A New Chapter for North American Trade

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October 1, 2018

A New Chapter for North American Trade

After 14 months of difficult and often fractious negotiations, Canada and the United States announced the successful completion of the NAFTA talks literally at the eleventh hour, late on a Sunday evening.  The deal brings Canada on board with the agreement reached earlier between the United States and Mexico, and ushers in a new name to replace NAFTA: the United States-Mexico-Canada Agreement (USMCA).

The new deal comprises 34 chapters, a dozen side letters and thousands of words, which is a lot of fine print.  Without getting lost in the many devils involved in these details, here is Earnscliffe’s take on USMCA and what it means for Canada.

The successful completion of negotiations is a huge win for the Trudeau government.  Negotiations were pushed to the brink, and through the skill and hard-headedness of its negotiators enabled a smaller and weaker partner to force a larger, more powerful one to accept several essential terms. Following its wins in Brussels in implementing CETA (negotiated earlier by the Harper government), and its signing of CPTTP, Canada can now celebrate a trifecta in trade negotiations, unheard of for a player of such modest scale.

At the end of the day, each side gave the other what it wanted most, proving that for both countries, the benefits of a deal were greater than the allure of standing on principle or admitting defeat.  Canada agreed to provide the U.S. with greater access to its dairy market, while the U.S. agreed to leave the existing NAFTA dispute resolution system intact, a non-negotiable demand for Canada throughout the talks.

The deal on dairy was likely somewhat easier for Canada to accept than the continuation of NAFTA’s dispute settlement regime for the United States. Under the new USMCA, Canada built on the supply management precedents set by the Comprehensive and Economic Trade Agreement (CETA) with the European Union and the Comprehensive and Progressive Trans Pacific Partnership (CPTTP).  Under CETA, Canada opened its market to 17,700 tonnes of cheese products per year.  In CPTTP, Canada conceded 3.25 per cent of its annual dairy production to foreign markets. Both deals provided for federal compensation to the dairy sector.  For Prime Minister Trudeau, he can position the net result as a successful defense of Canada’s overall supply management system.

Meanwhile, in the interests of securing a deal, the U.S. was forced to accept Canada’s victory a generation earlier on the flashpoint of dispute resolution in the original Canada-U.S. Free Trade Agreement. U.S. Trade Representative Robert Lighthizer had been determined until the final hours to avoid the continuation of what he saw as an affront to American sovereignty: the ability of a foreign power to use non-American controlled legal processes to resolve trade disputes. He wanted to establish a permanent U.S. thumb on the scales.  In the end, he lost that battle to the need for a deal.

Mr. Lighthizer was forced to accept the existing NAFTA Chapter 19 dispute settlement mechanism word-for-word.  The preservation of dispute settlement for Canada in exchange for the dairy concessions also provides a win for President Trump.  Replacing NAFTA was a key campaign promise that he can now tell the dairy farmers of Wisconsin and New York he has delivered.

Moreover, that a negotiating partner one tenth the size of the player opposite was able to not only avoid humiliation, but also win a defensible outcome in terms of Canadian national interest is as impressive as it was the first two times under the original Free Trade Agreement and subsequent NAFTA deals. Except this time was different. Facing an erratic and unpredictable leader behind the negotiating team opposite, Canada’s team maintained its discipline, kept its cool and rarely rose to respond to the public provocations and insults coming from the other side.

The agreement is also a win for Canada’s two-year, no-holds-barred campaign to force the chaotic Trump Administration to accept that the two most integrated economies in the world could not be ripped apart without inflicting massive economic damage on both sides. Now, Canada’s Maple Charm offensive will refocus on the U.S. Congress post the November elections and the need to convince both old and new members to agree to the new USMCA.  It will be an interesting juxtaposition: going forward, Canada will be firmly supporting the Trump Administration instead of trying to prevent it from harming Canada.

Perhaps the biggest winner of Sunday’s negotiation breakthrough is confidence in the Canadian economy. The protracted negotiations and accompanying threats increased business uncertainty and fears for Canada’s future security of access to our largest trading partner. These uncertainties and fears did much to depress an investment climate already weakened by Canada’s pipeline approval troubles and the Trump tax cuts.  The new USMCA removes at least some of the risks that have been delaying private sector capital investment decisions by removing a dark cloud from Canada’s economic horizon.

