FAIT Committee Report

CHAPTER 4: KEY ISSUES IN MANAGING
AND ADVANCING THE NORTH AMERICAN
ECONOMIC RELATIONSHIP

4.1       Introduction

As the Committee has previously observed, North American economic integration has increased since free trade in North America was first initiated in the late 1980s, continuing a longer-term trend. This trend towards greater North American integration has occurred despite the best efforts of the federal government to diversify Canada’s global trade. The focus of Canadian trade policy, at least prior to September 11, 2001, appeared aimed more at expanding trade relations outside North America than at strengthening economic links on this continent. But the obviously vital importance of those links, underlined by border disruptions, and the effects of increasing competition for the U.S. market¹, have renewed attention to economic relations with NAFTA partners. Indeed, in a recent speech, the Minister for International Trade Pierre Pettigrew outlined a “North American agenda” with the following six goals:²

First of all, I want to increase our share of the U.S. market. Canada typically supplies about 19 percent of U.S. imports, a trade weight well above our economic weight in the world. We should aim to increase our share on a yearly basis. Let us not be fearful of our trade with the U.S.; let us magnify it.

Second, I want to see greater flows of two-way investment on which trade increasingly depends.…

Third, we must advance an agenda of smart regulation.… We made great strides in this respect in NAFTA, but NAFTA is 10 years old and we need to make further advances.…

The fourth goal is a commitment to making serious efforts to bring trade remedy practice more in line with the growing integration of our shared North American economic space.…

As a fifth goal, I want to eliminate the border as an impediment to trade, investment and business development and move the border away from the border.

Sixth and finally, I propose the need for smarter advocacy and representation in the United States.

In all likelihood, North American trade and investment links will continue to become more deeply integrated in practice, whatever the policy orientation of governments, although several witnesses appearing before the Committee suggested that there may be limits to this “bottom-up” growth. To quote from Professor Stephen Blank of New York’s Pace University, additional integration “is blocked in some areas, for example, by the persistence of trade disputes. In other areas, patterns of interests and government policies create inefficiencies.”³

In the Committee’s view, a realistic analysis of the emerging North American economic space suggests it would be unwise as well as unfeasible in policy terms to attempt to deny or reverse these pervasive facts of progressive economic linkage. Consequently, responding to the evolving circumstances of continental economic integration, the principal choice is between two overall directions for managing the North American economic relationship.

The first is essentially to maintain the status quo, thereby enabling the private sector to determine the process of additional integration according to its own agenda. As one prominent business representative put it, leadership of the continental integration file has shifted to the private sector since the implementation of NAFTA.⁴ Under this scenario, the combined forces of commerce, technology and security would continue to steadily cement ties among the three NAFTA partners. The status quo option, as Danielle Goldfarb of the C.D. Howe Institute reminded the Committee, involves Canada managing the bilateral relationship “on an as-needed, reactive basis — issue by issue, event by event — with NAFTA as a framework. This is not necessarily a bad thing, but it’s not a strategic vision of where Canada wants the North American relationship to go.”⁵

Alternatively, policy-makers could seriously examine the costs and benefits of various options for managing increased integration, select an appropriate course of action and assess the strategies required to implement this desired policy direction. These strategies would be based on a new vision of North American relations. Daniel Schwanen felt that “we will have to invent our own integration model, a model that is peculiar to Canada and the United States, and perhaps Mexico as well, as we have already done in the case of trade relations.…”⁶

In his testimony before the Committee, Michael Hart of Carleton University identified a number of key areas where strategies would have to be developed: “… on dealing with the challenge of the border to commercial transactions; with the unfinished business of the FTA, the NAFTA, and the WTO; by dealing with the role of the physical border in slowing things down, in creating delays, and in raising costs in its administration; with the impact of regulatory differences, again involving costs, many of which are avoidable; by dealing with some of the factors that arise from deepening silent integration; and finally, and most importantly, with the fact that the institutions, the procedures and the rules the two governments have in place at this particular time are more in tune with the reality of a free trade agreement, but not with the depth of integration between the two countries, a depth that now goes far beyond the free trade agreement and is more like a customs union or even a common market.”⁷

After considerable reflection, we have concluded that it would be far preferable for the Government of Canada, following consultation with key stakeholders, to actively help shape the evolution of our relationship with the United States and Mexico — and to secure maximum advantage from it — than to wait and allow events to dictate what that future relationship will look like. As Jayson Myers of Canadian Manufacturers and Exporters stated: “Canada’s position in North America should be determined by clear policy goals aimed at making our integrated economy work better.…”⁸ What is therefore needed is the development of a more proactive approach to integration, not the current ad hoc, reactive approach. The risk of inaction is that Canada loses control over its economic and social future, thereby lessening the sovereignty it values so highly.

Several vital questions must be answered before such an activist approach based on long-term Canadian interests can be formulated. What solutions are available to deal with and resolve unfinished business left over from NAFTA? What are the best ways to improve upon existing dispute settlement mechanisms and to avoid trade disputes in the first place? What steps can be taken to enhance the economic climate in Canada? What should the border of the future look like? What should be done to facilitate a more efficient flow of goods, services, capital and people on the North American continent? What options for additional integration are available to policy-makers, and what are their advantages and drawbacks? Could a “strategic bargain” with the United States, in which Canada would offer greater security and defence cooperation in exchange for greater access to the American market, be in Canada’s best interests? Is there merit in adopting a common currency with the United States and possibly Mexico? These questions form the basis for this chapter on managing the future direction of the North American economic relationship to Canadian advantage.

4.2       Addressing Trade Issues and NAFTA’s Unfinished Business

A.  Assessing the North American Free Trade Experience

One way of assessing the current North American trade framework is to focus on the obvious concerns that are consistently highlighted in the media and that understandably surfaced in testimony to the Committee, notably: softwood lumber, agricultural subsidies and the U.S. Farm Bill, culture, energy, steel, water, the rights of corporations under Chapter 11 of NAFTA, and others. It is also important to take a broader view of the Canada-U.S.-Mexico trade context and ask a simple, yet revealing, question: have the 1989 Canada-U.S. Free Trade Agreement (CUFTA) and the 1994 NAFTA been successful in overall terms for Canada?

Some of the responses the Committee received on this issue were noted in Chapter 1, as was the general polarization between business representatives claiming clear economic success and labour spokespersons who were largely critical of the agreements and their effects on workers and society. Larry Morrison of the Canadian Association of Petroleum Producers spoke of one key export sector in the following glowing terms:

The oil industry has been doing very, very well over the past number of years in being very able to compete in the U.S. market. I would attribute this to good sound government policy, starting with the North American Free Trade Agreement. We have open market access, and governments let the price signals come through, although it’s sometimes painful when prices spike. But they have stayed away from policies that would dictate pipeline routes, or dictate certain tax treatment, which might put us offside. So it’s a very level playing field, with open market access and strong adherence to free trade principles.⁹

In contrast, Lawrence McBrearty of the United Steelworkers of America stated that “[b]oth NAFTA and FTA held out the promise of access to the U.S. market. This promise was not fulfilled in either agreement. The U.S. maintains powerful policy levers to protect its industries. … We have traded away our sovereignty for the illusion of access to the U.S. markets. NAFTA, while it doesn’t provide secure access, does limit the actions our country can take on behalf of its citizens.”¹⁰ David Orchard of Citizens Concerned About Free Trade carried this train of thought one step further by calling for Canada to withdraw from the FTA and NAFTA, in which case, he argued, Canada would be governed uniquely by the GATT under the WTO rules, rules he felt would be much more favourable to Canada.¹¹ William Kerr of the Saskatoon-based Estey Centre for Law and Economics in International Trade noted that Canada certainly could abandon NAFTA — perhaps as a way of regaining some voluntarily relinquished sovereignty — and thus fall under the WTO rules, but he warned that these rules do not “provide us with as much security of access to the U.S. or Mexican markets as the NAFTA does.”¹² Stephen Clarkson of the University of Toronto, however, made the following remark: “If I had to give a yes or no answer to whether we are better off without NAFTA, which is obviously too simple a question, I would say we would be better off without it because in many areas the WTO rules are better than the NAFTA rules.”¹³

This sort of back and forth in the different arguments put to us, which occurred throughout the hearings, indicates to the Committee that our trilateral trade relationship is working for some, even many, but not for others, and for a variety of reasons — a signal that some changes are needed.¹⁴ During our hearings in Mexico City, Antonio Ortίz Mena of the Centro de Investigación y Docencia Económicas provided a lucid assessment of NAFTA and an overview of some of the unfinished business:

NAFTA has performed very well, if measured in terms of the increase of trade and investment flows in the North American region, perhaps more so than either opponents or supporters expected in 1994. There are, however, significant challenges that must be addressed so that NAFTA’s benefits are shared more equally and its adverse effects minimized.… [A]mong them are poverty reduction, income distribution, participation of small and medium enterprises (SMEs) in export activities, regional development, and complementation of economic growth with protection of the environment, which can all be subsumed under the rubric of economic integration and social equity, and the challenge of keeping open borders for the legal flows of goods, capital, and people and closing them off for illegal flows.¹⁵

Many important themes emerged from the testimony before the Committee as witnesses assessed the CUFTA and NAFTA track record. These themes are noted throughout this chapter, but it is useful to highlight here some of the broad, “big picture” notions.

First, many pointed out that the vast majority of North American trade runs smoothly and without adverse incident. Donald MacKay of the Canadian Foundation for the Americas (FOCAL) sought to underline a balanced perspective and refused to define our trade relationships by the disagreements. In his words, “what we have is about 4% of the trade being subject to dispute. The other 96% goes on day by day without any difficulty whatever.”¹⁶

Several witnesses emphasized the relative success of the Canada-U.S. trade relationship by describing the softwood lumber dispute as a unique deviation, albeit a significant one. Brian Stevenson of the University of Alberta noted that “if you look at the enormity of the trade relationship, and then you measure it against the trade disputes, which are very important to us but really don’t represent a huge percentage of the trade we’re doing, you may find — and probably nobody could calculate this exactly — 99% of the bilateral relationship is working fairly well between the two countries. Unfortunately, sometimes that 1% in the trade conflict between us is found in areas that we’re very sensitive about and are very worried about, such as softwood lumber.”¹⁷ Professor Louis Balthazar of Laval University acknowledged that “softwood has been a snag and is a problem for us, but the greater part of our trade is working admirably well.”¹⁸ Professor George MacLean of the University of Manitoba highlighted the sensitivities inherent in any relationship of interdependence:

I don’t think the problems we are facing on softwood lumber, which are real and significant, are sufficient to say bilateral trade, commercial relations, and investment with the United States are not working. It’s simplistic.... Some people are suggesting softwood lumber is not working so the American-Canadian economic relationship is not working. It’s not the case at all. I would say that in any relationship of interdependence you have sensitivities to the relations among partners, but you also have vulnerabilities. When you have one state or one actor who makes a policy decision that’s going to implicate the other, then we become vulnerable to them. It’s clear. We’ve always known this. It’s clear we are vulnerable to what the United States is going to do. I would suggest, though, that the vulnerabilities we would experience without the close economic relationship would be far greater than we’re facing in a single sector.¹⁹

A second theme was how NAFTA has helped prevent an overwhelming North American “hub and spoke” model whereby the United States would act as the dominant hub and simply conclude bilateral agreements with the countries of its choice. Some, such as Laura Macdonald of the Carleton University Centre for North American Politics and Society, saw this success as the example Canada should look to in promoting sub-regional and broader cooperation agreements throughout the Americas.²⁰ George MacLean summed up these ideas well:

We were very successful, I would argue, with NAFTA in avoiding a hub and spoke mechanism that the Americans would have liked to have seen, which is to say bilateral free trade agreements with Mexico, then Brazil, and so on. What we were successful in doing is saying we’d like to be involved at the table in order to create a bilateral relationship, and make a bilateral relationship multilateral. What we were able to do effectively in the late 1980s and early 1990s is to curb a hub and spoke development that was taking place within the Americas. We have to do that now, even though in the Americas we are even less integrated than we were with Mexico, in order to maintain a true multilateral relationship.²¹

Yet John Foster, in his forthcoming review of NAFTA, astutely notes that despite the trilateral agreement, the hub and spoke attitude of the United States when negotiating with Canada and Mexico — a posture derived from the asymmetries of size and power between the partners — has kept alive certain key trade irritants, such as U.S. trade remedy actions.²² Such irritants are discussed later in this chapter.

Apart from tempering the hub and spoke structure, NAFTA formally introduced Canada and Mexico to each other — thus creating new and, as noted throughout this report, yet-to-be-tapped opportunities — and made each country realize that the obvious asymmetries they share within the NAFTA power structure provide them with a special bond that can augment their force in dealing with the elephant that is the United States.

These asymmetries and their significance signal a third broad theme. The weight of the elephant is massive. Stephen Clarkson commented that “[i]n terms of power, whether you want to use the word ‘domination’ or ‘hegemony’ or ‘influence’ or ‘asymmetry’, it’s obvious that the difference between Canada and the United States is enormous.”²³ Reg Whitaker argued that the “vastly disproportionate weight of the U.S.” leads to American government political decisions having a direct effect on the NAFTA partners because “neither Canada nor Mexico, even in an alliance, could wield enough weight to seriously influence the hold of U.S. national institutions over North American decision-making.”²⁴

Products of these asymmetries include the fourth and fifth common themes the Committee encountered: the current U.S. administration’s relative lack of interest in addressing North American integration issues at this time, and its tendency to unilateral action. As was clear from our meetings in Washington, D.C., in March 2002, any impetus for a reconsideration of the overall North American trade infrastructure embodied in NAFTA will likely have to come from Canada and Mexico. And even then, there is no guarantee it will even be considered. David Zussman of the Public Policy Forum explained that the resolution of trade disputes through development of new institutional responses “is not likely something the Americans are going to spend much time on, because we know it’s not an issue of particular importance to them.”²⁵ Isaiah Litvak of the Florida Atlantic University commented that Canadians are “fixated, focused and obsessed with respect to the United States,” while the United States “hardly notices Canada and Canadians.”²⁶

But all is not lost. Professor Stephen Blank of Pace University in New York rightly reminds us that the NAFTA relationship is one of interdependence, regardless of what the U.S. government says or does:

… one-third of U.S. exports now go to our NAFTA partners. That’s a reality. That ain’t tunafish or chopped liver; that’s real stuff. The reality is that in the United States we are deeply dependent upon this relationship. The realization of that dependence led major industrial segments, including automotive and so on, to say on September 12, “Do not close these borders, because if you do, you’re going to throw hundreds of thousands of Americans out of work.”²⁷

Furthermore, as the United States takes an aggressive stance on trade remedy actions, Canada and Mexico may wonder how best to deal with such political decisions, which may have social and economic repercussions throughout North America. Aaron Cosbey of the International Institute for Sustainable Development notes that in the environmental context, the way to deal with U.S. unilateralism “is to try to make the case to the United States that they are suffering as a result of their policies.”²⁸ The Committee agrees that in relation to the softwood lumber and other disputes, this sort of advocacy —  which is addressed in greater detail in Chapter 5 — is certainly one strategy that deserves consideration by Canada for implementing as effectively as possible. Moreover, the Government of Canada should “stay the course” with respect to its legal strategy in the dispute over softwood lumber while at the same time providing WTO-consistent assistance to the industry and affected communities.

A trade agreement is a political compromise. William Kerr describes this compromise within NAFTA as one lying “between the need at times to be able to respond to requests for protection from those suffering from short-run economic hardship or long-run deterioration in their international competitiveness and the desire of firms that wish to engage in international commerce for strong rules to protect their investments from some capricious acts of foreign governments.”²⁹ A sixth theme expressed by many witnesses is that this political compromise that is NAFTA may be skewed in favour of corporate rights. Stephen Clarkson describes NAFTA as a component of Canada’s “external constitution” because it places limits on government action and creates rights and institutions for certain categories of trade-related activity.³⁰ Pointing to the Chapter 11 investor-state provisions, he describes as an “aberration” the fact that NAFTA gives foreign corporations the right to sue governments. These provisions are discussed in detail below; suffice it to say here that Clarkson is not alone in this opinion. Michael Bradfield of Dalhousie University expands on the issue and proposes a possible solution:

… I would think that every trade agreement we go into should state in the preamble that nothing in the agreement supersedes the right of countries to act in the welfare of their people or for the protection of the environment, and nor can anything in that trade agreement abrogate such international agreements as the Universal Declaration of Human Rights, the International Labour Organization conventions, and things like that. What we get now is that these trade agreements supersede all of those other things, individual nations’ legislation and international conventions. And that’s basically saying that a tool, a hammer, can be used to smash whatever you want to smash. The law should say that a hammer is used to build buildings, not to smash things. The problem is, the focus of these agreements just assumes, even when there’s very little evidence to support the assumption, that corporations will act in the public interest.³¹

Regardless of the form any future North American integration may take, we must remember the continent does not exist in a vacuum. It is important to be aware of the global international trade context within which North America fits. Hemispheric negotiations are underway to attempt to create a Free Trade Area of the Americas (FTAA) by January 2005. In November 2001, the World Trade Organization (WTO) launched a new round of trade negotiations in Doha, Qatar, entitled “Doha Development Agenda,” and the new Director General of the WTO, Supachai Panitchpakdi, has announced his intention of completing these trade talks by mid to late 2004.³² Mexico will host the September 2003 WTO ministerial meeting in Cancun. Canada is also playing a leading role in this international trade forum, as earlier this year Sergio Marchi, Canada’s Ambassador to the WTO, was named Chair of the WTO General Council, the body that coordinates the WTO’s regular work program and that oversees the new round of global trade negotiations.³³ And, of course, the United States will be negotiating with renewed vigour and enthusiasm now that the Bush administration has been granted its coveted “fast track” or trade promotion authority.³⁴

These highlights in the global arena set the context for a final introductory theme: some have suggested that perhaps our attention should be focused on the WTO forum as the route to obtaining the greatest long-term benefit for all. Joseph Nye of Harvard University justified such a focused approach to free trade as follows:

I think we ought to be placing our greatest emphasis on completing the WTO round that was announced at Doha. I think there is a legitimate role for regional free trade arrangements, but we should think of them in the context of the old article 24 of GATT: they should be more trade-creating than trade-diverting. A world in which we allowed regional arrangements to divert trade away from global trade would not be a better world. We have to remember a larger perspective, which was expressed at Doha, but remains very important, that half the world’s people live on under $2 a day. … So we really have to keep an eye on making sure we don’t look to narrow versions of free trade that make us feel better in one dimension and get us off the hook on what we’re really doing on these larger questions of bringing developing countries into opportunities to prosper through trade.… I think, as we make judgments like how we should approach hemispheric free trade, how we should deal with our objectives in free trade, we ought to be very careful to ask ourselves whether we are doing something that will lead to a stronger, better international economic system that benefits poor people in poor countries.³⁵

While in agreement with Professor Nye’s comments, the Committee sees no reason why we cannot simultaneously focus on both the global and the North American trade contexts. Vision and initiative are required to maximize the potential of each. Clearly, there are some key issues and questions — and disputes, some brand new, some long-simmering — that have arisen or evolved in these first eight years of NAFTA and that need to be addressed: the unfinished business within the NAFTA framework. As Minister for International Trade Pierre Pettigrew recently commented, “we must not stand
still. We must not be complacent. Much like the bicycle theory of trade negotiations — as soon as you stop advancing, you stumble — the same is true for our North American agenda.”³⁶

B.  The Prevention and Resolution of Trade Disputes

Trade disputes most often arise from the unilateral imposition of protectionist measures — such as subsidies, tariffs or quotas — by a country attempting to insulate its own industries and economy from international trade competition. The aim of CUFTA and NAFTA was to prevent unilateral protectionism and to remove existing protectionist measures; in theory, under NAFTA, there should not currently be any such measures with respect to trade between Canada, Mexico and the United States. In reality, we know this is not the case as we hear about the extremely large, punitive tariffs the U.S. Customs Service is collecting from Canadian softwood lumber producers at the Canada-U.S. border.

