From “outside looking in” to being a player: Canada’s forward-looking trade agenda

Nothing less than the chance to become a vital trading partner with the world’s fastest growing economies – and to reduce the country’s reliance on the United States for its exports – awaits a Canada that can conclude trade agreements with Japan and other Asian countries. This scholar describes why Canada needs to put its pedal to the metal and negotiate such agreements.

Stagnant growth, high unemployment, and rising debt are the new mantras of the capitalist, developed world. Exports and trade are now seen as vital tools for breaking the downward spiral of debt and unmet expectations of disgruntled voters. Fortunately, leaders of both the richest economies and the developed world have learned the lessons of the 1930s. Through economic and financial forums like the G-20 — aside from regular meetings and international policy coordination — leaders now know that they must avoid introducing legislation like the disastrous Smoot-Hawley protectionist tariff measures passed by the U.S. Congress in 1930.

Canada is part of the shift to free trade and an active participant in free trade negotiations (FTAs) with the European Union and the Trans-Pacific Partnership, (TPP). It also has a bilateral pact with Japan.  Each agreement is important on its own. Together, they represent a dramatic opening of the Canadian economy and a clear shift from the managerial “culture of contentment” so derided by Canada’s global thinkers. Despite an over-riding consensus that Canada’s biggest economic challenges remain relatively low productivity and tepid innovation relative to key competitors, the country remains wedded to a small number of exportable products and services that rely, with only a few exceptions, on the U.S. market (some 26 of 1250 exported products account for over 50 per cent of all exports). Even here, perhaps half of Canada’s manufactured exports come from intra-firm transactions, e.g. Ford Canada selling to Ford United States.

With a parliamentary majority, the Harper government has made the negotiation of serious trade agreements a front-burner issue in Canada. As depicted in Table 1, Canada’s trade and investment strategies have changed dramatically in a generation. For most of its history, Canada’s relatively closed economy has exploited John A. Macdonald’s National Policy. Successive national governments have built an east-west manufacturing trade, condoned living with high tariffs and low production runs, and attracted foreign investment behind these tariff walls, all by enabling the setting up of  ‘miniature replica’ subsidiaries of the parent. Provinces reinforced these policies with high inter-provincial tariffs and trade barriers, and by extending them to the professions, construction, government procurement, and education.

The U.S.-Canada FTA, later expanded to NAFTA, has dramatically changed the domestic economic axis from east-west to north-south, as Canadian firms were forced to experience the brutal price competition in the open U.S. market.  The sheer size of the U.S. market and the fact that there is no geographic centre, just a number of significantly different regions, have forced Canadian companies to consider carefully issues such as corporate scale, plant scale, the need for long production runs to reduce unit costs, and the role of price alone as a competitive weapon. Indeed, Canada’s small population, only 34 million, is slowly forcing Canadian companies to also consider other markets where economic growth is higher than it is in North America.

The announcement of FTA talks with Japan will bring closer economic integration and position Canada within the industrial mainstream of Asia’s growth. Indeed, closer Canada-Japan ties will make both countries key players in the proposed Trans-Pacific Partnership. This paper address these trade issues, the impacts on Canada, and the implications for managerial decision-making. 

 

Table 1

Canada’s Trade Strategies: A Work in Progress

 

  Key Issues                            1867-1985                             1985-2010                     2012 and Forward

Industry

Nation-Building –

 East West

North-South via

FTA and NAFTA

Global–European Union and Asia

International

Trade Pacts

Commonwealth Preference & GATT

WTO, NAFTA

WTO, TPP,

Key Bilateral

Exports

Traditional Commodities

Commodities and

High Value Added Mfg (Autos, ICT)

Commodities, Energy; High Value Added Mfg and Services

Key Markets

UK and

Commonwealth;

USA

USA, Japan for

Commodities

50-50 Balancing: USA and Asia

Immigration

U.K., European and

Commonwealth.

