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If NAFTA dies ‘all hell will break loose’

Maclean's logo Maclean's 2017-11-14 Aaron Hutchins
A truck passes a Canadian flag reading "Canadian Made Matters!" at a picket line of the auto workers union Unifor outside the General Motors Co (GM) CAMI assembly plant in Ingersoll, Ontario, Canada October 13, 2017. (Chris Helgren/Reuters): A truck passes a Canadian flag reading “Canadian Made Matters!” at a picket line of the auto workers union Unifor outside the General Motors Co (GM) CAMI assembly plant in Ingersoll, Ont. on Oct. 13, 2017. (Chris Helgren/Reuters)© Used with permission of / © Rogers Media Inc. 2017. A truck passes a Canadian flag reading “Canadian Made Matters!” at a picket line of the auto workers union Unifor outside the General Motors Co (GM) CAMI assembly plant in Ingersoll, Ont. on Oct. 13, 2017. (Chris Helgren/Reuters)

To understand how the President of the United States views the North American Free Trade Agreement, as with anything, one need only check Twitter. In August, Donald Trump tweeted that Canada and Mexico were “being very difficult” in the negotiations. “May have to terminate?”

It’s a threat the President has repeated on multiple occasions, having at various times called NAFTA the “worst trade deal in the history of the world” and “the greatest disaster trade deal in the history of the world” and all terrible points in between.

It has become reassuringly common to dismiss Trump’s hyperbole as the hardball negotiating tactics dished out in his book The Art of the Deal—bluster that will eventually give way to some measure of compromise and an updated NAFTA—but the dire news trickling out from the talks is forcing a harsh rethink, and there’s growing reason to fear the worst. Based on various reported leaks, American negotiators have demanded steep concessions from Canada, such as rules that would require at least half of all parts in vehicles to be made in the U.S., or that a “sunset clause” be added that automatically terminates NAFTA every five years unless all three sides agree to renew it. Canada considers both demands to be poison pills.

Which is to say no one should really be surprised if Trump declares his intent to pull the U.S. out of NAFTA in a 5 a.m. tweet.

That brief bombshell would presumably be followed by a formal notice under NAFTA Article 2205: “A party may withdraw from this agreement six months after it provides written notice of withdrawal to the other parties. If a party withdraws, the agreement shall remain in force for the remaining parties.”

MORE: That time a kooky leader bizarrely killed a Canada-U.S. free trade deal

The question on the mind of every CEO, union leader, politician, investor, auto worker and trade lawyer—indeed, anyone with a stake in NAFTA’s survival—is what next?

After quarter of a century under NAFTA, our three economies are deeply intertwined, with spiderwebs of supply chains criss-crossing borders. In 2016, Canadian exports to the U.S. stood at $454 billion, according to Export Development Canada, about three-quarters of all outward trade from Canada. That’s equal to roughly 20 per cent of this country’s economy. Canadian companies, meanwhile, currently have roughly $475 billion worth of cross-border investment in the U.S., and NAFTA supports about 3.4 million Canadian jobs by way of trade and investments with the U.S. (Technically, Mexico and Canada would still be bound by NAFTA, even without America as a member. However, Canada’s exports to Mexico amount to a relatively paltry $8.8 billion.)

With the U.S. out of NAFTA, experts say, prices on everything from cars to groceries are expected to climb. Tens of thousands of jobs would be at risk as supply chains are torn apart and retaliatory protectionist measures crimp growth in both countries. Stock prices, particularly for export companies that depend on the U.S. market, would be sent into flux, and the loonie would plunge. Meanwhile, in Ottawa, the Trudeau Liberals would face searing questions about what went wrong.

“To put it bluntly,” says Ian Lee, an associate professor at Carleton University’s Sprott School of Business, “all hell would break loose.”

***

For more than 20 years, NAFTA has been a source of economic growth for the world’s largest trading bloc. Most economists view the free trade deal as a net positive for the three nations. In a speech in August, Foreign Affairs Minister Chrystia Freeland said Canada’s economy is 2.5 per cent larger every year than it would be without NAFTA: “It is as if Canada has been receiving a $20-billion cheque each year since NAFTA was ratified.”

Now imagine the uncertainty if that figurative cheque were suddenly torn up.

WATCH: Can Trump kill NAFTA?

It’s safe to say that companies with the heaviest exposure to the U.S. will be hit hardest and fastest. “Canadian exporters would really get hammered in the capital markets,” Lee says. “When markets are uncertain, you err on the side of caution. What would the market do to those companies? They wouldn’t know how much of their sales would be going down. I can’t predict a number, but it would have very profound negative consequences for those companies.” As a ripple effect, banks would also start to take a harder look at their lending exposure to export-focused business. “If a company is exporting to the U.S., they’ll be reviewing whether to increase their interest or reduce their line of credit to mitigate risk,” he says.

NAFTA’s demise would also instantly send shock waves through currency markets, putting the loonie into a tailspin. That should provide a cushion to exporters, since their products will be cheaper for American consumers to buy. But whether the currency discount would be enough to make up for any higher tariffs in the aftermath of NAFTA is a key question. The flip side of a weaker Canadian currency is that goods in Canada would cost more. For companies, that means forking out more to import equipment, tools and services to run their businesses. All these uncertainties would likely leave businesses wary of adding new staff, and may even spur some to cut costs, threatening to send Canada’s bustling job market into reverse.

