by Privcap
March 16, 2018

The Impact of U.S. Withdrawal from NAFTA

Privcap: If the U.S. exits NAFTA, what effect would it have on the middle market?

Joe Brusuelas,

Over the past 25 years, the U.S. and its main two trading partners, Canada and Mexico, have built a North American supply chain that has deep roots into U.S. auto manufacturing in general and manufacturing writ large. If the U.S. decides to just withdraw, a lot of the gains in terms of efficiency and output would be lost. And so that’s a generation’s worth of work.

The reason why that will disproportionately affect middle markets is because the large companies who created the ecosystems that spawned from the supply chains and the value chains have decided essentially that they’re going to just take the hits on increasing tariffs and continue to produce offshore or across the border. They then will pass along those price increases to middlemarket companies.

What are the fallacies behind the withdrawal from NAFTA?

There are two basic fallacies. One is that trade is a binary, that it’s a win-lose proposition or a zero-sum game. In truth, the gains from free trade are plentiful. It increases the welfare of all. Welfare benefits are distributed asymmetrically, but you tend to engage in win-win propositions.

The second major fallacy of the move towards protectionism is that it will tend to benefit companies across the spectrum in different industries, who will benefit from increased trade barriers. That’s not true. Those companies are embedded in an integrated North American economy and supply chain. They will see their costs go up. In the short term, that may create a few jobs, but in the medium and long term you will lose jobs, and I think that’s a critical thing to remember when there is talk about disrupting patterns of trade.

If you could rank Canada, Mexico, U.S., who comes out worst in a NAFTA withdrawal?

Mexico is facing the biggest risk. Our forecast is that if there is a U.S. withdrawal from NAFTA followed by a tit-for-tat series of retaliatory moves, you’ll see the Mexican economy in 2019 contract by 2.9 percent. You’ll see imports, exports, and capital investment decline by high double digits. Likely their central bank will lift their policy rate up to 8 percent to stem currency outflows out of the country. In essence, Mexico’s economy will contract sharply, and they would face some gutwrenching policy decisions in the aftermath of this.

Canada would likely see a 0.5 percent hit in terms of growth that would last 18 to 24 months, and then they would emerge. The U.S. would see loss of roughly 0.2 to 0.3 percent on growth, but you would see some seriously significant dislocation in terms of jobs, trade, and capital flows, and of course you’ll see tariffs reset—which we should not talk about them as tariffs. What we should talk about them bluntly as is what they are. They’re taxes on middlemarket firms and consumers downstream.

An interview with Joe Brusuelas, chief economist for RSM, on the impact of U.S. withdrawal from NAFTA.

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