A post-NAFTA world?


A Publication of BMO Financial Group

After nearly a quarter century of NAFTA, the future of the historic trade pact is uncertain. Talks to renegotiate the deal are ongoing and, depending on the day, and depending on your perspective, are either going well or going nowhere.

Negotiations are being pursued on two fronts: the policy level and the political level. From a policy standpoint, negotiators from all countries have agreed to terms, but the current battle is being fought on a political level. President Donald Trump made a campaign promise to renegotiate NAFTA or remove the U.S. from the deal if
Mexico and Canada don’t make it “good for America.” The most recent series of talks just concluded in Mexico City.

Over the 23 years NAFTA has been in effect, trade between NAFTA partners—that is the U.S., Canada and Mexico—has increased significantly from $290 billion in 1993 to $11 trillion in trade in 2016. What’s more, 32 U.S. states count Canada as their biggest export market, while nine other states count Canada as number two.

But thanks to the current wave of protectionism and the pursuit of renegotiating the terms of, or even a withdrawal from NAFTA, we’ve entered a period of uncertainty. Stakeholders in the U.S. are increasingly calling attention to the risk of abandoning NAFTA and are putting pressure on the administration.

The Business Roundtable has said the White House is putting relationships with our trade partners at risk and that the changes being proposed are dangerous. They warn that a NAFTA withdrawal could mean:
• The loss of 1.8 million U.S. jobs in the first year
• A 2.5 – 5.0 percent annual drop in U.S. exports in the short- to medium-term (up to 5 years)
• A boost to China’s economy with a 0.2 percent increase to GDP and 2 million increase in employment

Further complicating matters, Mexico will hold its presidential election on July 1. The candidate currently leading the polls—Andrés Manuel López Obrador—is a left-wing populist who has signaled that they will take a more confrontational approach toward the U.S. If the U.S. terminates NAFTA and López Obrador wins, he would likely attempt to rally Mexicans to agree to restrictions on trade with the U.S.

The situation has left the business community wondering what to do.

We spoke to four trade experts about the potential ramifications of a U.S. withdrawal from NAFTA:

Gary Clyde Hufbauer, Nonresident Senior Fellow at the Peterson Institute for International Economics. Hufbauer has served at the Council on Foreign Relations, was a professor of International Finance Diplomacy, as well as the Deputy Director of International Law Institute at Georgetown University.

Don Campbell, a Senior Strategy Advisor at DLA Piper and formerly Canada’s Deputy Minister for International Trade, where he supervised the negotiation of NAFTA.

David Jacobson, Vice Chair at BMO Financial Group. Jacobson previously served as U.S. Ambassador to Canada and as Special Assistant to the President for Presidential Personnel under President Barack Obama.

Kevin Lynch, Vice Chair of BMO Financial Group and former Clerk of The Privy Council of Canada.

Following are excerpts from our conversation.

 

Modernizing NAFTA

Don Campbell » We in Canada have recognized for a long time that NAFTA needed renovation. It needed renovation because NAFTA was negotiated in a time when we did not have the Internet, we did not have e-commerce, so we needed to bring NAFTA into the 21st century. So we have been looking for some time for a negotiation that would bring NAFTA up to the current level and the current way in which international commerce is done.

So here we are today with a U.S. Administration calling for either the elimination of NAFTA or a sharply different NAFTA, so we got ourselves a least in the space of a negotiation, which was something that we were interested in doing, but the nature of the negotiation, of course, has proven to be very different.

Kevin Lynch » Normally when you negotiate, you can have very different positions, but you’ve got clarity about who the negotiating team is, who sets the objectives, how you trade things off. That’s not the case currently. In previous U.S. negotiations it was totally clear as it is in the Canadian side. Now, is it the U.S. Trade Representative Robert Lighthizer? Is it the Commerce Secretary Wilbur Ross? Is it White House trade adviser Peter Navarro? Is it the White House? Is it only one person? So it’s very hard to negotiate and make a trade-off if you don’t know who you’re negotiating with and trading off. So it adds an element of uncertainty.

The Trade Deficit

Don Campbell » In terms of U.S. objectives, the president’s overriding objective has been to address the issue of trade deficits, although he has acknowledged that trade deficits are caused by a lot of totally different reasons than trade agreements themselves. But even if the agreement itself was an issue, Canada and Mexico are not the real problem since both of them put together are less than 10 percent in terms of any possible deficit that we have seen.

David Jacobson » Mexico does indeed have a large trade surplus with the United States. It depends if you count services, it’s maybe $60 billion a year. Just to put it in context, our trade deficit with China is about $375 billion a year. Maybe that’s important, maybe it’s not, but at least politically it’s very important.

