NAFTA to USMCA: We won because we didn’t lose (much)!

Source: Gary Clement, National Post, Oct. 2,2018, P. A1 
After a year and a half of uncertainty, we finally have a successor to the  North American Free Trade Agreement (NAFTA) (assuming it is ratified by Congress and the Canadian and Mexican legislatures). As Canadians, our biggest win is that we have an agreement at all—after all, Trump did promise to tear NAFTA up!  A loss of our very largest export market would have had disastrous consequences for Canadian jobs. While we might possibly have reached agreement faster if the Liberal government had not wasted efforts on trying to incorporate “progressive” elements, e.g. gender, it is unlikely that another Canadian government would have achieved much better results given the elephant next door and the current incumbent of the oval office who believes bullying is an effective negotiating tool.

 As I have written before[1], efficiency is achieved by “specialization of labour”. That is, instead of all of us trying to grow our own food, our own clothing etc. (and providing our own health care), we are much better off by many people specializing in those things they do well and trading for the many things that others produce--by selling and buying products and services in a free market. Less labour is used and better quality is provided. Moreover, when we specialize, we can improve our skills so that even less resources (material, labour. etc.) are used to produce a given quantity. In our modern world, that specialization occurs within businesses (people working together). Trade theory teaches us that free trade between countries encourages companies to produce as efficiently as possible. We can build bigger plants and attain economies of scale (world-scale plants). We have less waste of God’s resources and both countries and its consumers are overall, better off.

Canada, in fact, is heavily dependent on trade. Just over 40 percent of our production (GDP) is exported. Of that, about 75 percent goes to the U.S. Our next important trading partners are only a fraction of that: China 4.3% of our exports, the U.K. 3.2%, Japan 2.2%. etc. While we have tried to diversify our trade to other countries, that has proven very difficult. After all, the U.S. market is close; the cost of transporting goods anywhere else is higher. With small variations, the Americans speak the same language we do. They have the same basic institutions; our highway, rail and pipeline systems connect. Obviously, any company considering exporting will first look at the U.S. The fact remains, that we badly need our U.S. customers.

The Elephant Next Door

The Americans, however, are not nearly as dependent on Canadian trade—or trade in general. U.S. exports amount to only 11% of GDP (versus Canada’s 40%).   Of those U.S. exports, Canada’s share is only 18%  (versus 75% of ours to the U.S.). While that 18% is the largest share of U.S. exports, Mexico at 16% is only slightly behind and the European Union in total also has 18%. Thus, U.S. trade is less important to its economy and that trade is better diversified than Canada's. In the final analysis, they need us a lot less than we need them.

Given the size of the U.S. economy, its land mass and its diverse climate, the U.S. is able to obtain some of the benefits of trade merely by trading within the country. Moreover, Donald Trump appears to adhere to old-fashioned protectionist trade theory—whether for real or as a negotiating tactic. He called for the renegotiation of NAFTA—not us. His mantra is “fair trade” (whatever that means) rather than free trade. Even the new name, U.S.M.C.A --by dropping Free Trade--at least recognizes that we do not have free trade but instead “managed trade”. There is a widely shared belief that the U.S. made no real concessions (only the dropping of new demands) while Canada and Mexico had to make real concessions. In the rest of this post, we’ll review a few highlights of the USMCA.

Dispute Settlement

The most important “gain” of the agreement for Canada was probably to fight off the Americans’ determination to get rid of NAFTA’s independent dispute settlement process which would have left us dependent on U.S. courts to settle any “dumping” and “subsidy” disputes. While imperfect, the independent process provides some defense against the U.S. use of punitive tariffs when Canadian exports seemed to do too well. Actually one part of the dispute settlement mechanism which allowed individual companies to sue the individual governments if they believed they had been unjustifiably harmed by government action, has now been eliminated. While a gain for all three governments, the effect on business investment is unfavourable.

The Milk Cartel Preserved

For Canadian producers of milk and other supply managed products the U.S.M.C.A. is largely a success. The monopoly system is maintained with minor harm. The new agreement will broaden American access to these markets by about 3.6 percent. This access will, however, cost Canadian taxpayers billions of dollars in compensation promised to the farmers concerned. With little indication that the inflow of U.S. products will reduce consumer prices, the result is a win for farmers—a loss for taxpayers and status quo for consumers. The piece-meal compensation for farmers is likely to cost far more than what it would cost to dismantle the whole system.[2] The Americans have also gained by being able to impose a tariff on a special category, class 7 milk products such a high protein milk powders and baby formulas, in which Canadian producers had managed to carve out a competitive advantage. It is unfortunate that while Canada has now given foreign producers limited access to our milk markets, it has not provided similar opportunity for beginning young Canadian farmers who have difficulty buying quota. Moreover, there has been no discussion of reducing U.S. agricultural subsidies  which would improve Canada’s ability to compete in the U.S.

