Canada's international trade patterns and government trade policy

Canada International Trade

International trade accounts for a dominant share of the Canadian economy, led by exports of natural resources. Exports accounted for approximately 25% of Canada's GDP in 2010. Agricultural, energy, forestry and mining exports accounted for about 58% of total exports. Machinery, equipment, automotive products and other manufactured goods accounted for a further 38% of exports. The United States is by far its largest trading partner, accounting for about 75% of exports and 51% of imports (followed by China 11% and Mexico 5%.) Canada's combined exports and imports ranked 8th among all nations. Canada recorded a positive balance of trade overall in 2010: exports C$407B and imports C$ 406B. Canada enjoyed a substantial positive balance of trade with the United States in 2007 and 2008, but slipped into the red in 2009 and 2010. (See Exhibit 1) (CIA, 2010)

Among the world's wealthiest nations, Canada has the ninth largest economy, and is a member of the Organization for Economic Co-operation and Development (OECD) and Group of Eight (G8). The Canadian economy is dominated by the service industry (71%), which employs about three quarters of the working population (2010 estimate: 19 million people). Canada's unemployment rate in 2010 was 8% of the workforce, compared to 9.7% in the United States. Canada is unusual among developed countries in the importance of the primary sectors, with logging and oil extraction being the two most significant. These primary industries are dwindling in importance to the overall economy. Only about 4% of Canadians are employed in these fields, and they account for 6.2% of GDP. Canada is alone in the world of rich nations as a net exporter of energy. (CIA, 2010)

Government Influence on Trade

The Canadian government supports the expansion of foreign trade through international treaties and agreements. In 1989, Canada and the United States signed the Free Trade Agreement (FTA) which eliminated many tariffs and taxes on goods that were traded between the two nations. As a result, trade increased by 50% before NAFTA superseded the FTA in 1994. (Encyclopedia of the Nations, 2010)

Owing to the success of the FTA and NAFTA, Canada entered into similar agreements with other nations, namely Costa Rica, Israel, and Singapore. In 1997, it initiated a version of the FTA with Chile. This agreement was designed to prepare Chile for eventual entry into NAFTA. Canada is a member of a number of international economic organizations including the WTO, the Free Trade Area of the Americas, and the Asia-Pacific Economic Cooperation (APEC) forum. (Encyclopedia of the Nations, 2010)

Canada v. United States

Although generally friendly on the trade front, the United States and Canada have disagreed on a number of areas. When disputes arise between the two nations, they are usually submitted to international bodies for resolution, usually the WTO and NAFTA. A major fisheries dispute, centered on the Gulf of Maine, was settled by the International Court of Justice in 1984. In 1990, the United States and Canada signed the Fisheries Enforcement Agreement that was designed to discourage illegal fishing. This was followed by the 1999 Pacific Salmon Agreement that settled disagreements over salmon fishing. (Encyclopedia of the Nations, 2010)

The Canadian government has erected significant barriers to free trade in the form of restrictions on the ownership of companies headquartered in the country. Foreign individuals and companies are limited to 25% ownership in Canadian airlines and 20% ownership of telecommunications companies. They are also restricted to 49% stakes in commercial fishing ventures. (Encyclopedia of the Nations, 2010)

Owing to the potential dominating influence of American culture, Canada tries to preserve its traditions from being overwhelmed by the United States. For instance, the Canadian government kept cultural industries such as movies, music, or literature out of the NAFTA agreement. In addition, the provincial government of Quebec requires that all products marketed in the province be labeled in French, and throughout Canada both French and English are used in packaging and labels. While 90% of all imported goods enter Canada without any form of tax or tariff, certain products face tariffs that range from 0.9% to 13%. The highest level of tariff is applied to goods such as vegetables, cut flowers, sugar, wine, dairy, poultry, textiles, clothing, footwear, and boats. These tariffs apply to 35 different countries. (Encyclopedia of the Nations, 2010)

