Why A Canada-U.S. Customs Union is a Bad Idea

The potential shutdown of the Canada-U.S. border is a prospect that sends shivers down the spine of corporate Canada. These fears crystallized in the days after the September 11, 2001 terror attacks.

Since that time, pressure has been mounting for a new deal between Canada and the United States to ensure that the border stays open in the future. A new wave of pro-integration literature has emerged with hypothetical proposals for a “strategic bargain” (in the words of the C.D. Howe Institute) with the U.S. across a number of policy areas, including border security, defence policy and immigration.

Canadians need to think long and hard about the direction in which influential business leaders want to take us. There is no telling where a new, big negotiation with our neighbours to the South might lead, and whether it would really address our major concerns, such as access to the U.S. market. In a world where security trumps economics, there is no guarantee that greater integration with the U.S. will keep the border open in the event of another terror attack.

What is a Customs Union?

Among the deep-integration proposals is a call for a Canada-U.S. Customs Union (CUCU). While the North American Free Trade Agreement (NAFTA) has already achieved a high level of economic integration, it can be viewed as just one step towards deeper integration. A customs union is the next step. For supporters of free trade, a customs union is a natural extension of the same liberalization logic.

The key features of a customs union are the creation of a common external tariff that applies to all nations not part of the free-trade area and the establishment of a common trade policy. It also involves the elimination of rules of origin. Rules of origin appear in free-trade agreements to ensure that exports from country A to country B originate in A, or at least have substantial value added to them in A.

The principal source of benefit accruing to a customs union would be the elimination of rules of origin that, it is argued, pose administrative costs to exporters and distort trade patterns. It is worth taking such arguments with a healthy dose of skepticism. These are largely theorized costs and benefits in the economics literature. They do not seem to be a major irritant to exporters.

There is no reason to expect major economic benefits from the elimination of rules of origin because they are not really that costly. Businesses would save some money by not having rules of origin in place. But this would do little to ease congestion and delays at the border, as some have argued.

Because they create an incentive to source inputs domestically or within the NAFTA area, rules of origin may actually have benefits to the Canadian economy, so eliminating them would be a cost. As a result, any incremental gains fashioned from the move from the NAFTA to a customs union are likely to be extremely small, if there are positive gains at all.

Much has been made of the alleged complexity of rules of origin – several commentators note that some 200pages of NAFTA text are devoted to spelling out rules of origin – and the administrative burden this poses. While this may sound terrifying, it misrepresents rules of origin in practice. The vast bulk of these 200 pages is an annex containing a long list of the specific rules on a product-by-product basis. Not every exporter must understand every rule for every product, only those rules that apply to specific products they are exporting. The main legal text on rules of origin in NAFTA (Chapter 4) is actually only 26 pages in length – six of these are devoted to definitions, and another three specifically refer only to the auto industry. Even counting the entire 26 pages, this is shorter than the chapters on investment (Chapter 11) and intellectual property rights (Chapter 17), neither of which seems to be under attack for being overly complex, despite being quite prescriptive. To the extent that rules of origin mean additional paperwork for exporters, much of this is a one-time cost in terms of getting the paperwork right and ensuring that the product supply conforms to specifications. In practice, the NAFTA certificate of origin that accompanies exports across the border is a one-page document. There may be some legal and accounting cost that goes along with this, but it is unlikely that it is any greater than any of the other legal and accounting work that companies must comply with as part of doing business. Compared to the resource requirements dedicated to payroll, general administration, tax filing, application for permits and so on, the costs of rules of origin are a drop in the bucket.

The Downside: A “Common” Trade Policy

There are likely to be costs as well as benefits from a CUCU. A crucial downside of a CUCU would be the need for a common trade policy with the U.S. vis-à-vis the rest of the world. In practical terms, this would mean surrendering Canada’s trade policy to the U.S. Trade Representative. Such a move would have sweeping implications for Canadian institutions and how we manage our place in the world.

In both countries there are politically sensitive sectors that have been protected from the full force of international trade agreements. In Canada, these include public services, Crown corporations, agricultural marketing boards, the Canadian Wheat Board, cultural industries, telecommunications and banking. Many of these have been targeted for dismantling by Washington, and would be put on the table should Canada seek to negotiate greater economic integration.

Over the course of history, Canada and the United States have also developed different trade ties and political relationships with other countries. Reconciling these within the context of a customs union could prove to be difficult. The U.S. has embargoed trade relations with some countries – like Cuba and Iran – while Canada continues to maintain trade relations (often in spite of U.S. pressures to follow its lead).