To be fair, several of Canada’s demands fell by the wayside as the negotiations wound up.  The “progressive” elements of Canada’s self-styled “feminist foreign policy” and Indigenous rights did not find a place in this agreement, although the environment chapter now has more teeth with an enforcement mechanism. In addition, the  Section 232 actions on steel and aluminum remain intact for the U.S. But given that the damage President Trump’s threatened Section 232 tariffs on Canadian autos (25 per cent) would have caused has now been averted, Canada has every right to claim victory.

At news conferences today, both Prime Minister Trudeau and President Trump called the deal a win for all sides. Nevertheless, both acknowledged that their relationship had been tense and strained during the final weeks of talks. Minister Freeland was upbeat and identified the major Canadian wins as the auto agreement, the retention of Chapter 19 and the elimination of both Chapter 11 and the energy proportionality provisions under the FTA (and later NAFTA) that forced Canada, in times of an energy shortage, to cut Canadian supplies proportionally with cuts to US exports.

Most stakeholders were cautious in commenting today as they awaited the details to sink in. That was not true of two premiers who had been briefed along with their colleagues by the PM. Despite the promise of federal compensation, both Québec Premier Couillard and Ontario Premier Ford said dairy farmers had been thrown under the bus and said they would fight implementation of the deal.  Ford went further to complain about steel and aluminum tariffs remaining in place as did leaders in that sector, including the steel workers union. Nevertheless, Jerry Dias of Unifor welcomed the deal because of advances made in the agreement on autos.

In the United States, congressional leaders largely welcomed the deal and applauded the inclusion of Canada in the trilateral agreement.  The chairs of both the Senate Finance and the House Ways and Means Committees, which oversee free trade agreements, praised the deal.  Democrats were more measured, promising to study the detailed text to ensure it supports workers and includes strong environmental standards.  Major stakeholder groups such as the U.S. Chamber of Commerce, the National Foreign Trade Council, the National Association of Manufacturers and the American Petroleum Institute all expressed strong support.

U.S. dairy access to Canada

Under the new agreement, U.S. dairy farmers will have marginally more access to Canada than provided for in CPTTP: about 3.6 per cent of the Canadian dairy market as opposed to the 3.25 agreed to in CPTTP, according to the Dairy Farmers of Canada.

More importantly, within six months after the agreement takes effect, Canada will end “class 6 and 7 pricing.” These are milk classes established in 2017 that lowered prices on some Canadian-produced milk ingredients, also referred to as “diafiltered” milk.  The lower price made U.S. equivalents uncompetitive and severely damaged U.S. milk producers in Wisconsin and New York.  This aspect of the deal is already being claimed as a huge win by the Trump Administration.

There are additional changes in the supply-managed sector.  While the details are sketchy at this point, U.S. chicken producers will gain greater access to Canada, as will U.S. exporters of turkey and broiler hatching eggs.

The federal government has promised compensation to the supply management sector for loss of market share, to be negotiated in the coming months.

The auto sector

The deal establishes a five-year transition period after the agreement enters into force for the regional value content requirement for autos to increase to 75 per cent, up from a current 62.5 per cent. The pact also requires that vehicle manufacturers source at least 70 per cent of their steel and aluminum from within the three countries.  It also requires 40 per cent of the vehicle’s value to be made in high wage areas paying $16 an hour.  In addition to benefiting Mexican auto workers, this provision will also favour continued auto production in the United States and Canada.

The U.S. had earlier agreed with Mexico that it would not levy Section 232 tariffs on autos and auto parts so long as Mexican exports to the U.S. did not exceed 40 per cent.  For Canada, the U.S. has agreed that existing auto production facilities are excluded from potential Section 232 exposure.  The U.S. also agreed to exclude 2.6 million finished autos and US$32.4 billion from Section 232, resulting in Canada agreeing to what are in effect quotas.

Since Canada currently produces just under two million light vehicles in total, and exports auto parts with a value of $16 billion U.S., these are ceilings Canada can accept without difficulty.  Finally, the U.S. will refrain from imposing Section 232 tariffs on Mexico and Canada for “at least 60 days after imposition of such a measure” during which the parties can negotiate an “appropriate market-based outcome.