The “Zombie State” 

Gary Clyde Hufbauer » It appears that Trump will likely keep NAFTA in a “zombie state” through the midterm elections. That is, no actual movement but maintaining the rhetoric around altering or terminating NAFTA. That uncertainty will certainly affect investment in Canada and Mexico. And as far as Trump is concerned, that’s fine—let people be doubtful about investing in Canada and Mexico, let them invest in the United States, especially with the new very favorable tax law which he has gotten enacted with Congressional support.

Kevin Lynch » The global economy is doing pretty well. North America is pretty competitive. This is the time we should be investing in new technologies, new manufacturing processes, to not just trade amongst ourselves but to trade with the world. That’s not happening and the longer this goes on in the zombie state, it actually gets worse for all three countries. That uncertainty is not good over time.

The Potential Fallout 

David Jacobson » The non-trade, non-economic consequences of pulling the plug on NAFTA may turn out to be more important. We have the longest border between any two countries anywhere in the world. There are security issues at the border; there is efficiency which is important that border. We have to try to harmonize our regulations. We work together with respect to energy, with respect to the environment. We work together around the world to try to foster the values that Canada and the United States share. Now, is cooperation going to end if NAFTA goes away? No. But it is probably at the margins at least, and maybe pretty far into the margins. It is going to diminish and that’s not good for all of us.

Kevin Lynch » If the United States can’t do a trade agreement amongst two of its closest economic neighbors, and political neighbors and social neighbors, who in the world is going to do a trade agreement with the United States? So almost our entire postwar liberal trading regime, which the United States—to the benefit of everyone—created, is actually at risk because of the loss of confidence a termination of NAFTA would have on allies in Europe, the U.K. and elsewhere. It’s broader than just NAFTA.

The Mexico Elections

David Jacobson » López Obrador currently has a double-digit lead in the polls and if he wins, I think everyone believes that the level of cooperation with respect to all these things—the border and drugs and transnational criminal organizations and a whole host of other things—is going to diminish and may diminish significantly. We will have someone on our southern border who is not quite so much of a friend, and if we terminate NAFTA, we are playing into his hands.

If we terminate NAFTA, all the bad things he is saying about the United States are going to ring more and more true to the Mexican electorate. So whether you’re talking about Canada or you’re talking about Mexico, I think that when the dust settles, yes, we will lose jobs if NAFTA is pulled and, yes, it will hurt our GDP. Yes, it will hurt all these other countries, but in the long run, some of these other things may turn out to be much more important.

Winners and Losers 

Kevin Lynch » I think the two sectors that would be most impacted would be the auto sector and agriculture. But it’s not clear. They would impact all three countries. The United States has gained competitiveness in autos by actually moving parts of productions, supply chain, into Canada, into Mexico and across the United States. So it’s a very integrated supply chain in those two sectors—agriculture and autos.

Don Campbell » In the automotive sector we have a North American content requirement called Rules of Origin that 62.5 percent of automobiles traded within the North American economies must be North American content. The United States is demanding that that be 75 percent North American content and 50 percent U.S. content. The effect of this would, at the end of the day, make the North American automotive sector less competitive than it is today and would actually encourage companies from outside the sector to import over the 2.5 percent tariff that you have in the United States. So, it would, in our considered view and the considered view of industry, be a diminishing rather than an enhancing step.

Gary Clyde Hufbauer » In the agriculture sector, a NAFTA termination would mean jobs lost. Individuals, real people that you can photograph; will lose their jobs and go bankrupt. Agriculture, in terms of dollars of trade, it’s relatively small, but the political sensitivity is extremely high. If prices drop in the wake of any kind of NAFTA decision, then it will be blamed on the NAFTA decision. The political impact of that is probably five times as large as the economic impact of losing, let’s say, $1 billion of trade in manufactured products.

The other area where the U.S. is coming on strong, but this could be brought to a quick halt, is in energy. Because the U.S. with fracking and so forth is becoming a very competitive supplier of natural gas to Mexico, which can use a lot of it for electricity generation. But any interruption in NAFTA, it’ll be very easy to see Mexico going back to essentially an import substitution model on energy whereas now we’re getting a two-way trade.

Kevin Lynch » Trade and NAFTA were key issues at the World Economic Forum in Davos. One discussion was who’s the winner if President Trump terminates NAFTA? Nobody thought the U.S. was the winner. Everyone thought that China is the winner because China will actually gain from this. This is actually going to reduce American competitors. It’s going to reduce Canadian competitors. It’s going to reduce Mexican competitors. It’s not going to reduce Chinese competitors; it’s going to increase it.

PostNAFTAworld

 

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PostNAFTAworld

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