Signing trade deals does not amount to promoting trade

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The fine folks at the Institute for Research on Public Policy have undertaken an important and eclectic review of Canadian trade policy. They have marshalled 30 contributions from researchers addressing all aspects of Canada's recent trade performance, and how we can improve it. The contributions will eventually be published in a single volume, Redesigning Canadian Trade Policies for New Global Realities, edited by Stephen Tapp, Ari Van Assche and Robert Wolfe (part of the IRPP's "The Art of the State" series). But in the meantime individual chapters are being electronically released on their own. One recent and especially informative contribution was Koen De Backer and Sebastien Mirodout's review of global supply chains and how Canada is being sidestepped (on both the supply and the demand sides) by that important change in trade patterns.

The IRPP invited me to contribute to the project, and I chose to develop an empirical examination of Canada's disappointing international trade performance since the turn of the century -- highlighting the seeming contradiction between those lousy results, and the government's simultaneous ambitious effort to sign as many free trade and investment agreements as possible. If these deals are the key to trade success, why is it that the more of them we implement, the worse our trade becomes? Perhaps the deals are doing more harm than good. And perhaps there are other factors holding back our exports, rather than "lack of free access to foreign markets."

Here is the link to my full chapter on the IRPP site. And below I post a summary of my findings (which I also presented this week, via videoconference from Sydney, to the Senate Standing Committee on International Trade).

Under the previous Conservative government (from 2006 through 2015), Canada entered free trade arrangements with 10 new countries -- more than any other federal government in Canadian history. The government also signed two large multilateral trade deals (the CETA and the TPP), which would engage 35 more countries in free trade relations. In the same time, the Conservative government also reached investment protection agreements with 25 countries (including China); these agreements were also supposed to boost Canadian trade performance by attracting more foreign direct investment (including into export-oriented sectors).

Yet throughout this period, Canada's trade performance declined badly. In fact, that deterioration was more marked in bilateral trade flows with Canada's FTA partners, than with the rest of the world. So is signing more free trade agreements part of the solution to Canada's trade woes ... or has it in fact been part of the problem?

My paper divides the analysis of aggregate export performance for Canada's economy into two periods: from 1981 through 2001, and the period since 2001 (including the first three quarters of data for 2015). In the last 20 years of the last century, Canadian exports of both goods and services grew robustly, both in real terms and as a share of GDP. Total exports grew dramatically from 26.5 percent of GDP in 1981 to a peak of 42.0 percent in 2001. Since then, however, merchandise exports have grown by under 1 per cent per year. Services exports grew faster -- but less than one-third as quickly as in the pre-2001 period, and more slowly than GDP. Both goods and services exports therefore shrank as a share of GDP (dramatically so for merchandise), so that by 2015 the total export share shrank to 31.4 per cent of GDP, undoing most of the increase in trade intensity that occurred during the 1981-2001 period.

Imports have grown more rapidly than sluggish exports, with the result that trade balances and current account balances deteriorated significantly. Since 2010, weak non-resource exports, combined with the eventual collapse in the resource price bubble, has been reflected in merchandise trade deficits (unusual in Canada's history) and even larger current account deficits. Current account deficits have exceeded 3 percent of GDP, on average, since 2010, reflected in a consequent increase in net foreign indebtedness.

Canada's export performance has been weak relative to previous periods of history, and also relative to other industrial countries -- suggesting that our trade failures since 2001 cannot be blamed solely on global macroeconomic conditions. I compare Canada's performance on three comparative indicators of trade success, relative to the broader community of 34 OECD countries: real export growth, current account balance, and contribution of the external sector to growth. In every case Canada's trade performance since the turn of the century has been uniquely poor, relative to the broader set of industrialized countries. Ranked by real growth of exports since 2001, Canada performed second worst of any OECD country.

It is not just the quantity of net exports which has disappointed. There has been an important and, in my view, dangerous qualitative shift in Canadian exports. Since the turn of the century, the global commodities boom shifted both capital and policy attention toward extractive industries, and this reallocation was reflected in a rapid change in the composition of Canadian exports. Higher prices and growing real quantities of resource exports made primary products the most important component of total exports by the onset of the global financial crisis in 2008. By 2014 primary sectors accounted for 40 per cent of total exports, eclipsing the importance of value-added products. (Since then there has been an encouraging rebound in value-added exports, driven in part by the decline in the Canadian dollar.)

Further insight on the relationship between trade liberalization and trade performance can be gleaned by decomposing trade flows between Canada and its free-trade partners, and comparing that to Canada's trade with the rest of the world. Canada's exports to FTA partners grew slowly after 2001: by just 1.1 per cent per year for the U.S., and only slightly faster (1.2 per cent per year) for the other FTA partners.  In contrast, exports to countries with which Canada does not presently have a free trade deal grew six times as fast (by 6.8 per cent per year). On the import side of the ledger, the comparison is equally striking. With our FTA partners, imports grew twice as fast as exports: the key driver of the deterioration in overall trade balances. Imports from non-FTA partners also grew quickly, by 4.7 per cent per year. But with non-FTA partners that Canada's exports grew faster than imports.  Again, this contradicts the assumption that FTAs will somehow give Canadian exports "preferential" status in other countries; our exports performed better with non-FTA trading partners (both relative to imports from those same countries, and relative to our FTA partners).

The most recent FTA implemented by Canada was with South Korea. The fact that Korea shares many of the same structural features as other east Asian economies (such as Japan, Malaysia, Taiwan, and Singapore) also suggests this experience will be important in judging the likely impact of the proposed TPP. Unfortunately, Canada's experience with Korea is not encouraging. Exports to Korea actually declined by 4 per cent during the FTA's first year of existence, while imports from Korea grew by 9 per cent. It is impossible to conclude that this important FTA has stimulated Canadian exports, though it has clearly liberalized imports. And sadly, the Korean experience is typical of Canada's unbalanced trade performance with its other FTA partners during this period.

The evidence is strong that Canada's trade performance has deteriorated badly since the turn of the century, at the same time as our government implemented the most far-reaching trade liberalization in our history. Moreover, the evidence is strong that our trade performed worse with FTA partners than with the rest of the world. Merely eliminating bilateral trade barriers (tariffs and others) and cementing the mobility and rights of private investment, is no guarantee that all parties to an FTA will benefit from it. In reality (as opposed to economic theory), net benefits from trade liberalization depend on the competitiveness of domestic production (according to cost, innovativeness, and quality), whether exports grow more than imports, and whether more foreign investment enters than leaves. Our dollar was substantially overvalued (relative to its purchasing power parity benchmark) through most of this period, largely because of the resource boom. And Canadian firms (other than in the resource sector) were not prepared or able to increase their role in international markets, no matter how many trade deals were signed. The result was a loss of market share (at home and abroad), weak domestic investment, and a vicious circle of deindustrialization that only exacerbated our poor structural position in world trade.

The policy response to this disappointing set of circumstances should certainly not be "more of the same, but with more gusto this time." Canada's abysmal trade performance since 2001 has nothing to do with a lack of free trade deals -- to the contrary, the deals we signed probably made a bad situation incrementally worse. A better focus for trade policy should be supporting the efforts of Canadian-based firms (whether Canadian- or foreign-owned) to upgrade and expand their capacities, do a better job of innovation, and increase their exports. That is a much more concrete, but complex task, than simply sending our diplomats off to sign another trade deal.

Photo: Chambre des Députés/flickr

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