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Nafta Demise Emerges as a New Risk for Investors -- The Outlook

15 Oct 2017 5:00 pm
By Jacob M. Schlesinger 

WASHINGTON -- Donald Trump's presidency has so far been largely good for big business and investors, with deregulation in train, hopes for corporate tax cuts, and stocks hitting records. But the risk of a serious jolt now looms: the potential end of the North American Free Trade Agreement, which has governed continental commerce for a quarter-century.

Because the likelihood of a collapse has seemed so remote, analysts are only now starting to assess the implications. The early read: It wouldn't necessarily be catastrophic, but it would be a net negative for the overall economy, cause a big squeeze to some sectors and states and could dent stocks.

"The reversal of Nafta leads to a decline in real GDP, trade, investment, and employment in the U.S., Canada and Mexico," concludes one of the first detailed studies on the subject, by ImpactECON LLC, a Colorado-based economic consultancy. The firm estimates that while some production would move north of the border with Mexico, the U.S. would still suffer a net loss of 256,000 U.S. jobs over three to five years. Mexico would lose 951,000 jobs and Canada 125,000.

Nafta isn't dead yet. Talks to rewrite the pact are continuing, with fresh rounds scheduled through year-end. Even successful negotiations hit rough patches, as partners lay down extreme demands assuming they'll soften during bargaining.

But the current round -- launched last week and slated to run through Tuesday -- has proved unusually contentious. U.S. proposals, like a sunset clause that would subject the deal to regular renewal or a requirement that cars have 50% U.S.-only content to qualify for Nafta breaks, have been branded unacceptable by Mexico and Canada. With wide gaps remaining, all sides now talk openly about the risk of a Nafta collapse.

"We don't desire that it will, we don't believe that it will," Commerce Secretary Wilbur Ross told an audience Wednesday at the Dentons law firm Washington office. But, he added, "it is at least a conceptual possibility."

Most economists are staying away from calamitous warnings. "It would be like a mini-Brexit, with very modest effects on U.S. growth," says Harvard's Kenneth Rogoff, referring to the U.K.'s similar move to extricate itself from the European Union. Just as dire predictions before last year's British referendum have proven exaggerated, so too may be warnings about Nexit. "Most estimates of Nafta's effects on the U.S. have been relatively small in the aggregate," he adds.

The ImpactECON report sees a drop in U.S. GDP of less than a 10th of a percent, with bigger hits of about half a percent to Canada, and nearly 1% to Mexico.

If the pact disappeared without any negotiated unwinding, the three countries would likely impose tariffs on each other equal to those facing their other non-free-trade-agreement partners: a 3.5% average by the U.S., 4.2% by Canada, and 7.5% by Mexico, according to the Peterson Institute for International Economics. If the U.S. and Canada agreed to keep their pre-Nafta free-trade pact in place, they could still have zero tariffs between them.

In Brexit, the ultimate impact depends heavily on the terms and timing, still being negotiated more than a year after the referendum passed. An American exit could have a similarly long transition, on terms less disruptive than worst-case scenarios floated. The interdependence built up under Nafta may prove more durable than Nafta itself. The Mexicans would have the authority, say, to impose 9.5% tariffs on U.S. corn, but might not want to raise prices so much on the $2.5 billion their consumers have gotten used to purchasing.

"Even if the legal framework of Nafta is formally repealed, the infrastructure that Nafta has created will remain," predicts Guillermo Ortiz, former head of Mexico's central bank.

That doesn't mean a painless death. Just as some towns and companies suffered under Nafta, sectors and regions thriving under the pact risk getting pinched. Border states like Texas and farm states like Iowa have been among the biggest winners from Nafta, and would likely face the biggest hits from any reversal.

The ImpactECON study sees small gains in U.S. production and employment in some machinery and chemical sectors. But those would be offset by bigger losses among auto, food, and apparel makers that have crafted elaborate, efficient supply chains around duty-free passage of parts and goods across borders. Even the restoration of small tariffs would be disruptive and raise costs. The American Automotive Policy Council calls Nafta withdrawal a "$10 billion tax" on the U.S. industry, while auto parts makers say it would force them to cut up to 50,000 U.S. jobs.

Brexit may not have pushed the U.K. immediately into recession, but analysts now see supply constraints and other longer-term problems emerging, like slower worker productivity growth, chilled investment from uncertainty over future rules and higher inflation due to the pound's drop following the vote. In a similar vein, economists warn of a Nexit's incalculable, slow-motion damage to the U.S.

Nafta's collapse would raise broader doubts about American support for the international free-trading system, which most economists believe has lifted U.S. and global growth. "The death of Nafta and what that implies for protectionism and trade wars -- if the risk increased, we'd surely see a stock market correction," says Allen Sinai, chief economist at Decision Economics Inc.

Even some Nafta critics believe withdrawal would do the U.S. more harm than good. Robert Scott of the left-leaning Economic Policy Institute wrote the 2011 report widely cited by Nafta opponents claiming 700,000 U.S. jobs lost from the pact.

Killing Nafta, Mr. Scott says, won't bring them back. With the resulting higher costs, "multinationals like GM, Ford, and Toyota may just decide to shift production to Asia or Europe," he says. "The U.S. benefits from having that production in North America, even if it's in Mexico."

--Greg Ip contributed to this article.

Write to Jacob M. Schlesinger at jacob.schlesinger@wsj.com

(END) Dow Jones Newswires

October 15, 2017 13:00 ET (17:00 GMT)

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