ADM 3318: International Business

Essay Assignment: Trade

October 10th, 2018

 Revision on the North American Free Trade Agreement (NAFTA)

1.1 Introduction

The revision of the North American Free Trade Agreement (NAFTA) has been one of the most
talked about trade topic of 2018. For the past two years, citizens of the United States, Mexico
and Canada have been asking themselves the same question: What will happen to the economy
in case NAFTA falls off?

The North American Free Trade Agreement (NAFTA) holds much importance to all three
countries. NAFTA generated economic growth and increased the standard of living for the
people of all three nations. In 2017, the total trilateral trade surpassed the mark of $1 trillion.
("Foreign Affairs Trade," 2018) In case of a non-agreement, the economies of all three countries
will be negatively impacted; many industries will be affected, businesses will go bankrupt, the
unemployment rate will increase, and foreign investors will resist from investing in the three
countries.

This paper will examine the main trade issues holding up the negotiations on the revision of the
North American Free Trade Agreement. Firstly, we assess the reason behind the review to the
NAFTA. Following that, we will analyze in detail one of the most critical issues holding up the
negotiations: the Canadian Dairy Supply Management System and its impact on the steel and
aluminum industry. Ultimately, we will evaluate the new trade agreement, USMCTA.

1.2. Revision of the NAFTA

Revision on the NAFTA was first brought up during the 2016 U.S. Presidential campaign. Donald
Trump, a presidential candidate at the time, stated that renegotiations on the term of NAFTA
would start immediately if he is elected president. During his electoral campaign, he said: "I'm
going to tell our NAFTA partners that I intend to immediately renegotiate the terms of that
agreement to get a better deal for our workers. Moreover, I don't mean just a little bit better, I
mean a lot better. If they do not agree to a renegotiation, then I will submit a notice under
Article 2205 of the NAFTA agreement that America intends to withdraw from the deal."

After many months of negotiations, the United States and Mexico announced on August 27th,
2018, that they reached a bilateral agreement called the "United States-Mexico Trade
Agreement." Following the new bilateral trade agreement, Donald Trump stated, "I think it is
one of the largest trade deals ever made – maybe the largest trade deal ever made."

The USMTA main aim was to rebalance the automotive trade between the two countries and to
incorporate digital trade into a possible new NAFTA deal. Other important issues such as
Implementation of stronger labour and environment standards, trade dispute settlement, the
exception of "Global Standards" tariffs imposed by the US to Mexico and so on were also
examined in the new deal.
The USMTA meant that Canada would be in an awkward position to restart negotiations in a
new possible trilateral trade agreement. Even before USMTA, both the US and Mexico stated
that the old NAFTA deal was terrible. In February 2017, well before the USMTA, Mexico's
Minister of Economy Ildefonso Guajardo told financial times that "I hope the world understands
that what happens... [with the North American Free Trade Agreement] is going to be very
telling for the rest of the world... From public statements, the US is not very pleased with
multilateralism,"

Issues Holding UP the NAFTA Negotiations

2.1. General Issues in the NAFTA Negotiations

Following pressure by the Canadian public, Canada rejoined the trade talks and began working
on a trilateral trade agreement on August 27th, 2018.

The NAFTA agreement being called "a catastrophe" and "the worst deal ever" by U.S. President
Donald Trump in 2017, suggested that many trade policies had to be revised for a new possible
agreement to be reached. One of the main discussion topic during the NAFTA meetings was
Canada's Dairy Supply Management System, a system that was set in place in the 1960s to
control our local farmers by setting controls on dairy imports. Not only did this issue hold up
the negotiations process, but it also pushed the U.S. to retaliate by imposing a tariff on
Canadian exports of steel and aluminum, which is also an issue in the trade discussion.

