“NAFTA will remain largely intact despite U.S. campaign promises made to the contrary.”
Trade Stays Intact
The North American Free Trade Agreement will remain largely intact in 2017 despite U.S. campaign promises made to the contrary in 2016. The fact of the matter is that the trade ties and supply chains of North America are so tightly bound that a sudden and dramatic reversal to an agreement such as NAFTA would contravene the interests of all its members. The United States will nonetheless renegotiate the deal, albeit gradually, to honor the campaign promises made by president-elect Donald Trump. Those talks will likely extend beyond 2017.
That is not to say the United States is without options for improving the terms of the contract. The Trump administration could increase regional content requirements for products to qualify for tariff-free export to the United States and use non-tariff barriers more selectively. Mexico will have much more at stake in the negotiations, but its imperative is far simpler. It means to leverage its low labor costs and its high number of free trade agreements to maintain as much of the status quo as possible on trade and to maintain foreign direct investment flows into domestic manufacturing. And so Mexico will have a few tools to use against the United States. Mexico could influence the Trump administration by allying with businesses and states that would be hurt by more expensive labor and goods. (As a matter of fact, it has already begun to do so.) It could, moreover, leverage intelligence cooperation on counternarcotics operations to try and shape the dialogue.
Lower investment flows that could result from the uncertainty surrounding the NAFTA negotiations could hurt Mexico in the meantime. But even this will be tempered by Mexico’s proximity to the United States and its multitude of free trade agreements. Canada, with its advanced economy and high labor costs, will receive much less scrutiny. The Canadian government has indicated its willingness to take part in the NAFTA talks and will be seeking measures to protect its own manufacturing sector.
Canada could also renegotiate NAFTA’s investor-state dispute settlement, which allows an investor to sue a foreign government in international arbitration without going through domestic courts. Having been challenged under the ISDS procedure, Canada will certainly want to revisit its terms, even if a business-friendly Trump Cabinet were to resist measures that undermine foreign corporate protection abroad.
The negotiations will be slow going, no matter how they play out. Many of the points up for discussion would still center on concentrating economic production in North America, where supply chain interdependencies are developing organically.
The Trump administration will loosen regulations on domestic energy, enabling North America to more easily integrate as an energy bloc. It plans to streamline the process for federal permits on energy projects and to pull back from climate change initiatives, measures that could also provide a relative boost to the coal and nuclear power industries. They could also enable the beleaguered U.S. energy sector to rebound after a prolonged depression in the price of oil. A gradual recovery in North American production will, in turn, allow for a modest increase in global oil prices since it will take time for increased North American oil output to offset coordinated production cuts by the world’s oil producers.
Canada and Mexico will meanwhile continue to make measured progress in energy integration with the United States. In Canada’s case, this will include increased cross-border pipeline construction and supply integration. In Mexico’s case, it will entail implementing broader energy reforms, including further liberalizing domestic energy prices and loosening Pemex’s dominance in refining and distribution.
Latin American commodities exporters will continue to feel the pinch of low commodities prices in 2017. The economies of Brazil, Argentina, Chile and Colombia will begin to recover somewhat, but slow demand growth from China, low oil prices and an oversupply of agricultural commodities such as soybeans will otherwise keep exports largely depressed.
Further stunting economic growth and fiscal health is the strength of the U.S. dollar. Colombia, Brazil, and Chile have substantial dollar-denominated debt, which will become harder to repay or rollover. For Venezuela, which is already on the edge of default, heavier debt payments will increase the risk of default. For Brazil, Chile, Mexico and Argentina, more expensive debt payments amid the general commodity downturn will limit the amount governments can spend on domestic priorities.
A modest increase in global oil prices could meanwhile bring temporary relief for oil producing nations in Latin America. Even a temporary hike would be a welcome reprieve for central governments, which would then have a little more leeway in managing public finances. For Venezuela, a country already in an extreme state of economic deterioration, even a slight rise in oil prices could lower the odds that it will default on its foreign debt.
And so, faced as they are with relatively low export growth, certain Latin American countries will seek increased access to markets abroad by advancing trade agreements with nations outside the region. In light of the demise of the Trans-Pacific Partnership and the rise of new if limited NAFTA negotiations, Mexico will tentatively try to enter discussions on trade deals with Asian states, particularly with China. The countries that comprise Mercosur, or the Common Market of the South, will also continue to negotiate with the European Union on a future trade agreement, though political constraints on both sides of that dialogue could drag things out.
