Canada / Spotlight Reports
Renegotiating NAFTA: Winners and Losers

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by Ediz Ozelkan Analyst
Sep 20 2018

Since the North American Free Trade Agreement (NAFTA), the surplus in the trade of goods between the United States and Canada has widened from $46.0 billion (in real terms) in 1994 to a high of $150.6 billion in 2005, down to $83.3 billion in 2009, and slowly rising to an estimated $126.3 billion in 2018, with only two years of decline since the 2009 recession. A slowly deepening trade surplus of goods with the United States has fostered anti-NAFTA sentiment. This has resulted in steel and aluminum tariffs from the United States and the implementation of retaliatory tariffs from the federal government that began on July 1. However, tariffs on steel and aluminum come at a time of increasing commodity prices amid rising demand, which may dampen the effect of tempered demand from the US market. While the United States continues to operate with a substantial trade surplus when considering services, the primary focus of the ongoing NAFTA negotiation, as well as the implemented and threatened tariffs, is the trade of goods rather than services. Crucially, these discussions have emphasized agricultural products and the automotive sector, but there is much more at stake.

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The Goods and the Bad

Of the top 25 Canadian industries that trade with the United States in 2018, 15 industries are at the top of the list for both imports and exports, suggesting a level of bilateral interdependence in some of the most contentious sectors. For example, the domestic industry that exports the most to the United States by value is the Oil Drilling and Gas Extraction industry in Canada (IBISWorld report 21111CA). Exports to the United States grew 15.3% year to date between January to July 2017 and 2018, largely precipitated by an increase in prices. While oil and gas is one of the most significant industries in terms of imports from the United States, the trade surplus between Canada and the United States increased 16.7% year to date to $67.3 billion, compounding a 32.9% trade surplus expansion in 2017. Conversely, the second-largest source of imports is from the Petroleum Refining industry in the United States (32411), generating $9.4 billion thus far in 2018 from domestic customers. This facilitated a 48.2% decrease in the trade surplus based on year to date figures following a 59.8% decrease in the trade surplus in 2016, demonstrating the volatility of the energy sector and the evolving landscape of the North American energy supply chain. Importantly, while Canada has continued to push its crude oil and gas, many businesses have relied on US refineries to finish petroleum products, facilitating a bilateral cycle of raw material extraction to the north and refining in the south, with the finished product being pushed back up north as well as across the United States.

Outside of energy, the most contentious battle among NAFTA members has been in the automotive sector. In the motor vehicle manufacturing subsector (NAICS 3361), Canada has historically experienced a trade surplus with its southern neighbour, although this gap is quickly tightening. From a high of $45.7 billion in 2000 and a low of $11.2 billion in 2009 amid a recession, the trade surplus rose as high as $29.2 billion in 2016, down to an anticipated $14.1 billion in 2018 if year to date trends persist. This volatility is endemic to the broader bifurcation of automotive production in North America into passenger vehicle production and truck and commercial vehicle output. This transition from lower margin passenger vehicle production to higher margin commercial vehicle output has prompted a stagnation in the Car and Automobile Manufacturing industry in Canada (33611aCA) as profitability falls from a high of 7.1% in 2016 to a projected 5.5% in 2018.

evolving surplus

Consequently, most major automakers have moved their passenger vehicle production to Mexico while focusing on high margin activity in the United States, where commercial vehicle output widely outpaces that of its northern and southern neighbours combined. The SUV and Light Truck Manufacturing industry in Canada (33611bCA) is forecast to realize a $2.6 billion increase in exports, while automobile manufacturers (33611aCA) experienced a $12.4 billion increase in imports over the five years to 2018, which represents a clear split in automotive production trends. According to Statistics Canada, the number of trucks sold have outnumbered the number of other passenger vehicles. New truck sales rose 49.3% over the five years to 2017 (latest data available), while passenger vehicle sales declined 14.8% during the same period, which has incentivized truck makers to locate in Canada and the United States as opposed to Mexico to satisfy domestic demand. Still, according to data from the Organisation Internationale des Constructeurs d'Automobiles (OICA), while the United States consistently produces the most trucks in the NAFTA region (8.2 million in 2016 and 2017), Canadian output barely budged, rising 0.1 million to 1.6 million during the same time while Mexican production rose 0.6 million to 2.2 million commercial vehicles. Thus, while the broader North American automotive sector is moving toward making more commercial vehicles rather than low margin passenger cars, both the United States and Canada are losing output to Mexico.

