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This is John Raines with the S&P Global Country Risk team, and you are listening to the economics and country risk podcast on this day that this podcast is being reported. We will have gone one month almost to the day into the enactment of the United States, Mexico, Canada Free Trade Agreement, USMCA, a free trade agreement that the President of the United States Donald Trump has called the most significant trade agreements in history. And today, we have a panel of our experts to talk about this agreement just a little bit more specifically what it means for various industries, labor, and of course, politics.

To do so, we are joined today by John Anton, Associate Director of our Pricing and Purchasing team, Our Man of Steel, who looks at that commodity along with others. Emily Crowley, also an Associate Director of our P and P team looking at labor issues, and Joanna Marris, Senior Analyst with our Country Risk team, who covers Mexico.

Now, John Anton, why don't we go ahead and start with you, as we have mentioned in several podcasts before, there are conflicting views here as to the importance of this agreement. Now, some suggest as the President does that this is the largest most significant in history. Others who, however, simply called this NAFTA two slight modifications. We bring in technology, here are a few changes for labor and auto, from your perspective, where have we seen things change here, or is this a big deal? Or is it?

It's a big deal, but it's really NAFTA two, it's the status quo, and NAFTA was a big deal. So the fact that NAFTA was renewed as USMCA is a big deal. What does it mean? It means between the US, Mexico, and Canada no tariffs, no quotas. Those are very big things. Now there are a few differences for things like dairy and others. But mainly if you are trading from Mexico to Canada, no tariff, no quota. That is what was in NAFTA. That's what's in the USMCA renewal of it, as the status quo was actually not an automatic. So it's good that it was done. And it is a big deal. But it is not much of a change from NAFTA.

There are some changes, Joanna, if you can talk about some of the things that were changed within the USMCA and that are of significance.

Yeah. So I think as you say that the bulk of the agreement is, is very similar to NAFTA. And it's more securing the continuity of a lot of those trade terms. But there are several new chapters, there's now 34 in total, and some of those new additions are very much about updating the agreement and bringing it into the 21st century. So we've now got chapters on corruption on the environment, digital commerce, things that just weren't present. No one really has much of an issue. I think there are a lot of new opportunities within these new areas, particularly for SMEs and digital commerce. So we've got reduced customs procedures, we've got transactions being made more easy. So that's going to facilitate as well, a lot of transactions and trade for these in particular, I think the challenges that we've mainly been looking at, and also we've seen concerns raised about by companies are the increased local content requirements.

So this is particularly impacting the automotive industry, the local content requirements and are 75% compared to 62.5% under NAFTA. So that's obviously a big increase. And also for steel and aluminum. We've seen the local content requirement for that gone up to 70%. And we've seen in Mexico at least a lot of companies raising concerns over compliance there with those two requirements.

And the last thing I would highlight as well would be the addition of the sunset clause that we have now in the USMCA, which wasn't part of NAFTA. So the new agreement now will automatically expire in 16 years. Unless all three parties agree to extend it, and as well as that we have a joint review every six years to potentially update certain aspects of the agreement that people aren't in agreement with. But this is a good opportunity. But I think it could also lead to modifications being proposed over more controversial issues and the potential return to some of those areas of uncertainty that we saw for businesses during the last years of negotiations.

That's really interesting, Joanna, because in some ways, what you're saying here is that we have more certainty on some issues because now we have an agreement where, you know, we look about, you know, 18 months ago, we didn't even know if we'd have that, however, and the and the counter to this is is that you look at and we are going to continue and I'm certainly looking six years ahead, right. So we're looking at post-Trump, whether he wins re-election or not, these types of issues are going to come to the forefront yet again. And just a few years in one of those issues, which has been very, very controversial has been labor when this agreement was getting renegotiated part of the reason why the US was really pushing for this so vehement was that the idea that was gonna bring the US Manufacturing back to the shores. And a lot of that dealt with labor.

So, Emily, I was thinking maybe we could bring you in here and talk a little bit about the rhetoric behind it. Where do we see things going? As far as the labor movement? Is this going to assist US labor? How is it going to affect Mexico? Or again, is it something that we've heard from John before - is that some modest changes here, but nothing that significant?

Sure. Yeah, I think you raise a really good point with you know, under NAFTA, we saw a fair amount of trade increase between the US and Mexico in particular, and we did see manufacturing move kind of from the US to Mexico because of the lower labor costs there. So one of the pieces of this legislation, one of those pieces of the USMCA is kind of strengthening the rules around labor. So the first part is really unlike NAFTA, the USMCA requires parties to adopt and maintain laws on core worker rights. And those are set forth in the international labor organizations declaration on fundamental principles and rights to work, right. So they're pretty straightforward. If you're thinking about this.

