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Canada and the Enterprise for the Americas Initiative: a case of reluctant regionalism.

CANADA SITS AT the northern end of North America, and its trade, investment and political relations are concentrated on the U.S. As Table 1 shows, nearly three-quarters of Canadian trade is with the U.S., whereas Latin America and the Caribbean (LAC) account for less than 5 percent (and a third of this is with Mexico). Similarly, the U.S. is the predominant market for the rest of the hemisphere, with more than 40 percent of their exports and imports.

Investment patterns are also asymmetric. Canadian private foreign investment in LAC is not insubstantial ($8 billion in 1989)'; the bulk of investment in LAC has originated in the U.S. while the U.S. has itself been the major foreign location for Canadian investors ($50 billion in 1989).

Given Canada's minor economic ties with LAC, why should President Bush's plan to create a hemispheric free trade zone, under the Enterprise for the Americas Initiative (EAI), be of any interest to Canadian citizens, business people or politicians? Likewise, why should LAC care if Canada is involved or not?

CANADIAN TRADE AND INDUSTRIAL POLICY

Canadas trade, investment and political ties are heavily concentrated on the U.S. In 1988, 71 percent of Canadian exports (some $82 billion U.S.) went to the U.S., while 68 percent of Canadian imports came from the U.S. (See Table 1 for details on trade flows in the Americas.) Mexico has a similar trade pattern, 73 percent of its 1986 exports ($21 billion) went to the U.S., while 76 percent of its imports originated there.(2) Moreover the U.S. market is the destination of 43 percent of the exports of Latin America as a whole (including the Caribbean) and is the source of 44 percent of their imports. The U.S. is much less dependent on the markets of its immediate trading partners. Fully 60 percent of U.S. exports in 1988 were outside the hemisphere as were 65 percent of U.S. imports. All of Latin America accounts for only 2 percent of Canadian exports, with Mexico accounting for a quarter of this figure; the region was the source of only 3.5 percent of Canadian imports, with Mexico responsible for 40 percent of these. Given these trade flows, why are Canadian and LAC ties of any value?

Until the late 1970s Canada's national industrial policy involved some fairly high effective tariffs and nontariff barriers, amid an array of other policies designed to increase industrial output and reduce dependence on the export of semi- or unprocessed natural resource products.3 An important dimension was the promotion of regional development. Trade strategy up to the early 1980s could still be summarized as "mainly multilateralist." For a smaller nation heavily dependent on trade, the GAT offered an effective means to prevent its larger trading partners (especially the U.S.) from introducing unilateral trade

restrictions. At the same time it offered a means to reduce dependence on the U.S. market by promoting trade with third countries. But growing concerns about U.S. protectionism, coupled with a recognition of the U.S. emerging resistance to dealing in the GATT and (especially) its willingness to move faster with likeminded countries, led Canada to adopt a "broadly bilateralist" path.4 Moreover, a number of analysts thought that, while attempts to reduce dependence on the U.S. should continue, they were not likely to be very successful.

Initially (in 1983) the Liberal government considered a bilateral sectoral approach with the U.S., partly because most of the changes sought or predicted were intrasectoral in character, and also because it was felt to constitute a smaller threat to political sovereignty (Curtis, 1985)? But when the new Conservative government took over in 1984, negotiations were extended to a broad range of sectors and nontrade issues. Since the mid-1980s that government has introduced a series of radical changes, in keeping with its noninterventionist ideology and its attempt to reduce the fiscal deficit. A range of trade, industrial and regional assistance programs, which had been considered by some a failure,(6) have gradually been cut back? The economic programs for Western and Atlantic Canada have been separated from industrial support, and the orientation of the latter has shifted from firmspecific grants to the provision of services and knowledge on a non-firm-specific basis. According to Doern, this modification resulted from "... a lingering fear, only partly addressed in the FTA, that many Canadian industrial policy actions used in the past will be subject to countervail challenges under American trade law on the grounds that they are trade distorting" (1990, p. 56).

The Canadian-U.S. Free Trade Agreement (CUFTA) was seen as essential to promote rationalization of Canadian industry and to increase productivity through the achievement of economies of scale permitted by more secure access to the large U.S. market. This in turn was expected to attract private foreign investment to Canada and to protect growing Canadian investment in the U.S. from nascent nationalism. At the same time CUFTA was intended to deter a return to previous interventionist policies (subsidies, screening of most investment, etc.).

