Options for a Canada-China FTA Negotiation Strategy
Date: Tuesday June 20, 2017
China’s growing middle class and expanding international interests offer major opportunities to Canadian goods and services exporters and to investors in both countries. But the devil is in the details.
By Wendy Dobson, Rotman School of Management
When Canadian and Chinese leaders committed to regular high-level contact following their September 2016 meeting, they laid a foundation for deeper economic and security relationships. They identified 29 areas of agreement and cooperation, the fourth of which was “…to launch exploratory discussions for a possible Canada-China Free Trade Agreement.”
The purpose of this background note is to briefly explore alternative negotiation strategies. There is tremendous potential to tap into the bilateral economic relationship due to significant complementarities and opportunities for collaboration.
China’s growing middle class and expanding international interests offer major opportunities to Canadian goods and services exporters and to investors in both countries. As Canada’s second-largest national trading partner, China seeks security of supply where Canada seeks security of demand for energy and natural resources as well as food. China’s growing policy emphasis on clean energy, conservation and renewables are sectors in which Canadians across the country are innovators. Canada is a major food exporter and a future global food production powerhouse. Canadian institutions provide education and tourism services that are in increasing demand by China’s fast-growing middle classes. And Chinese investors, both SOE and privately-owned, have shown rising interest in other areas of services in Canada and the United States, most notably real estate, entertainment and high tech.
Is a comprehensive free trade agreement the best way to realize this potential? The two countries liberalized investment with ratification in 2014 of a Foreign Investment Promotion and Protection Agreement (FIPA). Surely this provides a promising foundation for a full-fledged FTA negotiation? Yes, and no. In theory, it makes sense to negotiate a comprehensive agreement that aims to “reduce substantially” all trade barriers to goods such as tariffs and quotas and non-tariff measures (NTMs) affecting services, as well as liberalizing policies and institutions affecting investment flows.
But the devil is in the details. A Canada-China FTA would be only the fourth such agreement made by the Chinese with a developed economy. In prolonged negotiations with South Korea and Australia, there were major issues arising from regulatory, legal and institutional differences in the systems and the scale of adjustment burdens faced by labour in less competitive sectors.
These FTAs were not negotiated overnight. Australia’s and South Korea’s negotiations each took nearly 10 years to complete — and then by agreeing to set aside investment temporarily in order to liberalize trade in goods and services in a timely fashion, and returning to the negotiating tables within two or three years. In other words, these agreements were step-by-step, or “living agreements” intended to eventually achieve comprehensive liberalization. For Canada, an additional strategic dimension arguing for a living agreement relates to any deepening of China’s relationship with the United States through, for example, completion of the prolonged negotiation of a bilateral investment agreement (BIT) in which the United States has demanded that China provide a negative list in which all sectors are liberalized unless specifically excepted. While some agreement has been reached, it has not been fully acted upon in China. Another possible change in the bilateral relationship could be further ad hoc trade liberalization such as the recent ‘100-day plan’ agreed by the two leaders at their April 2017 meeting.
There are also political reasons not to leap into major, complex negotiations at the present time. Chinese politics are particularly fraught in 2017 in the run-up to the 19th Party Congress, scheduled for some time in October, when major changes are expected in the top Party leadership including the five- to seven-member Standing Committee, the Politburo and the Central Committee. As officials receive new assignments, formal negotiations could well be delayed.
Countering that caution, however, is the reality that Canadian producers face increased competition in the Chinese market with the phasing in of the China-Australia FTA (ChAFTA) which was ratified in 2015. With tariff removals agreed on for 95 percent of goods and exports, Australians expect ChAFTA to add the equivalent of CAD 20 billion to bilateral trade in four years, particularly in agriculture, natural resources, energy, manufacturing and services. Without comparable concessions, Canadians will become disadvantaged in the Chinese market.
It is very much in Canada’s interest to move forward.
Proceeding with a single comprehensive agreement may be unrealistic in light of Australian and South Korean experiences. A step-by-step approach may be more efficient; that is, proceeding with a series of compacts on individual issues that could be consolidated over time into the comprehensive agreement. Four significant sectoral negotiations at the WTO where both countries are participants could also be used for informal bilateral consultations; these include the Trade in Services (TiSA) agreement, the Environmental Goods Agreement (EGA), the International Technology Agreement (ITA2) as well as the Government Procurement Agreement (GPA) to which China has yet to accede.
