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The U.S.-Canada free trade agreement: what it is and its implications for Montana.

The U.S.-Canada Free Trade Agreement

What it is and its implications for Montana

Many trade experts expect trade between the United States and Canada to expand considerably in coming years as a result of the Free Trade Agreement. Some believe this increased trade could particularly benefit U.S. border states and cities. This article briefly discusses major provisions of the Agreement and generally assesses what it may mean for Montana.

Last year, the largest multinational "free trade" region in the world (as measured geographically) was created when the Free Trade Agreement between the United States and Canada went into effect. The Agreement builds upon the most extensive trade relationship between two nations in the world. Two-way goods and services trade between the United States and Canada was valued at about $190 billion in 1988. During 1989, in the trade agreement's first year, trade between the two countries grew to over $205 billion and is expected to grow again this year.[*]

The Agreement (or FTA) was "fathered" by Canadian Prime Minister Mulroney and President Reagan through several years of formal and informal negotiations before being ratified by the Canadian Parliament and U.S. Congress in 1988. In proposing it to Congress, President Reagan hailed the Agreement as the sort of "market-opening steps the entire world should be pursuing."[1] Most industry and consumer groups favored it. However, the proposal was given mixed reviews by representatives of some U.S. industries, who saw little to be gained by freer access to a relatively small Canadian market and much to be lost by giving competing Canadian firms freer access to a much larger U.S. market.

In Congress, representatives of several western states were particularly reluctant to endorse the Agreement. One of Montana's representatives described it as an "economic suicide pact" for states and regions of the United States heavily dependent upon resource industries such as agriculture, energy, and forest products.[2]

Despite having the potential to either enhance or devastate a region's economy, depending upon one's perspective, surveys indicate a remarkable lack of knowledge of the Agreement by American business people, particularly those with small businesses. In part this may reflect the complexity of the Agreement, probably the most comprehensive trade pact ever entered into by two nations.

Elimination of Tariffs

Perhaps the most publicized and generally understood element of the Free Trade Agreement is its provisions for the eventual elimination of tariffs affecting U.S. and Canadian trade. These tariffs, or import duties and charges as they are sometimes called, are being removed in three phases. Tariffs on product categories where both nations were anxious to expand trade, and few conflicts were anticipated by doing so, were eliminated immediately last year. These include products such as computers and telephones, vending machines, furs and fur garments, rawhides and leather, unprocessed fish, and whiskey and rum.

Tariffs are being removed over a five-year period for another set of products including certain auto parts, chemicals, explosives, furniture, most machines, paper, petroleum, precious jewelry, printed materials, and certain types of meat. Tariffs on some products, where adjustments to a freer trade environment may be difficult for affected U.S. and Canadian industries, businesses, and workers, are being phased out more slowly. These include beef and most farm and fish products, most wood products, consumer appliances, plastics, precision instruments, base metal products, tires, textiles and apparel, watches, and other distilled spirits.

The Agreement also permits U.S. and Canadian trade representatives to accelerate these schedules for tariff removal. Under this provision, tariff are now being removed for goods including pharmaceuticals, telecommunication equipment, and scientific instruments.[*]

FTA tariff relief is explicitly limited to goods largely manufactured in the United States and Canada. According to the Agreement's "Rules of Origin," goods wholly produced in either country explicitly qualify for FTA coverage. Goods partly manufactured with third-country components must be significantly transformed by U.S. or Canadian manufacturers in order to qualify. Goods also must be shipped directly from the United States to Canada (and vice versa) in order to qualify for FTA tariff treatment.

Prior to the Agreement, about 70 to 80 percent of U.S.-Canada goods trade was already tariff-free. However, trade has been significantly impacted for product categories where tariffs did exist and Canadian tariff rates were roughly twice as high as U.S. rates. Canada has been steadily reducing tariff rates on most imports for years. Canadian tariff collections on U.S. imports amounted to about 4.5 percent of the value of these imports in 1987, compared with about 14 percent in 1960. In contrast, U.S. tariffs on Canadian goods in 1987 were 2.8 percent of their total value.[3] By 1998, these tariff charges on trade between the two nations will be almost completely removed. The United States also is cutting its custom user fee rate on goods brought into the United States from Canada, and these will be totally eliminated by January 1, 1994.

