Five New Pillars of U.S. Trade Policy (A.k.a. the “Poison Pills”)

Canadian business is navigating through a period of growing uncertainty in terms of both global politics and trade, and faces unprecedented challenges with respect to marketing, production and investment decisions. In the current climate, the Government of Canada’s policy can be summarised in the words of Minister Chrystia Freeland: “Hope for the best, plan for the worst.”

A review of the apparently fixed U.S. position in the NAFTA negotiations is both telling and discouraging for the future of the agreement and North American trade. Canada’s early “charm offensive” led by the Prime Minster, combined with an engagement strategy tied to the hope that the political base fueling the U.S. Administration’s aggressive approach would face strong enough domestic “push back” to blunt the “America First” trade strategy, was a key part of Canada’s Plan A approach.

Now the priority is shifting. Recently, Prime Minister Trudeau was quoted as pointing out, “…not only do we have a Plan B, we have a Plan C and D and E and F …” The U.S. Administration appears confident in its base and the view of many Americans that free trade is not working for them. It appears that it will continue to provide ad cover to pursue its “America First” version of a “Revised NAFTA.” In this, our second of three notes, we review the five basic positions or pillars that the U.S. negotiators have set out in the NAFTA negotiations. Canadian officials have tagged them as unacceptable “poison pills.”

Revised Rules of Origin for Autos

The first pillar—the issue of autos and auto parts—can be considered both central and definitive.

For the past several months, Canada’s negotiators have been pressing to find consensus in the hope that a deal on autos would satisfy U.S. negotiators enough to sign off on a “Skinny NAFTA”, with the amendments enough to push the other issues off to the distant future. In narrowing their focus and shifting from their goal of a comprehensive, progressive and modernised “NAFTA 2.0”, Canadian negotiators implicitly acknowledged that their U.S. counterparts have no appetite for the progressive agenda. For a while, it appeared that the U.S. side was prepared to “park” or at least temper other demands, acknowledging the several “red lines” laid out by Canada. Unfortunately, attempts to bridge the gap on this auto issue were unsuccessful and the “absolute” deadline of mid-May 2018 (to accommodate the Mexican and U.S. Congressional elections) passed without a deal.

The U.S. position on autos—that all NAFTA qualifying vehicles have at least 50% U.S. content and 85% Canada, Mexico, U.S. content—belies a move away from confidence in the United States’ ability to compete in both the North American and global market. Some see it as recognition that Japan, Europe and Korea have long displaced American know-how and capabilities in this sector, and a recipe of added tariff protection and managed trade was required to support this vital sector. This apparent retreat from free trade principles looks to be a repudiation of President Reagan’s “Arctic Circle to Tierra del Fuego” vision. Mexican auto workers are paid a fraction of what their Canadian and U.S counterparts earn. As was the case with China and other emerging economies, the United States is finding that the expansion of free trade and economic liberalization has brought rising labour standards and wages. While many consider that the loss of manufacturing jobs in the United States has more to do with technology than access to lower wage workers, free trade has become the easy target. The U.S. Administration determination to “repatriate” jobs in the auto sector should serve as a signal that the goal of increasing domestic manufacturing capacity across the board will trump arguments in favour of preserving the NAFTA and global supply chains—in spite of economic arguments.

This “developing country” advantage has been acknowledged by Canadian negotiators (a point pressed by Canadian auto workers) who have worked to bridge the gap with a formula that ensures a certain percentage of NAFTA products is produced by “high wage” ($17.00/hr) labour. While progress was made and Canada remains at the table, the auto issue has not been resolved.

The politics of the issue are difficult; Mexico does not want to give up its critical advantage in this sector. However, the U.S. Administration has launched a Section 232 tariff on auto imports and “upped the ante” as the spectre of tariffs on autos produced in Canada (and Mexico and the rest of the world) poses a threat to the very core of North America’s integrated market.

Currently, the U.S. Administration is pressing forward with the process which may end with the application of section 232 tariffs to autos and auto parts. The spectre of such a move now hangs over the future of NAFTA and the broader question of the future of the Canada-U.S. relationship.

Government Procurement

There is perhaps no starker example of the gulf between Canada and the United States in terms of what future free trade should look like than with government procurement.

Canada has gained greatly improved access to European and Asian markets in the CETA and CPTPP in exchange for broad and reciprocal access to Canadian federal, provincial and municipal procurement. The United States is proposing what many interpret as a major step backward from the current NAFTA standard with a range of “Buy America” provisions that limit the amount of access into U.S. procurement on a dollar-for-dollar basis—that access to procurements should be of an equal dollar value.

Given the relative size of the Canadian and U.S. economies, this approach is driven by the U.S. Administration’s need to ensure to its base that public funds are spent on U.S. suppliers. This is a significant step back from open market principles. Extending the logic of this philosophy would lead to reciprocal access based on market size with Canada having access to approximately 10% of the U.S. market in return for giving the United States access to the total Canadian market.

The Administration’s objective of ensuring that U.S. government funds are spent on American suppliers is a basic “red meat” issue for the President’s supporters. While this is not difficult to understand, the U.S. approach is arguably a symptom of a wider retreat from the days of American confidence in its competitiveness and the commitment to expanding its economic empire. The “take it or leave it” position that U.S. officials have maintained throughout has been flatly rejected by both Canada and Mexico. There has been little discussion and no movement on this issue. Recent comments by Canadian negotiators could be interpreted as meaning that fighting to keep the current NAFTA in place is the current goal. If the United States insists on maintaining its “offer”, the alternative may be to simply remove government procurement from the table and start constructing a diminished agreement: “NAFTA – Minus.”

