NAFTA/USMCA Flash, October 2018

New Canada-U.S. Trade Deal Reached; NAFTA Becomes USMCA

Key Issues:
  • Canada and the U.S. have reached a deal on a revised trade agreement, which along with the U.S.-Mexico agreement means that NAFTA will live on, though under a new name, USMCA.
  • Canada got as good a deal as it could have given that it was playing defense against the aggressive offensive stance of the U.S.
  • The big disappointment is the failure to remove steel and aluminum tariffs. This keeps the door open a crack for more U.S. actions on similar national security grounds, but this should not include autos for Canada and Mexico.
  • The main investment implications of the USMCA agreement for clients are at the macro level – a stronger economy, higher short-term interest rates and a stronger Canadian dollar.
  • A significant source of uncertainty has been removed from Canada’s economic outlook, suggesting stronger business investment ahead, and a slightly better economic growth outlook.
  • Reduced trade uncertainty gives the Bank of Canada more room to increase short-term interest rates, more in line with the U.S. Federal Reserve. Short-term interest rates are likely to be a little higher at the end of 2019 than we thought previously (2.25-2.50% instead of 2.00%).
  • Trade uncertainty has been a weight on the Canadian dollar, a weight that has been lifted. In the last several issues of the Big Picture, we stated that a successful renegotiation of NAFTA alongside rising commodity prices could push the Canadian dollar up toward the 85-87 U.S. cent range over time. Looking ahead, commodity prices are a plus for the loonie, and with some extra room for higher short-term interest rates, the likely path is for further gains in the Canadian dollar over the rest of 2018 and 2019. To get all the way up to 85-87 U.S. cents, we need to see solid evidence that the new agreement will become law and that the U.S. not pepper Canada with new trade actions, and global growth needs to continue at a decent clip. Over the next few months, a move to the 80-82 U.S. cent range seems likely.
  • The major industry impact is for autos, with new automotive provisions. This is largely status quo for Canada, but the impact on the global competitiveness of the North American industry will be depressed to some degree.
  • Canadian consumers will benefit from the dairy and duty-free exemption changes, though drug prices could increase slightly due to the new patent provisions.
  • Global trade frictions persist. However, the Canada-US agreement gives a potential template for EU, Japan and South Korea negotiations with the U.S. At the very least, it will provide some insights into areas where the U.S. will and won’t be flexible. This suggests to us that this agreement could help reduce global trade risks among the U.S. and its traditional allies.
  • Key policy issues for the Canadian economy are now domestic – pipelines and competitiveness. Big cuts in U.S. corporate taxes remain an issue and Canadian governments will need to take some actions on this front.

Key Details:

Key elements in the dispute resolution process for Canada are unchanged. Chapters 19 (which deals with anti-dumping and countervailing tariffs) and 20 (which deals with state-to-state issues) are retained in the new agreement. Chapter 11 (which deals with investor-state disputes) will be phased out between the U.S. and Canada.

Autos are critical for Canada and Ontario’s well-being. Canada and Mexico have received exemptions from potential U.S. auto tariffs. If the U.S. imposes auto tariffs on other countries, Canada and Mexico would each be exempt up to an import quota. Canada’s quota is 2.6 million units per year, well above its current export level of 1.8 million. Canada has lots of room to grow its auto production and exports to the U.S. and still avoid new U.S. tariffs.

Automotive rules of origin are in line with the U.S.-Mexico agreement and have little to no impact on Canada. The local content requirement is being increased to 75% from 62.5%, and 40% of each car must be made by workers earning over US$16 per hour. Canadian plants largely exceed the content requirement and pay wages that are higher than the minimum. This is a much bigger deal for Mexico, where wages are so low. These new rules are likely to dampen the global competitiveness of the North American auto industry, but the magnitude is unknown at present.

The U.S. proposed sunset clause is absent as in the U.S.-Mexico agreement. Instead, the new agreement has a sixteen- year life with a review every six years. After six years the agreement can be extended for another sixteen years if all parties agree. If not, it is reviewed annually until either a) an agreement is reached and extended for another sixteen years, or b) if ten years pass with no agreement, the treaty is abrogated or turns into a bilateral agreement between the willing parties. This allows regular updates to the treaty in a ten-year negotiating period, which should be long enough for businesses to make longer-term investment decisions.

The U.S. gets greater access to Canada’s dairy market (including eggs and poultry), with the threshold for tariffs increased to 3.59%. This is higher than the 3.25% threshold that was agreed to in the revised Trans-Pacific Partnership (CPTPP). Canada also agreed to eliminate its Class 7 milk pricing system.

Government procurement is unchanged after the U.S. dropped its ‘Buy America’ provisions.

Duty-free exemption has been increased, with Canada lifting its duty-free exemption threshold to C$150 from C$20.

U.S. steel and aluminum tariffs will remain in place. This was one of the biggest areas of give by the Canadian government in the negotiations. The U.S. seems to have retained the power to impose tariffs on national security grounds and this will be an area where Canada-U.S. trade frictions may persist.

Intellectual property protections are strengthened. Patent protections for biologics have been lengthened from 8 to 10 years and copyright protections have been extended. Canada and Mexico are converging to U.S. standards.

Passing the agreement into law: With the USMCA text published on September 30, the U.S. has fulfilled the 60-day deadline to sign the agreement before December 1, when the new Mexican President takes office. Once the agreement is signed, however, the bill itself may not be introduced in the U.S. House and Senate until mid-summer 2019 and might not get signed into law until August 2019 under Trade Promotional Authority (TPA) rules. The process could prove to be faster but is not without hurdles. For instance, a Democratic win could lengthen the timeline.

Thank you for reading,

John Johnston & The Davis Rea Team

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