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The Art of Trade: Knowing the US Position in NAFTA Negotiations

In the Art of War, Sun Tzu tells us that he who knows himself and knows his enemy need not fear the outcome of a hundred battles. This saying applies as well to trade negotiations as it does to war. On May 18, 2017, the United States served notice on Mexico and Canada that it intended to renegotiate the North American Free Trade Agreement (“NAFTA”). The first round of negotiations is scheduled to begin in Washington D.C. on August 16th continuing to August 20th.

On July 17, 2017 the US Trade Representative (“USTR”) released a document entitled “Summary of Objectives for the NAFTA Renegotiation”. This document sets out the goals of the US for revisions to NAFTA (the “US Objectives”). The US Objectives are subdivided into different categories, with each one a major component of the NAFTA negotiations.

In response to the release of the US Objectives, the Canadian government has decided to extend indefinitely the consultation period which was set to expire on July 18, 2017. Any Canadian person or organization is free to provide comment on Canada’s objectives.

Understanding the US Objectives is essential for the Canadian government to negotiate an outcome consistent with its goals. Understanding these US objectives is also essential for any stakeholders, such as Canadian or multinational corporations, in their advocacy on each issue.

Overview of the US Objectives

Overall, the US Objectives reflect a tweaking of NAFTA rather than full overhaul as Donald Trump had suggested as a Presidential candidate on the campaign trail. In many cases, the proposed changes echo the provisions of the Trans-Pacific Partnership (“TPP”), an agreement the US pulled out of shortly after Trump took office. Further, the US Objectives generally seem heavily tilted towards addressing perceived imbalances and issues regarding the US trade relationship with Mexico. Many of the provisions relate to matters in which there is already a great deal of coherence between the stated US position, and current Canadian law.

However, several points in the US Objectives demonstrate either a lack of understanding of the theory and practice of international trade, demonstrate a surprising inconsistency (some would say hypocrisy), or directly conflict with what have historically been fundamental Canadian and even American positions. We believe special attention should be paid to these issues:

  1. Trade in Goods - in particular agricultural products
  2. Trade in Services - in particular financial services
  3. Intellectual Property (“IP”)
  4. Federal and Sub-Federal Procurement
  5. The Elimination of Global Safeguards,
  6. The Elimination of Chapter 19 and Trade Remedies
  7. Investment Protection and Investor-State Dispute Settlement (“ISDS”)
  8. Labour and the Environment

Specific Provisions

1. Trade in Goods

(a) Overview

The US Objectives regarding Trade in Goods begins with the facile statement that the objective is to improve the US trade balance and reduce the trade deficit with the NAFTA countries.

This simple statement highlights two major themes with the US Objectives: (a) they apply almost invariably to problems the United States has with Mexico; and (b) they demonstrate a shallow understanding of economics and trade.

The trade balance between two countries is simply not an indicator of the fairness of their trading relationship. Even if it were, the data has been fairly consistent that trade deficits between the United States and Canada have been flexible and in fairly constant flux throughout the NAFTA period, as both countries have had periods where one or the other has maintained a trade surplus. The United States currently has a trading surplus with Canada. In the USTR view just expressed, this would require additional concessions in Canada’s favour. Tellingly, since the implementation of NAFTA, US exports of goods to Canada have increased by 165%, while its imports from Canada have only increased by 150%. This is hardly a relationship which requires modification in light of the US objective to “improve trade balances”.

But even if there were persistent deficits, that alone is not bad for a country’s economy. One can consider capital account movements, foreign investment, and the fact that a healthy US economy drives consumer spending which, in turn, increases imports as well as domestic production.

Consider petroleum. The US has a fairly sizeable trade deficit in petroleum products. The trade deficit in petroleum was over $100 billion per year in 2015 and 2016 according to the US Bureau of Economic Analysis. If trade deficits formed some type of persistent negative force on the US economy, the simple solution would be to close the US borders to imports of petroleum, and there would be an instant blossoming of US industry.

Of course, this is obviously an incorrect assumption, and such an action would likely cause devastation to the US economy and massive fuel shortages. While there may be an imbalance in trade regarding such products, the availability of cheaper and more abundant petroleum drives powerful downstream impacts for end users.

This is just one example. Imports of other products serve as inputs for US industry, which allow US service providers to improve their own trade surplus in services.

