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The 3 Disrupting Forces of the Modern US-Canada Relationship

What are the Implications of New Trump Policies to the US-Canada Relationship?

With more than 5,500 miles of shared borders, the US and Canada have long been strategic partners concerning trade, national security, and promoting democratic ideals. While continued cooperation between the two nations is expected, Donald Trump’s presidency could have commercial and economic implications for businesses operating in Canada. Specifically, Donald Trump’s intention to alter the US tax rate and renegotiate the North American Free Trade Agreement (NAFTA) may affect the competitive and economic health of Canada.

In short, a divergence of how each country views trade may affect Canada’s long-term economic health. Exploring this relationship with Dun & Bradstreet’s Canada analyst, Adam Morehouse, we found the following 3 forces that may potentially disrupt this relationship.

A Brief History on the US-Canada Relationship

The US and Canada had long-established trade links prior to NAFTA, jointly promoting the concept of deeper integration between the two countries as far back as 1911, when US President William Howard Taft signed a free-trade agreement with Canadian Prime Minister Wilfrid Laurier (although the agreement subsequently broke down). Additional attempts at bilateral trade agreements between the nations took place in 1965 (through the US-Canada Automotive Products Agreement, which liberalized barriers for the automobile industry) and, more comprehensively, in 1989 (via the US-Canada Free Trade Agreement or USCFTA).

In short, a divergence of how each country views trade may affect Canada’s long-term economic health.
 

Decades of trade between the two nations and the implementation of NAFTA in 1994 has led to increased dependence, broader market access, and deeper supply chain integration between Canada and the US. Canada’s share of total trade (exports and imports) with the US rose considerably after the implementations of both USCFTA and NAFTA. The average share of total trade rose to 75.3% in the ten years after the implementation of NAFTA (although the total share was always high, at an average of 69.9% in the ten years before NAFTA), and greater integration has led to deeper trade ties and interdependence. Recent data suggests that this share has fallen, with increasing proportions of total trade attributed to other nations, especially countries with which Canada has established bilateral and multilateral trade deals. The US, however, remains Canada’s largest trading partner.

Exploring the 3 Forces that May Disrupt the US-Canada Relationship

Currently, the relationship between the US and Canada faces three emerging political forces.

1. Differing US and Canadian Climate Change Policies

According to Dun & Bradstreet’s Canada analyst, Adam Morehouse, Prime Minister Trudeau’s proposed green policies – specifically the per-ton carbon tax that will unilaterally begin for all provinces in 2018 - may come into play and affect the US/Canada relationship. The carbon tax will effectively be a blanket tax encompassing all provinces in Canada that do not already have a carbon scheme. Given Trump’s overall support for the American coal industry, a matching US carbon tax appears very unlikely.

The US and Canada will likely remain strong strategic trading partners, yet the forces driving a potential ideological divide between them should remain on every business leader’s radar.

Trudeau’s green policies may also be detrimental to Canada’s fossil fuel industries, making businesses less competitive globally. Perhaps more importantly, these carbon taxes come at a time when Canada’s strategically important oil and gas sector is recovering from a period of low global oil prices and a from a May 2016 natural disaster. In addition, a carbon tax could negatively weigh on consumer spending and put pressure on already highly leveraged Canadian households, of disposable income (against 101.1% in the US).

President Trump demonstrated a differing viewpoint from Trudeau in June when he pulled the US out of the multilateral Paris climate agreement, which Canada remains a part of, widening the ideological rift between the neighbors.

Trump and Trudeau’s different stances on environmental policies will likely put pressure on Canada’s carbon-producing industries, including crude oil, natural gas and coal extraction, refinement, and oil-field and ancillary services. Reduced environmental regulation in the US, combined with Canada’s national carbon tax, will probably make Canada’s carbon industries less competitive than the US’s.

2. The Industries Most Affected by Bilateral Trade Agreement Renegotiation

NAFTA created a first-of-its-kind multilateral free-trade agreement between major developed and developing nation wherein the US, Canada, and Mexico agreed to liberalize trade by removing trade barriers on the goods and services of participating nations. Trump, in the action plan for the first 100 days of his presidency, vowed to renegotiate NAFTA, or to trigger Article 2205 - effectively removing the US from the agreement (requiring no Congressional approval).

On his 98th day in office, Trump softened his stance on the agreement and announced that the US will renegotiate NAFTA rather than withdraw from it completely. While this softens the impact of returning to pre-NAFTA trade relations, there is still significant uncertainty, especially as some industries, like dairy and lumber, might be more impacted than others.

A more recent trade deal between the US and Mexico could offer some clues on how the NAFTA renegotiation will affect the various players. On June 5, the US and Mexican governments reached a deal on an ongoing dispute over trading sugar. The deal avoids the sugar dispute spiraling into a series of retaliatory tariffs by the two countries, but imposes more stringent limits on how much sugar Mexico can import to the US. We could see similar limits imposed on Canada.

As the renegotiation unfolds, the Trudeau government will need to assess the impact of any new trade barriers established between Canadian and US businesses. If Canadian businesses do face new tariff or non-tariff barriers regarding the US market, the opportunity to pivot to other markets is possible, but will have to be weighed against the likely increased intermodal transportation costs given Canada’s geographic location.

3. The US Corporate Tax Rate Implications on Canadian Industry

Canada’s current corporate tax rate has often been characterized as being generally competitive, ranking highly in terms of attractiveness when compared to other members of the Organization for Economic Co-operation and Development (OECD). At 15%, Canada’s national corporate tax rate places it third out of the 35 OECD member states, while the US, at 35%, ranks last.

One of the cornerstones of Trump’s campaign was to make American businesses more internationally competitive by dropping the US corporate tax rate to 15% - a move that at first glance would put US corporate tax rates on par with their Canadian counterparts. However, Canada’s provinces require corporations to pay an additional rate on top of the national rate. While state tax rates vary, as an aggregate, the additional sub-central government corporate tax rates total around 6.0-6.7%. A summation of both rates reveals that while US corporations are currently at a comparative disadvantage to their Canadian counterparts, a new lower national tax rate in the US could tilt the cost advantage towards US businesses.

The US and Canada will likely remain strong strategic trading partners, yet the forces driving a potential ideological divide between them should remain on every business leader’s radar. While we do not believe there will be substantial damage to this relationship in the long-term, keeping abreast of NAFTA changes, climate change policies, and trade agreements will help businesses weather the tide of disruption.

Dun & Bradstreet Canada analyst, Adam Morehouse, also contributed to this article.

 

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