Boxing with the Elephant: A Hard Turn in NAFTA Negotiations

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June 5, 2018

Boxing with the Elephant: A Hard Turn in NAFTA Negotiations

As far back as October of 1993, President Trump has been on the record against the North American Free Trade Agreement (NAFTA) and has articulated his distrust of the partners involved. While many of his campaign promises have been neglected or derailed, trade is one area where he believes he has the leverage he needs to make good on his campaign promises. The application of the steel and aluminum tariffs on the European Union, Mexico, and Canada last Thursday clearly demonstrated his commitment to his trade agenda.  The fallout from those tariffs may well be the creation of separate bilateral agreements to replace NAFTA, though Canada rejects this approach.

Tariffs, Section 232 and National Security

It is important to note that from the United States administration’s perspective, the application of section 232 tariffs is solely about protecting domestic capacity. They have chosen to use an obscure 1962 United States law, interpret it as broadly as possible, and apply it across the board for imports of (in this case) steel and aluminum. There are no countries completely exempted, although Argentina, Australia, Brazil, and South Korea have negotiated Tariff Rate Quotas (TRQ) on steel or aluminum.  The top importers of steel to the United States are Canada, Brazil, South Korea, and Mexico, and the top importers of aluminum are Canada and China.

The argument that Canada is a long-standing ally, while accurate and compelling, does not meet the interpretation of section 232 that the Trump administration is relying on to implement these and other quotas. The use of this tariff is controversial in and of itself, and if the United States can be shown to be applying different standards of national security concerns on some industries as opposed to others, the entire house of cards will come tumbling down. The clause below is what allows the finding that the imports of those countries with which the United States has a treaty or alliance are also a threat to national security.

“…the Secretary and the President shall further recognize the close relation of the economic welfare of the Nation to our national security, and shall take into consideration the impact of foreign competition on the economic welfare of individual domestic industries; and any substantial unemployment, decrease in revenues of government, loss of skills or investment, or other serious effects resulting from the displacement of any domestic products by excessive imports shall be considered, without excluding other factors, in determining whether such weakening of our internal economy may impair the national security.”

In short, the national security argument as deployed by the Trump administration is about winning in a zero-sum game. Historical relationships and alliances do not matter.

Are We Headed for Bilateral or Trilateral Deals?

The rush to reach an agreement in principle for the renewal of NAFTA was the background to the tariff exemption discussion. The United States explicitly linked the two by stating that the first exemption was because the agreement was still in negotiations, and the second because the talks were moving positively, if nowhere near complete. Although the Canadian government rejected the linking of the one to the other, it continued to act in ways that demonstrated the United States was dictating the rules of the game.

In mid-May, with Minister Freeland leading the Canadian delegation in Washington D.C., Prime Minister Trudeau undertook a trip to New York City and Boston, where he took on the continuing issue of the sunset clause in an interview with the Fox News network. In hindsight, that may have created a target too rich for President Trump to ignore.

More recently, as the Prime Minister sought a face-to-face meeting with the President, he was held at bay until last Tuesday, two days before the exemption on the steel and aluminum tariffs ran out. That day, and acting in the role of “bad cop,” the Vice President called the Prime Minister and told him that the NAFTA negotiations would continue, but there would be no meeting with the President unless Mr. Trudeau accepted the five-year sunset clause in NAFTA.

The sunset clause has always caused concerns for Canada and Mexico due to the uncertainty it would introduce to investment decisions. However, agreeing to the sunset clause would buy five years of peace, possibly longer than the Trump era may last, and might also encourage all parties to get back to the table post-Trump. In addition, those concerned about long-term certainty should also recall that even the currently open-ended agreement has a six-month termination clause that can be triggered at any time by any party.

So, what happens to the NAFTA negotiations now?  Speaking to Fox News, White House economic advisor Larry Kudlow said the President is “very seriously contemplating a shift in the NAFTA negotiations. His preference now, and he asked me to convey this, is to actually negotiate with Mexico and Canada separately. Canada is a whole lot different than Mexico. It’s got different problems.” Kudlow also said he had floated the idea of bilateral agreements with Canada yesterday and expects to hear back today. While he said the President is not necessarily looking to withdraw from NAFTA, the sense that something needs to shift is clear.

Minister Freeland has repeatedly indicated that Canada will remain at the negotiating table as long as there is a table at which to negotiate. The Mexicans also have agreed to continue, however, they must pause for their elections at the end of June until the new Mexican government is formed and ready to re-engage.

