Skip to main content

The Globe and Mail

Tough trade: What Canada can learn from NAFTA’s flaws

THE NEW NAFTA

Tough trade: The lessons of NAFTA

The North American free-trade agreement was a deal Canada had to do to defend itself amid economic globalization. But more than two decades of trade have exposed many of the deal's flaws. From losing ground in the U.S. market to missing export opportunities, Canada's NAFTA experience will help shape the coming overhaul of the historic trade agreement.

A worker prepares coiled brake lines for shipping to Mexico at Caledon Tubing – a division of Martinrea International – in St. Marys, Ont.

On June 7 in Toronto, The Globe and Mail is holding a live panel discussion, Globe Talks: NAFTA in Play, on the future of trade with our biggest partner, featuring Globe journalists Barrie McKenna and Joanna Slater with experts Dan Ciuriak, Laura Dawson and Michael Kergin. For details and tickets, visit tgam.ca/NAFTA

For Canadians, NAFTA was all about the United States.

Canada entered into the North American free-trade agreement in 1994, not so much because exporters were clamouring to get into Mexico, but to protect its access to the huge market next door in the U.S. This country already had the big prize in hand – a free-trade deal with its largest trading partner. But Canadian officials worried Washington would do a deal with Mexico that would erode the benefits Canada already enjoyed, including the phase-out of most U.S. tariffs, and so the Three Amigos pact was born.

Story continues below advertisement

"NAFTA was a creature of its time, and it came out of different rationales for each of the three countries," says Eric Miller, a former top Canadian government official and now fellow at the Woodrow Wilson Center's Canada Institute in Washington.

While Canada wanted to protect the gains it had made in the Canada-U.S. free-trade agreement, the U.S. wanted to expand its trade horizons and create a counterweight to the European Union and Mexico wanted out of its cycle of poverty and economic crisis.

And it is from the perspective of the 49th parallel that Canadians still look at the North American trade landscape – especially now that U.S. President Donald Trump pushes to forge a deal more to his own liking, or even to walk away from NAFTA.

For the most part, Canada got what it wanted. The country's economy remains firmly tethered to the United States. The share of goods exports to the U.S. increased steadily, from roughly 70 per cent in 1988 to nearly 90 per cent in the early 2000s. More recently, Canada has diversified its trade a bit, but the U.S. is still the destination for roughly three-quarters of exports. Trade with the U.S. accounts for nearly 40 per of Canada's GDP.

NAFTA has been unequivocally good for this country – and, arguably, for all three partners. Since the deal came into force, the combined gross domestic product of the three countries has more than tripled. Canada's economy has grown by 70 per cent, exports to the U.S. and Mexico have more than doubled, and foreign investment in Canada has grown sixfold. Canadian companies have built vast supply chains, particularly in auto parts and aerospace, that stretch deep into Mexico, making companies more competitive and saving some from extinction.


But NAFTA is far from a perfect deal. Like the Trump administration, Canada also has its frustrations with aspects of the deal, including persistent U.S. denial of free trade in lumber and its losing record in investment disputes.

These problems have been exacerbated by wrenching changes in the global economy. Many of the initial benefits for Canada have either worn off or been impaired by outside forces, including greater U.S. border security and the emergence of new trade rivals. For example, China's entry into the World Trade Organization in 2001 has eaten away at Canada's export market share in the U.S.

Story continues below advertisement

"NAFTA is often blamed for what China wrought" on the U.S. economy, explains economist Daniel Schwanen of the C.D. Howe Institute. "We didn't take the U.S. by storm, but that's because someone else did."

Canada's exports to the U.S. have grown at the same pace as the U.S. economy since the original trade deal went into effect in 1988. But it's losing ground to others, including China, Mexico and some Eastern European countries. Canada's share of the U.S. market has shrunk from roughly 19 per cent in 1988 to 13 per cent last year. Mexico's piece of the U.S. market has more than doubled, to 13 per cent from 5 per cent, while China's market share has grown by nearly 1,000 per cent, to 21 per cent from less than 2 per cent.

That growth has seen China displace Canada as the top supplier of U.S. imports, knocking Canada into second place among U.S. trading partners. Canada remains the top purchaser of U.S. goods.


Over the past two decades, China has generated more than a third of the U.S. trade deficit. Canada and Mexico accounted for roughly 10 per cent combined, and most of that is due to Mexico.

