Posted on: February 4th, 2018
By Alan M. Field
With the completion of the fourth round of talks to modernize the North American Free Association in late October, the governments of Canada, the United States and Mexico are hoping to finish the entire series of seven rounds by the end of 2017. Whether or not the renegotiation process drags on for an additional few months in 2018, it’s clear that the net result will mark a turning point in the relationship between Canada and its North American trading partners. But what kind of turning point, and to what effect? What impact will the NAFTA renegotiation process have on the Canadian economy – and on the trading patterns and supply chains of Canada’s exporters and importers?
In 2015 U.S. exports to Canada accounted for only 18.3 per cent of overall U.S. exports, while Canada’s exports to the U.S. amounted to 77 per cent of Canada’s total exports in 2016, according to Statistics Canada. That year, exports of U.S. goods to Canada totaled $266.0 billion, while its imports of goods from Canada totaled $278.1 billion; thus, the U.S. goods trade deficit with Canada was $12.1 billion. Although the balance of trade was nearly even in dollar terms, for Canada, the bilateral relationship is significantly more vital than the relationship is for the United States, given the much larger size of the U.S. economy. At $544 billion in 2016, two way Canada-U.S. trade in goods amounted to a much smaller percentage of Canada’s GDP of $1.53 trillion, than it did for the U.S., which recorded a GDP of $18.57 trillion, or more than ten times the total for Canada. As 2018 approaches, what is the current status of the talks – and what impact is their outcome likely to have on Canada’s status as an industrial supply chains and corporate competitiveness?
Fundamental contrasts in U.S. and Canadian viewpoints
When the NAFTA negotiations were launched in Washington, D.C., United States Trade Representative (USTR) Robert Lighthizer’s remarks underscored “the huge trade deficits, the lost manufacturing jobs, the businesses that have closed or moved” that allegedly resulted from NAFTA. In sharp contrast, both Canada and Mexico framed the talks as an opportunity to modernize the agreement to better respond to the twenty-first century economy.
Despite USTR Lighthizer’s politically inspired critique of NAFTA, politicians from Canada and Mexico agreed that the text of the 23-year old agreement needed to be ‘modernized’ to reflect significant changes in intellectual property, digital trade, anti-corruption practices, technical standards, and trade in financial services. Canadian Foreign Minister Chrystia Freeland and Mexico’s Secretary of Economy Ildefonso Guajardo both asserted that NAFTA has benefited all three partners. Secretary Guajardo not only called NAFTA a “strong success for all parties,” but stressed that Mexico is not the problem but rather “the solution to the region’s competitiveness.” Given such diametrically opposed viewpoints, many trade experts in all three of the NAFTA member-states are pessimistic about the likelihood of forging a revised NAFTA text that serves the interests of Canada and Mexico, not just the political needs of the Trump Administration.
A year after Trump took office, Joy Nott, President of the Canadian Importers and Exporters Association, said that the reaction of her membership “has evolved since the victory of Trump. The consensus then was that while NAFTA was about to be renegotiated, it would be a modernized; and that ‘NAFTA was not going to go away, and hopefully it would be made better for their particular industry sector. “There was not panic and optimism; only mild concern that the changes might not be all that great for their sector.”
However, concern about Trump grew after he pulled the United States out of the Trans-Pacific Partnership, in which Canada and Mexico remain members. “Now, after round four [of the NAFTA renegotiations], it is starting to sink in for almost all of our members that there is a possibility that NAFTA will go away. And that if NAFTA goes away, what then?” Nott said.
On the positive side, Nott argues, “No matter what happen with NAFTA, the economies of Canada and the United States are so intertwined, going beyond automotive sector into others including food…. And supply chains cannot turn on a dime. People know that in the short term their lives are not going to change, but there is a lot of number-crunching happening now in back rooms [in Canada], where people are trying to crunch the what-if scenarios of ‘no NAFTA’ and ‘no free trade with the United States.’”
Along with that number-crunching, anxiety about the post-NAFTA era has risen in Canadian corporate boardrooms. “A lot of people said at the beginning that, even if NAFTA goes away, Canada has the Canada-U.S. Free Trade Agreement to fall back on. But after doing due diligence about that treaty, most Canadian companies have realized that it is of no help to us. It’s a really old agreement; it goes back to 1987-88.” Moreover, the consensus view now is that the U.S. will also back out of the U.S.- Canada FTA if the U.S. backs out of NAFTA. “But even if they don’t [back out], it won’t do much for most Canadian companies. In essence, it’s like they would have no free trade with the United States.”
