The collapse of the North American Free Trade Agreement would likely damage yet not derail the continent’s economy and business models of global corporations.
That’s the conclusion of economists trying to envisage life after the 23-year-old accord as increasingly tense negotiations over how to revamp it fuel speculation that U.S. President Donald Trump will follow through on his threat to withdraw.
Without NAFTA, the U.S. and Mexico would charge each other the higher tariffs they now levy on other members of the World Trade Organization. Those run as high as 7 percent on average in Mexico and 3.5 percent in the U.S., although Canada and America may be able to fall back on a pre-Nafta free-trade deal.
An increase in duties would potentially hurt growth, cost jobs and spur inflation for all three nations, with Bloomberg Intelligence and Moody’s Analytics predicting Mexico would be the hardest hit.
But none of the countries would be tipped into recession, according to Moody’s. It forecasts most of the pain would come in the first two years after the breakdown of the deal, assuming the U.S. and Canada would work out a bilateral arrangement.
“It will be bad for business, but it wouldn’t be cataclysmic,” said Mark Zandi, chief economist at Moody’s Analytics. “It will be disruptive to supply chains.”
Mexico has been the biggest winner from the pact among the three countries. Companies from General Motors Co (NYSE:GM). to Caterpillar Inc (NYSE:CAT). shifted production south of the U.S. border to take advantage of cheaper wages, helping Mexico stabilize its economy after a debt crisis in the 1980s.
It also stands to lose the most from a NAFTA exit. Mexico would shed almost 1 million low-skilled jobs, compared with slightly more than 250,000 in the U.S. and 125,000 in Canada, according to ImpactEcon, an economic consulting firm based in Colorado. The ImpactEcon estimate doesn’t assume survival of the U.S.-Canada FTA.
Mexico’s manufacturing sector would be most at risk if the accord ends, especially in the auto industry, according to an analysis by Bloomberg Intelligence. The U.S. had a $74-billion automotive trade deficit with Mexico last year — outsizing the overall $63-billion shortfall.
Private investment in Mexico has already been falling on trade-related uncertainty, and would likely suffer further on a NAFTA exit. But the short-term impact could be limited, since it could take time for companies to adjust their supply chains, and Mexico would likely remain competitive relative to the U.S. because of its low labor costs, according to BI.
A party can withdraw from the pact with six months’ notice, though it would probably trigger legal and political battles because the full extent of the president’s authority over trade is unclear. The path for reshaping America’s trade ties with Mexico and Canada could take years to work out. Congress’s trade powers would help frame a withdrawal and Trump’s successor could even decide to re-enter talks.
Negotiators bought more time by extending NAFTA talks through March after the U.S., during the latest discussions this month, unveiled hardline demands that were rejected by Mexico and Canada.
In Dispute
Similar to the expected impact of Britain’s exit from the European Union, tariffs might not be the biggest obstacle to business. The pact’s demise would dismantle the system of independent tribunals that govern investment on the continent. For example, U.S. companies would lose a safeguard that prevents Canada or Mexico from seizing their assets.
A weakening of protections for American companies would disproportionately hurt Mexico, where legal buffers for corporations aren’t as robust, said Carlos Capistran, head of Mexico and Canada research at Bank of America Merrill Lynch (NYSE:BAC).
“The impact of higher tariffs may actually not be that large,” he said by phone. “I’m worried about the impact on investment.”
Helping Workers?
One of the keys to Trump’s election last year was his appeal among voters in states hurt by the decline in manufacturing employment, such as Ohio and Pennsylvania.
Some companies would probably move production back to the U.S. if the president withdraws from the deal, said Michael Stumo, chief executive officer of Coalition for a Prosperous America, a non-profit group that has supported the administration’s skepticism toward free trade. However, addressing currency imbalances would be a more durable way of shifting trade flows, he added.
But others argue that companies would simply shift production to lower-cost production hubs in Asia, rather than return the U.S. to its manufacturing glory days.
“It’s unlikely NAFTA’s termination would lead to meaningfully higher job gains in the U.S.,” said Michael McDonough, global director of economic research at Bloomberg Intelligence. “Companies would probably pass higher prices on to consumers rather than spend billions over many years to bring capacity back to the U.S.”
This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.