Many witnesses before the Committee focused on, and expressed deep frustration over, what was commonly referred to as “U.S. protectionism” or “U.S. unilateralism”. Robert Keyes of the Canadian Chamber of Commerce made reference to a recent International Chamber of Commerce meeting he had attended where representatives from 82 countries universally condemned U.S. trade policy and its protectionist elements.³⁷ During our March meetings in Mexico City, Enrique Berruga, the Mexican Under Secretary of Foreign Affairs, spoke of the need for Canada and Mexico to have a joint approach to the protectionist attitude of the United States. The Canadian Wheat Board’s Larry Hill called for effective disciplines on abusive U.S. export credits and argued that it would make no sense to increase harmonization of our economic systems while the massive agricultural subsidies under the U.S. Farm Bill are in place.³⁸

Other witnesses pointed to the obvious U.S. protection of its shipbuilding industry under the Jones Act, which is something “the Americans have never wanted to let go of,” according to Ivan Bernier of Laval university.³⁹ Andrew Wynn-Williams, speaking for the British Columbia Chamber of Commerce, addressed the U.S. allegations that Canadian softwood lumber producers are unfairly subsidized by describing the situation as “a productivity issue and a quality of wood issue that makes our product much more attractive and much less expensive. The whole subsidy concern in the U.S. is driven by market share. All it boils down to is that they want protection of their market share.”⁴⁰ David Orchard argued that CUFTA and NAFTA actually increased American protectionism against Canadian exports by placing a new layer over the GATT processes, a layer that enables the United States to act according to its own trade laws.⁴¹

Protectionism, however, exists, and has always existed, around the world. It cannot be avoided, especially in a democracy. Joseph Nye recounted his analysis of the history of Canada-U.S. trade disputes and explained the relative inevitability of some amount of protectionism in a democracy:

… what struck me was how many of the disputes, fisheries, lumber, trade issues, water, were there in the 1920s and 1930s and continue this day. I think the larger question of protectionism is endemic in all democracies. In a democracy people who feel intense damage or intense concerns tend to be more politically active and mobilized, and they tend to speak to their Member of Parliament or their member of Congress and push harder. It often turns out that the producers are more easily organized than consumers. The net result is that all democracies have a certain amount of protectionism — the squeaky wheel gets the grease.⁴²

The Committee believes the way to prevent and resolve trade disputes is not to attempt to eliminate protectionism — a virtual impossibility and a recipe for perpetual frustration — but to ensure it is played out within a rules-based environment where the most problematic and damaging cases of unilateral protectionism can be dealt with directly, fairly and quickly.

1.    The Importance of a Continental, Rules-Based Approach

… it is very much in Canada’s interest, because of its relative size to the United States, because it is a smaller economy, because it is a smaller country, because we are so dependent on trade and on access to markets and, in particular, on access to the United States’ market, it is in Canada’s interest always to have a comprehensive rules-based system in place that allows us not simply to depend on the kindness or generosity of our trading partner, but rather on the existence of clear rules, which are enforceable, which are transparent, and whose adjudicative value is widely and broadly accepted by the parties to the dispute.

Robert K. Rae, “The Politics of Cross Border Dispute Resolution,”
Canada-United States Law Journal, Vol. 26, 2000, p. 66.

Canada entered the negotiations on CUFTA intending to emerge with a mandatory, rules-based dispute settlement system that would govern the implementation of the agreement and serve as a secure route for Canada to challenge U.S. protectionist actions without the asymmetry of U.S. power playing a role in the process.⁴³ In speaking of a “rules-based” system, the Committee is referring to a system of dispute resolution based on the adjudication of legal rules by an independent and impartial body, as opposed to a more power-oriented system that is based on diplomacy and consensus, and that is much more susceptible to political influence. The dispute settlement system that Canada obtained through the CUFTA — and later NAFTA — negotiations is only partly rules-based. Some of the rules leave open the possibility of political intervention, such that Canada, and now Mexico under NAFTA, is still susceptible to the adverse effects of U.S. political decisions and power.

Numerous witnesses before the Committee were adamant about the necessity for a continental rules-based system to deal with trade disputes. Reginald Stuart of Mount Saint Vincent University underlined the preventative function of a rules-based system. He felt that “the rules-based system was the very best way to go, because it removed a wide number of issues from the table. Setting up an elaborate system, going through the NAFTA tribunals, and so on, has actually discouraged a lot of these things from coming forth.”⁴⁴ Richard Ouellet of the Institut québécois des hautes études internationales put it bluntly: “The trade dispute settlement system between Canada and the USA must work well for integration to work well.”⁴⁵

While acknowledging that the dispute settlement mechanism could be improved, Brian Crowley of the Atlantic Institute of Market Studies argued “we must always strive to move trade issues into a rules-based arena. That was one of the primary motivations behind the free trade agreement. If you don’t have a treaty in which there are rules set down and in which you know how you’re going to resolve disputes, you are always at the mercy of the more powerful partner.”⁴⁶ Don Barry of the University of Calgary also underlined the asymmetries and noted, “[i]t is in our interests that as much of our interaction as possible takes place within a framework of rules in which issues are settled on the basis of agreed standards rather than sheer power. Moreover, Canada should not hesitate to use these rules to challenge unfair U.S. trade policies.”⁴⁷

The DFAIT Assistant Deputy Minister for the Americas, Marc Lortie, explained that Mexico is fully aware that it needs to improve the rules-based character of its system if it wishes “to be a welcome land for foreign investment.”⁴⁸ Danielle Goldfarb of the C.D. Howe Institute felt that any rules-based structure is positive for Canada, as well as for Mexico, but argued that we need “a more established rules-based framework, one where we’re expanding that beyond what we have currently. … Clearly, the framework we have in place is not strong enough to deal with a number of the serious disputes that have been going on for a long time.”⁴⁹ American scholar Robert Pastor also used his testimony to urge Canada to fashion and press for a North American agenda of rule-making and institution-building:

… Canada’s leadership has always been in developing international rules and institutions. These are most needed right now in North America today. They give you the greatest defence from the power of the United States. The United States will not always follow all the rules — we know the history — but by and large it will accept the institutions and the rules. So leaving these wide areas open for just sheer power to have its effect confuses me, from your perspective. Why shouldn’t you take advantage of your greatest strength, which is developing rules and institutions?⁵⁰

Witnesses were cautious, moreover, of Canada engaging in ad hoc arrangements — especially with the United States — outside of a rules-based framework. Danielle Goldfarb felt that such an “issue by issue” approach is fine with respect to Chapter 19 binational panel reviews of the “overzealous use of U.S. trade remedy laws,” but it does not constitute a “strategic vision of where Canada wants the North American relationship to go.”⁵¹ Louis Bélanger of the Institut québécois des hautes études internationales summed up a common theme:

I think we must start by resisting the inclination to deal with each cooperation problem with the United States on an ad hoc basis. This is what they will inevitably try to do in the case of the economy and security. So we must try to resist the temptation to establish quick dispute settlements with them in exchange for sacrificing future advantages. As we have seen clearly in the case of softwood lumber and the security perimeter, the Americans get us to negotiate ad hoc arrangements, non-institutional arrangements, arrangements outside NAFTA, and outside institutional agreements. I think there’s often a great temptation to reach quick compromises with the Americans, because there are some urgent short-term economic gains for us. However, I think that if we do this, we are agreeing to an approach that is a losing one for Canada.⁵²

The Committee accepts the view that Canada must deal with trade disputes through continental, rules-based solutions and institutions. The asymmetrical power structure of the NAFTA relationship puts both Canada and Mexico at a distinct disadvantage when negotiating with the United States outside of a rules-based infrastructure.

Recommendation 15

The Government of Canada should resist the temptation to seek short-term gains through reactive, ad hoc solutions to trade problems with NAFTA partners. Wherever possible, trade disputes should be addressed through rules-based, institutional mechanisms, and the Government should use its best efforts to improve and expand such mechanisms on a continental basis.

2.    Existing NAFTA Dispute Settlement Mechanisms

The key dispute settlement provisions under NAFTA may be divided into four broad categories:

The Chapter 11, Chapter 19, and environment and labour systems are each addressed in turn later in this chapter. Chapter 20 is addressed first because it is the dispute resolution system used for the general interpretation of NAFTA, and it is the default mechanism employed when a dispute does not come within one of the specific categories.

Dispute settlement mechanisms play a major deterrence role. The fact of their existence should be enough to prevent disputes from arising. Of course, the only way for this preventive function to work is for the mechanisms to be perceived as enforceable, and thus actually to be enforceable. Without such “teeth” the credibility of the mechanism is diminished. The Chapter 20 mechanisms are not enforceable; that is, they do not result in conclusions that are binding on the parties to the dispute.

When a dispute arises, the first step is consultations between the parties.⁵⁴ If the consultations do not resolve the dispute, the next step is a meeting of the NAFTA Commission, which is a political body composed of ministerial-level representatives from each party or their delegates.⁵⁵ This step enters the realm of diplomacy and power-based negotiations, thus derailing the rules-based focus of the system. If the NAFTA Commission is unable to resolve the dispute, the third step is for one of the parties to request that an arbitral panel be established.⁵⁶ The panel is composed of independent trade specialists from each country. After hearing from each party, it produces a report with recommendations that are not automatically binding on the parties; thus, the final decision on the dispute remains in the hands of the parties and is susceptible to diplomacy and power politics.

Commentators on this process have highlighted these shortcomings as follows:

The parties thus participate to a large extent in the settlement of their dispute as the negotiations that take place between them following the report are a determining factor in the outcome. The parties must, indeed, agree on a mutually satisfactory solution, which “normally shall conform with the determinations and recommendations of the Panel” (Art. 2018(1) of NAFTA [emphasis added]). It is therefore the disputing parties themselves who define ultimately the outcome of the dispute, the Commission having no role at this stage.… In practice … the parties use the Panel’s report as a basis for negotiations, the report therefore marking the beginning of new negotiations rather than the end of the dispute. Consequently, the final settlement of the dispute is more a matter of bilateral
negotiations — between the interested Parties — than a matter of jurisdictional logic. The settlement is thus left in the hands of the stronger party, which, in the absence of any mechanism of appeal or review of the negotiated solution, is actually very weakly constrained by the Panel’s report. This particularity of the North American dispute settlement mechanism is probably the main structural factor which explains its perviousness to the political factor.

Another indication of the jurisdictional weakness of NAFTA’s general dispute settlement mechanism is the non-binding nature of the Panel’s recommendations. Technically, the Panel’s recommendations — like those of the Commission — do not bind the United States, Canada or Mexico. This lack of binding force not only affects the final report of the Arbitral Panel, but also, indirectly and to some extent, the disputing Parties’ negotiated solution.⁵⁷

It is important to point out that these shortcomings do not exist in the dispute settlement procedures under the WTO, which are laid out in the WTO Dispute Settlement Understanding (DSU).⁵⁸ Disputes are administered by the WTO Dispute Settlement Body (DSB), which is composed of all WTO members and which chooses panels for specific disputes.⁵⁹ The panellists may not be citizens of either of the parties to the dispute, thus highlighting the third-party-adjudication nature of the WTO process. There is no equivalent in the WTO to the politically oriented NAFTA Commission, which enables the NAFTA parties to play a direct role in the resolution of their own dispute. As William Kerr has noted, in the WTO system “the implementation stage is not politicized. In short, the general NAFTA disputes system is less transparent than the WTO’s and hence increases the risks of investing in international trade activities for firms in Canada and Mexico.”⁶⁰

Furthermore, reports by DSB panels are binding on the parties,⁶¹ unlike the situation under NAFTA Chapter 20, where the panel’s recommendations may simply lead to further politically susceptible negotiations between the disputing parties. Use of the WTO route is not simply wishful thinking. Article 2005 of NAFTA states that disputes arising under both Chapter 20 of NAFTA and the GATT “may be settled in either forum at the discretion of the complaining Party.”⁶²

The most salient comments with respect to reforming Chapter 20 were put forward by Antonio Ortíz Mena of the Centro de Investigación y Docencia Económicas during our March 2002 meetings in Mexico City:

Chapter 20 panel decisions must be made binding. At present, panels are only entitled to issue recommendations but the flexible nature of the general dispute settlement mechanism has become more of a liability than an asset, and it is unwarranted given that WTO dispute settlement proceedings now call for binding panel rulings. The change could be achieved through a memorandum or protocol subscribed by the chief executives of all three countries and need not entail renegotiating NAFTA.⁶³

The Committee agrees. A dispute settlement mechanism must have the capacity to actually settle the dispute, not simply formalize negotiations within a semi-rules-based structure. To call such a structure an effective and enforceable dispute settlement mechanism is an exercise in hypocrisy. The Committee is hopeful that by working together and pointing to the globally accepted example of the WTO DSU, Canada and Mexico could convince the United States to modify the shortcomings of Chapter 20 described above. In particular, for greater certainty and in order to avoid any undue politicization of the dispute resolution process, the final reports of arbitral panels should be made automatically legally binding on the parties to the dispute, and the transparency of the process should be increased. If such modifications prove impossible to achieve, Canada, and Mexico if it so chooses, should at every opportunity choose the multilateral WTO dispute settlement forum for disputes that arise under Chapter 20 of NAFTA.

Recommendation 16

The Government of Canada should work with Mexico to encourage the United States to agree to improve the rules-based foundation of the general dispute settlement mechanism in Chapter 20 of NAFTA. The final reports of arbitral panels should be made automatically legally binding on the parties to the dispute. In the event that such a change is not possible, the Government should strive to make maximum use of the multilateral dispute settlement mechanisms under the WTO for resolving disputes that arise under Chapter 20 of NAFTA.

In addition, the Government should work towards increasing the transparency of the dispute settlement process by releasing all documents relevant to a proceeding, without causing prejudice to companies. The Government should also work toward increasing the openness of the process by enlarging participation beyond the NAFTA states to interested third parties, such as provinces, non-governmental organizations and others.

3.    The Trade Remedy Law Bugbear and NAFTA’s Chapter 19 Binational Panel Process

In a recent address to the Canadian-American Business Council, International Trade Minister Pierre Pettigrew stated that one of the key goals in building an improved North America is to make “serious efforts to bring trade remedy practice more in line with the growing integration of our shared North American economic space.”⁶⁴

The main reason for Canada entering CUFTA, which entailed relinquishing a large measure of Canadian sovereignty, was to secure unhindered access to the U.S. market. The cornerstone of this strategy was to obtain an exemption from the application of
U.S. trade remedies — in particular, anti-dumping (AD) and countervailing duties (CVDs) — found in U.S. domestic trade legislation. A brief review of the CUFTA negotiations in the late 1980s reveals why the access that Canada — and later Mexico through NAFTA —gained to the U.S. market under the free trade agreements was far from secure and unhindered. This is perhaps our most significant piece of unfinished NAFTA business.

The U.S. negotiators flatly refused the AD/CVD exemption proposal because they believed Canadian products were being subsidized and that U.S. producers required the protection of its domestic AD/CVD law.⁶⁵ The U.S. position on this matter was so entrenched that had Canada persisted, the free trade talks would have ended. Canadian negotiators then suggested that competition legislation replace anti-dumping duties in CUFTA, and that a common code on subsidies be negotiated — including a definition of what constitutes a subsidy — to minimize the use of countervailing duties.⁶⁶ These proposals were unsuccessful, as the Americans were unwilling to go beyond the GATT rules at that time and insisted on maintaining their trade remedy laws.⁶⁷ The U.S. government vehemently disagreed with Canadian claims that U.S. trade remedy
practices were inherently “politicized” — because they were decided solely in U.S. institutions — but to break the deadlock in negotiations, the U.S. put forward an interim solution whereby the existing judicial review of AD/CVDs by U.S. courts would be replaced with review by binational panels consisting of trade specialists from both countries.⁶⁸

During the NAFTA negotiations, Mexico, like Canada under CUFTA, was also seeking “secure” access to U.S. markets — as well as to Canadian markets — and thus fought hard for inclusion in the binational panel dispute settlement mechanism. This was granted on the condition that Mexico significantly amend its trade laws and administrative review processes to make them more explicit and transparent, more in line with Canadian and U.S. laws.⁶⁹ Thus, the binational panel system was included in NAFTA as Chapter 19, largely as it had existed in CUFTA. For Canada, maintaining the status quo was in itself a significant victory. Some U.S. politicians viewed the binational panel system as an unacceptable constraint on American sovereignty, and there was considerable U.S. Congressional pressure to downgrade or completely dismantle the Chapter 19 process.⁷⁰

The binational panel system under Chapter 19 has continuously generated voluminous commentary — our hearings for this report being no exception — and has been a key element of several of the major disputes, including those over softwood lumber, agriculture subsidies and steel. Over 80% of the disputes under NAFTA have related to AD and CVD and have thus come under Chapter 19.

The success of Chapter 19 in keeping many North American protectionist actions in check is indisputable. Some of the proof of this success is well-documented in the recently released instalment of the C.D. Howe Institute’s Commentary series, “The Border Papers.” The essay, by Washington Trade Lawyer Patrick Macrory, entitled “NAFTA Chapter 19: A Successful Experiment in International Trade Dispute Resolution,” makes the case that Chapter 19 “has been quite effective in curbing what Canadians believe to be the overzealous enforcement of AD and CVD laws by U.S. authorities.”⁷¹ Macrory notes that “only six Canadian products other than softwood lumber are currently subject to AD and/or CVD orders, and in most cases the volume of trade involved is small and the current duty level low.”⁷² He also emphasizes that “[s]ince the creation of NAFTA, imports from Canada and Mexico have been subject to far fewer investigations and orders than imports from other parts of the world, perhaps as a result of the increased integration of their economies with that of the United States.”⁷³

A fundamental feature of the Chapter 19 dispute settlement system is that binational panels do not create or apply new law, nor do they apply trilateral substantive legal rules on AD/CVD (such rules do not exist): they simply review the application of the domestic law of the importing country to ensure it was correctly applied.⁷⁴ Thus, in the case of a U.S. attack on Canadian policy, the panel would review the U.S. government agencies’ actions to ensure their consistency with U.S. domestic trade law.

