Canada can win at trade – even if NAFTA dies



by Eric Miller

The Globe and Mail
January 19, 2018

Trade negotiators from Canada, the United States and Mexico will gather in Montreal next week for the sixth round of talks on the North American free-trade agreement (NAFTA). It's an important moment in the renegotiation.

When the process began in Washington in August, there was much chatter that it would all be over by Christmas. This was never the Canadian government's view, nor was it realistic. One does not reopen the rules of the road for one of the world's largest trading blocs and expect the process to be swift or easy.

Going into the talks, the United States tabled more than 100 negotiating demands, making a balanced outcome – which is politically necessary for Canada and Mexico – hard to achieve.

Moreover, the United States has put forward controversial proposals on issues ranging from automotive rules of origin to dispute settlement to a five-year NAFTA "sunset clause." These are antithetical to established trade practices and injurious to Canadian interests.

Even so, U.S. Trade Representative Robert Lighthizer has grown increasingly frustrated about the slow speed and complexity of the renegotiation process.

Negotiators have made good progress on the less controversial NAFTA "modernization" agenda. These measures would do sensible things such as cover e-commerce and streamline border processes for trade. The bigger challenge comes from the more controversial U.S. proposals.

Being past his self-imposed deadline and facing the need this summer for U.S. President Donald Trump to secure renewal of his trade-negotiating authority, Mr. Lighthizer will make an assessment soon about the prospects for NAFTA deal.

Many in Canada and the United States are turning pessimistic and are beginning to prepare for a U.S. withdrawal. One must ask: How did things devolve to the point of a possible U.S. NAFTA exit – and does it matter, anyway?


Canadians are well aware that recourse to protectionism is a recurring pattern in U.S. foreign economic policy.

Being in a continental-sized country with a large internal market, U.S. firms, unlike their Canadian counterparts, tend not to instinctively believe that they have to export in order to prosper. Even today, the United States has one of the lowest ratios of trade as a percentage of GDP among rich countries – 27 per cent as compared to 64 per cent for Canada. Foreign competition is often viewed as something to be fought not just in the marketplace, but also in the corridors of Washington.

During the 1980s, in the midst of growing competition from Japan and Europe, the United States showed signs of turning protectionist. A federal royal commission, the Macdonald Commission, argued that if the walls were going up around the U.S. market, Canada's interests were best served by being inside.

Brian Mulroney embraced the idea, concluded negotiations with the Americans in 1987, and won an epic election campaign on free trade in 1988. Canada then joined the United States and Mexico in 1991 to negotiate NAFTA.

NAFTA was highly controversial in the United States. It took a well-organized effort by business groups, combined with the considerable political talents of then-president Bill Clinton, to get the agreed-upon deal approved by Congress. It entered into force on Jan. 1, 1994.

This coalition then moved on to other things.

Meanwhile, anger about the agreement persisted. As the first free-trade agreement with a developing country, NAFTA became synonymous in Middle America with the ravages of globalization, deindustrialization and income inequality. When jobs were being outsourced to China in the 2000s, NAFTA was blamed.

When Mr. Trump became a presidential candidate, he barnstormed the country decrying NAFTA as a "disaster," and tapped into a deep vein of resentment about the agreement and its alleged effects. As President, he swiftly made good on his promise to renegotiate.

Canadians are basically supportive of free trade and never thought seriously about the prospect of the United States reconsidering its trade policy. Rather, they got on with the business of making free trade a success.

Since 1989, Canada's merchandise trade with the United States has more than tripled, to $576-billion (U.S.) in 2015. Among the three NAFTA countries, trade has more than tripled since 1993 to more than $1-trillion annually. There also has been a fivefold increase in the value of foreign investment between the United States and Canada since NAFTA.

Because of this, any attempt to disentangle the complex relationships and supply chains built across North America since NAFTA would be costly and destructive. And while some economists armed with "general equilibrium models" are playing down the importance of NAFTA to Canada's economy, they are missing an important part of the picture.

For Canada, a key benefit is the narrowing of what could be called the "investment premium." When firms consider investing in, say, Ontario versus Ohio, they note that the U.S. location enjoys natural advantages: a larger market, greater economies of scale and, typically, lower all-in costs. By integrating the two economies, NAFTA has significantly lowered the "premium" investors must pay for choosing Canada over the United States. This has come through certainty of market access, more efficient borders and streamlining of costs across the economy.

The end of NAFTA – or even a period of prolonged uncertainty – could swiftly erode these hard-won advantages.

Safeguarding Canada's Preferred Position

From the beginning, Canada was alone in viewing a longer negotiation as something that would be in its interests. Its negotiating team has been rigorous in its preparations, clear-eyed in its strategy and deft in its handling of both the United States and Mexico.

The early risk was that the United States and Mexico would coalesce around a deal that was bad for Canada. From the outset, the Mexican government has been motivated to quickly address America's NAFTA concerns. Prolonged uncertainty, it feared, would be a significant drag on Mexico's ability to attract investment, particularly the type of export-oriented manufacturing in which it has thrived in recent years.

Ultimately, the Americans' slowness in tabling proposals coupled with the sharpness of some of their positions meant that an early U.S.-Mexico tie-up was not possible. Regardless, Mexico's motivation to conclude the NAFTA renegotiation remains unchanged.