2.2. Canada's Dairy Supply Management System

Put in place in the 1960s to regulate the dairy industry, Canada's Dairy Supply Management is
under heavy criticism as many believe that it is over regulated, thus, affecting international
trade. The U.S. was entirely against this system, President Trump stated on June 9, 2018: "It's
very unfair to our farmers. It's going to stop, or we'll stop trading." (Paneta, 2018)

Supply Management System is a system designed to match supply and demand. This system is
based on three principles: the use of administered prices, quotas, and import controls. (Grant,
2014) The Canadian Dairy Supply Management System uses quotas to match the Canadian
production of dairy with Canadian demand. This system prevents a possible over or under-
production of dairy, thus, avoiding saturation in the market.
Removing the traditional market forces gives the Government the power to decide how much
farmers are paid for their production. It is a way stabilizing Canadian farmers income.
(Reynolds, 2018)

The U.S. was undeniably against this system because the current policy set in place has a 241%
tariff on imports of dairy above the fixed import quota, a tariff that is only set off after the
quota is exceeded. The question that many Canadians are asking is why Canadian negotiators
are willing to risk a trilateral trade agreement over a sector that constitutes to less than 1% of
Canada's GDP. (Morgan, 2018)
One of the reasons why Canadian negotiators are working to keep the Canadian Dairy Supply
Management System is in place is because it provides stability to Canadian farmers who do not
have the same economy of scale of the U.S. Producers. Ending the dairy supply management
will remove all the tariffs, turning Canada's dairy market into a free market. Many economists
will argue that a free market for dairy is not necessarily a disadvantage to Canadian consumers,
but this view will be discussed later on in the paper.

The U.S. dairy industry is about five times bigger than Canada's dairy industry. Canada has
approximately 12,000 dairy farms with a net receipt of $6 billion in 2015 while the U.S. has over
49,000 dairy farms with a net receipt of $34.6 billion in 2016. ("Dairy industries in Canada,"
2017) A free market will allow American producer to export as much dairy products as they
want to Canada. The U.S. dairy exports to Canada already amounts to $471 Million which three
times more than our dairy exports to the U.S., but that number will considerably rise in case of
an end to our Dairy Supply Management System. Since the dairy farms in the U.S. are much
more prominent in farm size and number of animals, they can maximize their economies of
scale; thus, producing more milk at a lower price than Canadian dairy farmers. Without the
tariffs and quotas, a vast of the majority of their production will then be exported to Canada.
Even with, the cost of shipping the dairy products to Canada, the U.S. producers can sell the
dairy products at a lower price than Canadian producers. Canadian consumers will then buy
U.S. produced milk due to the simple fact that it is cheaper than milk produced.

Ending the supply management will impact many Canadian farmers. Quebec dairy farmer Peter
Strebel told the Financial Post magazine that the end of the dairy supply management would be
damaging, "There would be lots of bankruptcies … It would be devastating. We'll probably have
to cut back on investment, maybe lay off a couple of workers. I don't know how it would be
done." Another reason worth fighting to keep the dairy supply management system is because
of a pricing agreement that struck in 2016. This agreement called the "Class 7 Pricing
Agreement" has effectively blocked U.S. exports of milk ingredients such as milk powder that
used to make dairy products. (Reynolds, 2018) Ending the supply management system will
terminate the Class 7 Pricing Agreement, and according to the head of the Dairy Farmers of
Ontario, it would be detrimental to Canadian farmers.

"Either we'd try to get less capital cost per unit of milk shipped and try and live that way, or go
broke — or just try to ride it out for a few more years and then quit," said Ralph Dietrich,
chairman of an advocacy group and co-owner of a dairy farm in Ontario. This system is set up in
a way where new Canadian farmers have to buy the rights to produce a certain amount of the
products. The rights provide a quota which is the rights to sell a set amount of milk. The buy-in
ranges from $20,000 to $43,000. (Reynolds, 2018) In the case of an end to the Dairy Supply
Management System, these costly quotas will be worthless; thus, affecting any new farmers
with recent capital investments and bigger debt. "There are some farmers that have reinvested
in facilities and expanded in more efficient facilities, but are relatively new and financially
leveraged who could have a great deal of difficulty in that environment because they've lost
some of their ability to generate revenue," said Al Mussell, research lead for Agri-Food
Economic Systems in Guelph, Ont. To offset for the concession of milk, the Canadian
Government will have to compensate all the farmers affected, and that will cost millions of
dollars. (Reynolds, 2018)

As mentioned above the U.S. is against Canada's Dairy Supply Management System. Two
members of the Congress of United States, Lloyd Smucker and Ron Kind, even wrote a letter to
Robert Lighthizer, a U.S. Trade Representative outlining the different areas affected by the
system set in place by Canada. The letter states that the new Class 7 program could impact
40,000 farmers and 3 million workers. (Smucker & Kind, 2018)

