Canada: Canadian Free Trade Framework Mitigates A NAFTA Demise

Last Updated: December 12 2017
Article by John M. Weekes

The NAFTA is a very valuable agreement, but it would not be the end of the world if it disappeared.

That is a bold statement, to be sure, and "end of the world" sets a high bar. But many believe that if NAFTA somehow disappeared it would spell disaster. This view is far too pessimistic. Frankly, NAFTA was long overdue for an update, which is part of the reason we find ourselves in the current renegotiation scenario.

But there are several moving parts in play that should help mitigate the uncertainty hampering the investment climate in Canada, even now as the United States contemplates withdrawing from NAFTA.

First, there is some question as to what role the U.S. Congress would play and what treatment Congress would accord to both Canada and Mexico in the absence of NAFTA. It is important to note that in the United States, the free trade treatment accorded to Canada and Mexico is made effective through American legislation—not by the provisions of NAFTA. Clearly Congress would need to be involved.

Second, in the case of Canada, the country had a bilateral free trade agreement with the United States that was put into suspension when NAFTA came into effect. The intent of the suspension was that if the NAFTA for some reason disappeared, then the Canada-U.S. Free Trade Agreement (CUSFTA) would come back into being. CUSFTA is not as good an agreement as the NAFTA—it does not have the same clarity and it is not nearly as developed in the areas of services and investment and intellectual property—but it did provide for the elimination of all duties. For CUSFTA to come back into force would require goodwill between the two countries. Where it could get complicated is if people started thinking about “improving it” at the same time.

But even then there would still be uncertainty. CUSFTA contains a six-month withdrawal clause. So any action on NAFTA by the United States might also include notice that it was pulling out of the previous bilateral agreement within six months.

Third, under the terms of the World Trade Organization, NAFTA is a free trade agreement. Countries are only allowed to accord each other tariff preferences in the context of an FTA. So if NAFTA were no longer in place, Canada and the United States, and Mexico and the United States, would be required by the WTO to go back and apply WTO tariffs to each other. The level of tariffs in the WTO is actually lower, by about a third on average, than it would have been at the time of the NAFTA negotiations, so a lot of trade could still take place under WTO tariffs. It should be noted that if the United States withdrew from NAFTA, the agreement would remain in force between Canada and Mexico. So trade between Canada and Mexico would remain duty free.

Fourth, although no other country is going to replace the importance of the U.S. market, Canada has been negotiating free trade agreements with other countries. Canada has completed and provisionally implemented an FTA with the European Union. It has a free trade agreement with Korea, with the European Free Trade Association and with several countries in Latin America, including Colombia and Chile. In addition, Canada has engaged with 10 other partners in the former Trans-Pacific Partnership in an effort to bring that agreement into force in the coming year. Canada is also negotiating with India and is looking at the prospects of engaging in free trade negotiations with China.

Course of Action for Business

The biggest thing business should be doing now is analyzing what the actual effects of different scenarios would be and advising their governments and their legislators on how to defend their interests.

The Canadian government is suggesting businesses should be thinking about how to adjust to life without NAFTA. This does not mean the government considers American withdrawal the most likely scenario, but that there is a strong possibility that it could happen. If the United States withdraws, nothing happens overnight. NAFTA Article 2205 allows a party to withdraw from the agreement six months after it provides written notice. A lot can happen in six months regarding elections, court challenges, and evolving perceptions about the importance of NAFTA to the United States.

But businesses cannot sit back and wait for such eventualities. Risk mitigation planning should be taking place now, with businesses looking at supply chains and sourcing arrangements as well as sales and markets and making assessments on how a U.S. withdrawal would affect all of those elements. Such planning would have to extend to personnel, too. The temporary entry provisions in NAFTA, which allow Canadians and Mexicans to work in the United States in specific agreed situations, could be affected as well.

Originally published in BRINK. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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