Generally speaking, 2017 has been a good year for business, with consumer confidence on the rise, the stock market hitting all-time highs, and hundreds of thousands of jobs being added each month. If there’s one area that business owners need to exercise caution and thoughtfulness, however, it’s in regards to their supply chains, which could be greatly affected by a NAFTA renegotiation.
The North American Free Trade Agreement is a treaty between the U.S., Canada, and Mexico that was first ratified in 1994. The treaty is complex, but some of its basic tenets included eliminating tariffs added on to goods imported and exported between the three countries, bestowing “most-favored-nation” status to all co-signers, and establishing procedures to settle trade disputes.
There have been some issues with NAFTA, particularly as the world has changed while the treaty did not. These issues have caught the eye of new president Donald Trump: Early on in his time in office, Trump signed an executive order pledging to renegotiate NAFTA, and said he may pull out of the agreement altogether.
The biggest issue, or perhaps the most sensational, is the “maquiladora program,” which allows U.S. companies to set up low-cost factories in Mexico to assemble products, then export them back to the U.S. without paying tariffs. This program has become a major cog in many businesses’ supply chains, and their shuttering would possibly cause some chains to collapse.
Well, renegotiation time has come: The first round of the negotiations for the three nations will take place in Washington, D.C. in the third week of August, 2017.
What’s at stake for business owners in the U.S. as their government looks to modernize NAFTA? Let’s break down some of the potential ramifications and outcomes.
First: Is NAFTA getting dumped altogether?
That’s extremely unlikely. Although President Trump has talked tough at times in regards to NAFTA, early indications are that the administration will look to make small changes and emphasize enforcement of the treaty’s stipulations across the board.
The worst-case scenario, according to the co-chairs of the International Trade Group with Gardere, is that the U.S. may increase tariffs on imports “to the disadvantage of U.S. importers,” and subsequent retaliation from the other NAFTA partners may create new barriers.
Why would tariffs on imports hurt U.S. companies?
This is a question many consumers ask. Shouldn’t businesses be using U.S. labor and parts in creating their inventory anyway? Sure, maybe in a perfect world, but it’s not so simple. The formation of supply chains that cross our borders to the south and north plays a major role in keeping the cost of goods down overall and allowing all three NAFTA countries to compete in the international marketplace.
U.S. businesses depend greatly on these supply chains, trading in “intermediate goods” (materials or components that companies integrate into the production of their final product). While some might think that it would be more expensive to import these intermediate goods from other countries due to high transportation costs and risks of disruptions (and some firms do conduct all their business in the U.S. for those reasons), many believe that the final costs of making products is lower when importing from Mexico and Canada.
As a result, U.S. companies import much more from our neighbors than from other parts of the world, such as China or the European Union. Almost all major U.S. cities and states import from NAFTA countries, depending on which industries their economies focus on.
How would tariffs hurt U.S. businesses, by location and by industry?
One way to look at a NAFTA renegotiation that involves tariffs would be to examine how certain U.S. regions could be affected.
For example, since more than 3/4 of goods traded between the U.S. and Mexico travel via truck or rail, cities intimately involved with this trade—such as Phoenix, San Diego, and Kansas City—would see an overall economic decline if trade activity declines.
Also keep in mind that some of our states, such as Texas, New York, Michigan, and Washington import billions each year in intermediate goods. Reductions in the intermediate goods imported for these states would be a blow to them.
You could also examine the impact by industry. Advanced manufacturing, which includes the automotive and aerospace manufacturing industries, would take a major hit, as they rely on intermediate goods. This in turn would hurt the states these industries are centered in—Michigan, Texas and Ohio for automotive; Washington, Arizona and Kansas for aerospace.
Another major industry is energy: the U.S. is a major importer of crude oil from both Canada and Mexico. We use petroleum in everything from plastics to chemicals.
Would these changes to NAFTA help any businesses?
Of course, as a few industries or areas go down, others come up. Major industrial warehouse and distribution centers (of which there are more all the time) that are around major population centers like Los Angeles and Dallas would become new go-tos for domestic business if importing becomes financially unrealistic.
This is a good news for the warehousing industry, as warehouses are already becoming more automated, efficient, and technologically savvy. It would lead into another issue for U.S. businesses—which is the lack of jobs that will emerge from smart warehouses run by robots and drones. At this point, however, drones are helpers, not usurpers, in warehouses.
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It’s hard to know how these benefits would, if at all, make up for the greater losses of a tariff-imposing NAFTA agreement.
How can business owners prepare for a new NAFTA?
Regardless of whether NAFTA is updated to include tariffs—which is unlikely—it’s important for business owners to always be prepared for changes that could affect their supply chains.
Harvard Business Review outlines three types of actions that business owners could take to deal with the uncertainty of the situation. One is “no regret moves,” which mean finding ways to becoming more operationally efficient. No matter what happens, this is always a good mindset. If businesses do create a more cost-effective supply chain, they won’t have to pass on the weight of higher import costs to consumers, keeping them competitive.
Two other options are “hedges” and “big bets.” The former involves steps like increasing inventory and goods sourced locally, or to modernize operations. For example, a partially (or totally) automated operation could be more easily brought back to the U.S. from Mexico than one that depends mostly on manual labor. Big bets mean big investments that could go either way once the NAFTA negotiations and decisions play out, such as going ahead and moving all their operations back to the U.S., or double-down in Mexico as others flee.
Any way you slice it, business owners will have to operate in uncertain times—but that’s par for the course, isn’t it?
The main takeaway from the NAFA negotiations for business owners should be this: Don’t expect any major changes to shake the foundation of your business. But don’t let that stop you from finding ways to cut costs and be more efficient in your supply chain dealings—because if that shoe does one day drop, you’ll be better prepared to move ahead boldly.