During his presidential campaign, U.S. President Donald Trump promised to overhaul or eliminate the North American Free Trade Agreement (NAFTA), claiming it was killing American jobs. Seven months into his presidency, Trump took to Twitter (his preferred mode of communication) and threatened to scrap NAFTA, days before Canada, Mexico and the U.S. were scheduled to hold a second round of negotiations. He called it the “worst trade deal ever made”, adding that Mexico and Canada were being “very difficult”, and that he “may have to terminate.” Over three-quarters (77.7%) of Canada’s exports were delivered to its NAFTA partners in 2017, so its termination, or any re-negotiation, is sure to have a significant impact on Canadian trade.
What is NAFTA?
NAFTA is a trade agreement between Canada, the U.S., and Mexico that has systematically eliminated most tariff and non-tariff barriers to free trade and investment across those countries’ borders. In place since January 1, 1994, NAFTA is overseen by a network of transnational institutions that ensure the proper interpretation and smooth implementation of the agreement’s provisions.
What changes does the U.S. want to make?
Chapter 19 sets out NAFTA’s extensive list of rules for settling disputes. It provides an option of a panel of representatives from both countries to settle certain types of disputes, instead of going before domestic courts. Canada has used this option on three occasions, always regarding softwood lumber , with generally favourable outcomes.
Chapter 19 has roots in the 1988 Canada-U.S. Free Trade Agreement, where it was inserted at Canada’s insistence amid concerns about the reliability of the U.S. court system. At the first round of negotiations for NAFTA, Canada insisted that Chapter 19 will be a necessary part of any agreement.
Trump wants Chapter 19 eliminated because he feels that it is unconstitutional and that American courts should be able to determine what is legal under American law. However, the Canadian government has indicated that eliminating it is a non-starter.
Rules of Origin
Chapter Four of NAFTA discusses “rules of origin,” which are the rules dictating whether a good is considered to have originated in a NAFTA member nation. This chapter is what customs officials in the three NAFTA nations use to decide which goods have tariff-free access to the market and which do not. The general rule of thumb is that goods must comprise somewhere between 50 and 62.5 percent “North American content” to gain duty-free access to all three member countries.
A common criticism of NAFTA’s rules of origin is that they provide a “back door” for Chinese auto parts to enter the U.S. through Canada and Mexico, depriving NAFTA members of a potential economic benefit. U.S. negotiations are likely to focus on raising the content level and changing the “tracing list” used to identify which parts of a good must originate in North America.
Each NAFTA member allows the private sector to obtain government procurement contracts to supply goods and services. Under Chapter Ten of NAFTA, foreign suppliers from NAFTA member nations must be treated as favourably as domestic companies competing for the same contract. This provision allows companies in each country to compete for contracts on equal footing. Plus, procedures relating to government procurement contracts must be transparent, effective, and fair.
Trump’s plan includes changing Chapter Ten to strengthen the market for “Buy America” products, advocate for “America First” policies, and promote the hiring of American workers and use of American-made resources over those from Canada or Mexico. All of these proposed changes would clearly give U.S. companies favourable treatment.
What does this mean for Canada?
Without the dispute settlement mechanism discussed above, Canada will have to settle disputes through U.S. courts, which would favour American law over Canadian law. However, Canada has emphasized that Chapter 19 is an “essential” part of NAFTA, and the Trudeau government has strongly suggested that it would walk away from NAFTA negotiations without the inclusion of Chapter 19.
Tighter rules of origin would make it more difficult for Canada and Mexico to meet the threshold for goods qualified as North American. The U.S. is Canada’s largest trading partner, and if tariffs are applied to goods that were duty-free before, Canada will bear the cost of the new restrictions.
Lastly, favourable treatment of American companies in procurement competitions would mean that American businesses would get equal access to Canadian (and Mexican) government contracts, but Canadian businesses would be restricted from competing for U.S. bids. Such change would limit reciprocity of NAFTA and may leave Canada at a structural disadvantage.
So with American negotiators seeking to overhaul sections of NAFTA that Canada considers crucial, at the cost of the benefits Canada gains from participating in the agreement, what are Canada’s options? Recent announcements regarding the Comprehensive and Progressive Agreement for the Trans-Pacific Partnership (CPTPP, or the TPP 2.0) suggest that Canada is actively pursuing alternative trade agreements. Canada may need to rely on deepening ties with other trading partners, including the E.U. (through CETA), and potentially even China. After all, nobody knows is President Trump will wake up one day and decide to tweet NAFTA out of existence.
Sanya Ramnauth is a 2019 Master of Public Policy candidate at the University of Toronto’s School of Public Policy and Governance. She holds a Bachelor of Arts degree in economics and political science from McGill University. Her policy interests include foreign policy, international development, and gender issues within public policy.