The third and still ongoing phase of Canadian trade strategy can be characterized as one of reluctant regionalism. Canada has been involved in some loose regional initiatives, such as Pacific Basin Economic Cooperation, but with the understanding that this should not undermine multilateralism; the benefits negotiated in such arrangements were open to other members, and Canada continued to be a strong supporter of the GATt. The suggestion in early 1990 of a free trade agreement between the U.S. and Mexico took many in Canada, including the government, by surprise.

The strategy that has been adopted is a defensive and reaetive one. Canada would probably not have sought a free trade agreement with Mexico if the U.S. had not done so, nor become involved in free trade discussions with South America and the Caribbean in the absence of the U.S. EAI. Although renewed Canadian interest in the region dates from an earlier 1988 Cabinet review that led to various Canadian initiatives, notably full membership in the Organization of American States in 1990 (Miller and Pollock 1990), Cabinet has yet to approve the move from a flamework of regional trade, investment and/ or tax accords to fully fledged free trade agreements.

A chief official reason for Canada's participation in the North American Free Trade Agreement (NAFYA) negotiations is to ensure that Canada offers investors (of any country) the same advantage of free access to all three markets as does the U.S. If the U.S. negotiates a series of bilateral free trade agreements with other countries of the region, a "hub and spoke" trading system could emerge in which the U.S. as the hub would have a 1ocational advantage over any of the spokes (Lipsey 1990, Wonnacott, 1990). Another important reason is to try to protect Canada's recently acquired interests in the U.S. market through involvement in the negotiations on the auto sector, the rules of origin, and the phasing of liberalization. Several studies have underlined the risks of some trade diversion away from Canada due to the possible overlap between Mexican and Canadian products (Magun 1991, Morici 1991, Waverman 1991, Trela and Whalley 1991).

Some critics (induding a former CUFTA negotiator) are concerned about reopening the CUFTA, leading the U.S. to renew, for example, demands for concessions on cultural industries. Yet, Canada might seek additional concessions, for example, on financial services and government procurement. An alternative may be for Canada to negotiate its own bilateral agreement with Mexico, thereby dealing with investment. However, it could lead to a complex set of trade agreements in the hemisphere, each with its own rules of origin, etc. Another suggestion is that Canada pursue closer trade relations with the EC, Japan, or even ASEAN, which are more important markets.

Mexico remains a minor trading partner for Canada, although it is the largest in the hemisphere after the U.S. Canada does not share the U.S.'s geostrategic interest in the region. Immigration, though an important policy issue for Canada in light of the growing influx from Mexico and points south, is not as sensitive as in the U.S.s

In the case of the EAI there is a somewhat stronger rationale for Canadian involvement; it already offers preferential trade with several countries in the Caribbean and has wider bilateral aid interests in many parts of the region. Still, these links are considerably weaker than those with many countries outside the region, some of whom face the probability of trade diversion as a result of the EAI. In the aid area, only two Latin American/ Caribbean countries fell in Canada's top twenty-five recipients in 1988-89: Jamaica (3rd) and Peru (19th), with 2.6 percent of the total. In contrast the U.S. aid program gives greater priority to the region with nine countries in its top twenty-five, accounting for 11.3 percent of total U.S. aid.

In summary, it is hardly surprising that there has been an element of reluctance in Canada's approach to Western Hemispheric regionalism. But it is important to consider whether the potential gains (or losses) to Canada have tended to be misestimated.

CANADA'S INTERESTS IN WESTERN HEMISPHERIC FREE TRADE

Most of Canada's population of 27 million is spread along a band within 100 miles north of the U.S. border. The vision behind CUFTA is that Canada's survival as a high income country could not be guaranteed either by greater self-sufficiency (given the small dispersed population) or by "'going it alone" in international markets at a time when (1) the market once viewed as secure for Canadian business -- the U.S. -- is both increasingly competitive with new suppliers, foreign and domestic, and increasingly protectionist; and (2) it appears that the world may move significantly towards regional trading blocs. To compete effectively in either the U.S. or other major world markets, Canada needs to improve the performance of its manufacturing, service, agriculture, forestry and mining sectors. The transition to a new structure of production has been and will be painful. Parts of the country, especially Ontario and Quebec, are now in the throes of a difficult long-term restructuring, necessitated by a combination of macroeconomic concerns (a cap on the Canadian government's fiscal deficit and a new standard of low inflation), as well as microeconomic considerations (enhanced global competition, low Canadian productivity and the restructuring occasioned by CUFTA).

