If NAFTA falls—the implications for Canada

It remains unclear when President Trump will move to renegotiate NAFTA or what exactly his demands will be in any renegotiation. Given the fraught political relations between Mexico and the United States stemming from, among other things, a dispute over which country will pay for Trump’s wall along the Mexican-U.S. border, it’s possible that the poisonous political environment between the two countries will preclude any renegotiation discussions.

In this regard, Mexico’s Economy Minister and other prominent Mexicans have stated that Mexico might pull out of NAFTA if U.S. renegotiation demands make Mexico worse off. Given Trump’s expressed grievances about Mexico’s trade surplus with the U.S., it’s difficult to imagine any renegotiation leaving Mexico seeing itself as being better off than it was under previous NAFTA arrangements. In short, the smart money bet would seem to be on the death of NAFTA.

So where would the demise of NAFTA leave Canada? In fact, the cancellation of NAFTA would resurrect the pre-existing free trade agreement (FTA) between Canada and the U.S. At the time NAFTA was negotiated, it was formally agreed between Canada and the U.S. that, in the event of NAFTA’s demise, the FTA would be automatically revived.

If the future choice for Canada is to fall back to the FTA or have no free trade agreement at all with the U.S., returning to the FTA would seem to be the preferable alternative. In the absence of an FTA, Canada-U.S. trade relations would be governed by the rules of the World Trade Organization (WTO) to which both countries belong.

This, in turn, would effectively mean the reintroduction of tariffs across a range of products that would be traded between the two countries duty-free under the FTA. While U.S. tariff rates on most imported products are relatively low under the WTO, the tariffs could accumulate for individual products as semi-finished goods go back and forth across the border along supply chains that are prominent in the transportation equipment and several other industries. The resumption of the FTA would ostensibly mitigate tariff-based disruptions to bilateral vertical supply chains.

To be sure, Canada could attempt to renegotiate the FTA to include provisions in NAFTA that were seen by Canada as being improvements over the FTA including an expedited dispute resolution procedure. However, there’s no guarantee that President Trump would agree to restore NAFTA provisions for Canada. Nor, for that matter, is there any guarantee that he would not call for the U.S. to renegotiate or withdraw from the FTA if he became displeased with the balance of trade outcomes under the FTA.

Indeed, it’s possible that the president will demand tighter bilateral rules-of-origin restrictions as a condition of continued U.S. participation in an FTA. This would mean stricter restrictions on Canada using imports from third countries in the production of goods destined for the U.S. market. This would likely mean higher costs for Canadian manufacturers.

It’s also plausible that U.S. customs and border inspections would be strengthened to ensure that Canada is not using parts and components from third countries such as Mexico and China and then not accurately disclosing foreign value added in goods exported to the U.S. This would also increase Canadian business costs and diminish the benefits to Canada of an FTA.

More broadly, the entire rationale for a bilateral FTA is questionable in an environment where President Trump can and will bully and berate U.S. corporate executives to make goods in the U.S. in place of imports under threat of some type of financial punishment or public shaming. Such actions might be very difficult, if not impossible, for Canada to challenge under an FTA because they need not be manifested in the imposition of actual tariffs or other actions that clearly violate a free-trade agreement.

In short, President Trump makes the U.S. an unreliable free-trade partner. While the unravelling of bilateral free trade is certainly not good economic news for Canada, the emerging facts on the ground suggest that a significant unravelling is likely to occur, even if Canada can salvage the FTA with the U.S.

The issue that may soon face the Canadian government is how far it’s willing to go to placate an economically illiterate trade bully in order to maintain an unreliable and limited tariff-free access to the U.S. market.