Fresh from New Year celebrations, President Elect Trump reiterated his threats to impose punitive measures on US auto manufacturers that plan to expand production in Mexico. "Make in USA or pay big border tax!" he tweeted. Beyond the worrying implications of government policy conducted via Twitter, Trump's threats may be more bark than bite.
First of all, what does Mr Trump mean by border tax? Could it mean import duties on goods coming from Mexico? This is unlikely because legally, tariffs and customs duties are a non-starter. The reason for this is another one of Trump's frequent targets, the North American Free Trade Agreement known as NAFTA. This is a comprehensive trade agreement dating from 1994 that sets the rules of trade and investment between Canada, the United States, and Mexico. The brainchild of none other than Ronald Reagan and negotiated under George Bush Senior, the passage of NAFTA into law was hailed as one of the big achievements of the Clinton administration. The agreement has systematically eliminated most tariff and non-tariff barriers to free trade and investment between its three members. NAFTA operates by mandating that each member forgoes tariffs and customs' processing fees on imported goods originating in other members with clear rules of origin enabling customs officials to decide which goods qualify for this preferential tariff treatment.
Of course, to be fair to Mr Trump, in the new century, NAFTA has not been seen with the enthusiasm that characterised its early years. Both Republicans and Democrats (as well as many within Mexico and Canada) have been sceptical of its benefits and have called for its revision. However, thoughts on revising an existing arrangement do not translate into licence to violate legally enshrined provisions right now, no matter how strongly the incumbent president may feel about it. It is important to remember therefore that whatever one may think about the benefits of free trade in general, or NAFTA in particular, it is enshrined in law and its provisions cannot be changed unilaterally or quickly. Any attempt to reintroduce import restrictions and costs abolished by NAFTA will lead to both court actions and arbitrations. Mexico itself could take advantage of dispute resolution provisions within the agreement to challenge US decisions, but also affected individual manufacturers and their industry representatives could initiate actions. There is strong precedent of litigants using NAFTA provisions as a constraint on policy discretion. Even withdrawing from the agreement would not help, as those whose existing rights are affected would sue in a complex Brexit like environment.
Finally, potential withdrawal from NAFTA would not allow Mr Trump to set tariffs at will, as the US would still be bound by World Trade Organisation (WTO) rules that place their own restrictions. The WTO is an international organisation, established in 1995, that deals with the rules of trade between nations at a global level. The organisation operates on the basis of agreements, negotiated and signed by the bulk of the world's trading nations providing the legal ground-rules for international commerce. These rules bind governments to keep their trade policies within agreed limits, with the overriding purpose to help trade flow as freely as possible. If a dispute arises, for example when one country adopts a trade policy measure or takes some action that one or more fellow-WTO members consider to be breaking the agreements, the organisation's dispute resolution provisions kick in. A country found to be violating the rules risks being faced with retaliatory measures from others. Leaving the WTO to obtain the freedom to impose tariffs would be equivalent to opting out of global trade entirely, which is an unlikely aim for a US administration.
Could Mr Trump decide to impose a non-tariff 'border tax' once he settles in the White House? This would be legally less problematic than imposing tariffs, but will have huge consequences for US trade relations. Paul Ryan and Trump seem to have converged on a "border tax adjustment" proposal which would see US imports taxed at the corporate income tax rate, while exempting income earned from exports from any taxation. This means that imports would become significantly more expensive (as companies would have to pay a new corporate tax rate on their value), while exports are estimated to become cheaper because of the reduced tax burden. Deutsche Bank calculates that the average impact on the prices of exports and imports is equivalent to a 15% drop in the dollar. There could also be a 5% increase in inflation if corporates pass the increased cost of imports straight to consumers, or a marked hit to corporate earnings if they absorb parts of the cost. Any border tax with such significant consequences is likely to be challenged under the WTO system described above, once again causing the US government to spend a lot of money on lawyers, with questionable chances of success.
In conclusion, is Mr Trump likely to act on his threats and use his Twitter feed as a blueprint for policy? It is very doubtful that this is anything other than posturing. However, Mr Trump has clearly shown us one thing: he has a very different understanding of trade relations that any other American President in living memory.