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Canada Politics October 2018

Canada: Investors relieved as USMCA preserves North American free trade

On 1 October, after more than a year of tense negotiations, Canada and the United States agreed to maintain their longtime free-trade relationship, seemingly ending an uneasy chapter of neighborly brinkmanship that, only months ago, had threatened to upend the continent’s trading landscape. In the eleventh hour, Canada’s pact with the U.S. was folded into the “handshake” deal struck between the U.S. and Mexico a month earlier, and together replaced the existing North American Free Trade Agreement (NAFTA) as the rebranded United States-Mexico-Canada Agreement (USMCA). Investors breathed a sigh of relief as, despite the new name, the original agreement’s framework was left largely unchanged; notable tweaks aside, North America’s free-trading bloc looks to have survived 13 months of fraught negotiations intact. While the deal still requires ratification by all three legislatures, unresolved political risk appears minimal as the late-night drama should allow Mexico’s outgoing President Enrique Peña Nieto a chance to sign off on the new terms before leaving office in December. All along, analysts saw asymmetric risk in negotiations; little upside if successful and considerable downside if not. Although all sides were forced to accept a number of unpopular concessions, Canada’s economic prospects are set to benefit from newfound certainty in its trading relationship with the U.S. amid renewed confidence in existing cross-border supply chains.

Most significantly, negotiators appeared to spare the automotive sector from a nightmare scenario. Indeed, the rules of origin are set to include higher North American-content provisions (from 62.5% to 75.0%) and minimum-wage stipulations (worker earnings of at least USD 16 per hour). Nevertheless, most Canadian auto manufacturers look set to sidestep heavier tariffs. Moreover, Canada and Mexico won exemptions to U.S. national security-related auto tariffs as current production levels fall short of the agreed-to quotas. Rules for government procurement, an early target of the U.S., were left untouched in a major win for Canadian negotiators. Meanwhile, two of three dispute-resolution mechanisms—the cross-border appeals process available to aggrieved parties—were left intact, although the ability for slighted firms to sue governments was scrapped. On balance, a fragment of the Canadian dairy market will be opened to American producers. However, given the hard line taken by the U.S. on supply management, these concessions were seen by analysts as relatively minor. Meanwhile, in a loss for Canada and Mexico, existing steel and aluminum tariffs imposed by the U.S. earlier this year were left unaddressed by the new agreement.

Since negotiations got underway, FocusEconomics analysts were confident that a deal would be struck and, to that end, our panel priced-in a successful rewrite from the start. And aside from the more contentious points, a number of necessary updates to the original agreement were also added—including new internet-era rules. That said, although the USMCA is expected to clear up much of the uncertainty hanging over the external sector, some ambiguities remain. These include the introduction of a 16-year sunset clause—whereas NAFTA contained no such provision—and, in a swing at China, vague provisions barring members from pursuing free-trade deals with “non-market economies”. Although both points generate some degree of doubt, the USMCA nevertheless guarantees that free trade will persist in North America for the foreseeable future and should avert all worst-care scenarios.

Commenting on the news, Derek Burleton, deputy chief economist at TD Economics, noted:

“Despite that deal’s pitfalls and hurdles that it could face before implementation, general reaction has been swiftly positive. By removing a significant cloud of uncertainty around trade, it is very likely to be growth positive, especially for Canada and Mexico. […] The Canadian dollar is already benefitting from the news, reaching a four-month high of 78 US cents. […] From a broader global risk perspective, this weekend’s announcement spells good news. It shows that the U.S. can negotiate a trade deal rather than merely toss around threats and impose duties.”

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