Trade Relations Series 4: The US-Mexico-Canada Relationship

Historical North American Trade

The economic ties across North America stretch back centuries, long before the formalisation of modern trade agreements. During the colonial era, trade was largely dictated by mercantilist policies, with European powers extracting raw materials from their North American colonies and imposing restrictions on colonial manufacturing and direct trade with other nations. For instance, the British Navigation Acts mandated that colonial goods be transported on British ships and often funneled through British ports. The fur trade, in particular, was a significant driver of early North American commerce, leading to relationships and conflicts among indigenous peoples and European settlers.

Over the centuries, national independence brought three large countries into being, with significant power, demographic, and economic imbalances between them. However, in the spirit of an open and free world order, the US, Canada, and Mexico looked to exploit these differences for mutual benefit.

In the late 20th century, the North American Free Trade Agreement (NAFTA) marked a pivotal moment in the region’s economic integration. Signed in 1992 and coming into effect on January 1, 1994, NAFTA aimed to eliminate most tariffs and non-tariff barriers to trade and investment. The agreement significantly boosted regional trade, but it also faced criticism, particularly in the United States, regarding job displacement and its impact on manufacturing.

The debate eventually led to its renegotiation under the Trump administration, resulting in the United States-Mexico-Canada Agreement (USMCA). The USMCA largely retained provisions of NAFTA but introduced significant updates, particularly in areas like rules of origin, labor provisions, intellectual property, and digital trade. From the U.S. perspective, a key objective of USMCA was to bring manufacturing jobs back to the United States and ensure fairer trade practices.

Major Industries Benefiting from North American Trade Deals

NAFTA and now USMCA has significantly shaped the economic landscape of the continent, fostering growth in several key industries. The automotive sector stands out as a primary beneficiary, with highly integrated supply chains spanning all three countries. Parts and components often cross borders multiple times during the manufacturing process. 

Beyond automotive, electronics manufacturing, aerospace, and machinery have thrived due to reduced trade barriers and the ability to optimise production across the region. Agriculture, though sometimes a point of contention, has also seen increased trade volumes.

Small and medium-sized enterprises (SMEs) are increasingly recognised as crucial engines of growth within the USMCA framework, benefiting from streamlined customs procedures and reduced trade costs. The agreements aim to support these businesses, recognising their collective impact and job creation.

Manufacturing, Labor Costs, and Cross-Border Supply Chains

A critical aspect of North American trade integration is the interplay of manufacturing capabilities and labour cost differentials. Mexico offers significantly lower labour costs compared to the United States and Canada, where the average hourly manufacturing wage can range from $2.30 to $5.00, substantially lower than the US and Canada, where costs often exceed $25 per hour. This disparity drives the establishment of production facilities in Mexico, to the detriment of blue-collar work in the United States and Canada.

This cost differential has led to complex and interconnected cross-border supply chains. Products are rarely manufactured entirely within one country. Instead, raw materials might originate in one country, undergo initial processing in another, be assembled in a third, and then shipped back and forth for further finishing or quality control. This flow across borders optimises efficiency and cost, but it also means that the imposition of one-time tariffs applies multiple times to the same end product.

Energy Flows and Raw Materials: Powering North America

North America’s energy landscape is deeply interconnected, especially across the U.S. and Canada. Canada is the largest foreign supplier of crude oil to the U.S., with over 90% of its oil exports flowing south across the border, where it may be refined and sold onward, either within the United States or exported as refined product (either to Canada or elsewhere). Similarly, Canadian natural gas also contributes substantially to U.S. energy needs.

Beyond fossil fuels, Canada is a significant source of hydroelectric power for the United States, particularly for states in the Northeast. More than just price-driven, states that are still attempting to decarbonise, regardless of the federal government’s position, benefit from this hydropower trade as well. 

In terms of other raw materials and commodities, the trade in minerals and lumber is particularly noteworthy. Canada is a vital source of critical minerals for the United States, essential for various industries including defense, electronics, and renewable energy technologies. Bilateral mineral trade between Canada and the United States was valued at $146.0 billion in 2023, showcasing the robust exchange of these crucial resources. The U.S. has even invested in Canadian critical mineral projects to enhance supply chain security and reduce reliance on other sources.

The softwood lumber dispute, a long-standing trade issue between the U.S. and Canada, highlights the complexities within this sector. Despite ongoing tariffs and disagreements, Canadian softwood lumber remains a significant import for the U.S. housing and construction industries, supplying approximately 30% of U.S. demand. This enduring trade, despite its challenges, underscores the power of low trade barriers and the attractiveness of cheap commodities, regardless of their local impacts.

