The North American Free Trade Agreement (NAFTA) is a comprehensive agreement that sets the rules for international trade and investment among Canada, the US, and Mexico. NAFTA took effect in 1994 and remains in effect today.
President Trump indicated that he is interested in renegotiating NAFTA and specifically mentioned changing the definition of the “rule of origin” which is part of NAFTA. The rule of origin determines the “nationality” of a finished product, that is, the amount of domestic content in a finished product. If a finished product meets a certain percentage of domestic content, then a country will not levy a tax, duty or tariff (jointly tariff) on that product on import.
Though this may seem like a minor, esoteric issue, modifying the rule of origin for products imported into NAFTA signatory countries can have a significant impact on US companies exporting or importing products to or from our NAFTA partners, Canada and Mexico and on US consumers who may have to pay a higher price for these imported products if a tariff is levied on the finished product.
RULES OF ORIGIN
In addition to NAFTA, rules of origin apply to the Trade Agreements Act, the Buy American Act, US anti-dumping regulations, US export regulations, and various foreign treaties. The rule of origin is a back- handed way to legitimatize discriminatory trade practices.
Rules of origin can be preferential or non-preferential. Preferential rules of origin determine whether a finished product originated in a favorable or preference-receiving country or region, or has a percentage of domestic content in the finished product, thereby qualifying for trade preferences (automobile must be comprised of at least 62.5 percent of parts made in North America to avoid a tariff on import into the US).
Non-preferential rules of origin are used as a basket catch-all as a trade barrier—can this product enter a particular country, irrespective of the amount of domestic content (hypothetically, foreign light crude oil blocked as an import to Russia; “forced labor products” blocked as an import to the US).
Rules of origin for cross-border transactions are not implemented to generate money for a government for tariffs paid but are applied to manipulate trade. For most countries, the amount earned in tariffs is insignificant in relation to their overall budget. Rules of origin are used for protectionism or to encourage a country to use one part for finished product over another thereby increasing demand for a part. Rules of origin help countries manipulate trade.
As an aside, consistent with US Government contract law, if a Trade Agreements Act clause found in the Federal Acquisition Regulation (FAR) or the Defense Federal Acquisition Regulation Supplement (DFARS) appears in a US Government contract, then the procuring US agency cannot purchase that product unless the content requirements noted in the applicable FAR or DFARS clause is met—a preference which allows discrimination by rule of origin.
EFFECT of RULE OF ORIGIN MODIFICATION
If the rule of origin for automobiles made in Mexico was changed from 62.5 to 90 percent US-origin content for a finished product (finished auto), for example, and a tariff was levied by US Customs of 40 percent of the value of the finished product if it fell short of 90 percent US content, then on import to the US from Mexico an automobile not meeting the 90 percent criteria would have to pay 40 percent of the automobile’s value as a tariff to the US on import. In turn, the price for that automobile would probably go up to absorb all or part of the tariff.
NAFTA changed relations between the US and Mexico by, for the most part, eliminating tariffs between the two countries, and providing incentives for US companies to invest in Mexico. A benefit to consumers in Mexico and the US.
Mexico and the US enjoy "most favored nation" status because of NAFTA in contrast to those countries that are restricted by the terms of more restrictive trade agreements and those country with which US companies cannot do business like North Korea, North Sudan, Syria, and to some extent Cuba and Iran.
The effect of changing the rule of origin in NAFTA could be devastating to consumers in the US, Mexico, and Canada. The cost of goods could skyrocket, and more importantly, our most reliable trade partners could become embroiled in a trade war with us by boosting tariffs or worse yet blocking the import of certain finished or component goods.
COULD TRUMP MODIFY OR CANCEL NAFTA WITHOUT CONGRESSIONAL APPROVAL?
NAFTA's Article 2205, states that a party may withdraw from NAFTA six months after it provides written notice to the other signatories. Though memberS of the US Congress might disagree, President Trump, though challengeable in US courts, could unilaterally withdraw from NAFTA without congressional approval by providing the required notice. Even if the modification or cancellation of NAFTA were blocked by injunction in US courts, by an international tribunal, or by Congress, havoc would prevail during the movement of finished products among Mexico, Canada, and the US; a disruption that could have a long-lasting detrimental effect on all three economies.