Eliminate Binding Dispute Settlement

During the negotiating rounds, Canada has worked at chipping away at the impasse with respect to the United States’ overall position that reflects the Trump Administration’s distrust of allowing non-U.S. tribunals to take jurisdiction when its own interests are involved. The U.S. objective is to make state-to-state dispute settlement merely advisory and non-binding, and to eliminate NAFTA Chapter 19, which provides for third-party review of domestic findings on trade remedies (anti-dumping and subsidies).

Chapter 19 is a “red line” issue for Canada. No progress has been made on the state-to-state issue or Chapter 19. Canada has worked at chipping away at the overall impasse with a proposal that the United States simply withdraw from NAFTA’s Chapter 11 investor-state dispute settlement (ISDS) provisions. As the former head of the WTO’s Appellate Body (and former U.S. Congressman) James Bacchus has recently written,

The animus of President Trump and his administration … seems to be the end product of their visceral belief that the United States should never allow itself to be second-guessed by foreigners … Trump and his followers appear to believe that any national decision to defer to the judgment of an international tribunal … is a subversion of national sovereignty.

In Might Unmakes Right: The American Assault on the Rule of Law in World Trade, Bacchus argues that:

Those now in ascendancy in the United States cite their contorted view of national sovereignty as an excuse for employing America’s considerable economic leverage to try to bully other countries into doing as the United States demands on trade. … They issue ultimatums … threaten unilateral actions …tell other countries, in so many words, to take it or leave it. They see the rules of trade as tools they can choose to acknowledge or not, ignore or not, in the singular exercise of an American commercial realpolitik. Internationally, they answer to no one but themselves – not to their allies or their friends, not to the previous promises of their predecessors …

This perhaps explains both the strong drive by the U.S. Administration and its base to “de-claw” the NAFTA, and the equally strong push-back by Canada to preserve the recourse and remedy of independent and binding dispute settlement in the face of its powerful and increasingly aggressive and erratic trade partner.

While NAFTA’s Chapter 11 ISDS provisions are not vital and Canada does have recourse to the WTO for state-to-state disputes, the United States’ continued and aggressive use of anti-dumping and countervailing measures means the Chapter 19 issue will be in play to the very end of negotiations. As with the original FTA, Canada will need to preserve this and may have to cede ground on other issues.

Eliminate Supply Management

The U.S. Administration has elevated this and put it in the spotlight following the G7 meeting. Even in the midst of several ongoing foreign and domestic crises, the U.S. president continues to raise Canada’s dairy tariffs in his daily tweets.

The United States has made ending the import barriers that are part of Canada’s supply-management system a goal from the outset of the NAFTA negotiations, but now it has become highly politicized. The current NAFTA-consistent protections that block its exports of ultra-filtered milk to Canada is a big issue for the key (in terms of elections) state of Wisconsin and dairy farmers. The large tariffs are designed to protect the integrity of Canada’s system. Now it has been elevated as demonstrative of the claims that Canada is an “unfair trader” and that NAFTA was the “worst deal ever for the United States.”

These types of statements have made it more difficult for Canada to drop its hardline defense. It also obscures the fact that an estimated 98% of NAFTA trade is tariff- and barrier-free and that each NAFTA party has negotiated protections for its own sensitive industries—many in agricultural sectors. For example, Canadian officials have pointed to the U.S. programs of subsidization on its overproducing dairy and other agricultural goods, as well as in areas ranging from aircraft to lumber.

Some commentators have argued that Canada’s focus on its progressive trade agenda has meant that its attention and negotiating capital have been misspent, and that a more traditional approach focused attacking on U.S. barriers in search of trade-offs would have been better. In such a scenario the majority of corporate U.S. stakeholders would press U.S. negotiators to protect current programs and maintain status quo.

However, it is not clear that the U.S. Administration is looking beyond its own rhetoric and its political base and factoring in broad domestic corporate support for the current NAFTA. Canada has already negotiated modest access increases in CETA and CPTPP context, and the opening U.S. position allowed for a 10-year transition period for the elimination for the system. However, the U.S. Administration’s politicization of the issue is pushing the dynamics in the wrong direction, to the point where the Prime Minster is encouraging Canadian consumers to “Buy Canadian”

Sunset Clause

This issue, from the outset, has been a distracting “bright shiny object” for the Trump Administration.

Most trade experts (including those who are U.S.-based) find the concept both impractical (in the context of how complex trade deals are put together) and destructive (as it undermines the stability and confidence conducive to continued growth and investment in North American business).

Some progress had been made on this issue, with Canada suggesting an agreement for periodic review without automatic termination. However, while Canada and Mexico made it clear early in the negotiations that the concept was a “dealbreaker,” Vice-President Pence made the agreement to a Sunset Clause a condition for agreeing to a meeting of the leaders of the three countries to hammer out an agreement late last month. It has been reported that President Trump subsequently agreed to drop the U.S. demand during a bi-lateral meeting with Prime Minister Trudeau at the G-7.

Perhaps the U.S. side considers it to be an “insurance policy” in the event it cannot obtain enough concessions and needs to maintain the pressure. As Prime Minister Trudeau has pointed out, the current NAFTA provisions allow any party to withdraw after six months’ notice and that for this reason a sunset provision is unnecessary. Given this redundancy, the concept undermines confidence in the maintenance of an open and rules-based trading system.

Perhaps one might conclude that the fight over the sunset clause is a contest for a “trophy” and for which vision will prevail. If reports of private discussions between the two leaders during the G7 are accurate and the United States is prepared to give on this issue in return for concessions on supply management, perhaps this poison pill has become a bargaining chip.

Where to Next?

In our next and final segment, we will examine the current and likely future options in context of the future NAFTA negotiations post-Mexican elections.