Nott wonders what will happen to Canadian supply chains if NAFTA remains, because some of the American demands during the latest rounds of negotiations enacted – such as the Sunset Clause. She asks, “Would companies be willing to do the requisite amount of investments in Canadian supply chains, knowing that the deal [the revised NAFTA] would have this five-year clock that runs down all the time. That’s a very short span of time in which to justify making substantial investments.” Many people are skeptical about that, not just in Canada.
Although Nott is still not sensing panic, she believes “there is almost trade-drama fatigue now” in Canada. “Shortly after the U.S. election, there were a lot of things perceived as being very alarming because they were unconventional. Now there is a mental exhaustion about the drama about trade…. But the rationality is taking place in the Board rooms. The Plan B’s are being constructed in the what-if scenarios. No one is making the assumption that NAFTA is going away; but there is the widespread realization that it is a potential, very viable scenario and it needs to be planned for.”
Luz Maria de la Mora Sanchez, a former official of the Mexican Foreign Affairs Ministry, argues, “While a NAFTA modernization has been long overdue, this renegotiation was motivated by the wrong reasons; that is to say, to address the United States’ concern regarding its trade deficit with Mexico and to return lost jobs to the U.S. manufacturing sector.”
Sanchez added, “I am not very optimistic about how these trade negotiations are going to evolve because we are coming from very different perspectives. It is hard for me to say that this is a traditional trade agenda or negotiation, because the objectives that the U.S. has set for these negotiations are very far away from what we expected” – which were to reduce the U.S. deficit with Mexico, and bring back jobs to the manufacturing sector of the U.S. In view of the U.S. demands, “It is extremely difficult for Mexico to satisfy what the U.S. has decided has to be done. There is a real mismatch between our objectives. Mexico wants to modernize the trade agreement; recognizing that the agreement is already 23 years old” and that the (completed) Trans-Pacific Partnership talks – which involved U.S.-Mexico trade — would have provided a route for modernizing the NAFTA. But while “Mexico wants to deepen international trade; attract more investments and modernize the agreement for the 21st century,” the U.S. under Trump is focusing, instead, on “bringing back jobs to the manufacturing sector in the U.S. But I don’t see how the negotiations are going to bring them back.”
The agricultural lobby finally exerts its influence
Between 1993 and 2016 U.S. agricultural exports to Canada and Mexico rose by more than 400 per cent, from $8.9 billion to $38.1 billion. Mexico and Canada are now the most important overseas markets for U.S.-grown commodities including corn and soybeans, apples and high-fructose corn syrup. And yet, in the latest talks, the Florida fruit and vegetable industry have demanded a whole series of protective measures that were rejected during the original NAFTA negotiations, but which the Trump Administration appears to be embracing. And the textile industry wants restrictive rules to keep Asian fabric out of the U.S. market again,” all that was hashed out the first time around, when a compromise was reached; but the Trump administration is reopening it, said Ted Alden, senior fellow at the Council of Foreign Relation. That’s why Alden thinks the rosy scenario that NAFTA will merely have to be updated is “far too sanguine.”
What would be the consequences for Canada and Mexico if the Trump Administration got its way on those issues? The fruit issue “would hit Mexico a lot more than it would hit Canada,” argues Alden. “The short version is that Mexico is very competitive in winter fruits and vegetables that are otherwise supplied by the United States out of Florida and California.” Generally speaking, costs and wage rates are little lower in Mexico. The Florida fruit and vegetable industry fought this issue very hard during the NAFTA talks of years ago; they didn’t like NAFTA for exactly this reason. And they were by and large right; Mexico has displaced a lot of U.S production of fruits such as avocados.” Alden notes that the decision was reached, at the time of initial talks, that under NAFTA, “there were going to be losers and winners but it would be offset by the other sectors of the economy that would gain.” Now “the initial bargains are getting reopened again. The Florida industry is asking for a special safeguard measure that will allow them to block Mexican exports.”
