Renegotiating Nafta

Feature | 21 September 2017
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With the renegotiation of Nafta underway, Dentons provide a summary of what the US has set out to achieve and where the potential stumbling blocks lie

On July 17, 2017, the Office of the United States Trade Representative (USTR) issued a Summary of Objectives for the Nafta renegotiation. The summary, required to be published under US law before formally commencing the renegotiation, identifies the objectives of the Trump administration regarding the North American Free Trade Agreement (Nafta), and provides an insight into the issues that will be on the table in upcoming negotiations.

One of the fundamental objectives of the administration in the negotiations is the reduction of the US trade deficits with its Nafta partners. In the administration's view, there is a causal connection between Nafta and trade deficits, which the administration views as inherently negative. The summary also signals the administration's belief that trade agreements have the ability to resolve trade imbalances. While these propositions are controversial among economists and trade specialists, they provide an insight into how the administration will measure success and how it will seek to advance its negotiating priorities.

Overall, the summary did not cause excessive alarm in Canada and Mexico. Many of the elements restate the fundamental purposes of Nafta, and nothing suggests a rejection of free trade per se. For example, the summary reaffirms the maintaining of duty-free access and promotes regional integration. Many of the items proposed for renegotiation offer an opportunity for the parties to improve trade across the continent, and to modernise Nafta to reflect current economic and trade priorities.

Trade in goods

Fundamentally, the administration has affirmed its desire to maintain existing reciprocal duty-free market access for industrial goods and to strengthen disciplines on non-tariff barriers. Even in the historically sensitive area of textiles and apparel, the objective is to maintain existing duty-free access "while taking into account US import sensitivities".

On agricultural goods, the US wants to maintain current duty-free access but will seek an elimination of non-tariff barriers for American agricultural exports, including tariff rate quotas. The summary thus squarely takes aim at Canada's supply management system for dairy, eggs and poultry. Making any concessions on supply management will be very challenging for the Government of Canada. Canada was able to make some concessions acceptable to its trading partners in the recently concluded Canada Europe Comprehensive Economic and Trade Agreement (CETA) and in the Trans-Pacific Partnership Agreement (TPP). These concessions involved primarily the increase in duty-free quota available for exporters in the signatory states.

In Mexico, the objective to "improve the US trade balance and reduce trade deficit with Nafta countries" has raised concerns and created uncertainty. While the USTR clearly states its intention to maintain duty-free access for industrial and agricultural goods, if addressing trade deficits is the measure of success, the US may seek to impose trade barriers or tariffs, particularly in the manufacturing sector, in order to 'correct' such deficits. This would be completely unacceptable for Mexico.

A large part of Mexico-US trade is in manufacturing inputs that are part of established North American supply chains. In fact, across all three countries, it is not uncommon for intermediate inputs to cross the border several times before being incorporated into finished goods. These supply chains could be disrupted by either tariff or nontariff barriers. There are no modern precedents for trade agreement negotiations to directly address trade deficits. On the contrary, the economic forces of comparative advantage underpinning free trade agreements may well produce trade deficits. In any case, Mexico has made it clear that new tariffs are not acceptable.

Mexico's Secretary of Economy has clearly stated that the country is willing to review the trade deficit with the US, but as a side issue to the Nafta renegotiation. This position is coherent with the current text of Nafta, which does not deal with trade deficit reduction.

Also of concern to Mexico, on agricultural goods, the summary includes the elimination of cross subsidisation, price discrimination and price undercutting as an important goal. This is significant, for example, in the context of Mexican sugar exports to the US.

Customs and trade facilitation

The summary aims to facilitate transparency for importers and exporters by requiring member states to make laws and regulations easily accessible, and to increase standards for the implementation of World Trade Organization (WTO) agreements, that deal with facilitation and customs valuation. Canada's regulatory framework is already highly transparent - this position will, therefore, not likely be a topic of significant debate.

