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What will Trump target in a NAFTA renegotiation?

January 24, 2017

9-minute read

On his first full day in office, Donald Trump made good on his pledge to withdraw from the Trans-Pacific Partnership (TPP), effectively killing the deal. The administration then turned its sights on overhauling NAFTA, which may be more curse than blessing for Canada.

Under NAFTA Article 2205, any party can withdraw from the agreement on six months’ notice. The Trump administration has already threatened to scrap NAFTA if it is dissatisfied with the Canadian or Mexican responses at the table. Trump may even trigger the withdrawal process as a pressure tactic—something he can do without congressional approval.

Canada is entering these talks without a lot of leverage. The role of Canadian negotiators could be characterized as interpreting American self-interest in a way that’s convincing to U.S. decision-makers, but also advantageous to Canadian interests.

There are some areas, such as the rules of origin in the manufacturing sector, where interests potentially converge. As for most of the rest, as described here, it will be damage control and a readiness to assert Canadian interests against unreasonable demands.

Rules of origin (and domestic content)

Rules of origin are the complex way it’s decided which products are eligible for duty-free treatment under NAFTA. Normally a qualifying product is either “wholly originating” (fish caught in territorial waters), “substantially transformed” (imported flour used to produce biscuits), or contains no more than a certain level of non-NAFTA content (a motor vehicle might have up to 37.5% foreign content). In principle, higher North American content rules could benefit Canadian and Mexican producers by precluding manufacturers from using high levels of offshore content, such as auto parts from China or Indonesia, if they wanted to qualify for duty-free treatment within the NAFTA zone.

There are reports the White House may also be seeking U.S.-specific content rules in key sectors (e.g., a minimum of 25 to 33% U.S. content in autos). Such a requirement would violate the spirit and probably the letter of NAFTA. When determining eligibility for preferential treatment, NAFTA parties can’t distinguish between Mexican, Canadian and U.S. goods and materials; in principle, inputs from all three NAFTA countries should be interchangeable. Any discrimination would be a violation of national treatment for goods (Article 301), which is the core obligation that the rules of origin give effect to.

These rules are not infinitely flexible, and Trump and his advisors may find some other way to boost U.S.-only content. But simply revising the rules of origin won’t get them there. It is also important to remember that rules of origin are only relevant to qualify for duty-free access under NAFTA. An importer of Canadian or Mexican goods can always choose to pay the duty, which would be assessed at the U.S. most-favoured-nation (MFN) bound rate.

Binational panel review

When the Mulroney government negotiated the Canada-U.S. free trade agreement in the mid-1980s its main goal was to get Canada exempted from U.S. trade remedy laws, which had been used repeatedly against Canadian products including softwood lumber. It failed in this effort, even though chief negotiator Simon Reisman walked out of the talks in frustration. What Canada got, more or less as a face-saving gesture, was a binational review of U.S. trade remedy rulings, a feature that was carried over into NAFTA.

NAFTA Chapter 19 provides the option for an exporter to ask a binational panel to review final anti-dumping and countervailing duty rulings instead of using domestic judicial review. The Trump administration has notified Canada that it wants to change, and perhaps get rid of, this binational review process. It is not a true, independent dispute settlement process. Its mandate is strictly to determine whether the importing country’s trade remedy laws have been applied properly. Under NAFTA, U.S. trade remedy laws continue to apply fully to Canadian exports. The U.S. can amend its trade laws without Canadian consent. If a new U.S. trade law or amendment specifies Canada, then it will apply.

A 2005 House of Commons report identified major problems with the Chapter 19 process. Because of U.S. obstructionism, these reviews are arguably more time consuming, costly and unfair than appeals through U.S. domestic courts. Moreover, if you win in the U.S. courts you can get your money back. Under Chapter 19 the process just starts over again. Even if the review process were abolished completely, Canadian exporters will still be able to have a final determination reviewed in the U.S. courts. The Article 1904 review process has been used 21 times by Canadian exporters since 1995. Its loss would be felt, but its benefits should not be exaggerated.