The price of oil will make or break Venezuela in 2017. Venezuelan state oil and natural gas company Petroleos de Venezuela faces a much higher risk of default on its foreign debt this year, but even a slight rise in the price of crude could buy the government valuable time. Still, this does not put Caracas in the clear. A debt default would reduce the lending and foreign capital Venezuela’s energy sector depends on and would lower the country’s oil output. The subsequent loss of oil revenue would hasten the decline of already reduced food imports, compelling more Venezuelans to either flee the country or to rise up in protest.
To avert this crisis and preserve its power, the government will probably choose to cut imports rather than miss its debt payments. But this will only incite unrest. Venezuela’s attempts to deal with runaway inflation will create additional triggers for unrest. The Venezuelan government will try to introduce higher denomination bills in the new year to keep up with rising prices. But if such measures are implemented haphazardly, they will inflict further economic pain on the population and raise the likelihood of further unrest.
Some political unrest is all but unavoidable. As the threat of default looms, Venezuela’s currency will likely further weaken, driving inflation even higher than it is now. (Inflation is high because the government cut exports to keep making its debt payments.) The ruling party will try to contain unrest through security crackdowns and through increased control of the nation’s food distribution networks.
But the fate of the government rests in the hands of the armed forces. So far, the various factions of the government, including the armed forces, have presented a mostly united front against the political opposition. But there is dissension in the ranks; some factions are inclined to hold on to power as long as possible. If Caracas defaults on its debt, the government would initially band together to tighten internal security, but its cohesion would be tested by the intensity and duration of the ensuing unrest. If factions of the armed forces believe siding with the government threatens their power, they may have to reconsider where their loyalty lies.
The Colombian government’s main priority in 2017 will be to implement the revised peace deal it struck with the Revolutionary Armed Forces of Colombia (FARC) in late 2016. Bogota knows it must act quickly, while it still has the momentum and political authority to do so. The government received fast-track legislative powers in December, so it will be able to pass legislation underpinning the FARC deal more quickly throughout the year. The administration of Jose Manuel Santos will begin the process of demobilizing the rebels with the intent of having as much of the peace deal implemented as possible by the time it leaves office in 2018.
Brazil: Questioning Political Stability Again
Brazil will begin its climb out of economic recession this year, though growth will be hampered by relatively weak global demand for export commodities such as soybeans and iron ore and sluggish trade growth with its trading partners.
Brazil’s political stability will meanwhile be called into question – again. The corruption investigation into state oil firm Petroleo Brasileiro could ensnare much of Brazil’s lower house and senate. If lower-level politicians are mainly implicated, the government could withstand such a blow. It would be harder to overcome, however, if the investigation implicated higher-ranking officials in the administration of President Michel Temer — himself an interim figure who replaced Dilma Rouseff after her August impeachment.
Riskier still is a separate investigation concerning possible illegal donations to Temer’s re-election campaign as vice president in 2014. If additional evidence leads to a conviction, Temer would be ordered to step down from his post. Such a scenario, of course, probably would not hurt Brazil’s long-term economic prospects or affect the economic reform bills the president has already begun to move through the legislature. But it would throw Brazilian politics into utter disarray and would discourage foreign investment that Brazil certainly needs in the short term.
In Argentina, economic growth will pick up again in 2017, but moderately high inflation and reduced trade with Brazil, not to mention with the rest of Mercosur, will keep that growth in check. The state of the economy will come into play in the lead up to legislative elections in October, during which the government will try to cater to as many constituents as possible. The administration of Mauricio Macri will therefore refrain from implementing major austerity measures to curb the budget deficit.
And it will be unable to cut back on costly fund transfers to Argentine provincial governments – and on compensation to labor unions. Macri will continue to face domestic challenges from an increasingly united political opposition and from the backlash over utility price hikes, which are meant to raise state revenue and make natural gas projects more attractive in the long run. A more united opposition will limit what the ruling party can pass through parliament and prevent it from enacting economic reform without the opposition’s consent.
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2017 Annual Forecast series on PolicyLabs:
- An Overview
- East Asia
- Latin America
- Middle East and North Africa
- South Asia
- Sub-Saharan Africa
2017 Annual Forecast is republished with permission of Stratfor