Another key feature is laid out in Article 1903 of NAFTA, which specifies that if one party to the agreement makes amendments to its domestic AD/CVD laws and these amendments would affect another party, the affected party can request that the amendments be referred to a binational panel for a declaratory opinion as to whether they conform with the free trade objectives of NAFTA or the provisions of the GATT and the WTO Agreement on Subsidies and Countervailing Measures. The existence of this provision holds special relevance in the context of the softwood lumber dispute cases. Box 2 provides a brief overview of the dispute and the particular cases.

In 1994, the United States lost another of its many challenges to Canadian softwood lumber pricing and allocation policies under the CUFTA binational panel system. Following this panel decision in favour of Canada, which occurred just as the United States was preparing its WTO implementation legislation, the U.S. government seized the opportunity and amended its trade remedy legislation to reverse the most controversial aspects of the binational panel’s decision. Canada criticized the U.S. legislation with respect to its implementation of the results of the Uruguay Round of international trade negotiations, but surprisingly did not resort to Article 1903 of NAFTA and request a declaratory opinion on the conformity of the amendments with international trade rules. Commentators have suggested this is an indication of the weakness of the Chapter 19 rules, as the Canadian government may have assumed that a binational panel declaratory opinion would taint future Canada-U.S. relations and that the United States would simply disregard it.⁷⁵

Prior to CUFTA, any AD/CVD disputes originating in the United States were decided by U.S. agencies, and the only internal avenue of appeal was resort to judicial review of the governmental decisions by domestic courts. Chapter 19 binational panels now replace this judicial review process. The panels consider the record of the case and decide whether the final determination of the government agency is supported by evidence and is in accordance with domestic law. It is noteworthy, and has been problematic for Canada, that only the final AD/CVD determinations of domestic agencies can be reviewed through the binational panel process.

For example, on August 9, 2001 the U.S. Commerce Department issued a preliminary subsidy determination in its most recent countervailing investigation of Canadian softwood lumber.⁷⁶ Based on this preliminary determination, on September 4, 2001 the United States began collecting CVDs at the border on Canadian softwood lumber, retroactive to May 17, 2001. However, the final determination of the U.S. Commerce Department was not published until April 2, 2002, and it was only at this point that Canada could request a NAFTA binational panel review of the decision. Thus, Canadian producers were required to pay CVDs for almost a year before the binational panel process even began. In response to a question from a Committee member about how Canadian producers go about getting that money returned, Bob Flitton of Doman Industries Limited replied: “How do you get it back? You don’t get it back. ... Legally, technically, you should be able to go and get it back, but you’ll never collect it. It’s lost.”⁷⁷

Recommendation 17

When a NAFTA binational panel finds that the final determination by a government agency to impose anti-dumping or countervailing duties was in error, all duties should be repaid by the domestic authority to the foreign exporter. The Government of Canada should therefore propose to its NAFTA partners a formal system for the repayment of all duties, retroactive to the date set by any preliminary and/or final determination imposing duties.

Although it is still the domestic law that is being applied under Chapter 19, the binational panel process was intended to be more transparent — given that each country supplies panellists — and also faster, because Chapter 19 specifies that a final decision should be rendered within 315 days from the date when the request for a panel is made.⁷⁸ Panels are composed of five persons selected from a roster for which each country has chosen at least 25 candidates, a majority of whom must be practising or retired lawyers or judges.⁷⁹ Each country that is party to a dispute chooses two panellists, who then choose the fifth together; traditionally the fifth panellist has alternated between countries from dispute to dispute. The panel is limited to the administrative record before it and must use the standard of review of the domestic law in question. While panel decisions are binding on the parties to the dispute in question, they do not create law and cannot serve as binding precedents for other cases. Panels may uphold, overturn or remand the determinations of the domestic authorities. A panel decision may be appealed to an Extraordinary Challenge Committee (ECC), though only with respect to serious procedural violations by the panel or a panellist.⁸⁰ Furthermore, the ECC cannot set aside a decision unless it finds that the procedural error “materially affected the panel’s decision and threatens the integrity of the binational panel review process.”⁸¹

Is the binational panel review process under Chapter 19 of NAFTA working? In addition to the above-noted endorsement by Patrick Macrory, the Committee heard generally positive assessments of the Chapter 19 track record to date. Danielle Goldfarb of the C.D. Howe Institute felt that it “has provided a reasonably good check on the overzealous use of U.S. trade remedy laws. Many practitioners have noted that rulings under the Chapter 19 mechanism have been based on law rather than politics.”⁸² Laura Macdonald of Carleton University was not optimistic about Canada getting a better mechanism in the North American context “just because the United States is so dominant in North America, it’s the hegemon of the region, and obviously doesn’t want to set up more adequate mechanisms or include issues like softwood lumber that are very politically difficult. So I would tend to think, … it might be better to rely on WTO mechanisms, rather than expecting a better mechanism in North America.”⁸³ While others also suggested relying more on WTO mechanisms, Donald MacKay, who was a NAFTA negotiator for Canada and is currently with the Canadian Foundation for the Americas (FOCAL), compared the WTO and NAFTA processes and highlighted the unparalleled efficiency of the latter:

… when discussing dispute settlement, what you’re essentially saying is that governments or countries are voluntarily giving up a small portion of their sovereignty in respect of their ability to make decisions internally unilaterally. Chapter 19 multilateralized that, if you will, to the three parties with binational panels. No such mechanism with respect to anti-dumping and countervailing duties exists in the WTO. In the Uruguay round of negotiations there was an updating of the dispute settlement mechanism within the WTO, but with the timelines, cost factors, all of those sorts of categories, if you match them out between the NAFTA mechanism and the WTO mechanism, you will find that the NAFTA mechanism is more rapid. Even though it is, to many parties, too slow, it is faster than anything that exists out there at the multilateral level. It can obviously be improved, but that requires a movement on the political side.⁸⁴

The Committee heard that the only way to truly solve any shortcomings of the Chapter 19 process would be to find a way to get beyond the protectionist reach of U.S. AD/CVD laws. Don Barry of the University of Calgary felt the dispute settlement process was working “reasonably well.”⁸⁵ The real problem, he argued, is the lack of uniform trade laws. Michael Bradfield of Dalhousie University felt that it was fine to “have access to dispute resolution mechanisms that allow us to have our say about whether they are applying their laws properly, but that doesn’t prevent them from putting in anti-free-trade laws, which they have on the books now, and which they’re quite prepared to put on the books again.”⁸⁶ A lasting solution, he argued, would be for the United States “to really make its internal legislation consistent with free trade.” Similarly, Stephen Clarkson described the major failure of CUFTA and NAFTA as the fact that Canada, and Mexico with respect to the latter, did not get exemptions from the AD/CVD laws of the United States.⁸⁷

While the Chapter 19 binational panel system is in many ways a rules-based dispute settlement system, it is based on a hybrid set of substantive law: the
domestic anti-dumping and countervail law of Canada, Mexico, and the United
States. Furthermore, while the rules tend to work most of the time, it is the highly politicized disputes involving major economic interests — such as the softwood lumber dispute — that highlight the shortcomings of the Chapter 19 system and its inevitable susceptibility to political motives. The Committee supports the use of the NAFTA system — and the WTO system where appropriate — but is persuaded that the best way to prevent and resolve disputes would be to have a single set of North American AD/CVD rules in place.

During the CUFTA negotiations, it was understood that the binational panel system was to be a temporary measure that would be effective for five to seven years pending the development of a new, common AD/CVD regime.⁸⁸ Furthermore, Article 1907 of CUFTA called for the parties to set up a working group to develop more effective rules and disciplines concerning the use of government subsidies and the potential for reliance on a substitute system of rules for dealing with unfair transborder pricing practices and government subsidization. The development of this new regime by the working group went nowhere. Under NAFTA, the binational panel system became permanent. The working group was dropped, and instead the parties agreed to regular, general consultations on a new AD/CVD regime. The Committee feels these consultations should be vigorously pursued by the Canadian government with a view to actively engaging Mexico and the United States on the development of a North American AD/CVD regime.

We are well aware that given the protectionist bent of the current U.S. administration, such consultations may not go very far, if anywhere. And we take the point of Patrick Macrory in his Chapter 19 study, that even modest steps to alleviate the impact of U.S. trade remedy laws may be unrealistic in the current climate. However, we feel it is important to keep the issue in the forefront and on the minds of policy-makers, and thus to address it directly whenever possible.

Recommendation 18

The Committee supports the ongoing use of the Chapter 19 binational panel review procedure — and, where appropriate, the WTO dispute settlement system — and recommends that the Government of Canada continue to pursue all possible legal avenues for the efficient resolution of current trade disputes, especially the softwood lumber dispute.

Recommendation 19

Taking into account similar negotiations currently underway in the WTO forum, the Government of Canada should vigorously pursue consultations with Mexico and the United States under Article 1907 of NAFTA in order to actively engage them in the development of a common North American anti-dumping and countervail regime.

4.    To Link or not to Link?

The question of whether or not to link one trade sector with another — for example, using Canada’s energy resources as leverage in the softwood lumber dispute — was addressed by several witnesses before the Committee. The issue has arisen most prominently in the softwood lumber dispute where there have been aggressive calls by stakeholders — such as John Allan, President of the B.C. Lumber Trade Council — to link our trade with the United States in softwood lumber to exports of other commodities as a way of resolving the bitter dispute.⁸⁹

Most witnesses, however, were extremely cautious of linking sectors. Professor Don Barry of the University of Calgary thought the possibility of any “trade-offs” with the United States would be very limited in the midst of the current “war on terrorism,” which when coupled with “a very narrow and circumscribed view of American interests” indicates that “[i]t is really U.S. domestic politics that will determine the outcome of a whole range of economic issues that are on the table between Canada and the U.S. at this time.”⁹⁰ Harvard University’s Joseph Nye honed in on the underlying, recurring reality of the obvious power asymmetries that exist in the NAFTA relationship:

I would be a little bit suspicious of linkage, because you might say we’ll link gas or we’ll link water to this, then the Americans may link something even bigger. So before you get it all wrapped in one ball of wax, you ought to ask, is that the best strategy for Canada? I suspect probably not.⁹¹

Using linkage as a form of retaliation was also strongly discouraged. Professor George MacLean of the University of Manitoba agreed that domestic U.S. politics play too great a role in the Canada-U.S. relationship — which he described as a “tenuous”
one — to risk retaliation through linkage.⁹² Using the softwood lumber dispute as an example, he noted that

[t]hrowing a sector that works, such as gas, into that and saying we’re going to use this in retaliation could be a tremendously risky thing indeed, especially if the Americans were to say they are willing to actually fly in the face of WTO rulings or NAFTA tribunal rulings on this issue of softwood lumber for political reasons, for strictly political reasons. If they’re willing to do that, what would they be willing to do in terms of other sectors?

Similarly, Donald MacKay of the Canadian Foundation for the Americas (FOCAL) noted that for a country as “trade-oriented” as Canada, using retaliation “inevitably winds up hurting us more than it helps us.”⁹³

The Committee agrees. Linkage for the purposes of dispute settlement or retaliation is simply too risky, given the obvious power differentials that Canada and Mexico have with the United States. In devising prudent and effective Canadian strategies for countering U.S. protectionist actions, Canada should focus on addressing each dispute on its own terms within a rules-based framework.

Recommendation 20

The Government of Canada should generally refrain from linking different trade sectors as a strategy for retaliation or dispute resolution. Canada should focus on addressing each dispute on its own terms, and within a rules-based framework.

C.  Addressing the NAFTA Chapter 11 Controversy

“‘Chapter 11’ is a well-known phrase in the United States: it is the term used when someone seeks
court protection to avoid an impending bankruptcy. But under the North American Free Trade Agreement — NAFTA — Chapter 11 has another meaning. It is the part of NAFTA that deals with the protection of foreign investors from Canada, Mexico and the United States when they invest in one of the other NAFTA countries. For some, Chapter 11 is a vital requirement in promoting the free flow of capital in
an increasingly open North American market. For others, Chapter 11 represents another kind of bankruptcy — the bankruptcy of public policy and international law-making in the era of economic globalization.”

Howard Mann, Private Rights, Public Problems:
A Guide to NAFTA’s Controversial Chapter on Investor Rights,
International Institute for Sustainable Development and World Wildlife Fund,
Winnipeg, 2001, p. 1.

Chapter 11 of NAFTA has proved to be one of the most controversial aspects of the Agreement. Whether the controversy is justified, or whether criticisms of Chapter 11 are grounded in substantive analysis, are common discussion points among commentators. In fact, substantive analyses of the provisions and their effects exist on both sides of the argument.⁹⁴ The issue is not so much the credibility of the interlocutors and their arguments, because the investor-state cases handled to date under the arbitral process set up under Chapter 11 largely speak for themselves,⁹⁵ and any interpretation of them depends primarily on one’s opinion on the larger underlying issue. The issue is simply one of policy: how to balance investment protection, including the corollary rights of private investors, with public control over governmental policy making. The mere fact that Chapter 11 has generated so much widespread commentary — whether based on deep analysis or pure emotion — indicates that something is seriously wrong with the status quo and signals pressing unfinished business within the NAFTA framework. Our hearings emphatically confirmed this message.

1.    How Chapter 11 Works

The aim of Chapter 11 is to liberalize and promote investment, especially foreign direct investment, by creating a rules-based framework that protects the investment interests of foreign investors from discriminatory or trade-distorting acts by the government of the host country where the investment is made. Such rules are nothing new. They have evolved out of bilateral investment treaties (BITs) — known as foreign investment protection agreements (FIPAs) in Canada — largely initiated by the United States in the late 1970s to protect American investments from political, economic
and legal instability in foreign countries.⁹⁶ Chapter 11 is unique because it builds on this objective in several respects: it promotes the general liberalization of international investment, and it does so by being part of a larger trade and investment
agreement — NAFTA — thus enhancing the probability of its provisions being broadly interpreted.

The most controversial part of Chapter 11 has been the investor-state dispute settlement process, which enables a private foreign investor to bring an arbitral claim against its NAFTA government host for an action the investor believes has decreased its profits or expected profits. Article 1110 of Chapter 11 states that a NAFTA government may not take measures “tantamount to nationalization or expropriation” of an investment unless it does so for a public purpose, on a non-discriminatory basis, in accordance with due process of law, and only if it pays compensation to the foreign investor.

The arbitral process is governed by international commercial arbitration rules.⁹⁷ The investor and the government each choose one arbitrator, and the third is chosen together or by a neutral third party. The results of the arbitration are binding on each party, and there are limited provisions for review or appeal of such awards. The actual arbitration proceedings are closed to the public unless the parties agree that they be open. (This has not occurred to date.) On July 31, 2001, the NAFTA Free Trade Commission released Notes of Interpretation of Certain Chapter 11 Provisions. These attempt to improve the transparency of the Chapter 11 processes and the clarity of application of the rules.⁹⁸ Under the Notes, each country agreed to make publicly available all documents submitted to or issued by a Chapter 11 tribunal, with the following exceptions:

However, as John Foster of the North-South Institute notes in his forthcoming assessment of NAFTA, “critics quickly pointed out that lacking actual amendment of the treaty, international arbitration rules would prevail, and that ‘the regime of secrecy provided for by the arbitral rules is both explicit and clear.’”⁹⁹

2.    Witness Perceptions of Chapter 11

A repeated message the Committee received from witnesses was that Chapter 11 requires reform. For example, Stephen Clarkson of the University of Toronto argued that the significance of Chapter 11 was not fully understood by the negotiators of NAFTA, and certainly not by the public.¹⁰⁰ As he writes in a new book on Canada-U.S. relations, because of the “supraconstitutional” effect of Chapter 11, “the issue is no longer which order of government — federal or provincial — should initiate a regulation. It becomes whether either order of government can initiate such legislation at all.”¹⁰¹ Lawrence McBrearty of the United Steelworkers of America claimed that NAFTA protects corporate investor rights but does not provide equally solid protection for labour, environmental or human rights.¹⁰²

Various commentators we heard from in Mexico City — including Professor Maria Teresa Gutierrez Haces and Professor Isidro Morales, both of the Universidad Nacional Autónoma de México, and Luis Tellez Kuenzler of the DESC Group — also felt that problems with Chapter 11 had to be resolved so that governments could effectively stand up to corporate pressures. Antonio Ortίz Mena of the Centro de Investigación y Docencia Económicas in Mexico City proposed that the three countries conclude a memorandum clarifying the scope and coverage of Chapter 11 with respect to environmental issues.¹⁰³

Aspects of Chapter 11 directly targeted for serious reform included: transparency, accessibility, long-term implications for natural resources, and the “regulatory chill” effect. Don Barry of the University of Calgary argued that the rules should be more clearly specified and that interest groups should have standing to participate in the process, to balance the influence of corporate interests.¹⁰⁴ Jack Harris, the Leader of the New Democrat Party for Newfoundland and Labrador, highlighted the Chapter 11 claim that Sunbelt Water Inc. of California has brought against Canada because of the cancellation by the British Columbia government of a licence to export bulk water.¹⁰⁵ He explained that the Newfoundland and Labrador government had received differing legal opinions on the export of bulk water: Canadian lawyers concluded bulk water exports by one province would not create a NAFTA-enforceable precedent with respect to other provinces, while an American lawyer stated that they would.

