MEMORANDUM

TO:

FROM:

SUBJECT:

DATE:

OVERVIEW

This paper is concerning the removal of NAFTA and the formulation of an industry wide strategy to protect California’s agricultural industry. NAFTA has come under fire from the American government due to perceptions of unfair trading practices that benefit Mexico more than the United States; regardless of the truth of these assumptions, the political conversation surrounding the trade agreement has led to many to believe that NAFTA will be revoked. This will have serious effects on California’s agricultural sector, which is reliant upon intercontinental trade in certain goods to remain competitive. Business strategies were constructed by estimating the likelihood of each possibility and comparing them to the expected result, as well as through predicting market behavior.

DETAILS

While meeting with the president of Argentina, Trump told reporters, “I decided rather than terminating NAFTA, which would be a pretty big, you know, shock to the system, we will renegotiate. Now, if I’m unable to make a fair deal, if I’m unable to make a fair deal for the United States, meaning a fair deal for our workers and our companies, I will terminate NAFTA. But we’re going to give renegotiation a good, strong shot (Kane, 2017).”-President Donald Trump

 

The purpose of developing this business strategy is to provide valuable information to California’s producers who would face serious economic losses if NAFTA was repealed. Forecasting the agricultural demand in the future is made difficult because of the time it takes to produce the product, which means that in many circumstances the economic conditions that the farmer prepared for when planting his/her crops no longer exists once the crop is ready to be harvested. As such, it is safe to assume that farmers will “play it safe” and do the most to protect their interest instead of taking unnecessary risks. If NAFTA were to be repealed, farmers would need to understand and analyze the economic conditions immediately to plan how to best bring their goods to market.

Since NAFTA entered into effect, trade with Canada and Mexico has tripled; the two nations currently buy one-third of U.S. merchandise exports (Villarreal, 2017). NAFTA specifically helped increase exports of agricultural goods to both countries by 350%, which had a noticeable impact in California due to the state’s strong agricultural industry. Currently, Mexico purchases 16% of all California’s exports. In 2016, the total value of goods that were exported to Mexico from California equaled $25.26 billion. The agricultural industry in California alone equals $56 billion and also generates $100 billion in related economic activity. About 73% of the state’s agricultural revenue is derived from crops while the rest is derived of livestock. Understanding these numbers is vital to understanding how Californian companies will adjust to the end of the trade agreement.

A repeal of NAFTA would have several immediate effects on California’s agricultural industry, depending on the immediate reactions of the nation-states involved and the firms that are located in each country. For one, three-fourths of Mexico’s food imports come from the United States, and considering California is the leading producer of agricultural products in the US, the state will lose a large portion of its immediate business due to the expected increases in price resulting from tariffs. Formulating an appropriate business strategy is important; if NAFTA was cancelled, the immediate position of most agricultural companies would be compromised as uncertainty would pervade the market. President Trump campaigned on a platform that advocated abandoning the agreement, and while the discussion has not reached the floor of either Congressional chamber, business leaders must prepare for the worst.

It is possible for Californian companies to exploit the end of NAFTA, though the loss of such a large market for California’s agricultural products will still have an adverse effect on the state’s industries and GDP. To remain competitive on the international scale, Californian companies need to make several changes. The first is that it is highly recommended that Californian companies began to produce more avocados; assuming that Mexico implements tariffs again to protect their industries, the avocado will likely be one of the first products to be discussed. Demand for this fruit has risen exponentially in the United States during the past decade, and Californian companies will be able to exploit this to supply most of the country.

