Can we improve the coordination of trade agreements to better support the important supply chains that cross the Canada-US border?
Over the last decade, world trade in goods has increased dramatically from US$10 trillion in 2005 to US$16 trillion in 2015, while trade in services has doubled, from US$2.5 trillion to US$5 trillion. Much of this trade occurs within regional trade agreements (RTAs), of which there are currently over 600 around the world.
The most important RTA for both Canada and the United States is the North American Free Trade Agreement (NAFTA), with two-way trade in goods and services doubling since its implementation in 1994. Canada sells more to the United States in one year than it does to the rest of the world combined in three years. This represents over $2 billion in goods and services crossing the Canada-US border every day.
The Great Lakes-St. Lawrence region is a key driver of the Canada-US economic relationship and a critical continental and global trade corridor. The region employs 51 million workers, or nearly 30 percent of the combined American and Canadian workforce. The eight Great Lakes states (Illinois, Indiana, Michigan, Minnesota, New York, Ohio, Pennsylvania and Wisconsin) and the Canadian provinces of Quebec and Ontario represent 50 percent of the total value of goods imports and exports between the two countries. Further, the region boasts one-fifth of US and one-half of Canadian manufacturing.
The auto sector — which remains a manufacturing juggernaut in the region — best illustrates how intertwined we are, with its just-in-time supply chain that relies on speed, reliability and predictability at the border. It’s also the sector that best demonstrates the opportunities both countries could realize by pursuing a more coordinated approach on its common commercial interests.
The Auto Pact, signed in 1965, recognized that shared industrial and trade policy objectives were required for an industry that dominated the two economies and spanned the border. It allowed a single plant to produce specific vehicle models for both markets, which rationalized production and led to significant economies of scale. Unfortunately, the enthusiasm for pursuing shared policy objectives like the Auto Pact has waned, with President Trump today advocating for a “Buy American, Hire American” approach to trade policy.
One area with potentially important implications for the Great Lakes Region in the upcoming NAFTA renegotiations is “rules of origin,” which describe content requirements for goods — including autos and parts — to trade at the preferential NAFTA rate. The summary of the US objectives for renegotiating NAFTA highlights an objective to “ensure the rules of origin incentivize the sourcing of goods and materials from the United States and North America” (emphasis added).
It may be appealing to assume that setting rules that require more domestic inputs into the production process to qualify for preferential tariffs will increase employment and output in the home country, but in reality that usually isn’t the case. If any new jobs are created in the input sector, this can also lead to higher costs for all downstream industries, which makes final goods more expensive and thus less competitive overall.
Every country wants to drive more jobs and output in their economy using native material. However, in a borderless and increasingly liberalized global economy, and with the rise of global supply networks and value-added production, rules governing country of origin must be carefully calibrated to reflect and take advantage of this reality. This will be especially challenging in the upcoming NAFTA negotiations, where the three countries must work together to find new ways of leveraging and improving the performance and competitiveness of commercial platforms that extend across the border or the continent.
Negotiated outcomes from recent trade negotiations with South Korea exemplify the potential dangers of disintegrated trade and industrial policy for integrated sectors like autos. The Korea-US Free Trade Agreement (KORUS) was signed in 2011, and was later followed by the Canada-Korea Free Trade Agreement (CKFTA) in 2015. Both deals included important provisions for the auto industry, such as the treatment of tariffs, internal taxes, enforcement and standards. Yet, ultimately, uncoordinated outcomes were achieved.
For example, the US secured a snap-back provision that allows Washington to impose a 2.5 percent tariff if South Korea violates the agreement; an Automotive Working Group to address nontariff barriers; and an expedited dispute settlement procedure. Alternatively, although Canada’s deal with Korea also included an expedited dispute settlement procedure, it had no snap-back provision and no working group. Now the US has indicated that it wants to renegotiate its deal with South Korea, raising additional possibilities for major differences to arise between the Canada and the US with respect to South Korean trade in autos and other goods and services.
Overall, while it is still too early to assess the full impact of both agreements, the CKFTA is expected to increase Korean auto exports to Canada, which will have a modest impact on the Canadian auto sector, as Korean gains will come at the expense of third parties like US firms. Likewise, the trade diversion effects brought about by CKFTA will likely hamper the anticipated bilateral export gain between the US and Korea expected from KORUS.
What KORUS and CKFTA show is that, despite the high level of integration in the auto sector and the recognition that we are each other’s most important trading partners, when it comes to international trade agreements, Canada and the US part ways and hope that things work out for the sectors most impacted, many of which transcend the 49th parallel. This approach unintentionally creates supply chain inefficiencies and represents a missed opportunity to fully leverage our combined strengths — which include transportation infrastructure, skilled labour, advanced research and development, access to capital, affordable energy, etc.
As both countries pursue global trade policy agendas beyond North America, with Europe, countries in Asia and the Pacific Rim and other emerging markets, we need to consider how to better leverage binational economic platforms like the Great Lakes region and integrated industries like the automotive, aerospace and agri-food sectors with an aim to attract more foreign direct investment and do more business together and with the rest of the world.
In today’s global marketplace, the US and Canada, as well as Mexico, need to work closer together in negotiating future trade agreements, particularly with respect to cross-border or continental industries. If we fail to do so, we are cheating our families, our workers and our businesses out of the full benefits of these agreements and are creating unnecessary drag on our productivity and competitiveness.
This article is part of the Trade Policy for Uncertain Times special feature.
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