Some Context for Canadians Who Love or Hate the New Nafta

(Bloomberg Opinion) -- Americans are not the only ones still unpacking the new USMCA trade deal that is due to replace Nafta. Two issues have received a great deal of attention in Canada — one which is misunderstood as a great concession by Canada and the other wrongly celebrated as an unequivocal victory. Both deserve a deeper look.

Just recently, Canada’s prime minister and foreign affairs minister, Justin Trudeau and Chrystia Freeland, struggled to explain the significance of a provision that many Canadians have interpreted as a gross infringement of their trade sovereignty. This provision, Section 32, is one outcome of the trade talks that is not what it seems.

This is the section that appears to restrict the ability of parties to USMCA, aka the U.S.-Mexico-Canada Agreement, to negotiate free trade agreements with a “non-market economy” — presumably China. It has Canadians in a tizzy and led the Chinese Embassy in Canada to issue a statement against the “dishonest behavior” indicative of “hegemonic actions” that interfere with other nations’ sovereignty. U.S. Secretary of Commerce Wilbur Ross called it “a poison pill” that the U.S. may replicate in other trade deals to isolate China. Reuters stoked the hype in its reporting by claiming that Section 32 “effectively gives the United States a veto over Canada and Mexico’s other trade partners to ensure they are governed by market principles.”

Some observers of USMCA see Section 32 as a major concession made by Canadian negotiators who found it more important to finalize a quick deal with Canada’s largest trading partner than to preserve flexibility in relations with China, particularly given that trade talks with the Chinese had faltered independently. But the reality is more generous. Although handing a useful symbolic win to the Trump administration, Section 32 changes few realities from the times of Nafta. The new element contained in Section 32 is the ability of a party to USMCA to review another party’s potential trade deal with a non-market economy 30 days in advance of its signing. Although this may be a bad idea, it would be extreme to characterize it as a violation of one’s sovereignty. For one thing, at 30 days out, many trade deals are already in the public domain.

The alleged “veto” component of Section 32 is nothing new. It stipulates that if any of the countries in USMCA enter into a free trade deal with a “non-market economy,” the others can notify that party and leave USMCA six months from that time. Article 2205 of NAFTA also stated clearly that any party to the agreement could withdraw from it with a notice of six months. NAFTA does not delineate the reasons for which a party can withdraw, but presumably they include — but are not limited to — concerns that subsequent trade developments would provide backdoor access to the American market in a way that is detrimental to U.S. interests.

In fact, it was the very threat by the Trump administration that it would submit a withdrawal notification under Nafta’s Article 2205 that prompted the USMCA negotiations. That there is an entirely separate withdrawal clause in USMCA reveals to the close reader that Section 32 is mostly redundant, and included to allow the Trump administration to intensify its pressure on China.

A second outcome of the USMCA that is not widely understood is the dropping of what is known as “the proportionality clause.” This provision in Nafta had rankled Canadians since the deal went into effect in 1994. It stipulated that the Canadian government could not enact restrictive policies that would change the proportion of exports to energy production observed over the previous three years. In other words, the free market would decide what proportion of Canadian production would go to exports and what proportion would go to domestic consumption; the government could not have a target or cap. American negotiators sought this provision to guard against any repeat of Canada’s decision during the 1970s energy crises to redirect domestic production to Canadian markets.

Both Trudeau and Freeland highlighted the removal of this clause as a big win for Canada when they first announced USMCA. Canadian analysts and news outlets also have celebrated the disappearance of this clause in the USMCA, claiming a restoration of Canadian sovereignty.

This proportionality clause did impinge on Canada’s ability to adopt policies — regarding climate change or other purposes — that explicitly aimed to alter export levels relative to domestic consumption. As a result, it is understandable that Canadians welcome its fade to obsolescence. But this triumph is less unequivocal and certainly less meaningful than what has been portrayed.

The two graphs below demonstrate why. They reveal the dramatically changed energy relationship between Canada and the U.S. since Nafta was signed. In the early 1990s, the volume of energy trade was significant. Today, the trade in crude oil and petroleum products is still robust, but the export of Canadian gas to the U.S. has diminished by more than 40 percent from its peak on account of the shale boom in the U.S.

More interestingly, the energy trade of 24 years ago was all going in one direction — from Canada to the U.S. As can be seen from the graphs above, this is no longer the case. Today, the U.S. exports both natural gas and oil and oil products to Canada — a trade that was virtually nonexistent when Nafta was signed. Canada still produces more energy than it consumes, but the vastness of the country and the dearth of east-to-west infrastructure means it is more convenient, economical and safe to just import gas from across the border.

The new realities mean that the much-loathed proportionality clause, while still restricting Canada, also protected it. Although always discussed as a provision ensuring that Canadian energy would continue to flow to the U.S., Nafta only stipulated that “a Party” may not adopt or maintain a restriction on exports relative to production. In circumstances that the original negotiators of Nafta could have never foreseen, America’s new capacity to produce energy now meant that the proportionality clause would have also forbidden U.S. policy changes to curb American energy exports to Canada.

Given how many eastern Canadian states are supplied with American natural gas, a U.S. policy decision that restricted the export of natural gas north, while unlikely except under extreme circumstances, could be costly and disruptive to Canada. One could even imagine parts of Canada temporarily without gas, given that Canada does not have facilities to import sufficient amounts of natural gas from other countries to make up for a shortfall from the U.S.

The hype surrounding both of these provisions has been overblown. On the whole, understanding them better adds weight to those arguing that the transition from Nafta to USMCA is less consequential than it seems.

To contact the editor responsible for this story: Philip Gray at philipgray@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Meghan L. O’Sullivan is a Bloomberg Opinion columnist. She is a professor of international affairs at Harvard’s Kennedy School, and a senior fellow at the Council on Foreign Relations. She served on the National Security Council from 2004 to 2007.

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