After months of often rocky negotiations, Canada concluded the United Sates-Mexico-Canada Agreement (USMCA) to replace the North American Free Trade Agreement (NAFTA) on September 30, 2018. Although this new agreement may represent the best deal that was available for Canada, it highlights more than ever the need for Canada to diversify its exports markets and to develop its own international strategy. Canada must sustain its long-time relationship with the United States, but must also deepen its ties with major powers such as China. Canada has always been able to pursue both goals, but the USMCA can be interpreted as a tool by the U.S. government in its escalating trade war with China. President Trump indeed referred to the new agreement as a pact that “will bring all three great nations together in competition with the rest of the world.” The new USMCA contains an article (32.10) that restricts Canada’s ability to negotiate future FTAs with non-market economies – i.e. China – without being potentially excluded from the North American pact. Article 32.10 contains components that require a member state to get approval from the other members if it initiates trade negotiations with another country and to provide them with an opportunity to review the full text of the final agreement, which favors a U.S.-Canada-Mexico alliance on negotiating with China.
As the United States is increasingly taking a more confrontational posture toward China, many wonder about the impact of the USMCA and the United States on the future of Canada’s relations with China.
Discussion hosts: Iris Jin, senior program manager, trade, investment, innovation, and Canada-China relations, Asia Pacific Foundation of Canada, and Charles Labrecque, project specialist, Asia Pacific Foundation of Canada.
The USMCA’s signal to Canadian businesses can be assessed from two perspectives: (1) the Canadian government’s actions immediately after the USMCA negotiations and (2) the U.S. government’s strategy in requiring the inclusion of a “poison pill” provision in the USMCA, Article 32.10.
Despite the USMCA, the Canadian government has stated that it is eager to support stronger trading relationships between Canada and China. This might seem strange since Canada agreed to the poison pill clause in the USMCA – a clause that would allow the U.S. to terminate the USMCA with Canada (upon providing notice of six months) if Canada entered into a free trade agreement with any non-market economy (the U.S. regards China as a non-market economy and this term is widely-regarded as a reference to China). The U.S. would then be allowed to replace the USMCA with a bilateral agreement between the U.S. and Mexico. If Canada contemplates negotiating a free trade agreement with a non-market economy, then it must provide at least three months notice to the U.S. and Mexico. At least 30 days before signing the free trade agreement with the non-market economy (i.e. China), Canada must provide the full text of the agreement to the U.S. and Mexico.
However, Canada’s agreement to the inclusion of Article 32.10 should not be interpreted as a sign that Canada is willing to sacrifice its trading relationship with China. Under the USMCA, there is a general withdrawal provision (Article 34.6) that allows any party to withdraw from the USMCA upon provision of six months notice to the other parties. This is nothing new – a similar withdrawal provision existed under NAFTA (NAFTA Article 2205). Therefore, Canada was not really giving up much from a technical perspective by signing on to the USMCA – the U.S. could have torn up the agreement for any grounds anyway (although the U.S. would have to enter into a new deal with Mexico if the U.S. withdrew – so the poison pill provision does provide a slight advantage to the U.S. over the general withdrawal provision). So why did the U.S. insist on the poison pill provision? The poison pill provision is a U.S. signal to both China and Canada that the U.S. will exert its influence on its trading partners as a weapon in the current U.S.-China trade war.
Canada acted very pragmatically. Canada agreed to a provision that makes very little practical difference, given the general withdrawal provision, while attempting to defend its interest in Canada-U.S. trade. However, from a symbolic perspective, this was a bitter pill for Canada to swallow. Since Canada had an already existing desire to pursue more trade with China, Canada would have preferred to not include the poison pill clause – a clause that appears to have been specifically targeted at China. This could have potentially sent the wrong message to China and sabotaged Canada’s desire for a free trade agreement with China.
