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The Trump administration is demanding the right to levy massive tariffs on automakers that do not comply with tough new NAFTA rules – a proposal that is holding up a major breakthrough in year-old talks on the agreement.

American and Mexican negotiators have agreed to nearly all elements of a deal on NAFTA’s auto provisions, said people briefed on the closed-door bargaining in Washington. But they are stuck over the U.S. desire to punish European and Japanese car companies in Mexico that are not expected to comply with new automotive-content rules.

Canada, for its part, remains on the sidelines as the United States and Mexico work through their differences on autos and bilateral matters. And President Donald Trump is hinting that he will use Canada’s exclusion from those bilateral talks to turn the pressure up on Ottawa.

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Under new auto rules – demanded by the U.S. and agreed to by Mexico – automakers would be required to source 70 per cent of the steel, aluminium and glass in their vehicles from within North America, and produce 40 to 45 per cent of the content of each car or truck at factories paying at least US$16 an hour. Seven core components of cars, including engines, would have to be made entirely in North America. The new rules would be phased in over three years.

Under international trade laws, an automaker could choose not to comply with the NAFTA rules and instead pay World Trade Organization-mandated tariffs of 2.5 per cent. But the United States instead wants to force those automakers to pay 20 or 25 per cent, in order to give a massive advantage to companies that comply with NAFTA requirements. The move is largely aimed at European and Japanese automakers with plants in Mexico, who are expected to find it harder to follow NAFTA rules than their American counterparts.

Mexico is resisting.

“This is something the Mexicans will not be able to stomach … this will mean their sector will be on a steady decline path,” said Eric Miller, president of trade consultancy Rideau-Potomac Group. “What you’re looking at is no more new investment [in Mexico] and a decline in the stock that they already have. It’s a pretty stark situation.”

It is also unclear how such a demand, if included in NAFTA, would square with the U.S.’s WTO obligations, potentially opening the country up to lawsuits.

Despite the logjam, U.S. Trade Representative Robert Lighthizer said this week that he expected “in the next several days, we’ll have a breakthrough.”

Canada has already privately told the United States it is willing to agree to its auto demands, which are aimed at curbing investment in Mexico and would have little effect on the Canadian sector.

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Mexican officials insisted this week that Canada would be back at the table as soon as Mexico and the U.S. had sorted out their differences on autos and settled other bilateral issues, such as tariffs on seasonal produce.

But Mr. Trump said Thursday that he had also excluded Canada because he was upset with Ottawa over tariffs on dairy products. The President hinted that he expected concessions on the supply management system that protects Canadian-made milk from foreign competition.

“Canada charges us for dairy products, 275 per cent − tariffs of 275 per cent − which makes it ridiculous and impossible,” he told a White House cabinet meeting, adding later: “We’re not negotiating with Canada right now. Their tariffs are too high. Their barriers are too strong. So we’re not even talking to them right now.”

Daniel Ujczo, an Ohio-based trade lawyer with clients in the steel and auto sectors, said talks between U.S. and Mexican negotiators, including Mexican Economy Secretary Ildefonso Guajardo, have not been confined to bilateral matters, but have also touched on trilateral issues that Canada cares about.

“While the focus for Guajardo and Lighthizer is on key bilateral issues such as autos during their meetings, the negotiating teams are working on all issues, including intellectual-property rights and dispute resolution, such as Chapter 20,” Mr. Ujczo, of the firm Dickinson-Wright, told The Globe and Mail.

But Mr. Guajardo denied that Mexico and the United States have discussed any trilateral matters. Asked about Chapters 19 and 20, two key dispute-resolution provisions that the U.S. wants to gut and Canada wants to protect, Mr. Guajardo said they had not been broached.

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“There are Mexico-U.S. issues that have to be solved and then we’ll be ready for trilateral discussions,” he said as he left a meeting at Mr. Lighthizer’s office.

One Canadian official, speaking on condition of anonymity, said any U.S.-Mexico discussions on trilateral matters would be broad and general, and would not move into substantive negotiating without Canada’s participation. The official said there has been no indication when the U.S. and Mexico will finish with autos and Canada will rejoin talks.

Another Canadian source said Mexican officials have vowed not to cut a deal with the U.S. without Canada’s involvement. A third said that there is a healthy back-channel between Canadian and Mexican officials, from Foreign Affairs Minister Chrystia Freeland and Mr. Guajardo – who regularly speak by phone – to members of their respective trade negotiating teams.

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