Given the flurry of NAFTA headlines we’ve seen over the past year, it’s tempting to brush the latest round aside as yet more noise. However, we may now be closer to a crossroads as the legislative landscape in the U.S. and Mexico is set to shift with upcoming elections.
How did we get here? On July 17, 2017, the United States Trade Representative issued Summary Objectives for the NAFTA Renegotiation. The document highlights “exploding” trade deficits and the closure of “thousands of factories” over the life of the 24-year-old trade agreement. At their core, the objectives centre on maintaining and improving market access for American agriculture, manufacturing and services as well as improving the U.S. trade balance.
Canada has been supportive of modernizing NAFTA, pointing to areas such as labour, environmental standards, gender and indigenous rights. However, Foreign Affairs Minister Chrystia Freeland stated clearly that Canada was looking for a win-win, and is committed to a good deal, not just any deal.
The premise of a win-win aligns with economic theory suggesting that trade allows participants to specialize and be better off collectively. Of course, reality is not that simple. How these gains are distributed, both within and across national boundaries, is subject to extensive debate. And we see notions of “fair” and “balanced” trade clearly in the U.S. demands, in part to reclaim American manufacturing jobs.
To further complicate matters, the question around distribution of gains is intertwined with broader foreign policy, as evidenced in the National Security Strategy of the United States of America, released in December 2017. It explicitly challenges China and states that “we will work with our partners to contest China’s unfair trade and economic practices and restrict its acquisition of sensitive technologies.”
Overall, this sets a difficult stage for Canada and Mexico on NAFTA, and other allies on trade more generally. Stretching out resolution may have been a conceivable strategy initially. However, the U.S. is clearly raising pressure with steel and aluminum tariff exemptions for Canada and Mexico, along with the EU, expiring on June 1.
If Canada and Mexico don’t step up to meet U.S. demands over the coming days, would the U.S. really tear up NAFTA and hurt some of its own constituents in the process? Frankly, it seems too hard to call. The issue is that the U.S. may be in a better position to absorb the shock if NAFTA collapses, given its larger domestic market, lower dependence on trade and, let’s not forget, substantial fiscal stimulus through tax reform and new spending measures. If NAFTA survives, it’s perhaps with the realization on the American side that further delay may be enough to create uncertainty and hence refocus economic activity to the U.S. anyway.
NAFTA and the Granite Portfolios
Putting all of this in the context of our portfolios, we have been biased towards non-domestic equities for some time. NAFTA has clearly been a tail risk. More central though, we have seen our case founded on the regional difference between broader factors including economic fundamentals and government policy. As always, we monitor market developments closely, and reposition our portfolios in an effort to enhance returns and manage risks.
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