The USMCA negotiations reinforced to Canadians the extent to which Canada depends on U.S. trade and alerts Canadians to the need to diversify our international trade. The USMCA has acted as a catalyst for Canada-China trade relations. As of the date of this commentary, Canada has sent numerous high level government officials to China to promote trade. Canada has made it clear that, regardless of the USMCA, it will continue to pursue Canada-China trade. Jim Carr (Canada’s Minister of International Trade Diversification) visited Beijing on November 11 and 12, 2018 and promoted sector-by-sector trade while still keeping the possibility of a complete free trade deal on the table. Prime Minister Trudeau has stated that the USMCA will not hinder Canada from pursuing what Canada wants: a Canada-China free trade agreement.
On the downside, the USMCA’s poison pill provision is a manifestation of the U.S. government’s trade war strategy. If the U.S. was assertive enough to require the provision, then this suggests that it may aggressively interpret provisions of the USMCA. This could arise if Canadian businesses export goods containing Chinese content to the U.S. The USMCA rules of origin dictate whether those goods will be treated as Canadian (and thus receive preferential treatment under the USMCA). An aggressive interpretation of those rules could lead to increased imposition of tariffs on Canadian goods containing Chinese content. However, the USMCA would not be the cause of such an aggressive stance. Rather the USMCA’s poison pill provision is the result of an already-existing aggressive U.S. position in the ongoing U.S.-China trade war. Arguably, even under NAFTA, the situation would not be much different for Canadians.
Interestingly, the USMCA seems to have energized the Canada-China trading relationship. The USMCA reminded Canada of the need to diversify Canada’s trading relationships – particularly with China, Canada’s second largest trading partner. It also reminded China of the importance of maintaining trading relationships with Canada (especially in light of the USMCA poison pill provision that appears to be a U.S. attempt to isolate China in the midst of a U.S.-China trade war). If the USMCA poison pill provision was intended to dissuade Canada from pursuing more trade with China, at this point that strategy has prompted actions in the opposite direction. Instead, it has emphatically reminded both Canada and China that increased trade between the two countries is mutually beneficial and emboldened them to approach the matter with renewed vigor and determination. This is a positive sign for Canadian entrepreneurs seeking to do business in China as well as a cautionary note to those who export goods containing Chinese content to the U.S.
Article 32.10 is a jarring addition to the agreement, an unprecedented constraint on Canada’s ability to forge a free trade agreement with China. Analysts will continue to debate whether we really had a choice, if it is a violation of Canadian sovereignty, and whether it does much more than codify processes for consultation and acquiescence that would have come into play in any case.
Not in question is the geo-political backdrop. The Trump administration badly wanted this clause as a tool in its full court press against China and as a precedent for what it wants in future trade agreements with the EU and others.
Like it or not, and certainly not alone, Canada is having to navigate a deteriorating U.S.-China relationship and cope with an American administration intent on a policy of pressuring and confining China until it agrees to play by American rules in reshaping its economic and political structures.
In what might be described as a fingers-crossed-behind-your-back reaction to the agreement, the Trudeau government is already signalling that it will not be restrained in pursuing deeper economic connections with China. The ministers of Finance and Trade and Diversification will soon visit China. And the Prime Minister recently bucked pressure from the U.S. and some in our own intelligence community to continue a partnership with Huawei in the -development of our 5G capacity.
Even in advance of the USMCA, articulate voices were making the case that a full-fledged Canada-China FTA is neither feasible nor desirable, favouring instead a series of linked but discrete agreements on specific sectors including industry, agriculture, education, and co-operation on pressing global issues like climate change. See for example the new report by the Public Policy Forum.
It remains to be seen whether Beijing will be receptive to this novel idea of a sectoral approach and whether it will meet its specific economic objectives related to investment rules, energy, and particular sectors including artificial intelligence.
It is not difficult for Ottawa to convey that Article 32.10 was not of Canadian making and that continued and expanded economic relations with China are of mutual interest. What is even more important is that Ottawa find ways to signal that it has not signed on to the Trump administration’s definition of China as an adversary and its campaign of maximum, comprehensive pressure.
This will demand a more clearly articulated statement of Canada’s strategic interests and positioning in an era of Donald Trump’s America First running headlong into Xi Jinping’s China Dream.