Aaron Cosbey of the International Institute for Sustainable Development argued that there is “no alternative to reform” and used the ongoing Methanex v. United States of America case to provide a concrete example of the potential for Chapter 11 to cause a “regulatory chill” for governments:

… a Canadian company, Methanex, is suing the United States over a regulation propounded by the government in California that bans a gasoline additive that the government has reason to believe is a carcinogen and has been found to be leaking in great quantities into California’s groundwater. That sort of regulation would normally be thought of as undertaken in the proper domestic capacity of government, and would not normally, according to the international tradition, be thought of as an expropriation. It’s what’s called at the international legal level a police powers measure. However, there is no explicit carve-out in the NAFTA Chapter 11 for police powers; therefore, Methanex as well as several other companies have decided to try the system and assert that this sort of regulatory measure, which has a visible, palpable impact on their investment, is an expropriation and is compensable. In this case, they’re asking for just under $1 billion Canadian compensation. The money itself is not really the big problem here. The problem is their objective to try to freeze that sort of regulatory action, not only in California, but in the other states in the United States that are proposing it.¹⁰⁶

Others argued that when critically assessing Chapter 11, its benefits must not be overlooked. Michael Hart of the Centre for Trade Policy and Law (CTPL) at Carleton University has written extensively on Chapter 11 and feels that the criticisms of its track record and its effects on governmental ability to make policy have been blown out of proportion.¹⁰⁷ Nonetheless, he and William Dymond, Executive Director of the CTPL, in the paper they presented at a January 2002 CTPL conference on Chapter 11, list several suggestions for reform, including clarification of its scope, increasing transparency, and setting up a permanent tribunal to deal with Chapter 11 claims.¹⁰⁸ Robert Keyes of the Canadian Chamber of Commerce echoed the theme first noted at the beginning of this chapter, that the majority of trade and investment activity under NAFTA occurs without any problems. He acknowledged that there is a need for clarification of the workings of Chapter 11 but urged the Committee to consider its investment protection benefits and give it more of a chance to prove itself:

I would hope that in this discussion over Chapter 11 we do not lose sight of basic principles of investor protection, of non-discrimination, and of fair treatment. That’s what underlies investor protection mechanisms, be they in bilateral agreements, of which Canada has twenty-some-odd; be they in NAFTA; be they, as they’re going to be, considered in terms of so-called Singapore issues within the Doha round. The fundamental core is to protect the rights of investors, and if we want to attract investors and we want Canadian investors to be abroad — and you’ll have seen the recent statistics on just how much Canadian investment there is
abroad — then these investors have to be assured they’re going to get fair treatment. Chapter 11 gets blamed for virtually everything, something I don’t agree with. It is a mechanism where I think the jurisprudence is still being written. As with any law and any mechanism, I think we’re still finding the boundaries.¹⁰⁹

The Committee agrees that protection for foreign investors is an important element of liberalized trade and the promotion of foreign direct investment. However, the Committee is convinced that there are serious problems with the existing Chapter 11 of NAFTA, in particular the investor-state dispute settlement process. These concerns are not new to us. In recent reports on the World Trade Organization and on the Free Trade Area of the Americas, we recommended that investor-state provisions should be excluded from any new agreements. Our opinion has not changed, and in keeping with these recommendations we feel that consideration should be given to a complete review of Chapter 11 of NAFTA, especially the investor-state process.

We are encouraged by the recent policy shift of the United States with respect to the protection of American companies from foreign expropriation under investment provisions like those of Chapter 11. In bilateral trade negotiations with Chile and Singapore, the United States is attempting to narrow the scope of what is considered an expropriation.¹¹⁰ For example, the U.S. proposal on investment provisions states that a “mere diminution” in the value of an investment does not constitute an expropriation. In the ongoing Methanex case, the company is arguing that it does. Crafted to respond to congressional and environmental lobby criticisms of Chapter 11, this policy shift indicates the United States would likely be willing to reassess aspects of Chapter 11. The Committee sees this as an opportunity for Canada — and Mexico — to propose action on a key piece of unfinished business within the NAFTA framework.

Recommendation 21

In light of the United States’ recent policy change with respect to aspects of Chapter 11 of NAFTA, the Government of Canada should review as soon as possible with Mexico and the United States elements of Chapter 11 that have proved problematic, in particular the investor-state provisions.

D.  Evaluating the State of Trade-Related Environmental and Labour Cooperation

The genesis of the side agreements to NAFTA on the environment and labour was primarily a result of U.S. political machinations that occurred after the main NAFTA agreement had been concluded in August 1992. Responding to the calls of environmental groups and labour unions that were furious because NAFTA did not address their concerns, presidential candidate Bill Clinton declared on October 4, 1992, that “he could support NAFTA only if it were accompanied by two supplemental agreements on environmental protection and labour issues. The purpose of the supplemental agreements, according to Governor Clinton, would be to ‘require each country to enforce its own environmental and worker standards.’”¹¹¹ In 1993, the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labour Cooperation (NAALC) were finalized.

1.    Environmental Cooperation

The NAFTA environmental experience is in many ways a model for the world because it weds trade with environmental considerations in a revolutionary way. There is no question that more could have been done in both NAFTA and the NAAEC to address environmental priorities, but the NAFTA example is an important start. A recent compilation of in-depth essays on the NAFTA environmental experience, Greening the Americas: NAFTA’s Lessons for Hemispheric Trade, provides a lucid and valuable overview of how the lessons from NAFTA can be used in future trade negotiations — on the Free Trade Area of the Americas, for example — to advance both economic integration and environmental protection.¹¹²

Of the existing NAFTA institutions, the North American Commission for Environmental Cooperation (CEC) created by the NAAEC is the most “institutionalized” in its design. This point was emphasized by its Executive Director, Janine Ferretti, who offered a rough comparison of the CEC, the NAFTA Free Trade Commission, and the North American Commission for Labour Cooperation:

You have the Free Trade Commission, which doesn’t have a body or a secretary in one place; it’s made up of sections of the three governments that get together and work together. So it’s a virtual organization in that regard. The second institution is the Commission for Labour Cooperation, and it’s a little bit of both. It has a secretariat based in Washington, but it also has very much engaged sections of the three labour departments, which meet and actually carry out some of the tasks we would do at the secretariat. So the Commission for Environmental Cooperation has probably the most personality of an international organization among the three. It has its headquarters here [in Montreal], we have a staff of 60 people from three countries, we have a liaison office, and the secretariat executes the work program of the commission. The work program is approved by the three governments.¹¹³

The CEC Council is made up of cabinet-level representatives from the three governments, who meet at least annually. There is also a Joint Public Advisory Committee with five non-governmental members from each country, who work together — though independently of their governments — to provide advice to the Council. Article 14 of the NAAEC enables individuals and non-governmental organizations to submit a complaint that one of the countries is not enforcing its environmental law. If the complaint meets with the criteria in Article 14, the CEC may further investigate by preparing a detailed factual record, and the Council may, by a two-thirds vote, then make the factual record public. Since 1995, 35 submissions have been made under Article 14 and three factual records made publicly available.¹¹⁴

The NAAEC also contains dispute settlement provisions essentially consisting of: first, consultations between the disputing parties; second, a special session of the Council; third, the convening of an arbitral panel; and fourth, the imposition of sanctions. To date, these dispute settlement procedures have not been used. In testimony before the Committee in 2001, environment and trade law expert Pierre Marc Johnson described the implications of using them:

These provisions have not had to be applied up to now because they’re pretty tantamount to a nuclear “press the red button.” If you say you’re going to challenge a country’s behaviour, when it comes to implementing its own environmental legislation, by saying that it is systematically not doing its job, you’re pretty close to a declaration of commercial war here before you go to sanctions.¹¹⁵

Both Janine Ferretti and Pierre Marc Johnson described how the NAAEC and the CEC have assisted with Mexican environmental infrastructure capacity-building. Ms. Ferretti emphasized, however, that Mexico “is going to have a very difficult time being a full and equal partner in NAFTA unless it has its environmental infrastructure in place and it can deal with the vulnerabilities that might occur.”¹¹⁶ She noted that Mexico’s cooperation is crucial in dealing with certain environmental problems — such as long-range transport of atmospheric pollutants — that are important to, but beyond the control of, Canada and the United States. Kathryn Harrison of the University of British Columbia spoke of how the CEC has played a critical role in facilitating Mexico’s recent decision to create a toxic release inventory modelled on the inventories in Canada and the United States and the CEC’s own North American Pollutant Release and Transfer Register.¹¹⁷

Witnesses generally pointed to the CEC as an example of an institutional model that is working well and that should be given more financial resources for its activities,¹¹⁸ but which also needs greater enforcement powers. Laura Macdonald of Carleton University’s Centre for North American Politics and Society spoke of the need to better address both social and economic disparities that have accompanied North American integration to date.¹¹⁹ She called for “stronger enforcement powers” and “more funding” for the CEC. Daniel Schwanen suggested that the CEC could play a “very useful role in the area of integration” by providing a successful example of how trilateral cooperation and decision making can work in practice.¹²⁰

The Committee agrees that adequate resources and enforcement powers are key to building on the successes of the CEC. We find it extremely troubling that powerful enforcement tools are available to private investors under Chapter 11 of NAFTA, while the dispute settlement mechanism under the NAAEC, which is aimed at environmental protection for the public good, is so politically sensitive that it is never even used.

Recommendation 22

The Government of Canada should discuss with its Mexican and American counterparts ways to ensure adequate funding and enforcement powers for the North American Commission for Environmental Cooperation created under the North American Agreement on Environmental Cooperation.

2.    Labour Cooperation

The North American Agreement on Labour Cooperation (NAALC) marks a watershed as the first agreement to substantively link labour rights and standards to an international trade agreement. Under the agreement, each country has made a commitment to enforce its own labour laws and standards and to promote 11 labour principles.¹²¹ The NAALC sets up a dispute settlement process that is extremely similar to that in the environmental side agreement, the NAAEC, as described above. It is noteworthy, however, that sanctions may be applied only with respect to complaints pertaining to three of the rights — minimum wages, child labour, and occupational health and safety. Other fundamental labour rights are not sanctionable, including the rights to organize, bargain collectively, and strike.¹²²

The NAALC creates an institutional framework that is slightly different, and effectively less independent, than that under the NAAEC. Each country has established a National Adminstrative Office (NAO), which tends to work closely with the labour ministry of that country. The key coordinating institution formed under the NAALC is the Commission for Labor Cooperation (CLC), which consists of a Secretariat based in Dallas, Texas, and a Ministerial Council composed of the three national labour ministers. Complaints about the labour practices of a country are directed to an NAO and may be resolved by consultations, a meeting of the Ministerial Council, or an ad hoc Evaluation Committee of Experts. Only cases pertaining to the three sanctionable rights noted above may go to arbitration and lead eventually to sanctions for non-enforcement.

The NAALC has given labour rights markedly enhanced public exposure in the trade context and provided a forum for trilateral labour research and cooperation. There have also been tangible indirect effects on governmental policy. John Foster of the North-South Institute writes that “[i]n the first three years of NAFTA the Mexican Government increased funding for the enforcement of its labour laws by 250%.”¹²³ However, the labour union witnesses the Committee heard from were extremely critical of the agreement, in particular its limited scope and weak enforcement measures. Lawrence McBrearty of the United Steelworkers of America expressed frustration over the politically dependent nature of the process; he described the result of a complaint his organization filed at the Canadian NAO: “We were happy because we thought we had won. We didn’t win anything. We won our argument, but we lost the battle. The only thing it does is the ministers of labour have to meet to see how they’ll deal with it.”¹²⁴

Rob Hilliard of the Manitoba Federation of Labour was even more scathing in his remarks about the effectiveness of the NAALC complaint process:

The NAFTA sidebar agreements on labour, to be perfectly blunt, are useless. They do nothing. They even state in those agreements that there is nothing in terms of domestic law that we can change. Domestic law shall prevail. All the trade agreements say is that you must enforce your own domestic law, and even there they have proven to be toothless. We have clear examples where the Canadian labour movement has attempted to use those provisions for what are obvious violations of even Mexican labour law. They have proven to be absolutely toothless in preventing what is clearly employer-dominated unions from using violence in many situations to prevent legitimate unions from forming. They really enjoy absolutely no respect at all in the eyes of the labour movement in this country. If you really want to do something demonstrable to ensure that the standard of living of working people will rise, you put that upfront in the trade agreement and you say this must happen. We must not attack the rights to bargain collectively, a practice that does go on and that is a feature of these globalized trade agreements.¹²⁵

The Committee agrees that the rights of workers must be respected and protected for NAFTA to be successful at all levels of society. The “core conventions” of the United Nations International Labour Organization (ILO) are considered to be fundamental to the rights of people at work throughout the world as they set out the basic rights of workers in relation to: freedom of association; the abolition of forced labour; equality; and the elimination of child labour.¹²⁶ ILO standards are commonly cited in cases adjudicated under the NAALC. We cannot help but draw a similar conclusion with respect to labour rights under the NAALC as with our consideration of environmental protection under the NAAEC: if the rights of foreign investors can be so forcefully protected under Chapter 11 of NAFTA, the rights of workers should be entitled to equally effective enforcement. Furthermore, adequate funding for the NAALC Secretariat should be ensured.

Recommendation 23

The Government of Canada should initiate discussions with the governments of Mexico and the United States on ways to improve the enforcement of labour laws and standards under the North American Agreement on Labour Cooperation (NAALC). Ensuring adequate funding for the NAALC Secretariat should also be discussed.

E.  New NAFTA Institutions?

NAFTA does not currently have a strong institutional framework. Widespread economic integration in North America has not been matched by a corresponding level of institutional integration; indeed, the existing supranational institutions — the commissions on the environment and labour — are weak. According to Robert Pastor, who is one of the most active academic proponents of a North American community, the NAFTA agreement “did not envisage any unified approach to extract NAFTA’s promise, nor did it contemplate any common response to new threats. NAFTA simply assumed that the peoples of North America would benefit from the magic of a free marketplace and that the three governments would resolve old or new problems.”¹²⁷

Moreover, while NAFTA may have created an economic partnership of three countries, it did not provide any institutional ties outside of trade and commerce. Stephen Clarkson of the University of Toronto made the following comment about what the NAFTA negotiations did not produce: “… we didn’t get the kinds of institutions that would have given Canada a voice in Washington similar to Denmark’s voice in Brussels.” When talking of NAFTA institutions, it is difficult to avoid having comparisons made with the European Union (EU), which has a sophisticated set of institutions to govern trade and economics.

There are good historical reasons, however, for the lack of institutional structure in NAFTA. According to Alberta Sbragia, professor of Political Science at the University of Pittsburgh, the EU’s “overinstitutional” nature was the price the smaller European countries demanded for the creation of the EU. Because of the desire of European nations to avoid the creation of a European hegemon following the Second World War, the EU was created with many supranational institutions that could keep the more powerful nations (Germany, France) in check. In contrast, Professor Sbragia argues, the creation of the North American Free Trade Agreement with its distinct lack of institutions is a direct result of the presence of a hegemon, the United States, which has no need or desire to have its power constrained.¹²⁸

Economist Daniel Schwanen argued a similar point when he told the Committee: “A common intergovernmental decision-making structure, such as an EU-style council, which is sometimes talked about, could not function in North America, both because of the size imbalance between our countries and because, as is well known, Congress holds fast jealously to its powers.”¹²⁹ Instead, Schwanen suggests using the CEC as a model for new NAFTA trade-oriented institutions:

What we could do is create independent bodies, perhaps modelled on the existing Commission for Environmental Cooperation, whose role would be to provide common fact-finding — common to Canada and the U.S. — and common reporting on issues such as subsidies, environmental practices, qualifications, or product standards across North America.

Domestic agencies, such as the International Trade Commission in the U.S. and the Canadian International Trade Tribunal in Ottawa, would continue to be responsible for the administration of domestic laws and the protection of public interests in their respective jurisdictions. But they would be required to base any decision that created explicit obstacles to trade within their region, such as countervailing duties, on the fact-finding reports issued by these independent and multinational bodies, which, like the Commission for Environmental Cooperation, could embed processes for significant public as well as experts’ inputs. Among other advantages, the procedure could reduce the risk of capture of regulatory agencies by private interests at the expense of the public.

The whole idea is that we remain sovereign countries and each country will not jettison its trade laws and even the ability to impose, for example, countervailing or anti-dumping duties. But if we could manage to create a mechanism that would ensure that such decisions were created more on the basis of common fact-finding, including fact-finding based on public input, we would have made some progress toward mutual recognition.¹³⁰

Without strong NAFTA institutions, Canada and Mexico continue to face the reality that if they want to sell into the American market, they will have to continue to play by U.S. trade rules. As Perrin Beatty has noted: “There are many unfinished issues from FTA and NAFTA — antidumping, countervailing duties, agriculture, and softwood among others. Further integration cannot move forward without effective infrastructure to address these challenges and others that will inevitably develop. The political and economic dominance of the U.S., combined with inter-jurisdictional problems within Canada between federal and provincial governments, makes the development of such institutions particularly challenging.”¹³¹

In addition to the environment and labour commissions, the current institutional infrastructure of NAFTA consists of the Free Trade Commission, numerous NAFTA working groups and committees, and the NAFTA Secretariat, which maintains a section

office in each country.¹³² The Appendix to this chapter provides a detailed list of the inter-governmental bodies under, or inspired by, NAFTA. The Free Trade Commission, which consists of minister-level representatives from each country, is the principal NAFTA institution but is not a permanent institution in the physical or operational sense, as it simply convenes annually, or as needed, to supervise implementation and development of NAFTA. Each country designates a senior trade department official — the three NAFTA “coordinators” — to handle the daily management and administration of the NAFTA work program, much of which occurs through the various working groups and committees. The NAFTA Secretariat is responsible for administering the dispute resolution processes under NAFTA.¹³³ The Secretariat also provides some assistance to the Free Trade Commission, as well as to working groups and committees.

With regard to the NAFTA framework and the challenges of governing an increasingly integrated North American economy, many witnesses spoke of the importance of more effective, as well as more democratically accountable, institutions at the trilateral level, a subject we will explore further in Chapter 5. Related in particular to the management of growing trade relations among the three countries, some witnesses argued that new formal political and legal structures should be considered. In this regard, Robert Pastor was among the most explicit of our witnesses in providing suggestions for North American institution-building. His argument for such trilateralism is that “bringing all three sides together would enhance the ability to understand what problems are in common, and what solutions should also be forged in common.” In addition to proposals for an overarching “North American Commission” and a “North American Parliamentary Group” (observing in regard to the latter, “I daresay the United States Congress would benefit enormously from hearing the concerns and the sensitivities of our two neighbours.”) Pastor called for

… a permanent court on trade and investment to replace the ad hoc dispute settlement mechanism. There is now sufficient precedent that we should no longer rely on recruits for each dispute, particularly because that is increasingly leading towards conflicts of interest. A permanent court would allow us to build on those precedents and solve some of the trade and investment disputes perhaps more quickly.…¹³⁴

The Committee accepts that stronger North American rules-based institutions would help Canada maximize its potential under NAFTA while preserving control over its sovereignty and policy direction. As for enhanced parliamentary cooperation, Donald MacKay of the Canadian Foundation for the Americas (FOCAL) pointed out that interchanges between elected officials can go a long way toward solving trade disputes.¹³⁵ The larger point to be carried over to the next chapter’s discussion of possible future trilateral structures is that NAFTA’s current framework probably cannot be improved upon very much without adding a new fortified institutional framework. As Aaron Cosbey of the International Institute for Sustainable Development put it:

Pastor’s points are well taken. The sorts of disputes we’ve seen coming up, that range from softwood lumber and all across the board, have not been managed well because they have not been foreseen, and having not been foreseen, they have not been prevented. Neither can we take lessons from them in any sort of a meaningful institutional manner, because we do not have the institutions specifically devoted to managing the North American commercial integration.

