Harnessing New Investments in Industrial Policy to Advance North American Competitiveness

Following the severe economic and societal disruptions stemming from the global Covid-19 pandemic, many countries vowed to “build back better” to ensure greater supply chain resilience moving forward. This imperative took on new urgency as armed conflicts in Ukraine, the Middle East and the Red Sea have strained global trade routes and the strength of those supply chains. Ongoing U.S.-China rivalry has added further stress, with trading partners on both sides working to safeguard their supply chains, from raw materials to intermediate components and finished goods.

One response to this increasingly challenging global trading context is a return to regionalization. Nearshoring is gaining traction, the trend to reduce geographic distance, uncertainty, transportation costs and carbon emissions in supply chains. Other trends include friendshoring and ally-shoring, the relocation of supply chains to friendly or allied countries to reduce dependency on geopolitical rivals.

This paper offers recommendations on four key themes to move North America forward as a more integrated region that can compete internationally in the 21st century. They are: North American identity; maximizing the benefits of the trade agreement USMCA for regional supply chains; industrial policy for critical minerals, electric vehicles and semiconductor supply chains; and the need to build these supply chains on foundational pillars of subnational cooperation, cross-border infrastructure, and labor skilling and mobility.

Confronting North American Skepticism Head On

Greater North American economic regionalism confronts ongoing skepticism about the very idea of North America. Despite decades of growing economic integration among the three countries, North America comes under constant criticism from within—especially by the United States.

The United States has always pursued unilateralism in foreign and trade policy, even as it signed a trade agreement with Canada in the 1980s, which was extended to Mexico via NAFTA in 1994. The United States situates itself at the center of this trilateral relationship and regards Mexico and Canada as suppliers to U.S. interests.

Mexico and Canada have also played their own parts in reinforcing the status quo of a North America made up of two bilateral relationships. Both countries have focused on growing bilateral relations with the United States but have not always prioritized bilateral relations with each other.

Recommendation:

To generate the commitment and momentum necessary to develop globally competitive supply chains for the new economy, the three countries should work together to develop shared opportunities for long-term, stable partnerships within North America, and which reflect common goals regarding China.

Maximizing the Benefits of USMCA for Regional Supply Chains

NAFTA has already supported regional supply chain integration in several sectors, particularly automotive, aerospace and electronics. Although investments in industrial policy in the United States are undoubtedly responsible for reshaping supply chains for North American electric vehicles (EVs), tariff treatment is also playing a part. USMCA’s more restrictive rules of origin for vehicles and auto parts encourage the reshoring of manufacturing to North America. Despite this, overly restrictive rules of origin can also backfire, potentially reducing regional content if the country’s tariffs for non-trade partners are low.

In anticipation of further geoeconomic shifts that will increase the importance of USMCA’s preferential tariffs, the three countries should continue to improve the implementation of USMCA’s rules of origin in the auto sector. This includes the need for all three countries to adhere to trade enforcement and dispute settlement rulings around USMCA, including the United States. This is becoming increasingly challenging as of late March, as the Trump administration threatens to impose new tariffs on auto imports to bolster domestic manufacturing. Although a longstanding promise, such a policy would likely be detrimental, raising production costs and further straining relations between the three countries.

Recommendation: All three parties must work to implement rules of origin on autos as negotiated in USMCA and determined by dispute settlement processes.

Industrial Policy for Integrated Supply Chains

Several major pieces of federal legislation passed under Biden to accelerate the green transition and kickstart a new generation of investments in United States manufacturing have bolstered industrial policy in the United States. Most notably, the CHIPS and Science Act (CHIPS Act) offers US$39 billion in financial assistance and tax credits to stimulate semiconductor fabrication in the United States. President Trump has strongly criticized the CHIPS Act and expressed interest in terminating it, but he has not yet found the Congressional support to do so.

The Inflation Reduction Act (IRA) is a sprawling piece of stimulus legislation, with its electric vehicle subsidies and tax credits of primary interest to Mexico and Canada. This law, passed in 2022, allocates US$369 billion for energy security and climate change programs, including investments in electric vehicles, solar energy, battery production, and tax incentives for renewable energy. The IRA is likely to have mixed effects on North American competitiveness, with differential impacts on each of Mexico and Canada.

Critical Materials

Awareness of China’s global dominance in the extraction and processing of critical mineral supply chains such as lithium and cobalt has led the United States and Western allies to reduce their dependence by securing and increasing their self-reliance in critical minerals. While the United States, Canada and Mexico all have domestic reserves of at least some critical minerals needed to power electric vehicles and the transition to a clean economy, serious challenges exist in realizing a continental strategy for the critical minerals sector. In Mexico, President López Obrador’s steps to nationalize energy and mining resources have dampened investment from the United States and Canada, both major sources of Foreign Direct Investment (FDI) for these sectors in the past.

As a result, the United States has set its sights on Canada’s mining potential. Yet, despite an abundance of needed critical minerals and an early commitment by the Canadian government to succeed through its Critical Mineral Strategy, Canada faces serious regulatory challenges in enabling mines to become operational in a timely fashion. For example, lengthy environmental assessments and complex permitting processes have slowed project approvals. Adding to tensions, President Trump has even suggested making Canada the 51st state, a threat that will hopefully stop now that Trudeau is out of office.

