Could the USMCA Hinder Future Trade Deals?

November 1, 2018
Canadian Foreign Affairs Minister Chrystia Freeland walks from her vehicle as she arrives at the Office of the United States Trade Representative, on September 11 2018. (AP Photo/Carolyn Kaster)

Canada’s Foreign Affairs Minister Chrystia Freeland doesn’t think that the recently struck United States-Mexico-Canada Agreement (USMCA) restricts Canada’s “sovereignty” in any way.

At issue is the hotly debated Section 31.10 provision in the landmark trade deal, which requires any USMCA country to give three months’ notice to the other two countries before it begins negotiating a free trade deal with any “non-market country.” If any of the three countries is opposed to an agreement that is struck — say, a Canada-China free trade deal — they’re permitted to give notice to withdraw from the USMCA.

Trade experts following the situation aren’t so sure that the provision won’t have an impact on Canada’s ability to negotiate future trade deals.

“I know Chrystia Freeland says it’s not a restraint on Canada but we’ve never seen a provision like this, which holds out the threat of divorce if the US doesn’t like the terms of an agreement,” said Gary Clyde Hufbauer, a senior fellow at the Peterson Institute for International Economics in Washington. “It puts a cloud over the ability of Mexico and Canada to negotiate with China and other ‘non-market countries.’”

Canada appears to be the country most restricted by the measure, and any trade negotiations it enters into with China could be impacted.

“Mexico doesn’t have any commercial interest in doing a deal with China,” said Hufbauer. “But Canada has an interest in doing a deal with China.”

Any move Canada makes toward a trade deal with China would likely be met with hostility by the Trump administration, which has been engaged in an escalating trade war with China. The United States is reportedly preparing new tariffs against all remaining Chinese imports — roughly US$257 billion worth of product — which would be implemented if President Donald Trump and Chinese president Xi Jinping fail to reach an agreement.

Clifford Sosnow, an Ottawa- and Toronto-based international trade law specialist and partner at Fasken, notes that there is nothing in the USMCA that prohibits Canada from negotiating a free trade deal with China. However, he notes that the United States can pull out of the USMCA if it doesn’t like a deal Canada signs with another country.

“If we don’t agree with what you, Canada, has signed we have the authority and right to walk away from our agreement and resuscitate a bilateral deal with Mexico,” Sosnow said.

The provision in the USMCA creates all sorts of timing issues as well. Not only would Canada have to inform the United States three months prior to the beginning of formal negotiations with China or another non-market economy, it also would have to inform the United States of a Canada-China trade deal 30 days before signing it. It would be at that stage that the United States could decide that it wasn’t happy with the agreement."[The United States] may not signal a concern prior to the commencement of negotiations but they may say after the negotiations are virtually done, that ‘we're pulling the plug,’” Sosnow said. “That ‘it’s us or them.’”

The consequences of Canada’s decision in that scenario could have wide-reaching implications for any future trade deals it hopes to accomplish. “If Canada pulls out then, what does it mean about Canada’s ability to negotiate trade deals?” he said.

Legally, Canada, the United States and Mexico all have the same rights as regards informing each other when they plan to negotiate free trade deals with other non-market economies. However, Sosnow notes, practically speaking, the measure is tougher on Canada, particularly because the Trudeau government is considering whether to pursue trade negotiations with China.

“The measure sets up a level of closeness and consultation that one sovereign country typically doesn’t have with another sovereign country prior to reaching a trade deal with another country,” Sosnow said. “It is quite remarkable.”

Canada could also potentially face trouble if it were to try to formalize its existing business ties to Cuba, another “non-market” country. “Canada has no trade agreement with Cuba but does a lot of business there,” Hufbauer said. “This [provision] retards them from formalizing business deals with Cuba in a free-trade agreement.”

It is a strong possibility that US concerns about trade deals with China won’t disappear even after the Trump administration is replaced. “This provision will have teeth even in a Democratic administration,” Hufbauer said. “Democrats in Congress are trying to beat up on China. This cold war has deep roots in both political parties.”

At the very least, the measure will give Canada reason to pause before seeking to negotiate trade deals with China. It’s just one of a number of provisions in the USMCA that is intended to target China, the largest of which involves automobiles.

In order to qualify for zero tariffs, 75 percent of a car’s parts must be made in Canada, Mexico or the United States — a proportion up by 12.5 percent from the current 62.5 percent restriction. The increase in domestic production is targeted at China, which produces many of the components that go into automobiles manufactured in North America. “It hurts China,” Hufbauer said.

Some observers argue that auto manufacturers might simply disregard the parameters for zero tariffs and decide instead to accept the World Trade Organization’s (WTO’s) 2.5 percent rate. But Hufbauer argues that a large move by the major auto manufacturers to shift to standard tariffs for parts would be met with hostility by the Trump administration, which could move unilaterally to ignore the 2.5 percent WTO commitment. That’s why Hufbauer says he doesn’t think big American auto manufacturers will shift to importing at the standard tariff rate, even with all the complexity and headaches of the new rules.

“[Trump] doesn’t care about the WTO,” Hufbauer said. “It would be a violation, but he would impose new tariffs and give them a national security label.”

In addition, US Trade Representative Robert Lighthizer may be preparing USMCA-implementing legislation that would slash a US statutory de minimis threshold under which low-value packages can be shipped across international borders tax-free and duty-free. Hufbauer notes that the United States could cut its de minimis threshold from US$800 to US$117 per package, which is what Mexico and Canada have as their cross-border tax-free cap. A lower threshold, which could also apply to imports from China, would hurt sales at companies like Amazon and eBay and raise prices for consumers.

“Lighthizer is threatening to lower the US de minimis if Canada and Mexico don’t come up,” he said. “You can be sure that the US will lower the threshold so [Trump] can make it more difficult to import low-value parcels from China. As well, Trump will raise postal rates on packages coming from China.”

For now, the Trump administration is pressing ahead with a USMCA signing ceremony scheduled for either November 29 or November 30. The signing is scheduled so that outgoing president Enrique Peña Nieto can approve the deal before Mexican President-elect Andres Manuel Lopez Obrador's new government takes over. Even though there was an agreement in principle, with detailed language, there is still a lot of unfinished business — and negotiations are continuing.

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.

About the Author

Ronald Orol is a senior editor at The Deal and writes about hedge funds and bank and securities regulation for The Street. He is the author of the book Extreme Value Hedging: How Activist Hedge Fund Managers Are Taking on the World, and holds a master's degree in business and economics journalism from Boston University.