The Need To Know On Canada’s
Developing Trade Negotiations With The US
Frances Donald, Senior Economist
May 2017
ManulifeAM.com
The Need To Know On Canada’s Developing Trade Negotiations With The US
May 2017
Executive Summary
Recently-confirmed US trade representative Robert Lighthizer gave notice to Congress on May 18, that formal
NAFTA negotiations with Canada and Mexico would begin in 90 days1. We are therefore expecting a significant
ramp-up in news flow related to the US-Canadian trade conversation. This note summarizes what we believe are
the key “Need-to-Know” elements of the developing narrative.
In our view, it is most instructive to think about the US-Canada trade conversation as being comprised of three separate
and distinct issues that merit their own frameworks for analysis.
(i) The priorities and timeline of NAFTA renegotiation;
(ii) The blanket average lumber tariff of 19.88% applied on Canadian producers who export softwood lumber,
announced by the US Department of Commerce and effective April 282.
(iii) The Canadian-US dairy relationship – an issue which gained attention following US President Donald Trump’s
April 25th tweet: “Canada has made business for our dairy farmers in Wisconsin and other border states very
difficult. We will not stand for this. Watch!”
This note primarily addresses what we know and what we don’t about NAFTA renegotiations.
Broadly, there are four main conclusions at this early juncture:
NAFTA-related headlines will likely ramp up significantly in the coming weeks and, in our view, weigh on
international sentiment towards Canada. This is bad timing for Canada as concerns about housing are just
fading out of headlines.
Given that softwood lumber and dairy are not currently contained in the NAFTA agreement, we believe the
two issues will become negotiation tools during the NAFTA discussion, making it an even more lengthy and
complicated process.
At the margin, neither disruptions in softwood lumber nor dairy are by themselves game-changers for the
Canadian economy and are not sufficient to alter economic outlooks.
The economic problem in the near-term is indirect. The heightened market expectation of wide ongoing
uncertainty could damper growth by limiting both investment and hiring decisions in key trade-exposed
sectors. The uncertainty has the potential to keep the Canadian Dollar in a depressed range for an extended
period. The Bank of Canada will no doubt be monitoring developments closely.
Broadly speaking, we are currently most concerned about Canada’s auto exposure to NAFTA renegotiations.
NAFTA, lumber, and dairy are medium-to-longer-term trade issues that will easily flow into 2018 narratives or later.
However, in the next six months or so, we continue to expect Canadian export volumes to re-accelerate in lagged
sympathy with the recent resurgence in US manufacturing demand. This resurgence in trade will, in the short-run,
support growth and the Bank of Canada’s cautiously optimistic narrative.
1
2
USTR: Trump Administration Announces Intent To Renegotiate The North American Free Trade Agreement, May 18, 2017
US Department of Commerce: Press Release, April 24, 2017
2
The Need To Know On Canada’s Developing Trade Negotiations With The US
May 2017
What We Know
The Process & Potential Timelines
The US administration has already started the lengthy process of NAFTA
renegotiation. US trade representative Lighthizer provided a letter to
Congressional leaders on May 18 that informed Congress that formal
negotiations with Canada and Mexico would begin in 90 days3 (though they
could begin after the 90-day period).
As Canada’s Foreign Affairs Minister Chrystia Freeland noted, “I don’t have a
crystal ball, so I’m not going to predict the speed at which the negotiations will
advance”4. However, we have some clues about the potential timeline once
formal negotiations do start likely in mid-August, i.e. 90 days after May 18.
“What we do know is
that the political
calendar in the US and
Mexico may encourage a
‘sooner rather than
later’ negotiation. ”
US Commerce Secretary Wilbur Ross has said that “the negotiations, hopefully, won’t take more than a year”5. Critically, that
will depend on whether the US administration is seeking a fast deal or a ‘massive’ deal. What we do know is that the political
calendar in the US and Mexico may encourage a ‘sooner rather than later’ negotiation. Mr. Ross has pointed to the upcoming
Mexican elections in July 2018, saying that “the closer we get to those elections, the more difficult it will be for any government
to make a deal”6. Meanwhile, US midterm elections are on the horizon for November next year. This timeline suggests that
negotiations and NAFTA headlines could persist into early 2018, but it simultaneously heightens some sense of urgency.
