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  • OPINION – NAFTA: Are we ready to deal with the onslaught of curveballs the U.S. will throw at us?

    Posted on: August 30th, 2017

    By Theo van de Kletersteeg

    At a July 25 news conference in Ottawa, CBC reporter David Cochrane asked the PM if he was prepared to accept a renegotiated NAFTA deal that did not contain a dispute resolution mechanism. Mr. Trudeau responded by stating that his government’s goal is to conclude a “renegotiated and improved NAFTA agreement that will grow our economies and help our citizens”, and one which will contain a fair dispute resolution mechanism. Some journalists quoted an unnamed “senior Canadian official” who reportedly said that the PM considers the current dispute resolution chapter (Chapter 19) in NAFTA to be a “red line”, and would walk away from the negotiations if the U.S. insisted on abolishing Chapter 19, as it has demanded. Chapter 19 provides for multinational tribunals to rule on disputes when a NAFTA member wishes to impose anti-dumping duties on exports from another NAFTA member. The provision has been a thorn in the side of the U.S. – of the 71 cases brought before the tribunals over the years, almost 60 per cent sought redress from duties imposed by the U.S.

    Clearly, the three partners must have recourse to judgment by an impartial arbiter if and when disputes should arise that would provoke one of the three governments to impose sanctions on its NAFTA trading partners. An agreement without such a mechanism would quickly deteriorate to a relationship where the most powerful trader could arbitrarily decide to impose serious harm on its “partners”. One way or another, it seems that negotiators acting in good faith should be able to reach acceptable compromises on this important issue. Without acceptable compromise, there will likely be no renegotiated NAFTA, which would open the door to Mr. Trump cancelling the existing NAFTA deal, as he has threatened many times. Without a NAFTA deal, our trading relationship with the U.S. would revert to being governed by WTO (World Trade Organization) rules.

    Not everyone agrees, though. Bloomberg.com reported that, given that in the last decade Canada has only initiated three cases under Chapter 19, Robert Wolfe, professor emeritus at Queen University’s School of Policy Studies in Kingston, Ontario, questions whether Chapter 19 is essential. Wolfe suggests Canada may want to consider bluffing, and when push comes to shove, give in on Chapter 19 in exchange for something better, gaining concessions on Trump’s Buy America rules, for example, which restrict the ability of Canadian companies to bid on U.S. government contracts. “If you had to choose between a real restraint on Buy America and keeping Chapter 19, I’d yell and pound the table and give up Chapter 19,” Wolfe said. “A lot more Canadian jobs might benefit from stopping discriminatory government procurement in the U.S.”

    If, on the other hand, Chapter 19 turns out to be a red line for the Prime Minister, Canadian Centre for Policy Alternatives senior research fellow Scott Sinclair wrote that “If NAFTA were to come apart, …WTO-bound tariff rates would apply. This would be disruptive, but not catastrophic. Under that scenario, Canadian exporters could face an additional US$3.5-5 billion in customs duties, equivalent to the value of 1.25 to 1.8 per cent of current exports. That’s a speed bump, for sure, but would not bring trade to a screeching halt.”

    However, if there were to be no renegotiated NAFTA, and Mr. Trump would cancel the existing NAFTA agreement, would that not entail a lot more than the mere imposition of tariffs under WTO rules? After all, NAFTA is about a lot more than just tariffs. Think, for example, of the numerous foreign-owned enterprises that have located in Canada in part because of Canada’s status as a NAFTA zone member, facilitating unencumbered access to markets in the U.S. and Mexico. If the rules of the game were to change, many such corporations would have to re-assess their presence in Canada. The possible consequences for Canada without NAFTA could be quite severe over the long haul, particularly if the Republicans (with or without Mr. Trump) were to follow up on election promises of lower corporate income taxes and material reductions in regulations, which would constitute additional reasons for corporations to be drawn to the U.S., rather than Canada.