Buy America procurement rules

Canada is almost certain to be faced with Buy America provisions on new U.S. infrastructure spending. Under such programs, the U.S. government typically requires 100% use of American steel and 60% domestic content for other materials when funding state and municipal infrastructure projects. Buy America had strong support in Congress before Trump highlighted his Buy American and Hire American policies, and this support will outlast his administration.

Canada failed to gain any meaningful exemption from the Buy America provisions in the Obama administration’s 2009 Recovery Act. The former president dragged those talks out until almost all the stimulus money was disbursed, then gave Canadian suppliers only a brief opportunity to compete for the $1-2 billion worth in remaining contracts. The U.S. refused to budge on its Buy America rules during the TPP negotiations, as well, despite the fact that it was one of the Harper government’s highest priorities.

At a certain point, Canada has to face the reality that these preferences are going to remain in place. The Trump administration is even less likely than the Obama regime to weaken Buy America provisions. A sensible goal might be to try to ensure the current opportunities for subcontracting are maintained. Canada might also adopt mirror Buy Canadian provisions on its infrastructure spending, though this option will be largely precluded by the Canada-EU trade deal (CETA) that is very close to ratification.

Regulatory harmonization

It is hard to say what role the bilateral consultation and harmonization structures, built up through the Beyond the Border Action Plan and other post-NAFTA initiatives like the Regulatory Cooperation Council, will play under a more unilaterally minded Trump administration. Or how these structures might factor into a NAFTA renegotiation. But if, as expected, Trump unleashes a deregulatory tsunami south of the border, Canada will be inundated. We can be certain there will be intense pressure from the Canadian corporate sector to match U.S. regulatory standards step by step in order to maintain competitiveness. Civil society groups will need to strongly counter this pressure to revise Canadian regulations to align with weakened U.S. regulatory norms.

“Voluntary” export restraints

With the U.S. Lumber Council leading the charge to put quotas on Canadian exports, Canada is very likely to face pressure to limit softwood lumber exports. The previous softwood lumber agreement, which curbed Canadian exports, expired in late 2015. Canada rejected a U.S. proposal in mid-December. Meanwhile, the U.S. International Trade Commission (ITC) is investigating Canadian softwood lumber exports for evidence of injury to U.S. producers, which is the first step in the process of applying punitive tariffs. In November, U.S. lumber industry groups filed petitions with the ITC and the Commerce Department, alleging Canada illegally subsidizes its lumber producers and dumps products on the U.S. market at below cost.

While the softwood lumber talks will likely proceed on a parallel track, the U.S. may want to codify these export restraints in the new NAFTA. It’s conceivable other sectors, such as beef, could also be targeted. Incidentally, Robert Lighthizer, the new U.S. Trade Representative, was an architect of voluntary export restraints on Japanese automobiles when he worked for the Reagan administration in the early 1980s.

Supply management

After decades of trade liberalization, supply management is one of the last big chips Canada can put on the negotiating table. Losing supply management—a system that matches domestic demand for poultry, eggs and dairy with supply from Canadian producers—would be a tragedy for famers and rural communities. It would also risk a political backlash from Canadians. Supply management is a good system for Canadian farmers and consumers, with support from key provincial governments and the public, both rural and urban. The concessions on supply management the Harper government offered under TPP will likely be the starting point for NAFTA talks. But they are unlikely to satisfy the Trump administration or the U.S dairy industry, which is also upset with Canadian proposals to limit the use of imported protein solids and other fluid milk substitutes in Canadian dairy products.

Drug patents and copyright

Canada will undoubtedly face pressure to align its intellectual property (IP) rules with those in the U.S., especially around drugs. Key congressional Republicans were unhappy with the TPP—and threatened to block it—because they wanted even stronger IP protections for drugs than the Obama administration was able to get.