Are there restrictions on forced labor and compulsory labor essentially abolishing that abolishing child labor, elimination of discrimination, and at least a commitment to that. And then also freedom of association and the right to collective bargaining. So I mean, the biggest impact for this, the at least the legal changes, has really hit Mexico because Mexico the labor laws had been fairly weak in the past. So in 2019, there was actually a fair amount of work done to bring their labor standards up to scratch. This included increasing workers rights around organizations. So now workers can vote for unions on secret ballots. In the past, there was a practice that if you join a union, you needed to join the company union, which was not necessarily representing the workers, right. So now the workers has a freedom of association so that they can choose the union for which they want to join. So that's a really big change. And then also in Mexico, there is the establishment of a labor court to deal with any sort of, you know, issues or arbitrations between employers and union workers. So that's a fair amount of changes that happened incredibly rapidly. You know, we are still waiting for the enforcement side of this, I would say these are fairly new laws.

But but that was kind of the legal framework. And then there's also this other portion, which Joanna and John have talked about, which is specifically on the automotive sector. So Joanna mentioned that there are new local content requirements that have increased to 75%. And then there's also the introduction of labor value content. So now there's actually a rule around the level of wages that have to go into automotive manufacturing to be able to qualify for, you know, tariff free trade. So that's the thing $16 an hour, is that right? Yes, yes, exactly. So this is what's capturing everybody's attention is that the you know, the base wage. What we're basing this off of is that the top line level that we're starting with in 2021 for passenger vehicles is that 30% of labor value content has to be in an automobile must be coming from work. That make at least $16 an hour. And that will rise gradually through 2023 to 40% for passenger vehicles, and then 45% for trucks. Now, there's a way to get around this a little bit. I know that I was talking to some of the auto folks here, they're saying that, you know, if we look and we bring in like research and developments, or you look at computers, we can kind of massage these levels a little bit here or there. But Mexico is nowhere close to $16 an hour.

How is it that we think investors, car manufacturers, or others will deal with that new reality? How does this impact them? And again, you talk a little bit about the lag time, or is that a factor here that might actually be able to handle this type of changing situation? Yeah, I think that's an excellent point. There are carve-outs of about 15%. By 2023, you're looking at a quarter of the manufacturing that's going into a car has to be by workers making $16 an hour. As you mentioned, Mexican manufacturing wages in the automotive sector are about $4 an hour. So that's a steep jump going from $4 an hour to $16 an hour, and we don't necessarily think that we will see manufacturers in Mexico make that jump, what's more likely, is that we'll see supply chains reconfigure. So wages in the US and Canada are significantly higher than that threshold. So we might see manufacturers reorient their supply chains towards moving the higher value components of automobiles towards that higher wage area. Okay, and it possibility there actually, there will be some companies decide just to end up paying the tariff itself because they just not going to be able to meet these types of conditions. Yes, yeah, so the most favored nation tariff for passenger vehicles is two and a half percent. So if your option is to either quadruple your wages in Mexico or take a two and a half percent tariff, you might decide to take that two and a half percent tariff where we see the biggest risk is really on light trucks because that tariff is actually 25%. So we've actually have seen some reports of some automotive parts suppliers in Mexico, which has raised wages, these tend to be in areas of manufacturing that are highly automated. So, if your labor requirement is fairly low, and you're using robotics or something like injection molding where the labor content is actually fairly low, you might be able to get away with that. Okay, and now and I'm bringing John Anton, back into this conversation, part of the really controversial element of this agreement is really about steel.

One thing that you had mentioned to me previously, just in a private conversation, is that nearly 50% of all anti-dumping and countervailing duties that we see occurring involve steel, so a very controversial commodity far more controversial than when you hold it in your hand. What does this agreement say about steel are their main takeaways we should really let our listeners know what it covers here. Well, I first want to say it's steel and aluminum because the impact on aluminum may be even worse. I'll come back to that. But it requires very much the same for metal as it does for labor. 70% of the vehicle's steel and aluminum must originate in North America. And that means not only it has to be melted and rolled here that's significant.

