January 23, 2018 / 8:08 PM / a month ago

Breakingviews - Canada’s insurance policy on NAFTA isn’t loony

NEW YORK (Reuters Breakingviews) - Canadian officials are eager to keep alive the North American Free Trade Agreement. And if they fail, there’s an insurance policy. Even though a U.S. pullout would affect Canadian exports amounting to nearly 20 percent of the country’s GDP, Ottawa has other trade pacts in the works, and a flexible currency would help cushion any blow.

As negotiators from Canada, Mexico and the United States opened a crucial round of talks in Montreal on Tuesday, Finance Minister Bill Morneau told CNBC that Ottawa’s team would bring “constructive ideas.” Canadian and Mexican officials are prepared to respond flexibly to Washington’s demand for greater U.S. content in North American-made automobiles, Reuters reported. The U.S. side also wants to junk the pact’s dispute-settlement mechanism, which enables Canada and Mexico to challenge American anti-dumping duties, and insert a sunset clause forcing the pact to expire after five years unless all parties agree to renew it.

Canada has ample reason to bend. It exported $284 billion worth of goods to its two NAFTA partners in 2016, or 18 percent of its economic output. Comparable U.S. exports amount to just 3 percent of its GDP, which helps explain why President Donald Trump has taken such a hard line. If the pact collapses and the countries revert to the default rules and tariffs overseen by the World Trade Organization, Canada’s growth rate would suffer a 0.7 percentage-point hit in the first year, economists at Toronto-Dominion Bank estimate.

That may overstate Canada’s vulnerability, though. The economy is in good shape and stands to get a positive spillover from U.S. tax cuts, the International Monetary Fund said this week in raising its forecast for Canadian growth this year by 0.2 point, to 2.3 percent. Any trade hit would likely prompt a response from the Bank of Canada and the foreign-exchange market. TD Bank says the central bank would reduce rates by as much as three-quarters of a point and the loonie, as the Canadian dollar is known, would fall as much as 5 percent against its U.S. counterpart. That would more than offset the WTO’s 2.1 percent trade-weighted tariffs.

Canada also has alternatives. Japan announced Tuesday that a group of Asia-Pacific nations had agreed on a trade pact to replace the Trans-Pacific Partnership from which Trump withdrew the United States last year. Canada will sign the deal, a government source told Reuters. Indeed, 77 percent of respondents polled by Breakingviews in Toronto earlier this month said the impact of a NAFTA breakup would be only “minor pain.” It may not be Ottawa’s first choice, but there is life after NAFTA.

(This item has been updated to add the results of a Breakingviews poll in the fifth paragraph.)

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