To President Donald Trump, America's $500 billion trade deficitis a symbol of economic weakness. If he wants a revamped NorthAmerican Free Trade Agreement to shrink that number, he'll need aseismic shift in how cars are made on the continent.

With negotiations expected to start in August, makers ofeverything from toys to microchips are making their case for howthe Trump administration should reshape the 23-year-old tradeaccord with Mexico and Canada. Based on the president's zeal forreducing the deficit, the auto industry could hold the key to U.S.success in the talks. Trump has threatened to walk away from Naftaif he can't get better terms.

The U.S. had a $63-billion trade deficit with Mexico last year,compared with a surplus of $7.7 billion with Canada. The automotivetrade deficit with Mexico was $74 billion. In other words, if youtook out trade in cars and car parts over America's southernborder, the U.S. would actually be running a trade surplus withMexico.

Most of the world's biggest automakers have set up assemblyplants in Mexico, taking advantage of wages that are significantlycheaper than in the U.S. Traditional U.S. automakers still do muchof their advanced design work and research and development in theDetroit area. By taking advantage of the comparative advantages ofeach country, automakers have behaved much as trade textbooks wouldhave predicted when Nafta was born in 1994.

Yet the offshoring of assembly work has contributed to thesteady decline in manufacturing jobs in America, a trend to whichsome Rust Belt communities are still struggling to adapt. Duringthe election, Trump's promise to take a hard line on trade appealedto people who feel they've been left behind by globalization.

The car industry is “really the center of the basic debate abouttrade that's going on right now,” said Ethan Harris, head of globaleconomics research at Bank of America Merrill Lynch. “From anefficiency point of view, it's been a tremendously successfulaspect of the North American Free Trade Agreement. From theperspective of the appearance of fairness, it's a big sorethumb.”

Nafta helped create an integrated supply chain that sees manyauto parts cross the U.S. border at least eight times before avehicle is assembled, the Alliance of Automobile Manufacturers saidin a letter this month to Trump's top trade negotiator, RobertLighthizer.

“Disrupting this integrated supply chain would increase prices,lower sales, threaten exports and endanger American workers' jobs,”the alliance said, adding that automakers could seek suppliesoutside North America if the continental business model unravels.The group represents companies that sell cars and trucks in theU.S., including Toyota Motor Corp. and Volkswagen.

The president has been urging automakers to produce more cars inthe U.S. Even before taking office, he threatened to impose a “bigborder tax” on General Motors Co. for building the Chevrolet Cruzesouth of the border. U.S. officials have floated a range of Naftareforms that would affect car makers, such as tightening theso-called rules of origin that dictate how much of a product mustbe created in North America.

Future Plans

Trump's jawboning may be having an effect. Some automakers andparts suppliers are waiting to see how the negotiations play outbefore deciding on any actions, said Gregory Husisian, co-chair ofthe automotive industry team at Foley & Lardner in Washington.“It's put a bit of a freeze on future investment plans.”

Still, there's nothing stopping car companies from shiftingproduction to another country if North America becomes tooexpensive. Ford last week announced it will build its Focus smallcars in China, canceling plans to move production to Mexico, in adecision that Lighthizer called “troubling.”

Many economists argue trade deficits have more to do with thedifference between savings and investment within a nation than thetreaties it negotiates. By that logic, if the U.S. keeps investingmore than it saves, it will keep posting trade deficits. Even ifAmerica's trade deficit with Mexico disappears, it may simplymigrate somewhere else.

Convincing automakers to re-shore production in the U.S. couldgive a short-term boost to the economy, helping Trump fulfill hispromise to lift growth to 3% annually and create employment. Sincethe financial crisis, manufacturing jobs in the auto sector havebeen climbing steadily as companies have ramped up output — thoughthe employment level remains far below previous decades.

But longer term, there's no guarantee that re-shoring would be ajobs bonanza. Automakers are increasingly using robots to automateassembly-line tasks, a trend that could eventually decouple thelink between production and jobs.

“Look at the picture of a factory 50 years ago — it's stuffedwith people. Look at the same picture today, and there's very fewpeople,” said Harris, the Bank of America Merrill Lynch economist.“It's really hard to turn back the clock.”

There's already evidence automakers and their suppliers may noteven need Nafta. Under the agreement's rules of origin, cars musthave North American content worth 62.5% of the vehicle's value.

But companies can ignore that rule if they pay the basic 2.5%tariff the U.S. levies on car imports from countries that aremembers of the World Trade Organization. Currently, about 5% ofcars and parts imported from Mexico enter the U.S. in thatmanner.

Commerce Secretary Wilbur Ross has expressed optimism the U.S.could reach a new deal with Canada and Mexico by early next year.Lighthizer was less bullish last week on that timeline, stressingthat the administration won't hold itself to any deadline. The U.S.is holding public hearings this week to inform its negotiatingobjectives.

“This is going to be a lot harder than they think,” saidCaroline Freund, senior fellow at the Peterson Institute forInternational Economics in Washington. “It seems increasinglylikely to me that they'll take some incremental approach.”

Even if Nafta talks falter, the administration may seek tonegotiate a single-industry deal that limits the amount of cars andparts imported from Mexico, said Freund. In the early 1980s,then-president Ronald Reagan convinced Japan to sign a “voluntaryexport agreement” under which it cut the number of cars it sold tothe U.S., setting off a string of similar deals on everything fromsteel to shoes.

“That might be a direction they take to increase U.S. content,”said Freund. “But Americans are going to pay for it.”

From: Bloomberg News

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.