Under CETA and the TPP, Canada agreed to extend patent terms for up to two years to compensate for alleged regulatory delays. The U.S patent restoration system provides for extended patents of up to five years. Another bone of contention is data protection. The U.S. has the longest periods of data protection on the planet, providing a term of 12 years to biologics, in contrast to Canada’s eight-year term, which is also excessive by global standards.

Making such changes to harmonize with U.S. standards would be extremely costly for Canadians, who already have the second highest drug costs per capita, after the U.S., in the OECD. It is also very likely that a revamped NAFTA would include the longer copyright terms negotiated in TPP, and possibly the agreement’s other changes to copyright provisions.

U.S. energy security

The Trump administration may try to use a revamped NAFTA to lock in U.S. energy security. Corporate interests in all three countries could find common ground in their desire to open continental fossil fuel reserves (especially in Mexico) to private investment. Likewise, with the impending Keystone XL pipeline approval, NAFTA’s current energy provisions, which lock in the U.S. share of Canadian exports, take on a more ominous tone. The implications of intensified fossil fuel use for efforts to curb climate change are likely to take a back seat.

Investor-state dispute settlement (ISDS)

It’s conceivable a Trump administration, which has some libertarian and sovereigntist influences, could be somewhat sympathetic to reforming NAFTA’s investor–state dispute settlement process (ISDS) to curtail the role of unaccountable arbitration tribunals. But it is hard to be very optimistic about this prospect when Trump has appointed former Exxon CEO Rex Tillerson as his Secretary of State.

The U.S. State Department is the lead federal government agency on investment protection and investment arbitration. Exxon was a vocal supporter of investor rights and investment arbitration, and has used ISDS repeatedly, including against Canada. With Tillerson at the helm, the U.S.-owned Exxon restructured in countries like Venezuela to gain protection under European bilateral investment treaties.

There is also the sad reality that both the Canadian and Mexican governments support ISDS and are open only to marginal improvements to better safeguard public policy-making and regulatory autonomy. Canada’s current hobbyhorse, the “Investment Court System” introduced into CETA to salvage the unpopular agreement in Europe, was disliked by the Obama administration and opposed by the country’s powerful arbitration industry. This antipathy to an investment court will only harden under the Trump regime.

Border taxes or tariffs?

The backdrop to these talks will be heavily influenced by whether or not the Trump administration is prepared to take truly disruptive steps, including threatened border tax or tariff measures, to redress global trade imbalances that it sees, with some justification, as undermining U.S. industry and workers. In this area, key cabinet appointees are already walking back the campaign rhetoric. But if such measures are imposed it is difficult to imagine Canada escaping their impact.

Depending on their form and severity such steps would represent a real break with the current international trading system, comparable to Nixon taking the U.S off the gold-exchange standard and imposing across-the-board import tariffs in the early 1970s. It is too early to tell what might happen, or whether the desire to confront China could lead to serious trade and diplomatic friction, which could easily sideswipe Canada.

Exit strategy

The list of issues will get longer as talks proceed and U.S. negotiating asks are defined and firmed up. It would be prudent to expect the unexpected, and not to rule out even bizarre demands. Actually, it’s not too early for Canada to be thinking about the end game. If things get really ugly—and they could—Canada needs to have an exit strategy. That means being prepared to let the Trump administration make good on its threat of NAFTA termination. This outcome would be preferable to giving in to all U.S. demands, however extreme or unreasonable.

If talks end acrimoniously it seems doubtful the U.S. would reward Canadian defiance by allowing the two countries to revert to the Canada–U.S. FTA (which would have the advantage of maintaining duty-free access without the baggage of ISDS). But this option remains a legal possibility. A more likely fallback is relying on multilateral obligations and rules at the World Trade Organization. NAFTA termination would obviously be disruptive for Canada–U.S. trade, but so could a revamped NAFTA that puts “America First” on Trump’s terms.

Scott Sinclair is the director of the CCPA’s Trade and Investment Research Project. Photo by Woody Wood (Flickr Creative Commons).



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