We have crisis management tools in dispute settlement bodies, but to give you an example, there isn’t a free trade commission secretariat. It does not exist. It’s inconceivable, when one compares the European Union model and the North American model, to imagine that out of a scattered process like that we would get a managed sort of integration and one that would take into account the various policy objectives we have, not just economic but non-commercial as well, and shepherd them into some sort of a beneficial outcome.¹³⁶

Specifically in regard to the development of a permanent North American court on trade and investment, Pastor suggested to the Committee that it would provide an opportunity to improve existing NAFTA dispute settlement mechanisms.¹³⁷ He noted that the mechanisms have worked well to date, but their ad hoc nature has serious limitations: expert Chapter 19 panellists without conflicts of interest are increasingly difficult to find, because they are unpaid and the volume of work involved is substantial, given a growing body of case law. The Committee agrees that consolidation of the various NAFTA dispute settlement processes under the jurisdiction of a single trinational permanent court, with paid judges appointed for extended terms, would more efficiently and effectively resolve trade disputes.

We are well aware of the resistance such institution-building ideas would likely garner in the United States, given the current protectionist political climate and the post-September 11 security-driven agenda. Our meetings in Washington indicated the lack of interest of U.S. legislators in pursuing new ideas on North American integration. But we are simultaneously encouraged by the cooperation-oriented enthusiasm we witnessed in Mexico City in March when we met with Mexican officials and commentators. We think Canada should build on this enthusiasm to pursue discussions on new North American institution-building ideas, even if only at the bilateral level initially.

Recommendation 24

The Government of Canada should initiate discussions with Mexico and the United States on the feasibility of developing a permanent North American court on trade and investment that would consolidate the existing NAFTA dispute settlement processes under a single trinational juridical body.

4.3       The Need for a Trade-Efficient Border

A.  NAFTA and the Border

Well before the tragic events of September 11, 2001, the Canada-U.S. border had come under increasing stress from higher volumes of trade and travellers, especially at key border crossings. Indeed, it would not be inaccurate to suggest that the border, through which is conducted the largest trading relationship in the world, had been choking on its own success. There is no question that the pace of Canada-U.S. trade had outmatched the quantity of border machinery and the infrastructure capacity in place to deal with it.

Prior to September 11, some efforts had been undertaken to develop policy responses to border challenges. A key element was the October 1999 establishment by Prime Minister Chrétien and U.S. President Clinton of the Canada-U.S. Partnership (CUSP) to examine the future of Canada-U.S. border management. This collaborative effort encompassed three guiding principles:

The first CUSP report, completed in December 2000, recommended that CUSP continue a Canada-U.S. dialogue with public and private stakeholders on border issues. It also encouraged greater cooperation through such bilateral mechanisms as the Shared Border Accord, Border Vision, Cross-Border Crime Forum, and the Motor Carrier Consultative Mechanisms.

While much discussion was undertaken through these bilateral mechanisms, the two national governments did not display much haste in acting on proposed solutions. According to Robert Keyes of the Canadian Chamber of Commerce, a policy of “benign neglect” had allowed border infrastructure (e.g., the roads leading to the border, screening procedures and facilities, staffing levels) to cause problems even before the terrorist attacks. Indeed, the inadequacies of infrastructure and personnel resources were seriously hampering efforts to cope with burgeoning traffic at increasingly congested crossings such as the Ambassador Bridge linking Windsor and Detroit, which alone carries an annual volume of trade equal to that between the United States and Japan.

Keyes remarked that even though Canada-U.S. trade had risen greatly in recent years — by a factor of six, by his reckoning — resources allocated to the border had remained constant. Thus, there was much work to be accomplished to facilitate Canada-U.S. trade, from streamlining border procedures to reinvesting in infrastructure to increasing resources to customs agencies on both sides of the border.

B.  Impacts of September 11

The terrorist attacks on the United States highlighted a number of problems along the almost 9,000-kilometre border that Canada shares with its southern neighbour. The inadequacy of border infrastructure and personnel has already been noted; in addition, border security became the focus of attention. This, notably reinforced by the Ahmed Ressam case in late 1999, had to do with the ability of criminal elements and suspected terrorist operatives to cross borders. There were calls for enhanced screening and other security measures to protect against these threats, but without unduly restricting openness to vital commerce and travel within North America.

After September 11, it became clear that the United States would strengthen security at its borders. The unprecedented tightening of controls by U.S. authorities (e.g., the positioning of armed officials at the border) exposed, in sudden and dramatic fashion, concerns that had been accumulating for years. The American decision to close the border briefly that day, and continued tightening of security in the form of 100% inspections, focused attention on Canada’s high dependence on the U.S. market for Canada’s prosperity. Indeed, exports to the U.S. account for approximately one-third of Canada’s GDP. Evidently, Canada is severely affected by any disruptions at the U.S. border emerging from the United States’ heightened sense of vulnerability.

Exporters feared that the border would be tightened indefinitely, disrupting the free flow of goods between the two countries. Border delays immediately following September 11, often ranging from eight to twenty hours, were especially serious for Canadian border communities and for sectors highly dependent on ease and efficiency of cross-border access (e.g., airline and hospitality industries, trucking, and industries relying on just-in-time delivery, such as automotive and auto parts production). In the United States, automotive giants Ford Motor Company and DaimlerChrysler announced planned closures of their plants owing to the lack of automotive parts normally delivered from Canada on a just-in-time basis but now stalled at the border.

From an investment point of view, firms often locate in Canada on the assumption that they will be able to effectively service the U.S. market from there. In a November 2001 report on border issues, however, this Committee’s Subcommittee on International Trade, Trade Disputes and Investment observed that without “reliable access to that prized market, foreign-based companies may be reluctant to establish business operations in Canada. Others, both domestic and foreign, may wish to relocate existing facilities south of the border.”¹³⁸

In the period immediately following September 11, concerns were expressed that the Canadian economy would suffer broader and longer-term costs if no efforts were made to find joint solutions to address border issues arising from the new security environment. Business and industry groups, notably the Coalition for Secure and Trade Efficient Borders (which released a detailed report, Rethinking our Borders: A Plan for Action, in early December 2001), were most active in urging bilateral collaboration on a range of border security-related fronts, including sensitive areas such as immigration and asylum, risk assessment, and data sharing.

The Committee, in two reports it tabled late last year (Towards a Secure and Trade-Efficient Border and Canada and the North America Challenge: Managing Relations in Light of the New Security Environment), also made a number of recommendations and observations on securing a Canada-U.S. border that remains reasonably open, and on broadening the consideration of border security issues, both to include Mexico within a North American perspective and to evaluate where multilateral action on a wider scale may be needed to effectively counter potential terrorist threats.

During our 2002 hearings on North American integration, a number of witnesses reiterated the need to maintain a border that is open to legitimate trade and people, while effectively dealing with potential security threats. Canada, as John Furey from the Saint John Board of Trade informed the Committee, has indeed enjoyed the longest undefended border in the world (since the War of 1812) and it cannot afford to lose this advantage.¹³⁹ Professor Teresa Cyrus concurred, arguing that given the importance of trade to Canada, it was imperative that the border be kept as open as possible.¹⁴⁰ For his part, Daniel Schwanen of the Institute for Research on Public Policy highlighted both the economic and the security benefits that an easier flow of trade in goods and services can provide.¹⁴¹

C.  Recent Actions

Fortunately, as we noted in Chapter 3, concrete actions were taken after the events of September 11. The Government of Canada adopted certain measures to reduce border delays while, at the same time, ensuring an adequate level of border security. These actions included employing additional personnel at the border, establishing dedicated traffic lanes for commercial traffic, opening additional lanes for passenger vehicles, and designating special processing lanes for trucks that had already passed through expedited pre-clearing.

In conjunction with its own, independent actions, the federal government also cooperated with the Americans on a joint strategy for the border. On December 12, 2001, the two countries signed a declaration for the creation of a “Smart Border for the 21st Century.”¹⁴² The declaration includes 21 new objectives and expands on nine other Canada-U.S. initiatives set out in the 8-point Joint Statement of Cooperation on Border Security and Regional Migration Issues (signed on December 3, 2001) and in the RCMP-FBI agreement to improve the exchange of fingerprint data.

The Smart Border Declaration was accompanied by a 30-point Action Plan, based on four pillars: the secure flow of people, the secure flow of goods, secure infrastructure, and coordination and information sharing. The plan is designed to enhance collaboration in identifying and addressing security risks while efficiently and effectively expediting the flow of legitimate people and goods across the shared border. It leans heavily on the principle of managing risk by concentrating resources on individuals and products displaying higher degrees of risk. A Canadian Border Task Force was established for its implementation.

Many witnesses appearing before the Committee expressed satisfaction with the progress made in jointly addressing border shortcomings. There was also a
feeling, expressed perhaps most effectively by Robert Keyes of the Canadian Chamber
of Commerce, that the Canadian decision to be proactive on the border had ensured that it remained open and that our interests had been reflected in the solutions proposed.¹⁴³ The Committee is of the view that the Canada-U.S. border reform package, encompassing as it does a coherent risk management approach, exemplifies the success Canada can realize when it presents a concrete, wide-ranging reform proposal to the U.S. side. Indeed, the border management proposal produced by Deputy Prime Minister John Manley and his bureaucracy was left virtually unaltered by the United States.

To carry out the Action Plan effectively, both governments set aside significant financial resources. On this side of the border, the Canadian federal Budget of December 10, 2001 allocated $1.2 billion in future years to render the border more secure, open, and efficient. Roughly one-half of this funding has been directed towards the improvement of border infrastructure (e.g., improvement of access roads, addition of new lanes, purchase of electronic scanners for quicker inspections); the other half will be devoted to enhancing border security through enforcement, intelligence gathering for security purposes, and equipment. Most of the infrastructure money will be destined for Canada’s six major border crossings.

In January 2002, President Bush announced that his administration would be seeking US$10.7 billion in its next annual budget specifically to bolster border security, in addition to the planned massive increases in defence spending. Some U.S. troops were to be deployed to duties on the Canada-U.S. border as well as to the Mexico-U.S. border.

D.  The Need for Additional Progress

On June 28, 2002, Deputy Prime Minister John Manley and White House Homeland Security Advisor Tom Ridge released a generally favourable progress report on the implementation of the Smart Border Declaration and the 30-point Action Plan. This was followed up by the release on December 6, 2002 of a one-year status report on the Smart Border Action Plan.¹⁴⁴ It is evident from this status report that much still remains to be achieved. It also bears mentioning that both parties to the Smart Border Declaration have now officially invited business leaders to the annual Shared Border Accord meeting, thereby strengthening the process of securing effective private sector input.

On the positive side, Canada has been seeking innovative ways to streamline the movement of low-risk, pre-approved goods through such programs as Canada Customs and Revenue Agency’s Customs Self-Assessment (CSA). This program, implemented on December 6, 2001, after several years of planning, reduces pressure at the border through pre-approval of low-risk traders and post-auditing of their books. Similarly, the U.S. government recently unveiled its new Customs-Trade Partnership Against Terrorism (C-TPAT) program, which speeds up border crossings for low-risk commercial shippers while requiring companies shipping into the United States from Canada to agree to strict security requirements.

In September 2002, President Bush and Prime Minister Chrétien formally announced the launch of a new joint program (Free and Secure Trade, or FAST) to facilitate the movement of commercial shipments across the border. The FAST program is designed from the framework of the two existing (CSA and C-TPAT) unilateral programs. Among other things, this program establishes fast lanes for approved, lower-risk shipments (i.e., those purchased by pre-authorized importers and transported by pre-authorized drivers and carriers). Subjecting truckers to a rapid electronic security check in these lanes will, it is hoped, result in more efficient border processing. FAST lanes at Canada’s three busiest commercial border crossings (Windsor-Detroit,
Sarnia-Port Huron, and Fort Erie-Buffalo) are to be opened on December 16, 2002.

Moreover, fast lanes for low-risk pre-cleared travellers (as opposed to shippers) were opened in June 2002 at two B.C.-Washington State border crossings. Expansion of this NEXUS program to all border crossings is to occur by the end of this year. Plans are also under way to launch a new program incorporating fast lanes at airports for low-risk air travellers, referred to as NEXUS-Air. Pilot projects in Ottawa and Montreal are to begin by early 2003.

Despite these cumulative measures, not all witnesses were satisfied with the pace of the action already undertaken on the border. For example, Sean Cooper of the Atlantic Provinces Chamber of Commerce noted the need for rapid implementation of many measures announced in the Action Plan,¹⁴⁵ while Michael Hart of Carleton University registered sympathy with the frustration arising from a slow pace in implementing the border accord.¹⁴⁶

We note that security delays (owing to new security regulations) and the existence of red tape continue to delay truck traffic. A survey of cross-border trucking companies conducted in May 2002 by KPMG revealed that crossing into the United States was taking 20% longer than in May 2001, because of heightened security demands. Delays for trucks heading into Canada were also observed. All in all, progress on developing the infrastructure required to establish a more effective border-crossing network has been slow. Frequently used border locations such as Windsor¹⁴⁷ still require additional crossing points and/or the expansion of existing ones to provide for the separate lanes required to streamline traffic. This need for investment in border infrastructure was further reinforced by the Canadian Chamber of Commerce in its recent statement on border progress.¹⁴⁸

To resolve this situation, both major infrastructure spending and streamlined security measures will need to be put in place. It is hoped that the introduction of the FAST and NEXUS programs will help ease the delays. However, the funding required in the United States to upgrade technology and increase the quantity of border staff has not been appropriated by the U.S. Congress, even though Mr. Ridge has made a commitment to provide more funds for both infrastructure and staffing. A shortage of funding from Washington to provide more U.S. Customs officers at the border has historically been blamed for creating traffic delays there. Moreover, as the Canadian Chamber of Commerce recently pointed out, progress on shifting the clearance function away from the border (i.e., pre-clearance) has been minimal.¹⁴⁹

Recommendation 25

Given the critical need for new infrastructure at key Canada-U.S. border locations, the Government of Canada should accelerate its efforts to construct such infrastructure at existing border points and more actively encourage its American counterpart to do the same.

In addition, the Committee received evidence from Jérôme Turcq of the Public Service Alliance of Canada that Canada’s contingent of customs and immigration officers continued to be below requirements, that the monitoring of certain border points was deemed to be deficient, that the training given to students hired during peak summer periods was too brief, that their supervision was inadequate, and that the training given to customs officers to properly supervise their immigration colleagues was of insufficient quality. ¹⁵⁰

Recommendation 26

The Government should ensure that the number of customs and immigration officers at the border matches current requirements, given the new security demands imposed on these officials. Training and the equipment available to border officers should be enhanced.

Another shortcoming in the system is that customs regulations remain antiquated, and the mindset of customs officers continues to be fixated on collecting
revenues — which have declined in significance over the years — rather than finding ways to make cross-border traffic flow more rapidly. In his testimony, for example, George Haynal pointed to a staggering 186 legislative instruments that customs officials must enforce.¹⁵¹

Recommendation 27

The Government should thoroughly review the set of customs regulations currently administered by customs officials within the Canadian Customs and Revenue Agency, with a view to their modernization. Border officials should be fully versed in any resulting changes so that they can deal more effectively with today’s border realities.

A number of witnesses favoured even more drastic action on the border than the incremental action already undertaken or planned. For example, Danielle Goldfarb of the C.D. Howe Institute called for a fundamental review of the entire purpose of the border.¹⁵² Michael MacDonald of the Atlantic Institute for Market Studies stated that the border problems are more than congestion at key crossings such as Windsor-Detroit and should be considered as such by federal officials.¹⁵³ The Atlantic Provinces Chamber of Commerce, in its written submission to the Committee, suggested that border management be an integral part of the longer-term vision for the Canada-U.S. relationship.¹⁵⁴

In this context of a significantly revamped border, several witnesses brought up the possibility of establishing a new common North American security perimeter or zone of confidence. Under this scenario, which has already been discussed in Chapter 3, border controls could potentially move to a wide range of sites both in and out of North America. Professor Laura Macdonald discussed Europe’s Schengen Agreement, under which ease of movement between the majority of EU member countries has been assured; she identified concerns that adoption of such a move in North America would entail a gradual harmonization or convergence of many Canadian policies with those of the United States (i.e., a sacrifice of Canadian sovereignty).¹⁵⁵ For his part, Gordon Gibson of the Fraser Institute argued that the border should be buttressed by a common security perimeter, but that there was virtually no prospect of eliminating the border in light of the need to control or prevent the movement of illegal products (e.g., drugs) between the two countries.¹⁵⁶

Recommendation 28

The Government should undertake a thorough review of long-term options for the Canada-U.S. border and present its findings to the public. This assessment should include an evaluation of the European Union’s experience in easing the movement of goods and individuals between most of its member countries and an analysis of the implications of establishing a security perimeter around North America.

Finally, two other issues are worth mentioning. First, President Bush’s January 2002 State of the Union address indicated that additional entry/exit controls would be introduced for visitors to the United States. Although some of these provisions might not apply to Canadian citizens, the problems arising over Section 110 of congressional immigration legislation several years ago suggest that Canada will have to monitor this situation very closely to avoid further potentially negative border effects.

The second issue to consider is the possible trilateralization of border issues. Whereas Mexico would prefer to deal with the border under the rubric of NAFTA, Canada and the United States continue to remain in favour of a bilateral process. On this point, the Committee heard from Professor Laura McDonald of “an inevitable trilateralization of previously bilateral concerns.”¹⁵⁷ She offered the example of the Mexico-U.S. border accord, which had been patterned after the Canada-U.S. one previously entered into. However, this example has little to do with trilateralization and, indeed, is an example of “double bilateralism” at play. We will return to this theme of trilateral versus bilateral approaches in the subsequent section on future integration options and in Chapter 5.

4.4       Enhancing the Competitiveness of the Canadian Economy in North America

Improving the Economic Climate in Canada

A number of witnesses addressed the issue of how best to increase Canada’s ability to compete with the United States in today’s integrated continental economy. For example, Sean McCarthy of the Newfoundland branch of the Canadian Manufacturers and Exporters argued that the business environment had to be improved at home in order to take greater advantage of North American economic integration. According to Jayson Myers of the national office of the Canadian Manufacturers and Exporters, the key to enhancing competitiveness and ultimately Canada’s standard of living lies in reversing this country’s productivity gap with its southern neighbour. Achieving that goal, he observed to the Committee, could be aided by a boost in investment in new technologies and an increase in innovation on the part of Canadian business, as well as by investments in the domestic labour force and an accelerated introduction of new products into the marketplace.¹⁵⁸ Myers went on to offer these specific policy measures as remedies:

Peter Harder of Industry Canada made similar points during his appearance before the Committee. He suggested that the key way to close the productivity gap was to both attract and retain investment. In reality, Canada’s share of North American inbound foreign direct investment had declined to a figure of only 6% in 2000, with the robust U.S. economy having gained a corresponding market share. To help meet the challenge of North American economic integration, he called for “innovation and enhancing Canada’s activities in value-added products; creating an attractive climate for investment; retaining and attracting human and knowledge capital; and continuing to strive for reductions in barriers and impediments to the free flow of goods, services, and productive resources across the economy.”¹⁶⁰

Professor Isaiah Litvak of Florida Atlantic University argued that it was imperative for Canadian policy-makers to put in place the appropriate policy environment to ensure that Canada is the “preferred choice for business locations and growth in the North American space.”¹⁶¹ For example, Canadian tax rates should, at the minimum, be competitive with those in the United States. Otherwise, investment will flow into the United States, headquarters operations will be transferred south, and professionals and entrepreneurs will also relocate.

