A few days ago, cows and their owners were marching in front of Parliament in Ottawa. They were protesting against the Trans-Pacific Partnership (TPP), which, they argued, would cause the demise of the dairy industry’s supply management regime. Last week, it was Unifor’s (the largest private sector union in Canada) turn to manifest its concerns about the TPP. It claimed that over 25,000 jobs in Canada’s automotive sector were at risk because of TPP. Finally, in the recent Munk leaders’ debate, Thomas Mulcair and Justin Trudeau attacked Stephen Harper for not doing enough to protect Canadian interests in the TPP negotiations. Harper replied that he would only sign on a TPP deal that would be in the best interest of Canadians.
What are we to make of this debate around the TPP?
Let me focus on two key issues that are currently being debated in the context of the federal election campaign and the TPP ministerial meeting held in Atlanta on September 30 and October 1: supply management in the dairy industry, and rules of origin in the automotive sector.
Supply Management in the Dairy Industry
When Canada joined the TPP negotiations in October 2012 – late in the game, a couple of years after they had begun – Australia, New Zealand and the United States apparently made the opening up of Canada’s dairy market to TPP members a condition for membership. This meant, at a minimum, that the Canadian government would have to increase the amount of dairy products that could be imported at a much lower tariff rate (under what is known as a tariff-rate quota, or TRQ) from other TPP members into Canada. For dairy products, the TRQ tariff rate is around 7 percent whereas regular tariffs tend to be above 200 percent, reaching close to 300 percent for some categories.
Behind this tariff wall (despite some TRQ cracks), Canada is able to operate a system of supply management whose aim to offer milk producers a stable and adequate price for their investment and efforts. To do so, the federal and provincial governments, with the industry’s cooperation, set the amount of milk that can be produced in a given period and the price that will be paid to the producer. This system ultimately determines the price that Canadian consumers pay for dairy products of all sorts.
Benefits from greater market access to TPP members would surely outweigh any loss that the Canadian dairy sector might experience.
According to basic economic logic, if more dairy products are imported into Canada under TRQs, then the overall supply of Canadian milk has to decrease in order for the price to be maintained (given a certain demand). Alternatively, the quantity produced in Canada could remain the same, but the price would decline. Either way, Canadian milk producers would expect to see their revenues drop, which is why they oppose any increase in TRQs for TPP members.
Rumour has it that the Harper government would be willing to offer its TPP partners TRQs amounting to 9 or 10 percent of Canada’s dairy market, which is about five times more than it gave the European Union in the Comprehensive Economic and Trade Agreement (CETA). That was why farmers and their cows walked down Wellington Street in Ottawa the other day. They fear for their livelihoods.
It is not clear, however, what impact such a concession by the Harper government would have on the industry and its producers. Offering higher TRQs is one thing, but making use of them is another. For instance, it is not a given that dairy products (even if powdered milk) coming half-way around the world from Australia and New Zealand would be cheaper than their Canadian equivalent once transportation costs were taken into account. And let’s not forget that imports under TRQ still require the payment of a 6.5 to 7.5 percent custom duty.
Moreover, the biggest users of TRQs are members of the Canadian dairy industry, so their decisions will be based on their overall assessment of the Canadian market. For example, it is doubtful that Agropur, Canada’s largest manufacturer of dairy products and one of the largest holders of a cheese TRQ, would simply replace Canadian milk and dairy products with imports, especially given that it is a cooperative owned by milk producers. In the case of Saputo, another large player in the Canadian dairy industry, more imports could help it with its internalization strategy, whereby it could use freed-up Canadian milk to export some of its products abroad. Until now, because the supply of Canadian milk has been controlled, Saputo has had to invest in Latin America and Australia to pursue its expansion strategy. In Agropur’s case, the expansion has taken place with acquisitions in the United States.
It is also worth mentioning that the Harper government (or any federal government willing to sign onto the TPP) will likely have to offer some form of compensation to dairy producers negatively affected by the TPP. This is what the Harper government has promised for the CETA, though it has required evidence of financial injury in order to receive any compensatory payment. We can expect the same for the TPP, because it is the only way to make the deal politically acceptable. It is also what economic theory would tell you to do: the winners of a trade agreement should compensate the losers in order to reach a “Pareto optimal” outcome.
Rules of Origin in the Automotive Sector
The second big, contentious issue involving TPP concerns rules of origin in the automobile sector. Rules of origin are crucial in a free trade area because they determine which products can, and cannot, enter a member state tariff-free. Under the North American Free Trade Agreement (NAFTA), a car can enter Canada, Mexico or the United States without paying the normal custom duty provided that 62.5 percent of its content (e.g., parts, labour, etc.) comes from within the NAFTA region. Under the proposed TPP, which would supersede the NAFTA, this percentage would drop to 45 percent for an assembled car and as low as 30 percent for auto parts.
A TPP agreement without Canada would put Canadian auto parts manufacturers in an even more disadvantageous position.
Such a proposal has made many auto parts manufacturers in Canada and Mexico very upset. They fear that such TPP rule-of-origin provisions would threaten their profitability, if not their survival altogether, as a result of greater competition from lower-cost, non-TPP countries in Asia, namely China.
Although the Canadian auto parts manufacturers are right to be concerned and feel that they would lose out as a result of lower rule-of-origin thresholds under TPP, they effectively have no choice but to go along with the deal. A TPP agreement without Canada would put them in an even more disadvantageous position.
Consider the following scenario. A Japanese manufacturer like Toyota or Honda wanting to export a car to the US can have it assembled in either Canada or China. Under TPP rules, the China-assembled car can be exported tariff-free to the US as long as it has at least 45 percent of its content from within the TPP area. For the Canada-assembled car, it could enter the US tariff-free only if 62.5 percent of its content is from the NAFTA region. There is thus a high likelihood that Honda or Toyota would choose China instead of Canada to assemble cars for the US market, which means Toyota and Honda could very well decide to close their assembly plants in Ontario.
Being outside the TPP would also make it more difficult for Canadian auto parts companies to be part of increasingly global production chains in the auto sector. For instance, parts manufactured in Canada could not be exported to Japan tariff free for inclusion in an engine that would then be shipped to China for a car’s final assembly.
This explains why larger Canadian auto parts manufacturers like Linamar and Martinrea, which have operations scattered around the world in order to be an integral part of the above-mentioned global production chains, have publicly voiced their support for the TPP. For them, there is much more to lose if Canada is not part of the TPP.
For many smaller auto parts manufacturers, TPP membership will require significant adjustments to the way they operate. Some, unfortunately, may not survive this adaptation process. However, if Canada were to remain outside the TPP while the US (and possibly Mexico) are in, the Canadian auto sector as a whole might face extinction. But whether Canada stands inside or outside the TPP, the world for the Canadian automotive sector will change. The status quo cannot hold.
Based on the above, Canada must sign onto the TPP. For the auto sector, staying outside the TPP makes little sense. In the agricultural sector, allowing more imports of dairy products from TPP members was apparently the price to pay for entering the negotiations. However, being part of this new club will allow the beef and pork industries, for example, to obtain an easier (i.e. cheaper) access to the Japanese markets as well as that of the other East Asian members of the TPP. Such benefits arising from greater market access to TPP members would surely outweigh any loss that the Canadian dairy sector might experience, making compensation by the federal government easy.
For more than ten years, experts on North American economic integration have been calling for a deepening of the NAFTA. The TPP offers such an opportunity. Canada would be foolish to miss it.