NAFTA: Up the creek without a paddle?

Much has been said about President Trump’s threat to dismantle the North American Free Trade Agreement and the potential impact it could have on its direct southern neighbour. However, the implications of any re-negotiation or dismantling of the treaty would be more far reaching than first meets the eye, as issues such as immigration, remittances, trade and import taxes would have a ripple effect in the region, and the collateral damage within Latin America would see Central America and the Caribbean sub-regions take a huge hit (more than Mexico, as a proportion of its GDP), as supported by a recent report published by the Economist Business Unit. Mexico does have reason to worry, however, The US’s protectionist stance under the new administration could also prove to be a catalyst for a brighter and integrated future in Latin America if Mexico and its allies identify the right opportunities and play their cards right.

Trump and His Controversial Appointments

Mr. Trump has demonstrated a strong tendency for erratic behaviour and decision-making throughout the campaign trail, and this trend has followed him into the White House. What he is planning regarding international trade, whether it concerns China, Mexico, or even Canada seems to be on many people’s minds. A perfect case in point is the staffing of the new administration, which is a rather random mix of pragmatic leaders in their field and controversial, and arguably underqualified figures.

On the one hand, Trump has picked Reince Priebus, whom many people feel is ill-suited to the job (the botched job on the recent immigration ban has been widely attributed to him) and Steve Bannon, the former executive chair of Breitbart News, a far-right news, opinion, and commentary website, as his Chief of Staff and Chief Strategist respectively. He also appointed Mike Flynn, who was fired less than a month in the job after evidence surfaced of him having spoken to the Russian ambassador about US foreign policy before being formally appointed.

On the other hand, Trump has replaced Mike Flynn with Lt.Com. H.R. McMaster as his national security adviser, a wise choice given the latter’s achievements in the battlefield and in the academic sphere, as well as the respect gained through his leadership skills and his understanding of the importance of embracing foreign customs and cultures.

The POTUS is Trading in Deep Waters

At this point, POTUS has only signed an executive action (January 23^rd of this year) to “renegotiate NAFTA at the appropriate time”, which buys his administration time to analyse the options available to deliver on his campaign promise. Trump has many options at his disposal, but any renegotiation would mean Canada’s involvement, and an exit from NAFTA would get the WTO involved in some way or another.

The presence of the latter would certainly imply protracted discussions before any results can be delivered. Canada’s position is different to that of Mexico, as the US has a large trade surplus with the Canadians, although they buy three-quarters of Canada’s exports. Even though Trump has publicly described his country’s trading relations with Canada as “outstanding” and that with Mexico as “unfair”, it would be unwise for Mexico to rely on Canada’s leverage to support them in future negotiations, as even Canada’s trading position is not secure with the US. After all, Prime Minister Trudeau was one of the first to meet Mr. Trump to seek clarification on the matter. And in a smart display of emotional intelligence, Mr. Trudeau gifted Mr. Trump a photo of the latter with Pierre Trudeau, the former’s father and a glamorous prime minister in the 1970s.

Has Mexico Sustainably Benefited From NAFTA?

There is no doubt that in the short-term, any changes to NAFTA will have a greater impact on Mexico than on the US. The US is Mexico’s biggest export market, accounting for 26.9% of GDP in 2015. The Mexican government is fully aware of the potential threats the country faces as it announced on the 3^rd February a 90 day consultation period with businesses on what its negotiating position should be. However, the writing has been on the wall for some time. Both Barack Obama and Hillary Clinton promised in their election campaigns to renegotiate NAFTA. It could be argued that Mexico should have foreseen such a scenario a long time ago and planned accordingly. Instead, it has taken its foot off the gas and reaped the rewards of a sweet deal without making the necessary sacrifices.

In many ways, Mexico has not held its end of the bargain with Canada and the US. When NAFTA was signed, it was widely understood that Mexico would take advantage of its vast trade surplus with the US to invest in education and infrastructure to achieve purchasing power parity, instead of which it accumulated an even greater trade deficit with China, namely in the import of electronics and machinery.

Although a trade war with the US is unlikely, as the WTO would become involved, and the damage to US exporters would be considerable, Mexico should brace itself for a hard landing, as its economy absorbs the impact of slower growth resulting from Trump’s punishing trade policies.