Recommendation 29

To ensure that the Canadian economy remains competitive within an increasingly integrated North American economy, and to boost living standards in Canada, the Government should urgently implement additional measures to help reverse the Canada-U.S. productivity gap. Emphasis should be placed on providing tax and regulatory relief, working together with the provinces to eliminate barriers to inter-provincial trade and generating investments in Canada’s labour force.

4.5       Options for Managing Further North American Economic Integration

A.  The Debate Over Additional Integration

Recently, a debate over the merits of additional formal economic integration has been engaged. As the Committee has already observed, American reactions to the September 11, 2001 terrorist attacks have lent a new impetus to ongoing discussions about the future shape of Canada-U.S. economic integration. Generally speaking, proponents of economic integration stress the administrative and efficiency cost-savings associated with eliminating rules of origin, border controls and other barriers to trade. The deepening of integration that has occurred in North America has led trade analysts such as Michael Hart and William Dymond to suggest that the complex rules governing trade and cross-border exchanges “stand in the way of more beneficial trade and investment. Cumbersome rules of origin, discriminatory government procurement restrictions, complex anti-dumping procedures, intrusive countervailing duty investigations, burdensome regulatory requirements, vexatious security considerations, onerous immigration procedures, and other restrictive measures remain in place, discouraging rational investment decisions and deterring wealth-creating trade flows.”¹⁶²

Hart, in subsequent testimony before the Committee, noted that Canada and the United States were “trying to manage a common market on the basis of the rules, institutions, and procedures of a free-trade area.”¹⁶³ Advocating a high-profile, formal NAFTA-plus agreement, he called on the two governments to “manage the relationship and strengthen institutional and procedural frameworks to iron out differences, reduce conflict, anticipate change, seize opportunities, and generally manage the integration process.”¹⁶⁴

On the other hand, critics of formal economic linkage stress the loss of sovereignty in trade and other policy areas that further integration might entail. As one informed observer of North American integration put it, the political concerns of becoming even more closely aligned with the United States have already prevented the Government of Canada from actively promoting closer ties.¹⁶⁵ Don Barry of the University of Calgary cautioned the Committee that not only would an additional formal integrative arrangement be difficult to reverse; once in place it would exert great pressure for even further integration.¹⁶⁶ And we have already noted the warning from Robert Keyes of the Canadian Chamber of Commerce that “reopening NAFTA could also be fraught with difficulties.… It might lead to a reopening of discussions that we would rather not have, or we could face new demands, or we could have issues put on the table that were left out before.”¹⁶⁷

Another area of concern is more general: that if there is more concentration on regional trading blocs (whether the EU, NAFTA or APEC), the multilateral trading regime overseen by the World Trade Organization could be weakened. The evidence for this last theory, however, is inconclusive; many analysts hold that the emergence of trading blocs based on free trade could actually strengthen the international trading system.

The advances in European integration through an expanding European Union have also spurred speculation on the viability of a similar North American economic “community” or even union of some sort. Complicating the integration question for Canada is the fact that Canada (like Mexico) is dwarfed economically, militarily and demographically by the United States. Such an imbalance, already present in the everyday calculations of Canadian policymakers, would make the negotiation of further economic integration a difficult task, to say the least. It would have to overcome an existing bias in which, as Reg Whitaker put it: “The vastly disproportionate weight of the U.S. within NAFTA means that where political decisions are being made, they are almost invariably the decisions of the U.S. administration and Congress, the courts, and various administrative and regulatory agencies of the U.S government.…”¹⁶⁸ Indeed, an important question that remains to be answered is whether, given the power imbalance, the EU example has any relevance for Canada.

There is also the apparent lack of incentive for the Americans to launch a formal deepening of continental economic integration. Given the difference in size in the North American economies and the fact that U.S. merchandise exports to Canada contribute a scant 2% of that country’s GDP, what is in it for the United States? It would appear that such “big ideas” as a customs union are not on the U.S. radar screen, in contrast with the smooth movement of goods across the border, which is. That impression was reinforced by the Committee’s own meetings in Washington. Indeed, as Doris Meissner of the Carnegie Endowment put it in a final roundtable, “smart border” measures are “the only area right now where there is U.S. political will to move ahead.”

That was also a common view among witnesses in Canada. For example, Professor Barry saw little evidence that the U.S. administration is interested in such big ideas.¹⁶⁹ William Kerr of the Estey Centre for Law and Economics in International Trade felt that these new arrangements were premature in any event, since “the full adjustment to the changes brought by NAFTA have not yet been accomplished.”¹⁷⁰ Stephen Clarkson was strongly sceptical about whether Canada should want to devote its energies to the “big idea” approach, arguing that the U.S. administration would not respond to any new overtures from Canada and that buried in these types of proposals would be “small ideas that aren’t adequately discussed and understood, like the time bomb that was the Chapter 11 dispute settlement mechanism, which we buy into without knowing what the consequences are going to be.”¹⁷¹

Another issue is that, even if there were interest on the part of the Americans (and Canadians) in formally deepening continental economic ties, it is not clear that the preference would be for a trilateral, “one-speed” approach to integration. Under this approach, efforts to integrate further would be undertaken jointly (i.e., all three NAFTA partners participating) rather than on two different tracks (i.e., a Canada-U.S. as well as a Mexico-U.S. one).

Many policy-makers in both the United States and Canada continue to view NAFTA as a “double-bilateral,” “two-speed” form of integration as opposed to a trilateral agreement. In the former case, an invitation could perhaps be extended to Mexico, but only once it was “on a solid path to modernization.”¹⁷² The Government of Canada, for instance, continues to place considerable priority on bilateral relations with each NAFTA partner at a time when relations with Mexico have risen in importance. For many other observers as well, a bilateral approach for cooperation is deemed to be preferable to one incorporating all three countries. Robert Keyes of the Canadian Chamber of Commerce told us that the Canada-U.S. relationship was considerably more advanced than the relationship we have with Mexico and that the former, therefore, had to be accorded priority.¹⁷³ Michael Hart agreed, arguing that Canada and Mexico should move ahead in parallel (not joint) efforts to integrate until such time as their interests are more identical.

Other witnesses, however, differed in their choice of integration model. Gordon Mace viewed the adoption of a two-speed integration model as dangerous, in that it resurrects fears of the “hub and spoke” (the United States being the hub and Canada and Mexico the spokes) negotiating that NAFTA sought to avoid in the first place.¹⁷⁴ Several witnesses suggested that having two countries (i.e., not just Canada) negotiating with the United States could prove to be helpful, with Mexico serving as an additional counterweight to American interests. Others noted that even if the realization of a truly trilateral North America were to remain a long-term objective, Canada could begin to develop trilateral mechanisms for discussing common interests in such areas as migration, security, energy, and labour.

If a change in the North American economic relationship is desired, what shape should this change take? Should integration proceed following a traditional “top-down” analytical framework of moving from a free trade area to a customs union to a common market to a potential economic and monetary union, based at least partly on developments in Europe? Or should integration occur incrementally, dealing with problems on a case-by-case basis and in a less formal manner, without a guiding framework? Alternatively, is some blending of the two approaches desirable? The next section describes the options available and their relative merits.

B.  Top-Down Integration Options

One option would be to follow the European lead and adopt a logical progression, from free trade arrangement (the weakest form of integration link) to customs union to common market to economic union.¹⁷⁵ Presumably, some kind of international treaty among the three NAFTA members, or alternatively between Canada and the United States, would be required to formalize the new relationship.

1.    Customs Union

First, a customs union could be created. Under such an arrangement, participating countries would undertake to remove all restrictions on mutual trade and adopt a common external tariff (and joint quota regime) for non-member countries. Currently, many goods circulating within the NAFTA economic space are produced either wholly or in part outside the free trade area, requiring rules of origin to determine what is free of duty and what is not. Without these rules in place, firms would have an incentive to route imports into the free trade area through the country possessing the lowest external tariff.

Goods shipped across North America typically require extensive documentation in order for each country to apply its own tariffs to goods or components produced outside the NAFTA area. In a customs union, however, imports would face the same tariffs anywhere in the union; compliance with rules of origin to prove that an item was produced in North America would no longer be required. Once the item had been cleared for entry into the NAFTA economic space, it could then be shipped between NAFTA countries without any difficulty or intervention.

A customs union involves participating nations surrendering some degree of policy freedom (i.e., the establishment of common external tariffs and a common external trade policy) to achieve some economic benefit (i.e., elimination of the need for rules of origin). The Committee was informed, however, that while a harmonized tariff schedule would likely result in Canadian tariffs being brought down to U.S. levels, almost 40% of tariff items are already within 1% of each other. Moreover, as Professor Barry Scholnick of the University of Alberta noted, these tariff reductions would affect only the 20% of Canada’s trade that occurs with countries other than the United States and Mexico.¹⁷⁶ In other words, tariff harmonization would not appear to be that problematic.¹⁷⁷ According to Michael Hart, the “1% creates a requirement for rules — and therefore for
paperwork — that is the equivalent of 3% or 4% as a tax.”¹⁷⁸

Another matter is the harmonization, among NAFTA partners, of external trade policy in general. A NAFTA-based customs union would likely operate, like the EU, as a bloc in future international trade negotiations. A member country’s ability to act independently in its external trade policy would, therefore, be affected. The Atlantic Provinces Chamber of Commerce suggested that “Canada and the U.S. would have to arrive at internal consensus on positions for broad trade negotiations, or, at the very least, narrow their differences significantly.”¹⁷⁹ Professor Rod Hill of the University of New Brunswick in Saint John expressed his concern to the Committee that under the customs union option, trade policy would be set in Washington.¹⁸⁰ The Canadian Chamber of Commerce also questioned Canada’s ability to act independently of its NAFTA partners within such a union. For example, its current supply management regimes in agriculture could be threatened.¹⁸¹

It should be noted as well that trade and economic measures have grown in importance as means of implementing foreign policy in recent years, and the establishment of a customs union would involve the harmonization of part of our foreign policy. Consider the fact that Canada maintains commercial ties with Cuba and Iran, for example, although both are under an American embargo.

On the positive side, elimination of rules of origin should result in significant administrative cost-savings at the border and in efficiency gains. Reducing the need for border inspections and lowering the amount of paperwork required could result in significant savings amounting to 2% to 3% of NAFTA GDP, according to several witnesses. Professor Louis Balthazar of Laval University suggested that a customs union with the United States is eventually inevitable, given the tremendous economic integration that currently exists and the need to avoid the costly border delays already experienced immediately following the events of September 11.¹⁸²

Establishment of a full customs union would also deal with a major Canadian irritant, namely the American propensity to use domestic trade remedy legislation as a protectionist device. Such a union would entail the use of common NAFTA trade remedy mechanisms (e.g., anti-dumping, countervail) against non-NAFTA countries, as well as preclude the use of such mechanisms within the customs union. Simply put, under a full customs union, the United States would not be able to apply countervail or anti-dumping duties on any of its NAFTA partners. To quote from Alfie Morgan of the Windsor and District Chamber of Commerce, “a customs union would at least go a long way to reduce the trade irritants. It would open up the flow of goods a little more.”¹⁸³

However, as certain observers such as Professor Hill¹⁸⁴ fear, the United States might insist on maintaining its right to use such trade remedies as countervail and anti-dumping duties on internal NAFTA trade. The Americans could also continue to apply non-tariff barriers (e.g., health inspections, safety requirements) to Canadian exports.¹⁸⁵

Even so, economist Richard Harris of Simon Fraser University argues in a recent discussion paper on North American economic integration prepared for Industry Canada¹⁸⁶ that there would still be economic benefits (in the form of a lowering of administrative and transaction costs) to implementing an intermediate NAFTA customs union. Under this option, Canada, the United States and Mexico would adopt a common external tariff and harmonize other international trade policies, but NAFTA countries could still apply anti-dumping and countervailing duties at their internal borders. In his appearance before the Committee, Harris went so far as to refer to the rules of origin as an effective barrier to trade at this time of increasing vertical business integration.¹⁸⁷

Finally, Harris suggested that instead of officially converting NAFTA from a free trade agreement to a customs union, one could apply the customs union principles to those industries most in need of relief from the rules of origin.¹⁸⁸ Sean Cooper and Alfie Morgan both suggested that the highly integrated North American steel industry could be used as a prototype for a customs union. They noted that this industry displays considerable cross-border ownership, sourcing of raw materials, and common union representation. Such a prototype, according to them, would gauge the impact on Canada of a possible move to a common external tariff.

That view also received support in Mexico City from Rafael Rubio, Chair of the International Affairs Committee of the Mexican Steel Producers’ Association, who noted that there is for the first time a Canadian president of the North American Steel Council. In this highly integrated sector of the North American economy, he argued it is time to move away from temporary measures and trade remedies towards long-term solutions; in his words, “a customs-union type [of] situation [is a ] step we have to take.” There may be other sectors where the prospect of pragmatic movement in a NAFTA context towards a common external tariff merits consideration by Canadian policy-makers.¹⁸⁹ The Committee, therefore, agrees that these possibilities should be thoroughly investigated with a view to establishing what next steps could clearly serve Canadian interests.

2.    Common Market

The three countries could eventually also form a common market, in which capital, individuals, goods, and services flow freely between member countries. Currently, borders within NAFTA are serving as a barrier. Increasing labour mobility is really the principal objective at this stage of the integration process, with additional mobility seen to enhance economic efficiency and income growth. A common market would remove all obstacles to the temporary or permanent movement of citizens between member countries.

A common market is also often associated with a convergence of fiscal and monetary policies and a dismantling of non-tariff barriers such as the regulatory treatment of product standards. In a common market, the level of policy harmonization among member countries can be significantly enhanced.

The EU experience would suggest that a common North American market would provide the three NAFTA partners with sizeable benefits in the form of heightened competition and increases in productivity.¹⁹⁰ One common concern, however, is that the elimination of barriers in the form of a common market, without a prior convergence of incomes throughout that market, could result in extremely large cross-border migration from relatively poor Mexico to the United States. The concern here is that the infusion of large numbers of Mexican migrants would put at risk the standard of living in the wealthier countries, principally the United States.¹⁹¹ This same phenomenon has not been experienced in Europe, where migration across member state borders and even between regions within a single country has historically been weak owing largely to cultural and language factors. The income gaps present in Europe have not been sufficient to overcome these factors. Finally, another point to consider is that a common market would necessitate the creation of a range of bilateral or NAFTA-based political and legal institutions that simply do not now exist.

The establishment of a common market would be welcomed by a number of witnesses appearing before the Committee. Sean McCarthy of the Newfoundland and Labrador Branch of the Canadian Manufacturers and Exporters stressed to the Committee the urgent need for greater two-way mobility of human resources across the Canada-U.S. border.¹⁹² Also in favour was Professor George MacLean of the University of Manitoba, who felt that Canada could benefit from mobility of goods, services and labour and from the elimination of onerous trade remedy legislation (e.g., countervail, anti-dumping) within North America — advantages that would be made possible through a common market.

3.    Economic Union

A third and deepest form of economic integration would be the development of an economic union, within which competition, structural, fiscal, and monetary policies are harmonized. Supranational institutions and laws (replacing national law) would be needed to regulate commerce within the union, and transportation, regional, and industrial policies would typically be coordinated. Such a union could include the use of a common currency, possibly the U.S. dollar, and the adoption of a unified monetary policy. This topic is discussed in the next section of this chapter.

The creation of the European Union has, no doubt, spurred some to investigate the viability of a similar North American economic union. For instance, Mexican President Vicente Fox has advocated a move toward a European-style customs union and common market and other key features of closer integration such as common monetary policies and improved policy coordination among the three countries.

Also included in Fox’s “Vision 2020” was a fund to address economic disparities between Mexico — especially its poorer southern regions — and its NAFTA partners, similar to the EU’s social cohesion funds dispensed to countries such as Spain, Portugal, Ireland and Greece.¹⁹³ Ideally, from Mexico’s perspective, the source of the funding would comprise a refurbished NAFTA instrument, the North American Development Bank. Others, however, insist that the Inter-American Development Bank serve this function. As of yet, there does not appear to be a consensus in either Washington or Ottawa for the establishment of any additional North American fund or financing mechanism to address Mexican development needs. We will return to this in Chapter 5.

The Committee received virtually no evidence on the merits (or demerits) of an economic union in North America. Perhaps that is an indication that it is simply not seen to be a realistic prospect in the foreseeable future. One witness who did comment specifically on this subject, Professor MacLean, expressed his opposition to the concept, arguing that “it’s not clear at this time that harmonization of social or currency policy between Canada and the United States would be practical or even desirable.”¹⁹⁴

4.    The Blurring of Formal Options

The above, seemingly clear compartmentalization is not always evident in real life. In practice, not all applications of the different stages of integration display the same level of supranational co-operation. For example, in the critically important (for Canada) area of trade remedies, Canada continues to push for greater cooperation in the use of trade remedy measures (e.g. anti-dumping, countervail) in North America, with many Canadians believing that NAFTA did not satisfactorily address these issues.

These trade remedy actions seem inconsistent with the growth of free trade, and there is room for considerable progress in eliminating their use within this continent. The real question to consider, however, is whether or not the United States will agree to proposals for change. It is not certain that the implementation of a customs union, for example, would eliminate the application of the trade remedy regime to countries that were members of that union.

C.  “Bottom-Up” Approaches

Even before the events of September 11, business groups were raising concerns that NAFTA could be made to work better. It bears reiterating that the list of existing NAFTA irritants is long: abuse of anti-dumping and countervailing duty procedures, other non-tariff trade disputes, rules-of-origin complexities, government procurement restrictions, antiquated U.S. maritime laws that restrict Canadian firms from entry into U.S. shipping and shipbuilding markets, and differences in requirements for product standards, labelling, testing and certification, to name a few.

Moreover, in the face of economic integration, transborder environmental, migratory, and transportation issues, North American cooperation is necessary for each country to pursue many of its economic, social, environmental and security objectives. With respect to transportation, for example, the growing burden on existing transportation corridors needs to be addressed. Coalitions of business interests and government officials have lobbied for at least 11 trilateral trade corridors as part of an integrated transportation and infrastructure plan.