Hong Kong, Asia,

Caribbean

Global, based on Skills and

Higher Education

Special Case

Industries

NORAD and

Defense (NATO)

Auto Pact (1965)

Wheat Board

Bank Act 1867

NORAD, NATO;

Supply Management

(dairy sector)

Entertainment &Culture

 

 

To be negotiated

Defensive Policy

Measures

Inter-provincial Trade Barriers;

Crown Corporations

Investment Canada

Ownership Restrictions in Key Industries(e.g. Banking, Telecommunications,

Cabinet Approval?

Crown Corporations

3 P Partnerships

 

 

The Asian miracle

From 1953-1985, Japan’s economy generated the largest increase in wealth creation in world history. Today, starting with Southeast Asia and the four Asian Tigers, and extending to southern Asia and China, we can see that Asia has learned valuable lessons from Japan. Across countries, we can see numerous examples of a judicious mix of public planning and resource allocation. These include superb high schools and colleges, first-class infrastructure, and quality products and services for export. We can also see a private sector with a voracious appetite for foreign technology and management techniques, and one that tailors engineering and production to meet the high expectations of foreign customers. China’s current 20-year plan calls for it to be the world’s largest trading nation by 2015, a dramatic illustration of Asia’s economic development.1 The results are truly impressive.

By any measure, Asia is today the world’s growth region, projected to expand from $20.8 trillion GNP to $30.3 trillion in the years 2011-2016, i.e. twice the size of the American economy, according to IMF projections. Indeed, half of the global economy’s growth, from a projected $70 trillion to $91 trillion, will occur in Asia (2011-2016). After three terrible wars and conflicts, the Pacific War, the Korean War, and Vietnam, Asia has enjoyed two generations of peace, despite military tensions in North Korea and the U.S.-China rivalry. Steady economic growth has brought rising education and health standards, and steep declines in poverty, from about 77 per cent at the start of the 1980s to under 15 per cent today, as measured in per capita income below $3000.

A vital clue to Asia’s future is the demographic forces at play in the main countries. All Asian countries except Japan (which experienced the same phenomenon two generations ago) have huge rural populations clamoring to move to urban areas, where there is better education, health, and higher paying jobs. The ratio of youths (under 15) and elders (over 60) remains extraordinarily high – 30.8 to 7.5 in India, 26.7 to 8.9 in Indonesia, 29.1 to 7.8 in Malaysia, 33.5  to 6.7 in the Philippians, compared to 13.2 to 30.5 in graying Japan and 16.3 to 20.0 in fast- aging Canada. Demographics help explain the rise of new industries, infrastructure, and unmet business needs that rich countries have in abundance, from the quality of legal services, higher education, to financial and bank products, to sundry luxury products.

 

The Trans-Pacific Partnership

This strong, steady, and consistent growth in Asia, and resulting industrial integration has led to a new trade round, the Trans-Pacific Partnership (TPP). At first glance, the TPP founding members are an odd grouping of countries, with the Pacific Ocean as the only real common bond. The TPP started as a smallish four-country group: Singapore, Chile, Brunei, and New Zealand, and then added Australia, Malaysia, Peru, and Vietnam. In 2008, the U.S. was added, giving the TPP potential trade clout. Yet it still excludes the world’s two largest markets, India and China, and the world’s second-largest democratic economy, Japan. Two of the U.S.’s most important trade partners in NAFTA, Mexico and Canada, were added as negotiating partners, but only in the spring of 2012. Asia’s three biggest economies, Japan, India, and China, with a population of 2.6 billion, account for a projected $6.9 trillion of the forecasted $9.6 trillion in real growth by 2016, i.e. from $14.7 trillion to $20.9 trillion GNP. A free trade area with many small economies, each calling for trade exceptions, is an intellectual non-starter, with the biggest Asian economies excluded.

Ideally, TPP could be a forward-looking trade agreement, binding laws and regulations well beyond the traditional initiatives of cutting tariff and non-tariff barriers to trade. Services now dominate future trade relations, both within key regions and globally, in such areas as transportation and container flows; intellectual property, including in areas like culture, news, and entertainment; government procurement; e-commerce and the Internet; and professional services (including education) and finance.

