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Renegotiating NAFTA: Are We There Yet?



Dan McGeown, Tax Advisor, Toronto, Canada, TaxConnections

Canadians could be forgiven for experiencing at least some NAFTA fatigue. The talks that began back in August have moved along in fits and starts — with little to show in tangible outcomes. Meanwhile, U.S. President Donald Trump has threatened to abandon NAFTA, yet negotiations-watchers have struggled to read his true intentions.

The fifth round of talks ended in late November with some progress but little momentum. Negotiators from Canada, Mexico and the U.S. made headway on technical and less controversial files. However, the primary sticking points remain — among them automotive rules of origin, Canada’s supply management system for the Canadian dairy industry, mechanisms for dispute resolution and U.S. demands for a “sunset clause,” which would automatically terminate a new NAFTA in five years unless all three countries agreed to renew it.

Despite the uncertainty, ignoring the negotiations is not an option. The sixth round runs from January 23 to 28, and we may soon find out whether rhetoric gives way to results.
The stakes remain high for Canadian businesses. Thanks to NAFTA, Canada’s economy is 2.5 percent larger than it otherwise would be, according to Foreign Affairs Minister Chrystia Freeland, an increase of about $20 billion annually. Almost three-quarters of all Canadian exports go to our neighbour to the south, and about 1.9 million Canadian jobs are tied to these exports.

How are Canadian business leaders reacting?

BDO’s NAFTA survey in the fall polled 245 leaders of Canadian businesses to assess the business community’s reaction to the NAFTA talks – and preparedness for the pact’s potential termination. Among the highlights:

  • Three-quarters of business owners believe NAFTA will affect their business decision-making, regardless of their size or location.
  • Survey respondents were concerned an increase in duties would negatively affect their businesses, profitability and ability to compete in the U.S. market. Protectionist “Buy American” rules could harm exporters, increasing prices and duties for American customers of Canadian goods. They also feared job losses, and increases in the cost of doing business.
  • Only 34 percent of respondents are making contingency plans for the potential demise of NAFTA.
  • Operational planning was the contingency planning most cited by respondents.
  • One in 10 (92%) of respondents agreed or strongly agreed Canada should be looking to strengthen trade partnerships with other countries, regardless of the outcome of NAFTA negotiations.

What if NAFTA is terminated?

Since NAFTA talks were first announced, business owners have been concerned about a Canadian business climate sans NAFTA. The BDO survey results echoed these fears, with only 13 percent of respondents expecting a positive outcome for their business from negotiations. Almost half (48%) expect a negative outcome.

The clouds may be lifting, though, as government and business leaders begin to accept a NAFTA-less world. A webinar hosted by BDO in late 2017 analyzed the survey results and offered perspective for the months ahead.

“There are signs it would not be a long-term catastrophe for Canada,” said Dean Elliott, managing partner for BDO’s Central group, in the webinar. “Without NAFTA tying Canada to our close geographical neighbor, Canada could pursue agreements with other global partners.”

Over the last decade, Canada has negotiated a number of free trade agreements. Highlights include a new agreement with the European Union and one with South Korea. Discussions also continue with China and India, and on the Trans-Pacific Partnership, which would further open 10 markets, including Japan.

“CETA — the Canada-European Union Comprehensive Economic and Trade Agreement — is the most important one,” said Pierre Cléroux, vice president of research and chief economist at the Business Development Bank of Canada. “The EU has 500 million people, which is a bigger market than the U.S.”

Specific sectors of the Canadian economy do depend heavily on U.S. sales and would need to adjust their business model. However, the country’s businesses overall are less reliant on the U.S. than they once were.

Emerging countries now play a far larger role in the world’s economy. The U.S. now contributes only 13 percent of GDP growth. Annually, its growth rate is 2% — respectable but not near the pace that China and India (at 7%), Vietnam (6%) or even Malaysia (5.5%) now set.

A free trade vacuum?

If NAFTA falls by the wayside, some observers think Canada and the U.S. will return to their original 1989 agreement, but Cléroux expects the vacuum to be filled by default rules and rates of the World Trade Organization.

“Canadian businesses would need to pay tariffs when they export goods and services to the U.S. The good news is these tariffs are much lower than were 30 or 40 years ago. They would be between 2 to 6 percent, so they wouldn’t have a drastic impact on the Canadian economy.”

Planning amid uncertainty

The protracted NAFTA talks have a created a kind of limbo for Canadian business owners. In the words of BDO’s Elliott, “Overreacting at this juncture could be just as damaging as doing nothing at all.
“Our response to clients is that steps need to be taken to plan, to ensure that your business continues to thrive, no matter the outcome.”

Risk is increasing. As a first response, it is critical that Canadian businesses have a clear understanding of the implications and create plans designed to address them. Undertaking an analysis of the business and seeking the right answers for their individual situation can help protect the wealth they have accumulated and ultimately their legacy.

Business owners and leaders that take this opportunity to explore new markets may find success. If they pursue this route, they should move with purpose but remember that international success is seldom achieved overnight.

“I always tell my clients,” said Elliott in the NAFTA webinar, “to begin with research and answer the key questions: Why should you expand? Where would you like to expand? How to mitigate risk? What is the most effective structure? What business model makes sense for you and your business?

“Look at exports to safe havens and where we already have agreements and a track record of success. And obtain advice from trusted sources, peers, associations — and of course impartial, professional advisors.”

What’s next?

Round 6 of negotiations takes place in Montreal from January 23 to 28. The deadline to complete negotiations has been extended to March 2018.

 

Have a question? Contact Dan McGeown. Your comments are always welcome!

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