Canada

Canada's middle market and the future of NAFTA

INSIGHT ARTICLE  | 

The recent tri-lateral talks between Canada, the United States, and Mexico as to the future of the North America Free Trade Agreement, commonly known as NAFTA, are winding down. With the possibility of the United States triggering a unilateral exit from the agreement, many wonder what the future impact might be on Canada’s economy should President Trump succeed in unilaterally withdrawing from NAFTA.

Signed in 1992 by then Prime Minister Brian Mulroney, Mexican President Carlos Salinas de Gortari and President George H.W. Bush, NAFTA was ratified in 1994, shepherding in an era of virtually tariff-free trade between the three countries. NAFTA effectively replaced the Canada-United States Free Trade Agreement (FTA), which was signed in 1988.

Free trade proponents touted that the agreement would help address the labour productivity gap between Canada and the United States while naysayers fumed that manufacturing jobs would be instantly offshored to the United States or Mexico. Twenty-five years later – neither scenario occurred: Canada’s productivity gap with the United States still exists, the number of jobs in Canada increased since 1993 and there was a rebound in manufacturing employment in Canada after some initial losses.

What did occur? Canada’s economy became more interconnected and integrated with North America.

Canadian exports to the United States nearly tripled and imports from the United States grew at a similar rate. U.S. foreign direct investment (FDI) into Canada increased substantially and Canada’s FDI into the United States grew substantially as well. NAFTA (and the FTA, its precursor) has helped integrate North America into the economic powerhouse it is today. In doing so, it has also provided Canadian businesses confidence that they can compete globally. More intangible benefits like this is NAFTA’s true impact. Would Canada have signed a free trade agreement with the European Union (EU), agreed to sign the Trans-Pacific Partnership (TPP) or entertain free trade discussions with China were it not for FTA/NAFTA?

If the United States unilaterally withdraws from NAFTA, the impact to Canada will depend on what replaces NAFTA. If the FTA replaces it, then the impact would likely be a negligible as it is a similar agreement to NAFTA. On the other hand, the impact would be more substantial if there is a reversion to World Trade Organization (WTO) rules. This could also potentially unravel the close and mutually beneficial economic relationship between Canada and the United States and provide further impetus for Canadians to look beyond the United States.     

Supply chain gain

Certain sectors benefited greatly from NAFTA, especially the automotive industry. Thanks to NAFTA, the degree of supply chain interconnectivity increased significantly. The establishment of a cross-national supply chain in the automotive industry, which was built after NAFTA came into effect, enhanced integrated production between Canada, the United States and Mexico. For instance, every dollar of U.S. automobile exports has a growing and significant share of content from Canada and Mexico. NAFTA improved the competitiveness of North America’s automotive manufacturing sector and as a result helped maintain production levels and associated employment levels.

An opportunity we wouldn’t want to miss

Much of the talk around U.S. dissatisfaction with NAFTA may have obfuscated an important fact: NAFTA is in need of modernization.

Consider this: a lot has changed since 1994. The Internet was in its infancy, China became a member of the WTO and the rate of globalization and technological innovation has accelerated. E-commerce now represents a large and growing portion of global sales and a number of restrictions exist hindering cross-border e-commerce in North America. There is an opportunity to address these issues now and through the negotiations, some progress has been made.  

The impact on the middle market

Should the Trump administration formally withdraw, this action will trigger a six-month waiting period, after which time the United States could leave the agreement.

For small- to medium-sized businesses (SMBs), this will cause increased uncertainty over the short term, which will affect investment and expansion decisions in turn.

Our guidance for SMBs that rely on cross-border trade is to stay nimble. Canadian middle market firms need to look more concertedly outside North America, work on diversification and take advantage of opportunities in other trading blocks and countries, including the EU, TPP and China. While Canada is beginning to work on a free trade agreement with China, the government may need to concede on a few issues to move this forward sooner than later.

For smaller firms with less access to capital and international connections, diversification can be challenging. There is definitely a role for government to assist SMBs over the long term and there are many programs in place to help; SMBs should take advantage of these available resources. In the short term, the government can also speed up efforts to break down interprovincial barriers and facilitate greater trade within Canada.

Over the long term, the end of NAFTA could affect foreign investment decisions. Currently, a foreign company can open a facility in Canada to service the U.S. market on a duty-free basis. Termination of NAFTA could also lead to decreased foreign investment in Canada, which would also impact SMBs.

In many respects, the FTA and NAFTA opened Canada to the world and Canadian businesses proved to themselves that they can compete on a global scale. Termination of NAFTA is not going to change this: Canadian businesses including SMBs can compete and win globally.

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