The US holds considerable leverage in the NAFTA renegotiation, but to achieve an effective deal it must accommodate Canada’s and Mexico’s interests.

President Trump says that if he doesn’t get the renegotiation he wants, “we will terminate… NAFTA forever.” Canadians didn’t ask for this tempest. A positive outcome for all three parties is possible, but not if renegotiation implies capturing more of the benefits for the US at the expense of Canada and Mexico. Time is on our side. The President can’t be too ambitious because he needs the negotiations to wrap up quickly. The Canadian government has started off well by energetically seeking friends wherever it can find them — in Congress, the states, and industry associations. But what options does Canada have if that’s not good enough either to resist Trump or achieve our own objectives?

Answering this question starts by asking another: How much leverage does the US really have? That depends on the type of deal the Americans want. They have quite a bit of leverage for a good agreement that strengthens North American trade relations; but not so much leverage for a bad agreement that Canada and Mexico would find hard to accept.

President Trump started from false premises, thinking that NAFTA was a disaster. The loss of industrial jobs that he thundered against was primarily due to automation. It may have been due to trade too, but it probably wasn’t due to US trade agreements, and it certainly wasn’t due to US trade agreements with Canada.

Trump has a political problem of his own making: NAFTA isn’t the cause of the problem he wants to fix, and no sensible outcome of the renegotiation will likely help him with his voters. The problem is compounded by the first item in the July 17 Summary of the Objectives for Renegotiating NAFTA: “Improve the U.S. trade balance and reduce the trade deficit with the NAFTA countries.” This objective is something that trade deals are rather ill-equipped to deliver. So we now find ourselves entering a hugely complicated negotiation whose outcome can’t satisfy the apparent motivations of its instigator. American jobs haven’t migrated to Canada (and the US doesn’t even have a trade deficit with Canada); therefore, if the US objective is to redress the damage done to its economy by trade agreements, the NAFTA renegotiation will fail.

International relations offers three approaches for thinking about what determines negotiating outcomes. The first stresses the salience of power or material interests, such that outcomes are the result of coercion or power. This perspective rightly worries Canadians who think Trump might try to bully us. Others think that outcomes depend on bargaining, based on the interests the parties bring to the table. This perspective assesses what each side ought to want from the renegotiation to estimate the outcome. In contrast, many people think the outcome of negotiations is influenced by interaction and deliberation. These three theories construct a familiar trinity of explanations for international action. In reality no one factor dominates, and each influences the other.

Can Canada be bullied?

Let’s consider whether Canada could be bullied in the negotiations, by thinking about who has power and what it’s good for.

  • Does the US have the power to compel Canada and Mexico to accept a deal that isn’t in their interests? In trade negotiations the attractiveness of a large and rich market like the US is powerful, but only as an inducement, not as a compulsion. Moreover, trade policy remains foreign policy, and US bullying on NAFTA could harm its security interests on the country’s northern and southern borders.
  • Would such power, if it exists, also compel compliance with the new agreement’s provisions? Much of what NAFTA covers is actions of the three governments within their own borders, which are based on the implicit social and legal practices, as well as the formal legal systems of the parties. Deals that are perceived by one side as unfair will fail. Everybody needs to see themselves gaining, on balance, or they won’t play by the rules after the fact.
  • How much power does the President have to determine the outcome? It’s convenient to think that what the President wants is what the US will do, but the country and its government are not a unitary actor controlled by the White House. Congress has enormous influence over trade negotiations, and negotiators will ensure that congressional priorities are addressed. Negotiators will also make sure the package has something for everybody — or at least something to get enough votes for passage. Even if President Trump exercises his presidential power to abrogate the treaty, NAFTA provisions are given effect by legislation that Congress has to change, not the President. Trade legislation requires compromise involving pro-trade groups of Democrats as well as Republicans, which may in any event be improbable in a polarized, dysfunctional Congress.
  • How much power do the President and Congress have, given the political economy of US economic interests? Congress is heavily influenced by lobbies, especially the interests of the representatives’ home states, as communicated by governors and local politicians. It’s easy — but wrong — to think that on every issue where some American group has ever stated a maximal demand (like dairy farmers in Wisconsin) that this is what the administration will seek in the renegotiation. But there’s a reason why maximal demands haven’t succeeded in the past. The US Trade Representative’s call for NAFTA comments generated over 12,000 responses. Not surprisingly, they offer offsetting positions, even within the same industry.

Consider agriculture: Some farmers have done very well exporting to Canada and Mexico; others resent competition from farmers in those countries, while many food processors depend on those imports. No deal gets through Congress without support from agriculture, which is the number one industry in more than two dozen states that voted for Trump. With one small exception (ultra-filtered milk), the issues aren’t new, and all were addressed in the Trans-Pacific Partnership (TPP) negotiations. Since American farmers as a whole benefit from NAFTA, showing the attractive power of Canadian and Mexican markets, a small group might not get much support from the rest to take a hard line if it risks undermining the whole agreement — which is perhaps why dairy is mentioned only by inference in the negotiating objectives.

