“Buy American” has once again emerged as a major irritant in the economic relationship between the United States and its largest trading partners, including Canada. This time, it’s impacting the North American automotive manufacturing sector, one of the most integrated, harmonized and interconnected industries in the world.

On October 22, 2021, Canada’s Minister of International Trade, Export Promotion, Small Business and Economic Development, Mary Ng, informed senior U.S. officials of Canada’s “very serious concerns” with Buy American-type proposals included in President Joe Biden’s massive budget bill – proposals that have been called an “emerging trade irritant”. Mexico, the European Union, Japan, France, South Korea, and others have issued statements opposing the proposals.

In Canada’s letter, Minister Ng indicated that the proposals would “undermine decades of United States-Canada cooperation to foster a mutually beneficial integrated automotive production and supply chain, and hurt U.S. suppliers and their employees given that each assembled vehicle produced in Canada contains approximately 50% content”.[1]

If implemented, this Buy American measure could also set a dangerous precedent for regulation over other areas of the automotive sector and, more broadly, incentives and other measures governing emerging renewable energy markets. In this article, we explain that the legal framework governing the manufacturing of motor vehicles in the United States and Canada is extremely integrated. As such, any requirement to “Buy American” may end up crippling Canadian producers while causing supply chain disruptions and parts shortages in the United States. We also discuss the implications of the Proposals under international trade and investment agreements and the potential trade remedies available to Canada in the event one of the Proposals becomes law.

Proposed Tax Credits Conditional on Assembly in the United States

The proposals at issue are part of President Biden’s plan to “Rebuild the Middle Class” and his “Build Back Better Framework”. In particular, there are two draft proposals (one by the Senate Finance Committee and one by the House Ways and Means Committee), which would grant up to USD$12,500.00 in tax credits for consumers purchasing an electric vehicle, with this credit being conditional upon the vehicles’ being solely assembled in the U.S., at unionized plants (the “Proposals”).[2] The Proposals would disproportionally affect Canadian auto manufacturers, when compared to those of other countries who adhere to different vehicle safety standards systems than those in the United States and Canada. The discriminatory nature of the Proposals is also concerning from a trade perspective – in her letter, Minister Ng expressed Canada’s deep concern about the Proposals’ “protectionist elements”, emphasizing the inconsistency of the Proposals with U.S. obligations under international trade agreements.[3] Canada’s international counterparts agree.[4]

This issue is attracting particular attention because of its timing, resulting in Finance Minister Chrystia Freeland calling this “a focus” and “a priority”. This is because automotive companies are in the process of making long-term strategic decisions about where to build and assemble their electric vehicles, and the Proposals, if passed, will create a strong and potentially discriminatory incentive to choose the United States over competing jurisdictions.[5]

Understanding Market Integration Through Vehicle Manufacturing Standards

Whereas most countries generally follow, either through recognition or by mirroring in their national laws, the World Forum for Harmonization of Vehicle Regulations’ technical requirements regarding vehicle build standards, the United States and Canada are outliers, having developed their own sets of standards. This means that cars imported to the United States or Canada must go through further tests to attest to their compliance with local car safety standards in order to be driven on North American roads.[6]

Canadian Safety Standards in Brief.

In Canada, the Motor Vehicle Safety Act (“MVSA”) requires that motor vehicles and their parts, and motor vehicle equipment, whether manufactured in or imported to Canada, receive certification that they comply with all applicable Canada Motor Vehicle Safety Standards (“CMVSS”). The CMVSS identify mandatory minimum safety performance requirements for new motor vehicles and vehicle equipment in Canada. If manufacturers cannot demonstrate compliance to the CMVSS they will be denied market access.

Standards Largely Informed by U.S. Laws.

In enacting and updating the MVSA, Canada has largely followed the substance of U.S. Federal Motor Vehicle Safety Standards (“FMVSS”), developed and enforced by the U.S. National Highway Traffic Safety Administration (“NHTSA”). Most mandatory minimum safety requirements are the same in both countries. Canada’s vehicle safety laws also emulate the American system by using a self-certification process, leaving auto parts manufacturers solely responsible for ensuring their products’ compliance with CMVSS.[7] The few CMVSS points of divergence from the FMVSS generally reflect Canada’s particular environmental conditions; think of winter tires, all-day headlights and the metric system.

Harmonization and Integration.

These legal developments can largely be attributed to the Canada-U.S. Auto Pact, which lasted from 1965 to 2001. During this period, the Canadian and U.S. auto industries were progressively integrated into a shared North American market, which is still interconnected — whether in supply agreements, or in laws and standards. The result is that that vehicles built in either country adhere to essentially the same vehicle safety and emissions standards.

