The implications of US withdrawal from NAFTA for businesses

February 6, 2018
In response to customer questions about NAFTA’s influence on the weakening of the US dollar, OFX summarized facts and sentiments on the prospect of a US withdrawal from the trade agreement

Why businesses should care about what happens to NAFTA

As trade talks between the US, Canada and Mexico continue in earnest, much has been written about the impact of a world without NAFTA (The North American Free Trade Agreement). In place since 1994, NAFTA was designed to encourage investment and the freer flow of goods between Canada, Mexico and the US. Under NAFTA the countries pay nothing – no tariffs - on goods that cross the border. In the 23 years since introduction, US trade has more than tripled: in particular, US trade growth with Mexico and Canada has grown more rapidly than US trade with the rest of the world.

Here we will summarize the main points and distill the potential impact to US business. In sum:

  • Dollar weakness. The threat of NAFTA dissolving has influenced the weakening of the dollar as other countries begin to plan for American trade protectionism. This isn’t the only factor influencing the current dollar weakness but it is definitely having an effect. A weaker dollar favors those who are buying US products (because they are cheaper) and traveling to the US. However, a weaker dollar makes buying goods or parts across borders more expensive for US businesses.
  • Tariff increases. If the US backs out of NAFTA, the tariffs that will be charged for US goods moving across the Canadian or Mexican border will likely revert to those in place through the WTO (World Trade Organization), which are more than zero. Canada and the US had a trade agreement in place prior to NAFTA that they might revisit. Either way, pulling out would likely raise costs for American businesses.
  • Supply chain disruption. A byproduct of NAFTA has been the deep integration of supply chains across the three countries. By some estimates disrupting embedded supply chains will put tens of thousands of jobs in jeopardy. Large companies that operate in all three economies such as Ford, Coca-Cola, HP and GM are preparing for an uncertain future.
  • Bad feelings. The US has been a reliable partner in both Mexico and Canada, but that appears to be changing. With an onset of mistrust and trade protectionism there is speculation about how long any agreement will last. Some believe that if the US does withdraw, Mexico and Canada will retaliate by imposing additional restrictions on US products entering their markets (in particular, agricultural products, machinery and chemicals). Clearly, withdrawing will go against a mood of openness and predictability. 

 

The US Administration’s Position

The current US administration argues that NAFTA has been a bad deal for the American people. In sum, administration officials argue that:

currency
  • The US should not encourage US companies to invest in Mexico and Canada primarily for export back to the US
  • A national manufacturing policy dependent on Canadian and Mexican exports to the US hurts the US economy
  • Factory jobs should be created back home in the US
  • Mexico is stealing jobs from the US

NAFTA: A Scapegoat?

The reasons why NAFTA is deemed responsible for so many American economic ills are hard to untangle, but revolve around the US trade deficit and economic dislocation. Proponents of the repeal argue that NAFTA heavily contributes to an increasing US trade deficit. It’s undisputed that the US has become a net trade importer by importing more goods than are exported. In turn, both US political parties blame NAFTA for the decline of US manufacturing jobs, factory closures and job losses.

Experts are unclear about a direct link between NAFTA and overall US employment trends. But they acknowledge that those US industries that were more exposed to tariffs have been hit harder than others (textile, apparel, automotive). And, some economists argue that more jobs have been created than lost. Other factors such as rapid technological changes, demographic shifts and the role of trade with players like China have also added to the trade imbalance and perceived loss of jobs.

Hurry Up and Negotiate

The negotiation talks will extend through the end of March in several rounds. At the beginning of February, they had completed the sixth round with some progress made on appliances and solar panels. They are expected to take up agreements on telecom and digital next. At the moment, the US continues to reject perceived compromises on issues like dispute arbitration and a sunset clause for the deal. Time is running out though. The upcoming Mexican presidential election in the summer may create further delay. Talks could be put on hold through the summer and even possibly until a new Mexican president takes power in December.

 

US set deadline for NAFTA negotiations March 31st, 2018
Mexican Presidential election date July 1st , 2018
US mid-term election November 6th, 2018
Mexican Presidential inauguration December 1st, 2018

Expect Uncertainty

Policy experts disagree on the power of the US president to unilaterally withdraw from NAFTA without the approval of Congress. Meanwhile, other views hold that the US focus should be on the trade imbalance between the US and China. Regardless, any abrupt changes are likely to negatively impact the US and global economy with American businesses and consumers experiencing higher costs.

With a multitude of unpredictable factors impacting the direction of NAFTA negotiations North American currency market participants can only be sure of one thing this year: continued uncertainty.

OFX recommends that its business customers actively monitor the catalyst events listed above and consider your response to either the best and worst case scenarios in managing currency exposures. Also, keep in mind that NAFTA is just one potential market moving event on the horizon. Currency management strategies can potentially help guard against volatility and unpredictability from NAFTA and other market events to come this year.