Canada And The Renegotiation Of NAFTA – Analysis

By Rene Zou*

After retreating from earlier attacks on Mexico and China, Canada has become the newest target of President Trump’s economic nationalism, with the spotlight fixed on the Canada’s lumber and dairy industries. As Canada braced itself for the risk of a trade war with the U.S., rumors circulated that Trump was considering signing an executive order to end the North American Free Trade Agreement (NAFTA)—a three-country accord between Canada, Mexico and the U.S. that entered into force in 1994, promoting the gradual elimination of most tariffs in industries such agriculture, textiles, automobile, and manufacturing. Galvanized by ‘America First’ nationalists in his cabinet, President Trump was apparently about to make a dramatic exit from the trade deal just days before his 100th day in office. However, the idea was eventually shelved after foreign leaders, other cabinet members, and C-suite executives scurried in to prevent Trump from making any rash decisions. With this core constituency in mind, Trump had already decided to hold off before receiving calls from Canada and Mexico. According to media reports, Agricultural Secretary Sonny Purdue and Commerce Secretary Wilbur Ross showed the President a map of “Trump country” communities overlapping with areas that were most vulnerable to a trade war. In the end, President Trump announced plans to renegotiate NAFTA instead of scrapping it entirely, as originally promised, whilst maneuvering an internally divided staff, Congress, and U.S.

Does Trump Have a Negotiation Plan?

In the absence of a clear grand strategy, the effects of Trump’s policies on Canada remain ambiguous. With regards to NAFTA, two conflicting groups of advisers exist within the Trump administration: the ‘America First’ nationalists—Chief Strategist Stephen Bannon and Trade Adviser Peter Navarro—and the ‘New York deal makers’—Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn. As WSJ reports, one senior Toronto bank executive said that Cohn and Mnuchin (both former Goldman Sachs Group Inc. executives) have recently reached out to senior Canadian business officials to counsel them, with no expectations for significant changes to NAFTA.

Trade experts have dubbed Trump’s flip-flopping as a classic negotiation ploy that seeks to gain leverage from ‘the power to walk away.’ The U.S. is required to give 6 months advance-notice to other NAFTA members before it can withdraw from the deal. Moreover, it is running on a tight calendar, with the appointment of Trump’s nominee for US Trade Representative stalling, Congressional approval pending, and Mexican elections coming up next year. The move to start the clock can therefore be interpreted as a pressure tactic to force Canada and Mexico into making greater concessions.

Trump’s draft letter sent to Congress in March outlined a list of priorities for the renegotiation of NAFTA. Further, inviting the House and Senate to revise the letter under fast-track law. As per the president’s fast-track authority, Congress may grant Trump the permission to negotiate a trade agreement with the ability to pass it through Congress, given a simple majority and an up-or-down vote, with no amendments.

However, cracks within the Republican Party have surfaced alongside increased division and incoherency vis-à-vis not only its domestic, but also foreign policy agenda. Republican representatives in Congress are warning of negative economic, and eventually political, consequences. As Senator Ben Sasse of Nebraska notes, the bottom line is: “Trade lowers prices for American consumers and it expands markets for American goods. Risking trade wars is reckless, not wise.” Senator John McCain concurs, “It will devastate the economy in my state,” he told CNN, “I hope he doesn’t do that.” In fact, many of the areas that will be hardest hit from agricultural and manufacturing losses are located in the Rustbelt and South—Trump’s core constituents.

NAFTA and Canada

The Canadian dollar dropped to a 14-month low in light of this recent turmoil, before regaining its loss to grow as much as 0.6 percent to C$1.3534 after Trump called off plans to terminate NAFTA. Meanwhile, Canadian investors have responded to Trump’s lumber tariff in defiance, with upward share price movements. Hence, the big questions are who wins in terms of policy, and whether the market is able to weather this uncertainty at the macroeconomic level. A brief look at economic history will help us discern the costs and benefits of NAFTA’S renegotiation.

NAFTA has fundamentally reshaped North American economic relations. As the largest free trade region at the time of its inception, NAFTA drove economic growth and raised living standards across the continent via trade liberalization. While Canada and the U.S. had already entered the Canada US Free Trade Agreement (CUSFTA) five years before NAFTA, the addition of Mexico’s developing economy was unprecedented. Moreover, the trade deal has since tripled regional trade volume, from roughly $290 billion in 1993 to more than $1.1 trillion in 2016.

Total merchandise trade between Canada and the U.S. has more than doubled between 1993 and 2015, while the same figure for Mexico has increased over 8-fold. The U.S. was not only the top destination for Canadian merchandise exports but also the largest supplier of merchandise imports in 2015. As regional integration continues, companies no longer merely sell things to each other across the border, but are increasingly making things together. Bilateral agricultural flows have also increased, wherein Canadian agricultural trade with the U.S. has more than tripled since 1994. Finally, Canada remains the main foreign oil supplier to the U.S. and the fourth largest to Mexico.

