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Jonathan Drake/Reuters

AFTER NAFTA

The United States hasn't walked away from a trade agreement in 150 years, but that could change if Donald Trump takes up residence in the White House. The most anti-trade U.S. presidential candidate in decades, he's called NAFTA 'a disaster' and threatened to pull out of the historic trade pact. Can he do it? And if he does, how badly would Canada's economy be hurt?

It's July 4, 2017 – U.S. Independence Day – and President Donald Trump is celebrating his country's historic exit from the North American free-trade agreement.

"This will bring back our jobs and make America great again," he proclaims on the White House lawn.

Mr. Trump has pulled the trigger on his threat to pull the United States out of the deal after taking office, and six months later NAFTA's unravelling has begun.

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But few are rejoicing U.S. independence from NAFTA on this side of the border, where free trade and open borders have been the bedrock of Canada's economic policy for decades.

How a Trump presidency would affect Canada's economy The Republican candidate is pledging to overhaul – or even scrap – trade agreements involving Canada

NAFTA's demise means an end to the preferential market access and common rules that have bound Canada, the United States and Mexico since 1994 (and since 1989 under the Canada-U.S. free-trade agreement). Under Trump and a Republican-controlled Congress, the United States is expected to raise tariffs within the region to the consistently higher ones it imposes on all other countries. Canada and Mexico have already said they will likely retaliate by doing the same. A series of escalating trade barriers would cause trade within the region to drop sharply – by perhaps 5 to 10 per cent, economists estimate – and trigger a gradual unwinding of vast supply networks established over decades. Factories that produce in one country with components from the other two make a lot less sense amid all the economic disintegration.

A far-fetched scenario? Perhaps. But few experts expected Brexit to happen. So Amexit might not be such a long shot after a wild and unpredictable lead-up to U.S. election in November.

No matter that the United States hasn't walked away from a trade agreement in 150 years. Mr. Trump is the most anti-trade U.S. presidential candidate in decades. He is behind Democrat Hillary Clinton in the latest national polls, but he has a narrow path to potential victory if he can win a number of key states – including Ohio, Pennsylvania and Michigan, where globalization and free trade are hot, contentious issues. For her part, Mrs. Clinton is promising to "review" NAFTA after embracing a more trade-skeptical stance during her primary run against Bernie Sanders. She also says she will oppose the Trans-Pacific Partnership, a sweeping trade deal signed but not yet ratified by the U.S., Canada, Mexico and nine other countries.

It's no longer a given that the United States is unreservedly committed to free trade amid rising angst about globalization, trade deals and lost manufacturing jobs.

And that's a huge problem for a trade-dependent country such as Canada, which ships nearly three-quarters of its merchandise exports to one customer, the United States. Merchandise trade accounted for 55 per cent of gross domestic product in 2015, up from less than 30 per cent in the 1960s. Exports to the United States alone make up a fifth of Canada's economy. The economic integration between the two countries is even more sweeping when trade in services and investment flows are thrown into the mix.

Vehicles entering the U.S. from Sarnia, Ont.

Vehicles entering the U.S. from Sarnia, Ont.

Rebecca Cook/Reuters

A dilemma for auto parts firms

Consider Toronto-based auto parts maker Martinrea International Inc. Founded in the early 2000s, the company has never known a world without NAFTA. It's no accident that "international" is in its name. The company has 44 plants on four continents, including a ninth now under construction in Mexico, and more than a dozen across the United States. Martinrea, a so-called Tier 1 supplier to most of the major U.S. and foreign auto makers, goes where they go. It now produces significantly more outside Canada than at home after following the migration of new assembly plants to the southern United States and Mexico.

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"We make things together. It's a North American supply chain," Martinrea executive chairman Rob Wildeboer explains.

"Our strategy in terms of building our business has been to blanket North America with our facilities."

Martinrea components, such as chassis, frames and suspensions, will often cross the border multiple times before being installed on finished vehicles. Rear assemblies for the GM Equinox, built in Ingersoll, Ont., are produced using mainly U.S. parts, which currently enter duty-free but could face tariffs in a post-NAFTA world.

"We have to keep the border open because there is a supply chain, and typically parts cross the border a lot," Mr. Wildeboer says. "The thought of getting rid of NAFTA for the auto sector, which is pretty integrated, would be pretty difficult for us, and our customers."