Alden argues that a multifaceted trade agreement on the scale of NAFTA “is a sort of grand bargain: ‘We in Mexico and Canada will open up our markets in these areas; and you will open your markets in these areas and, hopefully, as the end of the day, the outcome will make us all a little wealthier.’” However, the Trump Administration is saying that the outcome will be unbalanced because of the large trade deficit of the U.S. The really hard part of that, argues Alden, is that normally countries “come into a free trade agreement at sort of the same level and you look for a balance of concessions. Each country will open a similar amount and will have sectors that win, and others that lose. But the Trump Administration is going into this [particular process of] negotiation with the premise that the United States got screwed by NAFTA. And therefore, that the purpose of this negotiation is to rebalance those concessions in favour of the United States. That is virtually an impossible thing for Canada and Mexico to agree to do.”
Why is that? First, because it is impossible for them to agree that the U.S. was the loser, and that they were the winners” in the NAFTA relationship, argues Alden. “They don’t agree either on what the current condition is, or on the kinds of changes that need to be made.” Alden adds, “There is a fundamentally different concept” between the views of the Trump Administration and everyone else who is a recognized specialist in this area. That other view is that the trade deficit is “largely the result of larger economic forces and policies, and that trade rules can affect trade deficits at the margins, but not fundamentally. The Trump Administration really disagrees on that. They believe that if you rewrite the trade rules, it will have an impact on the trade deficit. So far, the evidence is the opposite.”
A ‘very aggressive agenda’ that could leave little room for compromise
For his part, Lawrence Herman, a Toronto-based international trade lawyer, agrees that ‘the negotiations [between Canada and the U.S.] are getting increasingly contentious.” The U.S. has been pursuing “a very aggressive agenda, which is part of President Trump’s America First policies. Herman adds that “there is an emerging view [among Canadian negotiators] that the U.S. is not interested in seeking some sort of accommodation, but rather is pursuing negotiations to further its America First priorities – or possibly seeing the negotiations collapse.”
Herman said that the most difficult of those demands involve government procurement, which would be “almost impossible for Canada and Mexico to accept.” Those demands would set a firm limitation on the value of any U.S. government procurement projects that Canada and Mexico could bid for. “That essentially rolls back the arrangements in the current NAFTA; I’d call that kind of a ‘red-line’ [unacceptable] issue.” Herman is a member of the Board of the Canada-U.S. Law Institute, a non-profit, multidisciplinary organization that sponsors conferences and forums about the Canada-U.S. relationship.
The government procurement provisions in the current NAFTA text, explains Herman, allow Canada, Mexico and the U.S. to compete for procurement projects in each of the three countries. However, “The U.S. wants to roll back any commitments,” which would significantly cut back the U.S. obligations to allow bidders from Canada or Mexico to compete. That’s a very aggressive position that changes significantly the three-party arrangements in the NAFTA.” It would result in diminished opportunities for Canadian and Mexico companies in the U.S., where government procurement projects could play a significant role in any upcoming effort by the Trump administration to invest in the modernization of the U.S. infrastructure.
There are also a whole lot of other things “that are expected to be equally aggressive” in the final bargaining stance of the U.S,” adds Herman. One of these is NAFTA’s ‘binational panel review system,’ which is “under assault” by the United States, he asserted. Herman explained that Canada fought hard for the creation of NAFTA Chapter 19 during the 1980s, so there is a ‘neutral body to assure that the laws are applied, and that the facts reasonably support the conclusions.’ Opposition to Chapter 19 is nothing new. U.S. steel and lumber have long suspicious of binational panels. “The binational panel system allows for the appointment of a neutral body composed of three panelists, which review final decisions on trade-remedy matters. Currently, the Canadian softwood lumber industry is caught up in a major countervailing duty case; while Boeing has filed a complaint against Bombardier. Those major industry sectors would be affected if they couldn’t have recourse to a binational panel review system.”
Eliminating the binational panel system would have both an immediate and a long-term impact, says Herman. The immediate impact would be that it would potentially eliminate the binational panel in the softwood lumber case, “although I would assume that any cases underway would still have access” to such a panel. However, the softwood panel producers of Canada would not have access to the panel in the current dispute, nor would Bombardier have access to that panel in the current dispute with Boeing. “These binational panel proceedings are seen by the Canadian side as a way of assuring that they do not have to deal with the U.S. court system” with its delays and expenses, but rather that they can “have a neutral body dealing with the review. This is deemed to be vitally important for the Canadian side,” he says.
Christopher Wilson, deputy Director of the Mexico Institute at the Wilson Center, a think tank based in Washington, D.C., adds that under the Trump Administration’s proposals, “The U.S doesn’t want state-to-state disputes to be enforceable. Right now, if there is a disagreement about the implementation of a state-to-state agreement, then there is an ability to form an international panel and have that decision reviewed – and have a binding arbitration. The U.S. is now proposing to make that decision non-binding in a strange way, it means that every country could implement NAFTA to the degree they see fit.”
