Get ready for the U.S.-China sideswipe: Phase one trade truce could be devastating for Canadian exporters

As published in the Financial Post

Opinion: There is a real risk to Canadian exporters that China will turn its back on them as it seeks to fulfill its new commitments to the U.S.

After 18 months of stop-and-start negotiations, the U.S. and China have finally signed their so-called “Phase One” trade truce. The deal may be an important step in de-escalating the U.S.-China trade conflict but what does it mean for Canadian businesses? If China is a major export market for your business, you need to be concerned.

The deal sees China implementing new policies that could benefit all foreign businesses operating there. Seemingly enforceable commitments on intellectual property protection, limits on “forced” technology transfer, liberalization of financial services and reductions in non-tariff barriers in the agricultural sector may all help Canadian companies succeed in China.

But the good news for Canadian business stops there. The agreement also includes a chapter on expanding China-U.S. trade that could result in a significant decline in Canadian exports over the next two years as China switches a chunk of its buying power to the U.S. and away from other countries.

Under the deal, China has committed to no less than US$200 billion in additional U.S. imports by the end of 2021 (from a 2017 baseline). The problem for Canada is that 15 of its top 25 categories for export sales to China in 2017 are explicitly listed in the agreement, representing some 51 per cent of Canada’s total exports to China and $12 billion in value. Just as some Canadian suppliers had a windfall when China put tariffs on hundreds of billions of dollars worth of U.S. imports, they now risk being jilted in favour of U.S. suppliers.

Among key Canadian exports covered by the deal are agriculture, seafood, and forest and automotive products. There is a real risk to Canadian exporters in these industries that China will turn its back on them as it seeks to fulfill its new commitments to the U.S. This risk is highest for products where the landed cost of Canadian and American suppliers into China is similar.

U.S. competition is an especial concern for Canadian exporters of soybeans, lumber, autos and seafood. In each of these areas the U.S. was a top-three supplier to China even before the so-called trade war. All but autos are commodities, which means changing suppliers is relatively straightforward.

In what was widely viewed as retaliation for Canada’s acting on a U.S. extradition request, China has already blocked all purchases of Canadian canola. The U.S.-China deal adds a further complication for Canadian canola farmers, who will now face the threat of Chinese buyers favouring U.S. suppliers.

Canadian exports of lobster to China surged in response to China’s retaliatory tariffs against the U.S., with lobster exports reaching their highest levels on record at the direct expense of U.S. suppliers. But given China’s pledge to buy an additional US$32 billion in agricultural products from the U.S. —including seafood — these gains may now be threatened.

There is little Ottawa can do in response to managed trade between the U.S. and China. The new agreement is certainly not compliant with WTO rules, as the WTO requires each member country to provide equal treatment to all other members under the “most-favoured nation” principle. But given the current state of the WTO and its non-functioning dispute settlement Appellate Body, challenging the agreement there would be a fool’s errand.

For Canadian business, now is the time to prepare for a potential drop-off in demand from Chinese customers. Exporters in the affected sectors can try to remain competitive in the Chinese market so their Chinese customers drop other suppliers as they switch volumes to U.S. sources. And, given the continuing potential both for volatility in the U.S.-China trade dynamic and for tension in the Canada-China relationship, exporters should redouble their efforts to enter and grow their business in other international markets.

As we enter the brave new world of “every nation for itself,” trade diversification has never been more important.

Brian Kingston is Vice-President, International Trade and Fiscal Issues, at the Business Council of Canada. Michael McAdoo is a Montreal-based partner at Boston Consulting Group, and co-leads the firm’s world-wide trade and investment practice.