Werner's Blog — Opinion, Analysis, Commentary
State of the NAFTA negotiations: Canada standing firm while remaining flexible

‘NAFTA 2.0 is possible that is “the right deal for Canada”.’

NAFTA negotiations are proceeding slowly and a number of stumbling blocks remain. However, despite the Trump administration's self-imposed end-of-August deadline for concluding a deal, the negotiations remain on track and there is reason to be cautiously optimistic that NAFTA 2.0 is possible. Pro-trade forces in the US Congress remain committed to securing a continuing strong cross-border trade relationship with Canada. Our two economies are integrated closely, and further tariffs and retaliatory measures would hurt both economies. The White House threatens 25% tariffs on automobiles entering the US from Canada, but imposing these would hurt US automakers, whose supply chains are integrated across the border, as well as US consumers, who would face higher prices for new cars. The White House has only authority to negotiate a tripartite deal, not a separate new US-Mexico deal. A new trade agreement without Canada would require abandoning NAFTA first, and despite claims from the White House, authority to do so requires the ascent by Congress as they would have to pass a new law. While the US president is keen to have a "triumph" before going into the midterm elections in November, trade negotiations proceed at a slower pace. Essentially, Mr Trump wants Canada to capitulate and sign a take-it-or-leave-it deal. His divide and conquer strategy—first seeking a bargain with Mexico (considered the easier target because of their transition to a new government) and then presenting Canada with a fait accompli—may take a page or two out of his deal-making book, but it's not how the world of diplomacy works. Countries aren't businesses. Canada is standing firm on principles, while at the same time engaging in meaningful dialogue to reach a deal that is agreeable to both sides and also lifts NAFTA firmly into the digital era. Canada standing firm while remaining flexible is not an oxymoron; it is good diplomacy.

While the outlook is not as dim as it appears in the eyes of many commentators, there are major stumbling blocks that remain. I discuss three key issues below. There are several other issues that may help modernize NAFTA; see the references at the end of this article for discussions of these.

Chapter 19 and the Dispute Resolution Mechanism

NAFTA's Chapter 19 contains the key provisions for settling disputes between the parties. It deals with antidumping and countervailing duties and provides the ability for one country to challenge the ruling by another. In Canada, the Canada Border Services Agency (CBSA) makes dumping and subsidy determinations, and the Canadian International Trade Tribunal (CITT) reviews these decisions and determines if htere is "injury" or "retardation" to Canadian industry. The CITT can either uphold or reject a determination by the CBSA. In the United States, the Department of Commerce and the International Trade Commission play analogous roles. These two don't always agree. On August 29, 2018 the U.S. ITC overturned duties imposed on Canadian newsprint. When a ruling is disputed, a NAFTA panel is struck and the 5 members of the panel are drawn from rosters of experts (2 from each side, and the fifth alternates between countries).

‘Chapter 19 deters frivolous and arbitrary trade measures.’

Why is Chapter 19 so important for Canada? After all, among the various NAFTA disputes we've had, there have not been all that many rulings in Canada's favour. However, there have been some important "wins", notably in the case of softwood lumber. Without the Chapter 19 process Canada would be at the complete mercy of US politicians and the US court system, both of which are biased to their own interests. The process could also drag on for long periods of time. With Chapter 19 there are time lines that need to be met, and procedural safeguards that assure a fair outcome. Perhaps the main objective of Chapter 19 is not about the outcomes when they are used, but as a commitment device to prevent frivolous trade measures in the first place. When there is a dispute resolution mechanism, there is a commitment to follow procedure. That deters arbitrary application of trade measures. When Trump put tariffs on steel and aluminum from Canada, he did so ostentatiously to protect "national security"—and Canada is the United States closest ally. The Peterson Institute for International Economics shows that NAFTA has reduced the incidence of ADD/CV measures. Chapter 19 is truly essential. Canada should not give up on it, and Chrystia Freeland, Canada's Minister of Foreign Affairs, is wise to have held firm. She has shown Mr Trump's bluff. Meanwhile, she continues to negotiate with her US counterpart, Robert Lighthizer, towards reaching compromise. Canada's position is one of firmness on principles combined with flexibility on issues that could help improve trade, rather than retard trade.

Sunset clause

Originally the White House demand that NAFTA would automatically expire after a short period (five years) unless renewed. This is completely unacceptable because political constellations can conspire to reach a renewal in due time. What is on the table now is an offer of a sixteen year period with a review after six. This is much more workable. The world of trade changes, and a review process makes sense on principle. However, the time line should probably be stretched. A review once every decade allows for more substantive issues to arise, while pushing the sunset to 20 years ensures that there remain ten years to adapt to changes. Ultimately, Canada can probably live with the somewhat shorter period, but a longer time horizon for review provides greater predictability and certainty. The key argument against sunset clauses is that they distort business investments. If foreign companies fear that they may be frozen out of the US market if they invest in Canada or Mexico, they may not invest there. This is of course precisely the reason why the US is pushing for it: by creating uncertainty about NAFTA, they want to direct investment to the US.

Dare and Ditch Dairy?