Steel and Aluminum Tariffs

One thing our negotiators failed to get was a Canadian exemption of U.S. tariffs of 25-percent on our steel and 10 percent on our aluminum exports—even though Trump had tweeted at one time that these tariffs would be lifted once an agreement was reached.  Contrary to NAFTA’s free trade provisions, Trump has instituted these tariffs using a loophole in American trade laws claiming that these products pose a threat to U.S. national security. How imports from Canada could possibly threaten U.S. security is something no Canadian could visualize! Perhaps Trump is afraid we might attack them? How can you have a trade agreement which leaves the U.S. this massive loophole? While our negotiators are continuing to negotiate this issue separately, it is unclear what cards they might have available to deal.  The Americans apparently want to negotiate limits on the amounts of these exports (quotas) far below our normal export levels. Our government has so far rejected this. Perhaps we need to follow Mexico’s example and refuse to ratify the new treaty until these tariffs are lifted.

Vehicles and Parts

Since negotiation of the Canada-U.S. Auto Pact in 1965, the Canadian and U.S. auto industries have become highly integrated with parts and components moving across the border many times before a car is finally assembled. In fact, over 90 percent of our auto exports go to the U.S. Our auto dependence on the U.S. market was not lost on Trump who threatened us with a 25% tariff on auto exports. We “won” this round because we agreed to a tariff-free vehicle quota of 2.6 million units, well above the 1.8 million units we currently produce. A meaningless victory for Trump perhaps but the departure from “free-trade” is established and we may become constrained in the future. No doubt, auto companies will simply keep that in mind as they decide not to build their next plant in Canada. The recent G.M. Oshawa closure has already indicated that Canada has no significant advantage for the car manufacturers!

Canadian auto part suppliers also stand to benefit from new “content” rules. 75 percent of vehicles traded between the three countries must now be made in North America. That is up from 62.5 percent under NAFTA. While this provision may bring some production “home” from low-cost foreign locations, the increase cost will no doubt become reflected in the price of new vehicles. Similarly, the provision that 40 percent of an auto’s content be made by workers earning at least $16 an hour is likely to appeal to Canadian auto workers (since it will make them more competitive with Mexican workers) but will cost consumers in higher car prices. The provision defeats the tenets of free trade in that it will prevent Mexico taking advantage of its “comparative advantage” of lower labour costs.

Fuel

Of our most important export product, mineral and fuel, 90 % goes to the U.S. That is natural, since most of our pipelines run north-south. Of our last three major East-West pipeline projects, only one is still alive but on life-support. We have, as yet, no operating Liquefied Natural Gas export terminals although we may be getting close. That the new agreement maintains unimpeded access to the U.S. market for our oil and gas is a major success. As the U.S. has now become a net exporter of oil, that access cannot be underrated.

Benefit to online Shoppers

Canadian consumers have gained one small advantage in that the limit for individual tax-free imports has been raised from $20 to $150 for custom duties and $40 for sales taxes. At $20 the Canadian limit was one of the lowest in the world and the U.S. had pushed to have this increased to $800. While it would seem that if we have free trade, individuals also should be able to import freely, that was never the case. Canadian retailers are understandably not happy about this provision. A 2017 study estimated that an increase to $200 would have caused 286,224 retail or retail-related job losses, an $8.8 billion dip in labour income and an $11.5 billion drop in GDP.[3] Obviously, not something to be introduced overnight!

Drugs

 

Canadian consumers face extra costs due to a provision on patents on biological drugs. Patents on these have been extended to 10 years from 8. That’s two years longer we will have to pay the brand name price of drugs before generic ones can be introduced. An obvious win for U.S. pharmaceutical companies!

Influence on Canadian Autonomy

The new agreement gives the Americans a veto[4] over any trade deal that Canada might make with “non-market” countries i.e. China. It is, in fact, a good thing to be cautious in trading with such countries since many of their large companies are in part or whole owned by the government. Thus, making a profit may not be as important to these companies as other objectives e.g. exercising Chinese influence. They can, therefore, export their products at below cost and compete unfairly. Nevertheless, we appear to have given up a portion of our sovereignty to the U.S. with this provision while getting caught in between the U.S. and China in their trade war!

Furthermore, The USMCA contains provisions for a tripartite committee to monitor its exchange rates and tax policies. It is not clear whether this committee is consultative only or will have power to force changes. Some argue that this section has the possibility of undermining the independent authority of the Bank of Canada.[5]

In Sum

A deal that allowed president Donald Trump to proclaim victory (“truly historic news for our nation”) cannot be a win for Canada. Nevertheless, having basically maintained the status quo will provide us with reasonable trade stability. Canadian companies will, hopefully, face no new surprises.

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[1] https://johnmboersema.blogspot.com/2014/01/buy-local-think-global.html

[2] Martha Hall Findlay, of the Canada West Foundation quoted in Jesse Snyder “Deal does no Harm, breaks no new Ground”, Finanacial Post, Oxt. 2, 208, p. FP1

[3]  Taka Deschamps, “Benefits for online shoppers, trouble for some retailers”, Financial Post, Oct. 2, 2018, FP3.

[4] Technically, it gives the U.S. (and Mexico) the right to withdraw from the USMCA on 6 months notice if Canada were to sign a trade agreement with a non-market country.

[5] Malcolm Buchanan, “Is the USNCA a good deal for Canada