There are steel mills that buy semi-finished from Brazil or Russia and then roll it locally to the buyer spec. That would not be allowed; it has to be you can't buy the semi-finished import. You have to you can buy the iron ore or scrap, but you have to melt the iron ore or the scrap within the USMCA region to comply. It applies only to auto parts, but it's 70%. This will make certain steel mills unable to comply. And it really picks winners and losers that's already going on in the United States under Section 232. It would be sort of it would extend to people supply in the auto industry and all of USMA worse for Mexico is aluminum. Mexico has a steel industry, Mexico has no aluminum industry. So they have a hard time complying, have to get it all from Canada, or the very little that's left in the US. They buy imports from the rest of the world. And a lot of auto parts are made from aluminum. Now the steel and aluminum parts only go into effect in seven years, July 1, 2027. That's after the first review, which is six years away but well before the 16-year sunset, but it's going to be very hard.

If you are looking to build an auto parts plant that uses aluminum. It's going to distort your entire business thought, and aluminum and North America is mostly a Canadian product. I think so I think that brings in an important element when we're talking about Canada because this was an agreement oftentimes when we look at some of the controversies, oftentimes it involves the United States in Mexico, but Canada pretty much gets left out of the equation. And that's not fair because the Canadians fought pretty hard here, and they got most of what they wanted. For example, there are some changes regarding dairy and US access to the dairy market inside Canada. But Canada did win on dispute settlement. And so I was wondering, in some respects, if you had any comments on how it reflects as far as steel and aluminum and how that affects Canada here. There is a lot of mutual benefit to USMCA for the steel and aluminum industry, particularly for steel, where there has been relatively balanced trade between the United States and its two partners. So the US exports high amounts of steel to Canada and Mexico. We also import in the United States, high amounts of steel, there's less trade between Canada and Mexico, but even there, it goes on, but in general, it's a fairly balanced and high volume trade and anything that keeps that high volume trade going works to the benefits of the steel mills. So they may not get some business, they might lose it to Canada, but then also there's other business they can export, it is a net benefit keeping that trade going. Yeah. So it does seem like there's a win there.

As far as Canada vis vis-like just kind of continuing the status quo, I think it was a big threat for Canadians just a few years ago when they thought the prospects of NAFTA might just completely fall apart. And they would be retracting to, you know, the former Free Trade Agreement they had with the US or even that might been dissolved. just bringing Joanna back into the conversation here and talking about Mexico, again, kind of a big win for Mexico in the fact that we have a continuing trade relationship. I think I read that Mexico depends on 82% of its exports going to the United States, so heavily dependent there, but when we're looking at Mexican politics, is this a grand win? I mean, certainly a lot of controversy with the current administration. Does this make up for some of those concerns that some investors currently have?

The most important thing to take away is that this is stability for exports. It's securing this key export market for Mexico, which has eliminated also the threat of the US unilaterally withdrawing, which we were, you know, was being raised a couple of years ago. So I think overall, there's no question that this is beneficial. However, as we've been discussing, for Canada, it's more in the framework of it being continuity. And President Lopez Obrador in Mexico has actually used the agreement as a means of saying that this this is going to be a key mechanism for attracting directly new investment to Mexico. And it's going to be a key tool as well for the country to emerge from the economic recession following COVID-19. And I think we're a bit more skeptical about the agreement being this automatic generator of investment. And when NAFTA was implemented, we saw exponential growth in exports from Mexico to the US, and that was a real trigger for that to occur. But I think it's important to note that we're in a completely different context at the moment, we're getting a continuity of these trade terms. Still, the investment environment in Mexico is very different. We do have concerns over the deterioration of legal certainty. We've had international companies from Canada and the US raising concerns over that in the last few months.

For example, at least four projects canceled by a popular referendum since the current administration came in 18 months ago. And we've got in the energy sector as well concerns around the restriction of operations for electricity and renegotiation of contracts. So these are all things that we're monitoring. And we're aware that this investment environment is no longer as attractive as it was in previous years, particularly when the energy field reforms came in a few years ago, as well. So we think that this agreement alone won't be enough to attract this significant increase in investment that the government is saying it will do. It will require more cooperation with the private sector or consistency in its policy, and also an improved relationship and improve management of the COVID-19 crisis and economic fallout because we've had a lot of concerns raised by the private sector over the government's management and a lack of financial support for large companies in particular. So I think until some of those things are in place, companies are going to be more cautious about investing. So some positives but also maybe some concerns that are still out there. So I think that wraps up what we have today. As I mentioned, the BMP team will have another podcast coming out soon to dive into some of the issues surrounding potential steel and aluminum tariffs in the next week or so. Is that right, John? That is correct. That is correct. I encourage you all to listen to it. In the meantime, I want to thank all of our speakers today, John Anton, Emily Crowley, and Joanna Marris, and we'll see you next time.

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