The TPP takes place amid profound changes in the global economy. Massive industrial integration of Asian economies (where counties and local firms make specialized parts and components for assembly in other countries), first with Japan and Southeast Asia, then within Asia, and now with numerous bilateral trade deals, are real. Japan alone, the most multilateral-oriented economy a decade ago, has signed a dozen bilateral agreements, including those with ASEAN, India and South Korea (pending). More importantly, the new corporate linkages, involving India, China, and Japan, and the economic integration between Japan and Asia have profound implications for Canada. Indeed, while the European Union is the most integrated via supply chains and trade, at about 73 per cent, according to the World Bank, Japan and Asia are second, at about 55 per cent. NAFTA is only at 50 per cent. Remove the auto sector within NAFTA and this figure drops substantially.

 

The Trans-Pacific Round

The TPP negotiations are a serious round of talks, but the chance of a quick agreement on the full agenda is very unlikely, in part because the countries have so many stark differences  – their geographical location, their institutional development, the nature of the political systems, and their relationships with neighbouring countries. Some countries have a floating currency, some are pegged, some are linked to the U.S. dollar. Although TPP is a trade deal, there are political overtones of the China-U.S. rivalry, and some coastal states have prickly disagreements over land, border, and territorial water disputes, vital for fish stocks, oil and gas rights, and even national security.

Consider the differences between the United States and other members of the TPP round, as depicted in Figure 1. As the figure shows, common agreement without exceptions remains extremely unlikely. Only a narrow group of corporate executives and government officials understand the true scope of the Trans-Pacific Partnership agreement2. Indeed, in some of the key countries, notably the aggressive agricultural exporters like Australia and New Zealand, and the young, but big population markets like Vietnam or Peru, fully appreciate how a true trade agreement, with few industry or sector exemptions, will require substantial transformation of their domestic economy, even if spread out over a decade or more.  Allowing the market to perform its growth wonders, unencumbered by domestic electoral and political considerations, is a laudable goal.  But not even the United States is willing to allow its national trade laws, so often politicized for peculiar domestic considerations, to be trumped by international trade agreements.

The TPP talks, largely now an American initiative that excluded both Canada and Japan, is seen in Washington as a regional substitute for the WTO Doha round, though it comfortably ignores the fact that U.S. political interests, especially in agricultural subsidies, put Doha in the stall position in the first place. Further, by excluding Japan from the current TPP round, U.S. domestic interests, especially the Detroit car companies and their unions, have made intellectual nonsense of a true regional trade agreement that would be consistent with the WTO. Excluding the U.S., Japan itself has an economy twice the size of all the existing TPP members combined. Japan indeed is a technological superpower, as measured by R&D corporate spending, domestic and foreign patents, and receipts of worldwide payments for technology.  Japanese foreign subsidiaries employ more than a million people, and they are vital to the upgrading of technology in most of the Asian countries, including China.

Average scores of provisions on major issues

It is facile to argue that TPP is a regional ‘Asian’ substitute for the stalled WTO Doha round. The TPP may fail for the very same reason, namely that the full political impact of core, trade issues like labour and environmental standards, intellectual property, and investment and rules of origin may place participating countries in an extremely vulnerable vice: Political pressures become untenable for incumbent governments. Indeed, in any practical trade pact, dating from David Ricardo’s iron rule of comparative advantage, the advantages (benefits) are small and widely dispersed; the disadvantages (costs) are large and highly focused. In point of fact, projected low economic growth in the rich countries, high excess plant and industry capacity, and the perverse combination of high skills shortages and rising unemployment among young, less-educated workers are not an ideal formula for trade leadership. Unfortunately, there is now a stunning increase in national protectionism, often under subtle forms, some quite blatant, as in corporate bailouts.