It is important to note that Mexico’s tariffs before NAFTA was implemented was highest in the agricultural industry (Villarreal, 2017). As shown in Figure one, Mexico’s tariffs were significantly higher than the U.S.’ in general, and would likely increase to protect their own industries if NAFTA were to collapse. If the U.S. and Mexico were to increase tariffs after its removal, it can be expected that Mexico will also revert to protecting this industry again through tariffs. The biggest challenge confronting producers is the delay it takes in making the product; for example, rice takes a substantial amount of time to grow, and NAFTA could end when the planting season begins. Farmers will thus have a completely different market to sell in after their crop is ready to be harvested. In the short-run, they will attempt to compensate from the uncertainty of trade with Canada and Mexico by increasing sales in the U.S. and try to find new export markets to meet supply in the long-run. Agribusiness strategy will change significantly if NAFTA is ended; farmers will have to readjust to demand levels that are likely to be lower on account of the volume of agricultural trade that would have previously been sent to Mexico and Canada.

If NAFTA is cancelled, Californian producers will need to identify a new, cheap market to sell their products if they are to maintain the same sales’ volume as pre-cancellation. Californian companies have several options:

  • OPTION ONE: Increase sales within the United States through lowering prices where possible
  • OPTION TWO: Identifying new foreign markets to pick-up what would be left by Mexico and Canada
  • OPTION THREE: Continue exporting to both Canada and Mexico, which would only be possible if the status quo was maintained despite the end of NAFTA.

 

RECOMMENDATIONS

Option one is the best choice for California firms operating under uncertainty in the short-term. The federal government provides subsidies for several segments of California’s agricultural economy, including the large dairy segment within the state. California will be able to continue producing at the current rate and find markets while still receiving a considerable amount of revenue as a result. During the first five years after NAFTA, California will be competing with other southern states to supply the rest of the country in agricultural goods. Other states have large agricultural industries, but California’s can operate on a scale far larger and the state also has several markets cornered in its surrounding area due to its proximity. Agricultural companies need to focus on price reduction to maximize sales volumes during this time to increase internal market penetration.

Option two is viable in the long-term, and should be the result of the state’s ten year plan in agribusiness. When NAFTA was introduced, the volume of trade between the U.S. and Asia was dropping due to the Asian Financial Crisis. Now that this is long over and many of these economies have reported strong growth throughout the last decade, giving the state the potential to capitalize on increasing exports to the region. Good potential candidates are China, South Korea, Japan, and Taiwan, though California will have to compete with other growers that are closer in the sales of some goods, such as papayas. The demand for some of California’s produce may be low in the short-run because of the natural differences in cuisine between the U.S. and East Asian countries, but the livestock and dairy trade should not be significantly deterred. This is especially viable considering that both Japan and South Korea have free trade agreements with the United States, making the only significant costs the base cost of the produce along with transportation.

Option three is unlikely to occur, as tariff rates before NAFTA were considerably high in both the US and Mexico’s agricultural import sectors. Some goods will inevitably flow across both borders, but the goods that will be traded will drop significantly in volume. This means neither country will be a considerable source of agricultural income for California’s exports.

CONCLUSION

The end of NAFTA will require California’s producers and food distribution companies to find new markets to operate in to adjust to increased tariffs; the loss of exports to Mexico and Canada will lead directly to increased sales throughout the rest of the US, as other states will lose access to cheaper agricultural products. However, this is only viable in the short-run, as the loss of export revenue will constitute a serious blow to California’s agricultural revenue that is unlikely to be regained through relying solely on increased U.S. sales. In the long-term California should look to new markets to increase sales, such as East Asia, whose demand for American produce is expected to increase in the future. Through these two strategies, agricultural companies can survive the economic uncertainty inherent in revoking the free-trade agreement.

 

APPENDIX

Figure one: (Villarreal, 2017)

References

Kane, J. (2017). Trump, NAFTA and the economic stakes for CaliforniaSouthern California Public Radio. Retrieved 18 February 2018, from https://www.scpr.org/news/2017/04/27/71236/trump-nafta-and-the-economic-stakes-for-california/

Villarreal, A. (2017). The North American Free Trade Agreement (NAFTA). The Congressional Research Service. Retrieved from https://fas.org/sgp/crs/row/R42965.pdf

 

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