Latin America and the Caribbean (LAC) represent a market of 445 million people (1990 data) and $820 billion (1989). In 1989, the total imports of LAC were $115 billion (a little below the level of Canadian imports). If and when growth returns to LAC and the debt crisis subsides, imports will increase enormously; they fell by a dramatic 40 percent from 1980 to 1989. Liberalized trade in the Western Hemisphere would then offer an important advantage to Canada (the opportunities resulting from trade and investment preferences in this huge market),(9) and one disadvantage (increased competition from LAC producers in U.S. and Canadian markets). Given Canada's minuscule exports to LAC, trade creation would depend on a focused attempt by Canadian entrepreneurs to tap this growing market. Data for 1991 show that Canada has not yet benefitted from such trade creation with Mexico; in fact, Canadian exports to Mexico fell from the 1990 level, while imports from Mexico rose.(10) Canada's direct investment in Mexico is also minimal (some $440 million, of which $400 million existed prior to Mexico's recent liberalization); new Canadian investment in Mexico may be a necessary precursor to greater Canadian exports.

The extent of trade diversion that Canada might suffer in U.S. markets as a result of liberalized trade between the U.S. and LAC depends on the degree to which Canadian and LAC goods are substitutes and on the increase in North-South trade following liberalization. Mexico is likely to be the major LAC competitor for Canadian products in U.S. markets. Several studies, using a variety of methodologies, suggest only minor trade diversion for Canada following a NAFTA. Cox and Harris (1992), using a Computable General Equilibrium Model, predict that Canadian trade with the U.S. would fall by .009 percent. Waverman (1991) uses estimates of cross-price elasticities of demand and finds possible trade diversion of $100 million (Canadian exports to the U.S. in 1988 were $82 billion). As Mexican exports to the U.S. represent nearly 50 percent of all LAC exports to that market, major trade diversion against Canada following liberalized trade in the Western Hemisphere would, by extrapolation of that estimate, require substantial increases in LAC exports to the U.S. markets. Many products from LAC already enter under GSP and MFN tariffs. Thus, greatly increased exports would require a substantial reorientation of LAC industry (admittedly the obvious goal of LAC countries in trade liberalization) into areas where Canada is now a heavy exporter to the U.S. Areas of concern for Canada are autos (of paramount importance), textiles and apparel, office equipment, machinery and forest and mineral products.

Increased competition from many sources is a fact of contemporary life both in third markets and, unless one protects ever more vigorously, in one's own. The Canadian recession of 1990-91 is not primarily, if at all, due to CUFTA(11) but rather to the recession in the U.S. and to some of the same macro- and microeconomic problems that pushed the Canadian government towards CUFTA. Recent Canadian losses in U.S. markets are due to heightened competition from many sources -- Asian manufacturers and U.S. and European forestry producers, to name several, competition that cannot be attributed to trade pacts. Equally important from the Canadian perspective is the fact that the U.S. can enter free trade arrangements with LAC, leaving Canada on the outside. Displacement of Canadian exports in the U.S. markets occurs not because Canada liberalizes trade but because the U.S. does; it can therefore occur whether Canada is part of the Enterprise Initiative or not ! Liberalized trade in the Western Hemisphere will of course increase pressure in Canadian domestic markets, although it is but one of a number of sources of new competition. Such competition sometimes pushes domestic firms to be more efficient and generally improves consumer welfare through lower prices. Increased competition does, however, lead to dislocation of both labor and capital, and heightens the need for effective transition mechanisms and retraining programs, areas in which Canada is woefully lacking. The greater danger to Canada is not the competition itself but the country's ineffective reaction to it.

