Unprepared for a NAFTA emergency

Former prime minister Stephen Harper’s leaked memo on possible failure of North American Free Trade Agreement ( NAFTA) negotiations caught many by surprise. After my own visit to Washington recently, his pessimism seems warranted. So much so that the American business lobby is gearing up to forestall a U.S. withdrawal from the agreement.

President Donald Trump has reportedly told a group of senators at a private luncheon that issuing a withdrawal notification would force Canada and Mexico to agree to concessions he wants. It is similar to the strategy he’s tried in pressuring Congress to reform Dreamer immigration, the Iranian nuclear deal and Obamacare.

The White House is playing hardball. In the Trump administration’s eyes, the U.S. has been hurt by past trade agreements and China’s accession to the World Trade Organization. Trump’s remedies are one- sided and geared to American interests. Complaints by trade partners — such as Canada’s legitimate beef with Buy American infrastructure policies — don’t persuade him, because he thinks the U. S. got a raw deal the first time.

Now the U. S. is looking to revise “origin rules” to push for more auto production to the United States, which would hurt Mexico the most. It wants to undo Canada’s supply management f or dairy, eggs and poultry. It wants to eliminate NAFTA’s dispute mechanism, subjecting Canada and Mexico to unilateral import duties. The worst policy would be to put a five- year sunset clause on NAFTA that would create immense uncertainty for crossborder trade.

This “America First” strategy will not improve free trade. Instead it takes us backwards into trade protectionism. Although negotiation outcomes are far from certain, it struck me that Canadians are insufficiently paying attention to the big question: What if NAFTA fails?

There are two main reasons that this question is highly relevant. First, we should understand our “credible threat” in a negotiation: Would it be better to let NAFTA die or, as the Harper memo suggested, agree to terms of a “modernized” NAFTA yielding a worse outcome? Second, we should examine our current policy framework to make sure that our current policies won’t make our job harder in the future to spur growth.

Canada understands it has more to lose than the United States if NAFTA breaks down. The U. S. is the largest economy, worth about one-fifth of world GDP, while Canada is relatively tiny with little more than two per cent of world GDP. Canada therefore does not have much leverage as most of our trade is with the United States: almost $ 675 billion in exports and imports, or roughly two- thirds of our global trade.

While Canada has concluded a trade agreement with Europe and is looking to develop trade agreements with Asian countries, these markets are far less important than the American one. Canadian two-way trade with the faster- growing Asian-Pacific region is less than $170 billion, only a quarter of our trade with the U.S. Losses in American markets would not be made up easily with gains elsewhere.

Besides, Canada has done a poor job in developing alternative markets, especially for auto and energy products ( both currently in surplus with the U. S). Oil and gas is our most important trump card today, as it feeds the voracious U. S. demand for energy, which still exceeds U. S. production. Successive Canadian governments have failed to develop international markets for oil and gas in the past two decades giving the U.S. a monopsony on our product.

The U.S. would not want to lose this access to our cheap energy but it has alternatives. We don’t.

The latest policy rage is for Canada to cosy up with China, which has used its accession to the WTO to grab global market share while protecting its highly subsidized economy. Now the Chinese government plans to push for greater government involvement in the economy by not only subsidizing and protecting state-owned enterprises but also taking stakes in private companies or regulating them more stringently. Chinese trade therefore comes with danger not just in terms of intellectual-property theft but also unfair trading and investment practices.

Moreover, after the successful privatization of industry in Canada over the past three decades, there is little value to seeing it renationalized by foreign firms ( such as in the case of the proposed takeover of Aecon by China’s s t ate- owned CCC International, which was recently on a World Bank blacklist for fraudulent practices) While takeovers often lead to better management and technology adoption, this is far less likely in the case of state- owned enterprises that earn sub-par profits in the name of pursuing nationalistic goals.

So if NAFTA fails, the costs to the Canadian economy in losing access to the dynamic U. S. market won’t be made up easily. It would lead higher tariffs, trade protection and less investment in Canada to serve the North American market. If NAFTA fails, expect a depreciating Canadian dollar, rising interest rates, fewer investment inflows and slower growth over the long term.

What is the necessary Canadian response if it does fail? Like the U. K. following its Brexit experience, we will need to pursue more vigorously new avenues for trade and create a better business environment with better regulations and growth- oriented tax system.

Yet, in some ways, federal and provincial governments are headed the opposite way: regulating more heavily, raising business taxes and failing in their plans to get our goods to tidewater ( and not just oil and gas). If NAFTA fails, we are going to need an abrupt reversal.

FEDERAL AND PROVINCIAL GOVERNMENTS ARE DOING THE OPPOSITE OF WHAT WE’LL NEED.