Even NAFTA Tweaks Could Be Costly

Canadian Prime Minister Justin Trudeau did about as well as could be expected during his first face-to-face meeting with U.S. President Donald Trump, at least from a business perspective. After a conciliatory Oval Office chat on February 13, Trudeau didn’t exactly return to Ottawa with a Valentine’s Day card. But he did leave Washington with a personal assurance from President Trump that U.S. plans to renegotiate trade deals would not result in a major blow to the export-dependent Canadian economy.

“We have a very outstanding trade relationship with Canada,” President Trump said during a joint press conference with Trudeau, adding that Washington’s intention with its northern trading relationship was simply to explore ways of “tweaking it” with “certain things that will benefit both of our countries.”

That’s the good news. The not-so-good news is that Ivey Business School research suggests that even so-called tweaks to the North American Free Trade Agreement (NAFTA) could be very costly for businesses and consumers across the continent, especially if they thicken borders and hamper the integration of supply chains.

Now the bad news: President Trump made it clear that the United States will not live with Mexico’s US$58 billion trade surplus, which is why he plans to seriously revamp the U.S. trading relationship with Mexico. “On the southern border for many, many years the transaction was not fair to the United States,” he said. “We are going to make it a fair deal for both countries.” And any significant change to that relationship developed under NAFTA can also be very costly for businesses and consumers across North America.

In keeping with Article 2205 of NAFTA, Washington is free to walk away from NAFTA with six months’ notice. And as Trudeau diplomatically noted during his White House visit, Canadians can’t diplomatically tell the Trump administration how to manage U.S. affairs. But with all due respect to new U.S. policymakers, Ivey research clearly shows that any thickening of the U.S.–Mexico border will negatively impact production and supply chains across all three countries, particularly in the automotive industry.

According to We Make Things Together, a new study by the Ivey Business School’s Lawrence National Centre for Policy and Management, the trade interdependence between the Canadian province of Ontario and the eight U.S. states—New York, Indiana, Pennsylvania, Illinois, Ohio, Michigan, Minnesota, and Wisconsin—that make up the Great Lakes region (GLS8) is particularly vulnerable to being hurt by a thickening of the northern U.S. border. After all, as the Lawrence Centre’s detailed analysis of Canada–U.S. trade interdependence shows, the significant movement of goods and services between Ontario and the GLS8, estimated at about $200 billion in 2015, makes the binational region a powerful “super-cluster” that generates jobs thanks to the competitive advantage provided by its highly integrated supply chains. And due to interdependencies, a negative shock to any member of the cluster would be felt across the region and on both sides of the border.

To remain competitive, the Ontario–GLS8 cluster must operate as efficiently as possible by avoiding these cost increases and limiting red tape. In other words, the manufacturing plants that would “win” through a thickening of the Canada–U.S. border would not be in North America; rather, they would be in Asia or Europe, as Great Lakes firms would no longer be able to compete with low-cost developing regions.

Furthermore, if there is a so-called USexit from NAFTA, Canada would feel further pain, because pulling the plug on NAFTA would also eliminate the current trading rules that govern trade between Canada and Mexico—which is Ontario’s third-largest export market for goods.

Finally, it should be noted that there is no guarantee that the suspended Canada–United States Free Trade Agreement (CUSFTA) would remain in effect if the Trump administration pulls the plug on NAFTA, hoping to somehow improve its trade relationship with Mexico as a result. But even if CUSFTA remained in force, the Canada–U.S. trade relationship would probably face serious headwinds because NAFTA is much more than CUSFTA with Mexico added on. There are significant differences between the two agreements beyond the number of countries that could create significant economic turmoil across the continent.

Ivey research shows that NAFTA has been a good thing for its three signatory countries. Some might even say it has been great for the United States. Under NAFTA, U.S. companies saw tariffs on imports drop by 98 per cent, exports increase, employment climb, and output almost triple; Americans saw new jobs created, real wages increase, and welfare improvements. Governments saw GDP increase, unemployment drop, foreign investment flow in, and productivity improve.

As the Lawrence Centre noted, the natural outcome of NAFTA has been a highly integrated North American marketplace where goods generally move tariff-free across borders. It has also led to a new economic reality where exports are likely to include commodities and intermediary goods sourced from other countries.

Simply put, as the We Make Thinks Together study concludes, the United States will be harmed if its trading relationships become more expensive. Hampered trade would mean job loss, decreased economic output, higher costs of production, lower returns for investors, fewer choices, and higher costs for consumers.

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