Europe is coming back from the summer holiday, and as it does, Brexit negotiations, Italy’s government budget and confusion in the Balkans are all making headlines. Chinese President Xi Jinping is also back from his annual summer retreat with top Chinese officials – and looks stronger than ever. Important as these developments are, other events took precedence in the forecast tracker this week. The recent drama in NAFTA talks necessitated a bottom-up review of our forecast for the negotiations. And the relative quiet in Saudi Arabia in recent months seemed louder to us than EU horse trading or Xi’s renewed confidence. These are the two issues we will focus on this week.
Jacob L. Shapiro, director of analysis
From the Forecast: “NAFTA negotiations are ongoing, but the probability of the trade deal ending and tariffs being restored is extremely low. All parties need the relationship. In the U.S., too many states benefit from trade with Mexico or Canada. Mexico is the top export market for California and Texas, which means the two largest congressional delegations are opposed to ending NAFTA. Regardless of what the president wants, the deadlock holds.”
Update: The agreement reached on Aug. 27 by the U.S. and Mexico was not overly surprising: At the beginning of the year, we expected NAFTA to survive in some form, and the two sides had been telegraphing that they were close to a deal for weeks. But the way the U.S. and Mexico chose to break the news that they had reached an agreement forced us to re-examine the forecast in its entirety. That’s because U.S. President Donald Trump floated the idea that NAFTA would turn into the U.S.-Mexico Free Trade Agreement and exclude Canada if Ottawa could not get its act together by Aug. 31.
At first, this seemed to cut against the grain of our forecast that NAFTA would survive. After all, NAFTA is a trilateral free trade agreement, and the U.S. was suggesting that it would become a bilateral one. Canada might be worked in, or the U.S. might sign a separate bilateral deal with Canada, or the two sides might not reach an agreement at all and the recent tariffs imposed by the U.S. and Canada might just be a prelude to a larger trade conflict. Mexico and the U.S. both made concessions in their agreement, but just by signing a deal, they also took substantial leverage away from Canada. Now, if NAFTA talks fail, the U.S. can blame it on Canada because, after all, U.S. compromises were good enough for Mexico.
As events have developed since the hastily made announcement, it has become clear that all of this was more the melodrama of a negotiation soap opera than a real break between the U.S. and Canada. Aug. 31 was an unrealistic deadline for talks of this scale and complexity. In other words, it was a negotiating tactic to try to force Canada into joining the agreement on the United States’ schedule. It was also a completely arbitrary deadline. Canada and the U.S. have until Oct. 1 to present an agreement to Congress – and Mexico’s economy minister has said a deal might be in place as soon as Sept. 7.
To be sure, both sides continue to talk tough. Canadian Prime Minister Justin Trudeau has said no NAFTA deal would be better than a “bad NAFTA deal.” Canadian negotiators have insisted on a dispute resolution mechanism similar to Chapter 19 in the current agreement and protections for Canadian cultural industries (like broadcast and print media). The U.S., meanwhile, has accused Canada of putting up barriers to protect its dairy industry and being unwilling to offer concessions on the issue. And Trump was quoted in a Canadian newspaper as saying he won’t offer any concessions to Canada – that was the apparent reason that negotiations ended last week without significant progress.
But the two sides are still talking. After breaking from negotiations on Aug. 31, high-level U.S. and Canadian representatives resumed talks this week. For all its bluster, the White House’s notification to Congress of its intention to sign a trade deal mentioned Canada – a notable shift from just a week prior, when the White House seemed poised to exclude Canada completely. The U.S. and Mexico were at an impasse for two months over issues related to the auto industry and a sunset clause, but there was enough political will on both sides to get a deal done. The U.S. and Canada have a tough few weeks of negotiations ahead of them, but all indications suggest that a compromise will be reached by the Oct. 1 deadline.
From the Forecast: “Saudi Arabia is mired in a political crisis. It started with the fall of oil prices but has reached a point that even a recovery wouldn’t put a stop to it. The dip has made it abundantly clear to Riyadh that its control over oil prices is not what it was during OPEC’s heyday and that it has no choice but to transform its economy. Change, though, is anathema to those who benefit from the status quo, and serious political instability will follow.”
Update: This forecast was fairly straightforward. Saudi Arabia would not be able to withstand the combination of low oil prices, political instability, economic irrationality and jihadist threats. For every Saudi claim that the kingdom would sell off its stakes in Aramco and reduce Riyadh’s dependence on oil, there was an example of the country using up its reserves to fight inconclusive battles in Yemen. In the long term, we remain pessimistic about Saudi Arabia’s prospects. But for all the pressure the country is under right now, the year has been relatively calm for the kingdom.
This is surprising considering the trajectory the country had been on. Just last November, Crown Prince Mohammad bin Salman arrested some of the most powerful ministers and princes in the country, keeping some of them in a fancy hotel until they agreed to cough up enough money. That raised the prospect that the young crown prince was taking on the Saudi establishment and essentially seizing power for himself. So far, at least, there has been little pushback. In June, he announced a major Cabinet reshuffle, focusing on ministries related to culture, Islamic life and social development, as if to say that the military and the affluent – the first groups he targeted – were well in hand.
The primary reason for Saudi Arabia’s resilience appears to be the very thing it wants to wean itself off: oil. Saudi Arabia has benefited from a rise in oil prices brought on by Venezuela’s economic collapse and the U.S. withdrawal from the Iran nuclear deal. A Wall Street Journal poll of investment banks estimated that oil would average around $74 a barrel this year. Other projections see oil spiking to the $80 range in the coming months. Saudi Arabia’s foreign exchange reserves are up about $10 billion this year, and projections suggest they may rise to approximately $530 billion by the end of 2018 – a far cry from this time last year, when reserves had dropped below $500 billion and seemed primed to fall even further.
Even so, slightly higher oil prices can’t fully explain how the crown prince has managed to continue to consolidate his power without creating a tangible backlash. True, the Aramco IPO, as well as other ambitious economic reforms, seems to have been placed on the back burner. And Saudi Arabia has continued fighting in Yemen, at times cutting deals with al-Qaida militants to secure its objectives on the ground, with no end in sight to the fighting (and spending). But the kingdom’s political structure has been stable since the crown prince’s shake-up. Women are now allowed to drive in Saudi Arabia, a sign that the kingdom is making incremental steps toward satisfying the demands of some of its less traditional youth – and so far, the country is no worse for the wear. And domestic opposition to Riyadh, whether from young people, Shiites, jihadists or elites, has been held in check. That’s good for Saudi Arabia, but not for our forecast.