The worst case scenario

President Trump is in a corner given the need to put something in the window for his supporters for the 2018 Congressional elections. He might again threaten to rip up NAFTA if Canada and Mexico refuse to accept what he wants. Without NAFTA our trade with the Americans would be governed by WTO rules. Would that be good enough for us? On financial services, telecom, government procurement, food safety, and non-tariff barriers, the WTO framework has moved beyond NAFTA (although on temporary entry for service providers, NAFTA is better); supply management is safe under the WTO, and the softwood lumber dispute may end up there anyway.

If we lost NAFTA, which removes tariffs on trilateral trade for over 95 percent of tariff lines, prices would rise for consumers and on intermediate inputs imported from the other NAFTA countries. The Canadian Centre for Policy Alternatives compared NAFTA tariffs with those that would apply to any US trading partner under the WTO. It finds that much of Canada-– US trade would continue to enter the US market duty free even without NAFTA (including products such as natural gas, hydroelectricity and aircraft). Half of Canada’s exports would face new tariffs, although most of these tariffs would be below 3 percent.

American firms would also face higher tariffs in Canada and Mexico without NAFTA. Even a small tariff can be serious in an industry where profit margins are slim, but such tariffs are especially problematic in industries, like automobiles and light trucks, where complex supply chains criss-cross the border. Canada would prefer to keep NAFTA, but it’s not so valuable that we must accept a bad deal. Moreover, many of the reasons that Canadians want NAFTA also apply to many Americans, whose interests would also be harmed if the President tried to abrogate the treaty.

Can NAFTA be modernized quickly?

For Trump to have something to show voters in the 2018 Congressional elections, a deal must be submitted to Congress by January 2018. This makes speed a bargaining chip for Canada and Mexico. It’s no accident, therefore, that the US summary identifies many issues already addressed in TPP, which in effect modernized NAFTA, since the TPP approach is well understood by the three parties. Starting from the TPP is not simple though, even if it’s quick. Each of the NAFTA parties must ask if the TPP texts include provisions inserted only to gain the agreement of the other nine or if the other nine had blocked provisions that the three might want to bring back. Canada must also consider whether we made concessions to the Americans in the TPP only because we were obtaining a concession from one of the others.

Part of the initial bargaining will be agreeing on the issues for negotiation, and ensuring the agenda meets everyone’s needs, while excluding issues that will be too complicated given the time available (such as US offensive investment interests) or too protectionist for Canada and Mexico to accept (such as eliminating the global safeguard exclusion). All of the NAFTA parties might want easier terms for pipeline construction. Canada might want to make it easier for professionals to cross the border to provide services, including in sectors not covered in NAFTA.

But the Americans have to avoid stepping on landmines if they want to move quickly — i.e., issues that could slow the renegotiation considerably or even blow it up. Commentators have found problematic elements throughout the summary. My list includes the following:

  • Government procurement: The TPP chapter left “Buy American” provisions untouched, but any attempt by the US to devise a more restrictive chapter will be resisted by Canada (although the US might discuss applying the higher standard Canada agreed to with the EU).
  • Changes to NAFTA rules of origin: If they tried to shift production of motor vehicles and parts to the US would be unacceptable to Canada and Mexico.
  • Eliminating chapter 19 on review and dispute settlement in antidumping/countervailing duty matters: It would be hard for Canada to accept absent an alternative, but no new system could be devised quickly. Canada fought hard for this provision, but has used the current rules only three times in the last decade. Is it worth much to Canada? The answer hinges on why its use has declined. If its existence restrains the use of trade protection measures against Canada (which could be why lobbies like the softwood lumber industry want it eliminated), then taking it away would be a bad idea. Alternatively, as cross-border supply chains grow in importance, maybe trade protection measures that are self-defeating are behind the decline. In sectors of homogenous upstream commodity trade, disputes may not be much of a constraint anyway — softwood may end in another long-term managed trade arrangement. In short, the Canadian strategy may be to make the Americans worry that chapter 19 is a landmine, while being prepared to exchange it for something more important, like relief from Buy American rules.

It would be foolish to pretend that the US has no leverage in the NAFTA renegotiation. Their tough negotiators will have a lot of weight behind them, but they will have to listen to Canada and Mexico and accommodate their interests if they want to achieve a quick outcome and an effective deal. Since the results may look like the outcome of the TPP negotiations — most of which would have been acceptable to Canada — the prospects look good for a reasonable outcome, at least among negotiators. Their challenge will be to find something that can be presented as a political victory for President Trump.

This article is part of the Trade Policy for Uncertain Times special feature.

Photo: Shutterstock, by Willrow Hood


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