By William Mauldin and David Luhnow

Rather than kill Nafta, Donald Trump and his advisers appear set to push for substantial changes to the treaty governing U.S. trade with Mexico and Canada, an effort that could prove difficult to negotiate and perilous to the regional economy.

The president-elect vilified the North American Free Trade Agreement during the campaign and threatened to pull the U.S. out of the trade deal -- but only if Mexico doesn't agree to substantial modifications.

The U.S. trade deficit with Mexico rose 9.5% in 2015 to $60.7 billion, while the deficit with Canada fell 57% to $15.5 billion.

Mr. Trump hasn't released a blueprint for his new vision of Nafta, but his comments and those of his advisers suggest they want big changes. Among the likeliest would be special tariffs or other barriers to reduce the U.S. trade deficit with Mexico and new taxes that would hit U.S. firms that moved production there, according to Trump advisers. His team says it may also seek to remove a Nafta provision that allows Mexican and Canadian companies to challenge U.S. regulations outside the court system.

In a video released late Monday sketching some steps he'd take in the first 100 days, Mr. Trump hit on his trade intentions prominently but didn't mention Nafta. Instead, he said he would issue an executive action on the first day notifying 11 other countries that the U.S. was pulling out of the proposed Trans-Pacific Partnership, a sweeping trade deal completed in 2015 but not yet ratified by Congress.

Soon after he takes office, Mr. Trump is set to ask government officials to examine the ramifications of abandoning Nafta, according to a transition-team memo, CNN reported.

If Mr. Trump wins concessions from Mexico, Canada likely would seek comparable advantages with Mexico. Any talks with Canada, which had a trade agreement with the U.S. that predates Nafta, would likely bring up thorny issues that have long dogged relations, including softwood lumber imports from British Columbia, Canada's support for its dairy farmers and the labeling of beef in the U.S. produced from cattle born or raised in Canada.

Canadian Prime Minister Justin Trudeau said after the election that he and his administration are ready to discuss making changes to Nafta aimed at improving labor rights and wages on the continent.

The U.S. imported and exported $1.1 trillion in merchandise to and from Canada and Mexico last year, compared with about $700 billion with the European Union and $600 billion with China.

The U.S., Canada and Mexico are intertwined in a complex system of supply chains, with some components crossing borders more than once before final products are sold to consumers.

Breaking up Nafta would upend numerous industries, and deal a blow to Mexico, which promotes itself as offering global manufacturers duty-free access to the U.S.

Mexican officials say they are willing to update the 22-year-old treaty, including adding new chapters on e-commerce and other aspects that didn't exist in the mid-1990s.

But Mexican officials are wary of revisiting tariffs and export quotas. "We can't get lost in an old debate about traditional tariffs...that's a debate from the last century," Economy Minister Ildefonso Guajardo told a business conference earlier this month. Reopening the treaty would create "a long line" of special interests in all three countries trying to get protection, he said.

Jaime Serra, Mexico's trade minister when Nafta was negotiated, said steps like agreeing to voluntarily restrict exports should be off the table. Export quotas, he said, would be "the beginning of pure protectionism, and it would be shooting both of our countries in the foot."

Concluded in the George H.W. Bush administration and enacted with amendments under former President Bill Clinton, Nafta eliminated tariffs among the North American countries over time and set rules for investment, labor and the environment.

Mr. Trump repeatedly called for across-the-board, double-digit tariffs on imports from Mexico to reduce the trade deficit, which he linked to the loss of manufacturing jobs. While Congress has given presidents the ability to levy big emergency tariffs, they could eventually be challenged at the World Trade Organization.

Mr. Trump's warnings could be the opening bid in negotiations that end with relatively low tariffs or other barriers to Mexican goods.

Some Democrats and labor groups also have embraced bluntmeasures to reduce the trade deficit. The House Democrats who led the opposition to President Barack Obama's Pacific trade agreement said they're willing to work with Mr. Trump on a more balanced trade policy.

Rep. Brad Sherman (D., Calif.) suggested negotiating within the framework of Nafta the option for Washington to impose special tariffs of up to 4% on Mexican goods to reduce the bilateral trade deficit to $25 billion, excluding oil and agricultural goods. "Good neighbors have balanced trade relationships," he said.

Besides traditional trade barriers, enforcement cases and tariffs, Mr. Trump and his advisers have discussed special taxes that could be levied on goods produced by U.S. companies that have moved production off shore.

Among various tax plans, one supported by House Republicans would raise money from goods imported into the U.S., in a similar fashion to the value-added tax that affects U.S. products sold abroad. The "destination-based cash-flow tax" could be challenged at the WTO, but Mr. Trump's advisers say they will use Washington's leverage at the Geneva-based trade body to change the treatment of VAT and other border-adjusted taxes.

Some experts following Mr. Trump's trade plans say he is likely to negotiate removing some Nafta provisions that have grown unpopular, such as an international arbitration system that known as investor-state dispute settlement. This arbitration process, codified in Nafta's chapter 11, allows investors from one country to sue the government of another to obtain compensation outside the traditional court system when they claim their rights are violated or their property is seized.

If Mr. Trump doesn't get what he wants in the talks, as president he has the authority to pull the U.S. out of Nafta in a matter of months and could do so, perhaps warning about such a move in his first days in office, lawyers say.If the U.S. leaves Nafta, then the two-decade-old agreement could be replaced with bilateral trade agreements, which Trump advisers say they prefer to multilateral tie-ups.

Write to William Mauldin at william.mauldin@wsj.com and David Luhnow at david.luhnow@wsj.com

(END) Dow Jones Newswires

November 21, 2016 19:32 ET (00:32 GMT)

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