The Canadian government continues to impose its Manufacturers' Sales Tax. A value tax of 13.5 percent is assessed on domestic goods at the manufacturing stage of production and on imported goods by Canadian customs based upon the value of imported goods plus their assessed tariff. However, the Canadian government has plans to replace this tax with a much broader tax on both goods and services in the coming year. With the broader base, it expects to be able to meet revenue needs at a tax rate of 7 percent.[*]

Reduction of "Non-tariff Barriers"

Critics of free trade, at least as this term is used to mean the absence of tariffs, have often contended that removing tariffs may offer the illusion of "free" trade, but not necessarily the reality of "fair" trade. This stems from the potential presence of many institutional measures other than tariffs that alter the competitive standing of producers in different countries, thereby distorting comparative advantages in trade. These are commonly referred to as "non-tariff barriers" and include quantity restrictions such as product embargoes and quotas, trade-restricting product standards, restrictive customs procedures, discriminatory government regulations, direct and indirect government subsidies that distort true production costs from one country to the next, and a variety of other measures.

The Free Trade Agreement attempts to address these types of non-tariff trade barriers in a number of ways. First, just as remaining tariffs are being eventually eliminated, so too are most quantitative restrictions affecting U.S.-Canada trade (including Canadian embargoes on imports of used aircraft and older, used automobiles). The two countries even exempted each other from their meat import quota systems, which both regularly use to limit meat imports.

Second, steps are being taken to harmonize the myriad of technical standards on products and materials imposed by government agencies and certification bodies in both countries to reduce their effect on the flow of trade. Testing facilities and certification bodies in both countries that set and enforce these types of technical standards also are to be treated in a nondiscriminatory manner. This task is formidable. In the United States alone, 54 different federal agencies and all of the states are empowered to set product standards and there are about 270 private standard-setting organizations assisting in this.[*]

Third, a number of binational panels composed of experts from both countries have been created and charged with examining government subsidies received by various industries in both countries. Under the Agreement, both governments are committed to reducing such subsidies where they are found to be particularly uneven and capable of causing large distortions. At the same time, Canada and the United States have retained authority to apply "antidumping" and "countervailing" duty measures to offset subsidy differences until they are otherwise resolved.

The Agreement also creates the Canada-U.S. Trade Commission composed of cabinet-level representatives of both governments. The Commission is empowered to resolve most future trade disputes between the two nations.

Provisions for Services Trade

While addressing these types of non-tariff trade barriers in innovative ways, FTA provisions for freer trade extend beyond the more traditional products and commodities trade into services trade. The services sector accounts for about half of U.S. gross national product and is one of the fastest growing sectors in both the U.S. and Canadian economies. Total U.S.-Canada services trade valued about $37 billion in 1989.[*]

While both nations maintained relatively open markets for services trade in the past, the Agreement assures that these markets remain open. Future laws and regulations enacted by national governments in both countries must now treat U.S. and Canadian service providers the same (referred to as "national treatment"). Service providers from both nations also are assured the right to sell across borders and, when a greater presence is preferred in one or the other country, the right of local establishment in that country.

Over 150 individual service categories are covered by these FTA provisions, including wholesale and retail services, building and construction contractors, and a broad array of business and professional services. Various committees are now working to develop mutually-acceptable and uniform certification and licensing standards for many types of professionals that will permit them to practice on both sides of the border.

Special, streamlined border-crossing measures for Canadian and U.S. business persons also were instituted under the Agreement. These are meant to facilitate temporary entry into a country without undue delays that impair the conduct of trade. This ability to more freely service clients or customers across borders will also assist U.S. and Canadian retailers in after-sale product servicing. In the past, U.S. retailers of large appliances and equipment haven't been able to freely send service personnel across the border when repairs are needed by Canadian customers.

