U.S. Trade Representative Jamieson Greer speaks with reporters at the White House on April 2.Evan Vucci/Reuters
Claude Lavoie is a contributing columnist for The Globe and Mail. He was director-general of economic studies and policy analysis at the Department of Finance from 2008 to 2023.
Discussions about the renewal of the United States-Mexico-Canada Agreement have begun with Mexico, and details about the U.S. position are starting to emerge. The U.S. is pushing to strengthen rules-of-origin requirements, including a specific minimum threshold for American content. U.S. Trade Representative Jamieson Greer has also indicated that negotiations will focus on external tariff co-ordination.
External tariff co-ordination and rules-of-origin requirements are two distinct mechanisms for boosting North American content in goods and preventing third-party countries from using one of the three signatory nations as a backdoor into the USMCA. Pursuing both simultaneously would be duplicative, penalizing Canada’s trade twice for the same objective.
Co-ordinating external tariffs offers some economic efficiency advantages over stricter rules of origin, and for the U.S., it may also carry security benefits. However, it would constrain Canada’s diversification efforts and significantly erode our trade policy sovereignty. With that in mind, forgoing some efficiency to lay the groundwork for a more diversified and resilient economy may be the wiser course.
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The U.S. is currently focused on reshoring production to American territory, driven by security objectives and political considerations. The U.S. is particularly concerned about China, and worries that Canada or Mexico could serve as a conduit for Chinese products entering the American market, undermining the effectiveness of its trade and security policies.
Under the current agreement, for example, Canada can impose low tariffs on Chinese products, including parts, making them highly competitive on the Canadian market. Canadian producers can incorporate these imported parts as inputs, and as long as the Chinese content remains below a certain threshold, the final product can enter the U.S. duty-free.
This means certain Chinese components could effectively bypass higher U.S. tariffs and enter American supply chains. The maximum allowable share of external components for a product to qualify for USMCA preferential treatment varies by category. For automobiles, it currently stands at 25 per cent, down from 50 per cent under the original agreement.
Reducing this threshold further would limit the entry of Chinese (and other external countries) components into U.S. supply chains, but at a cost. Chinese parts tend to be cheaper, so stricter rules of origin would raise production costs and, ultimately, consumer prices. There is also a significant administrative burden. Demonstrating compliance with rules of origin requires extensive paperwork as it is increasingly difficult to identify the nationality of every component of a product. Exporters often prefer to pay tariffs rather than suffer the red tape of demonstrating compliance. That said, when tariffs on non-compliant goods rise, as they did when U.S. President Donald Trump increased them, more companies find it worthwhile to comply.
Rules of origin act as an implicit tariff. By most economic models, the tighter rules and added regulations introduced by the USMCA have reduced North American economic efficiency and GDP compared to the original North American Free Trade Agreement. Further tightening these rules, particularly by adding the complexity of a minimum U.S. content requirement, would erode those benefits further.
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Rules of origin are generally unnecessary when countries agree to co-ordinate external tariffs and establish a common market. Because all members share the same trade policies, goods can move freely within the bloc without origin certification. If all countries aligned on restricting Chinese imports, for instance, there would be no need to verify the origin of components at the Canada-U.S. border – provided each country trusts the others’ enforcement.
This is the logic behind the U.S. Trade Representatives’ suggestion that external tariff co-ordination or a common customs zone could reduce Chinese content in U.S. supply chains, and that it could become a condition for Canadian companies receiving preferential U.S. market access. Ottawa has signalled openness to this “Fortress North America” approach.
However, external tariff co-ordination would prevent Canada and Mexico from negotiating independent trade agreements with non-members, force them to renege on some existing treaties and undermine the current government’s efforts to diversify Canadian exports. In the European Union, for example, individual member states cannot negotiate their own trade deals.
Given the power dynamics in North America, an analogous arrangement would effectively mean Canada and Mexico adopting U.S. trade policies, which may not serve Canadian or Mexican industries well. Canada might negotiate limited exceptions, as Norway has with the EU, but this is far from guaranteed.
Stricter rules of origin would come with real economic costs. Co-ordinating external tariffs would come with sovereignty costs. Although diversification from the U.S. is easier said than done, some loss of efficiency may be a reasonable price to pay for greater independence. But there is no rationale for accepting both. A compromise could be the requirement to demonstrate origin compliance only if external tariffs differ by some threshold.