An additional barrier to North American cooperation on critical minerals is the enduring concern by both Canada and Mexico that Americans regard their neighbors only as a source of natural resource extraction. Thus, as the United States seeks to develop critical mineral supply chains in North America, it must work in partnership with the neighbors it is relying on for success. In addition, as all three countries seek to create a resilient critical minerals sector in North America, they should exchange views on the national security concerns and regulatory challenges they share to ensure these do not become barriers to local private sector participation or trade.

Electric vehicles

The IRA subsidies for EVs are large enough to attract new investment to the United States on their own. Without similar incentives, Canada and Mexico simply cannot compete. Canada is particularly challenged by its high labor and production costs, high corporate taxes and burdensome regulatory context, while Mexico is unable to match the eye-popping incentives offered by U.S. federal, state and local governments.

U.S. lawmakers are concerned about rapid nearshoring in Mexico by Chinese-headquartered companies to take advantage of USMCA preferences and IRA tax incentives, while avoiding punitive U.S. tariffs on Chinese imports. China has become the fastest growing source of FDI in Mexico, from US$78 million in 2016 to US$710 million in 2024.

Semiconductors

The United States has recognized the vital economic and national security importance of semiconductors and recognizes the geopolitical and economic risks inherent in China’s global dominance over some parts of related supply chains. The country is seeking to secure supplies of critical raw materials and to promote diversification of manufacturing, assembly and packaging across a wider range of countries through tariffs on Chinese semiconductors together with the CHIPS Act and associated projects.

Canada is already a world leader in semiconductor testing and packaging, and IBM’s Bromont Quebec facility is the largest in the world. Recognizing the capacity of Canada’s packaging capability to accelerate U.S. manufacturing plans, the two countries announced intentions to create a cross-border corridor during President Biden’s 2023 visit to Canada.

U.S.-Mexico semiconductor supply chain cooperation is also increasing. In March 2024, the U.S. State Department announced funding through the CHIPS Act to assess Mexico’s existing semiconductor industry, as well as its educational, training and capacity building needs for future joint initiatives. As all three North American countries focus on different aspects of these supply chains, it is essential to involve multinational enterprises with large North American footprints to position the region as a global leader in the sector.

Recommendations

• The United States and Mexico should expand their bilateral working group on foreign investment review to include Canada, helping to build a North American approach that can be reflected in all parts of the automotive, EV and semiconductor supply chains.
• To safeguard the North American integrated auto supply chain from external threats, the three countries should adopt a shared approach to “connected cars” that focuses on safety and threats posed by technological inputs and capabilities.

Subnational, Infrastructure and Labor Cooperation

Subnational engagement

Subnational cooperation offers another level on which to build long-term North American competitiveness, and which can prove vital when political headwinds at the national level undermine efforts. Yet, all three countries must be mindful of the potential negative consequences of current nearshoring efforts for subnational regions. The Biden administration has worked very deliberately to incentivize IRA investments in the heartland regions of the United States disadvantaged by trade liberalization.

There is less evidence that the other two North American countries are addressing the distributional consequences in ‘have-not’ regions of their countries.

Infrastructure

Regional economic competitiveness also relies on infrastructure, both within countries and to facilitate trade between them. North American infrastructure is falling behind, with the United States ranked 12th globally, Canada ranked 32nd and Mexico 51st in a 2019 survey.

Projects must advance in a coordinated manner; all three countries can point to past examples of having advanced cross-border infrastructure on their side of the border before the other country began work or even committed funding. State and provincial governments, as well as private sector employers, can play a positive role in supporting investment and better coordination, especially in the border regions that benefit most directly from these trade flows.

Labor

The improvement of labor standards in Mexico has received a lot of support from the Canadian and U.S. governments, including through the use of the Rapid Response Mechanism in USMCA. However, efforts to improve cross-border labor mobility have largely fallen victim to a U.S. political context that is seeking to reduce cross-border labor mobility rather than facilitate it.

The United States is also preoccupied with securing its borders from irregular migration and illicit drugs, primarily through Mexico but also increasingly through Canada. In this difficult political context, trilateral efforts to advance North American labor competitiveness must be carefully calibrated and advanced in a fashion that does not amplify unfounded concerns about valid and legal travel among the three countries.

Less attention has been paid to the responsibility of all three governments to use domestic policy to create, attract and maintain “good” jobs for workers. Gordon H. Hanson in “Modern Approaches to Workplace Development” argues that a greater focus on active labor programs and tailored skill development must be pursued by the United States and Canada to remain economically competitive.

Recommendations

• North American countries should develop mechanisms at the federal level to monitor and address the distributional consequences of funding for industrial policy and nearshoring in all regions of their respective countries.
• North American countries should establish subnational working groups for states/provinces engaged in North American nearshoring to share information, develop strategies for cooperation on joint initiatives, including infrastructure and private-public partnerships.
• Canada should support Mexico-U.S. bilateral efforts to address illicit drug trafficking and irregular migration border crossings from the south into North America. This will demonstrate Canada’s commitment to continental security and help maintain border efficiency at the U.S. northern border with Canada.
• Drawing on Canada’s successful labor mobility programs for skilled workers, national and sub-national frameworks to facilitate North American labor mobility should be developed, piloted, and built upon over time.

This White Paper is a summary of Lilly, M. B. (2024, May 16). Harnessing New Investments In Industrial Policy To Advance North American Competitiveness. North American Competitiveness Working Group.

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