Canada's dairy sector is protected by a shield of prohibitive tariffs, which allow dairy farmers to operate under a supply management system of fixed quotas and fixed prices. Farmers buy into the quota, and often have their life savings tied up in these quotas. Changing such a system would be painful, and even opening up the market as happened through the Canada-EU Comprehensive Economic and Trade Agreement (CETA) is expensive. The federal government agreed to bail out farmers for 18,000 tonnes of tariff-rate quota (TRQ) of cheese. Essentially, any further bit of market access yielded at the bargaining table will cost Ottawa hundreds of millions of dollars if it continues the current pattern of compensation. They will be reluctant to cede more than necessary. Many economists will probably agree with the notion that the dairy sector needs to be reformed, but simply abandoning the current system could cause adverse repercussions. Canada's dairy system is highly protective, but the Americans are no angels either: they heavily subsidize their farmers through other mechanisms. Canada also has rules that ensure the quality of dairy products: artficial growth hormones (rBGH and rbST) are banned in Canada (and the E.U, but not in the U.S.), and antibiotics are prevented from entering the milk supply.

‘Increased market access for dairy could become a quid pro quo for resolving disputes over softwood lumber.’

Enter ultafiltered milk into the picture. This is the protein content (and other not-fat solids) of milk that can be used for making cheese. The Americans have an oversupply of that (thanks to generous subsidies) and would love to dump it on the Canadian market. As originally it was not subject to dairy tariffs, US ultrafiltered milk (also known as Milk Protein Substances or MPS, harmonized system code 3504.00) entered the Canadian market rapidly. It reached a peak in 2016 but declined steeply in 2017 when Canada introduced reclassified "class 7" in HS 3504.00.12 when exceeding access commitments. The 270% tariff (or a minimum of $3.15/kg) impedes access from the US drastically. Despite these restrictions, the net balance of dairy trade across the border with the United States is positive for the US: they export to Canada while they import very little.

With dairy trade already tilting favourably to the US, what is all the fuzz about then? Mr Trump took up grievances by farmers from Wisconsin who lost their Canadian market when tariffs went up. Arguably, this access is something that could be negotiated, for example by increasing the access commitment. This would not amount to a full-fledged ditching of the supply management system. Farmers will still complain about death by a thousand cuts, but reform of the current system is necessary as Canadian farms remain smaller and less productive than their US counterparts. Canada's position will probably be one of give-and-take: ceding market access for dairy in exchange for resolving other disputes such as softwood lumber. It is not impossible to reach a sensible NAFTA compromise. To achieve it, Canadian negotiators need to match firmness on principles with flexibility on market access.

No deal, bad deal, or "the right deal for Canada"?

One of my trade professor colleagues, Meredith Lilly at Carleton University, argued that For Canada, a bad NAFTA deal is better than no deal at all in response to the government's mantra that "no deal is better than a bad deal". She's right that losing NAFTA would be a catastrophic (although not fatal) blow to the Canadian economy. However, one should not draw the wrong conclusion that we should simply sign whatever deal Washington offers. Meredith Lilly sees early missteps in Canada's negotiation and believes that "Trudeau must pay the piper and accept a worse NAFTA" or face the consequences of "an all-out trade war with Trump." I think it is premature to simply concede the game just because the home team is behind. This is defeatism. Lawmakers in Congress are quiet at the moment but will be more eloquent when vital economic interests of their constituencies are at stake, either in a vote in Cogress, or when Trump imposes auto tariffs that hurt firms and workers on both sides of the border. Prime Minister Justin Trudeau is looking for "the right deal for Canada", not just any deal. I find myself firmly in agreement with that position. Canada's negotiating position is not one of weakness as President Trump's tweets imply. From what emerges from the negotiations in Washington, Canada's negotiating team is determined and resolute, unfailingly polite, and engages in constructive dialogue. The good diplomacy shown at the bargaining table is in stark contrast to the language coming out of someone's Twitter account in the White House. The US president wants a deal before the midterm elections badly, so we can expect some "give" from their side as well. Mr Lighthizer's team seems genuinely interested in reaching a compromise, but his team's political master may yet instruct them to stonewall the negotations and not to entertain any sort of reciprocity. The US side ought to realize that the Canadian side could never face their own electorate by simply acceding to all US demands. There needs to be some give and take, and sufficient reciprocity, for a deal to emerge from the negotiations.

Canada-US trade relations will survive the erratic machinations of the current US president, because the cross-border relationship is one of mutual economic benefit and friendship. NAFTA is good for business. The American business community knows it, and most US politicians too. Sadly, the US president and his acolytes don't. If their economic ignorance destroys NAFTA, American workers will pay the price along with their Canadian cousins. I remain hopeful that economic sanity will prevail. As John Ibbitson put it in the Globe and Mail: "With good will on both sides, the talks will succeed, despite the President's tweets". I agree with him, and also with Eddie Goldenberg's conclusion that Canada still has a strong hand in NAFTA negotiations.

Further readings:

Posted on Monday, September 3, 2018 at 15:00 — #Trade
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