(b) Rules of Origin

Rules of origin form the backbone of any major trade agreement, by delineating which products are given preferential tariff treatment and duty-free access. Under NAFTA, products can qualify for preferential treatment if they are wholly obtained or produced in the NAFTA territory. Many products may also be considered “originating” if, during the manufacturing process in the NAFTA territory, their foreign components undergo a shift in tariff classification as set out in the specific rule of origin applicable to the final product.

Some products have additional requirements centered on the percentage of the product’s value that is derived from NAFTA originating inputs: a “regional value content” requirement. This generally makes it more difficult to use non-NAFTA originating inputs in the manufacture of the end product. These requirements are usually used for complex items or those for which additional protection is sought, for example, automobiles.

The US Objectives call for strengthening the rules of origin to ensure that NAFTA benefits accrue to products that are truly derived from NAFTA countries. This is a goal that is largely shared by the Canadian government, and is an area where there may be easy compromise between these two parties.

The odd man out, to a degree, is Mexico which has been accused by some of serving as a staging ground for foreign goods masquerading as NAFTA originating. It is likely that the US focus will be on moving certain goods to the more restrictive “regional value content” requirements, and increasing the regional value required in goods already covered by such a designation.

Any Canadian, US or Mexican manufacturer that makes and sells products built with foreign inputs must pay careful attention to the negotiations on these rules. While this chapter is exceptionally technical, it is one of the most critical areas of the Agreement. By defining what makes a product a “NAFTA product” it serves a gatekeeper function. Changes result in massive tariff costs for manufacturers whose products fail to qualify under a narrow definition of “originating”.

(c) Agricultural Products

The US has routinely objected to the Canadian supply management system which sets strict quotas on the production and import of dairy, poultry and other agricultural products. This system is put in place to create a price support for Canadian agricultural producers, without subsidization (such as that adopted by the US) and without generating surpluses which the domestic market cannot absorb.

The US will focus on non-tariff barriers to US agricultural exports and other “unjustified measures”. Given statements and tweets from President Trump in Wisconsin in April of this year, this is undoubtedly an opening salvo against Canada.

Defending supply management is likely going to be a difficult task for the Canadian negotiators, particularly in a context of “free trade”. Canada has already granted increased access, to some degree, to the Europeans under Canada-European Union Comprehensive Economic and Trade Agreement (“CETA”) (and did so in the TPP negotiations). So it will be difficult to then turn to the United States and declare that supply management is completely off the table.

The limited additional access granted to the EU, and the limited additional access negotiated (including with the United States) in the TPP should provide a backstop to too great a weakening of Canadian supply management.

Some will argue that the time has come for Canada to abandon supply management and to negotiate new concessions in return, but there would likely be reciprocal pressure for the United States to abandon its own glut-producing subsidization scheme, so it is likely we will see TPP-style softening of Canadian supply management but not elimination.

(d) Digital Goods

In the increasingly digital world, digital goods have become a focus - with dedicated e‑commerce chapters appearing in both the TPP and CETA. Some elements of the US Objectives regarding digital goods follow previous commitments, including securing customs duty free access for digital products flowing across the national borders of the parties. This is likely uncontentious.

However, what is likely to cause some concerns is the US Objective to prohibit measures restricting cross-border data flow or requiring the installation of local computing facilities. There are a myriad of problems with agreeing to this type of provision. First, many Canadian provinces strongly restrict the transmission of certain information (such as personal financial information or health data) across borders. Agreeing to such a measure would require significant changes to such domestic legislation by sub-federal bodies.

Second, any such change is likely to be politically difficult. Many countries, including Canada, have strong degrees of skepticism regarding US data protection and privacy guarantees - particularly as regards the information of non-citizens. This skepticism, both at the level of individual citizens and at the level of government bureaucracies, will be difficult to overcome.

Third, making this kind of change would require particular language to exempt certain types of data transfer, for example, transfers of blueprints or technical assistance regarding goods subject to Canada’s Export Control List or the US International Traffic in Arms Regulations. Once the parties go down the road of carve-outs, pressure builds increasing exceptions of general applicability to personal data or information.

(e) Customs Facilitation

The US Objectives regarding customs facilitation are largely chaff, with commitments similar to those that generally exist in the current version of NAFTA. Just about every element of the US Objectives in this category is already met or exceeded by Canada.

However, the US does seek US-style treatment of de minimis imports. These are imports the value of which is sufficiently small that the usual customs procedures, including assessment of duties, are not warranted. In Canada the de minimis level is currently $20; in the US the de minimis level is $800.