NAFTA's promise was not all about market share and tariff elimination. Free-trade advocates in Canada sold the deal as a way to toughen up the business sector, promising it would expose industries to more competition, weed out weaker players and make the survivors stronger. And to some extent, that's what happened. Mr. Schwanen says Canada enjoyed a bounce in labour productivity in the initial post-NAFTA years, particularly in manufacturing and other older industries.

CN Rail is the classic example of a Canadian company that embraced NAFTA's potential, and thrived. Shortly after being privatized by the Canadian government in 1995, CN grappled with the problems of all for-profit companies: how to make a profit. At the same time, free trade was shifting the flow of its customers' goods from east-west to north-south. For a railway with a network that came to a halt in Chicago, that was a problem.

Story continues below advertisement

CN responded with the $2.4-billion (U.S.) purchase of Illinois Central Railroad, which travelled from Chicago to the Gulf of Mexico ports of Mobile, Ala., and New Orleans. The line roughly traced the Mississippi River along the backbone of the United States and touched the vast agricultural, consumer and industrial sections of the U.S. Midwest, a region with an economy three times the size of the Canadian economy.

"That was transformative for CN," said Patrick Leblond, a professor at University of Ottawa who has studied CN and its response to free trade. "That's what allowed it to become a North American railroad and really be able to service goods all the way from B.C. down to Louisiana, and even, with some connections, to Mexico."

CN later filled out its U.S. network with more deals, including the 2001 purchase of Wisconsin Central, and, in 2009, the Elgin, Joliet and Eastern Railway. The latter deal gave it a route around Chicago, North America's busiest – and most congested – rail hub, bolstering CN's status as a company with a superior railroad.

NAFTA and the 1988 Canada-U.S. free-trade agreement "gave us a strong impetus to achieve what we wanted to achieve," said Paul Tellier, CN's chief executive officer from 1992 to 2003. "When I look back, I'm very pleased we became exactly the kind of North American company that we wanted to be in terms of trade flows and in terms of shareholder base."

The wider U.S. network also meant CN no longer had to rely on U.S. carriers to get its customers' goods beyond Chicago. Today, a third of the company's $12-billion (Canadian) in annual revenue comes from north-south flows. Generally, natural resources such as lumber, paper and oil flow south while manufactured goods like automotive products and machinery move north. The company also ships fracking sand to natural gas drillers in B.C. and Alberta from a mine in Wisconsin, on the rail line it purchased in 2001. It's a trade that moves free of tariffs, and earns CN $300-million a year in sales.


But examples like CN are few and far between, particularly in new and emerging sectors of the economy. Canada has lagged the U.S. in fostering new technology-based industries that have emerged in the post-NAFTA years. And there is no evidence that the deal helped make Canadians more entrepreneurial, innovative or competitive over the long haul.

"We had this one-off improvement in the economy and productivity. But our economy didn't keep up with the U.S.," C.D. Howe's Mr. Schwanen suggested.

In the 1980s, much of the tension was about the U.S. coveting Canada's vast resources, most notably its energy. With the U.S. now much closer to energy self-sufficiency, thanks to the shale oil and gas boom, the dynamic has changed. Now it's Canada demanding guaranteed access for its energy exports.

Over the past decade, Canada has run a large and growing trade surplus in energy and resources with the U.S. Indeed, crude oil exports largely explain why Canada has consistently had a trade surplus in goods.

NAFTA also did not immunize Canada from periodic trade strife with the U.S. – particularly in areas that remain essentially outside the deal. In spite all the talk of economic integration and international supply chains, large swaths of Canada's economy remain essentially outside the NAFTA orbit. The most notable examples of un-free trade are lumber and agriculture.

"In many ways, the problems are in areas where either Canada or the United States wasn't prepared to go to full free trade," pointed out John Weekes, Canada's chief NAFTA negotiator and now an adviser at law firm Bennett Jones. "That's not a fault of the agreement, but a failure of the parties to create a framework to deal with those issues."

For example, the U.S. has never recognized Canada's right to freely ship softwood lumber into its market, alleging that the provinces unfairly subsidize producers. For most of the past three decades, Canada's lumber industry has faced steep U.S. duties or negotiated export controls, despite NAFTA arbitration panels repeatedly ruling in Canada's favour. Canada's biggest lumber producers, including Canfor, West Fraser and Interfor, have responded to on-again, off-again free trade in their industry by building parallel U.S. lumber operations. That's the reverse of NAFTA-style integration.