Renegotiations Aren’t New
NAFTA may have elements that are obsolete, but it has been a living, breathing document since its implementation in
1994. Canada’s Foreign Affairs Minister Chrystia Freeland has noted that NAFTA has received significant updates 11 times
since 19947. This implies that negotiation shouldn’t necessarily spell doom for NAFTA’s interested parties.
It’s Not All Bad For Canada
It is entirely plausible that Canada emerges better off from NAFTA renegotiations. Mr. Lighthizer’s letter to Congress
emphasizes the “modernization” of NAFTA, which would benefit all parties3. We believe Canada could benefit from
several specific US-suggested tweaks to NAFTA:
Modernizing elements of services trade within NAFTA has been floated around over the past few months and would
likely be welcomed by Canada. Services represent two-thirds of the
Canadian economy, 4 out of 5 Canadian jobs and 15% of Canadian
“It is entirely plausible
trade (half of which heads to the US).
Both CETA and the TPP focused on removing barriers to digitally
delivered goods and services along with other digital security concerns.
Canada could benefit from addressing those issues with the US.
A scan of the notification letter can be found on the USTR website
CTV: Trump Trade Czar Now In Place, Wins Senate Vote, Sets Up NAFTA Process, May 11, 2017
5
CBC: NAFTA Talks On Big Changes To Start This Year, US Commerce Secretary Says, March 8, 2017
6
Bloomberg: Ross Backs Trump’s China Criticism With Most Protectionist Dig, March 31, 2017
7
CBC: Chrystia Freeland Says Canada Prepared For ‘Strong, Offensive Position’ On NAFTA, February 8, 2017
3
4
3
that Canada emerges
better off from NAFTA
renegotiations.”
The Need To Know On Canada’s Developing Trade Negotiations With The US
May 2017
NAFTA’s approach to labor mobility (the TN visa) could use a makeover. For instance, the list of occupations included
in the agreement needs to be updated to reflect the changing nature of jobs. All three countries might benefit.
Changes to public/government procurement could mean Canadian companies would be able to compete for crossborder infrastructure projections.
Ultimately, Canada has one major advantage over Mexico: Canada had a free trade agreement before NAFTA, the 1989 Canada-US
Free Trade Agreement. Under that agreement, about 75% of US-Canada trade was tariff-free and there was a timetable for reducing
all tariffs over time. NAFTA simply accelerated that timeline. In our view, a reversion to bilateral trade agreements could work in
Canada’s favor, though as of now, all players seem keen to keep negotiations tri-lateral.
“Rules of Origin” Appears To Be A Priority
The US Commerce Secretary has frequently mentioned the “rules of origin”
element of NAFTA5 which specifies that a minimum share of the content in
a good/product must originate in the US, Canada, or Mexico to move freely
between the three countries. For example, cars need to have at least
62.5% NAFTA content to be exempt from tariffs – they currently contain
63% NAFTA content8. That minimum amount could be adjusted for certain
products such that tariffs become newly applied on some goods. Autos
would be our concern, though we have virtually no specifics on which
sectors the US is most keen to target with “rules of origin” changes. Note
that energy is well insulated from changes to “rules of origin” given that
almost the entirety of energy products is domestically sourced.
“Note that energy is well
insulated from changes
to “rules of origin” given
that almost the entirety
of energy products is
domestically sourced.”
