The pros and cons of leaving NAFTA behind
During negotiations, Canada will want to preserve and enhance what it gained in the original deal, but the protectionist-driven U.S. is unlikely to budge
Striking a two-way trade deal with the United States is being touted by some as an antidote to Donald Trump's America-first plans.
After all, it is Mexico, not Canada, that is in the cross-hairs of the new U.S. President.
So why not simply go back to the good old days – before the North American free-trade agreement – when Canada enjoyed better access to the massive U.S. market than any other country in the world?
Back to the future on Canada-U.S. trade
It's a seductive notion. And it turns out that the Canada-U.S. free-trade agreement is still on the books. When NAFTA came into force in 1994, linking Canada with the U.S. and Mexico, the rules of the original FTA were suspended, but never formally terminated.
Dust off the old document, and voila, free trade (circa 1987). Virtually all Canadian goods would enter the U.S. duty free.
That's not an option for Mexico, which has no other arrangement to fall back on if NAFTA collapses. For Canada, it's better than nothing, but far from a perfect option.
"The fact that we have the Canada-U.S. free-trade agreement as a fall back gives us greater leverage in a negotiation," said trade lawyer Matthew Kronby, a former Canadian trade negotiator who is now a partner at law firm Bennett Jones in Toronto.
Without getting too far into the weeds of trade rules, a return to pre-1994 days would be a good thing for Canada in some respects. Take Mexico out of the picture and Canada would gain a clear competitive advantage in the U.S. market.
Both Canada and the United States want an upgrade
It's not as simple as reviving a 30-year-old agreement. NAFTA was changed in some ways that made it significantly better for Canada. And Ottawa would want to preserve those advantages in any modernized trade arrangement with the U.S.
Among other things, NAFTA expanded the range of professionals allowed to work freely in the United States – from accountants and architects to librarians and nutritionists. NAFTA also greatly improved Canada's access to the vast U.S. services market. And it boosted the protection of investors, allowing them to directly sue the U.S. and Mexican governments for compensation (although Canada has been successfully sued more often than the other NAFTA partners under this provision).
The original deal provides a starting point. But it would have to be overhauled and modernized.
Merely reverting to the original free-trade agreement is a "bit of a red herring," argued John Boscariol, a trade lawyer at McCarthy Tétrault in Toronto.
"Realistically speaking, we're never going back to it," he said, pointing out that if the United States can walk away from NAFTA, it can also abandon the earlier Canada-U.S. deal.
What Canada wants
Canada would want to preserve and enhance what it gained in NAFTA in any new round of talks with the U.S. In an ideal world, that would mean it would want better access to government contracts for Canadian companies and relief from strict Buy American rules.
Ottawa has also long made the case that in a true free-trade zone, countries should not be allowed to hit each other with punitive duties for allegedly dumping or subsidizing exports. The two countries have two major such cases on the go – the United States on Canadian softwood lumber, and Canada on U.S. drywall.
What the United States wants
But Washington is unlikely to budge on any of that in the current political climate. And given its unabashedly protectionist stance, the Trump administration would almost certainly demand major concessions of its own.
In last week's inaugural address, Mr. Trump rejected the economic underpinnings of free trade by stating that protectionism will lead to "great prosperity and strength."
So in any negotiation, the United States would likely want Canada to bend. It could, for example, seek greater protection of U.S. intellectual property in Canada for its movies or pharmaceuticals, plus a dismantling of the tariff wall and rules that shield the dairy and poultry sectors. They might also push for an end to rules that limit foreign ownership of Canadian telecom companies, or push for tighter restrictions on Canadian beef and pork exports.
The Trump administration has already made noises about wanting to get rid of NAFTA's dispute-settlement regime, which Canada has used successfully to fend off previous U.S. attacks on its lumber.
"The administration attitude seems to be that exports are good and imports are bad," Mr. Kronby pointed out. "It's likely to enter any negotiation with Canada looking to limit Canadian access to the U.S. market, not expand it."
Abandoning Mexico could prove costly
Walking away from NAFTA and pursuing a separate deal with the U.S. would be hugely disruptive to companies that have extensive supply chains in Mexico. This is particularly true in the automotive and aerospace sectors, where companies such as Magna and Bombardier have significant investments there.
The two sides would have to rewrite the complex rules of origin, which set out how much North American content various products must have to get into the United States duty free.
"It would create a lot of uncertainty and unnecessary complications to balkanize trade within the NAFTA region, rather than to further integrate it," Mr. Kronby pointed out.
It would be a remarkable strategic step for Canada to say it doesn't really care about Mexico, pointed out economist Daniel Schwanen of the C.D. Howe Institute. And it would make Canada poorer.
"If we revert back to the original FTA, we would be basically cutting ourselves off from using Mexican inputs," he said. "All the supply chains operating down there would have to be revisited."
Companies would have to make a stark choice: shut down their operations in Mexico and move back to Canada, or relocate them to the United States to avoid tariffs. "I suspect they would go to the U.S.," Toronto trade lawyer Mark Warner said.
The big dilemma for Canada in a bilateral negotiation would be to extricate itself from NAFTA "without hurting ourselves," Mr. Warner added.
What a new deal might look like
So just what would a revamped Canada-U.S. free-trade deal look like? Mr. Boscariol, a trade lawyer, said it might well be similar to the recently completed free-trade deal Canada has with the European Union, or even the 12-country Trans Pacific Partnership deal, which Mr. Trump has already said he won't pursue. These deals extend their reach beyond tariffs and into areas of regulation and intellectual property.
Canada's best bargaining chip is that it isn't Mexico or China, both of which are running relatively large trade deficits with the United States. Canada, on the other hand, is the largest purchaser of U.S. goods in the world, typically running a small trade surplus with the U.S. Measured by the broader current account, which includes trade in services and investment income, the Canadian and the U.S. economies are in near perfect symmetry, under the current rules.