The United States is using all the leverage it has to shut down China’s ability to access global markets, including to Canada’s, as part of its trade war tactics. Article 32.10 of the new USMCA, which requires Canada to inform the United States of its trade negotiations with a non-market economy (NME) and gives grounds for termination or modification of the USMCA should Canada proceed to indeed enter into a free trade agreement with an NME, is just one feature of U.S. policy with that objective.
Another is in the rules of origin, where normal NAFTA Marking Rules do not apply to inputs from China that are subject to the U.S. Section 301 sanctions. Rules of origin are the gatekeepers to free trade market access for products. Products must meet content requirements to be considered as being “made in the NAFTA region”, otherwise they must pay tariffs. Accordingly, companies organize their supply chains to comply with the applicable requirements for their exported goods and collect and store the documentary evidence to demonstrate that when audited. US customs has, however, indicated that normal NAFTA rules concerning “substantial transformation” (e.g., when parts that are imported under one tariff classifications and are assembled into a new product with a different tariff classification) might not apply to products contained inputs from China depending on how complex the “transformation” is. This ruling means that products containing imported inputs from China might not qualify for NAFTA/USCMCA access and rather might be subject to the Section 301 tariffs (including any Canadian labour and other inputs combined with those imported inputs). This will create uncertainty for businesses shipping to the United States and impose additional administrative costs to ensure they retain free trade market access.
These measures will damage Canada’s trade with both China and with the United States – indeed, as is usually the case with U.S. trade measures, Canada will likely be the most affected because of the extent of its integration with the U.S. economy. However, this affects transpacific trade in general given the deep and complex Asia Pacific production networks.
U.S. trade policy is subordinate to its foreign policy. Two specific bits of history are highly relevant today. First, the 1947 General Agreement on Trade and Tariffs (GATT), which went ahead in place of the International Trade Organization, the intended sibling of the IMF and the World Bank, excluded the communist bloc as part of the geopolitical policy of containment of communism. Second, the original Trans-Pacific Partnership, which from the U.S. perspective was framed to have the United States setting the rules for Asia Pacific trade rather than China, was unusually endorsed by a number of retired U.S. generals as essential to U.S. strategic interests in the Asia Pacific. The marriage of convenience between China and the United States that enabled China’s entry into the World Trade Organization in 2001, on the heels of 9/11, is over.
For Canada, having the equivalent of an Iron Curtain descend across the Pacific is decidedly against the national interest. It is in Canada’s interest to see a de-escalation in trade tensions across the Pacific. Canada has a long history with China as an honest broker and should draw on that diplomatic capital. This is the proverbial ‘rainy day’ for which one saves.
Canada can help in three ways. First, Canada should engage China on the same terms it is engaging the U.S. – seeking a positive win-win trade arrangement on a progressive trade agreement. China has requested this and the USMCA does not preclude talks and only requires Canada to inform the United States of its objectives. Keeping the United States informed in fact would be part of Canada’s objective of opening talks with China.
Second, Canada has now issued its own WTO reform discussion paper. It would make eminent sense to take this discussion to Beijing ASAP to identify points to which China could realistically move but that also address the concerns of the wider trading community.
Third, Canada should request a panel at the WTO on grounds that the U.S.-China trade war is harming Canada’s trade interests. This would create a forum that other countries could join as observers to contribute to dialogue that could broker a new trade peace.
Dan Ciuriak’s commentary is based on a recently published article for the Asia Pacific Foundation of Canada.
The USMCA has been the subject of much debate, including because of its so-called ‘China clause’ (Article 32.10), which appears to put constraints on ambitions for a Canada-China Free Trade Agreement. This clause sets a worrying precedent in codifying an obligation to consult and share text about an FTA with a third country. In essence, it formalizes what would have been an informal practice of discussing such an undertaking with our largest trading partner. Given the current U.S. administration’s perspective on China, we could anticipate, with or without Article 32.10, a negative reaction to the prospects of a Canada-China FTA.