Even when embargoes are not involved, Canada and the United States have differing relationships with other countries. Canada has a different set of international trade agreements than the U.S., and different trade preferences granted to developing countries. Reconciling these differences would be complicated and difficult. Moreover, a common trade policy with Washington would foreclose on all kinds of independent policy initiatives for Canada. For example, what if Canada wants to move ahead with the generic production of AIDS medication for poor countries in Africa that do not have domestic manufacturing capacity? After a long fight at the WTO, this could become practice in Canada, but under a common trade policy with the United States it would likely never happen, due to the powerful influence of brand-name pharmaceutical companies in that country. What Kind of Bargain?

If anything, Canada needs a more multilateral trade policy – the gains from more trade are not with the U.S. but with the rest of the world. Yet, a customs union would not only be a shift away from multilateralism – at the same time as Canada fails to diversify multilaterally, the very tools needed to pursue a multilateral trade-diversification strategy would be given away.

There could be benefits for Canada in achieving some sort of agreement on trade-remedy measures (like anti-dumping and countervailing duties) – though these are not considered part of a customs union. The failure of Canada to secure exemptions from U.S. trade-remedy laws has proved, from Canada’s point of view, to be a major weakness of the Canada-U.S. Free Trade Agreement (FTA). However, given prevailing attitudes in the U.S. Congress, changing trade-remedy laws or even negotiating an exemption is a non-starter. This potential source of gain for Canada is, for all intents and purposes, off limits.

Ultimately, what is politically feasible would determine the outcome of a new round of negotiations with the United States. The history of such negotiations is cause for concern. There is a great danger that Canada would have to give up a lot to get little in return.

Washington would be focused on the following list of issues, were it to enter into a new negotiation with Ottawa: agricultural supply management; Canadian content provisions and other cultural policies; border measures (including refugee policies, entry and customs procedures); provincial and federal agricultural programs and practices; intellectual property-rights issues; and foreign investment and ownership restrictions (in particular in banking and telecommunications industries). Canada would be required to make serious commitments in these areas – commitments that many Canadians would find unacceptable.

Canada’s energy resources are also cited as something that Canada could bring to the table as part of a “strategic bargain.” While critics of the original Canada-U.S. FTA and NAFTA rightly point out that Canada has already given up a lot in the energy sector, the U.S. obsession with acquiring cheap energy to power its economy means that Canada could offer a deal that included greater energy integration.

What’s the Alternative?

Canada should reject entering into a new negotiation with the United States over a customs union, or a broader negotiation that would include as one component a customs union. Ultimately the potential gains from a customs union are rather small, and nowhere near some of the incredible numbers being cited in favour of a customs union. And to bring about a customs union, Canada would have to forgo its independent trade policy, and potentially its sovereignty in a variety of other areas.

Canada should consider pragmatic initiatives on a case-by-case basis. Under the NAFTA, for example, there is already an agreement to waive rules of origin for most computers and parts. If it is in the interest of companies on both sides of the border, there seems to be little problem in negotiating sectoral agreements where there is the most to gain. There are a large number of sectors where most-favoured nation tariff rates are already identical or close enough that they could be harmonized on a sectoral basis. Autos and steel, for example, represent sectors where Canada and the U.S. could gain from a common trade policy. As long as costs to Canadian industry and workers are taken into account, such an approach could harvest the “low-hanging fruit,” reaping most of the benefits, but without a dramatic loss of sovereignty.

The gains from trade for Canada are more likely to be found in enhancing trade with Europe or the Global South, which suggests a multilateral approach to trade policy rather than a narrow bilateral one. Canada’s concerns would also be better addressed via multilateral institutions and international cooperation with other countries that share those concerns. This is the only way to get the leverage necessary with Washington to make changes on issues of real substance, like its punishing trade-remedy laws.

When benefits and costs are laid out, there is little case for entering into a new negotiation with the United States over a customs union, and great risks entailed in a broader negotiation that would include a customs union as one component. Closer economic ties to the United States via a customs union would likely lower Canadians’ standard of living, not raise it, due to negative consequences for public services and sovereignty that underpin the quality of life in Canada. Hopefully, good sense will prevail, and a new national debate will not be necessary, because Canada chooses to chart a different course than deeper economic integration with the U.S.

Marc Lee is an economist with the Canadian Centre for Policy Alternatives. He is the author of Indecent Proposal: The Case against a Canada-U.S. Customs Union, available at http://www.policyalternatives.ca.