Recommendation #5—Modernize NAFTA to
Today’s Business Realities and Standards
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Key areas that need to be modernized in NAFTA 2.0 include the
agreement’s rules of origins, the proportionality clause attached to
the energy sector, investor-state dispute settlement mechanisms, and
labour and environmental standards.
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The NAFTA rules of origin should be reviewed to make it as easy as
possible for small and medium-sized businesses to comply with them and
to take into account today’s global supply chains.
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To restore the public’s trust in investor-state dispute settlement
mechanisms, the composition of NAFTA’s investment tribunals should be
reviewed to ensure decisions are consistent and predictable and to
prevent unreasonable claims by foreign investors.
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The labour and environmental side agreements should be incorporated
into the main agreement and updated based on recent trade deals.
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In the energy sector, the proportionality clause currently found in
NAFTA, which requires Canada to maintain a consistent ratio of export
to supply for energy commodities and related products, should be
removed. There is little evidence of its use and impact on North
American energy trade and investments to date.
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.