Alternatively, the Canadian negotiators believe that the U.S. is pushing to end the dairy supply
management in Canada is because there is an excess supply of dairy in the U.S. The state of
Wisconsin alone produces as much milk as the entire dairy industry of Canada. This excess
supply in the U.S. is hurting not only on the country's dairy industry but also the agricultural
sector. In 2017, as dairy exports to Canada fell, there was a massive surge in dairy products. The
prices of milk plummeted, and about 100 million gallons of excess supply milk was thrown
away. The loss in income of the U.S. farmers will have to be compensated by the U.S.
Government. According to the Wall Street Journal, the Trump administration promised to pay
$4.7 billion to farmers to compensate for the losses from trade dispute. (Newman & Haddon,
2018)

If Canada decides to end its dairy supply management system, it will have a slight negative
impact for local farmers and Canadian negotiators should not be willing to risk a trilateral trade
agreement over a sector that constitutes to less than 1% of Canada's GDP. (Morgan, 2018)
Many economists believe that the supply management system is an outdated method of
government intervention in the free market.

Michael Grant, Director of Research at the Conference Board of Canada, believes that the dairy
system in Canada is "inequitable and "inefficient." His research shows that the system "favours
dairy producers over other commodity producers and does not encourage the best producers
to expand." His main argument was "If we get dairy assets in the hands of the best producers
and open markets they will grow. Efficiency and growth generate more resources to fund
equitable reform. We can move Canada to a more equitable and efficient dairy sector while
increasing output and jobs. Producers and consumers will be better off than before reform."
(Grant, 2014) This system only protects 6% of Canadian farmers and hurting the agricultural
industry. Producers of beef, pork, grain, oilseed, and pulse will benefit far more from global
trade. (Findlay, 2017)

Let's take a look at New Zealand since they abandoned their dairy supply management; their
dairy industry grew massively. Their dairy sector has become the country's top export earner. In
2017, their overseas shipment equalled NZ $11.9 billion. After the deregulation, they went
through a 6-year transition period where the farmers received some support, and only 1% of
the farmers left the industry. (Reid, 2018) That proves that if Canada reregulates its system and
provide the right support, Canadian farmers will not be affected. They will have the opportunity
to grow their farms and expand globally. According to the U.S. Dairy Export Council, global
demand for milk is expected to rise at a rate of 3.7% until 2020, and if the dairy supply system
stays, Canada cannot take advantage of this opportunity.
Canada's dairy supply management system is causing Canada more harm than good. It
provoked the U.S. to impose a tariff on steel and aluminum, and now, there is a threat that the
U.S. impose a tariff on Canada's auto exports. (Connolly, 2018) These tariffs will be explained in
greater detail in the section before.

2.4 Tariff on Steel and Aluminum

To retaliate against Canada's Dairy Supply Management System, the United States announced
on May 31, 2018, that they would impose tariffs of 25% on imports of Canadian Steel and 10%
on imports of Canadian aluminum taking effect on June 1, 2018. The steel and aluminum
industries are far more significant than the dairy industry, and the tariffs will cause a substantial
impact on the economy.

The steel and aluminum industry is a key driver of the Canadian economy as it provides many
jobs as well as critical feedbacks for other major sectors, including energy, advanced
manufacturing, construction, and auto-making. In 2017, over 23,000 people were employed in
the Canadian steel industry, contributing $4.2 billion to Canada's GDP. Similarly, the aluminum
industry is as big the steel industry contributing $4.7 billion to Canada's GDP and employing
over 10,500 individuals. ("Steel and Aluminum," 2018) The Canadian and the U.S. aluminum
and steel industries are also greatly integrated, and it helps both countries in global
competitiveness. In 2015, the two countries traded over $14 billion worth of steel, and they had
a combined trade of over $11.4 billion on aluminum. ("Steel and Aluminum," 2018)

According to the 2018 Canadian Steel Export Report, over 80% of Canadian steel is exported to
the U.S. The graph below displays the top 5 export markets of Canadian steel.

https://www.trade.gov/steel/countries/pdfs/exports-Canada.pdf
The tariffs imposed by the U.S. will impact not only Canada but also the U.S. The tariffs will
cause Canadian steel and aluminum producers to increase the price of these products to keep
the same financial stability and income as before. The effect of the increase in price will cause
American purchasers of steel and aluminum to look for other options. As described by Peter
Warrian, a steel expert at the University of Toronto, "What happens in the short term is
American prices rise, and Canadian production falls." (Evans, 2018)