Mexico shouldn’t play the waiting game. Most people did not foresee (or simply could not imagine!) a successful Trump presidential campaign. However, it is time for Mexico to step out of its comfort zone and to embrace the big wide world. There is a unique opportunity to replicate the model established between the US and Mexico of cross-border supply, which has rendered US firms so competitive, across Latin America and improve economic integration. The timing could not be better if one considers the political climate in countries such as Argentina with the arrival of Macri, or Chile, where Governments have shifted to the center right, favouring a liberal trade and markets policy. Throw the UK into the mix, and Mexico has a long list of willing potential business partners to work with. If American firms are forced to give Mexico the cold shoulder, the infrastructure is already in place to attract multinationals from further afield. Korea and Germany are a testament to that.

Sacrifices need to be made. Mexico will have to tackle its poor crime and insecurity track record, improve education, and gradually pull out the large workforce tied up in the informal economy in order to push innovation and technology, which are key drivers in increasing Mexico’s notoriously decreasing productivity.

The Wall Means More Jobs; But not for The Mexican Builders!

Mr. Trump’s argument for tearing up NAFTA is that the agreement is shifting jobs south of the border. He feels that by scrapping the agreement he will be able to create more jobs north of the wall. He is clamping down on illegal immigration and is looking into imposing a points system on legal immigration (similar to that in Canada and Australia). The reasoning is that scrapping NAFTA in combination with strict immigration rules will provide US citizens with access to more job opportunities. This idea is, of course, flawed, as migrant workers fill the void left by locals unwilling to take on unskilled work paid at minimum wages. It is unlikely you will see an American picking out weeds or cleaning the family pool anytime soon. Numerous studies over the years have shown that immigrants provide a great boost to any local economy.

Pro-business lobbyists in the US all agree that disrupting the fully integrated trans-border supply chain will have an adverse effect on the US job market, as US companies that currently benefit from cheaper costs in the supply chain in Mexico will end up having to absorb the additional costs of any import tariffs imposed. Consumer prices will increase and sales will decrease as a result, putting pressure on the economy.

The mindset of many pro-Trump voters has not adapted to the fact that their economies are no longer regional but global. Trump has understood his voters all too well, and unfortunately, his rhetoric is music to their ears.

More Jobs or Less Workers?

As one senior oil and gas executive once said, we did not move out of the stone-age because we ran out of stones. Mr Trump is looking at the problem from the wrong end. Instead of trying to go against what makes business sense (something which should come naturally to him, surely…) and forcing businesses to relocate to the US, he should be looking at ways to offer the blue collared unemployed tools to be able to find a way back into the job market with new skills, by investing in education, for example. Germany, after all, has shown the world that integrated supply chains spread out globally can be highly successful, without giving its working class population the sense that they have been abandoned.

Trump plays on the fact that the US has hard power in greater measure than Mexico, but by telling the world that he will place America first with his immigration bans, deportations and punishing trade deals he is playing a dangerous game, as his country’s soft power is taking a serious pounding. Soft power is difficult to quantify, however, badly managed, it can greatly affect a country’s international clout, which can put a strain on diplomatic relations and have devastating consequences on the business sector.

Mr. Trump is as unpredictable as a loose cannon, but there is no doubt that his administration is not going to do Mexico any favours, whether NAFTA is dismantled or not. Mexico has proved in the past that it has the guile and the knowledge to negotiate successful outcomes when locking horns with the US (the temporary US ban on Mexican truckers in 2010 for example). However, it is now time for the Mexican government to pull its weight further afield and put the country on the global map. For a country that has so much to offer, it is sad to see that most of the world associates it with beaches, siestas and tequila. This will require deft and tactful manoeuvring, but if Mexico can prove to the folks in the US that they are getting a raw deal in the long term, that coconut water you buy next time at Heathrow airport, which should say “made in Mexico” rather Thailand, will taste all the much sweeter.

POTUS is set to either renegotiate or dismantle NAFTA. In the short-term this is bad news for Mexico and its Latin neighbours, as they suffer the consequences of lost business opportunities and seek new trade agreements further afield. Nevertheless, with the right amount of initiative and business acumen, in the longer term the real estate tycoon’s actions could kick start a movement across Latin America for an integrated economy by replicating the highly cost effective trans-border supply chain model in place between the US and Mexico. It will also force Mexico into action on the global scene as it aims to assert itself as an appealing country to do business with, thanks to its track record with the US.

Biz Latin Hub can assist with your investment in Mexico whether it be through international trade, company formations or start-ups. Contact us now, and see how we can assist you to do business in Latin America.