As NAFTA Drama Drags On, How Should Businesses Respond?

The international trade landscape continues to change. Senior officials from the U.S., Canada and Mexico met in early May to continue talks to renegotiate NAFTA without having agreed to terms. As if that weren’t enough, in late May, President Donald Trump announced the U.S. would impose tariffs on steel and aluminum imports from three key allies—Canada, Mexico and the European Union—citing national security grounds. Mexico and Canada responded with their own tariffs on American goods. EU officials lodged a formal complaint with the World Trade Organization and also plan to announce duties on U.S. products.

While the new trade skirmishes complicate the picture, the long-term focus remains on NAFTA. Because of upcoming elections in Mexico and the U.S., there was a sense of urgency to strike a deal to update the trade pact by the middle of the month. With that deadline passed, there continue to be several sticking points that make even an agreement in principle a challenge, including:

  • Trump’s insistence on the sunset clause.
  • Investor-state dispute settlement.
  • Rules of origin for the auto industry.

As the talks continued, Treasury Secretary Steven Mnuchin said renegotiation efforts could spill into 2019. The situation is creating tremendous uncertainty for business leaders in the U.S. and Canada. Despite the turmoil, there may be ways for business leaders to move forward while mitigating potential risks.

A long way to go

U.S. Trade Representative Robert Lighthizer had hoped to secure an agreement in principle by May 17—the deadline House Speaker Paul Ryan set to start the Congressional approval process. With Lighthizer stating the parties were “nowhere close to a deal,” it’s looking more likely that a new Congress—elected after the November midterm elections—will sign off on any deal.

“It looks like the Democrats are going to win the House,” says Gary Clyde Hufbauer, nonresident senior fellow at the Peterson Institute for International Economics. “If it spills over into 2019, I don’t think it matters what the agreement says—the Democrats are not going to vote for it. It won’t have enough on labor, environment, gender and what have you. In the House and the Senate, the Republican Party is still largely an establishment party which believes in free trade amongst other things, and they don’t like it. They don’t want to get rid of investor-state dispute settlement, they don’t like what’s happening in the auto industry with this new agreement.”

Further complicating congressional approval is Trump’s insistence on the sunset clause, which would require renegotiation of the agreement every five years. Of the five so-called poison pills, the sunset clause is particularly troublesome, as it flies in the face of long-term capital investment.

It’s hard to envision many foreign investors being comfortable making long-term capital investments when the agreement could dissolve in five years. There is hope that this particular poison pill would be modified to become a review trigger as opposed to a dissolution.

“You can imagine what that does for investment certainty,” says Donald Campbell, senior strategy adviser at DLA Piper and a former Canadian deputy minister for international trade. “That is anathema to Canada and to Mexico—I would think to anybody who wants long-term certainty in terms of investment. I’ll go out on a limb and say that I don’t think there will be an agreement with a sunset clause as it is currently drafted by the United States.”

A path through uncertainty

For business leaders, all signs point to both short- and long-term uncertainty. The current political climate makes an agreement difficult to reach in the near term. And the sunset clause, if it goes through, will make long-term capital investment from foreign countries difficult.

But while a scrapped or retooled NAFTA could complicate matters on a federal level, there will still likely be plenty of opportunities among states and provinces. There are 40 states that count Canada as their number one or number two trading partner. Those state governments don’t have the same protectionist leanings as the Trump administration; they want foreign direct investment to create jobs and bring in much-needed revenue. Also, U.S. tax reform has made foreign direct investment more attractive.

For business leaders, it’s a matter of making calculated investments that can work to their advantage, as well as making sure they have a risk management strategy in place to avoid being blindsided by potential changes to the trade agreement. That means seeking guidance from trusted partners and advisers who understand how to navigate these issues.

Nobody wins with a poorly modified NAFTA. With the U.S. in the ninth year of recovery from the recession, a slowdown seems inevitable. From the Canadian perspective, the trade experts we spoke with indicate the country is better off walking away from a bad deal than signing on to one that’s fair to all parties. As for Mexico, the country’s upcoming presidential election is adding further uncertainty to its long-term policy direction.

Should the countries fail to come to agreement, the trade relationship between the U.S. and Canada isn’t going away. The difference is that it will likely require a more considered approach to making long-term investments.

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