So far in these negotiations, the notion of two separate bilateral agreements has been rejected by both the Mexicans and the Canadians, their belief being that negotiating with an angry and protectionist superpower one-on-one would be more difficult than sticking together. On the other hand, Canada’s issues with the U.S. are very different from the Mexican factors such as labour costs, trade deficit/balance, economic integration and border migration.

In normal times, willing partners could accommodate these differences in a trilateral agreement, but these are not normal times.  Taking the bilateral route with the U.S. would remove the contentious issues the U.S. has with Mexico.  In addition, Canada and Mexico have the pending CPTTP waiting in the wings, an agreement that was always intended to be part of a badly-needed update for NAFTA.  How much the separation of the two would disrupt the North American supply chain would be an ongoing challenge, but is likely a manageable one between the resulting agreements.

While neither Canada nor Mexico has yet received a formal request from the U.S to move to the bilateral, Canada’s Trade Minister Francois-Philippe Champagne and Mexico’s Economy Minister Ildefonso Guajardo in separate remarks yesterday shunned the idea of any bilateral deal.

Turning the Temperature Up

On June 1, the United States applied 25% tariffs on steel and 10% tariffs on aluminum. Those affect virtually all categories of steel and aluminum exported from Canada into the U.S. Many of those categories include end products that are hewn from steel imported into Canada.  Some of those (55% of steel imports or 4.8 million metric tons) are from the U.S..

Without question, the U.S. tariffs will affect the North American supply chain adversely. Canada’s retaliation measures against steel and aluminum will increase the adverse effects, with the goal of demonstrating to the United States what a trade war really costs. Canada’s retaliation list was drawn up through months of work by Global Affairs, as the North American team identified where the integrated supply chains facilitated by NAFTA ended – job-by-job, state-by-state, lawmaker-by-lawmaker.

All the work poured into the “maple charm offensive” should pay big dividends now. Each item on Canada’s target list has been cross-referenced not just by politician, but by domestic producers and consumers – the list is also designed to inflict maximum pain in the U.S. while limiting adverse impacts on the Canadian consumer. Additionally, the consultation period provides time to ensure that there are no unintended consequences to Canadians from the retaliatory action.  The consultation period will also give the Canadian government time to determine what kind of assistance can be provided to affected industries and businesses.

If Canada feels under attack by the United States, it is important to note that in the early days the tariffs are not supported by Congressional leaders. Speaker of the House Paul Ryan almost immediately noted that he disagreed with the decision to levy tariffs against allies, as did Senate Majority Leader Mitch McConnell. Senator Ben Sasse, a Republican from Nebraska, tweeted out about the tariffs, “This is dumb.” In addition, Sen. Bob Corker, the chairman of the Senate Foreign Relations Committee, and House Ways and Means Chairman Kevin Brady spoke out against the President, as did Senate Finance Committee Chair Orrin Hatch.

For the first time, there was an obvious split last weekend among Canadian Conservatives over how the federal government has handled trade with the U.S. and NAFTA.  Conservative leader Andrew Scheer and foreign affairs critic Erin O’Toole were both critical of the Prime Minister, calling the U.S. imposition of the tariffs a “failure” in the PM’s approach to Canada-U.S. relations.  But Alberta United Conservative Party leader Jason Kenney and former Saskatchewan Premier Brad Wall both tweeted strong support for the PM’s and Chrystia Freeland’s response to the U.S. tariffs.

What’s Next?

The Prime Minister opened the issue of supply management on NBC’s Meet the Press when he said the U.S. wants “more access on certain agricultural products like dairy to Canada” and that “we were moving towards flexibility in those areas that I thought was very, very promising.”  That brought a sharp rebuke from the Dairy Farmers of Canada, who demanded a meeting with the PM and called his remarks “deeply troubling for our dairy farmers.”

The Prime Minister also met steel producers who requested that Canada’s retaliatory measures go into effect immediately instead of waiting for the end of the 30-day consultation period.  The PM responded that he would follow through on the consultations while trying to persuade the U.S. to drop the tariffs.  In addition, the Minister of International Trade will be participating in a summit of G7 aluminum producers in Montreal.

Canada has filed both a WTO challenge to the tariffs and requested a NAFTA Chapter 20 panel. The European Union and Mexico have also filed challenges with the WTO. Meanwhile, the U.S. continued to prepare tariffs against a range of goods from China as a way to express its displeasure with China’s actions on intellectual property ( both China and Canada were placed on the priority watch list). In recent days, both China and the United States have walked back earlier promises of détente – with the Chinese announcing that they’re not sure they will abide by their agreement to purchase more agri-food commodities and energy from the United States.

