Why NAFTA's Fate Isn't Decided Yet

4 MINS READFeb 6, 2017 | 09:15 GMT
Why NAFTA's Fate Isn't Decided Yet
Mexican President Enrique Pena Nieto (L) and his U.S. counterpart, Donald Trump, hope to open talks on NAFTA. The dialogue's fate will be determined in part by where the United States comes down on its border wall and trade deficit with Mexico.

A diplomatic feud over trade and border security has been brewing between the United States and Mexico for over a week. At the center of it is the North American Free Trade Agreement (NAFTA), which encompasses the United States, Mexico and Canada and which new U.S. President Donald Trump claims is unfair to the United States. In a recent breakthrough, officials from both sides declared their desire for a dialogue to amend NAFTA. Agreeing on the need to talk is a positive step, but whether the talks make headway will depend almost entirely on the moves each party makes before it even gets to the table.

It is no surprise that one of Trump's first orders of business has been to reshape Washington's relationship with its neighbor to the south. In this year's annual forecast, we predicted that:

"The North American Free Trade Agreement will remain largely intact in 2017 despite U.S. campaign promises made to the contrary in 2016. The fact of the matter is that the trade ties and supply chains of North America are so tightly bound that a sudden and dramatic reversal to an agreement such as NAFTA would contravene the interests of all its members. The United States will nonetheless renegotiate the deal, albeit gradually, to honor the campaign promises made by president-elect Donald Trump. Those talks will likely extend beyond 2017."

So far, this timeline appears to be intact. Wilbur Ross, Trump's nominee for secretary of commerce, is slated to lead the talks with Mexico once his appointment is confirmed, and Mexican officials are eager to begin the discussion by midyear. But many important questions about the negotiations have been left unanswered, including what their scope will be. For instance, a broad discussion of NAFTA's future could slow or stall in the face of its complexity, while talk of deportations and a proposed border wall might create enough controversy to impede progress on trade issues.

Most of Trump's more contentious statements regarding Mexico, including his demand that the Mexican government pay for a wall along the two countries' shared border, are more rhetoric than actual threat. But in any negotiation, perception matters. From a political standpoint, Mexican President Enrique Pena Nieto cannot easily try to broker a truce with the White House if Trump continues to insist that Mexico City finance a border wall it does not want. In fact, any attempt to do so would risk popular backlash in Mexico against Pena Nieto, and perhaps against his efforts to negotiate NAFTA's future.

Uncertainty surrounding Trump's plans for the two countries' trade ties could also throw a wrench in things, particularly if the White House tries to link NAFTA negotiations to policies that would hamper the growth of the Mexican economy. The new U.S. administration has floated the idea of reducing its trade deficit with Mexico by imposing hefty taxes on imports of Mexican goods. If the White House follows through with the proposal, or if it tries to erect other barriers to trade between the United States and Mexico, Pena Nieto will have a hard time justifying working with Washington on the free trade zone. In the end, Mexico hopes to preserve as much of NAFTA's original form as possible, but it cannot ignore the risk that negotiations may fail, leaving Mexico City holding the bag.

Of course, that does not mean the talks are doomed. Fiery words aside, the collapse of NAFTA would have immediate and serious consequences for both countries' economies. Manufacturing supply chains would rupture, uncertainty would reign, and jobs would be lost on both sides of the border — including in U.S. states currently held by the Republican Party, such as Texas and Michigan. Meanwhile, a rapid depreciation of the peso, capital flight and a dip in foreign direct investment would slow Mexico's economy to a crawl as the two countries scrambled to piece together a new trade deal.

The economy would not be the only concern. Faced with deteriorating economic conditions in Mexico, more undocumented immigrants would flow northward across the border. Those numbers would rise even higher if inflation skyrocketed in response to the depreciation of the peso. (That said, a depreciated peso, coupled with Mexico's proximity to and integration with the United States, could actually help to keep a fairly healthy trade relationship alive between the two in the long run.)

For now, the United States and Mexico appear ready to set aside their differences long enough to broach the thorny subject of NAFTA. But how much success those talks yield — or whether they are destined to fail before they even begin — will depend on whether both sides can see eye-to-eye on the trade deal's details, and where the United States comes down on its border wall and trade deficit with Mexico.

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