Mexico also plays a role in North American energy and raw materials trade, though perhaps less prominently than Canada in terms of direct energy exports to the U.S. However, its significant oil and gas production, coupled with its role in refining and petrochemicals, contributes to North American energy. The integration of supply chains for various raw materials, including industrial minerals, also extends to Mexico, further solidifying the continent’s interconnected resource base.

Defense Cooperation: A Cornerstone of North American Security

The defense relationship between the United States and Canada is arguably one of the closest and most comprehensive in the world, with the North American Aerospace Defense Command (NORAD) a prime example. NORAD is responsible for the early warning system for North America, agreed and developed during a tense time of the Cold War.

Both the U.S. and Canada are founding members of NATO, too. Their collaboration within NATO extends to various global security issues, demonstrating a unified front on the international stage. This robust defense relationship provides a stable backdrop for the economic ties between the two nations, ensuring a secure environment for trade and investment.

Militarily and security-wise, the relationship is important. But there is also a major economic aspect to the relationship as well. Canadian companies are embedded in U.S. defense supply chains, contributing critical components and technologies across sectors ranging from aerospace to cybersecurity. This integration has created thousands of high-paying jobs on both sides of the border and has established Canada as a trusted supplier of defense-related goods and services to the U.S. market. The reciprocal nature of this relationship means that U.S. companies also benefit from access to Canadian defense markets and the military integration means a broader customer base for well-established U.S. defense companies.

The close defense alliance and a sort of “Fortress North America” also enables the U.S. and Canada to be bulwarks for wealth security when conflict arises in other parts of the world. Of course economic and institutional stability contribute significantly to this benefit, but a strong defense alliance also reduces the likelihood of miltary conflict in North America to nearly zero, making the U.S. and Canada safe havens in times of heightened armed conflict elsewhere.

Canada-Mexico Relations: Beyond the US Anchor

While the United States often serves as the central anchor in North American trade discussions, the bilateral relationship between Canada and Mexico is also significant and growing. These two nations share a vibrant and multi-faceted relationship. 

Trade between Canada and Mexico has been steadily increasing, encompassing a wide range of goods and services. While specific figures for services trade can be complex to isolate, overall merchandise trade has seen substantial growth. In 2022, two-way merchandise trade between Mexico and Canada exceeded $49.7 billion. This direct trade is crucial for both economies, providing alternative markets and supply chain routes.

Foreign Direct Investment (FDI) also plays a significant role in the Canada-Mexico relationship. Canadian companies have invested substantially in Mexico, particularly in sectors like mining, finance, and manufacturing. For instance, Canadian FDI in Mexico amounted to US$3.22 billion in 2024, making Canada one of the top investors in the Mexican market. This investment reflects confidence in Mexico’s economic potential and its role as a manufacturing and export hub. Similarly, Mexican investment in Canada, though smaller in scale, is also present, contributing to a reciprocal economic relationship.

This growing bilateral engagement between Canada and Mexico demonstrates a strategic effort to build stronger ties independent of, yet complementary to, their relationships with the United States.

Foreign Direct Investment (FDI) in North America

Foreign Direct Investment (FDI) is a critical component of economic integration and reflects the long-term commitment of businesses to a foreign market. Within North America, FDI flows are substantial between the three countries.

US-Canada FDI: The United States is by far the largest investor in Canada. As of 2022, U.S. FDI in Canada totaled an impressive $438 billion. This investment spans various sectors, including manufacturing, finance, and energy, underscoring the close ties between the two economies. Conversely, Canadian FDI in the United States is also substantial, with Canadian companies investing heavily across diverse industries, contributing to job creation and economic growth in the U.S. This two-way investment flow demonstrates a mature and highly integrated economic relationship.

US-Mexico FDI: Mexico has consistently been a major recipient of U.S. FDI, reflecting its role as a key manufacturing hub and a growing consumer market. The United States has historically been the largest source of FDI in Mexico, holding approximately 36% of the total FDI stock as of 2022. In the period from January to December 2024, FDI from the United States to Mexico reached US$16.5 billion. This investment is concentrated in sectors such as manufacturing (particularly automotive and electronics), financial services, and retail. Mexican FDI in the United States, while smaller in scale, is also present and growing, indicating increasing economic sophistication and outward investment from Mexico. 

These robust FDI flows across North America not only facilitate trade but also create jobs, transfer technology, and foster deeper economic integration. And as countries invest in each other, their preference for continued business tends to create pressure to keep tariffs and trade barriers low.

