Tag: USMCA

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Investment set to fall as business is baffled by Trump

Economic growth is closely linked to investment. In the short term, there is a demand-side effect: higher investment, by increasing aggregate demand, creates a multiplier effect. GDP rises and unemployment falls. Over the longer term, higher net investment causes a supply-side effect: industrial capacity and potential output rise. This will be from both the greater quantity of capital and, if new investment incorporates superior technology, from a greater productivity of capital.

One of the biggest determinants of investment is certainty about the future: certainty allows businesses to plan investment. Uncertainty, by contrast, is likely to dampen investment. Investment is for future output and if the future is unknown, why undertake costly investment? After all, the cost of investment is generally recouped over several months or year, not immediately. Uncertainty thus increases the risks of investment.

There is currently great uncertainty in the USA and its trading partners. The frequent changes in policy by President Trump are causing a fall in confidence and consequently a fall in investment. The past few weeks have seen large cuts in US government expenditure as his administration seeks to dismantle the current structure of government. The businesses supplying federal agencies thus face great uncertainty about future contracts. Laid-off workers will be forced to cut their spending, which will have knock-on effect on business, who will cut employment and investment as the multiplier and accelerator work through.

There are also worries that the economic chaos caused by President Trump’s frequent policy changes will cause inflation to rise. Higher inflation will prompt the Federal Reserve to raise interest rates. This, in turn, will increase the cost of borrowing for investment.

Tariff uncertainty

Perhaps the biggest uncertainty for business concerns the imposition of tariffs. Many US businesses rely on imports of raw materials, components, equipment, etc. Imposing tariffs on imports raises business costs. But this will vary from firm to firm, depending on the proportion of their inputs that are imported. And even when the inputs are from other US companies, those companies may rely on imports and thus be forced to raise prices to their customers. And if, in retaliation, other countries impose tariffs on US goods, this will affect US exporters and discourage them from investing.

For many multinational companies, whether based in the USA or elsewhere, supply chains involve many countries. New tariffs will force them to rethink which suppliers to use and where to locate production. The resulting uncertainty can cause them to delay or cancel investments.

Uncertainty has also been caused by the frequent changes in the planned level of tariffs. With the Trump administration using tariffs as a threat to get trading partners to change policy, the threatened tariff rates have varied depending on how trading partners have responded. There has also been uncertainty on just how the tariff policy will be implemented, making it more difficult for businesses to estimate the effect on them.

Then there are serious issues for the longer term. Other countries will be less willing to sign trade deals with the USA if they will not be honoured. Countries may increasingly look to diverting trade from the USA to other countries.

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Questions

  1. Find out what tariffs have been proposed, imposed and changed since Donald Trump came to office on 20 January 2025.
  2. In what scenario might US investment be stimulated by Donald Trump’s policies?
  3. What countries’ economies have gained or are set to gain from Donald Trump’s policies?
  4. What is the USMCA agreement? Do Donald Trump’s policies break this agreement?
  5. Find out and explain what has happened to the US stock market since January 2025. How do share prices affect business investment?
  6. Which sector’s shares have risen and which have fallen?
  7. Using the Data link above, find out what has been happening to the US Policy Uncertainty Index since Donald Trump was elected and explain particular spikes in the index. Is this mirrored in the global Policy Uncertainty Index?
  8. Are changes in the Policy Uncertainty Index mirrored in the World Uncertainty Index (WUI) and the CBOE Volatility Index: VIX?
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USMCA or NAFTA 2.0?

An agreement in principle was reached on September 30 between the USA, Canada and Mexico over a new trade deal to replace the North American Free Trade Agreement (NAFTA). President Trump had described NAFTA as ‘the worst trade deal maybe ever signed anywhere, but certainly ever signed in this country.’ The new deal, named the United States-Mexico-Canada Agreement, or USMCA, is the result of 14 months of negotiations, which have often been fractious. A provisional bilateral agreement was made between the USA and Mexico in August. At the same time, President Trump threatened a trade war with Canada if it did not reach a trade agreement with the USA (and Mexico). The new USMCA must be ratified by lawmakers in all three countries before it can come into force. This could take a few months.

So is USMCA a radical departure from NAFTA? Does the USA stand to gain substantially, as President Trump claims? In fact, USMCA is little different from NAFTA. It could best be described as a relatively modest reworking of NAFTA. So what are the changes?

The first change affects the car industry. From 2020, 75% of the components of any vehicle crossing between the USA and Canada or Mexico must be made within one or more of the three countries to qualify for tariff-free treatment. The aim is to boost production within the region. But the main change here is merely an increase in the proportion from the current 62.5%.

A more significant change affecting the car industry concerns wages. Between 40% and 45% of a vehicle’s components must be made by workers earning at least US$16 per hour. This is some three times more than the average wage currently earned by Mexican car workers. Although it will benefit such workers, it will reduce Mexico’s competitive advantage and could hence lead to some diversion of production away from Mexico. Also, it could push up the price of cars.

The agreement has also strengthened various standards inadequately covered in NAFTA. According to The Conversation article:

The new agreement includes stronger protections for patents and trademarks in areas such as biotech, financial services and domain names – all of which have advanced considerably over the past quarter century. It also contains new provisions governing the expansion of digital trade and investment in innovative products and services.
 
Separately, negotiators agreed to update labor and environmental standards, which were not central to the 1994 accord and are now typical in modern trade agreements. Examples include enforcing a minimum wage for autoworkers, stricter environmental standards for Mexican trucks and lots of new rules on fishing to protect marine life.

Another area where the USMCA agreement has made changes concerns trade in dairy products. This particularly affects Canada, which has agreed to allow more US dairy products tariff-free into Canada (see the CNN article at the end of the list of articles below). New higher quotas will give US dairy farmers access to 3.6% of Canada’s dairy market. They will still pay tariffs on dairy exports to Canada that exceed the quotas, ranging from 200% to 300%.

The other significant change for consumers in Mexico and Canada is a rise in the value of duty-free imports they can bring in from the USA, including online transactions. As the first BBC article listed below states:

The new agreement raises duty-free shopping limits to $100 to enter Mexico and C$150 ($115) to enter Canada without facing import duties – well above the $50 previously allowed in Mexico and C$20 permitted by Canada. That’s good news for online shoppers in Mexico and Canada – as well as shipping firms and e-commerce companies, especially giants like Amazon.

Despite these changes, USMCA is very similar to NAFTA. It is still a preferential trade deal between the three countries, but certainly not a completely free trade deal – but nor was NAFTA.

And for the time being, US tariffs on Mexican and Canadian steel and aluminium imports remain in place. Perhaps, with the conclusion of the USMCA agreement, the Trump administration will now, as promised, consider lifting these tariffs.

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Questions

  1. What have been the chief gains and losses for the USA from USMCA?
  2. What have been the chief gains and losses for Mexico from USMCA?
  3. What have been the chief gains and losses for Canada from USMCA?
  4. What are the economic gains from free trade?
  5. Why might a group of countries prefer a preferential trade deal with various restrictions on trade rather than a completely free trade deal between them?
  6. Distinguish between trade creation and trade diversion.
  7. In what areas, if any, might USMCA result in trade diversion?
  8. If the imposition of tariffs results in a net loss from a decline in trade, why might it be in the interests of a country such as the USA to impose tariffs?