Recommendation #5—Modernize NAFTA to Today’s Business Realities and Standards

Despite being in effect for less than a quarter-century, NAFTA is a mature trade agreement. Moreover, NAFTA itself has completely transformed trade patterns across North America, powering the close integration of North American supply chains. Canada has an interest in the modernization of key aspects of NAFTA for two reasons. First, to support trade, investment, and economic growth across the region. And second, to ensure NAFTA’s rules and regulations are fair to both firms and the public. Key areas that need to be modernized include NAFTA’s rules of origins, investor-state dispute settlement mechanisms, labour and environmental standards, and the proportionality clause currently attached to the energy sector.

Rules of Origin: Reducing the Burden on SMEs [L2]

Among the key requirements firms need to comply with to get preferential treatment under NAFTA are the rules of origin (ROO). These rules are incorporated into trade agreements to ensure that only the goods originating from participating countries are subject to preferential treatment.11Brenton, ”Preferential Rules of Origin.” However, as they currently stand, these rules disproportionately disadvantage SMEs in all three NAFTA countries. Canada should work closely with the U.S. and Mexico to streamline the NAFTA rules of origin to make it easier for SMEs to comply with them and to take into account in today’s global supply chains.
Rules of origin can take various forms, with the most common ones being changes of tariff classification and value added requirements. To prove that their products meet the NAFTA rules of origin, exporting firms need to produce a certificate of origin for their goods.22Office of the United States Trade Representative, Fact Sheet: NAFTA Certificate of Origin ., 33Brenton, ”Preferential Rules of Origin,” 308. Under existing rules, it can be particularly cumbersome for SMEs to qualify for the preferential treatment under NAFTA. As such, for small shipments, SMEs may find it makes more financial sense to pay the “most favoured nation” duties rather than have to pay the additional costs required to comply with the NAFTA requirements.44Kunimoto and Sawchuk, ”NAFTA Rules of Origin.” In contrast with larger firms, SMEs are less likely to have the available financial resources needed to afford the necessary legal and accounting advice on how to comply with these requirements.
Based on a measure of rules of origins’ overall restrictiveness level, the NAFTA rules of origin are among the world’s most restrictive.\cite{Brenton_2011} \cite{Estevadeordal_2009} Estevadeordal and Suominen, Bridging Regional Trade Agreements in the Americas , 32; and Kunimoto and Sawchuk, ”NAFTA Rules of Origin,” 283. One of the key reasons for this is that the NAFTA rules of origin are detailed at a product-by-product level, spanning over 450 pages. The product-by-product approach is considered as more restrictive than necessary and can result in “an overly complex system \cite{Brenton_2011} for businesses to comply with and for governments to administer. In line with this assessment, a 2006 report on the state of NAFTA after 10 years found that:
NAFTA rules of origin are restrictive, create policy-induced inefficiencies in sourcing and production, impose compliance costs on firms engaged in intra-NAFTA trade, and inhibit NAFTA trade. The elimination or reduction of these costs associated with the NAFTA rules of origin would provide positive economic benefits to Canada by lowering costs to producers and prices to consumers, by increasing intra-NAFTA trade, and by reducing NAFTA ROO-induced inefficiencies.\cite{sawchuk}
Luckily, over the past 15 years, rules of origin have been the subject of ongoing revisions to adapt them to changing trade and production patterns. Between 2005 and 2009, three sets of changes to NAFTA rules of origin were fully implemented. The fourth package of amendments is currently at the preliminary implementation stage, and preliminary work on a fifth package is under way.88 Audet, e-mail communication with Global Affairs Canada in March 2017; Global Affairs Canada, 2012 NAFTA Commission Meeting, 2009 NAFTA Commission Meeting, and 2007 NAFTA Commission Meeting .
The rules of origin applying to crude oil exports are a good example of rules of origin that could be updated under this fifth package or within NAFTA 2.0. (See “Crude Oil Exports: Adopting the TPP’s Revised Rule of Origin for Diluent.”) NAFTA 2.0 would also be a good opportunity to seek further and more extensive reforms to the rules of origin, particularly with the goal of reducing the compliance burden put on SMEs across North America.
In a report by the Toronto-based C.D. Howe Institute, author Dan Ciuriak proposed a practical reform to the administration of rules of origin that could meet this goal.99More details on this reform can be found in Ciuriak, Making Free Trade Deals Work for Small Business ;also Ciuriak and Bienen, Overcoming Low Preference Utilization in Preferential Trade Agreements . The proposal calls for modifying the threshold above which businesses need a certificate of origin to comply with the NAFTA rules of origin and obtain preferential treatment.
Under existing rules, this threshold stands at US$1,000 worth of shipments.1010Global Affairs Canada, North American Free Trade Agreement—Customs Procedures . Under the proposed reform, the $1,000 threshold would be a cut-off point for the corresponding payable duties under standard most favoured nations (MFN) tariffs. The hypothetical $1,000 of payable duties would be used to determine the threshold above which a shipment must comply with the rules of origin to get NAFTA treatment. The lower the MFN tariff, the higher would be the shipment threshold under which no certificate of origin is required. In turn, this would make it easier for firms with small shipments crossing the borders to qualify for NAFTA preferential treatment. To illustrate this concept, let’s look at the following examples.1111Ciuriak, Making Free Trade Deals Work for Small Business, 8.
For an MFN tariff of 20 per cent, the threshold above which a certificate of origin would be required would be $5,000 (the shipment value corresponding to payable duties of $1,000). Similarly, for goods with an MFN duty rate of 5 per cent, only shipments above $20,000 would need a certificate of origin to get NAFTA treatment. And for MFN tariffs of 1 per cent, the shipment threshold would be $100,000.
Such a change in the exemption thresholds would be highly beneficial for many SMEs, since the value of their shipments is more likely to be small compared with those of larger firms. Also, it would allow them to benefit from preferential treatment without having to bear the costs of producing a certificate of origin. This could be a way for many SMEs to test the market for their products, before having to dedicate significant resources to comply with NAFTA requirements.