Despite the Trump Administration’s criticisms of Chapter 11, the “U.S. has done pretty well under that chapter,” argues Wilson. “ISDS (Investor State Dispute Settlement) is the area where the U.S. has clearly been the winner. The U.S. has a perfect record. I think the ISDS can be fixed rather than scrapped. I think U.S. companies want to have investor protection, particularly when they invest in Mexico. And certain sectors such as energy are adamant about that because they are starting to invest billions of dollars in Mexico’s economy following that country’s energy reforms, so there are strong reasons to save ISDS; to improve it and fix it; to make sure that there are safeguards in there, so that legitimate regulation isn’t misconstrued as an action tantamount to expropriation.” However, when talks resume in January 2018, “if the U.S. is serious [about its demand regarding ISDS], that could become a serious sticking point in the negotiations.
Proposals that would transform the automotive sector
Christopher Wilson is particularly critical of the U.S. proposal that would introduce the concept of a specifically U.S.-based content requirement in the automotive sector. Right now, NAFTA rules require that for an automobile to receive NAFTA relief from tariffs, at least 62.5 per cent of its content must be made within the NAFTA ‘region’ (i.e., within Canada, the U.S. and Mexico combined.) “That’s already as high as you find in any free-trade agreement,” says Wilson. Not satisfied, the U.S. negotiators have been “talking about increasing that ‘regional content’ standard to 85 per cent, while also introducing a 50 per cent U.S. content requirement. From that starting point, “there could still be a discussion of increasing some North American requirements.” As aggressive as those U.S. demands are, “that’s a very different idea from introducing this idea of [fifty per cent] ‘domestic U.S. requirements’ – leaving little room for Canadian or Mexican components in the final product.”
Nott says that the 50 per cent U.S. content requirement is “a non-starter in Canada. I have not heard a single member [of Parliament] who is willing to live with that…Or heard a single government person who is willing to accept that. The whole concept is not acceptable….it doesn’t matter if it is 50 per cent or 20 per cent” or another figure. “It is not the number, but the concept” of identifying any percentage figure as a requirement for NAFTA treatment.
Forcing automakers to source at least 50 per cent of their value in the U.S. “would require a significant reworking of American supply chains to meet those standards,” says Wilson. More bizarrely, “from a Mexican or Canadian perspective, the idea of a free trade agreement that would not give free access for one of the countries [for vehicles] built in one of the other countries is unthinkable.” Even more oddly, if the new rules call for 50 per cent U.S. content, “you could theoretically have an automobile made 100 per cent in Mexico –or 100 per cent in Canada—which would [thus] be made 100 per cent within North America – but which [nevertheless] would not get tariff-free access to the U.S because such a vehicle wouldn’t have 50 per cent U.S. content.”
Ironically, Caroline Freund, a senior fellow at the Washington-based Peterson Institute for International Economics, argues that if Canada and Mexico accede to the U.S. proposals on local content, the resulting NAFTA text could damage the competitiveness of the entire North American automotive sector; not just that of Canada. “If, for example, you increase the domestic U.S. local content requirements, [U.S.-based] auto companies will be required to replace cheaper parts [that are imported] with parts that are American-made [and are therefore more expensive.] As a result, [all] cars produced in North America that are imported through NAFTA are going to cost more. And so, they will all become less competitive with cars produced in other places. The difficulty is that we live in a world with global supply chains, where some countries specialize in different stages of production” or specialize in specific components that go into the assembly of the car, Freund explains. “How much impact this has would depend on how strict these [new NAFTA] rules are. If the rules are too strict, that completely unravels NAFTA” because at some point, companies can calculate that it’s not worth adhering to these strict new rules, and that it might be in their best interest to pay the tariffs rather than avoid them, just to be able to source products from anywhere.
How much damage would result?
Not everyone is convinced that this ‘unraveling’ of the relationship between the NAFTA and its automotive sector would be a disaster. Christopher Wilson is not convinced that the North American economy would even suffer a recession if the U.S. pulled out of NAFTA. “Despite the importance of NAFTA, the U.S. auto industry would continue to be strong if NAFTA disappeared because there is only a 2.5 per cent tariff for cars entering the U.S. under WTO rules,” which would go into effect on U.S. automotive trade if NAFTA were dismantled. “In such a case, the worst that happens is that [North American automakers] give up their NAFTA preference altogether, and they go ahead and import [by the old-fashioned WTO rules].”
