Trump should be careful what he wishes for
Last week I laid out the consequences to the U.S. which I expect to follow from the passage of the tax “reform” in the US Congress. This week I outline the potential impact upon Canada; effectively Trump has declared economic warfare on Canada and we need to mitigate the effects to the extent possible.
First the impact of the U.S. tax cut. The reduction in the corporate tax rate to the lower 20s will greatly reduce if not eliminate the advantage Canada has previously enjoyed with our (till now) lower corporate rates.
Moreover, the U.S. reduction highlights the excessively low small business rates in Canada. Surely one thing that can be done now is to give a more modest tax advantage to small businesses and thereby lessen the incentive to remain small rather than grow into internationally competitive enterprises.
Contrary to popular belief, there is an increasing amount of data showing that larger rather than smaller businesses are the generators of most new jobs.
But the greatest danger to Canada will be the steadily rising interest rates occasioned by the excessive stimulation that tax reform, added to existing deficit spending, will put on the already-surging U.S. economy.
As U.S. interest rates increase in response to rising rates of inflation, there will be upward pressure on rates in Canada if we are to have any hope of lessening an outward flow of investment capital in search of higher returns south of the border.
Higher rates in Canada will serve to dampen expansionary investment throughout the national economy. Outflow of funds will put downward pressure on the loonie, helping exports, but the overall impact will be a downward movement in the rate of economic growth in Canada and probably a rising rate of unemployment.
The other worrying result of rising interest rates is the impact upon mortgage rates. An increase of one percentage point on a $1 million mortgage (something quite normal in Greater Vancouver and Toronto) means an additional $10,000 of costs annually. What will happen? First, the rise in housing prices will stop. Second, the number of defaults and personal bankruptcies will soar. That will further depress consumption and lessen economic growth.
Given the reluctance of the U.S. government to stabilize its fiscal position, the adjustment in Canada to this new reality will be both severe and prolonged. Not a happy prospect. Now consider the Trump-led protectionist posture of the United States. Trump, I believe, will try and rip up NAFTA, while blaming the intransigence of both Mexico and Canada. The head of the U.S. negotiating team apparently believes that any “fair” result would have both Canada and Mexico accepting all of the American proposals and the U.S. .not accepting any of the other two nations’ proposals.
Consider just two of the most egregious U.S. proposals. First they propose a term for a revised treaty of only five years. Think of a major company considering making an investment of many millions with the aim of serving the entire North American market. Building such a facility in any place but the U.S. — no matter what the cost advantages offered by the other two nations — would maximize the risk of being shut out of the U.S. market by high tariffs were the treaty to end after five years.
Think the American negotiators don’t know that? Dream on.
Second, consider their proposal to alter the dispute-settlement procedure. They want NAFTA disputes settled in U.S. courts. Why?
Because they correctly believe that this would give U.S. firms an overwhelming advantage. If Canada were to agree to either of these proposals remaining in NAFTA would be equivalent to economic suicide.
Trump should be careful what he wishes for.
If he pulls out of NAFTA and Congress repeals the relevant legislation, 37 states will lose their largest export market. That sounds like the brilliant business strategy of someone who has declared bankruptcy six times.