U.S-Canada Trade Relations 2009 - A "Buy America" Bump In An Otherwise Smooth And Steady Road

Sunday, October 4, 2009 - 00:00

Last October, I wrote an article for The Metropolitan Corporate Counsel where I reported on "the relatively calm state of U.S.-Canada customs/trade relations" and the steady and increasing flow of goods between the two countries. I predicted that with the settlement of the most-recent round of the decades-old softwood lumber controversy, trade relations between the U.S. and Canada would continue to be "strong, steady and non-controversial" for the foreseeable future.1Well, to put it bluntly, I was wrong, albeit for a reason that I don't believe anybody could have predicted at that time.

Before discussing the reason trade relations have taken a turn for the worse in 2009, it is important to briefly review the impact of the "great recession" on U.S.-Canadian trade.

Import volume: In 2007 - 2008, Canada was the world's second leading exporter of merchandise to the United States, trailing China by less than one percent (2007: China: $323 billion; Canada: $312 billion; 2008: China: $337.5 billion; Canada: $334.8 billion). In 2009 (Jan. - Jul.), Canada remains No. 2, but its exports to the United States have declined by 40 percent from a comparable period (Jan. - Jul.) in 2008 (2008: $205 billion; 2009: $123 billion), compared to a mere 14 percent decline in exports from China to the United States (Jan. - Jul. 2008: $185 billion; Jan. - Jul. 2009: $158 billion)

Trade deficit: The U.S. trade deficit with Canada was $99 billion in 2007 and $112 billion in 2008, not as large as the deficit with China ($262 billion in 2007 and $270 billion in 2008), but still significant, accounting for 12 percent of our $920 billion deficit for 2008. In the first seven months of 2009, the U.S. trade deficit with Canada shrunk to $28 billion, a decline of 60 percent from a comparable period in 2008, and was merely 8.7 percent of the total U.S. trade deficit for that period. (In contrast, the U.S. trade deficit with China has declined by merely 13 percent in Jan. - July 2009).

Petroleum product imports : The U.S. imported $78 billion of oil (and related products) from Canada in 2007 and $111 billion in 2008. In the first seven months of 2009, petroleum product imports from Canada declined to $34 billion, 51 percent less than in a comparable period in 2008.

Non-oil imports: The US$ value of non-oil imports from Canada remained relatively constant from 2004 - 2008: $206 billion in 2004; $222 billion in 2005; $230 billion in 2006; $234 billion in 2007, $223 billion in 2008. In the first seven months of 2009, imports declined by 34 percent from a comparable period in 2008 ($89 billion from $136 billion). Particularly hit hard was the all-important automotive sector in which Canadian exports to the U.S. fell to $14.5 billion in Jan. - Jul. 2009, a decline of 50 percent from the $29 billion exported in a comparable period in 2008.

As the data indicate, Canadian exports to the U.S. have declined precipitously and a once-healthy trade surplus is shrinking. The impact has been felt across-the-board, including Canada's petroleum and automotive industries.

Given these problems, and the positive impact of cross-border trade on both the Canadian and U.S. economies, our friends to the North could reasonably have hoped that when the United States enacted its $787 billion stimulus package in January 2009 ("Recovery Act"),2some of the benefits would have been directed to Canada. At the very least, they could have expected to be treated no less favorably than other U.S. trading partners. To everyone's surprise, the Recovery Act had the opposite impact.

One of the more controversial provisions of the Recovery Act is Section 1605, the Buy America clause. When initially incorporated into the legislation, Section 1605 was intended to constitute an almost complete bar to using foreign "iron, steel, and manufactured goods" on any project funded by the Recovery Act "for the construction, alteration, maintenance, or repair of a public building or public work." Three general exceptions to this ban were carved out where:

(1) applying Buy America would be inconsistent with the public interest;

(2) iron, steel, and the relevant manufactured goods are not produced in the United States in sufficient and reasonably available quantities and of a satisfactory quality; or

(3) inclusion of iron, steel, and manufactured goods produced in the United States will increase the cost of the overall project by more than 25 percent.

These three exceptions survived passage of the Act. In addition, extensive lobbying by our trading partners and the importing community convinced the administration and Congress that enactment of Section 1605 in its original form would be contrary to the international obligations of the United States and potentially lead to a full-scale trade war. Analogies were made to the Smoot Hawley Tariff Bill of 1930 and thus fears were raised that the original Section 1605 could contribute to a deepening worldwide recession. The solution for Congress was simple; it added a short clause to Section 1605:

This section shall be applied in a manner consistent with United States obligations under international agreements.

The devil of course is in the details - which were not readily apparent when the United States agreed to construe Section 1605 as consistent with our "international agreements."

Two of the most important U.S. international agreements subject to the Buy America exemption are the World Trade Organization Agreement on Government Procurement ("WTO GPA" - which encompasses U.S. trade with 37 major countries, e.g., EU and Japan)3and the North American Free Trade Agreement ("NAFTA" - which encompasses trade with Mexico and Canada).4Both of these agreements require that the U.S. refrain from applying "Buy America" laws to projects entered into by government entities "covered by" these agreements.

While Canadian central government agencies are bound by the NAFTA and WTO government procurement provisions, Canadian provinces are not. The United States has taken the position that until Canadian provinces give national treatment to U.S. goods and services, the U.S. will not require its states to give such favorable treatment to products of Canada in public works projects. As a result, Canadian-made goods are not eligible for the Recovery Act funds that flow through state agencies. In contrast, state governments which volunteered to be bound by the WTO Agreement must give national treatment to fellow signatories' goods and services. The only country excluded from national treatment by American state governments is Canada.