Dispute settlement

The old NAFTA agreement had two key sections that addressed dispute resolution:

  • NAFTA Chapter 19 allows companies to request arbitration of countervailing and antidumping duties that is reviewed by independent binational panels. That regime remains the same as in NAFTA.  This is both a very significant win for Canada and the suspected quid pro quo for Canada’s supply management/dairy concessions.
  • NAFTA Chapter 11, the Investor State Dispute mechanism is now removed from the new agreement. This allowed companies of each country to sue the others’ governments against alleged damages caused by public policy decisions.  Over the years, successful suits from U.S. companies claiming damages under Chapter 11 have cost Canada hundreds of millions of dollars.  The demise of Chapter 11 is seen by many as a net positive for Canada, but certain investors will find its absence provides less assurance.

The “sunset” clause

 Canadian opposition to the U.S. proposal to open the new agreement to review after five years was vehement, on the grounds that it would place a chill on investment in Canada and steer capital spending to the U.S. due to the potential risks of losing Canadian access to the U.S. market.  The new agreement provides an overall lifespan of 16 years, with a review after six years’ operation. 

De minimis

De minimis refers to the threshold at which goods that cross the border are exempt from additional fees like duties and taxes. Currently goods from the US are exempt only up to $20(CDN). US online sellers and couriers had put extraordinary pressure on the US to raise that threshold substantially.

In the earlier U.S. Mexico negotiations, Mexico bent to US demands and moved its de minimis threshold to $100 (US) on both taxes (Mexico has a VAT like the HST) and duties.  There had been concerns that a similar regime for Canada would have had retailers here compete with online US sellers who would not have to charge the taxes and duties that Canadian sellers do.

Canada made concessions on de minimis provisions for online purchases, but they are far less significant than what the Mexicans gave up in their bilateral deal with the U.S.  Nevertheless, there was some immediate pushback. The agreement reached on September 30 moves the Canadian threshold to $150 (CDN) on duties and $40 (CDN) on taxes – far less than what the Mexicans agreed. To put it into context, the average duty imposed by Canada on US goods is 2% so the maximum price reduction would be 2% on the first $150, or three dollars.

The new tax relief would represent an average of 12 per cent on the threshold increase of $20 or $2.40. Of course, there are goods that carry higher duties like auto chemicals, national brand tires and outdoor furniture. The savings on those would be larger for Canadian consumers who shop online and create more pressure on Canadian retailers who sell them. Some retailers carry a significant inventory of goods that can be bought online with levels of duty at the higher end.  In fact, Canadian Tire today issued a press release calling on the government to level the playing field and says it expects and assumes it will be accorded the same treatment as online US retailers.

Curiously perhaps, the agreement applies only to courier-delivered goods (at least for the moment) and not to postal shipments where the de minimis threshold will remain at $20 (CDN). That may not change much given that Canadian customs have always had difficulty keeping up with postal packages (essentially checking only randomly if the sender is liable for duty and taxes), whereas couriers work with brokers and collect duties and taxes.

Preliminary estimates suggest the total revenue loss to the federal government will be less than $300 million offset somewhat by the reduced cost to customs operations.

Intellectual property

In line with what Mexico agreed to earlier, Canada will extend the patent protection for certain prescription drugs—biologics—from eight to 10 years, with a five-year phase-in period.  The agreement makes no reference to ongoing Canadian efforts to restrain pharmaceutical prices through changes to the Patented Medicine Prices Review Board, although it does reinforce the patent term restoration and linkage system negotiated in CETA. Also under the intellectual property heading, the copyright terms in Canada will now extend for 50 years beyond the year the creator of the work dies. The U.S. and the EU currently have 70-year terms; this change will bring Canada more in line with those jurisdictions. This is good news for Canadian creators but will increase the cost for those who access their work.