Free Trade Agreement

Daniel Trefler, of the University of Toronto (1999), has assessed the impact of the Canada-U.S. Free Trade Agreement on Canadian manufacturing during the period 1989 -- 1996. For the most impacted industries, the tariff eliminations reduced employment by 18%, output by 12% and the number of firms by 12%. For all manufacturing the respective numbers were four percent, two percent, and four percent. The tariff cuts raised labor productivity at a compounded rate of 3.2% per year for the most impacted industries and at 0.6% per year for all manufacturing. Trefler concluded that "the effects of the FTA tariff concessions are smaller than one would imagine from the heat of the debate." (Trefler, 1999)

Labor Mobility

Steven Globerman of Western Washington University (April 1999) discussed and evaluated the relationship between trade liberalization and the migration of skilled professional and managerial workers in the Canadian context. In particular, he considered whether and how the Canada-U.S... Free Trade Agreement (FTA) and the North American Free Trade Agreement (NAFTA) may have affected bilateral flows of permanent and non-permanent immigrants between Canada and the United States. (Globerman, 1999)

Globerman referenced classical economic theory, which predicts that trade and factor movements are substitutes, so that less restrictions on trade between Canada and the United States would lead to reduced bilateral migration. On the other hand, Globerman said, the modern theory of the multinational corporation stresses the potential need for factor movements, especially the relocation of managers and technical experts, to expedite production rationalization... Since the overwhelming bulk of international trade is carried out by multinational companies (MNCs), foreign direct investment theory suggests that freer trade between Canada and the United States may have increased economic incentives for the cross border movement of skilled labor. (Globerman, 1999)

Globerman observed that laws and regulations that establish criteria and quotas for permanent and temporary immigration would have an important influence on actual immigration patterns. He discussed major changes in immigration laws and regulations implemented by the U.S. And Canadian governments. He reasoned that the net impact of those changes would be to make permanent bilateral immigration more difficult but to lower the costs and difficulties associated with temporary immigration. He then went on to consider the following issues: 1) Has there been a significant increase in bilateral temporary immigration between Canada and the United States? 2) Was any such increase primarily the result of & #8230;increased trade, investment and factor mobility, or did it primarily reflect other factors, such as better earnings prospects in the other country? (Globerman, 1999)

Globerman's examination of the data showed that patterns of permanent bilateral migration had been fairly constant over the past two decades, suggesting that trade liberalization in fact had little impact on permanent immigration. On the other hand, temporary migration under the new visa arrangement introduced by the FTA (the TC visa) and continued under the NAFTA (the TN visa) had increased consistently since the implementation of the FTA. In particular, the migration of Canadians to the United States using the TC/TN visa increased by approximately 3,000 to 4,000 (visas granted) per year. Globerman also noted that the number of American professional workers immigrating temporarily to Canada had also increased consistently since 1989, although at a substantially slower rate than comparable migration of Canadian TC/TN visa holders. Globerman concludes that the increase in temporary migration reflects the adjustments of North American MNCs to trade liberalization. This observation is also consistent with increased bilateral flows of intra-company transferees. (Globerman, 1999)

Globerman concluded his report with a brief assessment of the policy implications of his main findings. While he did not feel that they led to strong or unambiguous conclusions, he felt that they leaned against a growing perception that Canada was suffering a substantial and economically damaging "brain drain." Firstly, the number of temporary migrants had been small, absolutely and relatively. Secondly, some (unknown) portion of temporary migration had been a function of increased integration with the U.S. economy, and that, he reckoned, was a benefit to Canada. Also, some temporary Canadian immigrants had acquired managerial and technical skills in U.S. companies that provided benefits to the Canadian economy when those immigrants returned to Canada. At the same time, the data provided some grounds for concern to policymakers about the labor market environment for highly skilled workers in Canada. In particular, higher after-tax incomes in the United States were an incentive for skilled Canadians to migrate. Leaving aside further discussion of tax reforms, Globerman concluded that the temporary migration of Canadians would be of net benefit to the Canadian economy as a whole. (Globerman, 1999)