Montreal poses a new challenge. Canada needs to drive enough progress to constrain the Americans' ability to leave the table. If Canada is seen as pragmatic and solution-minded, Washington's ability to walk away and credibly blame Ottawa for NAFTA's failure diminishes.

This matters because if NAFTA collapses, Canada's perceived conduct in the present discussions will influence its ability to secure a U.S. commitment to negotiate a renewed bilateral deal.

Progress, of course, need not mean agreement. It does, however, mean some forward movement on the less controversial "modernization" issues and the identification of workable ways of getting traction on the more controversial ones. The final formulations must both address U.S. concerns and leave Canada at least as well off as it is today.

The other core challenge is for Canada to begin making tangible progress on its offensive interests, such as expanded government procurement and temporary entry of business professionals.

To date, the Trump administration has been unwilling to deal seriously with these issues. That may change as the talks move to a more advanced bargaining stage where big trade-offs can happen.

In order to get there, Canadian negotiators will have to push hard in Montreal to reinforce the idea that trade-offs, not stark demands, are the only way to secure a NAFTA agreement.

Canada has reportedly made tangible progress on "trade facilitation" measures that will make the border work better, and on a number of other matters. Still, while the path ahead will not be easy, the right combination of tactics and strategy can secure a good NAFTA deal for Canada.

Diversification Imperative

Looking ahead, Canada must ask how it can reduce its vulnerability to the vagaries of American politics through trade diversification. Given that the United States takes 75 per cent of Canada's exports, there is no perfect answer.

Saving NAFTA is the preferred option, but if it falls apart, Canada should pursue a renewed bilateral deal with the United States. The U.S. would likely demand inclusion of key issues such as supply management and softwood lumber, so Canada should begin considering what it might be willing to do on these issues.

For its part, Canada should seek a comprehensive agreement. This would include full exemption from "Buy American" rules and a cross-border labour-mobility regime.

Some analysts suggest that Canada may not need a free-trade agreement at all and can simply rely on the World Trade Organization (WTO), but this is a risky bet. If the Trump administration is willing to withdraw from NAFTA, surely it is willing to erode the effectiveness of the WTO and skirt its rules. In what seems an ominous sign of things to come, the United States is presently blocking the appointment of new members to the WTO Appellate Body.

So diversification is a must.

In Asia, Canada must prioritize the swift completion of the new Trans-Pacific Partnership (TPP). It offers immense opportunities for Canadian exporters and can go a long way to fulfilling the goals of trade diversification. Once completed, Canada should champion the entry of a new group of TPP members, including Indonesia, Taiwan and Thailand.

Some have suggested that China can replace a protectionist United States in Canada's export mix. Geographic proximity alone suggests that this can never happen. But the two can still develop a mutually beneficial trade relationship.

In order to do so, the federal government should appoint a crack team of trade experts to map out China's economic interests, identify where Canadians have comparative advantages in the Chinese market, develop workable mechanisms for guaranteeing that Canadian firms get real access in that market, and design ways to administer the agreement – including settling disputes.

In September, 2017, the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union entered into force. Canada also has an important trade agreement with South Korea. On both fronts, the government needs a comprehensive strategy to turn the deal into business.

It is often said that free-trade agreements create opportunities, but do not guarantee results. With so much riding on the trade diversification agenda, it is time for Canada to up its game on trade promotion. This includes considering how to better utilize and resource the Trade Commissioner Service, Export Development Canada and the Business Development Bank.

Ottawa should also get more hands-on in developing export consortiums of Canadian companies that can provide integrated, coherent service offerings in target markets. Japan, for example, frequently offers partner countries infrastructure projects. A subway system, for instance, is built top-to-bottom with Japanese technology, materials and financing. Canada should do the same in areas where it has a critical mass of expertise.

Finally, Canada should fully align its domestic-policy regime, including at the provincial level, to reinforce the push to expand exports and build competitive companies. A variety of measures, from B.C. log export restrictions, which impede timber trade with Asia, to restrictions on the distribution of wines, which are under challenge by Australia and the United States at the WTO, ensure that Canada punches below its weight in sectors where it has comparative advantages.

Opportunity Abounds

It is often said that out of crisis comes opportunity. With NAFTA at risk, farmers, business groups and ordinary citizens are publicly supporting the deal for the first time in years. A November Pew Research poll found that 56 per cent of Americans now think that NAFTA was "good for America," up five percentage points since May.

While this support has to be turned into leverage and then married with careful, creative negotiating techniques, it does raise the real possibility that the three countries could end up with a good agreement at the end.

If Canada comes out of Montreal having made meaningful progress on automotive rules of origin and can realistically foresee closing this issue within a couple of rounds, the sessions can be considered a success. After all, if the three countries can crack one of the most high-profile controversial issues, the others may not look quite so impossible.

Nothing, of course, is guaranteed. If Canada ultimately does retain its preferential access in the U.S. market while pushing ahead in Asia and Latin America and better utilizing its Europe deal, it may enter the 2020s as one of the advanced economies best positioned for growth.

In an uncertain world, that would be a pretty good outcome indeed.

Eric Miller is President of Rideau Potomac Strategy Group and a Fellow with the Canadian Global Affairs Institute.

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