In the broader transportation equipment manufacturing sector, the aerospace product and parts manufacturing industries (NAICS 33641, IBISWorld reports 33641aCA and 33641bCA) have dramatically shifted their trade patterns over the past year. Year to date data shows that the trade deficit in this industry grew 3095.1% to $1.9 billion between 2017 and 2018. This sizable shift is primarily attributed to the coalescence of increased import activity, chiefly from Canada-based Telesat, which launched satellites made by Maxar Technologies with rockets by SpaceX, which carry heavy price tags in 2018. The 79.8% anti-dumping duties levied on Bombardier coupled with a heavy 220.0% tariff on the company’s C Series jets in the United States. As an industry leader in this space, Bombardier’s reduced marketability in one of its major markets has hurt its growth prospects, and by extension, the industry in aggregate.

Commodity Commotion

Meanwhile, the Iron and Steel Manufacturing industry in Canada (33111CA) diminished its trade deficit 79.5% based on year to date figures between 2017 and 2018 to reach a $117.0 million deficit for the period between January and July. However, there is a seasonality of demand. Exports and imports typically drop between May and June. Still, June 2018 was the first month of US tariffs, which hit the industry hard, with exports dropping 57.0% compared with a 12.6% drop in 2017. Historically, the industry has had a trade surplus with the United States, ranging between $2.8 billion and $5.5 billion since 2000. In 2017, the trade surplus grew 20.4% to reach $5.5 billion, aided by rising prices and robust demand across North America. From this starting point, this historically high trade surplus can be threatened by tariffs from the industry’s largest market, although domestic consumption remains a powerful force and the available trade data only reflects one month of tariffs.

steel balance

Similarly contentious, lumber and wood products industries have been at the forefront of trade negotiations since 1982 and have recently come to the fore again. A tariff on softwood lumber was levied in early 2017 to a few key operators and then applied more broadly by that November. The softwood lumber trade surplus, included in the Sawmills and Wood Production industry in Canada (32111CA), has fluctuated from a high of $9.4 billion in 2001 to a low of $2.3 billion in 2009 during the recession. However, this surplus has strongly improved since then, reaching $7.6 billion in 2017, with an anticipated 4.6% increase in the trade surplus in 2018 based on year to date figures amid a forecast 9.1% increase in US housing starts this year. The implemented tariffs’ inability to constrain the growth in this trade surplus may pressure other tariff injunctions.

Recently, the Paper Mills industry in Canada (32212CA) experienced the full cycle of a tariff negotiation. The industry was subject to newsprint tariffs in January 2018, as its US counterparts argued for protection from less expensive imports. However, pressured profit margins from US newspaper companies instigated numerous lobbying efforts that worked to eliminate newsprint tariffs as of last month, although the effect of this is not reflected in the trade data at the time of this writing. This serves to highlight the widespread effects of tariffs and how downstream ramifications can force change.

Trading Spaces

The United States has benefited from a consistent trade surplus with Canada when including services since 1985, despite growing Canadian service industries. Nonetheless, most of the tariffs that the United States has sanctioned have been aimed at primary metals, where Canada fares much better in terms of trade balances. The balance of trade as it stands has been only marginally affected by Canadian retaliatory tariffs that began on July 1, but the trade patterns that will emerge are yet to fully manifest in the data. Steel tariffs implemented during a period of commodity price hikes may work to compound the effect of tariffs if US demand remains strong, resulting in even higher prices for domestic producers. For example, secondary steel producers (33122CA) are expected to generate 95.6% of industry export revenue from the United States, and have had relatively consistent levels of trade to the United States in terms of its share of trade, which is above 92.0% every year since 2013. Similarly, the Iron and Steel Manufacturing industry in Canada (33111CA) and the Aluminum Manufacturing industry in Canada (33131CA) consistently derived more than 82.0% of their export revenue from the United States, with that percentage rising since 2013 to reach an estimated 85.6% in 2018 for steel producers and 98.1% for aluminum producers. Persistent demand for steel and aluminum, evidenced by rising commodity prices, can support the value of exports to the United States despite tariffs. However, the potential loss of these industries’ major export market can have a deleterious effect on their viability if they do not quickly adopt new sources of demand.

While a confluence of factors may give steel producers’ reason to rejoice similar to newsprint and softwood lumber companies, the pressure is on for most businesses across North America. The US administration has just signed the Miscellaneous Tariff Bill Act into law on September 13, although this only affects a handful of goods among thousands of existing and threatened tariffs. The administration’s willingness to sign legislation such as this into law may be indicative of a more relaxed trade environment that should serve to encourage production and consumption across the region. The United States’ concerns about a trade war of goods may hurt US businesses more than Canadian ones, and this can become an ample opportunity to widen the goods surplus that has characterized the United States-Canada trade environment for decades.

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