The US has been running persistent trade deficits with both Mexico and Canada. Observers believe that the negotiations are unlikely to be concluded this year. It is also not very likely that negotiation will break down this year. That said, Mexico’s threat to retaliate against US steel tariffs might raise US-Mexican tensions. Same for US-Canada.
An analysis of US jobs that rely on exports to Canada and Mexico finds that a NAFTA dissolution would cost less than 200,000 jobs in the US export sector over a 1-3Y period. By comparison, a total of 7.4m US workers were displaced or lost their jobs involuntarily during 2013-15. The most affected states would be Arkansas, Kentucky, Mississippi, and Indiana. The most affected sectors would be autos, agriculture and manufacturing.
NAFTA supply chains help reduce production costs by providing low-cost intermediate inputs to US firms. Lower production costs mean domestic consumer prices and the cost of US exports are lower than they would otherwise be. In order to be eligible for duty-free imports under NAFTA, member countries must abide by rules of origin. Tightening rules of origin, which effectively raises the cost of trade, is unlikely to increase trade or lower the trade deficit but is very likely to disrupt supply chains. Often higher tariffs are circumvented or third-country producers step in to provide additional supply. The economic impact on the US will be limited.
As for Mexico, if NAFTA is dissolved, Mexico would default to WTO rules. This will affect trade, but the macro impact would be manageable, not least because the Mexican peso would adjust, keeping Mexican exports to the US competitive. Higher inflation following currency depreciation would require higher interest rates, but the economic shock would prove temporary. Mexican manufacturing exports would face an average tariff of 2.4%, while Mexico under WTO rules would be allowed to impose import duties of 5.2% on US manufacturing exports. This is an average. Individual products may face stiff duties (e.g. Mexican pick-up truck would 25% tariff). Not all Mexican and Canadian exports to the US use NAFTA rules. This will further mitigate the impact of NAFTA dissolution on Mexican exports to the US,
A NAFTA break-up would hit domestic Mexican investment and cause a short-lived recession. Moody’s estimate of Mexico’s medium-term GDP path may be somewhat optimistic. Mexico’s growth potential is 3% at best. But the NAFTA shock would prove temporary and Mexico would return to its pro-dissolution growth path after 12-18 months. The impact would be manageable for the following reasons. Mexico would revert to (low) WTO tariffs on the slightly more than 50% of its exports to the US that currently take place under NAFTA rules. US companies would continue to have significant incentives to do business with Mexico due to significant supply chain integration and low transportation costs. Mexico’s flexible exchange rate regime would act as an automatic stabiliser and help the economy adjust to less favourable terms-of-trade. Mexico would also be aggressively pursuing trade agreements with other countries following NAFTA dissolution to offset some of its negative impact.
Mexico is rated investment grade and has access to the IMF Flexible Credit Line. Its macro policy track record is strong. A flexible exchange rate will help Mexico absorb any trade shock.
Mexico is rated investment grade and has access to the IMF Flexible Credit Line. Its macro policy track record is strong. A flexible exchange rate will help Mexico absorb any trade shock.