Written on behalf of Feigenbaum Consulting
The fifth round of NAFTA negotiations finished in Mexico City last week. At the end of the talks, Canadian Foreign Affairs Minister, Chrystia Freeland, stated that several stumbling blocks remained in the ongoing talks, including the U.S’ continued insistence on a five-year sunset clause and stiffer content rules for the auto sector.
With major differences remaining unresolved, there is doubt as to whether a deal can be reached by the end of March 2018 as originally planned. Moreover, President Trump continues threats to withdraw from NAFTA unless the agreement can be reworked in favour of the United States. This week we explore some possible implications of a NAFTA termination.
Potential Impact Overall
In a recently issued report entitled The Day After NAFTA, BMO concludes that the end of NAFTA would clearly be a net negative for the Canadian economy, and a mild negative for the U.S, but that this is a “manageable risk that policymakers, businesses, and markets would adjust to in relatively short order.”
If NAFTA is terminated, trade between the NAFTA countries would revert back to tariffs set by the World Trade Organization (WTO). A more dramatic scenario, which the report views as remote, would be the Trump administration entirely bypassing the WTO and international trade norms, and reimposing tariffs different than the current international rates.
Potential Impact on Canada
The report predicts that the end of NAFTA would ultimately lead to a reduction of between 0.7% and 1.0% of Canada’s GDP. The Canadian dollar would likely weaken, the Bank of Canada would likely stop further rate hikes, and might even lower rates at least once.
In terms of industry, the most vulnerable Canadian sectors would include auto, textile and clothing, and food, beverage & tobacco.
In terms of region, Ontario would be the most affected, since the province’s economy is the most integrated with the U.S., with 86% of exports going immediately south of the border.
Factors that could work together to mitigate the economic damage of an end to the trade agreement include:
- The Canadian dollar adjusting lower;
- Trade policy aiming at securing new arrangements;
- Adjustment of fiscal policy.
Potential Impact on the U.S
The report notes that, as the largest economy in the world, the U.S. is better positioned to weather a NAFTA termination than are Canada and Mexico.
The report predicts that the economic impact of the end of NAFTA would result in a 0.2% net reduction in real GDP for the U.S. (from what it otherwise would have been over the coming five years). In terms of industry, the equipment and textile sectors would be particularly vulnerable. In terms of region, some of the border states and those with a heavy focus on agriculture would be most vulnerable.
The report also notes that even if the U.S does eventually achieve its goal of reducing its trade deficit with the NAFTA partners, there is a large possibility that this would be offset by an even wider deficit with Europe and Asia.
In addition, the U.S economy could also be impacted by potentially lower productivity due to supply chain disruption, the need to shift resources into tariff-protected (but less productive) industries, and the need to transform business processes.
The sixth round of NAFTA talks is scheduled to take place in Montreal in January. We will continue to follow developments in this regard and will provide updates as they become available. In the meantime, if you have begun to anticipate what impact the ultimate outcome of the negotiations will have on your business in Canada or the U.S., contact the knowledgeable team at Feigenbaum Tax Law. To make an appointment, contact us online, or call our office toll free at (877) 275-4792.