What is NAFTA?
Trade agreements, such as the North American Free Trade Agreement (NAFTA), foster free trade and encourage imports/exports, allowing businesses of all sizes to leverage cross-regional transactions with relatively low costs (tariffs), and generate comparative advantages in developing strategic global supply chains.
NAFTA: The Original Tri-Party Agreement
NAFTA is a trilateral pact between the US, Mexico, and Canada creating less friction in trade across these neighboring borders. The agreement, ratified in January 1994, has provided modest growth to the now $23.4 trillion North American economy. The trade agreement has allowed businesses of all sizes to leverage cross-regional transactions with little-to-no tariffs and helped companies develop a comparative advantage in strategic supply chains.
After 25 years, the United States-Mexico-Canada Agreement (USMCA) is poised to replace NAFTA, introducing changes to North American trade, manufacturing, and supply chains. Under NAFTA, US manufacturers are incented to offshore production to Mexico where per capita income is 30% that of the United States. Critics of NAFTA believe this is to blame for US job losses, wage stagnation, and a growing trade deficit that went from a $1.7 billion surplus to a $73 billion deficit in 2018 according to the United States Trade Representative. This imbalance created a loss of up to 600,000 US jobs over two decades, according to the Economic Policy Institute. USMCA is hailed as an opportunity to change this.
USMCA: The Future of North American Trade
The USMCA, pending legislative ratification expected as early as the end of 2019, is aimed at creating a level playing field in the production of goods and materials across the trilateral regions. The agreement adjusts wages and sets content production requirements. Notably, automobile imports to the three countries must contain 75% of North America-produced content, pushing more production to back to the US. Imported goods failing to meet content production requirements will be subject to a 2.5% tariff. Additionally, the USMCA clears prior restrictions on US access to Canada’s dairy market, providing US farmers and producers access to an additional 3.6% of the Canadian dairy market.
Although changes to trade agreements can provide short-term hurdles for corporations involved in foreign direct investment (FDI), they also create a tailwind for the job market in industries such as automotive, industrials, and agriculture. For example, the United States Trade Representative believes USMCA will support $23 billion of automotive purchases in the US, stimulate US automotive parts purchases, and create approximately 76,000 additional jobs within the next five years.
The agreement calls for 40% of automobiles and 45% of light trucks to be manufactured with an average wage of $16 an hour by 2023. This eliminates the disparity in wages across the three countries – mainly Mexico – and the trilateral cost of production, on average, becomes balanced, pushing US and Canadian manufacturers to consider alternative regions of production. However, USMCA is not without its risks and adjustments, and disruptions might prompt corporations to re-structure and re-finance their supply chain and liquidity processes. This can be a daunting task.
These changes come at a time of rising uncertainty in US monetary policy and the looming prospect of prolonged, bitter trade wars. Businesses with both domestic and international operations should prioritize internal optimization to generate stable, long-term cash flows rather than depending on revenues subject to economic instability. Although the US, Canada, and Mexico have reached a deal, the matter of tariffs remains subject to volatility in the future.
USMCA Brings a Changing Landscape to Working Capital Management
USMCA’s potential impact on supply and demand is prompting businesses to find efficiencies to maximize their working capital. The continued trend of corporates holding strong balance sheets presents the twin dilemmas of maintaining liquidity vs. utilizing excess cash reserves. With a shift towards balancing the trade deficit in the US, businesses will need to seek ways to fund their operations and investments if a demand in alternative regional production exists.
For example, if automotive production surges in the US and Canada, capital expenditures within the automotive sector will rise due to the costs of relocation and creation. Companies will work quickly to shorten their cash-to-conversion cycle (C2C) and provide liquidity to fund inventory or alternative investments that contribute to positive cash flow.
Mizuho offers a variety of working capital solutions to help stabilize and optimize free cash flow. Short-term losses catalyzed from the effects of re-sourcing and redeveloping supply chains can be mitigated, and US automotive executives believe there is a long-term upside for the market as long as the necessary precautions are taken.
Mizuho Americas is a leading financial institution comprising several legal entities, which together offer clients corporate and investment banking, financing, securities, treasury services, asset management, research and more. With professionals in offices throughout the US, Canada, Brazil, Mexico, Chile, and Colombia, Mizuho’s operations in the Americas connect a broad client base of major corporations, financial institutions and public sector groups to local markets and a vast global network. Mizuho Americas is part of Japan-based Mizuho Financial Group, Inc. (NYSE: MFG).