Vice-President and Strategist
Signature Global Asset Management
October 5th, 2018
The United States-Mexico-Canada Agreement (USMCA) has now replaced the North American Free Trade Agreement (NAFTA), and while on the surface not much appears to have changed, there are some longer-term effects for Canadian industries and markets that are worth considering.
It’s important to note that while this is not a victory for Canada in the sense that the new agreement offers new opportunities, it’s a victory for what it has not done – it hasn’t destroyed Canada’s auto industry and much of Canada’s manufacturing sector overnight. President Trump’s threat to impose a 25% tariff on Canadian auto exports needed to be taken seriously and was likely instrumental in getting Canada back to the negotiating table.
In other words, for the foreseeable future, things will roll along as they have under NAFTA. Canada has retained Chapter 19, a critical provision regarding independent dispute mechanism which is important for attracting investment and providing some degree of certainty. There is some debate around the true benefit of Chapter 19 because there are alternative routes to address disputes; however, the provision maintains the status quo, which is important in terms of business sentiment.
In the long term, there are sections in the new agreement that will be more challenging for Canada and will push the country to become more productive and ultimately more competitive, or fail. Moreover, any such failure will further diminish Canada’s industrial base.
Take Section 232, which states that Canada will be subject to a 25% tariff if auto exports reach 2.6 million units a year. Current exports total 1.8 million units, so it remains a long-term prospect; but it suggests that Canada will need to invest in productivity-enhancing measures and move up the value chain in order to remain viable.
If Canada cannot increase volumes significantly or if our competitive position declines because labour costs rise – pushing up the cost of doing business – then one requires a strategy to reverse the trend. That strategy is raising the value of the underlying product. In the case of Canada, it means discarding the very basic parts that are made in Canada and investing in the components that are higher value. Within the auto sector, transmissions and engines are a higher value-add while bumpers are lower value-add and better made in a country with low labour costs such as Mexico.
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