The USMCA’s impact on Canada’s trade agenda, though, should not be over-stated. Canada already has a vibrant and commercial relationship with China worth over $80 billion annually, and this has been achieved without the benefit of a free trade agreement. Canadian companies are actively pursuing new opportunities in China, supported by federal and provincial trade representatives on the ground across China.
The Chinese market presents a number of systemic challenges to Canadian companies that would be difficult to address even with an FTA in place. These include lack of transparency and predictability in its regulatory system, provincial and local rules that discriminate against foreign sources, and ongoing issues with corruption. State intervention in certain sectors creates an uneven playing field for Canadian companies, and the lack of a fully convertible currency, along with restrictions on the outflow of foreign currency, put more restraints on doing business.
Given these challenges and the current constraints on an FTA with China, Canada should consider a different approach to strengthening the architecture of our trade relations with China. The two sides should establish a bilateral umbrella agreement – an Economic Partnership Framework (EPF) – incorporating a number of trade-related economic initiatives aimed at improving bilateral trade flows while respecting WTO rules on non-discrimination.
The EPF could, for example, establish a robust engagement on regulatory issues, promoting finding ways to enhance transparency and predictability, and exploring initiatives like mutual recognition, certification, and customs facilitation agreements that would reduce the administrative burden associated with bilateral trade. Better regulations in China would benefit both sides, and this regulatory engagement could also include working with Chinese companies and certification agencies to help reach more international standards in areas like product and food safety. Such a framework could also include formal, high-level mechanisms for swiftly addressing bilateral trade disputes, rather than going through the slow and increasingly dysfunctional WTO process. These initiatives could be captured through focused, sectoral agreements that bring together key players from each country.
Co-operation under an EPF need not be limited to bilateral issues, but could extend to global issues, like food security, trade, the environment, and supporting the rules-based system that have been identified as priorities by each country.
Finally, building China competence and enhancing our bilateral economic framework would help better position Canada in China, all without violating the letter or even the spirit of the USMCA.
Phil Calvert’s commentary is based on a recently published article for the China Institute at the University of Alberta.
I am a little bit disappointed with what Canadian negotiators achieved with the USMCA. NAFTA, similar to the World Trade Organization’s (WTO) agreements, was seen as a leading agreement that not only benefitted the development of economic co-operation in North America, but that also set an example for the world. As we understand, Canada renegotiated NAFTA with the goal of modernizing the trade deal and making it reflect North America’s twenty-first-century economic reality, but Canada and Mexico had to accept most of the requirements from the United States. As a consequence, Canadian industries such as dairy and other agricultural sectors will face more competition while others risk more dependence on the American economy.
An FTA is a platform where parties try to reach their own economic objectives without necessarily negotiating with their partners the same level of market access or time table for the phasing of barriers to trade. In this regard, if Canada cannot start exploring the possibility of an FTA with China where such a negotiation would happen, it will be at a disadvantage in further developing its bilateral economic co-operation. China is determined to continue a process of opening-up and prefer negotiating FTAs with its partners. Without a FTA it will be harder for Canadian companies to benefit from China’s growth and from the explosion of its domestic market.
I would like to emphasize that for the future of China-Canada relations, the respect of international routines and practices is essential. Remaining open and transparent and resolving problems and concerns by negotiation instead of via unilateral decisions can bring positive effects for all; China will not bully other economies like the United States does. There are quite a lot of areas and possibilities for both China and Canada to co-operate in the future. We welcome Canadian companies to grasp the opportunities of China’s further openness to investment and to benefit from more voluntary tariff reduction like those in the auto sector this year. There will also be more possibilities for co-operation in research and development to explore how to meet the quickly changing consumption demand in China.
Subnational governments and chambers of commerce could also play a more active role to favour co-operation. In the past five years, provincial governments in China have been increasingly active in creating better international co-operative platforms with other partners that strengthen economic co-operation with other countries. I have always been and I and remain confident in the future of bilateral co-operation between China and Canada because I believe that market forces will prevail. If there is an opportunity for co-operation, the private sector will surely find its way in the most innovative industries.