Take, for example, the case of a Toyota plant that does some final assembly in both the United States and Mexico. Currently, to qualify for NAFTA preferences, they have to prove that 62.5 per cent of their content comes from a North American supply chain; that is to say, the combined supply chains in any of the three NAFTA members. “If the NAFTA rules of origin were tightened to 85 per cent, as U.S. negotiators have proposed, these automakers could pay the extra amount to relocate those parts plants to North America to meet the new rules of origin, but that would raise their cost of doing business by more than 2.5 per cent, so they’re simply not going to do that. They’ll simply say: ‘When we send that [fully assembled] car across the border to the U.S., we’ll just pay a 2.5 per cent tariff on it,’ rather than apply NAFTA rules to them.”
The gap between the politicians and professional negotiators
Some experts remain optimistic that the professional negotiators will have a major say in the final details of these talks, even if their role is publicly overshadowed by statements from the politicians. Cyndee Todgham Cherniak, an international lawyer at LexSage PC, a Toronto firm, says: “The political folks, including President Trump and USTR Lightizer have their political agenda – and are, for the most part, outside of the room — and some of their views enter into the discussion. But the bureaucrats, who have also negotiated other free trade agreements, do their job inside the room, [where] everybody is working productively to improve NAFTA. There are many areas where NAFTA can be improved, and the negotiators are working to come up with a trade agreement that we can take back to our three leaders, and discuss the improvements and merits of signing this particular deal.”
Christopher Wilson sounded an optimistic note often ignored by press reports about the NAFTA talks. “Many of the topics and mechanisms – including [those involving] labour, environment, state-owned enterprises and trade in digital products — have essentially already been agreed upon by all three countries through the Trans-Pacific Partnership (TPP) negotiations. The more that can be rescued from the text of the TPP [abandoned by Trump], the more likely that the NAFTA negotiations will be concluded quickly and successfully.”
Susan Kohn Ross, an international trade lawyer at Los Angeles-based Mitchell Knupp & Silberberg, added, “The reason we don’t know what’s going to happen is that there is so much chaos within the U.S. Administration. It’s unknown whether it is being run by Gary Kohn, the finance advisor, or Robert Lightizer, the USTR. Who runs the negotiation is going to dictate a lot about what is going to happen” – including whether stricter NAFTA country of origin rules will require somewhere about 75 per cent U.S. content. Such a proposal would be “totally ridiculous,” adds Ross.
A turnaround on government procurement
Equally startling is the Trump Administration’s repudiation of NAFTA provisions to open up government procurement opportunities. Cherniak explains that in the current text of NAFTA, “they are actually supposed to become more liberalized over time… But [under Trump], they are thinking of backing up; no more state and no more local procurement at all.” If that proposal makes it into the revised text of NAFTA, Canadians will have “to keep track of how much U.S. companies receive in terms of Canadian government contracts – and we’re going to match that with how much Canadian companies can get on U.S. government contracts…The U.S. is not going to award contracts to Canadians if [Americans] think that they aren’t getting the same amount of money from Canadian government contracts.”
How Canada could benefit from some modernization measures
From the Canadian view, Cherniak notes, “the purpose of any free-trade agreement is to improve the trade relationship.” But the position of the Trump Administration goes in the opposite direction. Assuming it survives the talks, “NAFTA will no longer be the North American free trade agreement; it will [in effect, if not in name] be the North American protectionist agreement,” laments Cherniak. She adds that the U.S. is “backtracking from where we are in NAFTA and from where we are at the WTO [World Trade Organization]. And when you compare NAFTA to all the other free-trade agreements that the U.S. has entered into, Canada is going to be worse off than every other WTO member-country with which the U.S. has signed an agreement, except Mexico.”
Nevertheless, there is plenty of room for modernizing the details of NAFTA, so that it works more effectively not just for the U.S. but Canada and Mexico, argues Cherniak. “We developed rules of origin during the 1980s, and some of them are not working. The economy has changed, or we thought [at that time] that we needed more restrictive rules of origin but [now we realize that] they don’t need to be that restrictive.” Cherniak cited rules three exemplary product areas:
Protein powders and drinks: According to current NAFTA rules, if the protein that goes into a protein powder does not originate in the United States, the concoction [say, drink] made with that powder “does not legally originate from the United States, even if everything else mixed in it comes from the U.S.” Thus, a concoction does not qualify for NAFTA tariff benefits even if only the powder comes from New Zealand.
