US would take action "early and often" to challenge any potential violations of the USMCA.

Mexico's automotive, steel, and aluminium industries are likely to struggle to meet new USMCA local content requirements. Besides increasing local content requirements in the automotive industry to 75%, Mexico is committing to generate 40-45% of its automotive and automotive parts production at hourly wages of USD16 by 2023; Mexico's average hourly manufacturing wage was USD3.73 in 2019 according to Mexico's National Autoparts Industry chamber (Industria Nacional Autopartes: INA). Likewise, 70% of steel and aluminium that is melted and poured must be sourced from North America. Mexico's failure to further develop its own industries within the seven-year transition period would imply greater Mexican reliance on US and Canadian supply

Given this context, Mexico is likely to seek greater flexibility around the implementation and enforcement of new USMCA chapters. Some temporary exceptions or extensions for compliance are likely through mechanisms such as the Alternative Transition Regime announced in May. Some Mexican automotive industry representatives have said that where specific requirements have been published only recently and imply higher costs, companies may choose instead to pay tariffs. Although the USMCA stabilizes Mexico's external trade relations during the global recession, its foreign direct investment inflows are still likely to be limited by a broader deterioration of the business environment under the current Mexican administration. US, Canadian, and European companies and diplomatic officials have raised concerns in recent weeks over Mexican government actions that are increasing legal uncertainty for investors, including project cancellations, gas supply contract renegotiations, and new restrictions for renewable energy providers. The government is also pursuing an aggressive tax collection strategy against private firms and thinking about modifying the privately-run pensions system in Mexico, to grant the executive greater control

Indicators of changing risk environment

Increasing risk

• A continued lack of Mexican government financial stimulus measures for the private sector in response to the COVID-19 virus outbreak, particularly for exporting firms, will limit their ability to adapt to new USMCA regulations and take advantage of tariff-free trade opportunities.
• Any Mexican violation of USMCA labor requirements, including the need to pay higher wages and eliminate child and forced labor, would increase the risk of penalties for exporters.

Decreasing risk

• A government support program for the Mexican automotive industry would facilitate its compliance with increased costs and additional regulation.
• Signs of improved collaboration between the government and national private-sector groups such as Coparmex and Concamin would increase the likelihood of new government measures to incentivize foreign investment.

Posted 06 July 2020 by Johanna Marris, Senior Analyst, Latin America, Country Risk, S&P Global Market Intelligence