While the net economic effects of Canadian participation in EAI can be debated, the political gains to Canada are clear. Canada, long a leading advocate of multilateralism and GATT, realizes that multilateralism provides important benefits to small countries. Although many Canadian nationalists decry the loss of Canadian sovereignty implicit in CUFTA, they tend to ignore what could be a greater loss of U.S. sovereignty. A multilateral institution whose decisionmaking mechanisms are autonomous and rules based can, as long as the rules are neutral, lead to a much greater relative loss of power for the stronger partner(s).

The current tensions between Canada and the U.S. reflect the fact that, in a bilateral rules-based institution, attention is focused on the one other party, with the risk that the rules will not in fact remain neutral, hence Canada's long-standing preference for multilateral institutions. There the attention of the powerful is diffused. In addition the plurality 01' voices, and decisionmaking procedures based on one vote per country rather than on power relationships, tend to favor small countries. (12) Thus, because Canada would be better off in a Western Hemispheric free trade area where rules-based institutions were maintained by the decisions of many countries, the EAI offers political gains.

THE BENEFITS TO LATIN AMERICA FROM CANADIAN INVOLVEMENT IN EAI

There are, in turn, a number of potentially significant benefits to Latin America from Canada's involvement in an EAI, benefits whose possible magnitude belies the modest current level of economic and political interaction between Canada and Latin America. In purely economic terms, Canada has special expertise in several industries of importance to Latin America and has been an important source of direct investment flows. Canada's economic experience, both over the longer and run and more recently, provides lessons of natural interest to other countries that share a hemisphere with a dominant economic power somewhat ahead of them economically and technologically. Canada's involvement in the same trading system would substantially dilute U.S. economic and political dominance, an advantage for Latin America symmetrical with the advantage for Canada of Latin American involvement discussed above. Of value to LAC in all these issues is Canada's long experience in close trade and investment relationships with the U.S. and the learning that has accompanied it.

Technical/Industrial Expertise and Direct Investment

Although not as diverse as the American, the Canadian economy is highly productive in many sectors, and has developed pockets of comparative advantage and technical skills that are relevant to several of the countries of Latin America. In those primary industries that remain important in Canada (such as forest products, wheat and other agricultural products, nickel, iron and other minerals), the current or recent technologies can be useful in Latin countries.

Of great relevance to Latin American countries is Canada's experience in the transition to high productivity, high tech and service industries, and the expertise that Canada can now provide in a number of those areas. Especially intriguing is the experience of the province of Quebec, whose evolution from a very primary product-oriented region to one that is now the base for some of Canada's front rank firms/industries is the sort of achievement to which many countries of Latin America aspire. Because, thirty years ago, the province of Quebec had to confront both a relatively backward industrial sector and an underdeveloped educational system, its success is the more impressive.

Canada as a Development Model

Like most countries of the Latin region, Canada had its phase of primary product exports, followed by (though also overlapping with) a stage of import-substituting development, in which it fostered domestic industry and encouraged "tariff factories" behind protectionist barriers. Also like those countries, it has felt the continuing tension between a fear of fleer trade with the investment from the U.S., and a belief that its own productivity and competitiveness depends on fleer trade and investment flows. Like most Latin countries, Canada's international economic relationships gradually shifted from an early focus on Europe to one on the U.S., a natural response to physical proximity, similar life styles and a capacity to get along with each other. The tight economic ties in a naturally asymmetric power relationship led Canadians to wonder (as many still do) whether economic dependency would gradually lead to greater and greater political and cultural dependency. In terms of economic size, Canada is about equal to Brazil and Mexico combined, but only 60 percent as large as Latin America and the Caribbean as a whole. Canada thus shares, both with individual countries like Mexico and Brazil and with the region as a whole, the experience of economic association with a dominant power at least eight times larger. Few economically small (but yet not tiny) countries in the world have had Canada's experience of such focused economic interaction over such a long period of time with a much larger partner. For this reason much of interest can be read from Canada's economic history.

Though it has passed through similar phases of development to those characteristic of Latin America, Canada has remained a relatively open economy at all times. Exports currently (1989) account for 25 percent of GDP (up from 19 percent in 1965), compared with 14 percent for LAC (up from 13 percent), and to 16 percent for Argentina, 16 percent for Mexico and 7 percent for Brazil (the 1965 figures were just 8 percent for each of these countries). Even in the early part of this century, Canada's export share of GDP was typically in the range one-quarter to one third, with a low of 20 percent in the depression year 1931.