Life preservers: Under current NAFTA rules, life preservers manufactured in the United States are not considered U.S.-origin goods so long as their fabrics originate in China. Ironically, “that kind of fabric is actually something that no one in the U.S makes [any more]. There are many types of fabric that are not manufactured in the U.S at all nowadays. What to do? We have fiber-forward and yarn-forward rules and they can be adjusted to reflect which of these fibers, yarns, etc. are not manufactured in the U.S.”
Theater curtains: When a company that manufactures theater curtains does all of its work in the U.S., those curtains are considered to be of NAFTA origin. But under current NAFTA rules, a lot of those curtains aren’t considered to be of NAFTA origin, “because of the restrictions on those fibers, yarns in the NAFTA agreement for treating those materials.”
Concludes Cherniak, “These are three examples where NAFTA hasn’t worked the way it should. And if its rules of origin are improved, there will be [imports] into Canada [of those products] from the United States, which would mean that there are more manufacturing jobs in the U.S. in protein drinks; and life preservers and all kinds of fabric-related products. Because under current NAFTA rules, Canadian companies are saying they might as well supply their markets entirely from China; not from the United States, because none of these products, whether actually made in the U.S or not, are considered of NAFTA origin.
Such examples also illustrate that changes in rules of origin can be win-win propositions, for the industry NAFTA members, rather than a zero-sum game. “There would then be a cost benefit for Canadian companies to buy in the United States. And this would not hurt Canada either,” insists Cherniak. “It is not a zero-sum game because we have to buy these goods anyway,” so why not buy them from the U.S., rather than, say, China?
Ted Alden, argues while there are some issues that will be “really, really hard to resolve,” there is a second basketful of rules whose impact will be more difficult to assess. “There are lots of things in NAFTA that can be updated, and where there will be some significant agreements among the three countries,” he says. “The rules for digital trade are probably the easiest basket there. A lot of this was hashed out during the Trans Pacific Partnership negotiations. There’s this sort of technical updating on which you’ll get pretty broad agreement. The second category is much more fundamental to the challenges underlying NAFTA – the Trump Administration’s desire for American-only content rules in some sectors. That’s the reconsideration of whether there should be binding dispute settlement; and the desire to strengthen Buy America laws under NAFTA. All of these represent a fundamental philosophical challenge to what NAFTA was supposed to be about. Those are far more difficult issues to resolve. And then, there’s a third category that nobody is paying attention to – and which could be the hardest in some ways. Any trade deal creates winners and losers. And all of the industries that see themselves as the losers from NAFTA now have another kick at the can. They are trying to rewrite rules that were agreed to, twenty or twenty-five years ago, just because they didn’t like the outcome.” It remains to be seen how many other people get damaged during the process.
Scenarios for success and failure
With the next round of negotiations scheduled to begin on November 17, three weeks later than originally scheduled, the entire NAFTA renegotiation process is likely to continue well into 2018. During the next rounds of talks, negotiators Mexico and Canada will have an opportunity to respond more thoroughly to the U.S. demands, and to consider which issues are fighting for, and what negotiating tactics are likely to yield the best results. Economist Freund is skeptical about the likelihood of significant success. “They are trying to complete the negotiations before the end of the year. In my mind, that’s not going to work because they don’t have enough time between meetings to rethink and go back to industry and figure out what to do – and go back with a new offer. So, very little is being accomplished on the difficult issues with these rapid-fire rounds, so they are going to end up at the end of the year not having completed a comprehensive renegotiation. And with the elections in Mexico and mid-terms approaching in the U.S. [both in 2018] the negotiation could drag on for quite a long time.”
Freund argues that her research shows that comprehensive trade agreements generally take a lot longer to complete. The only agreements that have been done in under a year are agreements where they have used a template. Where they have a text ready and they say, this is our standard agreement – which is what the U.S did with Jordan, Bahrain, and Dominican Republic. “But for a serious agreement, especially such a controversial agreement as NAFTA, I do not see any way it can be done in the time-frame that they have allotted.” Echoing such sentiments, Ross said, “Even the simplest of trade agreements takes many years to get right. The sign of a good agreement [or other legal deal] is that the two parties walk away feeling that they can live with the deal, both sides feel that they have given away more than they should have.”
