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Economics - Jan 10, 2018

NAFTA's path to survival: the shadow agreement

January 10, 2018

Negotiators from Canada, the U.S. and Mexico are back at it this month, resuming work in Montreal on Jan. 23 to reach consensus on a revised, updated North American Free Trade Agreement (NAFTA). The risk remains that talks could stall out - or even collapse - although this is not our expectation. Even in a worst-case scenario, such as the White House declaring that NAFTA is dead, it could actually remain alive.

This form of “Shadow NAFTA” could be for the good: it could persist long enough for all three parties to reach an eventual agreement that preserves the extensive benefits of the trade pact.

“We expect 2018 to be filled with difficult headlines on NAFTA, but its essential elements should remain largely undisturbed,” says Scotiabank Deputy Chief Economist Brett House. “The challenge for business, investors, and individuals will be to look beyond the headlines.”

You can read the complete analysis from Scotiabank Global Economics here.

WHY NAFTA IS AT RISK

American priorities: The United States is distant from its NAFTA partners Canada and Mexico on key issues. One example is its effort to raise minimum requirements for American content in auto manufacturing. Research suggests this is probably unwise, difficult to define and reliant on questionable data in the first place. Still, Canadian and Mexican negotiators must find a way for their U.S. counterparts to claim victory on this and other ‘red-line’ issues, including supply management of some foodstuffs and access to government contracts.

The ticking clock: There may be too little time to bridge the gaps. Last August, there was optimistic talk of agreement by year’s end. The deadline has since been pushed to March 2018, but with little evidence of significant movement, even that target seems ambitious. If there is no deal by spring, talks may move to a holding phase amid the surge in political campaigning ahead of the July presidential election in Mexico and November midterm elections in the U.S.

The slow lane or the nuclear option: The result would be you might call Shadow NAFTA: a state of extended uncertainty, with negotiations continuing (or pausing) while awaiting a return to greater political stability. Alternatively, the combination of stalled negotiations and political ambitions could push the American president to invoke Article 2205 of NAFTA, which starts a six-month clock to potential withdrawal.

SHADOW NAFTA: KEEP CALM AND CARRY ON

The slow-motion button: Suppose President Trump declares that the U.S. is exiting NAFTA. Then things get really complicated. For one, the six-month notice of withdrawal is neither irrevocable nor automatic. Negotiations could easily continue. Secondly, American constitutional law is not entirely clear on whether the president has authority to withdraw from the agreement, let alone undo the hundreds of regulations and laws that enact the details of the pact. A recent analysis by the Congressional Research Service suggests that legal challenges to such executive action (to be expected from industry and trade groups that favour the cross-border integration forged under NAFTA rules) could delay action by 12 to 18 months – again leaving Shadow NAFTA in place while talks continue.

Call it ‘ExTA’: To exit NAFTA, U.S. courts may find that the order of the U.S. president is sufficient. But to erect something in its place, such as establishing the new tariffs and other rules for Canadian and Mexican imports, the U.S. Congress would almost certainly have to draft, debate and pass a complex bill on a host of sensitive topics. Congress has experienced difficulty over the past year passing simpler and less contentious legislation.

NAFTA in the shadows: In the absence of legislation reversing it, NAFTA would remain the law. This alternative state of Shadow NAFTA would of course be fraught with uncertainty and could undermine investment in Canada and Mexico – although it is relevant to note that there has been no sign of weakening investment intentions in Canada or Mexico so far. But a Shadow NAFTA period could also sustain the agreement long enough for negotiators to get back to the table and seal a deal on the U.S. demand to "renegotiate and modernize" the accord.

WHAT TO WATCH FOR

President Trump needs Congress to extend or renew U.S. Trade Promotion Authority (TPA), which authorizes the White House to negotiate trade agreements and then present them to Congress for a simple yes-or-no vote. The current TPA lapses at the end of June, and any revisions to NAFTA would have to be presented to Congress 90 days beforehand. Any hiccup in the TPA process could could signal additional turbulence for U.S. trade relations.