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The North American Free Trade Agreement (NAFTA), the tri-nation trade agreement between the U.S., Canada and Mexico, represents more than $1.7 trillion of trade. It is the world’s largest trade agreement.

President Trump contends that NAFTA is often unfavorable to American interests and had repeatedly sought to renegotiate its terms. However, both Canada and Mexico were resistant to change. As a result, he sought to replace NAFTA with separate trade agreements with each country. And on Aug. 27, President Trump and Mexico announced a trade agreement that would replace NAFTA. But there was one missing ingredient in this new agreement — Canada.

Yes, Canada was welcomed to join this new agreement, but President Trump’s conditions were swift and direct — accept similar terms that Mexico agreed to, or be left out, and a 25 percent tariff would be imposed on Canada’s auto and car parts industries. Canada was placed in a brutally challenging position. If it agreed to join the U.S.-Mexico agreement, it would have to give up sizable concessions on its protectionist tariffs, quotas and trade restrictions it uses to safeguard its agricultural industry. If Canada rejected the terms, a 25 percent tariff on its auto and car parts industries would decimate its economy.

The dilemma for Canada is its reliance on its supply management system — a national framework of policies that govern Canada’s dairy, poultry and egg producing industries. It strictly regulates production, prices and even competing imports from other nations.

Canadian farmers purchase quota allotments — which is essentially a license — that dictates how much of a given product they are allowed to produce. They are then paid a minimum price for their product. Finally, foreign imports of these products are subject to quotas and prohibitively high tariffs, that combine to restrict access to the Canadian marketplace.

The net effect of this supply management system is that it protects Canadian farmers from global competition while providing them above-market prices for their products. It does allow a small amount of foreign dairy, poultry and eggs into Canada duty-free or at very low tariffs. But above that minimal quota, as President Trump has frequently criticized, the tariffs are punishing — 270 percent for milk, 245 percent for cheese and 298 percent for butter.

But last Sunday, President Trump announced that Canada had agreed to significant concessions on its supply management system. This new U.S.-Mexico-Canada Agreement, or USMCA, would officially replace NAFTA, pending approval by Congress and the respective legislatures in Canada and Mexico.

By joining the USMCA, Canada agreed to the basic structure of the U.S.-Mexico agreement. To be exempt from a 25 percent U.S. tariff, 75 percent of a car’s content must now be made in the U.S., Mexico or Canada. Starting in 2020, 30 percent of the content must be made by workers earning at least $16 per hour. In 2023, this increases to 40 percent. The agreement also expands trade covenants on manufacturing and agriculture, strengthens enforcement of intellectual property rights and imposes protections on digital technology, among others.

As part of Canada’s negotiated inclusion, President Trump agreed to keep the arbitration system used in NAFTA to settle trade disputes. He had wanted to scrap this system, viewing the arbitration panels as a challenge to U.S. sovereignty. Despite this small victory, overall, Canada’s concessions were sizable.

Canada agreed to open expanded markets to U.S. farmers to its poultry and egg industries, allowing additional tariff-free imports into its country. But the greatest gain was for U.S. dairy farmers. Canada agreed to a near 300 percent increase in the tariff-free import of U.S. dairy products. Furthermore, Canada must eliminate key dairy pricing structures set by the Canadian Dairy Industry that American farmers contend are unfair and non-competitive.

So, why did Canada agree to such one-sided concessions to join the USMCA? As I’ve previously mentioned, in the realm of trade disputes, economic leverage reigns supreme. Trade disputes exact a toll on a nation’s economy, and the nation that can best withstand this punishment typically prevails. And as the U.S. economy continues to surge, most of the world’s economies — including Canada’s — are in steady decline. In the end, Canada’s economy is struggling, and faced with a further 25 percent tariff on two of its key industries, the outcome was fairly inevitable.

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Mark Grywacheski spent more than 14 years as a professional trader in Chicago, where he served on various committees for multiple global financial exchanges and as an industry Arbitrator for more than a decade. He is an expert in financial markets and economic analysis and is an investment advisor with Quad-Cities Investment Group, Davenport.

Disclaimer: Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. Quad-Cities Investment Group LLC is a registered investment advisor with the U.S. Securities Exchange Commission.

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