In The Media

'Everything is in play': What could happen to our auto industry if NAFTA falls apart

by Alicja Siekierska (feat. Eric Miller)

Financial Post
January 4, 2018

The General Motors Co. plant in Oshawa, Ont., has been gearing up over the past several months to start producing GMC Sierras and Chevrolet Silverados this year. The $400-million investment will help it meet rising truck demand across North America, the automaker said.

But while the plant is being repurposed to pump new trucks off the line, contentious negotiations around the North American Free Trade Agreement — which could dramatically impact the auto industry — have continued. Indeed, the very future of GM’s truck production in Oshawa may be in question if Canada and Mexico can’t prevent the United States from sprinting out the exit it appears to be eagerly eyeing.

Goldman Sachs said in a recent report it expects the U.S. to announce its intention to withdraw from NAFTA, which U.S. President Donald Trump has called the “worst trade deal ever made” and repeatedly threatened to terminate.

Without NAFTA, truck exports to the U.S. face a steep 25-per-cent tax, which analysts and economists believe would force GM to move truck production from Oshawa to one of its facilities south of the border.

“There would be fairly significant immediate consequences in terms of investment decisions and production mandates for plants if negotiations fell apart,” said Dan Ciuriak, a senior fellow at the C.D. Howe Institute and an international trade consultant. 

Although GM Canada spokesperson Jennifer Wright said the company is “focused on a successful launch and (doesn’t) find speculation useful,” others say Canada’s auto industry, which is highly integrated with the U.S. and Mexico, is particularly vulnerable in the event NAFTA collapses. They expect exports to decline since new tariffs could potentially drive up the price of vehicles. 

But exactly what would happen to the Canadian automotive industry in a post-NAFTA world depends on many factors, such as whether a bilateral trade agreement with the U.S. is pursued, which Ciuriak said could leave Canada’s economy essentially unharmed.

Eric Miller, president of Washington-based Rideau Potomac Strategy Group and an adviser on the 2009 auto bailout, likened NAFTA negotiations to an old building set for demolition.

“Everything is in play, because it depends on whether the building falls nicely in on itself without damaging surrounding buildings and you can quickly rebuild a new structure, or whether it falls into neighbouring buildings and it’s a big mess for a long time,” he said.

If NAFTA falls apart, Miller said we should know within six months to a year “whether it is devastating, relatively neutral or actually positive.”

Some economists and automotive companies, including Guelph, Ont.-based auto-parts manufacturer Linamar Corp., expect the countries to revert to the 2.5-per-cent most favoured nation (MFN) tariff set out under World Trade Organization rules.

But the 2.5-per-cent rate only applies to vehicle exports to the U.S. The truck tariff would be set at 25 per cent.

Brett House, deputy chief economist at the Bank of Nova Scotia, said about 50 per cent of Canada’s overall trade with the U.S. would be affected by the move to MFN rates, but the auto industry could be particularly impacted.

“The 2.5-per-cent tariff is not such a big deal overall, but it is a big deal for the auto sector because production is so integrated across borders,” he said, pointing out that it’s commonly believed auto parts may cross the border six to eight times during production. “The problem is if they cross that much, you are potentially compounding that 2.5-per-cent tariff multiple times.”

House expects that if the U.S. pulls out — something he thinks is unlikely — the 2.5-per-cent MFN rate may push Canada and the U.S. to negotiate a bilateral trade deal, such as the previous Canada-U.S. Auto Pact.

C.D. Howe’s Ciuriak said MFN tariffs would likely force companies to reassess and optimize their supply chains to reduce cross-border activity, something that “would reduce the degree of integration between Canada and the United States.”

He also said automakers may opt to leave their production facilities where they are and pay the 2.5-per-cent tariff, which could be offset by other repercussions from NAFTA’s demise.

“A devaluation of the Canadian currency in the wake of the lapse of NAFTA could offset the tariff completely,” Ciuriak said.

A recent C.D. Howe report, authored by Ciuriak, studied the implications of three scenarios: NAFTA lapses; NAFTA lapses but a Canada-U.S. free-trade agreement remains; and NAFTA lapses, but Canada-Mexico free trade remains.

The report said a full reversion to MFN tariffs under WTO rules would result in an 8.65 per cent decline in the total value of NAFTA exports of goods and service to the North American region to about $122 billion by 2023. Canadian exports would decline by $20 billion, or 2.8 per cent, something the report called “important but not apocalyptic.”

However, Canada’s trade volume would essentially remain unchanged if a bilateral free trade agreement with the U.S. was struck, with estimates suggesting “minor trade gains, largely at Mexico’s expense.”

The report also said Canadian auto industry exports would decline by $5.2 billion if NAFTA lapses, but increase by $1.1 billion if free trade with the U.S. remains.

Of course, Canada would not be the only country to experience economic loss if NAFTA collapses.

“The sharp and narrowly felt pain in the U.S. automotive and farm sectors means that this battle will be fought within the United States, between U.S. stakeholders, Congress and the White House, as much if not more than between Canada and Mexico and the Trump administration,” the C.D. Howe report said. “Indeed, awareness of this reality may even make the Trump Administration’s threat to terminate NAFTA look like a bluff.”

A major point of contention in the negotiations has been automotive rules of origin, which currently stipulate that vehicles must contain at least 62.5-per-cent North American parts in order to get access to the NAFTA market.

The U.S. has proposed hiking that level to 85 per cent and introducing a 50-per-cent U.S.-specific content rule, which was called “wholly unworkable” by Canada’s chief negotiator.

“The U.S. domestic content provision they’ve proposed, which is a minimum of 50 per cent U.S. content, would tend to attract production in the U.S. at the expense of Canada and Mexico,” Steve Verheul told a House of Commons trade committee in December, adding that the proposal is one the biggest concerns for negotiators.

“Many suppliers would move to the U.S. to ensure that they could make that minimum 50 per cent. Meeting that 50 per cent would be the first priority of any manufacturer or any parts manufacturer. We have said that this part of the proposal is entirely unacceptable.”

A Scotiabank Economics report released in late December said tightening the rules of origin on autos and auto parts may actually drive production overseas instead of to the U.S., especially since electronic components make up a greater part of vehicles.

“An (85 per cent NAFTA, 50 per cent U.S.) rule of origin would already be nearly impossible to satisfy and is likely to become even more difficult to meet in the future,” the report said. “For some models with habitually low profit margins, such as compact cars, entire production lines could be moved to lower-cost jurisdictions outside of North America if NAFTA’s rules of origin are tightened.”

The report also said truck production at GM, Ford Motor Co. and Fiat Chrysler Automobiles NV — three companies that rely on substantial profit margins from light-truck production — would be particularly hard hit by tighter rules.

One result could be to move production out of Mexico, where at least six different trucks are being produced, and halt any pickup production in Oshawa.

“Light truck makers would likely face a costly shift to reconfigure their supply chains toward higher cost production in the U.S.,” the report said.

Many U.S. automakers and politicians are adamantly against pulling out of NAFTA since they say it would hurt the U.S. economy, but Trump’s threat to leave will hover over officials as they prepare for a sixth round of negotiations, scheduled to take place at the end of January in Montreal.

“The U.S. has formulated a negotiating position that aims to increase uncertainty about access to the U.S. market and, therefore, reduce the incentive for American corporations to use foreign countries — including Canada — to produce and export goods back to the U.S,” Ciuriak said.

“I can’t see this being decided by Canadian or U.S. negotiators. This has to be decided by the U.S. auto companies.”

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