Capital Flows

Mack Ott, (2008), Library of Economics and Liberty, has provided a tutorial on international capital flows. The most general description of a country's balance of trade, covering its trade in goods and services, is called its current account balance. If the country has a surplus or deficit on its current account, there is an offsetting net financial flow consisting of currency, securities, or other property claims. This net financial flow is called its capital account balance. (Ott, 2008)

When a country's imports exceed its exports, it has a current account deficit. Its foreign trading partners who hold net monetary claims can continue to hold their claims as monetary deposits or currency, or they can use the money to buy other financial assets, real property, or equities in the trade-deficit country. Net capital flows comprise the sum of these monetary, financial, real property, and equity claims. Capital flows move in the opposite direction to the goods and services trade claims that give rise to them. Thus, a country with a current account deficit necessarily has a capital account surplus. (Ott, 2008)

Canada recorded a positive balance of trade overall in 2010: exports C$407B and imports C$ 406B, and so its capital account was essentially flat. Canada enjoyed a substantial positive balance of trade with the United States in 2007 (C$52B) and 2008 (C$50B), but slipped into the red in 2009 (-C$5B) and 2010 (-C$4B). While the current account and capital account with any given country will not necessarily balance, Canada's capital account with the United States was -- C$16B in 2007, and jumped to +C$60B in 2010.

Capital Markets

Canada and the United States have been walking hand-in-hand in the capital markets for the past four years or more. The Toronto Stock Exchange index and the S&P 500 index in the U.S. have moved in the same direction with the S&P only slightly more volatile on the down side. Both suffered substantial losses in 2008 and 2009, and enjoyed double digit gains in 2010. (See Exhibit 1)

The monetary authorities in both countries have been working from the same playbook. The Canadian real interest rates were: 2007 (2.5%), 2008 (0.8%), 2009 (0.4%) and 2010 (-0.9%).

For the same years the U.S. real rates were: 2.2%, -0.9%, -0.8% and -0.9%. (See Exhibit 1)

Exchange Rate Determination

T. Dung (1998) has presented the following brief on the theoretical determination of exchange rates between any two countries. Long run exchange rates are best explained by factors including real income differentials, inflation rate differentials, productivity changes, and the like. In the short run, exchange rates respond to real interest rate differentials, news about market fundamentals, and speculative opinion about future exchange rates. The nominal interest rate refers to the interest rate unadjusted for inflation. The real interest rate equals the nominal interest rate minus the inflation rate. International investors are especially concerned about the real interest rate. An overvalued currency tends to lead to a balance-of-payments deficit for the home country, while an undervalued currency leads to a balance-of-payments surplus. For the past four years, real interest rates and the exchange rate between Canada and the United States have been essentially at par. (See Exhibit 1)

Exhibit 1

CANADA INTERNATIONAL TRADE

(C$ millions)

2007

2008

2009

2010

Current Account

Exports Canada - USA

427,911

438,852

328,877

361,368

Imports USA - Canada

376,087

388,657

333,591

365,261

Balance of Payments

51,824

50,195

-4,714

-3,823

Capital & Finance Account

Net Flows

-16,083

51,344

60,126

Commodity Price Index

Consumer Price Index

Bank Rate %

4.61

3.21

0.65

0.85

Inflation %

2.14

2.37

0.31

1.78

Real Interest Rate %

2.46

0.84

0.35

-0.93

Toronto Stock Exchange Index

13,700

12,446

10,230

12,091

% Change

-9

-18

18

United States

Fed Discount Rate %

5

3

0.5

0.75

Inflation %

2.85

3.85

-0.34

1.64

Real Interest Rate %

2.15

-0.85

-0.84

-0.89

S&P 500 Index

1,477

1,243

1,129

% Change

-16

-24

20

C$ / U.S.$

1.08

1.07

1.14

1.03