For Martinrea, Amexit might look a lot like the 2008-09 financial crisis. There would be dislocation, lost revenue and perhaps plant closings as supply chains get disrupted.

"Remember the Great Recession. Trade slowed down much more than GDP," points out Dan Ciuriak, a former deputy chief economist at Global Affairs Canada and an expert in modelling the effects of trade agreements. "That was because of the supply chain effect."

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The same, of course, would be true for a broad swath of the Canadian economy, which is structured to take advantage of the largely seamless integration that NAFTA offers. In the beef industry, cattle born in one country are often fattened across the border before returning home to be turned into cuts of meat destined for grocery stores. The impact of even a small incremental tariff could quickly escalate with each time a product crosses the border.

It's not just final products and inputs that cross the border. There are also ideas, intellectual property and people. Companies routinely take advantage of the mobility provisions of the agreement to move employees back and forth, as required.

"New investment could bypass Canada," Mr. Ciuriak warns. "Canada could lose its lustre as a place to serve the North American market."




The legal issues

The broad consensus among economists who've looked at NAFTA is that the deal has been undeniably good for all three countries by massively expanding trade and spurring economic integration.

Mr. Trump sees it quite differently, in spite of the evidence. He has called NAFTA a "disaster" that has allowed Mexico to steal U.S. jobs.

Mr. Trump's vow to renegotiate NAFTA or "break it" raises a number of complex and untested legal issues. For starters, it's not clear that a U.S. president can unwind a trade agreement on their own without the approval of the U.S. Senate and House of Representatives, which have ultimate control over trade under the U.S. Constitution. Presidents can only enter into trade deals after securing trade negotiating authority from Congress.

"This is a very complex piece of business," says former prime minister Brian Mulroney, who negotiated the original Canada-U.S. free-trade agreement and later fought to secure Canada's place at the NAFTA table.

But, in the end, it won't be the law that saves NAFTA, it will be overwhelming economic logic and political reality, Mr. Mulroney argues.

"For anyone to come forward and suggest getting out of a free-trade deal with Canada, and to get that through the Congress, is going to be a frosty Friday, believe me. It's not going to happen," he predicts. "The Canada-U.S. trading relationship is a model for the world."

Former prime minister Brian Mulroney in 2012.

Former prime minister Brian Mulroney in 2012.

Fred Lum/The Globe and Mail

NAFTA's unwinding would raise another intriguing scenario – that Canada and the United States would simply revert to the original Canada-U.S. free-trade agreement, reached in 1988. NAFTA suspended the earlier agreement, but never formally terminated it, according to Matthew Kronby, a former top Canadian trade official and partner at law firm Bennett Jones in Toronto.

"So if Trump were to make good on his promise, [the Canada-U.S. free-trade agreement] would apply to Canada-U.S. trade – at least until Trump pulled out of it too," Mr. Kronby argues. "I don't think there is much legal ambiguity about that."

From a Machiavellian point of view, a return to pre-1994 trade rules might not be a bad thing for Canada. Canada has never been the primary target of Mr. Trump and other NAFTA critics; Mexico is. With Mexico out of NAFTA, Canada would gain a clear competitive advantage in the U.S. market.

And if a U.S. president insists on renegotiating NAFTA in its entirety, both junior partners would likely have trouble saying no.

"A Trump presidency will mean rough waters for Canada, whether or not he tries to rip up NAFTA," insists Lawrence Herman, a Toronto trade lawyer. "He's not going to show any leniency with American trading partners."

A Clinton administration might also be troublesome for Canada. There is a strong current of anti-trade sentiment among Democrats, a mood that Mr. Sanders, like Mr. Trump, exploited in the primaries.

People hold anti-TPP signs at the Democratic National Convention.

People hold anti-TPP signs at the Democratic National Convention.

Mandel Ngan/AFP/Getty

The nostalgia factor

Why NAFTA is so much more controversial in the United States than in Canada is understandable. Canada is a small, open economy that depends heavily on being able to sell its natural resources and advanced manufactured goods far beyond its borders. Goods and services exports account for 32 per cent of gross domestic product in Canada versus 13 per cent in the United States, which has the largest domestic economy in the world.

Canadians made a choice to embrace open markets in the 1988 federal election, which was fought over the merits of the Canada-U.S. free-trade deal. For the most part, Canadians haven't looked back. Not so in the United States.

