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Canada is joining Mexico in an escalating dispute with the United States over how much of a car or truck must be made in North America to qualify for duty-free treatment under the United States-Mexico-Canada trade agreement.

This is the second conflict in six months with the United States over automotive trade. Canada and Mexico are also fighting President Joe Biden’s efforts to bolster U.S. auto jobs by awarding tax credits to consumers who buy electric vehicles assembled in the United States.

The Canadian and Mexican governments are concerned that auto companies might switch manufacturing from their countries to the United States.

Trade experts say it’s disturbing to see disagreement over a key element of the 2018 trade pact so early in its history. Negotiated when Donald Trump was U.S. president, the United States-Mexico-Canada Agreement (USMCA) was supposed to seamlessly replace the 25-year-old North American free-trade agreement. Autos and auto parts are a vital portion of manufactured goods trade between the United States, Mexico and Canada.

“The auto industry is the heart and soul of North American integration,” said Christopher Sands, director of the Canada Institute at the Woodrow Wilson International Center for Scholars. “If the auto industry part of Canada-U.S. free trade breaks down, the whole agreement breaks down. You cannot exaggerate the importance of these disputes.”

International Trade Minister Mary Ng on Thursday announced Ottawa is joining Mexico in a request for judicial arbitration of how the United States calculates North American content. Both countries have asked for the establishment of a legally binding dispute settlement panel to rule on Washington’s interpretation of automotive rules of origin under Chapter 31 of the USCMA.

By 2025, 75 per cent of a car or light truck and core components such as engines or transmissions must be manufactured in North America to avoid duties. It’s a significant increase from 62.5 per cent under the NAFTA. This means automakers have to reduce the use of cheaper offshore parts.

Cars have thousands of parts, and at the heart of the disagreement is whether the auto industry can round up the calculated North American value of smaller parts that go into major components when performing the math to reach overall 75 per cent. The U.S. opposes allowing this.

Ms. Ng said Canada believed the new auto content rules were settled in 2018.

“The outcome was the result of negotiations and close consultations with automotive stakeholders, which ensured that these new rules of origin would deepen regional integration and support the competitiveness of automotive producers in North America,” she said.

Mexican Economy Minister Tatiana Clouthier welcomed Canada’s move on Thursday, tweeting: “Together we will defend the competitiveness of this regional industry.”

International trade lawyer Lawrence Herman said the Biden administration is under heavy pressure from U.S. autoworkers’ unions to defend a stricter interpretation of North American regional content rules.

Mark Warner, also an international trade lawyer, said it’s not unusual for signatories to a new trade agreement to “test the limits of it.” He said it’s wrong to assume “we sign an agreement and there will no disputes.”

The Americans are clearly advancing an aggressive interpretation of the content rules, but it’s the sort of case that’s appropriate for arbitration, he said. “The issue of how much Chinese and Asian parts should go into Mexican and Canadian auto parts is always going to be controversial.”

Flavio Volpe, president of Canada’s Automotive Parts Manufacturers’ Association, accused the Americans of reneging on agreed-upon rules.

Mr. Volpe said the United States is becoming “increasingly and permanently protectionist” and Canada needs to be “permanently awake to this problem.” He said the Americans are acting without due regard for their close allies.

He predicted major U.S. auto assemblers would side with Canada and Mexico.

Mr. Herman said if the U.S. prevails it will mean higher costs to build cars.

He said the Biden administration is mindful of midterm Congressional elections in 2022 and the presidential ballot in 2024 and cannot afford to alienate a key Democratic constituency: U.S. autoworkers.

“They are heavily dependent on support from organized labour,” Mr. Herman said.

“They’re being pushed by U.S. auto workers to take this approach. It’s difficult for the Biden administration to show flexibility on this.”

If this dispute cannot be resolved, automakers could respond by ending efforts to comply with USMCA regional content rules for parts and instead pay the extra duties incurred as a result of using offshore parts. But that would be bad for North American jobs because automakers would be under no obligation to use parts made on this continent.

Mr. Sands said disputes about how much offshore content should be allowed in North American-made autos stretch back decades. “What the U.S. is trying to do as a goal – bring more production home – is shared by all three countries,” he said. “But we need to give the industry the flexibility on how to move in that direction while reconciling it with consumer demand.”

He said he believes the concerns of Canada and Mexico about the future of auto trade – including the regional content rules – are being not taken seriously enough in the United States, and he sees the request for dispute settlement as an effort to draw attention.

Mr. Sands said failure to resolve these auto-related disputes could jeopardize the future of the USMCA.

With a report from Reuters

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