Despite an improved outlook, it is possible that the U.S. political authority will trigger a six-month review period for exiting the North American Free Trade Agreement (NAFTA) sometime during the next 90 days. At stake is more than $1 trillion in cross-border trade and more than 14 million jobs across three economies. While Mexico has the largest exposure to such an event — in the case of a hasty exit, its economy could contract 2.9 per cent in 2019 — Canada has significant direct and indirect exposure to such a radical policy shift. For Canada this would mean a 0.5 per cent hit to growth between 2019 and 2020.
Middle market businesses across the three economies, and a number of specific industrial ecosystems, face direct risk from potential disruptions of supply and value chains built up during the past generation. But the impact will be asymmetric throughout middle market ecosystems and the North American economy.
By pulling out of the treaty, the United States will likely trigger a series of unintended consequences and indirect economic effects that will negate any short-term positive changes the U.S. economy might experience. Substitution effects would quickly be outweighed by the overwhelming shift in costs, losses in competitiveness, rising prices for consumers and widespread disruption to the mature North American supply chain.
Under the status quo, tariffs — which are better understood as taxes on imports and exports — are zero. Once the United States withdraws from the treaty, they would reset under current World Trade Organization rules 4.2 per cent on average. Most importantly, assuming neither Canada nor Mexico withdraws from the treaty and remains members of the Trans Pacific Partnership treaty, all other major competitors in that treaty will have access to both Canadian and Mexican markets at a zero tariff rate, while U.S. firms will not.
While Mexico will fall into a recession if the United States withdraws from NAFTA, we estimate Canada will take a 0.5 per cent hit to GDP in 2019. Canada receives about $392 billion in foreign direct investment from the United States each year that accounts for 47.5 per cent for all foreign direct investment annually. With 1.2 million Canadian workers employed by U.S. firms, a disruption to commerce in a context where the United States purchases 72.6 per cent of total Canadian exports, there are significant risks to the overall economy. The Canadian auto industry would face a particularly large shock with truck exports facing a 25 per cent tariff in contrast with the 2.5 per cent applied to auto exports. Overall Canadian exports would likely decline by $23 billion or about 3 per cent.
