The Risks of Missing the May Deadline for NAFTA 2.0

It isn’t the Siege of Leningrad, but if a deal on the North American Free Trade Agreement (NAFTA) is not completed by Thursday, May 17, the renegotiations will become a battle of attrition as talks stretch into 2019 and beyond.

Who benefits and who suffers if NAFTA talks are prolonged?

The Canadian economy will clearly suffer from continued uncertainty over the terms of market access to the export market for 75 percent of its exports. Statistics Canada reported just 1.7 percent gross domestic product (GDP) growth in the fourth quarter of 2017, an appreciable slowdown from 2016, with the lowest level of foreign direct investment in the Canadian economy since 2010.

Low GDP growth is one reason that the Liberal government led by Prime Minister Justin Trudeau is losing ground in polls. Another is the decision to raise taxes, including through the imposition of a federal carbon tax in every province that does not have a carbon price equivalent to $50 per ton.

Tax reform in the United States is also a factor. Even though it brought U.S. corporate tax rates in line with Canadian rates, combined with NAFTA uncertainty, the U.S. tax reduction is an added incentive for Canadian companies to expand in the United States and for international firms to access the Canadian market from the United States as well.

Canada has a federal election scheduled for October 2019. If Trudeau is seen to have “lost NAFTA” and even if he fails to stop the economic pain of NAFTA renegotiation, his chances of a second mandate will suffer.

The Mexican economy shows signs of similar damage from NAFTA uncertainty. The Mexican peso has fallen in value as the renegotiations have continued. The likelihood that business-unfriendly Morena presidential candidate Andrés Manuel López Obrador could win the July 2018 presidential election has also worried markets. If Lopez Obrador wins, he will face opposition majorities in the Mexican Congress that will make governing more difficult.

It is not on the table in the NAFTA talks, but U.S. hostility to illegal migration from—or in the case of Central Americans through—Mexico is another source of negative pressure on the Mexican economy. For the Trump administration, the failure of the U.S. aspiration that NAFTA would create enough economic growth in Mexico to keep Mexicans at home is one of the glaring failures of “the worst deal ever.”

Both Canada and Mexico have tried to mitigate the negative economic effects of the NAFTA renegotiation through the negotiation of new trade agreements with Europe and Asia. The Canada-European Comprehensive Economic and Trade Agreement (CETA) is slowly being ratified by all parties and already has taken provisional effect. Mexico and the European Union agreed to an upgrade to their longstanding trade agreement in April. Both Canada and Mexico agreed to join nine other Pacific rim markets in the Trans-Pacific Partnership (TPP). The Trump administration is reconsidering its decision to walk away from the TPP, but for now none of these new trade agreements with Canada and Mexico will resolve the questions over market access to each country’s largest export market, the United States.

The U.S. economy, meanwhile, seems to be undaunted by ongoing NAFTA uncertainty. Economic growth continues, unemployment is at a record low, and President Donald Trump’s approval ratings are climbing. Even if NAFTA talks fail to produce a deal before 2020, Trump can credibly claim to have met his campaign promise to seek improvements to the deal. Prolonged renegotiation of NAFTA imposes few costs for the United States.

In order to conclude the NAFTA renegotiations this month, which President Trump and Trade Representative Robert Lighthizer have set as their goal, the United States would have to pay the biggest price. The fastest way to reach agreement now is by abandoning some U.S. proposals and objectives and carrying over much of the extant language of NAFTA 1.0 into a version 2.0 and adding only the least controversial elements of the TPP for the sake of modernization of the text.

So, the United States has little to lose if NAFTA talks are prolonged and something to lose in order to get a deal done this month; Canada and Mexico would benefit (or at least stop suffering) if a deal is struck quickly and have more to lose if talks continue inconclusively over the next year or more.

This gives the United States a certain amount of bargaining leverage that might be exercised in two NAFTA scenarios. By stalling on a deal and insisting on extreme demands, the United States could seek to wear down Canada and Mexico and gain more concessions from both.

Or, as Lighthizer suggested after the seventh round of NAFTA talks in March, he could put talks with Canada on hold and pursue a deal with Mexico ahead of the Mexican election. The United States could restart bilateral talks with Canada next year. The result would be replacement of the trilateral NAFTA with two bilateral deals in which only U.S. content can enter any market duty free—providing a big “America First” boost to the U.S. economy.

Yet the United States could benefit in different ways from reaching a NAFTA 2.0 deal now. Trump supporters, farmers, and business leaders would hail such a deal as a major Trump victory. Add this to tax reform and other Trump economic policies like reducing the regulatory burden, and both Trump and the GOP-majority in Congress would benefit politically in the 2018 midterms and beyond.

The United States has larger trade fights ahead with China and the European Union, and the potential for military conflict with Iran and North Korea is on the horizon. Despite the possible advantages of prolonged talks for the United States, it may be best for all three NAFTA partners to agree to a NAFTA 2.0 deal now.

Christopher Sands is a senior associate of the Center for Strategic and International Studies and a senior research professor and director of the Center for Canadian Studies at the Johns Hopkins University School of Advanced International Studies.

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Christopher Sands

Christopher Sands

Former Senior Associate (Non-resident), Americas Program