Will Environmental Issues Shape Future Canada-U.S. Relations?

Canadians are divided on the approach that their Government should adopt during the expected talks with the U.S. on “tweaking” the North American Free Trade Agreement (NAFTA), per a new poll conducted by Angus Reid Institute. Fearing possible harm to the historical relationship with their southern neighbor, some Canadians are willing to make concessions to avoid such outcome, while others think that Canada should not agree to adjustments that are not in its best interest. More importantly however, is that a great majority believes that Canada should maintain its present course and existing strategies in international relations, irrespective of positions or actions of the U.S. Administration. Such divide, as expected, also characterizes the informed opinions of experts and observers who addressed issues that may be the subject of the anticipated talks.

Among those who assume that the U.S. has an upper hand in the negotiations normally point to factors that define its leverage, most common of which: The fact that the U.S. is the largest market for Canadian exports with a share of three quarters of total exports, the trade surplus that Canada has with the U.S., the low valuation of the Canadian dollar, along with other grievances related to several technical barriers to trade raised in the 2016 Annual Report of the U.S. Trade Representative.

The perception of stronger U.S. negotiating position does not hold under objective scrutiny, since the dependence is mutual and equally vital to both countries. This equivalence of interdependence is primarily shaped by geography and high level of complementarity between two free markets, for which there are no feasible substitutes. Unlike trade in services, geographical proximity is the most important factor shaping trade in goods and basic commodities. This has contributed over the years to a buildup of cross-border regional/provincial inter-dependencies, equally if not more significant than those on the national levels. Thus, countering Canada’s heavy dependence on the U.S. markets is an equally heavy dependence of about 35 States on the Canadian market.

Neither can Canada be apologetic about its trade surplus with the U.S. for several good reasons. Firstly, it is relatively negligible. This surplus was 11.9 billion US dollars, or only 1.8 percent of the total trade volume of 662.7 billion dollars in 2015. Secondly, The U.S. enjoys a trade surplus in services of 27.1 billion dollars or 31 percent of the 87.5 billion dollars’ total trade in services. Services have usually higher value added and generate more job opportunities for the economy than energy products and other basic resources that ranks first among Canada’s exports to the U.S. In other words, U.S. exports to Canada generate more employment opportunities than Canadian exports to the U.S. generate jobs for Canadians. Thirdly, and of relevance to the debate about the benefits of NAFTA, the U.S. trade deficit with Canada have been consistently shrinking over the past decade. Fourthly, the energy exports, which constitute the largest category of Canada’s exports to the U.S., are the least cost and most reliable source of energy to the U.S. A point duly emphasized by Prime Minister Justin Trudeau at the CERAWeek Conference organized by IHS Markit in Houston.

The concern about the exchange rate featuring in any future talks on trade between Canada and the U.S. is not justified considering Canada’s monetary policy which insures a flexible (floating) exchange rate. The main objective of this policy is to meet “the inflation-control target, which is two per cent, the midpoint of a 1 to 3 per cent target range. First introduced in 1991, the target is set jointly by the Bank of Canada and the federal government and reviewed every five years”. As a floating currency, the Canadian dollar’s exchange rate is strongly influenced by Canada’s terms of trade with the rest of the world. However, the terms of trade are unduly influenced by the significant contribution of energy exports to total Canadian exports, which in turn exerts upward pressures on the relative valuation of the Canadian dollar. The appreciation of the CAD reduces the competitiveness of Canada’s non-energy and services exports, and results in consequential advantage to exporters to the Canadian markets, especially the U.S. This has been the case for more than a decade before the oil price correction in 2014. The decline in the value of the Canadian dollar observed over the past two years has much to do with the retreat in oil prices over the period. Many would argue that the present exchange rate is more conducive to the much-needed growth in the non-oil economy in general, and particularly in the high technology sectors.

There are several other trade issues that the new American Administration is likely to be more insistent about discussing. These are identified in the 2016 Annual Report by the U.S. Trade Representative of 2016 prepared under the Obama Administration and referenced in the 2017 Trade Policy Agenda issued in March 2017. These issues are presented under the general title “Technical Barriers to Trade”, whose resolution, some observers believe, would also benefit Canadian consumers while strengthening NAFTA. Such outcome will be more certain if the process of “tweaking” NAFTA is not approached as a "zero-sum game" as urged by Canada’s Prime Minister at the CERAWeek Conference.

The above trade issues notwithstanding, more consequential challenges to the bilateral relation seem to be rising somewhere else. The campaign era threat by now president Donald Trump of “deconstructing the administrative state” have started to materialize in the President’s Budget Proposal. Specifically, the proposed downsizing of the Environmental Protection Agency (EPA) and the planned roll back of environmental regulations will, if came to pass, will likely destroy the alignment between the environmental policies of Canada and the U.S. Since 2004, The Canadian On-Road Vehicle and Engine Emission Regulations aligned the emission standards with the U.S. federal standards. These standards “apply to light-duty vehicles (e.g., passenger cars), light-duty trucks (e.g., vans, pickup trucks, sport utility vehicles), heavy-duty vehicles (e.g., trucks and buses), heavy-duty engines and motorcycles”. Regulations for off-road vehicles and engines, which cover among others: power lawn engines, garden equipment, engines for agricultural, construction and forestry equipment , followed in 2005 , 2006 and 2011, were also aligned with U.S. regulations. In addition, car efficiency standards, known as CAFE (Corporate Average Fuel Efficiency) are also aligned including future targets, as can be observed in the figure below from the International Council on Clean Transportation (ICCT).

The alignment in regulations has been instrumental in enhancing the trade in transport vehicles, equipment, and other final and intermediate products serving the on-road and off-road vehicles and engines sectors. It has contributed to the deep integration and the high level of complementarity between the industrial sectors of the two countries. Moreover, it facilitated and streamlined the exceptional volumes of flows across the borders. Quoting a recent report by the Canada Global Affairs Institute (CGAI), “400,000 people cross Canada-U.S. border daily” and “18,500 trucks cross Windsor-Detroit border each day”, among other indicators that underscore the strong interdependence of the two economies, and hints at the potential harm, hurried and insufficiently studied policies may cause.

The roll back of emissions and fuel efficiency standards are bound to be extremely unpopular in many States such as California, who have led the fight for clean environment and succeeded in promulgating emission standards that exceeded the federal levels. Moreover, this rollback will be costly to the U.S. economy according to the American Council for an Energy-Efficient Economy (ACEEE), who stated that “backtracking on vehicle standards puts at risk tens of billions of dollars of fuel savings for consumers and big reductions in tailpipe emissions”, and will cost the US auto industry its competitiveness in the global market.

So many in Canada and around the world would hope that domestic opposition in the U.S. will prevail in preventing a retreat in the environment and climate agenda. Otherwise Canada’s policy makers will be faced with difficult strategic choices and challenges.

K.Z.

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