 

Japan – Canada Bilateral FTA

Clearly, for Canada, TPP represents an opportunity that can’t be dismissed, but the likelihood of a generally acceptable agreement for the negotiating parties soon remains an open question. It doesn’t help that their other potential trade blocs may rival the TPP – a so called China, Japan, South Korea trade pact, or a Chinese-led rival trade bloc (including some South American countries), perhaps using the Chinese yuan as the reserve currency. But clearly for Canada, the most important priority by far is a bilateral free trade agreement with Japan.

The Japan-Canada trade talks, once launched formally,  will enjoy the advantage of having two industrialized, complimentary economies who have extensive experience with bilateral agreements, and with leaders of the private sector having regular forums to discuss mutual interests. Hopefully, a successful agreement with Japan stands to place Canada in a highly favourable position with the two largest democratic economies in the world, although main Asian countries like Japan and South Korea trade enormously with China, a point that few Canadians fully appreciate.  

Japan and Korea's Exports to the US and China (Share)

Politically, these talks won’t be dogged by the controversies of the U.S.-Canada FTA negotiations, partly because the benefits of Japanese investment in Canada are widespread. North American’s most productive pulp and paper plant, owned by Dai Showa,  is in Alberta, and there are aluminum plants in Quebec and BC, and a new pharmaceutical alliance in PEI. Ontario, with four Japanese auto plants, each expanding output, channels its production into the mainstream of its global manufacturing export strategy, as does the eight or more Japanese R&D facilities located in the Toronto region. But nothing can be taken for granted, and the Canadian Government can afford to be extremely forward-looking and take the lead in working with the provinces and the private sector to engage the public in both countries to spell out and reinforce the mutual benefits.

Both Japan and Canada face severe productivity problems in too many low-value added sectors, including huge parts of Canada’s pulp and paper sector, where so many plants use old equipment and out-dated technology. But in strong sectors, including energy, not just from Alberta’s Oil Sands, Canada can compete with the world’s best. Equally, it took the new Japanese car plants and their massive investments in Ontario to turn what was a declining sector – GM and Chrysler declared bankruptcy – into a new growth sector with state of the art machinery, well-trained workers, and exports to Japan and other Asian countries.

 

A Canada-Japan FTA?

A Canada-Japan FTA must be compatible with the WTO, like NAFTA. It can also be a truly 21st century benchmark for other bilateral and regional trade agreements and set a standard for a multilateral Doha round. Three issues should guide Canada’s positions. (These are above the conventional topics of forward-looking trade agreements such as services, intellectual property, e-commerce and agriculture).

1. Despite the historic trade imbalance which has seen Japan export high-value-added products like cars, trucks and electronics to Canada (about $12.5 billion per annum) and Canada export about $4.5 billion in commodities, Canadian manufacturers can become part of Japanese global manufacturing by manufacturing specialized parts and components or even sub-assemblies for sectors like autos, aerospace, electronics and many others. They can also become a market platform for smaller Japanese firms to sell in North America. Estimates vary, but of the over 1200 products Canada exports, more than 50 per cent come from only 26 products. Global marketing and distribution, in part because of the huge trading-house sector, is a huge Japanese strength.

2. Largely unknown to North Americans, Japanese banks, trading firms, and manufacturers have entered into strategic alliances and networks to invest in new technologies, share production and technology transfer, and entry into new markets. Japan is becoming an aggressive exporter in telecommunications, nuclear power stations, and even high-speed rail (the famous bullet train), as well as in new fields like fashion, health care products, and industrial design. In new areas like LED lighting or mobile phone payment systems, Japan is 10 years ahead of the rest of the world.

3. Japan gave the world lean production and just-in-time production, and it is aggressively transforming global supply chains, in part based on ocean-based shipping, which carries over 90 per cent of world trade. Japan is advancing new forms of inter-modal infrastructure, from ports to shipbuilding, and experimenting with the technology of smart phones in car design, building architecture, and health care  management. Canada indeed can become a North American Gateway for container flows from both Europe and Asia, and the Canada-Japan FTA is a clear signal to link transportation, logistics and trade flows.3 Canadian governments must note these vital linkages in departmental structures, needing close cooperation between trade, transportation, border security, and infrastructure needs.

