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Canada's best bet to win trade war: Ignore Trump, take case directly to states

As NAFTA is "tweaked" to death, the best Canada can do is collaborate with the 35 U.S. states that need its trade partnership.

Trade rules between Canada and the United States are about to change, big-league. Minimizing damage to Canada will be the Canadian government's biggest challenge. Under normal circumstances, you'd expect some give-and-take negotiations, with net positives for both the United States and Canada. But we are not dealing with a traditional Washington.

There are two sources of upheaval; both come from the GOP. The first is congressional Republicans' "A Better Way" plan, which includes a 20 percent border tax on imports and tax exemption of U.S. exports. The second is President Donald J. Trump's interest in "tweaking" Canada-U.S. trade.

Something will give.

President Donald Trump meets with Canadian Prime Minister Justin Trudeau at the White House on Feb. 13, 2017.
Mandel Ngan | AFP | Getty Images
President Donald Trump meets with Canadian Prime Minister Justin Trudeau at the White House on Feb. 13, 2017.

Today, Canada-U.S. trade is essentially balanced (unlike U.S. trade with Mexico), but its impact is different in each country. Roughly 25 percent of Canada's GDP stems from trade with the United States, but American trade with Canada accounts for merely 2 percent of U.S. GDP. Canada has little economic leverage to negotiate at a federal level, and changes to the trade rules hit Canada harder than the United States.

The biggest change in the congressional Better Way blueprint is the addition of a consumption tax. All well and good, except it excludes taxation of exports, which is great for an inward-looking "America First" supporters but poor for trade partners like Canada.

The border tax idea would effectively end NAFTA and its predecessor, the underlying Free Trade Agreement. Economists predict the Canadian economy could lose at least 1.5 percent of GDP because of such new trade barriers. Canada would be forced to retaliate.

A weaker Canada will have less productivity to share with the United States. Right now there's more juice to be squeezed from Canada, but the United States can expect diminishing returns as the Canadian economy retracts from American protectionism. A smaller apple produces less juice, even if you squeeze it harder.

"Canadian politicians have pointed out the disproportionate impact Canadian trade has on 35 U.S. states. ... Finding a way to get the states and provinces to the table could be Canada's best strategy."

Canada's government under Prime Minister Justin Trudeau has adopted a smart approach — get ahead of change, and show great eagerness to engage with the United States. Negotiate bilaterally — and quickly — without Mexico at the table. This strategy might mitigate damage, but it's unlikely negotiations will result in concessions to Canada, such as a change in dispute mechanisms. For example, Canada's longstanding desire to change the softwood lumber rules to allow subsidies will not be solved. It may get worse.

Canadian politicians have pointed out the disproportionate impact Canadian trade has on 35 U.S. states. It is conceivable the GOP may carve out the deeply integrated supply chains for manufacturing and commodities exchange that occur under NAFTA in these 35 states. Effectively, this would create a 'mini NAFTA.' Actually, more like a renegotiation of the FTA and Auto Pact.

Politicians in the 35 states may pressure the federal government to maintain elements of the status quo. Their supply chain is so well integrated, the job upheaval would be punishing for all involved. Those states would neither want a trade war nor the decrease in economic activity resulting from new trade rules.

Finding a way to get the states and provinces to the table could be Canada's best strategy.

Trump's idea of 'tweaking' — don't trust it

The wild card is the Trump administration, and Trump's executive orders and deal making.
It's silly to assume that Canada's soft leverage of cultural likability or proximity will have any effect on Trump. As a businessman, Trump routinely demonstrated a zero-sum approach to deal making. Often, it was his business partners who got burned the worst. Trump's idea of a good deal is, he wins and everyone else loses.

When Trump says he wishes to 'tweak' NAFTA, it sounds innocuous, but David Cay Johnston's book "The Making of Donald Trump" doesn't describe a man who tweaks anything. It's hard to imagine something positive for the Canadians coming from Trump, a disingenuous player lacking a sense of fairness.

Recently, the Wall Street Journal reported Trump plans to change the way trade deficits are calculated. Assets of integrated manufacturing under NAFTA — say, the auto industry — would be tracked as imports as they move through America, but not as exports as they move out. This will artificially inflate the American trade gap with Mexico and manufacture the illusion of a trade deficit with Canada.

This is Trump preparing to tweak.

Recent polling, sponsored by Canadian daily The Globe and Mail, shows that Canadians wish their government would push back strongly against U.S. efforts toward import tariffs or reduction of labor free movement. But how effective could this be?

The size and opportunity the U.S. market represents to Canada are immense. Moreover, Canada-U.S. balanced trade shows that it is a mutually effective relationship. But only the United States truly stands to gain from re-litigating NAFTA.

The recent U.S. election showed an overwhelming desire for change, and a mandate was given to Trump, who — it cannot be argued — had the primary message of disrupting the status quo. For generations, Canada and the United States have had a mutually enriching trade relationship. It has grown as time passed. This is because it works, and the two countries work well together.

As NAFTA is "tweaked" to death and the Better Way comes to pass, the best Canada can do is collaborate with the 35 U.S. states with the closest relationship to Canada. It deconstructs traditional international trade relationships. But it's Canada's best chance to penetrate the insularity of the new USA.

By Jason Martin, CEO of iotum, a SaaS collaboration company with offices in Toronto and Los Angeles, and a member of the CNBC-YPO Chief Executive Network.

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