The step-by-step approach could resemble an Economic Partnership Agreement (EPA), which allows for exceptions, as Canada has experienced in negotiations with Japan where agricultural sensitivities on both sides prevented the comprehensive approach. China and other East Asian governments are familiar with EPAs; the Regional Comprehensive Economic Partnership (RCEP) is a major multi-country goods-only negotiation ongoing among the 10-member Association of South East Asian Nations (ASEAN) and Japan, Korea and China. Unlike FTAs, which aim to remove “essentially all” trade barriers, EPAs are less demanding and promote deeper economic cooperation as well.
Some significant ground work for a step-by-step approach has already been laid by Canadian and Chinese officials in the 2012 Canada-China Economic Complementarities Study, which selected seven sectors for analysis of trade patterns and existing trade and investment barriers, and complementarities and opportunities for growth. Based on this work, negotiations could begin with those sectors where each party faces tariff or non-tariff barriers to different goods or services, such as Canada’s interests in the treatment of vegetable oils and seeds in agriculture. In some sectors both parties could cooperate around common interests, such as by removing intra-sectoral barriers. In other instances, removal of barriers would have to be addressed through inter-sectoral negotiations as mutual confidence and trust are established in sectors where gains to deeper cooperation are evident. The sequence could be agreed at an appropriate stage by senior officials of both countries at the Financial and Strategic Dialogue which was agreed in 2016.
The step-by-step approach should be guided by a clear set of principles. First, negotiations should be WTO-consistent, observing the principles of non-discrimination and national treatment. Second, the goal should be to reduce and eventually eliminate barriers to trade in goods, services and investment in ways consistent with eventual inclusion in a FTA. The larger framework for the end game is essential to allow the inevitable tradeoffs involved in inter-sectoral bargaining. For example, tariffs in one sector may be reduced by one of the parties in exchange for reductions by the other party in another sector. Third, there should be a heavy emphasis on implementation with explicit agreement that neither party will impose ad hoc regulatory restrictions after negotiations are complete (something that Australia has experienced). Finally, the emphasis on implementation should include agreement at the outset to upgrade the step-by-step talks into a full-blown FTA agreement within a specified time period, such as five years.
The seven sectors identified in the 2012 Complementarities Study are:
- Agriculture and agri-food;
- Clean tech and environmental goods;
- Machinery and equipment in agriculture and mining;
- Natural resources and related products including pulp and paper;
- Textiles and related products; and
To create a cooperative context, both governments agreed in 2016 to double two-way visits and bilateral trade by 2025 and to improve the environment for cooperation in agriculture, energy, manufacturing, financial services and infrastructure. Aviation, air transport, educational and health care services are also mentioned.
How might these areas of economic cooperation be organized into identifiable sectoral components of an eventual FTA?
Examination of four sectors illustrates the possibilities for sequencing. As noted earlier, Canada’s endowments of energy, natural resources and food are complementary to China’s goal of secure supplies; Canada is a supplier of a range of services. Yet Canada is relatively invisible in the Chinese market, ranked as the 18th-largest supplier where Australia ranks 6th.
Agriculture and agri-food are first on the list of sectors in the Complementarities Study yet there are good reasons to place this sector later in the overall sequence. While there is ongoing cooperation in international forums and bilateral mechanisms and agreements covering biotechnology, sustainable agriculture and food safety, there are significant barriers to trade. On both sides tariffs remain high and exceptions exist in certain product areas such as dairy, where Canada’s protection of its market prevents dairy exports of any significance. Concessions in CETA and TPP negotiations will loosen the restrictive regime somewhat. Overall, China’s tariffs average 15.6 percent while Canada’s average is 11.3 percent. Regulatory obstacles also exist with both sides identifying sanitary and phytosanitary measures and differing standards that raise uncertainties and trade costs.
Negotiating tariff reductions and addressing product exceptions from negotiation as Canada has done with softwood lumber in NAFTA negotiations (“paying” for the Chapter 19 dispute resolution compromise by opening energy to regional free trade) are high-stakes negotiations. Tradeoffs across sectors are likely to be necessary and therefore are better dealt with at a later stage in the negotiation sequence.
Clean tech and environmental goods and services might be discussed early in the sequence because of their high importance to China, the existing level of bilateral cooperation and potential for more. Early attention could help establish mutual confidence and trust needed for dealing with other difficult issues such as agriculture. In clean tech and environment, both parties are already addressing domestic and global challenges and have a shared interest in doing so. Trade in goods is small but growing fast. China imports clean tech goods from Canada, particularly parts and components for wind power generators and smart grids, while Canada imports solar cells. Cooperation takes the form of science and technology partnerships and initiatives to match Canadian capacities to Chinese needs. Barriers to growth in this cooperation relate to the small size of Canadian companies relative to the scale of solutions sought by Chinese customers; intellectual property protection is an additional concern.