Since Trump’s election, Justin Trudeau has repeatedly stated that the country is “ready for anything.” But could anyone really be ready for this?

***

As with every facet of the Trump administration, nothing is straightforward. One question being asked on both sides of the border is: Can Trump effectively kill NAFTA all by himself?

If you had asked most American legal scholars this question last year, they would have told you the president does have authority to trigger a withdrawal from free trade agreements, says Mark Warner, a Canadian and U.S. trade lawyer. “That was the mainstream consensus view—circa November 2016.”

Now, Warner says, “there’s a newer group of scholars and lawyers advancing the principle that no American president—and particularly not this American president—has that constitutional authority to trigger a withdrawal from NAFTA.” Instead, it’s argued that Trump needs the support of Congress to do so—a bet, perhaps, that Republicans, traditionally the party of free trade, would stand up to their president in defence of NAFTA.

“You’ve got presidential powers on one side and congressional powers on the other. How this process works, I have no idea, because nobody does,” says Jon Johnson, senior fellow at the C.D. Howe Institute in Toronto. “This is uncharted territory because no president has ever wanted to get out of a trade agreement.”

The reason there’s a six-month notice period to withdraw from trade deals stems from a provision in the U.S. Trade Act of 1974. “What it doesn’t say,” says Johnson, “is who can give that notice.”

RELATED: What Mexico really wants from a free trade deal: respect

So if Trump unilaterally withdraws the U.S. from NAFTA, expect a flurry of lawsuits seeking a stay on his order, says Warner. That would delay the six-month notice period until the courts have ruled. “When one court in a Democratic-leaning state inevitably rules against Trump, everyone in Canada will go, ‘See! See!’” says Warner. For what it’s worth, Warner predicts the U.S. Supreme Court will ultimately side with the White House, setting NAFTA’s doomsday clock in motion.

***

Few people working in trade law today have bothered to read the 1989 Canada-U.S. Free Trade Agreement (CUSFTA). Why would they? The deal was suspended when NAFTA took effect in 1994. But the paperwork has been dusted off in recent months as policy-makers debate whether this old deal—despite its imperfections—might be awakened from its quarter-century coma should Trump pull America out of NAFTA.

Some maintain the original deal will automatically take hold, meaning Canada and the U.S. would still enjoy tariff-free trade across many industries even without NAFTA. Others aren’t so sure—even those informing U.S. Congress: “The [CUSFTA] potentially could snap back into force after a withdrawal from NAFTA,” reads a Congressional Research Service report from May 2017, “but it may require the issuance of a presidential proclamation to return it into force.”

Yet some experts are taking a closer look at the CUSFTA and finding it may not be the post-NAFTA saving grace some Canadians hope for. For instance, one point of contention in the current talks is NAFTA’s chapter 19, titled “Review and Dispute Settlement in Antidumping and Countervailing Duty Matters.” The Americans want to be rid of the measure—which allows for a third-party arbitration system to handle disputes where penalties have been applied—but Canada has stood firm. Chapter 19 has been referred to as Canada’s “red line” for negotiations.

The CUSFTA also had a chapter 19 dispute resolution chapter. So if NAFTA dies, would Canada be able to rely on that version to take its place? Probably not, say experts. “Go back to CUSFTA and you’ll find that chapter 19 was sunsetted for five years and technically is expired,” Warner says. That means if the CUSFTA takes effect, “the Americans could technically give notice that they regard it as finished.”

Or Trump might simply decide not to issue a proclamation to bring CUSFTA back to life at all. In all his talk of unfair trade deals, the president has largely directed his ire toward Mexico for what he perceives as the unfairness of NAFTA. But that doesn’t mean he’ll be in a hurry to restore Canada’s free trade safety blanket. After all, doing so would undercut the U.S.’s negotiating position.

It’s entirely possible, then, that Canada and the U.S. could be without any free-trade deal six months from the day Trump gives the word.

***

The absence of a free-trade deal between the U.S. and Canada does not mean there would be no trade between the two countries. The U.S. would remain Canada’s largest trading partner. The question is just how much that cross-border trade ($673 billion in 2016) will drop.

US President Donald Trump (R) welcomes Canadian Prime Minister Justin Trudeau at the White House in Washington, DC, on October 11, 2017 (SAUL LOEB/AFP/Getty Images): US President Donald Trump (R) welcomes Canadian Prime Minister Justin Trudeau at the White House in Washington, D.C., on Oct. 11, 2017 (SAUL LOEB/AFP/Getty Images)© Used with permission of / © Rogers Media Inc. 2017. US President Donald Trump (R) welcomes Canadian Prime Minister Justin Trudeau at the White House in Washington, D.C., on Oct. 11, 2017 (SAUL LOEB/AFP/Getty Images)

Faced with uncertainty, economists are trying to find reasons to remain optimistic. “We don’t have free trade deals with China and they’re still our second-largest trading partner,” says Jacqueline Palladini, a senior economist with the Conference Board of Canada.

