Free trade agreements
From the October 2019 print edition
Free trade agreements (FTAs) provide great opportunities for exporters, as they enable those companies’ products to enter these markets mostly free of tariffs (or customs duties), giving them a competitive advantage. Likewise, importers, distributors and manufacturers benefit, since they can import raw materials, components, parts and finished products mainly with zero customs duties. These agreements also provide other advantages for the trade in services, investment, business travel and so on, but in this article we will focus on the trading of goods.
Canada’s main FTA, the North American Free Trade Agreement (NAFTA), linking us with the US and Mexico, has been in effect since January 1, 1994. It would be hard to find a businessperson who is unaware of NAFTA and there are two reasons for this. First, because year after year, the US market represents 75 per cent of our exports and about 60 per cent of imports, illustrating the importance of this special relationship for Canada and how our economies are, to a certain extent, integrated. The second reason everyone in Canada knows about it is that the current US administration has embarked on a renegotiation process, also called modernization, of the agreement. This exercise has been highly publicized, often via social media, sometimes using undiplomatic language like “worst deal ever” and so on.
In addition to NAFTA, Canada enjoys FTA’s with a number of countries, namely Chile, Columbia, Costa Rica, the European Free Trade Association (Iceland, Liechtenstein, Norway and Switzerland), Honduras, Israel, Jordan, Korea, Peru and Ukraine, some of which have been in effect for some time—such as with Israel since 1997—and many of which mirror agreements the US has too. In addition, we enjoy two relatively new FTA’s, linking us to two markets that are even larger than the US, namely CETA and the CPTPP. CETA stands for the Comprehensive Economic and Trade Agreement, the FTA signed with the European Union and its 28 member countries, and provisionally in effect since September 21, 2017. CPTPP stands for the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, linking us with 10 other Pacific countries, the most significant one, in economic terms, being Japan, the world’s third-largest economy. The TPP has been partially in effect since December 30, 2018.
And what do these two massive FTA’s have in common? They are unique in that the US has no such agreement, neither with Europe nor with Pacific countries, giving Canada a definite competitive advantage. The other interesting aspect is that these FTA’s are not well known in Canada, hence they are largely underutilized by Canadian companies. How do we know this? By looking at our monthly trade figures, for example with Europe, where we see that Canadian exports have not grown as fast as our imports have. Secondly, according to a survey of Canadian exporters released by Global Affairs Canada in June, only seven per cent of surveyed businesses were familiar with the details of the Canada-EU agreement. The survey asked questions of 507 exporters in March and April and involved 40 “in-depth” telephone interviews.
Researchers asked questions about a dozen of Canada’s FTAs and found that CETA wasn’t the only deal in need of more promotion. “Among Canadian small-to-medium-sized enterprises, there was fairly low awareness of Canada’s free-trade agreements,” said an analysis that accompanied the results. “Few companies use any of these free-trade agreements, the exception being NAFTA”. In addition to CETA, respondents were asked about Canada’s deal with Pacific countries and only seven per cent were aware of the CPTPP’s details. The questions also took up other FTAs and the majority of companies said they had never heard of Canada’s bilateral deals with Ukraine, Israel, Chile, South Korea, Jordan, Panama, Colombia, Costa Rica, Peru or Honduras. Evidently, more promotion needs to be done in Canada to entice our exporters to take advantage of these trade agreements.
Why are Canadian businesses very aware of NAFTA and apparently unaware of our other trade deals? Geography speaks for itself, since most of the Canadian population (and industry) lives within a few hundred kilometres of the US border, it is easier to develop sales there than, say, in Finland or in New Zealand.
But distance is not the only reason and another survey done by Reuters-KPMG in 2015 gives a hint. They surveyed 446 corporate trade specialists from multi-national corporations in 11 countries and found that 70 per cent of companies were not fully utilizing FTAs.
Rules of origin
Respondents said the biggest challenge they faced was managing complex and changing regulatory requirements. The other survey findings were that 79 per cent of respondents said their biggest roadblock was complex rules of origin. Other factors were the time and resources needed for documentation, import product classification, licensing, interpreting rules across borders and changing requirements. Indeed, to manage these activities properly is demanding and requires trained resources.
What are rules of origin (ROO)? If all products were manufactured from local raw materials and components, we wouldn’t need ROOs. And if we excluded products containing foreign content from free trade agreements, not many products would qualify. ROO’s are designed to enable products that contain a certain proportion of foreign content to qualify for the preferential tariff, usually 0 per cent customs duties.
Because there isn’t one ROO that could fit all products, negotiators who conclude these agreements, sometimes after months, if not years of negotiations, agree on product-specific rules of origin (PSROOs), that vary according to the product. They are organized by HS code (harmonized system), the international numbering system of products managed by the World Customs Organization in Brussels. To the untrained eye, they are hard to read: once you find your product amongst the 99 chapters of the HS code, you must decipher what a tariff change means, especially as some refer to chapters, some to headings, others to sub-headings, and lastly understand the percentages of local content requirement.
There are often two possibilities: a percentage based on the net cost of making the product, and another percentage based on the “transactional” price, meaning the sales price of the product. And the exporter decides which one applies, for example under which of the two formulas his product qualifies. To navigate through these rules requires a certain level of knowledge that only specialists may have. However, it’s also a matter of taking the time to learn about these very important details of trade agreements.
We can say that globalization has opened tremendous opportunities, but it doesn’t mean that exporting or importing goods is easier. In fact, several factors, in particular protectionism and non-tariff barriers, actually make things more complex, and companies must be agile and keep up to date on rules and regulations to thrive. The same applies to benefitting from free trade agreements: managing their rules of origin and other requirements is quite a job but it is definitely worthwhile, as it provides a competitive advantage and works for both exporters and manufacturers/importers/distributors. With NAFTA or its successor, and with CETA and the CPTPP, Canadian businesses have the tools to conquer the world, or at least a good chunk of it.