Investment Provisions

Many of the same opportunities for freer trade provided to service providers also are extended to U.S. and Canadian investors. More than 30 percent of U.S. foreign direct investment is invested in Canada, totaling about $61 billion. Also, Canadian subsidiaries of U.S.-based multi-national corporations account for over 40 percent of Canada's total manufacturing sector, dominating Canadian auto, oil and gas, and mining industries. Canadian investors are the third largest source of direct foreign investment in the United States, with investments totaling $27 billion. Canadian-based multinationals also are increasing their presence in the U.S. economy.[*]

In negotiating the Agreement, both countries agreed to provide each other's investors equal treatment with respect to the acquisition or establishment of new businesses in either country and in the operation of those businesses after their establishment. While the United States has always been relatively open to foreign investment, Canada has shown some resistance to it. The Canadian Parliament enacted legislation in 1974 to more closely monitor, review and potentially limit foreign investment activity (the Foreign Act). However, Review Act). However, this act was repealed in 1985 and replaced with legislation much more open to foreign investment (the Investment Canada Act).

The Free Trade Agreement freezes in place this more liberalized foreign investment climate in Canada and bars most new measures that could adversely affect U.S. investments in Canada. Each country is prohibited from adopting policies requiring minimum levels of equity holdings by their nationals in firms controlled by investors from the other country. Furthermore, neither nation can prohibit the other country's investors from transferring profits or other investment earnings out of the country.

Investing in and operating financial institutions such as banks, trust and loan companies, and savings and loan institutions also is significantly liberalized under the Agreement. Canadian subsidiaries of U.S. banks are now exempt from current restrictions on market share, asset growth, and capital expansion in Canada, just as are U.S. subsidiaries of Canadian banks.

Government Procurements

A common practice by both the U.S. and Canadian governments in the past was the use of "Buy American" and "Buy Canadian" preferences in federal government procurements. These measures favored domestic firms over foreign firms in supplying goods procured from private vendors. This preferential treatment is being eliminated on individual procurements of $171,000 and more under other trade measures. FTA provisions lower this threshold level even further and require open competition between Canadian and U.S. suppliers on federal procurement orders valued as low as $25,000.

These provisions for freer and fairer competition between U.S. and Canadian firms in each nation's procurements apply only to goods, not services, and cover only procurements by national governments, not those by provincial, state, and local governments. An estimated $500 million in Canadian procurements and $3 billion in U.S. procurements are affected.[*]

Special Provisions for Energy and Agriculture

The United States is the largest user of energy in the world. Although a major energy producer itself, the United States imports considerable energy in various forms from around the world. In fact, last year the United States imported 46 percent of the oil it consumed, slightly less than the record of 48 percent in 1977. Canada is by far the United States' largest energy supplier. It supplies more crude oil and petroleum products to the U.S. than any other country, including Saudi Arabia, and supplies the United States with virtually all its natural gas and electricity imports. Canada is also the largest export market for American coal. Two-way energy trade between the United States and Canada is valued at over $10 billion annually.

The Free Trade Agreement encourages the freest possible energy trade between the United States and Canada and prohibits most restrictions on energy imports and exports between the two nations. This provides U.S. energy users more secure access to the vast energy resources of Canada, and Canadian energy producers more secure access to U.S. energy markets. Canadian hydro-electric utilities in western Canada are interested in providing more electricity to growing markets in California. The Agreement eliminates any discriminatory treatment for these Canadian utilities in gaining access to the Bonneville Power Administration's intertie with the California electricity market.

The United States is the top exporter of agricultural products in the world, with over $40 billion in agricultural exports in 1988. About 10 percent of these exports go to Canada. At the same time, Canadian agricultural exports total about $9 billion, with about one-third of these going to U.S. markets.[4] The United States and Canada are major competitors in supplying other foreign markets around the world, particularly world grain markets.