That said, the US is likely to push Canada to raise its 'low value' threshold for duty-free shipments. Currently, Canada's duty-free, low value shipment threshold is CAD20, while the US level is US$800. The US position on this will be highly contentious for Canadian bricks and mortar retailers. A major concession on this front by Canada would also be complicated by the Canadian Goods and Services Tax, which applies to all merchandise sales, whether domestic or import. Allowing a CAD800 tax and duty-free threshold would tilt the playing field in favour of imports over locally-sourced goods. Of course, the US position could be that the current divergence in threshold levels favours Canadian exporters to the US. This issue may likely receive significant attention because the administration has consistently expressed concerns about lack of "reciprocity" in many US free trade agreements (FTAs). Reducing the value threshold would also facilitate e-commerce.

Mexico is in a similar situation to Canada, since Mexico's low-value shipment threshold is US$50; although, to date, the focus has been primarily on the Canadian thresholds. Trade facilitation is an essential area for Mexico, which has made significant progress in reforming its domestic legislation to reduce burdens associated with the clearance of goods, customs procedures and border requirements. However, more progress remains to be made. For Mexico, the most important objective on customs and trade facilitation is the implementation of the WTO Trade Facilitation Agreement (TFA) (which the three countries have accepted).

Financial services

The summary calls for increased market access for US financial services suppliers, but remains unclear which specific sector will be targeted. In Canada, foreign institutions already have significant access to the main financial services markets but there are limits on foreign ownership of our large banks.

One item that is likely to be highly controversial in Canada and Mexico is the objective to limit measures that restrict cross-border data flows in the financial services sector. Any limit on the ability of Canadian or Mexican regulators to control cross-border flow of private customer data will likely meet with very stiff opposition in both countries.

Besides the issues of the liberalisation of cross-border data for financial services, Mexico will be open to establish high standards in this chapter, mainly because US and Canada financial institutions operate in Mexico without major restrictions. However, the improvement of the transparency and predictability of its regulatory procedures may remain problematic for Mexico.

Digital trade in goods and services, and cross-border data flows

The US will seek to constrain the ability of the Nafta countries to limit cross-border data flows, or to require the use or installation of local computing facilities. Although Canada has few statutes that require data to retain in Canada, these few statutes combined with governmental policies (such as the Canadian government's 2016 cloud computing strategy) create significant barriers to cross-border data flows. For example, the Income Tax Act requires companies to maintain records relating to business records to be retained in Canada. The Canada Revenue Agency has long considered records kept on servers hosted in the US not to be kept in Canada for the purposes of satisfying these provisions, even if the records can be retrieved from within Canada at any time. In addition, British Columbia and Nova Scotia prohibit public bodies (including municipalities, universities, schools and hospitals) from storing personal information outside of Canada. New Brunswick has a more limited version of this prohibition for health information.

The US is also seeking commitments not to impose customs duties on digital products (such as software, music, video and e-books). The US appears to be concerned that Canada may attempt to use these measures to advance its cultural policies, such as through a Netflix tariff to fund Canadian cultural content. Canadian consumers may cheer for the US on this point, but the Canadian cultural industries will not. Finally, the US is seeking to establish rules restricting the right of governments to require disclosure of computer source code. Privacy and security advocates argue that this could limit the government's ability to protect itself from vulnerabilities or spyware by making such code available to security researchers or auditors. Requirements for source code disclosure are often included in Government of Canada software development contracts.

With respect to e-commerce and data flows, Mexico and Canada are likely to be willing to make the same commitments as those included in the TPP, while the US is seeking stronger commitments. If the parties do agree on digital trade beyond the scope of existing TPP provisions, Mexico and Canada may need to amend their legal frameworks.

Intellectual property

The summary calls for increased protection of intellectual property rights under Nafta. The objectives in relation to patents and trademarks are worded broadly and, in large measure, are similar to the IP objectives negotiated as part of the TPP. Though the summary does not suggest a significant deviation from current intellectual property law in Canada, it does hint at some changes that will be sought in relation to trademarks in Canada.

With respect to patents, the summary does not appear to deviate significantly from the provisions of Annex C of the Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement, as they currently exist, but we note that the US has long complained that Canada has been slow to fully implement its commitments under that agreement.