Work by the Canada-United States Regulatory Cooperation Council has helped ensure that any new norms are developed in cooperation to maintain this level of harmonization, one recent example being Vehicle to Vehicle (V2V) and Vehicle to Infrastructure (V2I) communications technology.[8] More recently, because of the structure of the North American market, changes to vehicle builds aimed at reducing greenhouse gas emissions and increasing product sustainability have been much easier to implement and operationalize.[9]

Integration of the North American automotive manufacturing industry also intensified with increasing local content requirements for preferential tariff treatment under the Canada-United States Free Trade Agreement in 1989, and when Mexico was brought into the fold in the 1994 North American Free Trade Agreement. This has continued with the implementation of the 2020 United States-Mexico-Canada Agreement (“USMCA”) (also known as “CUSMA” or the “new NAFTA”).

Trade Retaliation and Governing Trade Agreements

In her October 22, 2021 letter to U.S. lawmakers, Minister Ng described the Proposals as inconsistent with U.S. obligations under the World Trade Organization (“WTO”) and the USMCA. In Mexico’s related letter of October 30, 2021, the Proposals were described as “detrimental to the international trade commitments acquired by the United States”. The October 29, 2021 letter signed by various ambassadors “representing countries of automotive producers that support millions of U.S. jobs in the sector” expressed related concerns.

This opens the door to potential trade disputes and, if successful, trade remedies.

Canada is no stranger to trade disputes with the United States.

As a member of the WTO, Canada has participated in 40 cases as a complainant, 23 cases as respondent, and 167 cases as a third party.[10] On at least 20 occasions, Canada has turned to the WTO in resolving trade disputes with its southern neighbour.[11] While not without its criticisms (for example, former U.S. President Trump branded the WTO as a “broken” and “horrible” institution and used his administration to cripple the WTO appeals process by blocking appointments to its appellate body),[12] the Canadian government recognizes the WTO as a “key way to help ensure the rights of Canadian traders are protected and help maintain the integrity of the dispute-settlement system as a whole”.[13]

Canada has likewise been party to disputes with the United States under NAFTA, and is already party to disputes with the United States under the year-old USMCA. (For example, in May 2021, the United States requested the establishment of a dispute settlement panel regarding Canada’s administration of its dairy tariff rate quota policies.)

The Proposals discriminate against foreign producers.

Article III of the General Agreement on Tariffs and Trade 1994 (“GATT 1994”), set out in Annex 1A of the 1994 WTO Agreement, sets out the “national treatment” provision. This key principle of international trade requires that imported and locally-produced goods are treated equally, at least after foreign goods have entered the country.

Paragraph 1 of article III sets out the parties’ recognition that taxes, laws, regulations and other requirements affecting the internal sale, offering for sale, and purchase of products should “not be applied to imported or domestic products so as to afford protection to domestic production”. Paragraph 4 further provides as follows:

The products of the territory of any contracting party imported into the territory of any other contracting party shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use (emphasis added).

NAFTA, as well as its successor, the USMCA, contain similar language in articles 301 and 2.3.1, respectively, which provisions explicitly adopt the national treatment principle from article III of GATT 1994. NAFTA’s and the USMCA’s investment chapters each also contain a national treatment provision (articles 1102 and 14.4, respectively), which require no less favourable treatment for investors than that accorded to a country’s own investors in like circumstances. (We include references to NAFTA because of the continued availability of investor-state dispute settlement in respect of legacy investments, discussed further below.)

The USMCA’s “performance requirements” provision (article 14.10.2) is also noteworthy. This provision prohibits parties from conditioning the receipt or continued receipt of an advantage related to an investment upon compliance with a requirement “to purchase, use, or accord a preference to a good produced in its territory, or to purchase a good from a person in its territory”.

At first blush, electric vehicles produced internationally would arguably receive treatment that is “less favourable” than that accorded to like U.S.-made vehicles as a consequence of the Proposals. The Proposals could also arguably be considered an advantage conditioned upon purchasing a good produced in the United States.

Justifiable on environmental grounds? Seems unlikely.

A laudable policy objective underlies the Proposals: by lowering the cost of an electric vehicle by USD$12,500 for American families, the U.S. government is clearly trying to incentivize consumers to transition to electric vehicles.