Two options for incremental, less formal change are possible. Richard Harris pointed out in his Industry Canada paper that the integration of North America is proceeding outside a formal common market framework, and that certain areas are already experiencing pressures for policy convergence or harmonization. These pressures will grow as the Canadian and American economies inevitably integrate further.

Given this reality, Harris suggests examining more informal mechanisms to facilitate cross-border mobility within the NAFTA region and to bring about gradual policy convergence. This “bottom-up” approach involves convergence in a number of policy areas such as border issues, transportation, labour mobility, tax competition, exchange rates, regulation and competition policy, administrative trade policy (e.g., anti-dumping, countervail), environmental and resource issues, and intellectual property rights.

By engaging in an incremental process of harmonization, as has begun to occur in customs and immigration procedures since September 11, Canada could (according to Harris) end up with a form of integration that begins to approach a more structured common market arrangement. Harmonization of North American policies in the above areas could continue to be achieved through bilateral or trilateral agreements. Under this framework, changes would be undertaken because they would increase Canada’s prosperity and help address the country’s social and economic needs.

Another option, which recognizes the need for improvements in the North American relationship while setting out a realistic course of action, is what Daniel Schwanen calls “interoperability,” in which each country keeps its own policies and systems but ensures that these allow each “to cooperate effectively on an ongoing basis in areas where their deep interdependence means that lack of cooperation could entail serious losses.”¹⁹⁵ According to Schwanen, “Such an [interoperability] agreement could help strengthen mutually beneficial economic and security relationships without compromising the existing powers of domestic legislatures.”¹⁹⁶

Schwanen sees such interoperability as resting on four pillars:

1.    Regulatory Issues

On the topic of regulation, while market and production systems are becoming increasingly integrated, businesses are facing non-tariff barriers in the form of separate standards (e.g., health and safety, packaging, electrical standards, emission controls, food testing, language), regulations, labelling requirements, etc. Inevitably, these mean higher costs, duplication, delays, etc. Each of these forms of regulation imposes a cost on trade that is equivalent to tariffs. Before a good can cross a border, it may have to be modified physically, relabelled, or its origin and components certified.¹⁹⁸

There are essentially three ways to resolve this problem: mutual recognition, harmonization, and common policies. In Europe, efforts to harmonize regulations, found to be expensive and inefficient, were replaced with an agreement that each government would recognize the regulations put in place by the other governments. Under this mutual recognition scenario, if a good met the standards of Country A, then it could enter Country B without restrictions, as long as A also accepted goods produced according to the standards of Country B.¹⁹⁹ For its part, the Vancouver-based Fraser Institute has called for the harmonization of regulatory policies, or mechanisms for joint recognition of regulatory policies, in the fields of transportation, the environment, endangered species, energy, competition law, and pharmaceuticals. We note that Minister for International Trade Pierre Pettigrew has advocated a move to mutual recognition of regulation in his October 16 address to the Canadian-American Business Council.²⁰⁰

Several witnesses appearing before the Committee advocated moving to greater regulatory harmonization. For example, Alfie Morgan called for Canada “to harmonize our standards, to harmonize the procedures so that they’ll be predictable for business people and therefore the movement of trade will be predictable as well.…”²⁰¹ Guy Stanley of the University of Ottawa concurred with this approach, arguing that initiatives “should be designed to bring the networks and industries that are so important economically under a common set of rules. In some cases, that would imply going beyond national treatment.”²⁰² He gave the environment, financial services, telecommunications, and agriculture as examples of areas where greater convergence of operating rules and regulatory standards would enhance North American prosperity.

On the other hand, Robert Keyes of the Canadian Chamber of Commerce and Danielle Goldfarb of the C.D. Howe Institute argued for a mutual recognition approach to regulatory issues: “The advantage of mutual recognition is that it requires us to say we recognize your standards as appropriate standards and you recognize our standards as appropriate standards. That doesn’t mean you have to change your standards or we have to change our standards. I think that is potentially much more politically feasible, and it doesn’t require us to harmonize to the U.S. standard. That’s a potential way of moving this relationship forward and ensuring more secure access to the U.S. market while avoiding this issue of requiring harmonization.”²⁰³ It was suggested that mutual recognition could be undertaken on either a sector-by-sector or commodity-by-commodity basis.

Michael Hart also supported mutual recognition, suggesting that there was “no need for Canada and the United States to harmonize regulations, but much benefit is to be gained from a process whereby we mutually recognize each other’s regulations, because for most of those regulations, the differences are very small and are the result of history, legislative differences, and so on.”²⁰⁴

Recommendation 30

When evaluating measures to ease the burden that different regulatory systems can impose on companies undertaking business in North America and to avoid the drawbacks of regulatory harmonization, the Government of Canada, in consultation with the provinces, should seriously consider entering into agreements with its NAFTA partners to implement mutual recognition schemes for existing regulations. Under such arrangements, countries would recognize each other’s regulatory standards as appropriate, thereby facilitating cross-border commerce.

2.    Transportation Issues

Given the volume of Canada-U.S. trade, an efficient and cost-effective transportation system over our shared border is needed — whether using ground (highways, bridges and rail), air, or marine transportation — at points in all regions of Canada. One of the challenges associated with a network of North American trade corridors is to develop the partnerships needed among federal departments, between federal and provincial levels of government, between Canada, the United States, and Mexico, and between the private and public sectors. A greater focus on a broad-based infrastructure program would support the quest of many for a comprehensive, integrated, intermodal national and North American transportation system. It would also demonstrate to NAFTA partners our commitment to facilitating trade and would enhance opportunities for improved cross-border transportation links.

Such integration might be particularly important in such transportation sectors as rail, where an integrated North American rail industry is already developing, and trucking, where both countries are striving for harmonized regulation and the seamless movement of goods. In the case of rail, transborder options were not hampered by the events of September 11. A streamlined, electronic exchange of rail traffic information data already takes place in advance of the border crossing. For these reasons, the Railway Association of Canada has argued that the rail mode possesses a “comparative advantage” for the transborder movement of goods.²⁰⁵ Action is urgently needed, however, in removing the inconsistencies in safety standards that exist across the border, which is also a problem plaguing the trucking industry.

An integrated continental plan to enhance transportation links between the three NAFTA countries could incorporate common vehicle safety standards as well as eliminate restrictions against domestic carriage (e.g., airlines) by foreign providers. If harmonization of standards proves difficult, an alternative would be to arrive at minimum standards and then have each country recognize each other’s standards (mutual recognition). Regarding air transportation, John Furey of the Saint John Board of Trade advocated the introduction of cabotage into Canadian air transport policy.²⁰⁶ Under a system of cabotage, foreign carriers would be able to transport Canadian passengers between two Canadian destinations.

In recent years, various Canadian local governments, businesses and trade-related organizations have formed corridor associations, often with participation from their American counterparts, to promote the economic interests of their regions by facilitating transportation and thereby fostering trade, tourism and investment. An important contributing factor in the formation of these corridor associations has been the United States Transportation Equity Act for the 21st Century (TEA-21), which has authorized up to US$219 billion for surface transportation programs over the next five years. Of this, $700 million in total ($140 million annually) will be directly dedicated to corridor and border projects. These programs are financed through the Highway Trust Fund, which collects a portion of the fuel tax and sets it aside for highway improvements.

Recognizing the importance of corridors to trade facilitation and economic development, in 1997 the Canadian government formed an Interdepartmental Working Group on Trade and Transportation corridors, which serves as a focal point for consultations and exchange of information with provinces, stakeholders and corridor groups, and as a mechanism for coordinating efforts with the U.S. Department of Transportation, particularly with respect to the border infrastructure and corridors program, but also vis-à-vis Intelligent Transportation Systems (ITS) deployment, reciprocal recognition of standards, research and data compilation.

Sean Cooper discussed “fears about the way some things are going with trade corridor development across this country.… The fear that we have out this far east is that the federal government, in looking at that trade corridor, as they see it move down through that area into New York from Quebec, will take it as the eastern corridor. That again cuts off New England and Atlantic Canada, so we want to make sure the Trans-Canada highway from St. John’s to the border in New Brunswick and down through Maine, down through to New York, remains high on the priority list for trade corridor development in this country.”²⁰⁷

Canada’s Strategic Highway Infrastructure Program, announced in the February 2000 Budget, will allocate $600 million to highway infrastructure beginning in 2002, with $63 million allocated specifically for improvements at or near border crossings. Moreover, funding for ITS deployment will be available to promote more efficient use of existing infrastructure. The December 2001 Budget announced $600 million over five years for a new border infrastructure program to ensure there is sufficient capacity to assist trade at our major border crossings. Through partnership with provinces, municipalities and the private sector, the federal government will help finance infrastructure improvements at or near the border. These improvements might include: new or improved highway access for border crossings; processing centres for commercial vehicles to expedite clearance times; and ITS. Canada will also work with the United States to ensure a co-ordinated approach towards border infrastructure.

Infrastructure modernization is only one component contributing to corridor development. Federal policies and initiatives have also centred on other components such as: the harmonization of standards; the Canada Customs and Revenue Agency’s Customs Self-Assessment program; and the development of a framework for the coordination of transportation initiatives and border infrastructure modernization, based on principles contained in the Memorandum of Cooperation signed by Transport Canada and the U.S. Department of Transportation.

D.  Where To From Here?

Wendy Dobson (and others, including some of the Committee’s witnesses) called for Canada to negotiate a customs union with the United States, a common market, or some agreement that would enable Canada to achieve the benefits of a single North American economy.²⁰⁸ This visionary, “big idea” approach would, ideally, provide Canada with greater assurance of access to U.S. markets. To be acceptable from a Canadian standpoint, the new arrangements would have to include the abolition of anti-dumping and countervail rules. In exchange, Canada would likely have to support even closer continental defence and security arrangements, common policies on the border, immigration, energy, and so on, as determined by the negotiation of such a “strategic bargain”. Underlying the logic of this argument is that pursuing an economic goal of deeper bilateral integration without taking into account U.S. security preoccupations is a non-starter. Of course, it also presumes the goal itself is a desirable policy aim in terms of Canadian interests.

As this report has already indicated, a number of our witnesses would contest both the assumptions behind and the propositions contained in such a “bargain”. Some were also uncomfortable with this “big idea” approach, as much for reasons of strategic pragmatism as of philosophical difference. Instead, they chose to advocate a more cautious, incremental path to managing North American integration realities, one designed to safeguard as well as advance Canada’s best interests.

The Committee takes the view that additional policy measures that have the potential to produce significant net benefits for Canada through greater continental economic integration are “legitimately on the table for debate”, as Reg Whitaker put it so astutely.²⁰⁹ In that regard, elements of both more “visionary” and incrementalist approaches may have to be considered. As Antonio Ortίz Mena of the Centro de Investigación y Docencia Económicas advised the Committee in Mexico City, devoting full attention to “the big ideas” could result in postponing measures required in the short term (e.g., transportation infrastructure, cabotage, development of a North American trucking regime, decentralization of borders, improvement in dispute settlement, gradual convergence of external tariffs). Other immediate measures supported by some of the witnesses appearing before the Committee have already been identified in this report.

While these actions are being implemented, debate over the relative merits of the bolder “big idea” policy changes could be launched. The Committee received considerable evidence, both pro and con, on the idea of a North American customs union. While the Committee has not taken a position on this matter, we believe that it would be useful for the federal government to undertake a detailed assessment of the potential advantages and disadvantages of this option.  In connection with such a study, the already largely integrated North American steel industry might be assessed as a possible prototype among others for a broader customs union of some kind.

Recommendation 31

The Government of Canada should consider undertaking a two-track approach to North American economic integration. Identified barriers to more efficient conduct of cross-border business should be removed in an incremental manner in conjunction with Canada’s NAFTA partners. While the Committee has taken no position on the merits of a North American customs union, we believe it would be useful for the Government concurrently to initiate a detailed review of the advantages and disadvantages of the concept in the North American context. The review could include an assessment of the use of the integrated North American steel industry, among others, as a prototype for a broader customs union of some kind.

4.6       Towards a Common Currency?

A.  Background on the Debate

Except from 1962 to 1970, when Canada’s exchange rate with the United States was fixed, market forces have determined the value of the Canadian dollar since the Second World War. Since the collapse of the Bretton Woods system in 1971, when the United States delinked its dollar from gold, Canada’s monetary system has been anchored exclusively by flexible exchange rates. No other developed country can claim such a long and mostly crisis-free track record with flexible rates.

In recent years, however, several factors have emerged to prompt a debate about whether Canada should seek a more fixed exchange-rate arrangement, in the form of either a currency union with the United States (and possibly Mexico) or the adoption of the U.S. dollar as the nation’s currency, an option known as dollarization. No doubt the onset of Europe’s economic and monetary union (EMU) and the corresponding introduction of the euro as that continent’s primary currency have served to stimulate interest in a corresponding North American monetary union. Of arguably greater importance, accelerated weakness in the value of the Canadian dollar since the onset of the Asian financial crisis in 1997 has caused some observers to advocate greater exchange rate fixity for Canada.

The two above-mentioned monetary options are fundamentally different. Under dollarization, Canada would simply abandon its currency and adopt the U.S. dollar as legal tender. This option appears to have little support within the Canadian population, according to EKOS polling. (There is greater support for a new continental currency.) On the other hand, the currency union option would involve the creation of a common North American currency analogous to the euro, presumably after some period of operating under a fixed exchange rate. The likelihood of this option being selected is considered by many to be weak, in that it would involve convincing the United States to give up its own currency, to which it is deeply attached.

Even if Canada were able to negotiate a currency union with the United States and Mexico, it would almost certainly have to adopt a fixed exchange rate until the finer points of the transition to the new currency were worked out. Setting this peg could be a matter of considerable debate, especially since purchasing power parity calculations by the Organisation for Economic Co-operation and Development (OECD) suggest that the Canadian dollar should be trading closer to 84 U.S. cents than the 62 to 65 U.S. cents witnessed during the last year. If the fixed exchange rate were not carefully chosen, Canadians could find their real purchasing power diminished.

B.  The Pros and Cons of a Common Currency

Any assessment of the merits and demerits of a common currency must, in the end, weigh the economic benefits against the economic and political costs. Although the issue is essentially economic, it is worth remembering that currencies are generally created to respond to political needs (e.g., solidifying ties among EU countries) as much as economic ones. In the end, however, the biggest obstacle to movement towards a fixed exchange rate, currency union, or dollarization-by-decree is probably political, boiling down to a question of how much Canada is willing to give up to enjoy the benefits that flow from using U.S. dollars.

1.    The Case For

The case for a common currency tends to rest on two points: the microeconomic gains accruing through the removal of currency volatility and risk; and the argument that a flexible exchange rate provides businesses with a disincentive to make productivity improvements. In turn, the economic arguments in favour of a common currency usually rest on such potential for gains as:

Movement to a common currency, whether it be in a monetary union or otherwise, would eliminate currency fluctuations and provide Canadian exporters and importers with greater certainty on which to base their day-to-day and long-term decisions. As it stands now, the existence of three different currencies in NAFTA represents a substantial obstacle to trade and capital flows. Importers and exporters, tourists and business travellers, and the movers of capital between the countries need to buy and sell foreign currencies and deal with transactions costs and the volatility of exchange rates. Foreign exchange costs may be as high as one half of 1% in Canada and Mexico, less in the United States.²¹⁰ Economic efficiency, competitiveness and investment decision-making could all be enhanced as the risks associated with exchange-rate fluctuation and currency misalignment are eliminated. Both volatility and misalignment are problematic in that they contribute to greater uncertainty, which may permanently hamper trade and investment.

Proponents of a common currency also argue it could lead to lower interest rates on long-term government bonds. The logic here is straightforward: under a floating exchange rate, investors demand a "risk premium" to compensate for volatility and the potential for long-term declines in the currency. Consequently, a risk premium is built into the interest rate structure, and this has the potential to discourage investment, productivity and ultimately economic growth in the affected country.²¹¹ Under a currency union, the potential for currency fluctuations and hence the risk premium cease to exist. The new, relatively lower interest rates could spur investment; this, in turn, should ultimately lead to higher productivity and growth.²¹²

Another benefit associated with reduced exchange-rate volatility would be greater transparency of costs and prices in both Canada and the United States. Under a floating exchange system, it is difficult to distinguish between changes in the exchange rate that are the result of real factors (such as changes in productivity) and those that are temporary or nominal. In the case of an appreciation in the value of the currency, this lack of transparency can lead to allegations of dumping or predatory pricing against foreign companies, not to mention large increases in import penetration domestically. As one expert has observed: “This issue would no longer arise under a fixed exchange rate regime; the level playing field would be easier for all to see, and confusion over real cost changes versus exchange rate changes would be reduced. This might reduce the existing tension over the application of U.S. antidumping and countervail laws against Canadian exports.”²¹³ To the extent that a fixed exchange rate or common currency eliminated this problem, fewer trade disputes and greater economic efficiency, both of which should translate into lower costs, would be expected.

A common currency or fixed exchange rate could also lead to lower transaction costs because firms would no longer need to worry about hedging their U.S. dollar sales. One estimate suggests the gain from removing currency conversion costs could reach $3 billion annually.²¹⁴ Lower foreign-exchange transaction costs would lead to expanded trade, and Canada’s income would consequently rise as the resources that used to be devoted to managing exchange risk could be redeployed to other areas such as production. The savings in the costs of foreign exchange could bring dynamic benefits greater than suggested by the initial cost reductions alone.

On the other hand, some have suggested that transaction costs related to foreign exchange may be exaggerated. Canada has had a flexible exchange rate system throughout most of the post-war period and still managed to develop the largest two-way trade flow in the world. Combined, the direct costs (e.g., the cost of conversion) and associated costs of operating in more than one currency (e.g., hedging, accounting) normally do not represent a major proportion of the total cost of carrying out business across national boundaries. For example, with respect to Canada’s commercial dealings with the United States, we only have to “stop at one window” to obtain U.S. foreign exchange. Contrast this situation with that in Europe, where the gains from eliminating exchange rate uncertainty and transaction costs will be multiplied many times over, in line with the large number of currencies. There, the prospects of lower transaction costs and greater economic certainty because of reduced currency risks are much larger motivating factors in the move to a common currency.

Finally, some analysts argue that a monetary union with the United States would encourage wage and price flexibility as companies and employees in both Canada and the United States pay more attention to their North American competitive positions. This should, all things being equal, improve economic efficiency as wages and prices adjust more quickly and accurately to economic conditions.²¹⁵

Another claim often made by those who want to abandon the Canadian dollar is that Canadian firms have been sheltered from the full weight of foreign competition by a low dollar and thus have not made the productivity improvements that would lead to greater prosperity. This “lazy dollar” hypothesis, however, is controversial, and there appears to be little evidence to back it up.

