What does the new USMCA trade deal mean for Ontario?

What does the new USMCA trade deal mean for Ontario?

On October 1st the United States and Canada reached an agreement to revise the North American Free Trade Agreement (NAFTA), following 14 months of negotiations and an August bilateral deal between Mexico and the US. The new United States-Mexico-Canada Agreement (USMCA) largely preserves the architecture, trade barrier restrictions, and dispute resolution processes of NAFTA—which is a considerable achievement given some parties’ initial negotiating positions. However, Canada had to agree to increase access to dairy and poultry markets and did not receive guarantees against US steel and aluminum tariffs, among other concessions. While the USMCA preserves the preferential US market access that has long benefited Ontario’s economy, the concessions required to retain the status quo and the generally fraught negotiating process highlight the perils of continued over-reliance on our southern neighbour.

New USMCA deal retains most NAFTA provisions

Overall, not much has changed in the USMCA from its predecessor, NAFTA—which is largely good news for Canada and Ontario. Canada successfully defended the inter-state dispute settlement mechanism and protected against future auto tariffs, while dropping some of its initial objectives such as government procurement, environmental standards, and new chapters on gender and indigenous rights. Most importantly, the USMCA preserves tariff-free trade on nearly all goods and services traded between Canada, the US, and Mexico. Unlike most free trade agreements, consumer price reductions as a result of USMCA are unlikely (except for online purchases and potentially dairy and poultry) since the deal generally maintains the current free trade provisions of NAFTA instead. New automobile content of origin provisions may even increase prices for consumers.

One clause that is concerning requires signatory countries to give each other three-months’ notice of free trade negotiations with any “non-market country” and allows their exclusion from the USMCA if this other trade deal is signed. Yet this does not actually represent much change: any signatory country can already leave the agreement with six months’ notice, under any circumstance. Nonetheless, the addition of this clause is likely a shot across the bow from the US warning against Canada or Mexico signing a trade agreement with China. A chapter limiting currency manipulation is also currently unnecessary, but similarly restricts policymaking in an area traditionally left to national governments.

Opening up Canadian dairy and poultry markets

Although Canada already has a dairy trade deficit with the US, the USMCA grants the US increased access to Canada’s domestic dairy and poultry markets, beyond even what it would have gained from the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Canada has also agreed to limit its producers’ dumping of surplus milk proteins into global markets. These concessions will be costly for Ontario’s $3.5 billion dairy, poultry, and egg industry.[1] However, these provisions were key to preserving the rest of the free trade agreement because Canada’s supply management system was increasingly in the cross hairs of US trade negotiators. Moreover, increasing dairy and poultry imports could reduce consumer prices: the supply management system costs Canadian consumers $444 per year on average. However, since retail prices also depend on market structures and other factors, there is no guarantee that cheaper producer prices will reduce prices for consumers. There are also significant transition costs associated with moving away from the protectionist system. The federal government has already promised to compensate dairy and poultry farmers for changes under the USMCA.

Auto sector escapes threat, but protections still needed from steel and aluminum tariffs

Tariffs are off the table for any Canadian auto exports below a threshold of 2.6 million passenger vehicles—20 percent higher than Canada’s peak number of exports in 1999 (Exhibit 1). Canada is similarly unlikely to reach the tariff threshold on auto part exports. This guarantee is a relief since those tariffs could have plunged Ontario’s economy into a recession. The trade-off is that by 2023, 75 percent of the content of tariff-free autos must come from the US, Mexico, or Canada, up from 62.5 percent under NAFTA (but less than the 85 percent the US initially demanded). Canadian automakers already source approximately 71 percent of content from North America, so this provision is unlikely to require major changes from producers.

Exhibit 1: Passenger vehicle imports to United States from Canada and Mexico, 1996-2017

In addition, the USMCA includes a new requirement for 40 percent of auto content to be produced by workers earning at least US$16 per hour. This will double or even quadruple some labour costs in Mexico, but should require only small wage increases in Ontario, where the average wage for motor vehicle assemblers is already only US$2.31 less than the new USMCA minimum hourly wage.[2] If the Canadian dollar remains low, these provisions could result in Canada becoming the new ‘low-wage jurisdiction’ in North American auto production, with some production then shifting to Canada from Mexico given the low productivity and high production costs there.

On the other hand, US tariffs on steel and aluminum remain in place, although analysts expect Canada and Mexico to be exempted from the tariffs by December following agreed-upon further discussions. Steel and aluminium exports to the US made up nearly 1.5 percent of Ontario’s gross domestic product in 2017.

Inter-state dispute settlement mechanism preserved

The USMCA retains the inter-state dispute settlement processes from chapter 19 of NAFTA, which was one of the Canadian government’s ‘red lines’ in negotiations. This provision allows the Canadian government to continue appealing to independent panels—rather than potentially-biased US courts—any US actions that it believes unfairly impose trade duties. Canada also retains its right to challenge US national security tariffs under World Trade Organization processes. On the other hand, the USMCA gets rid of the investor-state dispute settlement mechanism (previously in NAFTA chapter 11), which allowed companies to sue governments for actions that hurt their investments. This could benefit Canada given its poor record in these cases.

Challenges for Canadian innovation

Stronger intellectual property (IP) protections in the USMCA, such as longer terms of copyright and pharmaceutical patents protection, could hurt Canadian innovators by increasing the protection afforded to US competitors. This could hamper Canada’s efforts to boost commercialization and could increase the already-large gap between the number of patents invented by and owned by Canadians as well as Canada’s $8.3 billion IP trade deficit.[3] Unfortunately, short-term concerns around Canada’s automotive, steel, and aluminium sectors seem to have received higher priority in negotiations than Canada’s longer-term goal of boosting innovation. Increased protection of generic pharmaceuticals may also increase drug prices for Canadian consumers.

What next? Ratification, while focusing on diversification

The USMCA still needs to be ratified by each country’s legislature and it is unclear whether this can occur before the US congressional midterm elections in November. This could result in negotiations reopening to include some US politicians’ demands for stronger labour and environmental protections. The USMCA will also automatically expire in 16 years, unless the three member countries agree to proactively extend it during a formal review six years from now.

Moving forward, the Canadian and Ontario governments should recognize that continued dependence on a single trading partner will only lead to more headaches in future USMCA trade negotiations. Compared to its peer jurisdictions, Ontario’s economy is far more dependent on exports generally and on its largest export markets specifically (Exhibit 2). Ontario should therefore look to develop other trade relationships while encouraging federally-led efforts to build new trade agreements. The newly signed CPTPP and Comprehensive Economic and Trade Agreement with the European Union provide plenty of openings to create and expand export markets. The Ontario government should provide export supports and other programs to ensure that the province’s businesses take full advantage of the opportunities enabled by this new market access.

Exhibit 2: GDP share of exports to top five export destinations and all other export destinations, Ontario and peers, 2016

Written by: Jacob Greenspon

Photo credit: Mark Bruxelle, istock

 

[1] Institute for Competitiveness & Prosperity analysis based on data from Ontario Ministry of Agriculture, Food and Rural Affairs Farm Cash Receipts by County and Crop, 2017. Calculations include receipts from dairy products, chickens, turkeys, and eggs.

[2] Institute for Competitiveness & Prosperity analysis based on data from Statistics Canada Table 14-10-0328-01 for average offered hourly wage for NOC 9522 in 2018Q1, calculated at quarterly average exchange rate of 1 CAD = 0.79 USD.

[3] Institute for Competitiveness & Prosperity Working Paper 31, The final leg: How Ontario can win the innovation race.

Category: Public Policy