Especially given the evolution towards e-commerce, setting a higher de minimis threshold would be good for online businesses, but likely of little practical utility to larger retail chains in Canada who would face increasing pressure from online stores sending smaller value items to larger groups of individual recipients and staying beneath that de minimis threshold.

While the customs duties on items may not be high (especially if Canada and the US agree to further liberalization on certain goods currently caught by duties such as certain textiles), imports below the de minimis threshold are also generally not assessed GST/HST at the border so preservation of tax revenues will also be an issue.

If the Canadian government gives ground on this front, it would likely pay major dividends for Canadian consumers, but could deliver another body blow to an industry that is already on uncertain ground. To the extent that on-line e-commerce for small volume delivery to Canadian consumers is more heavily US-centred than Canada-centred, the blow to Canadian retailers could be significant.

2. Trade in Services

While NAFTA was comprehensive with regard to eliminating tariffs in trade in goods, the commitments regarding services were far more limited. Under the present NAFTA, the Services chapter follows what is known as a “positive list” approach. That is, the commitments to liberalization made by a party only apply to the services sectors specifically listed.

Since NAFTA, trade agreements have increasingly moved towards adopting a “negative list” approach. This approach, followed in CETA, applies the liberalization commitments to all service sectors unless they are specifically exempted. Given the increasingly important role services play in a post-industrial economy, granting market access is considered vital for both the United States and Canada.

This explains why one of the US Objectives is to enhance the access to foreign markets for service providers. This will likely be met with open arms by a Canadian government that has made such an approach the norm in its trade agreements. One critical issue will be ensuring that Canada achieves reciprocal access to US markets, particularly for access for Canadian service providers who must travel to or be present in the United States to provide their services.

There are two major industries that the US Objectives have emphasized as priority areas for more commitments: telecommunications and financial services. There are likely to be impediments to making any major concessions in both of these areas. Canada’s regulations on the financial services industry was one key factor in preventing contagion from the US banking crisis. The United States has also highlighted removal of any restrictions in cross-border data flow – this is also difficult to implement for the reasons discussed in the section above regarding digital goods.

Telecommunications is another area that has structural and legal barriers to entry in Canada that the United States is likely to seek considerable liberalization. Given political and economic concerns, it may be difficult to deregulate the industry in a way that would accommodate US demands.

3. Intellectual Property

Additional protections and disciplines on IP have become commonplace in trade agreements. Canada has a comprehensive IP chapter in CETA, and the IP provisions in the TPP were also highly detailed. Canada’s concessions on IP in prior trade agreements include having recognized the need for patent-term restoration for pharmaceuticals, camcording provisions regarding the criminalization of certain copyright violations, and strengthening our IP regime generally.

Here again, much of the emphasis in the US Objectives regarding IP is likely directed at Mexico as Canada has already enacted many of these positions. Canada has moved towards a strong enforcement regime as required under the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights. Canada has also enacted prohibitions on the use of devices and software to break technological protection measures (also known as “digital locks”) to preserve the integrity of digital goods.

These measures already fulfill more than half of the final positions indicated in the US Objectives. This potentially provides considerable leverage for Canada to extract concessions in other areas from the United States with little domestic sacrifice as Canada can easily concede to many of these demands without having a major impact on our own economy. Indeed, by agreeing to stronger IP-related measures, Canada also protects its own innovator community.

Two of the US Objectives are likely to be highly disputed. The first regards strengthening Canada’s standard of protection for IP rights. This may be code for attempts to force Canada to adopt a “notice and takedown” system for copyright enforcement. This is the prevalent form of copyright protection in the US, and is far more aggressive than the Canadian “notice and notice” system. Under the US “notice and takedown” regime, when an online service provider receives notice of infringing content that is on its service, it must then takedown that content. Under the Canadian “notice and notice” regime, a similar online service provider only needs to forward that notice of infringement on to the user that is allegedly engaged in infringement.

This was an element in the TPP negotiations, and the ultimate result was for the broader agreement to adopt the notice and takedown system, with an exception created for the few countries (such as Canada) that had a notice and notice system. The US is likely to exert increasing pressure on Canada to make this change.

Second, the US appears to be concerned about Canada’s system of Geographic Indications (“GIs”). GIs are codified in Canadian law and signify that certain products are associated with production in a certain geographic location using certain methods. Common examples are Scotch, Bourbon, or Champagne.

Canada has recently adopted a broad range of new GIs into its regulatory system as part of its CETA commitments. The US will likely pressure to exempt common US cheeses, such as feta or parmesan. It is unlikely that major concessions in this regard can be made without falling offside of Canadian commitments under CETA.

