Why Does NAFTA Matter to Canadian Investors?
The answers adds up to $1 trillion in growth
NAFTA is one of the largest free trade agreements in the world. NAFTA eliminated tariffs between the US, Mexico, and Canada which means each country can produce what they are best at and trade without barriers. Each country ends up better off as free trade facilitates growth.
As neighbours, if I can produce oil for $45 a barrel and you can produce iPhones for $500 and it costs us both double to make the opposite goods we should trade. Given these costs it makes more sense to each to do what we are good at and trade. We each do what we are better at and the economy grows. Free trade means this exchange happens without a tax on the goods by each country that would make it less attractive.
There are many reasons NAFTA has helped Canada. Here are just a few:
- Canada is resource rich and oil and gas are the largest Canadian exports to the US
- Foreign trade makes up over half of Canada’s GDP and three quarters of Canadian exports go to the US
- Half of Canadian jobs are directly or indirectly trade dependant
All three economies have grown since NAFTA was signed and trade between the three countries has reached $1 trillion
The Impact to Canada of Proposed Additions to NAFTA
The US, lead by Trump, is proposing a number of changes that Canada and Mexico are opposed to. Trumps main argument is that NAFTA has cost the US jobs. However, more American jobs have been lost to machines and automation than have moved from the US to Mexico.
One of Trump’s fist initiatives after taking office was to open NAFTA and the conversations are ongoing. While any country can leave NAFTA all three have to agree so there is a lot of work left to go. There are a few clauses that are under heavily negotiation.
Five-year sunset clause
This would expire each agreement after five years unless it is renegotiated successfully. This would decrease certainty and increase costs of negotiation. It would slow investment in Canada as ongoing free trade to the US would be uncertain. The changes would be gradual but impactful. For example Canada recently had new investment from GM to build a truck line in Canada. Having made this investment, GM is likely to build trucks in Canada and maintain the plant regardless of being able to export the trucks freely to the US. However, with the uncertainty of a sunset clause the next GM expansion in North America will face greater risk of tariffs for any exported cars. This added cost will make Canada look less attractive and the US more attractive (less risk) and Mexico more attractive (less cost).
Remove formal disputes settlements
The US wants to remove formal disputes settlements. This would take away the formal process and the ability to have a final and binding decision. In addition, the current process protects Canadian investors in the US and Mexico by giving them the same rights as domestic investors. Without this protection fewer Canadian companies would move part of their manufacturing to the US or Mexico fearing they will not be treated fairly.
Increased US content in manufactured goods
The US wants to increase NAFTA country content to 82% (so a car would have to be made of at least 82% parts from US, Canada, Mexico). Further the US components have to be at least 50% (so a minimum of 41% of the car from the US). If you include intellectual property and technological investment this is not too far off. However, there is a long way to go to turn this into an agreement.
There are three most likely outcomes. The first option – we keep ‘talking’ and given the elections in the US and Mexico it becomes a low priority. This continues the status quo with a little more uncertainty since it will continue to be on Trump’s agenda.
Second option – one leader pulls out. Any one of Canada, Mexico, or the US can pull out of the agreement. If NAFTA is dissolved Canada will still have favoured nation status but with fewer incentive to trade or invest in cross border manufacturing. Over the medium to long term there will be greater uncertainty when investing in Canada. International manufacturing in particular is likely to slow in Canada, as an open door to the US was one of our selling points. Despite the threats and tweets Trump is unlikely to pull out of NAFTA as the US also benefits from the agreement.
The third outcome is most likely in the long term. In years rather than months there will be agreement to new clauses. However, this is not likely to happen soon and the impact will depend on the clauses that are changed. There are a lot of negotiations to go before this occurs.
For each situation the short-term harm to Canada is the uncertainty. People and corporations are slower to invest when there is looming uncertainty.
Bottom Line for Investors
Live in Canada invest in the US. We are incredibly lucky to live in Canada and that wouldn’t change regardless of what happens with NAFTA. There should be minimal impact for most people, especially in the short term.
For your personal finances NAFTA is just one more reason to diversify. The US will continue to grow and is a source of geographic diversification (i.e. it is a different country) and an opportunity to invest in industries that are underrepresented in Canada (like tech and health care which have boomed over the last year). While you’re at it consider investing in Europe and emerging markets. Neither of these will be directly impacted by NAFTA so provide diversification while being good investments.
Diversification is especially important in your retirement savings. Any extra growth will compound over your lifetime. Your retirement plan also has a longer time horizon, so NAFTA, or lack there of, may have a greater impact on your portfolio by the time you retire if you don’t diversity.
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