 “Anti-China” trade clause

The agreement contains what many are already reading as a check against Mexico and Canada negotiating free trade agreements with China in the future.  At least three months prior to commencing negotiations, any party to the agreement must inform the other parties of its intention to commence free trade agreement negotiations with a non-market country for purposes of its trade remedy laws. This definition would include China. In addition, “Entry by any Party into a free trade agreement with a non-market country, shall allow the other Parties to terminate this Agreement on six-month notice and replace this Agreement with an agreement as between them (bilateral agreement).”

The geopolitical implications of this clause are as yet unknown.

Canadian cultural protection

It was never entirely clear why the U.S. placed this issue on the agenda so late in the negotiations, as there was certainly no discernible push from the U.S. broadcast sector.  The previous protections for Canadian cultural industries that appear in NAFTA are retained in the new agreement.

Side letter on water exports

The agreement contains a “side letter on natural water resources” stating that the “Agreement contains no rights to the natural water resources of a Party to the Agreement.”  Further, “Nothing in the Agreement would oblige a Party to exploit its water for commercial use, including its withdrawal, extraction or diversion for export in bulk.”

This new provision closes a hole in the original FTA/NAFTA, neither of which explicitly banned bulk water exports.

Energy

The original FTA and subsequently NAFTA contained a provision in the energy chapter that required Canada, in times of an energy shortage, to cut Canadian supplies proportionally with cuts to exports to the U.S.  This provision was long regarded by many as the hidden US motive in accepting the FTA because it provided them enhanced energy security.

The new agreement removes this requirement.

British Columbia wines

As part of the new agreement, Canada has agreed that the province of British Columbia will modify by November 1, 2019 its current requirement that retail stores only sell imported wines through a “store within a store” rather than on the same shelves as domestic wines.

This change would appear to solve a long-standing trade irritant that has resulted in the U.S. lodging a formal complaint at the World Trade Organization about B.C.’s practices.

Procurement

Under its Buy American initiative, the U.S. wanted to severely curb the other countries’ access to public works contracts. Specifically, they demanded limits on the ability of Canadian and Mexican firms to bid on U.S. infrastructure projects, while seeking much greater access for American firms to Mexican and Canadian government projects.

The obvious unfairness of these demands caused outrage among the Mexicans and Canadians, and USTR Lighthizer quietly withdrew them this summer.

Simultaneous substitution

In 2015, the CRTC issued a ruling that prevented the simultaneous substitution (simsub) of Canadian ads for American ads during the Super Bowl broadcast.  The ruling reversed a policy that enabled broadcasters to distribute the signal of a local or regional over-the-air station in place of the signal of a foreign or non-local television station, when the two stations are broadcasting identical programming simultaneously.

The CRTC’s ruling was vigorously opposed by a variety of stakeholders, especially rightsholder Bell Media, the National Football League and advertisers.  The NFL urged the U.S. government to take retaliatory action under NAFTA, while other foreign rightsholders decried the potential extension of the ruling to all simultaneous substitution.  This would seriously devalue their rights and result in the loss of hundreds of millions of dollars if major ad revenue earned via simsub were lost.  This issue is currently before the Canadian Supreme Court.

The new agreement resolves this issue.  Canada has agreed to take down the 2015 CRTC ruling.  Annex-15 in the USMCA says “Canada shall rescind Broadcasting Regulatory Policy CRTC 2016-334 and Broadcasting Order CRTC 2016-335. With respect to simultaneous substitution of commercials during the retransmission in Canada of the program referenced in those measures, Canada may not accord the program treatment less favorable than the treatment accorded to other programs originating in the United States retransmitted in Canada.”

The past 14 months have been the usual rollercoaster of rhetorical excess that normally accompanies such negotiations.  Countless times, the truth has been stretched beyond all recognition by both sides.  Bellicose threats and insults have filled the air, at times frightening legislators, stakeholders and citizens on both sides of the border.

In the end, though, it’s quite surprising that despite everyone’s worst fears, the normal rules of trade negotiations have ultimately prevailed.  Fake “deadlines” have been ignored.  Immutable lines in the sand have been crossed and third rails not only touched but simply moved aside or transformed, by all sides.  In the final analysis, the need for a deal for all parties to the agreement overcame the short-term tactical considerations and the grand statements of principle.

President Trump may not realize it yet, but his “art of the deal” became the “art of the necessary” accomplished by the “art of the possible.”  The same could be said for Canada.