Chapter 19 & NAFTA Dispute Resolution Tribunals
The reason the lumber trade file is particularly relevant right now is that Canada has historically turned to NAFTA dispute resolution
tribunals to successfully challenge countervailing and anti-dumping tariffs imposed by the US on softwood lumber. The US
administration has frequently said they want to do away with the NAFTA tribunal which would have direct consequences for Canadian
lumber. To be clear, softwood lumber is not part of the NAFTA agreement, but the industry has used the tribunal on several occasions.
8
Scotiabank: Global Auto Report, April 17, 2017
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The Need To Know On Canada’s Developing Trade Negotiations With The US
May 2017
What We Do Not Know
What The US Wants From Canada, Exactly
It remains unclear what the US administration specifically wants from Canada in the
upcoming negotiations. Some believe that the US administration itself isn’t sure of what it
wants to accomplish yet either. The Globe and Mail reports that some would like to enhance
NAFTA to make cross-border business easier while others have a protectionist view9. It is
worth noting that Mr. Lighthizer himself has said precious little about Canada so far.
There have been frequent references by the US Commerce Secretary and President Trump
about the need to narrow US trade deficits. However, the US runs only a small and shrinking
goods deficit with Canada (US$1.4 billion in March 201710). In total, the US’s trade deficit
with Canada makes up only about 2% of their total trade deficit – that’s akin to the size of
its deficits with Russia and Indonesia. The US’s trade deficits with China and Mexico are
significantly higher, at 40% and 11% of the US’s total trade deficit respectively10. When it
comes to services, the US actually has a trade surplus with Canada. Moreover, the vast
majority of Canada’s goods trade deficit with the US is generated by the oil & gas sector
which doesn’t seem to be receiving much concern from the US administration so far.
What Sectors Will be Targeted Within NAFTA Renegotiations
We know that softwood lumber and dairy fall outside the scope of NAFTA, but within NAFTA, the
greatest ongoing Canadian market concern appears to be the auto industry. That’s likely because a
hit to auto trade represents a non-negligible risk to the Canadian economy. After all, auto trade
comprises about 20% of total Canadian exports to the United States8. On May 18, Mr. Lighthizer
stressed that NAFTA had been unsuccessful for US manufacturing, but “particularly with regards to
Mexico”. That Mexico is the manufacturing focus is likely good news for Canada, but it doesn’t
necessarily preclude Canadian manufacturing receiving attention as well.
The US Commerce Secretary does frequently reference the autos component of NAFTA as an
example of how obsolete the trade agreement is. He has said, for example, that “many parts
described are not even used in cars anymore because automotive technology has changed”11. But it
isn’t clear what will replace the ‘obsolete’.
Adjustments to autos trade will be complicated. According to Scotiabank Economics, more than
90% of all US auto industry shipments head to the three NAFTA countries – that’s 10 percentage
points higher than other manufacturing sectors8. Plus, auto parts can crisscross NAFTA borders as
many as eight times before being installed in one final car in the US, Mexico or Canada. As
mentioned earlier, 63% of a car shipped from Canada to the United States consists of US content.
It is nearly impossible to analyze how this sector might be affected without knowing what part of
that supply chain is targeted.
Other sectors that have been identified by the US administration and may receive adjustments
are of a much smaller economic significance. They include intellectual property, access to
telecommunications, public procurement, e-commerce and duty exemptions.
The Globe And Mail: NAFTA At Stake Amid Backroom Battles At The White House, April 15, 2017
Bloomberg, Manulife Asset Management calculations, May 18, 2017
11
Barron’s: Wilbur Ross On Trade – NAFTA “Obsolete”, China “Protectionist”, May 3, 2017
9
10
5
The Need To Know On Canada’s Developing Trade Negotiations With The US
May 2017
How Dairy & Lumber Could Play Into Negotiations
Softwood lumber and dairy have received the most heat from the US administration so far,
but critically neither is contained in NAFTA. This suggests that they are part of bilateral, not
trilateral, negotiations. We are increasingly of the view, however, that they could become
important bargaining chips and part of the NAFTA negotiation process between Canada
and the US, particularly with NAFTA dispute resolution tribunals, which have been an
important part of prior lumber trade agreements.