Historically, controversial issues in agricultural trade have posed major stumbling blocks in government efforts to liberalize trade. Many of these issues were sidestepped or postponed by Canadian and U.S. trade representatives in negotiating the Free Trade Agreement. However, the Agreement has several provisions specifically directed at agriculture. First, just as in other areas of trade, the Agreement eliminates all tariffs on agricultural products, but ordinarily does so according to ten-year schedules allowing adjustments by agricultural producers. Second, the countries agreed to not use government-financed export subsidies for agricultural goods shipped directly or indirectly to either country. Canada also agreed to exclude agricultural goods, destined for U.S. markets and shipped via West Coast ports, from receiving special, reduced transport rates under its Western Grain Transportation Act.

Third, Canada agreed to eliminate its import licenses for U.S. wheat, barley, oats and related products as soon as various government subsidy support levels in the United States and Canada are equivalent. Canada's licensing requirement for oats and oat products from the United States has been removed. Special studies of the broad range of Canadian and U.S. subsidies for agricultural producers are now underway to determine the relative levels of support each nation provides. The two nations have pledged to eliminate all subsidies shown to distort trade.

Finally, as mentioned previously, the two nations have exempted each other from their meat import quota systems and are attempting to harmonize technical standards and regulations on food quality and safety to facilitate the sale of agricultural products across borders.

Overall Assessment

In many respects, the Free Trade Agreement is of far greater importance to Canada than it is to the United States. With a population of only about 26 million people, Canada is the only major industrialized nation in the world without a domestic market of at least 100 million people. The free trade region created under the Free Trade Agreement provides Canadian producers with a consumer market of over 265 million people, 90 percent of whom are U.S. citizens.

The United States has the world's largest economy and is the largest importing nation in the world. The potential advantages to a foreign nation in having relatively free access to this market are immense. The Canadian government estimates that increased trade with the United States resulting from FTA provisions will add 120,000 new jobs to the Canadian economy and increase the nation's real income 2 to 3 percent on a permanent basis. This is equivalent to $450 in additional income for each Canadian each year.[5]

While the United States is the world's largest trader as measured by its two-way trade with other nations, Canada is actually more trade-dependent. About 25 percent of Canada's gross national product is exported and over 70 percent of these exports go to U.S. markets. Only 5 to 7 percent of U.S. gross national product is exported, with 20 percent of this going to Canadian markets.[*] This makes the Canadian economy particularly vulnerable in trade disputes with the United States, and the Canadian government particularly skittish whenever the U.S. Congress considers protectionist trade measures. The Agreement addresses these Canadian concerns.

U.S. goals under the Agreement are more multifaceted. While it, too, wants to increase trade, securing access to vast reserves of energy and other resources and providing a stable and conducive climate for U.S. investors in Canada are of equal importance. Key members of the Reagan Administration heavily imbued with a "free trade" ideology pushed hard for the Agreement, as did representatives of many U.S.-based, multi-national corporations that operate around the world and are able to do so much more freely without national trade barriers.

Those opposing the Agreement in Canada fear even further domination of Canada's economy by U.S. companies and investors and further loss of national identity and culture. Opposition to the Agreement in the United States stemmed from perceived adverse impacts on agricultural producers and other natural resource industries.

Historically, natural resource industries in the United States have received varying degrees of government protection and assistance, both in servicing U.S. markets and in supplying foreign markets. However, this also has been the case in Canada and most other industrialized nations. A Canadian study found that industries receiving the greatest protection in the United States are essentially the same industries receiving the greatest protection in Canada.[6] With this the case, reducing trade barriers between the two countries may entail less industry adjustment and restructuring than anticipated, while still offering lower prices to both U.S. and Canadian consumers.

However, whatever adjustments U.S. natural resource industries must make as a result of increased competitive pressure from Canadian producers will be further magnified as ways to reduce government subsidies they now receive are pursued.