Navigating a Belligerent US: Canada and Mexico’s Diversification Strategies

The prospect of a more protectionist or ‘belligerent’ United States, characterised by increased tariffs and trade barriers, raises significant questions about how Canada and Mexico might adapt their trade strategies. Both nations have deeply integrated economies with the U.S., but they also recognise the importance of diversifying their trade relationships to mitigate risks and ensure economic stability. In such a scenario, strengthening ties with other major economic blocs, particularly the European Union (EU) and China, becomes a strategic imperative.

Canada’s Pivot: Canada has historically sought to diversify its trade beyond the U.S., as evidenced by its comprehensive trade agreements with the EU (CETA) and its ongoing efforts to deepen engagement with Asian markets. If the U.S. were to adopt more aggressive trade policies, Canada would likely accelerate these diversification efforts. This could involve increasing exports to the EU, leveraging CETA to expand market access for Canadian goods and services. Recent moves by Canada to deepen defense partnerships with the EU also signal a broader strategic alignment that could extend to economic cooperation.

Furthermore, Canada might seek to enhance its trade and investment relationships with China, despite existing geopolitical complexities. While Canada has its own concerns regarding China’s trade practices and human rights, economic necessity could drive a pragmatic approach to expanding trade in areas less sensitive to U.S. pressure. 

Canadian realignment could lead to windfalls for exporters on the coasts, whereas those with strong ties to the U.S. via land routes or pipelines could be impacted negatively.

Mexico’s Strategic Reorientation: Mexico, heavily reliant on its trade with the U.S. due to geographical proximity and integrated supply chains, would also face considerable pressure to diversify. Mexico has already been actively pursuing trade agreements with other regions, including the EU (through the updated EU-Mexico Free Trade Agreement) and various Asian countries. A more belligerent U.S. trade stance could push Mexico to further strengthen these alternative trade routes. Increased exports to the EU, particularly in sectors where Mexico has a competitive advantage, would be a logical step. 

Similarly, while China is a competitor in some manufacturing sectors, Mexico could explore opportunities for increased trade and investment with China, particularly in areas where their economies are complementary. The recent surge in FDI into Mexico, partly driven by nearshoring trends, could also be leveraged to attract investment from non-U.S. sources, further diversifying its economic partnerships.

In essence, while a protectionist U.S. stance would undoubtedly create challenges for Canada and Mexico, it would also likely serve as a catalyst for these nations to accelerate their efforts to forge stronger economic relationships with other global powers. This strategic reorientation would aim to reduce their over-reliance on the U.S. market, enhance their economic resilience, and secure their positions within a more multipolar global trade landscape.

North American Trade in Context: A Comparative View

To fully appreciate the scale and significance of North American trade, it is useful to compare it with the United States’ trade relationships with other major economic powers like China and the European Union. The following table provides a snapshot of total trade volumes, based on numbers from the USTR.

As the table illustrates, the combined trade volume within the USMCA bloc is substantial, underscoring the deep economic integration of North America. While trade with China and the EU is also significant, the regional ties within North America represent a unique and highly interdependent economic partnership that also has geographic proximity on its side.

Conclusion: Navigating the Future of North American Trade

The trade relationship between the United States, Mexico, and Canada is a dynamic set of interconnections dating back centuries. From the mercantilist policies of colonial times to NAFTA and USMCA, the economic integration of North America is an ongoing trend. 

From the U.S. perspective, the North American trade relationship improves consumer prices, encourages production efficiency, and offers an avenue for influence in other areas; conversely, some areas and demographics in the U.S. have fared worse with closer integration. While challenges and occasional trade disputes are inherent in any complex relationship, the benefits outweigh the costs, most of the time, and some form of free trade is likely to persist.

Looking ahead, the future of North American trade will undoubtedly change, though. The potential for a more protectionist U.S. stance could prompt Canada and Mexico to further diversify their trade relationships with other global powers like the EU and China. However, the strengths of USMCA and the deeply embedded economic ties are likely to ensure that North America remains an integrated economic bloc.

For investors, there is plenty of opportunity for sector-based investing as the relationships evolve. Auto parts suppliers may take a hit but any exemptions could very quickly create winners in other areas, like mineral mining.  Identifying sectors and themes that are poised to benefit from, or be impacted by, shifts in trade policy and regional dynamics can provide a significant edge. 

Using DCSC to find these opportunities (and to identify and mitigate risks) is a straightforward way to play the Canada-US-Mexico relationship changes.