Canada, because of its longstanding commitment to multilateralism and fleer trade, has progressively reduced barriers. Many studies of the impacts of reduced barriers exist. The analyses of how trade and investment liberalization has affected the structure of industry and trade, labor markets and wages, income and welfare are of great value to the countries of LAC.

As the only other high-income country in the Western Hemisphere besides the U.S., Canada offers interesting alternatives to the U.S. model in other ways as well. It has been somewhat less inclined to the free market model or to the ideology of individualism, as reflected in its widely praised (though now financially vulnerable) socialized health care system, and its more publicly funded educational system.

Like many of the countries of Latin America, Canada is regionally quite diverse, not only in topography but also, more relevant here, in terms of cultural and economic characteristics. It has two main languages. It has regions that live primarily from the production and export of primary products, and others where the import substituting and export oriented manufacturing activities are heavily concentrated. Some regions are considerably better off and more dynamic than others. The federal political system has meant that many regional conflicts and differences of preference have manifested themselves in negotiations and compromises involving the federal and the provincial governments.

These elements are crucial in distinguishing Canada from the U.S. Thus, while LAC countries would like greater access to U.S. markets, the Canadian development model provides a perspective on how two-way access can be achieved through fleer trade and investment and how independent economic, cultural and political values can be maintained.

Canadian Experience in Dealing With The U.S. The 1989 GDP of Latin America was only 13.6 percent of the combined GDP of the U.S. plus Latin America; when Canada and Latin America are both involved, their share of Western Hemispheric GDP is a more substantial 20 percent. Both Latin America and Canada have trade patterns in which the U.S. features very prominently, while the U.S. does a higher share of its trading outside the hemisphere. Although this obviously leaves an asymmetrical dependence, it does mean that in absolute terms the flows in each direction are of comparable magnitudes. The inclusion of Canada in a trading region greatly increases the importance of that region to the U.S., because (in 1988) the essentially balanced U.S.-Latin America trade flows accounted for only 10 to 11 percent of U.S. trade while Canada accounted for 21.6 percent of U.S. exports and 18.7 percent of its imports. Although it is hard to predict the ways in which Canada's inclusion would affect negotiations and outcomes, the large absolute size of Canada's trade dearly makes it relevant, whether to diminish the power of the U.S. in the bargaining or to avoid the sort of losses that would result to both Canada and Latin America from the imposition of the hub and spoke model.

CONCLUSION

Given Canada's limited economic ties with Latin America, why should Bush's EAI be of interest to Canadian citizens, business people or politicians? The answer involves both simple, direct economic effects, and more general political-economic ones. The potential for significant economic gains is suggested by the currently low level of such trade, i.e., that low level may signal potential but unrealized gains from trade. Moreover, as Latin America grows and opens up, opportunities for Canadian exports and investment in that region will multiply. The other side of this coin, a potential economic cost to Canada, lies in increased competition for Canadian goods in U.S. markets. A second type of benefit is less immediate and has a political as well as an economic aspect; for Canada, a small nation (population 26 million) heavily tied to the North American market, there are large potential benefits as a spreading Western Hemispheric Free Trade Area develops institutions and rules-based mechanisms for preventing any country's use or abuse of unilateral powers. In fact, Canada's main agenda has always been to develop multilateral rules and institutions. This "small country agenda" would be advanced by the expansion of the CUFTA into a larger, multilateral trading area.

Looking from South to North, why should Latin America care whether Canada is involved or not?

Four reasons come to mind. 1. Canada has expertise in a number of areas, related in part to its experience of development in a relatively inhospitable climate, reflected in a comparative advantage in various product lines and available via direct investment or other types of technological transfer. Some of these skills are of potential value to Latin America.

2. Canada is home to many multinationals (seventh highest on a per capita basis) and is the world's fourth largest capital exporter ! 3. Canada provides a development model of interest, including phases of capital imports, import substitution, and trade liberalization.

4. Canada has a long history 01' trade, investment and political ties with the giant -- the U.S. This experience is of great relevance to countries in the Western Hemispheres that may be contemplating closer ties.