4. Federal and Sub-Federal Procurement

In both the TPP and CETA, Canada made significant concessions on procurement, including opening our sub-federal procurement markets. In CETA this included, for the first time in an international trade agreement, Canadian municipal and utility procurement. Given that the Canadian public procurement market is valued at over $200 billion, and the US public procurement market is valued at $1.7 trillion, open access for bidders represents massive new markets on both sides of the border.

Unfortunately, the US Objectives seem to argue out of both sides of the mouth. On the one hand there is a demand for better access to procurement markets in Canada and Mexico. On the other, there is also a demand both to exclude US sub-federal coverage and to maintain, indeed to expand, discriminatory US procurement provisions (such as small business offsets and “Buy America” requirements).

This is an area where Canada can show some strength. While the Canadian procurement market is comparatively smaller than the US market, it still represents an excellent new opportunity for US businesses. These US businesses face the real risk of losing out on these markets to European competition that will soon enter Canadian procurements with a significantly greater degree of protection and more access than their US counterparts.

This may allow Canada and Canadian businesses to pressure the United States to adopt measures more in line with the provisions under CETA, and at a sub-federal level. If the United States were to adopt the commitments equivalent to those found in CETA, it would mark a happy liberalization of the US procurement market. Meanwhile, allowing Canada access to US procurements on equal footing with US companies would not be a major imposition on the US market. Given the integration of many North American businesses and supply chains across borders, this may also be supported by US prime contractors that want to diversify their supply sourcing on projects.

5. Elimination of the NAFTA Exclusion from Global Safeguard Action

The USTR has also proposed the elimination of NAFTA’s global safeguard exclusion, currently enshrined in NAFTA Article 802. Originating in American 1940s protectionist legislation, a safeguard allows a country to minimize the impacts of liberalized trade on domestic industries. More particularly, it allows for the suspension of imports and application of duties and even retaliatory measures when a nation determines that imports of a product increase to an extent that causes or threatens serious injury to domestic industries. Global safeguard measures are, subject to certain conditions, permitted under the agreements of the World Trade Organization.

NAFTA Chapter 8 imposes significant constraints on a NAFTA government seeking to impose such global safeguards to the extent that they cover imports from another NAFTA country. Most significantly, imports from a NAFTA country must be excluded from such safeguard action unless (i) they account for a “substantial share” of total imports (i.e., the NAFTA exporting country is among the top five suppliers of the good subject to the action) and (ii) such imports considered individually, or in exceptional circumstances collectively with imports from the other NAFTA Party, “contribute importantly” to the serious injury or threat thereof to the domestic industry. Another important requirement under Chapter 8 is that, if a NAFTA Party such as the United States takes such safeguard action against imports from another NAFTA country, it must provide “mutually agreed trade liberalizing compensation”, failing which the aggrieved NAFTA Party may take action against the United States having substantially equivalent trade effects.

The USTR likely sees these restrictions as unduly prohibitive and compromising of its ability to respond to perceived injuries in certain industries. It has therefore expressed an intention to eliminate the NAFTA exclusion so as to allow the application of future global safeguard actions with no special treatment for Canada and Mexico.

6. Elimination of Chapter 19 and Trade Remedies

Under NAFTA Chapter 19, member nations benefit from a dispute resolution mechanism that may be triggered by aggrieved companies, providing an alternative to judicial review by domestic courts in antidumping and countervailing duty cases. Instead, binational panels would hear petitions and render judgements, binding upon NAFTA governments.

While US firms were initially active as applicants, having instituted approximately fifty percent (50%) of hearings brought before binational dispute resolution panels in the first two years of NAFTA coming into force, the United States has nonetheless been primarily on the receiving end of dispute resolution proceedings, having acted as respondent in approximately two thirds of matters instituted under NAFTA Chapter 19.

Notably, the binational panels established under NAFTA Chapter 19 were convened for the Softwood Lumber disputes, whereby Canadian softwood lumber exporters contested duties imposed by the US Department of Commerce (“DoC”). On August 13, 2003, a NAFTA binational panel found that the benefits granted to Canadian exporters were not sufficient to constitute a subsidy, such that imposed duties were unjustified. NAFTA panels later rejected, on five separate occasions, the calculated duties suggested by the DoC.

