Modifications and revisions to the North America Free Trade Agreement (NAFTA) will impact sourcing decisions, supplier relationships, existing contracts and agreements and logistics. Once dismissed as campaign bluster, negotiations recently began with United States trading partners Mexico and Canada to revamp major sections of this important trade agreement.
Primary negotiations are focused on the rules of origin. While additional negotiations include digital trade, cross-border investment, intellectual property, and environmental issues, all new elements that did not exist during the construction of the original agreements, it is the changes to the rules of origin that seems to be the one creating the most uncertainty for supply chain pros.
The rules of origin in NAFTA are already considered more restrictive than those found in other trade agreements. Additional tightening may actually be counterproductive.
As a result, supply chain professionals need to pay attention to the negotiations and outcomes, as even minor changes to NAFTA will have a major impact on procurement and logistics. Those in the large automotive supply chain are especially nervous about upcoming changes to content calculations around rules of origin, but other industries impacted include aerospace, agriculture, and textiles.
Changes, or even the potential elimination of NAFTA itself, should find itself on the top of the list for supply chain risk these days. The changes can be far-reaching — even companies without direct NAFTA involvement could be members of supply chains that will experience an impact. Warehousing, transportation, sourcing, regulatory filings, and far-reaching changes top procurement will all be affected as rules of origin are revamped. The ramifications are not getting the attention they deserve.
The Roots of NAFTA
The creation of NAFTA predates the careers of many working in the supply chain. Sourcing and operational decisions and financial relationships with trading partners outside of the United States were ingrained into company processes that might not be given a second thought.
However, the recent explosion of global sourcing and the extended reach of supply chains complicates NAFTA regulations like rules of origin. Lapses of control of multi-tier suppliers may make it difficult to manage some of the fundamental, albeit shifting, aspects of the trade agreement.
According to a policy brief from the Peterson Institute for International Economics, Senior Fellow Caroline Freund notes the rules of origin in NAFTA are already strict, and while they vary from product to product, they typically require higher regional value shares than in other trade agreements. She advocates for the simplification of the rules of origin and warns that tightening of the rules may result in higher costs and inefficiencies for business.
From a supply chain process standpoint, strengthening the rules of origin will create substantial changes and potential hardship
Supply Chain Dive
In a well-performing trade agreement, goods move between trading partners with reduced or eliminated tariffs and support for regional economies. These economic incentives drive cost savings benefiting customers, suppliers, and employees. If the rules of origin are too slack, countries outside of the agreement may benefit, to the detriment of the member countries. If the rules are too tight, producers may be driven source outside of the agreements where parts may be less expensive, impacting the existing supply chain.
How rules of origin are reconfigured will have a major effect on supply chain operations.
Effects on the supply chain
From a supply chain process standpoint, strengthening the rules of origin will create substantial changes and potential hardship. In summary:
- The United States is seeking to increase U.S.-based and North American content in order to protect and expand high paying US manufacturing jobs.
- Product that flows between NAFTA countries, or tri-laterally, has no duty associated with them. However, prices may still be higher than offshore sources that supply product at low tariffs due to the Most Favored Nation status. It may be more cost-effective to use suppliers outside of NAFTA once the rules are changed.
- If the rules of origin get tighter, bills of material will need to be analyzed for all sourcing applications and changes will be required to meet the new rules. New tracing rules, to identify parts made in North America, will be implemented. There will be additional regulatory and compliance issues around all facets of procurement and transportation. No one is sure about the scope of these changes.
- Complex supply chains are at risk if the ratio of regional content changes. While the larger organizations may have the staffing and analytics to manage through the changes, smaller companies may be at a disadvantage.
- If compliance becomes too costly and burdensome, companies will buy outside the NAFTA agreement, as an increase in material costs and associated tariffs will easily offset the expanding cost of compliance. The changes in NAFTA will incur the rule of unintended consequences … what was thought to make it stronger may actually weaken it.
Josepha Parilla, a fellow at the Brookings Institution’s Metropolitan Policy Program, notes that advanced manufacturing, like the automotive industry, depends on intermediate imports from Canada and Mexico.
Suppliers provide more than 60% of Michigan’s total intermediate imports, including tens of billions of dollars in motor vehicle seats, ignitions, wires and other parts. Outside of Michigan supply chains from Canada and Mexico $3 billion worth of parts to Ohio and $2 billion to Indiana. To support the automotive industry’s trend to move south, Texas imports $6 billion worth of parts from Mexico, Tennessee $2 billion, and Kentucky about a billion and a half.
Matt Blunt, president of the American Automotive Policy Council, said NAFTA’s current requirement of 62.5% local content requirement was fine as it supported local manufacturing and also maintained competitive costs. He is against changes to the rules of origin and urged a cautious approach to changes. According to Blunt, changes in content calculation could negatively impact costs and the ability to export.
He also notes that it could deny his member companies (FCA, Ford, and General Motors) access to supply chains that would drive up costs and affect employment in the industry.
NAFTA is far-reaching
Changes in NAFTA are not limited to members of the automotive supply chain.
Supply managers in industries working within the NAFTA framework need to understand how their companies operate within the agreement, develop a quantitative model to ascertain regional content, and make the tough sourcing decisions necessary to comply with the current regulations and any increased regulations coming in the near future.
This analysis extends throughout the supply chain as well. Supply managers should be prepared for shifting costs, new sources of supply, educating their suppliers about NAFTA, and prepare for rapid changes in their industry should the trade agreement be modified, or at worse, eliminated. They have an important role to play in the fundamentals of trade, a role many are at this point are unprepared to take.