Still, trade barriers would begin to be erected if NAFTA dies and the old Canada-U.S. free trade deal remains dormant. Exports from Canada to the U.S. could be subjected to a maximum tariff of 3.5 per cent under the World Trade Organization’s “most favoured nation” provision, to which Canada would almost certainly respond with its own tariffs on imports from the U.S. “For Canada, under WTO rules, we’d have to put up barriers with the U.S., and the retaliation would be one of the biggest sources of negative impact for us,” says Dan Ciuriak, a former deputy chief economist with the Department of Foreign Affairs and International Trade.

Things would suddenly get more expensive for Canadians. The free flow of goods across North American borders has played a big part in keeping consumer prices in check. The mix of higher tariffs, a falling loonie and the inevitable “buy American” and retaliatory “buy Canadian” protectionist policies that would follow NAFTA’s collapse would all serve to push up prices for consumers.

What’s more, says Ciuriak, Canada would instantly become less of a draw for companies: “We had positioned ourselves globally as being a good place to invest because we have access to the North American market. [NAFTA’s demise] would make Canada less attractive for companies looking to establish global mandates.”

RELATED: Nations ponder how to deal with Trump’s ‘withdrawal doctrine’

Ciuriak isn’t predicting companies will pull up roots and flee Canada, but they will be less likely to invest and expand their operations here, and international businesses looking to set up operations in North America may opt to bypass Canada altogether. Business investment in Canada, a crucial driver of economic growth, has barely risen from where it was before the Great Recession a decade ago. The collapse of NAFTA would only weigh investment down further.

Bank economists have analyzed various post-NAFTA scenarios. Much depends on the thickness of the walls erected in its place. When Scotiabank economists crunched the numbers earlier this year, they looked at what would happen if the 3.5 per cent tariff were applied to all goods traded between Canada, Mexico and the U.S. The answer: Canada’s real GDP growth (a measure of the economy that accounts for inflation) would slow by about half a percentage point.

However, Trump has also threatened to pull the U.S. out of the World Trade Organization. If the president does cancel NAFTA, it becomes far more likely he’d follow through on this threat, too. And that could mean even higher tariffs. For instance, Scotiabank looked at a scenario in which the U.S. applied a tariff of 20 per cent on imports from Canada. In that instance, annual growth in 2018 would slow from the current projection of two per cent to 0.6 per cent, and in 2019, growth would slow to just 0.1 per cent. Scotiabank also acknowledged that its simulations don’t reflect the maximum possible impact of NAFTA’s demise, such as the onset of a global trade war “that would be a major brake on global growth.”

“GDP could slip into what could be close to a recession, but keep in mind you’d also see a response from monetary policy,” says Brett House, a deputy chief economist with Scotiabank. “Interest rates would probably drop close to the zero lower bound again to keep the economy from tipping into a recession.”

This time around, however, there’s far less room for the Bank of Canada to manoeuvre. In the 2008 recession, the bank ultimately chopped its target overnight rate from 4.5 per cent to 0.25 per cent. Today that rate stands at just one per cent.

The reality is that if the worst-case scenario unfolds, and Trump not only scraps NAFTA but erects a thick wall, no one really knows how bad things could get.

***

Upon occupying the White House in January, Trump made a “contract” with the American people that in his first 100 days in office, he’d decide to either renegotiate the trade deal or simply withdraw from it.

MORE: Justin Trudeau’s mission to save NAFTA

For a brief moment, all signs seemed to point to the latter. By late April, with Trump’s arbitrary 100-day deadline looming, a draft order to pull the U.S. out of NAFTA was reportedly in the final stages of review. Then Trump tweeted that he’d received phone calls from both Trudeau and Mexican President Enrique Peña Nieto asking him not to terminate the deal, and he obliged.

Trudeau has since been lauded for his calm demeanour during talks with Trump. Meanwhile, Team Canada, made up of diplomats, politicians, lobbyists and executives, has travelled the U.S. to meet with governors, mayors, congressmen and business leaders to talk up the benefits of NAFTA. Even so, if Trump decides he’s done with the agreement, Trudeau’s government could be among the first big casualties.

“Any prime minister of Canada—doesn’t matter what political party—has two things in their job description: don’t lose Quebec on your watch and don’t mess up the relationship with the United States,” says Lee, the Carleton University professor. “If you mess up either one of those two things, you lose your job.”

As catastrophic as it would be for Canada if Trump terminates NAFTA, it’s worth noting that optimism for the deal’s future still prevails. None of the economists, academics or trade lawyers interviewed for this article believe NAFTA will ultimately cease to exist—Trump’s bluffing, they say, or the Republicans in Congress will stop him, or someone from Trump’s inner circle will intervene before it’s too late, or Canada will have to agree to concessions to keep the deal alive.

Still, there are those with first-hand experience negotiating trade deals who think otherwise.

“I also believe that President Trump’s threat to terminate NAFTA is not a bluff,” wrote former prime minister Stephen Harper in a memo that was leaked last month. “I believe this threat is real.”

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