"In the United States, there is the illusion that we can do without world markets, and indeed we export less as a percentage of GDP than you do," points out Christopher Sands, a professor and director of the Center for Canadian Studies at Johns Hopkins University. "And the stubbornly high dollar makes our exports more expensive."

U.S. opposition to NAFTA is less about economics than it is about nostalgia. When Mr. Trump talks about making America great again, he harks back to a perceived Golden Age before NAFTA, the World Trade Organization and China's rise out of poverty. Back then, U.S. workers made everything worth owning, from cars and fridges, to pots and socks. And they did well. In 1960, 24 per cent of the labour force was engaged in manufacturing – good-paying jobs, with benefits, even for those without a college education. Today, 8 per cent of the U.S. work force is in manufacturing. Since 2000, five million factory jobs have vanished.

Many in the U.S. baby boom generation grew up wanting and expecting what their parents had – a country where white, male fathers could work in factories their entire lives and provide for their families, Prof. Sands explains.

"They sought the same, but got displaced by automation," he argues. "They came to blame NAFTA as the event by which the United States said 'yes' to the globalization that left them behind."

And that is one of the ironies of the debate about NAFTA in the United States. A far more obvious villain is technology, not trade. Robots and machines have replaced far more U.S. workers than Mexicans or Chinese. Today, U.S. factories produce twice as much stuff as they did in 1984, but with one-third fewer workers. Manufacturing as a share of GDP is virtually unchanged from 1960.

Over all, the U.S. labour market is in pretty good shape. July's unemployment rate of 4.9 per cent is not far off the average of the 1950s or 1960s. But the geography of jobs has changed dramatically. Employment has shifted to the coasts, and manufacturing jobs to the South – out of large swaths of key political battleground states, such as Pennsylvania, Ohio and Michigan. These are all places where Mr. Trump will need to do well to win the presidency.



A selection of Trump's NAFTA tweets



In many respects, globalization has been far more damaging to the manufacturing base in Canada than the United States. Canada has been steadily losing its share of the U.S. import market – to China, Mexico and others. Canada was the first U.S. free-trade partner. Now it's one of 20, and the United States has deals negotiated or in the works with dozens more.

"The benefits of free trade have been diluted as the U.S. entered into other trade agreements, and would be diluted further under the [Trans-Pacific Partnership]," says Mr. Herman, the trade lawyer.

And NAFTA is hardly without its flaws, from a Canadian perspective. The border, particularly since 9/11, has become less seamless. And, unlike the European Union, NAFTA countries retain the right to hit each other with duties for alleged dumping and subsidies. Indeed, Canada is already bracing for another volley of duties on billions of dollars worth of lumber exports – an industry that has enjoyed only brief interludes of free trade since the late 1980s.

But even targets of U.S. protectionism would acknowledge they're better off with NAFTA than without it. Consider TransCanada Corp., which recently launched a $15-billion (U.S.) arbitration case against the U.S. government over President Barack Obama's rejection of the Keystone XL pipeline. Without NAFTA, that legal recourse would be unavailable to the company.

So could Canada survive without NAFTA? Of course.

Martinrea's Mr. Wildeboer insists his company would probably do fine, although growth might take a hit. Its Mexican plants would likely sell more outside North America and its U.S. plants would do fine behind a higher tariff wall, as long as the United States was still producing cars domestically.

Likewise, the United States would still need everything else Canada has to sell, including oil and gas, paper, nickel and aluminum.

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And it's not as if Canada would be entirely without options if NAFTA is unwound. Mr. Ciuriak, along with fellow economists Ali Dadkhah and Jingliang Xiao, argue in a new study for the Business Council of Canada that the country should unilaterally declare itself a free-trade area. Eliminating all remaining barriers on goods, services and investment would generate $61-billion (Canadian) a year in gains for the Canadian economy, according to the study. That is roughly four times the estimated combined benefit of recently negotiated free-trade deals with Europe and the Trans-Pacific Partnership.

Prime Minister Justin Trudeau, who has become the anti-Trump when it comes to open borders for immigrants, could presumably forge a similar reputation on trade.

"Canada could position itself to be an open market regardless of what's happening in the rest of the world," Mr. Ciuriak says. "There is no way that Canada can prosper if it cuts itself off from the world."

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