Before the tariffs, exports of both steel and aluminum were rising significantly. However, in
June 2018, there was a massive drop in exports of both metals. From May 2018 to June 2018,
the value of steel shipment dropped to $536.8 million, a 36.8% decline from the previous
months. Aluminum exports, subject to a 10% tariff also fell by 7%, and the trade value was
$851.2 million. These unexpected tariffs are relatively new, and the consequences cannot be
determined yet. However, many economists are predicting that the impact will be massive, and
many companies will lay off workers to keep the same financial stability. (Ljunggren, 2018)

Knowing that many companies in the steel and aluminum industry will be affected by those
tariffs, the Export Development Canada (EDC) is taking measures to assist these companies. The
EDC made over $900 million in commercial financing and insurance available, and it could be
used to:
 "Providing for additional liquidity based on existing commitments by your commercial
lender
 Partnering with banks to guarantee the issuance of eligible letters of credit, freeing up
working capital
 Providing insurance to ensure payment by a foreign buyer
 Providing access to working capital to fulfill an international contract."
https://edc.trade/steel-and-aluminum/

To combat the U.S. tariffs, the Government of Canada announced on June 29, 2018, that
reciprocal taxes on $16.6 billion of imports of steel, aluminum, and other consumer product
from the U.S. Government of Canada is also making $2 billion available to protect the Canadian
workers and businesses in the steel and aluminum industry. The Canadian Government will also
invest of $50 million over five years. That will help Canadian companies in diversifying their
exports to take advantage of new trade agreement such as the CETA. (Global Affairs Canada,
2018)

"Canada has always been a safe, secure and reliable source of steel and aluminum for the U.S.
market. The tariffs introduced by the United States on Canadian steel and aluminum are
protectionist and illegal under WTO and NAFTA rules – the very rules that the United States
helped to write. It is with regret that we take these countermeasures, but the U.S. tariffs leave
Canada no choice but to defend our industries, our workers and our communities, and we will
remain firm in doing so. The real solution to this unfortunate and unprecedented dispute is for
the United States to rescind its tariffs on our steel and aluminum." - Hon. Chrystia Freeland,
P.C., M.P., Minister of Foreign Affairs (Global Affairs Canada, 2018)
 The new deal:
United States-Mexico-Canada Agreement (USMCA)

The U.S and Canada reached a last-minute trade agreement on September 30, 2018. The
tentative deal which comes after one year of negotiations brought a few revisions to the
NAFTA. However, the USMCA is not the most desirable deal for the Canadian negotiators. Even
though they were able to keep the Chapter 19 Trade dispute resolution, the application of
antidumping and countervailing duties was held; Canada had to concede and give the U.S more
access to the dairy industry. The tariffs on aluminum and steel imposed by the U.S is also still in
place.

Canada wanted free trade for most industries, and the dairy industry was not one of the
industries they wanted free trade. As mentioned above, the outdated system prevents global
growth and gives Canadian consumers less option in dairy. In the new agreement, Canada
agreed to give the U.S. roughly 3.9% of the market and also agreed to end the class 7 pricing,
which lower prices on some Canadian-produced dairy ingredient such as skim milk, powdered
milk and so on. (“Dairy concessions in new”, 2018)

The tariffs on steel and aluminum imposed by the U.S. is still in place. This issue is being dealt
with separately from the trade agreement. “We also recognize that moving forward on
eliminating the tariffs on steel and aluminum remains a priority for us, for Mexico, and is
something the Americans have indicated they’re more than willing to work on,” Trudeau said in
a news conference in Ottawa. These tariffs should have been the main priority of the
negotiators, but they chose to focus on the dairy supply management system that does more
harm than good. As stated by Prime Minister Trudeau, the U.S. are willing to work on
eliminating these tariffs. Many economists believe that these tariffs will only be removed if
Canada ends its Dairy Supply Management System and give American dairy producers access to
free trade. (Powell, 2018)

If that is the case, the Canadian negotiators to take the offer. These tariffs were imposed as a
form of retaliation because of the dairy system in place in Canada. With the right support given
to the Canadian farmers, there is a high possibility that the U.S eliminate these tariffs if Canada
ends its supply system. The tariffs on aluminum and steel will not only impact the metal
industry but other industries such as the auto industry and manufacturing industry. (Powell,
2018)
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