The U.S. industries expected to benefit most from the Agreement are largely concentrated among manufacturers and service providers. Firms thought to have the brightest sales prospects in Canada include manufacturers and distributors of computers and telecommunications equipment, auto parts and trucks, aircraft and related parts, plastics, construction machinery, electronic components, and scientific and medical instruments. Considerable expansion in the U.S. and Canadian travel and tourism industry also is anticipated.[*]

FTA Impact on Montana

Montana's long-standing niche in the U.S. economy is as a producer of natural resource-based commodities and associated products. Any comparative advantages the state may possess in continuing this role are clearly diluted by giving similarly if not superiorly endowed regions to the north freer access to essentially the same markets now supplied by Montana producers.

Some argue that this threat to Montana's traditional economic role will actually benefit the state by forcing it to diversify into areas other than natural resource industries. A study by the 49th Parallel Institute at Montana State University states: "While natural resources remain crucial to the state's current economic fortunes, their role in future economic development is doubtful, unless processing and other value-added industries locate in Montana. Most of the benefits of freer trade with Canada are expected to be concentrated in these same areas, manufacturing and services, and the removal of trade barriers could help accelerate Montana's push for modernity."[7]

Some believe Montana will benefit from expanded U.S.-Canada trade simply because it is a border state. Montana is the only state sharing a common border with three Canadian provinces: British Columbia, Alberta, and Saskatchewan. Economic and population growth in Canada has shifted to these same western provinces in recent years. The elimination of U.S. duties on retail purchases, fewer restrictions on services trade and other commercial activity, and expansion of tourism in the region undoubtedly will increase traffic across the border in both directions. However, much of the Montana-Canada border region is sparsely populated and major Canadian and Montana trade centers are separated by relatively great distances. North-south transportation corridors in the region are still relatively underdeveloped. Hence, it is difficult to predict what forms transnational trade activity may take in Montana as a result of increased U.S.-Canada trade overall.

Free trade is a two-way street; there will be winners and losers on both sides of the border. For Montana, gains should occur in such areas as retail and services trade, transportation, tourism, and certain specialized areas of manufacturing. Some losses could occur in the state's natural resource industries, but how extensive these may be is anybody's guess.

Irrespective of which industries gain or lose, freer trade with Canada and other nations is a growing reality. The task for Montana business persons and policymakers at this time is to steadily grasp the intricacies of this evolving trade environment and to devise and adopt creative strategies for pursuing the opportunities it presents.

[1]"United States-Canada Free-Trade Agreement," Communication from the president of the United States, House Document 100-216, 100th Congress, 2d Session (Washington, D.C.: U.S. Govt. Printing Office, July, 1988) [2]"Is the Canada Trade Agreement a good idea?", Rural Montana, Montana Electric Cooperatives' Association, Great Falls, Montana, May, 1988 (quote by Congressman marlenee) [3]"Trade Barriers Between Canada and the United States," Department of Finance, Government of Canada, Working Paper No. 88-3, Ottawa, 1988 [4]"Trade Agreement's Impact: Few Gains for U.S., Canadian Farmers," Farmline, Economic Research Service, U.S. Dept. of Agriculture, Washington, D.C., February, 1990 [5]"The Canada-U.S. Free Trade Agreement: An Economic Assessment," Department of Finance, Government of Canada, Ottawa, 1988 [6]ibid [7]U.S.-Canada Free Trade, A Western Regional Perspective, 49th Parallel Institute for Canadian-American Relations, Montana State University, Bozeman, Montana, August, 1988 [*]Discussion based upon information and analysis of the International Trade Administration, U.S. Dept. of Commerce, Washington, D.C., and various articles from the ITA publication, Business in America.

Larry Swanson is director of economic analysis, Bureau of Business and Economic Research, University of Montana, Missoula.
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Author:Swanson, Larry D.
Publication:Montana Business Quarterly
Date:Jun 22, 1990
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