Free trade agreements often feature exceptions that allow national governments to implement measures that support legitimate policy objectives, including protecting the environment, even if those actions may otherwise violate the agreement in question. Chapter XX of the WTO Agreement, for example, sets out a number of “General Exceptions”, providing that nothing in the agreement should be construed as preventing the adoption of measures that, among other things, are “necessary to protect human, animal or plant life or health” or which relate to “the conservation of exhaustible natural resources”. Importantly, however, these exceptions are subject “to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail or a disguised restriction on international trade”. According to the WTO, these restrictions exist to “avoid the misuse of such measures for protectionist ends”.[14]

Subject to certain terms and conditions, NAFTA and the USMCA each incorporate Chapter XX into their respective agreements (see articles 2101 and 32.1, respectively). Other provisions in both agreements contain similar caveats, restricting exceptions to measures that “do not constitute a disguised restriction on international trade or investment” (e.g., USMCA, article 14.10.3) or which “avoid the creation of unnecessary barriers to trade” (e.g., USMCA, articles 12.D.5 and 24.14).

In the event of a trade dispute, the U.S. government could assert that such an exception applies. This argument may not be very persuasive, however, as it is difficult to see how the requirement for U.S. production is necessary to support the objective, irrespective of the objective’s recognized importance. To the contrary – if the goal is to increase the number of consumers using electric vehicles, it seems a broader tax credit, applicable to vehicles produced anywhere in the world, would be more effective, as it would make the tax credit attractive to all consumers and not just those who prefer or are willing to buy a U.S.-made vehicle. For this reason, it is unsurprising that the Proposals have been described as “contrary to the spirit ... of what we have been trying to achieve with our American colleagues”, which is a joint effort to pivot toward greener technologies to fight climate change.[15]

A brief look at the dispute settlement process & potential remedies.

If the one of Proposals becomes law, we may well see Canada initiate a trade dispute to the resolve its concerns. Indeed, with the amount of government and media attention this issue is already attracting, the commencement of a challenge under one or more of the trade agreements appears likely.

Under the WTO, the dispute settlement process consists of three main stages: mandatory consultations, adjudication by panels, and if applicable, by the Appellate Body, and implementation of the ruling. Absent implementation of the recommended remedies, compensation may be sought; and if the parties cannot reach an agreement on compensation, complainants may seek permission from the Dispute Settlement Body (“DSB”) to impose trade sanctions against the respondent.[16] Canada has been granted such permission in the past – for example, in 2000, in Brazil – Export Financing Programme for Aircraft, the DSB authorized Canada’s request to suspend tariff concessions and other obligations to Brazil to a maximum amount of CAD$344.2 million per year. Such sanctions can be significant – last year, the DSB granted China authorization to impose US$3.6 billion in sanctions against the United States.[17]

Use of the WTO dispute settlement mechanism may be questionable for the time being – since 2020, the Appellate Body has ceased to function as a result of the United States blocking the selection of new tribunal members when their predecessors’ terms expired. Although this started with the Trump administration, there appears little indication that this will soon change under President Biden.

Under the USMCA, parties are also encouraged to settle their disagreements through cooperative means, such as consultations. If those efforts fail, the agreement allows for the establishment of an arbitral panel. If an arbitral panel finds that a party has failed to implement its obligations under the agreement, that party must remove the violation; if not removed, the winning party is automatically entitled to suspend benefits of equivalent effect (such as increased import duties).[18]

Finally, while not an option for the Canadian government specifically, it should be noted that NAFTA affords a potential remedy for aggrieved Canadian (or Mexican) investors with “legacy investments” who suffer loss or damage in connection with the Proposals. Article 14.2 of the USMCA allows for the continued application of NAFTA’s investor-state dispute settlement mechanisms until July 1, 2023 for “legacy investments”, which are those established between January 1, 1994 and the date of NAFTA’s termination (July 1, 2020), subject to the three-year limitation period set out in NAFTA’s article 1116. This arbitration process would allow Canadian and Mexican investors in the North American automotive industry to seek damages for losses suffered arising out of U.S. breaches of its NAFTA investment protection obligations.

Buy North American? Final Remarks

For many observers, the Canadian and U.S. auto manufacturing industries share such similarities and ties that each cannot be considered (respectively) as a purely “national” industry. If the legislative commonalities can be evidence of anything, it may be that a Buy American regulation should rather be a Buy North American, if it is to adequately consider market structures and trends.

Canada’s new Minister of Foreign Affairs, Melanie Joly, recently noted that “[a]s close partners with deeply integrated supply chains, particularly in the automotive sector, Canada and the United States must work together to find a mutually beneficial solution”. At the time of writing this article, Prime Minister and Justin Trudeau and President Biden did discuss the measure’s impact on Canadian automotive sector, but President Biden “was non-committal when asked if his administration would exempt Canada from such a tax plan.[19] Going forward, it will be interesting to see whether and how the United States responds to this public plea and the numerous concerns that have been expressed by U.S. trading partners around the world.