Slowly, Canada is opening up to the world, broadening the historic mind-set that kept it focused on North America. The rise of Asia represents a shift of the world economy, though the shift in the centre of gravity, from the Atlantic to the Pacific, began a generation ago. Fortunately, Canada is catching up, but it must run faster to keep pace. New trade agreements will accelerate this push for an exciting new era of growth, prosperity and jobs creation. Two Asian trade negotiations are under way, the TPP and the bilateral FTA with Japan, and each will impact Canada, meaning that the production of undifferentiated products and services will have less demand in the future.

The TPP negotiations — however laudatory in its aims and however noble in its statesmen-like features of competitiveness for the Asian region — may face severe political challenges. Each participating country faces an awesome set of internal political challenges, as vested interests prefer protection, not just for economic growth but also for managing their demographic-influenced policy issues like health care, education, immigration and the rising number of retirees. They also face a set of global and regional issues for which there are no easy answers, and few global statesmen are can articulate bold solutions and doctrines. Around the world, regional issues are paramount for politicians, from the Arab awakening in the Middle East, to the continuing reforms in China, to the persistent stagnation and policy gridlock in the United States. As David Brooks notes, in a perceptive column in the New York Times,

It’s not multi-polarity; it’s multi-problemarity. As a result, this is more of an age of anxiety than of straight-up conflict. Leaders are looking around warily at who might make their problems better and who might make them worse. There are fewer close alliances and fewer sworn enemies. There are more circumstances in which nations are ambiguously attached. In this environment, you don’t need big, bold visionaries. You need leaders who will pay minute attention to the unique details and fleeting properties of each region’s specific circumstances. You need people who can improvise, shift and play it by ear.

Trade agreements are inherently bold statements of principles, involving bold architecture and edifices. The more countries that get involved in these trade negotiations, the more difficult it is to get comprehensive solutions. Politicians thus prefer national exemptions to deal with specific industry problems.

Regardless of the outcome of the Trans-Pacific Partnership Trade round, a free trade agreement with Canada and Japan would be a signal that Canada takes Asia’s trade partners seriously.  But these negotiations are only the prelude to what must be new Canadian corporate investments, strategic alliances, and aggressive diplomatic efforts across Asia. Unfortunately, a likely response to these global trade initiatives is a series of high-profile executive conferences. This approach is akin to castle building in a sand box: young children enjoying an outing at the beach, building castles near the water’s edge, only to learn the next day the tide has come in, there was a short rain spell, and the sand castles disappear. Canadians in large corporations and governments have an insatiable appetite for consultative conferences, often mistaking consultation when action is required, and action when consultation is required.

Executive bookshelves are weighted down with treaties on the global economy, but what is really needed are corporate initiatives that enable companies to become active beyond the markets of Canada and North America. Canadian business must become an active participant, with a corporate presence and a team devoted to building strategic alliances, shared production, and even shared R&D facilities. An active presence leads from small investments to pro-active marketing and exports to other Asian countries, and lessons for the North American market. With a free trade deal with Japan, Canadians can learn the ten-percent solution: Use ten percent of current profits as a down-payment investment in the Japanese market and let it grow over time. This opportunity to win, where stakeholders in Canada and Japan are involved, is Canada’s to lose.




1 See William Buiter and Ebrahim Rahbari, Trade Transformed: The Emerging New Corridors of Trade Power (New York: Citi GPS: 2011).

 

2 For one perspective, from an American viewpoint, see Bernard K. Gordon, Trading Up in Asia,” Foreign Affairs (July August 2012, pp. 17-23.

 

3 For an overview of the North American Gateway concept, see Charles McMillan and George Stalk ,Jr. “Canada’s Pacific Century: Work in Progress for a New Era “, Policy Options (Vol. 33),  September 2012.

 

 

 

About the Author

Charles McMillan is Professor of Strategic Management and International Business at York University, and served as senior policy adviser to Prime Minister Brian Mulroney.