Canada's protected dairy, chicken and egg sectors are another NAFTA aberration. The agreement grandfathered Canada's massive tariff wall that protects producers from imports, which allows farmers to set artificially high prices in the domestic market. The World Trade Organization has ruled that Canada's manipulation of domestic prices constitute a subsidy. As a result, Canada is largely blocked from tapping into vast and growing export opportunities, particularly in China.

The U.S. isn't a saint when it comes to dairy, either. It subsidizes its farmers when milk prices are low. But these measures have not kept the U.S. from exporting, including to Canada. It has grown to become the third largest dairy exporter in the world, behind the EU and New Zealand. Since 2010 alone, its exports have doubled to roughly $1.4-billion (U.S.) a year.


Because of production issues and WTO rulings, the U.S. now exports large quantities of butter and milk ingredients to Canada, while virtually nothing flows the other way. The result is that Canada is a non-player in a growing global market for dairy products. And its own protectionist practices undermine its ability to object to U.S. dairy practices.

The absence of full free trade has cost Canada billions of dollars of revenues and thousands of jobs.

"What we've done is essentially take ourselves off the playing field," said Mr. Miller of the Woodrow Wilson Center's Canada Institute. "We've destroyed our ability to compete in fast-growing markets that want our butter and cheese and milk, and have handed it over to the U.S."

To some, it's a disappointment NAFTA never morphed into a European-style common market, with near seamless borders. Instead, the border has thickened, with new security measures and bureaucracy layered on after the 2001 terrorist attacks. This has slowed trade, added costs, and hindered Canada's ability to fully exploit the benefits of more open borders.

"Under the guise of security and anti-terrorism, the Americans have increased the friction at the border very significantly – much more north to south, than south to north," said Gordon Ritchie, a former Canadian trade negotiator and one of the architects of the Canada-U.S. free trade agreement.

Another area of controversy for Canada is dispute resolution. NAFTA introduced a new form of dispute resolution, allowing investors and companies to sue governments for compensation if they can prove they've been treated unfairly. The mechanism, contained in Chapter 11, was included in the deal at the insistence of U.S. negotiators, who didn't trust Mexican authorities to play fair with U.S. companies. They wanted an insurance policy in case Mexico arbitrarily nationalized key industries, as it had done in the oil business.

Few would have imagined what actually happened.

Canada has become the main target of Chapter 11 claims, which allow companies to seek compensation before quasi-judicial panels for investment losses caused by government actions deemed unjust. Ottawa has been sued 39 times since 1994 – more than either the United States or Mexico – resulting in damages of about $170-million, paid mainly to resource and chemical companies. The U.S. has never lost a case nor paid a dollar in compensation.

"It is a disaster, badly conceived and badly implemented," Mr. Ritchie says of Chapter 11.

Critics argue the clause has been abused by some companies and their lawyers, who have stretched the definition of expropriating an investment to include government policy decisions they didn't like.

The defeats in these investor lawsuits, have typically been caused by the actions of provincial governments. In 2010, Ottawa compensated forestry company AbitibiBowater $130-million for Newfoundland's expropriation of hydroelectric facilities and timber rights. And in 2015, the government paid more than $17-million to Exxon Mobil and Murphy Oil over a requirement they spend research money in Newfoundland and Labrador.

On the other hand, the ability of investors to sue the U.S. government could prove useful at time when the Trump administration is threatening "Buy American, Hire American" protectionism.

Economic integration cuts both ways for Canada. Extending North American supply chains into Mexico has helped keep industries, such as autos, competitive against rivals in Asia and Europe. Roughly three-quarters of the content of North American-built vehicles is from NAFTA countries. And parts cross NAFTA borders at least eight times before final assembly in Canada, the U.S. or Mexico.

"Without Mexico in NAFTA, Canada would become less globally competitive," according to a recent report by economists at the Bank of Nova Scotia.


Consider Canadian auto parts maker Martinrea International Inc., founded in the early 2000s and built to capitalize on NAFTA. The company has 44 plants, including 14 in the U.S., 12 in Ontario and 10 in Mexico. Martinrea, a so-called Tier 1 supplier to most of the major U.S. and foreign auto makers, goes where they go. It now produces significantly more outside Canada than at home after following the migration of new assembly plants to the Southern United States and Mexico. Forty per cent of its sales are in the U.S. and 20 per cent in Mexico.

"We make things together. It's a North American supply chain," Martinrea executive chairman Rob Wildeboer said in a 2016 interview. "Our strategy in terms of building our business has been to blanket North America with our facilities."

Martinrea components, such as chassis, frames and suspensions, will often cross the border several times before being installed on finished vehicles. Rear assemblies for the GM Equinox, built in Ingersoll, Ont., are produced from a combination of U.S. and Canadian parts, and installed on cars built in all three countries.