Canada has concentrated its economic ties on the U.S. Yet, as the countries of Latin America and the Caribbean open to trade and investment in a series of pacts, the opportunity exists for Canada to gaze beyond the Rio Grande. Canadian hesitation with the EAI rests on its concentration on the U.S. market. Canadians fear that their preferences in U.S. markets will be eroded and that Canadian industry will suffer from more direct competition. However, all Canadians realize that to be stranded, at the northern tip of the Hemisphere, outside a large trade and investment pact is a risky long-term strategy. Thus, EAI finds Canada's policy to be one of "reluctant regionalism ." While important economic and political gains can be gained from the EAI, these gains will require Canadian politicians and primarily Canadian business to pursue LAC aggressively.

FOOTNOTES

1 In 1989, the stock of Canadian investment in the UK exceeded Canadian-held investment in LAC. Canadian investment in LAC, however, exceeds Canadian investment in Europe outside the UK.

2 These data do not include maquiladora operations set up near the Mexican border to assemble products for sale in the U.S.

3 The rest of this section draws on a paper by Ann Weston on "Trade Bargaining in Canada and the U.S.; Drffting Towards Regionalism?" with funding from the International Development Research Center.

4 For an articulation of the Canadian view that the time had come to look beyond the GATT to advance Canada's trade interests, see Curtis, 1985, p. 183. Curtis also notes the long history of Canada's bilateral deals with the U.S., dating from the late 1800s.

5 A number of earlier deals with the U.S. had been on a sectoral basis -- on agricultural machinery in the 1920s, on arms production in the 1940s and the 1965 autopact.

6 For example, the Economic Council of Canada (1988) concluded that sectoral policies had retarded rather than promoted adjustment to change. It recommended that general labor adjustment policies, e.g., the expansion of the Industrial Adjustment Service, be substituted for capital subsidies.

7 As in the U.S., it is important in the Canadian case to distinguish federal and subfederal policies. The Quebec provincial government in particular has continued to adopt an interventionist industrial policy in various high tech and other sectors, e.g., aluminum processing and power projects. The Ontario government has also initiated a more active industrial policy, and there are several other examples of provincial support. How far these are compatible with the obligations of the CUFTA remains to be seen.

8 In 1987 immigrants from Latin America and the Caribbean accounted for 27 percent of the total, or about a third of those from all developing countries; this compares with figures of 15 percent and a quarter, respectively, for 1980-86.

9 Additionally, if it turns out that trade liberalization leads to much better growth performance in the LAC region, Canada would share the benefits from this "indirect" effect. The evidence is not in on this question yet. Chile is the only LAC country to have liberalized far enough back in time to provide a sort of test, and its subsequent performance has shown signs of attaining strong sustained growth. Mexico's liberalization is too recent to assess in any meaningful way.

10 Canadian firms such as Northern Telecom do have substantial business in Mexico; these sales likely appear as U.S. exports because they came from Northern Telecom's U.S. plants.

11 Pauly (1991), using Project Link's macroeconometric model, estimates that CUFTA provides a small stimulus to the Canadian economy.

12 This is a variant of a proposition by Stigler (1971), who argues that regulation of private activities (such as medicine or architecture) increases the power of the smaller members.

* A1 Berry is Professor of Economics and Leonard Waverman is Director of the Center for International Studies, University of Toronto, Canada, Ann Weston is Trade Program Director, North-South Institute, Ottawa, Canada,

'See footnotes at end of text. A list of references will be sent on request to The Center for International Studies, 18 Madison Ave., Toronto M5R 2S1, Canada.

Canada's limited economic links with Latin America and the Caribbean and a historical preference for negotiating through the GATT underlay its reluctant response to the U.S. Enterprise for the Americas Initiative. But Canadian participation may safeguard parts of the 1988 Canada-U.S. Free Trade Agreement and prevent the emergence of a "hub and spoke" regional trading system. While Canada will experience some trade diversion, there will be both economic and political gains from a broader-based trading group. LAC should benefit from closer trade and investment links with Canada and its experience in development and bargaining with the U.S.

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Author:Berry, Al; Waverman, Leonard; Weston, Ann
Publication:Business Economics
Date:Apr 1, 1992
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