A major wild card is the position of the United States, which could turn out to be rigid in its demands, or more flexible. On the one hand, Alden notes, that the U.S could announce it will abrogate NAFTA, and say ‘screw you,’ in effect, to Canada and Mexico. “Trump came very close to doing that last April, and he was talked out of it by industry folks.” Another complexity, notes Alden, is that it’s not certain whether NAFTA “would go puff because Trump says so, or whether the U.S. Congress has to act” for that to happen. After all, “Congress passed the NAFTA-implementation legislation” in 1993 and its approval for the dismantling of NAFTA might be required now.
In all, one of the following high-level outcomes seems likely.
First, Canada, the U.S. and Mexico get a deal that ‘modernizes’ or reforms NAFTA and the U.S. Congress approves it. Alden considers that possibility the “least likely,” while Freund, gives this a “one percent possibility.”
Second, the parties conclude a deal, but it dies in the U.S. Congress. “There is a distinct possibility of this because you can be sure that the Democrats, virtually as a block, will be opposed to that deal,” says Alden.
Third, the U.S. pulls the plug on NAFTA, following its inability to pressure – or bully – Canada and Mexico into supporting positions that are harmful to their interests. Alden says, “There are lots of signs indicating that the Mexicans are trying to prepare themselves for that possibility.” One key indicator is that both Canada and Mexico are diversifying their trade; “looking at what U.S. tariff rates would do under the WTO agreement in the absence of NAFTA.” In neither case, would such diversification be either a quick or easy process, say analysts.
Fourth, there is a possibility that no one is talking about. In such a scenario, “Everybody quietly agrees to live with the current NAFTA – and continue to negotiate indefinitely.” Thus, the Trump Administration decides not to pull the plug, while pretending that it is approaching an agreement that remains elusively around the corner. There’ll be a lot of pressure on the Trump Administration for this to happen, say some observers. For her part, Freund argues that the ‘nothing happens’ scenario is “the most likely scenario because that’s in Canada’s interest, Mexico’s interest, and U.S. industry’s interest to keep negotiations going slowly [and indefinitely] rather than to get a bad agreement.”
Both Canada and Mexico depend on in a very significant way on market access to the U.S. – so both have a lot on the line. “In gross terms, the U.S. probably has much in stake as anybody, but we have an economy that is about ten times larger,” says Wilson. But the U.S. does not have “limitless” leverage, he asserts. A strategic dilemma for Mexico and Canada is that “they cannot be seen as walking away from the negotiations because that plays right into the justification that this Administration needs to pull out of NAFTA, and that’s not in the interest of Canada or Mexico,” argues Wilson. Therefore, Canada and Mexico must stay at the table, “no matter what the U.S. says. The U.S. can put some pretty outrageous proposals on the table, and Mexico and Canada have to sit there and keep negotiating. But that doesn’t mean that Mexico and Canada have to give in. If they say, for national interest, ‘This is something we cannot accept,’ then, people in Mexico and Canada understand that is because there’s no desire in Canada or Mexico to negotiate away the deal that they currently have. They may even accept something along the edges in order to make this agreement politically viable for the Trump Administration.”
Fifth, in conjunction with the failure to renegotiate a new NAFTA text, the parties conclude a ‘side agreement’ between the three NAFTA parties that is not really part of NAFTA – or a direct repudiation of NAFTA — which Trump would sell as a major victory. Unlike NAFTA, such a deal would be limited in its scope, and would be voluntary, says Freund. “It wouldn’t have to go through Congress.” The Trump Administration would say, “We are still working on NAFTA, which is more complicated than we thought, so it’s going to take longer… In the meantime, we’ve got this sort of side agreement that maintains current levels of U.S. content, rather than expanding it” as the Trump negotiators had insisted.
American attorney Ross argues that “all of the above scenarios are reasonable. The only thing we know for sure is that the first reaction of the Democrats [to a revised NAFTA text] will be – no matter what the change is — that it’s terrible. Because from the Democrats’ perspective, in the absence of really strong labour union rules, they’re not happy and they view just about every free trade agreement as horrible.”