The downside of NAFTA integration has been the migration of auto assembly and parts production to the Southern U.S. and Mexico. Canadian vehicle production peaked in the late 1990s and has been on a slow decline ever since. On the other hand, Mexico's share of production is steadily growing. The country has attracted nine out of 11 new assembly plants announced in North America since 2011.

Now, as the three countries prepare to reopen NAFTA, much is at stake for Canada – most notably, the many ways that companies have structured their operations, supply chains and work forces to take advantage of North American opportunities.

The good news is that the Trump administration seems to have backed away from its overtly protectionist intentions in the looming talks. Earlier this month, U.S. Trade Representative Robert Lighthizer formally gave Congress 90 days' notice of the administration's intent to reopen NAFTA. In his letter to congressional leaders, he talks about a "modernized" NAFTA and improving U.S. trade and job opportunities. Mr. Lighthizer listed broad areas – including the digital economy, intellectual property protections, and labour and environmental standards – where he says NAFTA rules are outdated.

An earlier leaked draft of the letter was far more specific in spelling out U.S. demands, including scrapping the dispute-settlement system that Canada has successfully used to win past disputes over lumber and wheat. It also talked of targeting Canada's merchandise trade surplus with the U.S.

It's not clear if the new gentler tone reflects a downgrading of U.S. demands, perhaps in response to feedback from Congress, or a tactical decision by the Trump administration to not lay out its negotiating objectives.

Some sectors are clearly in Mr. Trump's crosshairs, including Canada's highly protected dairy industry, and softwood lumber. Canada's dairy farmers will face pressure to give up a greater share of their market, perhaps for cheese and other milk products. Canada's auto, steel and aluminum sectors are also vulnerable, given Mr. Trump's focus on repatriating manufacturing jobs. And the U.S. has signalled that it will go after state-owned enterprises such as Export Development Canada, which finances sales of Bombardier commercial aircraft. Boeing and Bombardier are already embroiled in a dispute over allegations that the Canadian-made C-Series jets are benefiting from illegal subsidies.

Canada's posture will be primarily defensive. After all, it's the U.S. pushing for renegotiation. But there are also things Canada will want, including putting stricter limits on Chapter 11 investor disputes, less border red tape and mobility of workers.

The challenge is that what Canada wants isn't what the U.S. wants.

Canadians are long over the bitter debates about the merits of continental free trade. "The controversial issue was the [Canada-U.S.] free-trade agreement," says Mr. Ritchie, the former trade negotiator. "NAFTA was a pimple. It was not a controversial issue in this country."

For most Canadians, NAFTA was a case of been-there, done-that. They put the emotional lead-up to the 1988 Canada-U.S free trade agreement behind them and embraced the notion that Canada's economy depends on opening its borders to the world. Not so in the U.S., where NAFTA has become a symbol of manufacturing job losses – despite the fact the main culprits are technology and automation, not trade.

Not surprisingly, 74 per cent of Canadians now say NAFTA has been good for the country, according to a recent Pew Research Center survey. That compares with just 51 per cent of Americans who believe the deal has been good for the U.S.

"NAFTA really got Canada thinking as a global player," says Mr. Miller of the Canada Institute. "It changed Canadian attitudes. It wasn't just about Canada and the United States any more."

With files from reporter Eric Atkins

On June 7 in Toronto, The Globe and Mail is holding a live panel discussion, Globe Talks: NAFTA in Play, on the future of trade with our biggest partner, featuring Globe journalists Barrie McKenna and Joanna Slater with experts Dan Ciuriak, Laura Dawson and Michael Kergin. For details and tickets, visit tgam.ca/NAFTA

Follow The Globe's ongoing coverage of trade issues and track of the renegotiation of the North American free-trade agreement. tgam.ca/trade

Report an error Licensing Options
Comments

The Globe invites you to share your views. Please stay on topic and be respectful to everyone. For more information on our commenting policies and how our community-based moderation works, please read our Community Guidelines and our Terms and Conditions.

We’ve made some technical updates to our commenting software. If you are experiencing any issues posting comments, simply log out and log back in.

Discussion loading… ✨

Combined Shape Created with Sketch.

Combined Shape Created with Sketch.

Thank you!

You are now subscribed to the newsletter at

You can unsubscribe from this newsletter or Globe promotions at any time by clicking the link at the bottom of the newsletter, or by emailing us at privacy@globeandmail.com.