Analysis by Canada West Foundation
With the fourth round of North American Free Trade Agreement (NAFTA) renegotiations underway, there is still understandable concern that U.S. President Donald Trump will make good on a threat he has made repeatedly since assuming the Oval Office: that the U.S. will terminate NAFTA.
With 76 per cent of Canadian goods exports (2016) and more than half our service exports (55 per cent in 2016) sent to the U.S., any disruption in our relationship with our largest trade partner would have serious consequences. While Trump’s bluster appears to be a negotiating ploy, it’s worth considering potential ramifications.
Scrapping NAFTA is not as easy as it sounds. Many scenarios could unfold. The four below cover the range of possible outcomes. The bottom line is that under any scenario, a Trump withdrawal from NAFTA is likely to turn into a legal and political mess.
Four scenarios for the U.S. terminating NAFTA
1) The President tries to end the deal but Congress doesn’t agree
NAFTA text is clear that any signatory may leave the pact after giving the other members six months notice of intent to withdraw from the agreement. But there are various opinions in the U.S. as to what would happen if a president unilaterally terminates a trade deal. The U.S. Congress passed legislation authorizing then-President Clinton to enter into NAFTA and integrate the measures into U.S. law. Congress also gave the president authority to withdraw from trade agreements – although it’s unclear that this is Constitutional. Under the U.S. Constitution’s commerce clause, Congress has the sole power to regulate foreign trade. If President Trump terminates NAFTA on his own, there would likely be a legal challenge that would quickly wind up in the Supreme Court. And many congressional Republicans, like Senate Leader Mitch McConnell, support NAFTA. Congress could also attempt to block funding for activities needed to carry out the withdrawal.
2) President and Congress agree to pull out of NAFTA, CUSFTA kicks in
If the president could get congressional approval to leave NAFTA, the deal’s predecessor, the Canada-U.S. Free Trade Agreement (CUSFTA), would kick into place. NAFTA essentially rolled over the tariff eliminations made in the CUSFTA with added provisions for trade with Mexico, so there would be little tariff-related change in the Canada-U.S. trade relationship under CUSFTA vs. NAFTA. In this scenario, NAFTA would continue to exist between Canada and Mexico.
3) The U.S. withdraws from both NAFTA and CUSFTA, WTO trade rules govern trade
If the U.S. withdrew from NAFTA, it probably wouldn’t want essentially the same measures to continue governing its trade with Canada, under the CUSFTA. (Although it might, since a lot of its NAFTA concerns, like job losses, are directed at Mexico.) If the U.S. also broke the CUSFTA, then Word Trade Organization (WTO) most favoured nation (MFN) tariff rules would govern Canada-U.S. trade. The U.S. MFN average tariff in 2016 was 3.5 per cent (some goods have a WTO MFN of zero percent). NAFTA would continue to exist between Canada and Mexico.
4) The U.S. withdraws from both NAFTA and CUSFTA, imposes tariffs higher than WTO levels
It is possible the U.S. would impose tariffs higher than the WTO most-favoured-nation levels if it withdrew from NAFTA/CUSFTA. While WTO member countries agreed to reduce tariffs through the Uruguay Round Agreements of the late 1980s/early 1990s, the tariff reductions are not legally binding.
Despite the Constitution’s commerce clause, other U.S. laws give the president authority to impose tariffs during national emergencies and times of war. President Trump has mused about imposing 35 per cent tariffs on imports from companies that move operations out of the U.S., placing a 20 per cent tariff on imports from Mexico to fund construction of a border wall, and proposed a 45 per cent tariff on imports from China. It is unlikely the U.S. would impose tariffs this high on Canada, but it is possible we could face something higher than the 3.5 per cent average WTO MFN, or the 4 per cent average tariffs in place before the CUSFTA was implemented. If the U.S. imposed higher than MFN tariffs, Canada (and Mexico) may decide to retaliate, causing tariff escalation. It is also possible a U.S. withdrawal from NAFTA/CUSFTA would be combined with trade action against other countries, which could have trickle-down impacts on Canadian supply chains.
While it seems both legally and logistically difficult for the U.S. to withdraw from NAFTA, nothing should be taken for granted. It is worth considering the impact on western Canada’s merchandise trade with the U.S. under the scenarios above.
What trade data tells us about how the West would fare
The western provinces have varying levels of reliance on trade with the U.S. In 2016, 86 per cent of Alberta’s total exports were sent to the U.S. About half of B.C. and Saskatchewan’s exports go to the U.S., 53 per cent and 48 per cent respectively last year. Manitoba shipped 67 per cent of total goods exports to the U.S. in 2016.
Softwood lumber is B.C.’s biggest export to the U.S., accounting for more than 20 per cent of the value of all U.S.-bound exports in 2016. Since softwood lumber is excluded from NAFTA, U.S. withdrawal would not directly impact U.S. tariffs on this commodity. However, the U.S. is pushing for the removal of NAFTA’s Chapter 19 dispute resolution mechanism in a renegotiated deal. If this occurs, it will have a major impact on the current (and any future) Canada-U.S. softwood lumber dispute. NAFTA Chapter 19 provides a process for any NAFTA member to appeal the imposition of countervailing or anti-dumping duties on a good implemented by another NAFTA partner. Canada has used a NAFTA panel multiple times since the 1990s to overturn U.S. imposition of duties on Canadian softwood lumber. Prime Minister Trudeau has indicated the removal of Chapter 19 from a renewed NAFTA would be a deal-breaker for Canada.
Natural gas is B.C.’s second largest export to the U.S., making up nearly 10 per cent of the province’s total exports to the U.S. last year. It faces no tariffs in NAFTA and the CUSFTA, or under WTO trade rules.
Four of B.C.’s top 10 exports to the U.S. would be subject to a tariff if NAFTA/CUSFTA were no longer in place. However, the tariffs are relatively low and would be unlikely to have a major impact on the trade of these commodities.