The difference between how Canada and our other trading partners are treated for Recovery Act projects is graphically illustrated in the list of "U.S. States, other Sub-Federal Entities and other Entities Subject to U.S. Obligations Under International Agreements," found in the Appendix to Subpart B of Part 176, Office of Management and Budget Regulations, 74 Fed. Reg. 18,449 (April 23, 2009). Multiple agencies in 40 American states are listed as parties to the International Government Procurement Agreement (encompassing 37 countries) and bilateral free trade agreements ("FTA") with Australia, Chile, Singapore, Morocco, and Peru. Conspicuously missing from the list of "relevant international agreements" is the "NAFTA" and even more significant is the fact that next to the listing for "WTO GPA" is the notation "except Canada." In other words, Buy America prohibits the use of Canadian iron, steel, and manufactured goods in programs administered by state governments and agencies, but allows the use of such products when they are sourced from many of our other major trading partners.

Not surprisingly, Canada businesses and the Canadian public are not happy with this recent development. Canada producers have been placed at a clear disadvantage vis-à-vis their competitors for a share of the $787 billion the U.S. is authorized to spend on stimulus projects. This "technical" trade issue has made its way up the bureaucracy. On September 16, 2009, at a joint news conference with Canadian Prime Minister Harper, President Obama acknowledged that Buy America had become "a source of irritation between the United States and Canada," noting that the Prime Minister "has brought this up with me every single time we've met, so he's been on the job on this issue." The Prime Minister agreed that "these are important irritants; they are having some real impacts." At the same time, both Obama and Harper stated that the two governments were "pursuing, on a bilateral track, efforts to make sure that these sources of tension diminish" and had "negotiators who are looking at a range of options" to solve the problem of Canada being treated less favorably than other exporters of goods used for Recovery Act projects.

Whether the Obama administration and Prime Minister Harper will succeed in closing the gap before the Recovery Act funds run out remains to be seen. Much depends on the ability of negotiators to come up with a quick, all-encompassing solution, without the need for Congressional approval.

Until the gap is closed, Canadian companies wishing to provide "iron, steel, and manufactured goods" for public works projects will be subject to the Buy America restrictions and will lose out on the ability to participate in many projects.

All, however, is not lost. Exceptions to Buy America exist.

First, Canada is exempt from Buy America with respect to Recovery Act projects funded and administered by the U.S. federal government and certain federal agencies.

Second, the Environmental Protection Agency ("EPA") has granted an across-the-board waiver of Buy America for "incidental components" which cumulatively comprise no more than five percent of materials used in and incorporated into a water infrastructure Recovery Act project.5The waiver is intended to apply to "miscellaneous, generally low-cost components that are essential for, but incidental to, the construction and are incorporated into the physical structure of the project, such as nuts, bolts, fasteners, tubing, gaskets, etc." but arguably applies to any component falling within the five percent cut-off. Recipients of grants wishing to use this waiver should determine the items to be covered by this waiver, and then must: (1) "retain relevant documentation as to those items in their project files"; and (2) "summarize in reports to the state the types and/or categories of items to which this waiver is applied, the total cost of incidental components covered by the waiver for each type or category, and the calculations by which they determined the total cost of materials used in and incorporated into the project."6

Finally, Buy America only applies to products of Canada and other non-exempt countries. In this regard, Section 176.160(a)(2), OMB Regulations, defines "domestic iron, steel and/or manufactured goods" as including

In the case of a manufactured good that consists in whole or in part of materials from another country, has been substantially transformed in the United States into a new and different manufactured good distinct from the materials from which it was transformed. There is no requirement with regard to the origin of components or subcomponents in manufactured goods or products, as long as the manufacture of the goods occurs in the United States.

Thus, Canadian-made ingredients or parts shipped to the United States and combined with other ingredients or parts to form new and different "manufactured goods" by a process that qualifies as a "substantial transformation" can be used in a Recovery Act project. In determining whether the requisite "substantial transformation" has taken place, the agency administering the project most likely will apply traditional Government Procurement rules of origin as discussed in country of origin determinations issued by Customs and Border Protection ("CBP") under Section 177.21, et. seq ., Customs Regulations. In these determinations, "CBP considers the totality of the circumstances and makes such decisions on a case-by-case basis." HQ W563587 (Feb. 8, 2007). Relevant factors include "the country of origin of the article's components, the extent of the processing that occurs within a given country, and whether such processing renders a product with a new name, character, or use." CBP also considers "facts such as resources expended on product design and development, extent and nature of post-assembly inspection procedures, and worker skill required during the actual manufacturing process." Id .

I'll end this article with another prediction. While the controversy surrounding Canada's exclusion from the exemption to Buy America has strained our trade relations with Canada, this unanticipated bump in the road will soon pass (either through negotiation or the passage of time), and in next year's article I will once again focus on a "strong, steady and non-controversial" relationship between our two countries. 1The Metropolitan Corporate Counsel, October 2008, at 60 (Canada - Law Firms; "American Trade Relations With Canada: Strong, Steady and Non-controversial, But.")

2 American Recovery and Reinvestment Act of 2009, PL 111-5 (H.R. 1) (February 17, 2009).

3 See Section 101, Uruguay Round Agreements Act of 1994

4 Part Four, Chapter 10 (which Congress adopted in the NAFTA Implementation Act of 1993).

5 See Environmental Protection Agency, Notice of Revised Nationwide Waiver of Section 1605, 74 Fed. Reg. 39,959 (August 10, 2009).

6Id., at 39,960.

Ned H. Marshak is Of Counsel in the firm of Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP, a firm concentrating primarily in customs and international trade matters.

Please email the author at nmarshak@gdlsk.com with questions about this article.