Patrick Westaway

 

February 5, 2025

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Markets and supply chains are global, diktats to the contrary by Canada’s southern neighbour notwithstanding. Global trade is older than the written word and the earliest precursors to the written word signified trade goods. Global trade is, then, good. It was ever thus and ever will be. So what then, is to be done about those contrary and costly diktats?

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The trade war lately threatened by Canada’s southern neighbour—under the specious grounds of national security, coincidentally the only exemption available under the United States-Mexico-Canada Agreement (USMCA), negotiated under the current American president just five years ago to replace the less-divisively named North American Free Trade Agreement (NAFTA)—failed to reckon on Canada’s long experience finding workarounds to its own self-inflicted internal trade barriers.

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From time immemorial, the Canadian provinces have outright prohibited the interprovincial trade in alcoholic beverages. The regime of Canada’s most populous province, Ontario, is typical in its approach,  prohibiting anyone other than the Liquor Control Board of Ontario (the LCBO) from importing beer, wine or spirits from another province for the purpose of consumption, excepting only beer imported by the brewer itself to a facility of the brewer’s own within the province. There is no exception for the commercial importation of spirits for consumption and the only exception for wine is in respect of the “sacramental” variety. For generations, then, Canadians have been well motivated to find workarounds to trade barriers.

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So what, then, is the lesson to be learned from Canada’s breweries, distilleries and wineries? Given that tariffs apply when goods cross the border, regardless of who the recipient is to be or the use to which the goods are to be put, any solution must involve local production. Yet, just as Canada’s brewers, distilleries and wineries cannot affordably set up production in ten separate provinces, so Canadian producers cannot generally afford to duplicate production in the U.S. The solution, then, is what is known as “contract” production.

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Contract production involves, as the name suggests, contracting a local producer to produce on one’s behalf. One licenses one’s intellectual property, be it a recipe, patent or otherwise, to enable such production and then either pays a fee or shares the profits. Not only are tariffs avoided but Canadians can then also obtain the benefit of the local U.S. producer’s own distribution network. All is subject to negotiation having regard to potentially competing interests and other contextual factors. If such a deal can be made then goods do not cross the border and tariffs do not apply. So far as this one-way scenario goes, the transaction costs are, in theory, limited to the amount by which the negotiated fees or shared profits exceed the Canadian production, delivery and associated insurance costs. If, however, we assume retaliatory Canadian tariffs such that U.S. producers require corollary arrangements, the results to Canadian and U.S. producers would, so far as this goes, be net neutral.

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In structuring and giving effect to such arrangements, the following must be addressed:

 

• the licensing and protection of the Canadian party’s intellectual property;

• the commercial terms of the production and, if applicable, distribution;

• Canadian and U.S. domestic, as well as separate cross-border, tax treatment of the fees or profit sharing; and

• the application of transfer pricing rules if the parties do not deal at arm's length.​

 

In summary, then, the answer is not protectionism or retaliation but ever closer cooperation. There are deals to be made in the private sector even, and perhaps moreso, when a government proves itself unstable and untrustworthy.