    Interestingly, people in the U.K. are mulling over similar questions related to the economic cost of Brexit. The Economist of July 22-28 reported, for example, that “The government has not published any estimates of the impact of the various types of Brexit since the referendum, but academic studies suggest that even the “softest” option – Norwegian style membership of the European Economic Area – would cut trade by at least 20% over ten years, whereas the “hardest” exit, reverting to trade on the World Trade Organisation’s terms, would reduce trade by 40% and cut annual income per person by 2.6%.”

    If the U.K.’s exit from the European Union and its reverting to trade based on WTO terms would have such a dramatic impact on the U.K., is it reasonable to expect that Canada’s exit from NAFTA would have only minor consequences? Admittedly, the U.K.’s situation is altogether different from Canada’s – however, we should not underestimate the price we would have to pay for a possible life without NAFTA.

    The Administration’s objective of a renegotiated NAFTA is to improve the U.S. trade balance, and reduce its trade deficits with NAFTA countries. According to the U.S. Census Bureau, Canada exported US$277.8 billion of goods to the U.S. in 2016, but imported only US$266.8 billion of goods from the U.S., creating a trade deficit of US$11 billion for the U.S. in 2016. During the first five months of 2017, the trade deficit widened substantially, to US$10 billion. The U.S. trade deficit with Mexico is far greater than that with Canada, and stood at US$64.4 billion in 2016.

    Although U.S. trade with Mexico is far more unbalanced than its trade with Canada, one should not assume that Canada will come out scot-free. Is it possible that Mr. Trump aims to improve the U.S. trade balance partly by achieving consistent and more sizeable trade surpluses with Canada? Let’s face it: there are not that many products that the U.S. imports from Canada that are truly critical to its economy. At one time, Canadian energy exports were important, as were automobiles manufactured at lower cost in Ontario under the Auto Pact. However, with U.S. oil production slated to rise to 10 million barrels per day by the end of this year to become the world’s number two oil producer (after Russia), U.S. dependence on imported energy products is waning, and Canada’s role as a “critical” supplier of energy products to the U.S. will become less so in the future. As for autos, Mexico has become a very strong North American manufacturer. Indeed, Mexico’s manufacturing sector has grown by leaps and bounds, which has benefited not only Mexico, but also customers and suppliers in the U.S. and Canada. Attacking Mexican manufacturing output may well be similar to threatening mass deportation of undocumented Mexican labourers that have streamed across the border into the U.S.: it’s hard to imagine that the U.S. can truly do without either, and it therefore appears that aggressive deportations of undocumented Mexican citizens or initiating actions that would cause the U.S. trade deficit with Mexico to drop substantially might produce more harm to the U.S. than good. Is it possible that the U.S. sees Canada as a “soft” target from which it can extract more concessions than from Mexico?

    There are numerous vague ideas expressed in the document setting out U.S. demands. For example, since the principal stated objective for the U.S. is to reduce its trade deficits with Canada and Mexico, does this mean that the U.S. wants some sort of provision to curtail trade when trade deficits begin to exceed predetermined limits? That would be unprecedented but, who knows? Also, the U.S. wants to “strengthen the rules of origin” that determine whether goods being traded between the partners qualify for duty-free movement across borders, or not. Presumably this means that the U.S. will insist on raising the percentage of North American content, which might become very disruptive for overseas corporations that have established or intend to establish “branch plants” in Canada or Mexico to access U.S. markets – the objective of the U.S. is to have those plants located in the United States, rather than in a state that provides “backdoor” access to the United States. I suspect that Canadian and Mexican negotiators will be facing a number of very tough U.S. demands once the numerous vague “principles” will be clarified.

    Overall, ignoring some obvious inconsistencies, many U.S. demands for a renegotiated NAFTA appear to be reasonable, such as: “The new NAFTA must continue to break down barriers to American exports. This includes the elimination of unfair subsidies, market-driven distortions and practices by state-owned enterprises and burdensome restrictions of intellectual property.” Many demands appear to celebrate transparency and common sense. Yet, at the same time, U.S. negotiators will be asking to “maintain domestic preferential purchasing programmes”, including the Buy America programme and massive U.S. farm supports.