Canada is the second largest market for US service exports, at nearly CA$122.8 billion in 2015, a 205.1% increase since 1993. Canada’s FDI stock has also grown from $70 billion pre-NAFTA to $353 billion post-NAFTA in 2015. In addition, Canada and the U.S. have one of the world’s largest investment relationships, with bilateral investment stock amounting to CA$836.2 billion in 2015. Today, one in six Canadian jobs are related to exports. Moreover, with the creation of 5.2 million net new jobs from 1993-2015, unemployment has decreased from 11.4% (1993) to 6.9% (2015).

Although economic growth is undeniable, it has been difficult to discern the trade deal’s effects from other factors such as technological change and China’s economic expansion. Still, neither Canada’s worst fears, nor its highest hopes for NAFTA have materialized. Contrary to what critics had predicted, Canada did not become an economic appendage or the “51st state”  of America. Yet, it has also fallen short of closing the productivity gap between the two countries, as Canada’s labor productivity still remains at 72% of US levels.

Canada is much more dependent on NAFTA than the U.S., with 49% of Ontario and 50% of New Brunswick’s GDP accounted for by trade with the U.S. Meanwhile, only two American states’ trade with Canada surpass 10% of their annual economic output, as others sit between 1-3%. Still, the Canadian government likes to point out that Canada is the leading export destination for 35 U.S. states. Although Canada has traditionally been the largest importer and exporter to the U.S., both these two figures peaked before NAFTA. Canada purchased 23.5% of American exports in 1987, a figure that was matched in 2005 and has since fallen to 18.6% in 2016. Meanwhile, the Canadian share of American imports peaked at 20.6% in 1984, falling to 20.1% in 1996, thereafter declining to 12.6% in 2016.

Trade Tensions

Although most tariffs have been eliminated under the treaty, dairy and lumber are not covered under NAFTA. President Trump recently announced a 20% tax on softwood lumber coming into the U.S. from Canada, but more precisely, the Commerce Department is levying a range of tariffs that average around 20%. Feuds over protectionism have been recurring since the 1980s, wherein Canada has been criticized for providing an indirect subsidy to its lumber producers with cheap access to public land. Nevertheless, this is a longstanding issue, and one that is usually settled through an agreement to cap imports, the latest one was signed in 2006 and expired in 2015.

The two countries thus find themselves in a state of limbo. A drawn-out trade war would likely harm US exporters and increase some prices for American consumers. However, it would certainly hurt Canada more, since trade with the U.S. represents a larger percentage of Canada’s GDP. The Canadian government is well aware of this fact and has been seeking a “third option” of late. Moreover, Canadian lumber exports have showed increased trade diversification since the Great Recession. The Canadian government’s Twitter response to Trump’s lumber tariff has flaunted this: “Asia is an increasingly important market for Canadian softwood lumber. China and Japan alone now represents almost 20% of total global exports.”

Against the backdrop of protectionism, a letter from a Wisconsin farmer caught Trump’s attention, which lead to his April 25th dairy tweet: “Canada has made business for our dairy farmers in Wisconsin and other border states very difficult. We will not stand for this. Watch!” By way of response, Prime Minister Trudeau emphasized: “The US has a $400-million dairy surplus with Canada so it’s not Canada that’s the challenge here. Let’s not pretend we’re in a global free market when it comes to agriculture.” Ironically, Canadian dairy markets would have been opened to American exports under the Trans-Pacific Partnership (TPP) Obama negotiated. However, Trump’s first order in office was to withdraw the U.S. from negotiations.

Potential Outcomes

A new North American trade regime will have implications for Canada’s role in the world and its bilateral relationships with other countries. At the moment, there are three possible scenarios to the renegotiation of NAFTA. They include: 1) a return to the original Canada-US FTA (NAFTA’s predecessor from 1989); 2) a renegotiated deal with Mexico included; and 3) a minor “tweaking” of the current deal with smaller side deals just enough for Trump to fulfill the claim of reforming it.

Canada itself is looking for its “third option” of diversifying its trading partners. Across the pond, the EU is Canada’s second largest trading partner. Moreover, with the Comprehensive Economic Trade Agreement (CETA) signed last year, 98% of tariffs will be eliminated on both sides, making the deal even broader in scope than NAFTA. Across the Pacific, Canada is also looking to bolster Asia-Pacific trade. Though Trump has withdrawn the U.S. from the TPP, the other 11 signatories have showed intentions of regrouping with China’s help instead. A new free trade agreement with China may also be expedited given changes to geopolitical circumstances, not to mention, the opening of security talks concerning extradition between the two governments.

While job losses from NAFTA had the trade agreement front and center in debates during the 2016 elections, the President Trump’s approach to solving the issue has been muddied by dueling factions within his cabinet and a divided Republican Congress. Although Canada is unlikely to lose out more than Mexico, old trade issues remain and Trump is taking a new approach by publicly calling Ottawa out. On the campaign trail, Trump accused Mexican and Chinese leaders of outsmarting the U.S. in negotiations. Now he is pointing the same finger at policymakers in Ottawa. However, when it comes to the brokering a new deal, Trump doesn’t have much to show for thus far.

This article was published at Geopolitical Monitor.com

Geopolitical Monitor

Geopolitical Monitor

Geopoliticalmonitor.com is an open-source intelligence collection and forecasting service, providing provide research, analysis and up to date coverage on situations and events that have a substantive impact on political, military and economic affairs.

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