With regards to the protection of new and emerging technologies, this aspect of the summary is somewhat confusing, as doing so requires those technologies to be first patented. Much of these technologies are computer-based and, as such, face additional hurdles to patentability as a result of jurisprudence arising from both within and outside of the US. The test for patentability is, generally, the same worldwide, including Canada and the US. Accordingly, we would not expect any significant impact in this regard for Canada unless the US amended its patent legislation or adopted new legislation regarding the patentability and protection of such technologies, and then pressed Canada and Mexico to adopt similar legislation.

In relation to Mexico, the summary's key points are: first, improving IP enforcement through the full implementation of the TRIPS Agreement (a long-standing complaint against Mexico), including the Declaration of the Doha Round; second, including measures that protect generic terms and prevent the reduction of market access to US products through the protection of geographical indications. The second point is closely related to the geographical indications system that the EU seeks to include in its free trade agreements with other nations, which has caused the loss of market access to some US products (mainly cheese and wine products). In this regard, Mexico will be required to protect European geographical indications without reducing market access to US products (such as brie). Canada's recent experience on this issue with CETA could help the parties find common ground.

Since the USTR proposes to liberalise cross-border data for several areas, Mexico will be required to greatly improve the enforcement of IP rights, not only related to counterfeiting and piracy, but also in relation to cyber theft. In this sense, Mexico will feel significant pressure to more meaningfully commit to the rule of law on IP rights.

Trade remedies and Chapter 19 dispute settlement mechanism

Perhaps most difficult for Canada, the summary calls for the outright elimination of the Chapter 19 dispute settlement mechanism for countervailing and antidumping decisions made by regulatory authorities in the Nafta countries. This mechanism provides an alternative to contesting the decisions before the local courts. Chapter 19 dispute settlement is considered a very hard-fought negotiating victory for Canada. In fact, Canada pulled out of the initial Canada-US free trade negotiations in 1987 over the Chapter and it is widely considered one of the fundamental quid pro quo concessions Canada made to secure the Canada-US FTA, and then Nafta. Abandoning this prize will not be easy, and Canada would likely demand significant concessions to eliminate this alternative dispute settlement process.

This objective also came as a surprise to Mexico, since the US has resorted to the dispute settlement mechanism on a greater number of occasions than Mexico. Mexican officials have expressed their intention to insist on maintaining the dispute settlement mechanism. Interestingly, some Mexican congressmen have already exhorted the Mexican Ministry of Economy to reject the US proposal.

The US also wishes to eliminate the Nafta global safeguard exclusion. This means that the Nafta countries would no longer be excluded from global safeguards measures imposed by other Nafta countries.

It is not clear whether Chapter 19 is a deal-breaker for Mexico. Notably, Mexico has made significant progress recently in implementing specialised trade courts as part of the reform of the Federal Tribunal of Administrative Justice. That said, Chapter 19 will likely be an area where both Mexico and Canada present a consistent position, if for no other reason than this is one of the top priorities for USTR, and they may be able to obtain significant concessions in other topics if they agree to eliminate Chapter 19.

Final thoughts

The summary raises several issues that will be very challenging to negotiate, notably on the Chapter 19 panels. Both Mexico and Canada have signalled that they consider Chapter 19 to be a crucial element of Nafta. Overall, however, the summary provides reason for optimism that the Nafta parties will be able to renegotiate the Nafta to modernise the agreement. In many respects, the summary reaffirms basic principles of Nafta and raises issues that have been successfully addressed in other trade agreements (like the TPP and CETA). To the extent the summary takes aim at specific existing controversial measures, the negotiating goals are largely set out in sufficiently general language that the negotiators will have some flexibility and the parties should be able to arrive at an acceptable compromise.

The summary is ambitious and sets out numerous complex negotiation priorities for the US. This suggests that the negotiations will not be completed quickly. Some of the issues that have already been worked through in other negotiations, like the TPP, or the Mexican and Canadian agreements with the EU, could be resolved swiftly, but others deal with sensitive national interests that will be difficult to resolve. In all three countries, Nafta has a complex political dynamic. Elections and other domestic political forces will play a significant role in the negotiations. It will not be easy to truly modernise Nafta and arrive at a workable compromise for all three parties. The process may take longer than most observers currently anticipate.

This is a condensed extract of Dentons' report on the USTR's Summary of Objectives. The complete report can be found here: http://bit.ly/2wmVv8x

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