Frequently Asked Questions On The Softwood Lumber Tariffs
Why Impose The Tariff On Lumber?
The US’s decades-long gripe is that Canadian lumber is being unfairly subsidized by the government and is too cheap. The
provincial government’s practice of selling logging rights on its public land below market-prices is often cited as a reason that
supports this view. Canada rejects the notion that the practice amounts to a government subsidy.
Was The Tariff A Surprise?
In our view, not at all – the only surprise was that the tariff wasn’t higher.
This is the fifth time since 1981 that Canada and the US have argued over softwood and Canada has won most of its
international trade and US legal challenges against softwood duties12. The latest softwood agreement reached in 2006
expired in 2015 but there was a year’s grace period before the US could take legal action13.
Countervailing duties were well telegraphed by US officials in advance and many market players had expected tariffs to
be more punitive than the average 20% announced, i.e. closer to 40%. Indeed, markets had already efficiently priced in
a tariff, with lumber prices rising through February in expectation of the move.
Is The Tariff Now Official?
There is a long process ahead before final countervailing duties are decided or a new softwood lumber agreement is reached.
As of April 28, lumber companies have had to pay cash deposits to cover preliminary countervailing duties. These cash deposits
are collected by Customs and Border Protection when the lumber crosses into the US as a form of security as the investigation
proceeds . So far, lumber companies have been able to pass on the majority of the countervailing duties to customers because
lumber prices accelerated earlier in the year. More preliminary duties are likely on the horizon. On June 23, the US is due to
issue a decision on anti-dumping duties which could add to the current average 20% countervailing duty14. Analysts are
expecting a further tariff of 5-10%. These would take effect seven days following the decision.
In the meantime, it is completely possible that a new softwood lumber agreement is made. In 2001, the US applied countervailing
duties to Canadian lumber and it took five years before the 2006 Softwood Lumber Agreement (SLA) was reached. At that
point, it was negotiated that Canadian lumber companies would be refunded 80% of their cash deposits (plus interest)13.
Canada’s Natural Resources Minister Jim Carr said following the tariff announcement that reaching a new long-term deal is the
best option15, a sentiment shared by Quebec’s lead negotiator, Raymond Chrétien.
12
13
14
15
6
Financial Post: Canada Vows To Fight ‘Unfair And Punitive’ Duty As Trump Slaps Tariff On Softwood Lumber, April 26, 2017
You can read more about the US-Canada Softwood Lumber Agreement (2006) here
Details on the legal procedures and how Canadian lumber companies must cover countervailing duties can be found here and here
CBC: Quebecers Protest Softwood Lumber Tax, Hope To Send Strong Message, April 30, 2017
The Need To Know On Canada’s Developing Trade Negotiations With The US
May 2017
Is There Scope For Canadian Retaliation?
According to a news report from CBC, Canada’s Prime Minister Justin Trudeau was contemplating two separate actions in
response to the lumber tariff16. First, he expressed that he was considering banning US coal exports through British Columbia
(B.C.), per the B.C.’s provincial government’s request. Secondly, it is reported that he is also considering implementing duties
on Oregon’s plywood, wine, flooring, wood chips and packaging materials. (As an aside, John Ries professor at the Sauder
School of Business at UBC said the coal ban is probably an empty threat17).
Historically, however, Canada has not retaliated but has instead appealed to the NAFTA and WTO dispute resolution
tribunals. These tribunals have not been legally binding but have been highly persuasive.
Given that (i) the softwood lumber negotiation appears inextricably linked to NAFTA renegotiations, (ii) the fate of NAFTA
dispute resolution tribunals is unknown, and (iii) Canada is substantially more leveraged to US trade than the other way
around, we are not expecting immediate forms of retaliation before further conversations ensue.
How Quickly Will The Tariffs Be Felt By The Economy?