Recently, however, the softwood lumber dispute has reared its ugly head. On April 24, 2017, the DoC made a preliminary determination that countervailable subsidies are being provided to producers and exporters of certain softwood lumber products from Canada; a final determination on the subject is expected no later than September 6, 2017. It would be expected that imposed duties would be subject to the dispute resolution process provided by NAFTA Chapter 19, which had previously been used to great success by Canadian softwood lumber exporters. It is therefore unsurprising that the USTR has expressed its desire to eliminate the NAFTA Chapter 19 dispute settlement mechanism.

In the negotiation of the Canada-US Free Trade Agreement, Canada’s key objective was the elimination of trade remedy cases with the United States, a laudable and eminently logical goal for a true free trade area. The binational panel system, which continues today under NAFTA, was a second-best solution. Canada has made clear that this was essential to trading confidence, and that Canada would not sign a NAFTA which left Canadian exporters to the unreviewable mercy of US courts. Canada may well have to re-examine its attachment to Chapter 19.

7. Investment Protection and ISDS

The US Objectives are relatively silent on investment protection and ISDS mechanisms, providing only two points of interest. First, they speak of securing more rights for US investors in NAFTA countries, while simultaneously ensuring that foreign investors are not granted greater substantive rights in the United States than US investors. Second, they speak of reducing or eliminating barriers to US investment in all sectors in the NAFTA countries.

It is highly unlikely that either Canada or Mexico will agree to an alteration in the investment protection provisions that would see substantial gains for US investors in their territories without any form of corresponding or reciprocal gains for their own investors.

What is more likely is that the investment protection provisions and ISDS mechanisms will remain relatively stable. The current rules certainly have not been operating to the detriment of US investors and, historically, the United States government has been a major champion of the forms of investment protection provisions set out in NAFTA. Those seeking to anticipate what tweaks the United States may seek might look to the investment chapter negotiated under the TPP.

What may be interesting is whether Canada attempts to sell the United States and Mexico on buying into the “Investment Court” concept it is developing with the EU under CETA. The intention of the EU has been to expand this concept into a truly multilateral venue that would replace ad hoc arbitration with a system more analogous to a court - which can develop its own binding appellate authority.

However, the US track record with supranational judicial bodies is far from enthusiastic. Given the nationalistic drum that was beaten heavily by the Trump campaign, and by the current leaders of the USTR, it appears highly unlikely that such an accommodation would be made.

The second US Objective in the investment sphere, improved market access for US investors, is also unlikely to bring many Canadian changes. Canada has traditionally always strongly protected the Investment Canada Act, provincial securities laws requiring Canadian board members and representation on Canadian corporations, and the protection of certain industries (especially the cultural industries).

Given that Canada has recently made certain concessions, such as a major increase in the Investment Canada Act threshold for reviewing transactions, any further concessions would likely be difficult.

8. Labour and the Environment

The US Objectives claim to want to bring both the current Labour and Environment side agreements into the actual body of NAFTA. Both sets of US Objectives appear to be wholly in accordance with current Canadian policy - with an emphasis on ensuring that the parties will have or put in place adequate environmental and labour protections. Given that Canada would likely be in full agreement with many of these requirements (and indeed, would likely agree to even stronger commitments than those advocated for by the United States), one can only assume these provisions are targeted at Mexico.

There are two points of interest here. First, while both sets of US Objectives discuss incorporating the sections into NAFTA itself, and contain provisions requiring certain actions and panels to investigate and ensure commitments are met, there is no US Objective setting out proposed consequences for breach. CETA attracted a great deal of attention for being a “Green” free trade agreement because it included a chapter on the environment. However, without concrete enforcement provisions, including the loss of concessions up on a breach, these commitments remain window dressing. CETA, for all of its progressive claims, falls into this category: the environmental and labour chapters lack teeth.

Second, the US Objectives on labour do not deal with the freedom of movement of citizens or residents of the countries for business or other purposes. One of the key elements of CETA was a recognition that, to properly supply services, there had to be a guarantee for business travellers and business travel between the participating countries. There were also ground-breaking provisions relating to the framework for mutual recognition of credentials for professional workers (such as architects, engineers, or lawyers).

It will likely be difficult for the Canadian government to extract any concessions on this front from the United States. All the same, given the current trajectory of US demands, including broad access for service suppliers conducting business internationally, there may be limited room for liberalization for professional and business workers.

Conclusions

The US Objectives provide a window into the potential outcomes of NAFTA negotiations and provide considerable insight for Canadian stakeholders that have an interest in the outcome of those negotiations. With the start of negotiations rapidly approaching, time is of the essence for any interested parties to make representations to the government regarding their views on the components of NAFTA which they wish to see addressed.

Expertise