If the Trump Aministration decides to pull the plug on NAFTA, how much damage would that inflict on Canada and Mexico? Alden says, “It does real damage in some industries; the damage in the auto industry is not insignificant, particularly in the light truck segment because U.S. tariffs are so high [for that product]; the U.S. has a 25 per cent tariff. For cars, however, it is less of a big deal because tariffs are lower. But there’s no question it would be disruptive, depending on what the Mexicans do; it would be disruptive in agriculture. Why? A lot of Mexico’s tariffs before NAFTA were high and if they were to revert [to WTO levels], that would do some real damage to U.S. exports” to Mexico, argues Alden. However, some experts argue that WTO tariffs are so low that U.S. exports to Mexico would not suffer much.
Apart from economic damage, Alden argues, “I think the real damage would be to relations between the U.S., Mexico and Canada. People forgot how poisoned U.S.-Mexico relations were for years and years. NAFTA was a real turning point in that. You’re now seeing inklings of that old relationship. The next Mexican election is going to be fought on terms of which Mexican presidential candidate is more anti-American. The economies will adjust at one level or another. It will be more painful for some sectors than for others…. One of the central themes will be who can stand up to Donald Trump.”
Making contingency plans: What will Canadians do if NAFTA disappears?’
What kinds of contingency plans are major Canadian companies making in the event that Trump pulls the plug on U.S. membership in NAFTA, and the NAFTA comes to an end?
According to Nott, a lot of companies are asking questions about what it would take to set up new supply chains – either inbound or outbound — in Asia and Europe. “If NAFTA goes away, it would completely flatten the world.” In the absence of NAFTA, “the United States is no more competitive than Indonesia or China,” she says. “If there is no advantage [for Canadian firms] to select the United States [to invest in or buy from]; then, I might as well look at China” or Vietnam and Indonesia. “You counter-argue that your transportation costs will be much higher, but the hourly wage you pay workers in Indonesia will be much less than what you pay in America. Those are the numbers that are being crunched by Canadian firms. And if you’re talking high-tech and highly specialized industry sectors, where it is not just a commodity skill set you need –where you need highly educated workers – that’s where [the Canadian companies] are looking at Europe. Take the Canadian dollar against the euro — and we have that Canadian trade agreement with Europe which eliminates duties with Europe – and you look at our currency versus the euro and versus the U.S. dollar – and you look at transit times, and at the sustainability of the supply chain. So, if you are looking at making long-term investments, a relationship with Europe is very steady. There is no reason that any sort of investment would be in jeopardy, whereas right now there are so many things up in the air in the United States.”
Nott says there are two reasons why Canadian firms have few qualms about investing in Europe, despite Brexit. First, Canada and the UK are already talking about striking a bilateral free trade agreement. “And while [the EU] is less than ideal after the UK actually leaves the EU, there are still some very interesting [other] markets [for Canada] within the EU – such as Germany and France; and still lots of opportunity. In Canada, because of our longstanding history, we have already started talking with the UK about a free-trade agreement. And there’s no reason to believe that won’t be quickly negotiated –and resolved. No, Brexit is not causing any hiccups here at all. People wish there were no Brexit; but the fact that there will be is not changing the dynamics.”
South of the U.S. border, all political parties are united in their denunciations of the Trump trade policy. However, some Mexican pundits are trying to put the best face on the possible demise of NAFTA, arguing that NAFTA’s existence has had lasting positive effects on Mexico that will survive NAFTA if NAFTA ceases to exist. Luis de la Calle, Vice-President of the Mexican Council on Foreign Relations (Comexi), says, “The U.S. didn’t open up in NAFTA; it was Mexico” that opened up itself. “The U.S. economy was already wide open, but it was in Mexico that made a big effort to open up, to cement the idea that Mexico was serious…. The temptation that many in Mexico will have is to say that if the U.S. is closing up [by shutting down NAFTA], that we [Mexicans] should do likewise.” But Mexico has to commit itself to doing all the things that Mexico should be doing anyway, he added.
NAFTA or no NAFTA, Canada and Mexico aim to further diversify their export markets, now that their trust in U.S. global leadership has been damaged. In the case of Mexico, the diversification out of the U.S. orbit will include strengthening its membership in the Pacific Alliance, which also includes Colombia, Peru and Chile; and further strengthening Mexico’s ties with Europe – with which Mexico recently signed a free-trade agreement. De la Calle argues that the recent electoral victory of Japan’s Prime Minister Shinzo Abe was “crucially important” because it signaled Japanese public support for proceeding with its membership in the Trans-Pacific Partnership, which will advance along despite the withdrawal of Trump – and with the continued hope that the next U.S. Administration will repudiate Trump and his America First policies