Companies in Quebec, the higher-cost producers, are apparently already reducing hours and cutting staff. While these capacity cuts
have been viewed as a reaction to the tariffs, the companies themselves have said that these are more due to volatility in market
pricing, and the fact that some US customers had built up some supply in anticipation of the duties18. Key Quebec producers have
also been exposed to a deteriorating newsprint market which has weighed particularly hard on these Quebec companies.
From our conversations with industry analysts, we understand that lumber companies in B.C. and Alberta are not yet showing
any signs of capacity curtailment, largely because they are lower-cost producers and because lumber prices have been resilient.
In the current price environment, we do not expect large-scale layoffs from B.C. or Alberta lumber companies as a result of
countervailing duties. Note that many analysts are expecting sawmill closures in B.C. over the coming five years, but this is due
to fiber availability and not countervailing duties.
What does the lumber tariff mean for the Canadian economy?
Directly, not much. Exports of softwood-lumber to the US represent less than 2% of all Canadian exports, and the forestry
sector accounts for 0.3% of Canadian jobs19. Among Canadian provinces, British Columbia is the most exposed.
The problems are once again indirect as they relate to lumber being used as a negotiation token for other sectors and/or that
lumber headlines continue to pop up through to 2018.
16
17
18
19
7
CBC: Trump Team To Trudeau Team: Softwood Lumber Threats ‘Inappropriate’, May 6, 2017
BNN: Clark’s Coal Ban Comment Is Grandstanding And Won’t Benefit Canada, May 17, 2017
The Globe And Mail: Quebec Lumber Workers Among The First Affected By Duty Inspired Layoffs, May 14, 2017
Statistics Canada, Manulife Asset Management calculations, May 17, 2017
The Need To Know On Canada’s Developing Trade Negotiations With The US
May 2017
Frequently Asked Questions On The Dairy Debate
What’s The Gripe With Canadian Dairy?
The US (and many other countries) have a longstanding gripe with Canada’s supply management of dairy (along with egg and
poultry industries) which dates back to the 1970s. In essence, farmers increase or decrease production according to consumer
demand and overproduction is therefore avoided20. The supply management practices support prices, enabling farmers to earn
a stable, predictable revenue without direct subsidies.
The problem for Canada’s trade partners is that for supply management to work, Canada severely restrict imports. For instance,
imported milk is subjected to tariffs as high as 270%21. The group of dairy products subject to import tariffs has risen in the last year.
The issue was a point of contention during negotiations for both the Comprehensive Economic Trade Agreement (CETA) with
the European Union and the Trans Pacific Partnership (TPP).
Why is the US President tweeting about dairy?
75 dairy farmers in Wisconsin who were supplying double filtered milk to Canadian dairy processors for cheese products lost
contracts after classification rules changed and import taxes applied to their products in April22. President Trump happened to
be visiting Wisconsin at the time and was said to have been deeply moved by the plight of the US farmers.
Does Canada buy dairy from the US?
Yes. Five times as much as the US buys from Canada. The US has a US$400 million dairy surplus with Canada so it’s not Canada
that’s the challenge here20.
How important is Canada’s dairy industry for the economy?
In short, the dairy industry debacle is not a major concern for economists. The dairy industry’s economic significance regarding
jobs and investment is not material in the grand scheme of the Canadian economy.
The concern is that dairy will become a sticking point amidst NAFTA negotiations – dairy is not currently contained in NAFTA
but is being added to the list of trade gripes that the US has with its trade partner to the North. Canada’s fierce defense of its
system means that dairy could become a bone of contention over the coming year.
20
21
22
8
You can read more about Canada’s Supply Management system here
The Globe And Mail: A Guide To Understanding The Dairy Dispute Between The US And Canada, April 25, 2017
Business Insider: Here’s What’s Behind The US-Canada Diary Spat That Has Chuck Schumer Agreeing With Trump, April 22, 2017
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