These characteristics suggest the possibility of an agreement on environmental cooperation, perhaps as a side agreement (the North American Agreement on Environmental Cooperation in NAFTA is an example) in which both parties commit to enforce their own domestic laws and perhaps establish a Council on environmental cooperation that fosters partnerships between Canada’s clean tech SMEs and Chinese firms in the effort, among others, to facilitate inputs into global supply chains of OEM manufacturers’ international operations.
Natural resources and related products including pulp and paper: This is a third example where China has strong interest in Canada’s energy and natural resources but there are policy sensitivities about wood products including pulp and paper. The virtual elimination of Chinese tariffs on Australian natural resources and related products including coal present a competitive challenge to Canada. Significantly, ChAFTA excluded wood and paper products from the agreement, one of Canada’s largest exports to China.
FDI screening is an issue in this sector. Both Canada and China have highlighted market access problems and the need for greater regulatory clarity on FDI, as well as attention to differing technical requirements and lengthy approval processes. Australia’s experience suggests the possibility of difficult negotiations if the focus is product-specific. Finding offsetting product areas where there are common interests within the sector, such as around uranium supplies in the energy mix, would be one option to explore. Another option might relate to innovative, new and complementary wood and forest products and supplies of other Canadian mineral products. Given the scale of investment that Canada will need to continue the development of its natural resources endowments, it is likely that China will follow through on officials’ rhetoric criticizing Canada’s opaque investment screening regime with demands for modification and greater transparency. Worthy of note, however, is China’s reported withdrawal of a request for equal treatment of SOE investments in exchange for Australia accepting smaller-than-desired Chinese tariff reductions in sensitive products such as sugar and rice.
Services: A fourth example is services where two-way trade is already significant despite the large difference in the economic importance of services in the two countries. Services contribute more than two-thirds of Canada’s GDP compared to China where the 12th Plan goal was to bring services value added up to 47 percent of the GDP. In 2009 China ranked seventh in Canada’s export market for services and eleventh as a source of imports (in transportation, government services and travel). Canadian firms active in China are both SMEs and very large firms in financial services, engineering, architecture, mining and environment services.
Yet challenges exist for both parties in such areas as trade facilitation and establishing commercial presence through, for example, allowing more cross-border labor mobility. Market access is restricted; operating wholly foreign-owned service companies in China is restricted and minimum capital requirements, transparency and various regulatory requirements are imposed by different levels of government. As a result, the Complementarities Study concludes there is considerable unrealized potential in the relationship.
Despite the trade and capital restrictions, there are opportunities for deeper cooperation. China’s major economic rebalancing strategy emphasizes the development of services sector production and employment, and Canada has the potential to export best practices and enhance competition in the domestic market. Both parties will gain from deeper integration in commercial services. Perhaps less than seems possible in clean tech and environmental goods and services, the goal can be achieved through cooperation and intra-sectoral bargaining but will also require inter-sectoral negotiations to eliminate barriers to trade and investment.
These examples of a step-by-step approach in sectoral cooperation and negotiations could contribute momentum to the eventual achievement of a comprehensive FTA.
The Complementarities Study identifies three more sectors for cooperation and bargaining. It is important to realize that while the first steps can be sectoral, later steps will require cross-sectoral bargaining on such trade and investment issues common to all sectors as intellectual property protection, FDI regulation and screening, export controls, SOEs and competition policy and dispute settlement.
In conclusion, this background note suggests serious consideration of a step-by-step approach in negotiating a Canada-China FTA. Opinion polls show a warming of Canadian public opinion toward such a deal, but much more groundwork is needed to build the capabilities of Canada’s SMEs to do business in China and much more public education is required about Chinese doing business in Canada. Win-win economic partnership agreements in specific sectors can be building blocks for both public opinion and the business community. It is also important to recall that the context for Australia’s negotiations included two white papers and a generation of public discussion and debate. In contrast, Canadians have taken for granted their dependence on the US market and have only recently begun to realize the case for greater market diversification.
Note: Two sources used in preparing this note on negotiating issues are:
- Global Affairs Canada, 2012. Canada-China Economic Complementarities Study available at http://www.international.gc.ca/trade-agreements-accords-commerciaux/agr-acc/china-chine/study-comp-etude.aspx?lang=eng&_ga=2.202071185.1615292795.1496690562-229452383.1416510303.
- Kerry Sun, 2015. “China-Australia Free Trade Agreement: Implications for Canada”, China Institute, University of Alberta, Occasional Paper Series, 2 (1), March.