    Canada’s dairy and poultry supply management system will be attracting a good deal of U.S. attention. However, one trade analyst commented that while the U.S. could live with Canadian supply management, it objects to increasing Canadian dairy exports, which deprives U.S. exporters of selling opportunities in Canada, and crowds out foreign markets.

    America also seems to feel that restrictions to investments and activities in Canada by U.S. telecommunications and financial institutions should be scrapped. Again, this seems to make common sense: if our banks can have significant operations in the U.S., why should U.S. banks not be welcome in Canada?

    Last, but not least, we should remember that protectionism comes at a price. In Canada, supply management has cost consumers dearly, and lack of real competition among telecom providers and financial institutions has similarly led to high consumer prices. Moreover, when domestic corporations are able to make plenty of money at home in a relatively protected and uncompetitive market, what incentive do they have to expand internationally, or to put greater emphasis on exports? Opening up Canada to greater competition may be the wakeup call that many Canadian corporations might ultimately benefit from, forcing them to reduce costs to compete with new market entrants, to create more innovative products and services, and to devote serious resources to developing new overseas markets. The process of becoming leaner and meaner would ultimately create stronger Canadian businesses that would be better equipped to seek out incremental opportunities on a global scale.

    My bottom line is that, no matter what, we cannot afford to lose the benefits that NAFTA has created for Canadian trade, to face the nightmarish disruptions to supply chains and international investments that the loss of NAFTA would entail, or to see our share of world trade sink even further. Given that Canada is dealing with a U.S. President who is focused on making America great again, the negotiations will obviously be very, very straining on Canadian and Mexican trade representatives. However, if Canadian concessions will ultimately result in greater competitiveness, we might yet come to thank Mr. Trump. Thinking of Canada of a nation without preferential access to U.S. markets is truly unthinkable.

    Whatever the ultimate outcome of these negotiations will be, if there is one thing we should have learned recently, it is that we need a reset of domestic policies to reflect a future in which Canadians’ reliance on free trade with the U.S. will not be as secure as it was in the past. Our success in attracting foreign investment through our ability to serve as a “backdoor” to the U.S. may be compromised, in addition to potentially facing export losses in industries that are of paramount importance to Canada, such as energy and autos.

    Canada has recently lost a major opportunity to become a global player in the export of liquefied natural gas (LNG), after many years of talking. While Canada talked, Australia and the U.S. got to work to build LNG plants. Today, although both Conservative and Liberal governments have emphasized the need for Canada to become less dependent on traditional trade flows with the U.S., there is still no viable plan for exporting western oil through eastern ports, and the federally-approved twinning of Kinder Morgan’s Trans-Mountain oil pipeline is mired in strong opposition in B.C., and may never be built. Canada is a country focused on natural resource exploitation, which we have learned to do well and responsibly, and which will likely remain the mainstay of our economy for decades to come, despite condemnation of such industries by die-hard greens who, apparently, do not need jobs to live well.

    Given that we can no longer rely on unfettered access to U.S. markets which are easily accessible through rail, road, and pipelines, we must increasingly rely on overseas exports which are accessible primarily through our seaports. One way or another, we must ensure that new ports are built as the need for them arises, and existing ports expanded to accommodate this trade, and we must ensure that increasing volumes of goods produced anywhere in Canada can be transported safely and cost-effectively overland to these export ports. Not everyone will like the expansion of “legacy” industries, or our intra-provincial moral obligation to provide free movement of goods to our export ports. However, it’s an inconvenient truth that Canada’s economic future will continue to depend on such industries for a very long time to come, perhaps even more so in the future, if only because we don’t have much choice: After all, not everyone is skilled in biotechnology or artificial intelligence, but we all want to live in relative prosperity!