The Potential Effects of a U.S. Withdrawal from NAFTA

February 1, 2018 | Simpler Trading Team

As President Trump gave his first State of the Union Address on Tuesday night, one topic was glaringly absent…

NAFTA.

The North American Free Trade Agreement is a trade agreement between the United States, Canada, and Mexico which took effect on January 1, 1994.

While campaigning, Trump called NAFTA “the worst deal ever” for the U.S. Now, 24 years after going into effect, President Trump is threatening to pull the U.S. out of NAFTA if the agreement can’t be renegotiated to favor the U.S. more heavily.

What does this mean for the economy and the markets?

Essentially, NAFTA was created to increase trade between these three countries by removing tariffs from imports and exports on all industrial goods. And it has succeeded in that regard, as trade has increased significantly in North America.

Sen. McCain Opposes U.S. Withdrawal from NAFTA

In 1993, the year prior to NAFTA’s implementation, bilateral trade between Mexico and the U.S. sat at $290 billion. In 2016, that number rose to $1.1 trillion — about a 300% increase. While in 2017, bilateral trade between the U.S. and China was just half that number — $650 billion.

While trade has increased significantly between the U.S. and Mexico as a result of NAFTA, that only accounts for 1% of the U.S.’s GDP.

What could hurt more if the U.S. pulls out would be jobs. According to the U.S. Chamber of Commerce, about 14 million jobs rely on NAFTA, with at least 6 million of those jobs being within American borders.

Critics of NAFTA say that the deal is responsible for hundreds of thousands of manufacturing jobs being lost to Mexico, particularly in the Rust Belt. However, even if the country withdraws from NAFTA, those jobs don’t necessarily come back home.

But many industries rely on cheap labor from Mexico. The auto industry being an example, with 20% of all North American light vehicles being produced in Mexico. Withdrawing from NAFTA could potentially hurt the U.S. auto industry more than any other sector. Another sector that could find itself in a similar boat — electronics.

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U.S. consumers also pay lower prices for food and goods produced in Mexico, which would change the instant NAFTA was no longer in effect. But it’s not just food imports that could suffer, but U.S. agriculture, as well. According to the U.S. Department of Agriculture’s Economic Research Service:

“With the productivity of U.S. agriculture growing faster than domestic food and fiber demand, U.S. farmers and agricultural firms rely heavily on export markets to sustain prices and revenues.”

With Mexico and Canada being neighbors, they make the most logical trade partners for perishable goods. With no protection from tariffs, and a potential trade war looming, U.S. agriculture could be hit hard by withdrawing from NAFTA. Increased tariffs on agricultural exports would drive down demand and potentially cost Americans jobs.

While jobs may or may not be on the line, the stock market almost certainly is. In a letter to their clients, Oxford Economics warned that a U.S. withdrawal would lead to higher inflation, increasing rate hikes and tightening of monetary policy by the Fed. As a result, the dollar would strengthen, slowing stock market gains, or even causing the market to drop. The companies whose shares would suffer most would be those with operations in all three NAFTA countries, such as Ford, Coca-Cola, HP, GE, and GM.

Watch the Video Below to See What Fox News Has to Say on the Topic:

Consequences of withdrawal aside, Trump is unpredictable.There’s no saying whether the U.S. will really pull out of the agreement, or if it’s just a leverage tool. For now, we wait. The three countries will meet this month in Mexico City for another round of negotiations regarding the fate of NAFTA.

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