Those advocating a common currency argue that the decline of the Canadian dollar over the past 25 years has been excessive and counterproductive to the country’s economic aspirations. The existing currency regime, they suggest, has merely brought about a vicious cycle of currency devaluation and lower productivity, and a drastic decline in the Canadian standard of living. A common dollar, on the other hand, would help stop the erosion of our currency and productivity, the key factors underlying a country’s long-term wealth.

The argument about the link between Canada’s currency and productivity is twofold. First, empirical studies have shown that the value of the Canadian dollar over the past 25 years has closely followed the trend in commodity prices. As a result, flexible exchange rates have delayed the resource sector’s necessary adjustment: the declining value of the Canadian dollar has shielded commodity producers from the full brunt of the drop in world prices and delayed the necessary movement of labour and capital out of the production of commodities towards other, more advanced, productivity-enhancing industries.²¹⁶ The difficulty in this development is that the long-term trend for commodity prices has been downward, yet our dependence on commodity exports — and thus an implied reduction in our standard of living — continues to be reinforced by current exchange-rate policy.

Second, it is sometimes argued that a weak dollar helps keep exports competitive without the need for increased productivity. Although a decline in the value of the national currency may provide Canada with a short-term competitive advantage, it puts less pressure on industry to make the required structural changes that might improve productivity. Moreover, if the technologies and equipment required to innovate have to be imported, any sizeable depreciation of the dollar will cause import costs to rise. A weaker dollar may also make it more difficult for firms to pay the competitive salaries needed to draw workers from abroad or keep their existing employees. Thus the persistent depreciation of the dollar’s value has made Canadian companies less interested than they would have otherwise been in making the sound investments or hiring the workers they need to improve productivity. It has been suggested that, “In the Canadian case, the robust demand growth in the recovery plus the low exchange rate probably delayed appropriate productivity-improving investments in our manufacturing industry until much later in the decade [of the 1980s].”²¹⁷ Thus, it is argued, fixing one’s currency to a stronger entity would take away the "competitive crutch" provided by the floating exchange rate.²¹⁸

This perceived effect is known in the economic literature as the “lazy firm” hypothesis, because it assumes that companies are no longer interested in profit-maximizing behaviour. It assumes, in other words, that firms do not behave in the competitive, cut-throat way that economic theory says they normally do. After all, if the weaker currency does in fact give them an added temporary advantage, then theory suggests firms should maximize the opportunity to gain market share at the expense of competitors (which is implied by dumping complaints tied to nominal changes in the currency), all the while investing in new technologies. Even if the depreciation of the currency makes machine imports prohibitively expensive, there should be sufficient  incentive for local firms to fill the gap. This was precisely the strategy pursued by Japanese firms during much of the post-war era, in both the Bretton Woods period and much of the 1980s.

Advocates of flexible exchange rates argue that the “lazy firm” hypothesis is a myth, pointing to examples such as Japan as proof. After all, they say, companies’ boards of directors are paid to ensure that management is constantly on the lookout for ways to maximize profits and the firm’s share value, no matter what the exchange-rate situation. If companies fail to operate in this manner, they will feel the sting of the market and jeopardize their competitive standing.

They also claim that the critics have not brought forward evidence of a cause-and-effect relationship between the Canadian dollar’s long-term fall (in real terms) since the mid-1970s and weak productivity growth. In fact, they argue that the causality actually runs in the reverse sense: changes in productivity bring about changes in real exchange rates, and exchange-rate depreciations merely represent a symptom of declining economic welfare.²¹⁹ According to empirical research by the Bank of Canada and others, the decline in Canada’s economic performance since 1970 can essentially be attributed to two factors: changes in commodity prices (leading to real economic shocks) and differences in Canadian and U.S inflation rates.²²⁰

Moreover, it is pointed out that not all the recent decline in global commodity prices has been offset by the depreciation of the Canadian currency. Whereas the decrease in commodity prices from the early part of 1997 to the end of 1998 (Asian financial crisis) was approximately 20%, the exchange rate fell by only 8%, with the result that commodity producers were not totally shielded from the outside shock. As such, labour and capital retained an incentive to transfer to other sectors of the economy, such as manufacturing. Thus the existence of flexible exchange rates has not totally restrained the industrial adjustments that otherwise might have occurred.

As a final point, common-currency proponents argue that flexible exchange rates have not served the country well: continuing weakness in the Canadian dollar suggests that currency markets sometimes do a poor job of signaling the correct price of currencies, and short-term currency speculation only exacerbates the tendency for currencies to overshoot and undershoot their “real” value (i.e., the value that reflects the underlying strength or weakness of the economy). If they last long enough, these misalignments can potentially harm productivity and long-term growth by delaying shifts of labour and capital into more productive areas. A fixed exchange rate, dollarization, or a monetary union, on the other hand, would render these concerns moot.

2.    The Case Against

On the negative side of the ledger, proponents of the status quo raise several considerations: the observation that Canada and the United States (and possibly Mexico) do not yet represent an “optimum currency area” (OCA), a concept pioneered by the Canadian economist and 1999 Nobel Prize winner Robert Mundell; the usefulness of flexible exchange rates in absorbing outside shocks to the economic system; the loss of control over monetary policy, together with the difficulties inherent in a “one size fits all” monetary policy; and the loss of seigniorage (revenue created by printing one’s own currency, minus the actual cost of printing it) that could ensue with the introduction of a common currency.

First, there is considerable doubt that the three NAFTA partners represent an OCA. Mundell postulated that a monetary union should, ideally, proceed only when four key economic conditions have been met. For one thing, member countries should have relatively high levels of trade integration. This is probably the most persuasive argument in favour of a currency union for Canada and the United States: more than 85% of Canada’s exports are shipped to the United States, and two-way trade has more than doubled in the past decade.

Moreover, countries entering into a currency union should have similar economic structures so that outside economic shocks, such as a sudden increase in energy prices, influence member countries relatively evenly. Moving to a fixed exchange rate or monetary union may not be useful when countries are affected differently by the same economic shocks. Many opponents of monetary integration believe the U.S. and Canadian economies are, in fact, quite different. For example, Canada is a net exporter of commodities, while the United States is a net importer. In volume terms, commodity-based exports continue to account for over 30% of total Canadian merchandise exports. Even though commodities’ share of Canadian exports is now less than half what it was 25 years ago, it is still much higher than in other industrialized countries and is likely to remain so in the foreseeable future. The typical volatility of commodity prices allows them to deliver key external economic shocks to Canada.

Yet another precondition to an OCA is a transfer system designed to provide insurance relief against region-specific shocks. As a proxy, participating countries could coordinate their fiscal policies so that revenues and spending smooth out business-cycle variations. This is the idea behind the financing conditions set out in the European Growth and Stability Pact. Member countries that incur deficits greater than 3% and debt-to-GDP ratios greater than 60% can be fined up to half a percent of their annual GDP.

Historically, the preconditions for an optimal currency area have rarely been met even within existing currency areas — including the European Union, where a common currency was implemented mainly to foster greater political integration, rather than for economic reasons. This suggests that the creation of a common currency is more a political than an economic matter.

Fixed exchange rate advocates, however, believe that the Canadian economy is becoming increasingly integrated with that of the United States and that Mundell’s four conditions for monetary union are becoming ever more actual.

A second key point to make against the introduction of a common currency is that flexible exchange rates have served the country well by helping it to weather short-term economic storms, such as the 1997-1998 Asian financial crisis, when Canada suddenly found its competitive position weakened by a steep devaluation in many southeast Asian currencies. If Canada had operated with a fixed exchange rate — which is usually a precursor to monetary union — the Bank of Canada would have been forced to buy the currency or increase short-term interest rates, or both, to defend its fixed value. Firms, meanwhile, would have had to cut costs by either reducing wages or, more likely, laying off employees and shutting down factories.

In a flexible exchange rate system, the Canadian dollar — rather than wages and prices, or employment and output — adjusts to economic shocks. Given the close relationship between the value of the Canadian dollar and global commodity prices, the Canadian dollar has played an important “buffering” role. When world commodity prices rise, the Canadian dollar is strong. When they are weak, our flexible exchange rate tends to act as a shock absorber, making Canadian exports more affordable in world markets.

Third, a common currency would prevent Canada from pursuing independent monetary policy. The problem is that a “one size fits all” monetary policy may not be appropriate for all participants, and monetary policy tailored to the needs of the United States could harm Canada. In Europe, peripheral regions’ fast growth and accelerating inflation could put pressure on the European Central Bank to raise interest rates. At the same time, other parts of the union (e.g., Germany) could be witnessing an economic slowdown that would be exacerbated by higher interest rates. In other words, monetary policy for one country might not be suitable for another country if their economic structures differ.

In a nutshell, Canada would have to give up some sovereignty. Under a currency union, one could reasonably anticipate that this country would retain a voice within a proposed North American Central Bank (in the form of, for example, being treated as one Federal Reserve District) in the setting of monetary policy. Under dollarization, however, a complete loss of monetary sovereignty would occur, in that all decisions about the money supply and interest rates would be made in the United States, with little or no Canadian input.

Countries joining currency unions, or contemplating doing so, are often motivated by the prospects of gaining credible monetary policy. Major benefits can accrue when the major trading partners are less tolerant of inflation than the domestic central bank. In this light, the policy constraint imposed by a fixed exchange rate regime is actually viewed as a positive development. For example, many still argue that certain Latin American countries with floating exchange rates are less inclined to follow appropriate economic policies than those with fixed rates. The situation in Canada is, of course, quite different in that Canadian monetary policy is generally held in high regard.

The flip side of this story is that currency union members lose a degree of economic and political independence by ceding monetary policy making. Historically, many national governments have been reluctant to adopt another country’s currency out of fear of losing control over monetary policy, such as the ability to independently set interest rates or print money. Many economic nationalists and individual Canadians are also, rightly or wrongly, concerned that adoption of a currency union might ultimately lead to political union.

Given its dominant position in North America and indeed the world, the United States has no pressing need or apparent desire to sponsor a North American Monetary Union (NAMU) arrangement. Any move towards a NAMU would, therefore, likely have to come from either Canada or Mexico and would almost certainly result in both countries adopting the U.S. dollar.²²¹ This seems especially true given the Americans’ strong attachment to their dollar. The U.S. government would also probably not be willing to give up decision-making power — or seigniorage income for that matter (see below) — to help the NAMU movement. Canada and Mexico would therefore have to surrender substantial control over independent monetary policy to the U.S. Federal Reserve. The most Canada could probably hope for would be for the Bank of Canada to become the 13th Federal Reserve District.

Even then, the U.S. monetary authorities would more than likely make their monetary policy decisions on the basis of mainly domestic economic considerations. For example, the Federal Reserve could very well set interest rates at levels that Canadians did not appreciate, perhaps to cool off a robust U.S. economy out of step with Canada’s economic cycle. Such action would not pose much of a problem if individual Canadians could move readily to the United States to take advantage of superior economic opportunities; however, the movement of labour between the two countries is very limited, mostly for institutional reasons. As of yet, there is no common market or free movement of labour in North American to support a currency union.

In the long run, theory holds that monetary policy can only influence the rate of inflation. Flexible exchange rate supporters argue the Bank of Canada has done a better job of keeping inflation under wraps than the U.S. Federal Reserve, and so there is little or no reason to form a currency union on this count. As proof, they point to the fact that Canada’s inflation rate was below that of the United States for most of the 1990s. Critics of the flexible exchange rate system, on the other hand, question whether the loss of sovereignty occasioned by monetary union would be that significant, arguing that the Bank of Canada has not displayed much monetary policy independence from the Federal Reserve during the last 20 years and that the recent evidence of lower inflation has been purchased at a steep price, namely the prolonged recession of the early 1990s. Given that Canada’s business cycle is highly dependent on that of our southern neighbour, the Governor of the Bank of Canada has, for example, often had little choice but to adjust interest rates in Canada following a shift in U.S. rates.

Finally, moving away from flexible exchange rates could involve a loss of seigniorage. Currently, the Bank of Canada collects a total of some $1.5 billion per year in domestic seigniorage, or income accruing to the government from issuing currency on an interest-free basis. Any move to a straight adoption of the U.S. currency would jeopardize the receipt of seigniorage-related revenues, since these would begin to accrue to the U.S. Federal Reserve. Under a North American monetary union, on the other hand, seigniorage could be preserved; the Canadian Mint could continue to produce currency notes and coins (with a possible North American designation on one side and a Canadian one on the other). This, of course, would have to be negotiated.

C.  Witness Views on the Debate

The evidence received by the Committee, including that heard in meetings in Washington and Mexico City, was largely negative on the overall merits of Canada’s abandoning its currency. To a large extent, the criticism of such a policy shift focused on two areas: the problems associated with varying economic structures in North America, and the loss of monetary policy decision-making that a move to a common currency would entail.

Regarding the former, several witnesses pointed out the appropriateness of continuing with a floating exchange rate until the Canadian and U.S. economies become more structurally similar. The observation was made that with Canada’s economy experiencing different shocks from that of its southern neighbour, a flexible exchange rate would be a useful tool for the country to have to deal with such shocks. For example, a drop in the price (typically on the world market) of our exports causes the value of the dollar to fall, thereby cushioning us from the outside shock while also enabling Canadian firms to more successfully export manufactured products into the U.S. market.

On the question of monetary policy, the Committee heard frequently that a common currency would lead to less sovereignty by reducing or removing Canadian control over such policy, in particular removing the flexibility the Bank of Canada now has to influence monetary policy. In contrast, it was argued, flexible exchange rates have worked effectively for Canada up until now in those cross-border dealings for which effective dollarization has not been a factor. Canadian monetary policy making has been sound, so there is little incentive to replace it with the U.S. one.

With respect to prospects for a North American common currency area, Professor Susan Minushkin of the Centro de Investigación y Docencia Económicas observed to the Committee in Mexico City that the degree of financial integration among the three countries varies from “very advanced” between Canada and the United States to “virtually non-existent” between Canada and Mexico. While the peso’s volatile exchange rate relative to the dollar continues to be of concern (recently because it has been too high; the opposite of the Canadian case), Mexican interest in dollarization options has been cooled by the recent experiences of Latin American countries such as Argentina. Nor is it obvious how such a move would help Mexico with what it sees as the pressing challenges of income inequality and labour mobility in a North American context. In Minushkin’s view, Mexicans have no illusions about the fact that gaining representation in any shared monetary authority would be a long shot at best. So while currency union can be studied and might turn out to be a good idea “20 years from now”, in the present circumstances “North America is not ready”.²²²

The point was also made by a number of witnesses that the chances of realizing a monetary union were very weak, largely because of a lack of American interest. As Dr. Laurence Meyer, a distinguished scholar at the Center for Strategic and International Studies who served on the U.S. Federal Reserve System Board of Governors until January 2002, told the Committee in Washington, there is no indication that the United States would ever share any monetary authority with another country. That leaves de jure dollarization (to use Pastor’s above-mentioned terminology) as the only realistic option.

Not all of the comments received on the currency question were negative, however. On the positive side, a number of witnesses pointed to the elimination of exchange rate uncertainty that a common currency would bring about. Removing this risk would help increase trade between Canada and the United States, even if the resulting loss in monetary sovereignty would likely outweigh any gains.

Three other arguments were raised to support greater exchange-rate fixity. First, several witnesses noted that the low value of the currency had served to “protect” very low levels of productivity. This observation holds that the falling dollar has allowed the country’s industries to remain competitive without the necessity of adequate productivity growth and innovation. As Gordon Gibson noted, “the continuing escape valve of the falling Canadian dollar has made it possible for the Canadian economy to resist adaptation to more modern times.”²²³

Other witnesses, however, made the reverse argument: that the strength of our currency would improve once the root causes of low productivity were addressed. Moving to dollarization at today’s exchange rates would, unfortunately, lock in losses in real incomes. According to this line of thinking, implementing an effective productivity-enhancing agenda would be the preferred option.

Second, Gibson argued that in ten to twenty years, de facto dollarization will have been completed, and Canada will not have put itself in a position to obtain the benefits (e.g., seigniorage, some monetary influence) that a currency union would bring.

Third, Fred McMahon observed that concerns over the loss of sovereignty brought about by the sacrificing of monetary decision-making are overrated, in that the purpose of monetary policy would not change with the policy shift and that all central banks now have price stability as “the single, unambiguous goal.”

Finally, notwithstanding the witnesses’ general resistance to the entire concept of monetary integration, several voiced the need for a serious examination of the issue from a Canadian perspective. This suggestion may have merit regardless of one’s views on the issue. The review would need to include an examination of the extent to which the Canadian economy is already dollarized. As Robert Pastor informed the Committee, there is a process of de facto dollarization that is now occurring in North America, in which “Canada and Mexico use the U.S. dollar. Businesses and travellers use the dollar, everybody uses the dollar. More than half of the deposits in the banks in Canada, I understand, are now in U.S. dollars. Almost all the major corporations trading are trading in dollars. If we don’t do anything, we move in that direction.”²²⁴

D.  The Committee’s Views on Monetary Integration

The debate over monetary integration tends to pit the microeconomic advantages of a common currency against two elements: the inability of fixed exchange rates to absorb external economic shocks; and the resulting loss of sovereignty for nations giving up their currency and decision-making over monetary policy. Choosing between the two sides represents a challenge, with both proponents and opponents making strong and valid points.

Whatever the result of that debate, “optimal currency area” theory suggests that Canada is a long way from satisfying three of the four key conditions to membership in a monetary union. These include: differences in economic structure between Canada and the rest of North America; the dearth of labour mobility among NAFTA partners; and the lack of a fiscal transfer system designed to provide insurance relief against region-specific economic shocks.

Even if the OCA conditions have not been met, these differences are not insurmountable or necessarily permanent. Moreover, over time, the ability of flexible exchange rates to buffer commodity price shocks will probably become less valuable, as both manufactured products and services come to increasingly dominate Canadian exports, as they do in the United States. With commodity exports representing a declining feature of Canada’s domestic economy, a re-examination of the costs and benefits of a North American currency union could have merit in the future. Even senior officials of the Bank of Canada, the institution whose very survival would be threatened if a common currency were to be attained, have suggested that monetary integration could eventually become a viable option.

In the short run, the Committee believes that the correct policy response is to take strong measures to strengthen the Canadian dollar, not abandon it. We agree with the bulk of the evidence received that it is currently in Canada’s best interests to retain exchange rate flexibility.

Recommendation 32

Given that certain vital preconditions to North American monetary integration (e.g., similarity in the economic structures of NAFTA participants, existence of labour mobility across borders, availability of a fiscal transfer system) are not presently met, the Government of Canada should oppose any current calls to abandon its existing flexible exchange-rate system. The Government should continue to carefully review its long-term currency options and, in so doing, assess the extent to which the Canadian economy is already dollarized and any associated impacts.