The United States has also taken the first steps towards initiating additional tariffs on automobiles. This investigation is almost assuredly directed primarily at non-North American auto makers but has the potential to set higher tariffs for all automobiles not built in the U.S. One of the pressures on the rules of origin discussion in NAFTA is the threshold at which it is simply cheaper and easier for automakers to build abroad and import. The outcome of this investigation could set that bar higher.

Ironically, in the midst of all this uncertainty, a number of President Trump’s trade priorities have now been achieved. He has successfully redefined the trade landscape and created an environment where those that need the support of the United States or access to its market are beholden to the chaos that his announcements, deadlines, and twitter feed create. Now 500 days into his term, and heading into midterm elections, he has the second highest ‘own party’ approval rating of any president (second only to George W. Bush, post 9/11). Neither he nor his pronouncements can be ignored. The final year of the federal government’s mandate will clearly be marked by increased tension in the Canada-U.S. relationship.

G7 Implications

The timing of the imposition of the tariffs on the EU, Canada and Mexico (Japan was already subject to the tariffs) coincided with the meeting of the G7 finance ministers in Whistler. U.S. Treasury Secretary Steve Mnuchin, one of the few free traders left in circle of Trump advisors, attended. At the conclusion of the meeting, the finance ministers issued a rebuke to the United States in the text of the chairs’ summary:

Ministers and Governors had a frank exchange on the benefits of an open rules-based trading system and many highlighted the negative impact of unilateral trade actions by the United States. Ministers and Governors agreed that this discussion should continue at the Leaders’ Summit in Charlevoix, where decisive action is needed. The aim of this should be to restore collaborative partnerships to promote free, fair, predictable and mutually beneficial trade. 

Looking ahead to the G7 leaders meeting, the meticulously prepared agenda will likely be turfed in favor of unfolding trade events. The protectionist and unilateralist approach undertaken by the current U.S. administration threatens the global order, economic stability and is of paramount concern to the other G7 members.

How the six nations move forward with a G7 agenda, and whether the U.S. President decides to attend the summit are still open questions. President Trump has no patience for multilateral engagements, prefers to be the host rather than be a guest, and has little alignment or agreement with the summit themes, not to mention a meeting focused on his bad behavior.

As we have seen before, the Vice President is often pressed into duty for multilateral or uncomfortable meetings. His deployment as the bearer of bad news last Tuesday is likely foreshadowing for Charlevoix.

What This All Means for the Trudeau Liberals

There comes a time in the life of every government when it must stop trying to be all things to all people and draw red lines simply because of the national stakes involved.  In such situations, it’s all about decisive leadership—nothing else matters.  The last two weeks have been one of those times for the federal Liberals and the Prime Minister. This shift may indicate the beginning of political positioning that will harden positions and more clearly define Mr. Trudeau and his government.

First came the decision to disallow the sale of Aecon to a Chinese state-owned enterprise. Although the PM said there were security considerations, he went out of his way to portray the decision as a way to protect Canadian sovereignty.  Last Tuesday, the government moved to purchase the Trans Mountain assets of Kinder Morgan to assume the risk of twinning the hugely controversial pipeline from Edmonton to Vancouver.  Ensuring export access for Alberta’s oilsands bitumen to diversified markets is essential to the Prime Minister’s climate change bargain between energy-producing provinces and those concerned about the environment. The decision also pits the PM and federal powers against environmentalists in a province that returned more Liberals to Ottawa than at any time in almost 50 years. It runs against the conventional political calculus and underscores a renewed federal government decisiveness and determination.

Three days later, the U.S. tariffs on steel and aluminum hit.  The PM and foreign minister Chrystia Freeland eloquently expressed the anger of the federal government in their response.  Mr. Trudeau called the national security justification of the tariffs “totally unacceptable” and “an affront” to a country whose soldiers have fought and died alongside American soldiers.  Minister Freeland was equally scathing in speaking with CNN’s Dana Bash this past weekend: “We are hurt and we are insulted.  What you are saying to us and all your NATO allies is that we somehow represent a national security threat to the United States.  Seriously?” Both the PM and Ms. Freeland used language Canadian leaders have not used since Mr. Diefenbaker, words that will be hard to walk back.

Unless there is a climb down from Mr. Trump, which is highly unlikely, Canada-U.S. relations are now on dramatically different footing.  Since the beginning of the protracted NAFTA renegotiations, the position has been that “No NAFTA deal is better than a bad NAFTA deal.”  Last week’s U.S. steel and aluminum tariffs may end up making that argument a reality. It may also re-define Mr. Trudeau’s political positioning vis-s-vis the U.S. in the Canadian pre-election period, moving from the “charm offensive” to a much tougher focus on economic nationalism and sovereignty.