Publication: C.D. Howe Institute Commentary
Publication Date: 01-AUG-05
Delivery: Immediate Online Access
Author: Goldfarb, Danielle

Article Excerpt
In its 2005 International Policy Statement, Ottawa expressed concern that the flurry of recent U.S. free trade agreements is diluting Canada s once nearly exclusive access to the United States market. The federal government is responding in part by trying to negotiate a set of free trade agreements of its own. (1) Canadian policymakers should approach that route with caution.

This Commentary briefly discusses the implications for Canada of a trading system riddled by overlapping free trade agreements. It focuses in particular on the implications of the U.S. bilateral free trade agreement strategy for Canadian interests because of the overwhelming importance of the U.S. market for Canadian prosperity. It also considers the merits of Canada's available trade strategies in the face of U.S. and other bilateral trade accords.

The U.S. agreements spread Canada's duty-free access more widely, establish precedents and new rules without Canada at the table and possibly undermine multilateral and regional trade liberalization efforts in which Canada has a large stake. However, because these agreements are with marginal economies, the overall effects of current U.S. free trade agreements will be relatively minor to Canadian--and U.S.--economic interests.

Ottawa's current trade approach in this context is to complete already initiated free trade negotiations, while considering new opportunities. According to the International Policy Statement, the federal government plans to conclude stalled negotiations with the European Free Trade Association, Singapore, and four Central American countries. It recently opened negotiations with South Korea, and says it will open negotiations with the Caribbean Community, the Andean Community and the Dominican Republic. It is establishing a trade study with Japan that it hopes will lead to a free trade accord. And it is considering other targets (Sanford 2005; McKenna 2005). All of this is in addition to NAFTA and free trade agreements with Israel, Chile and Costa Rica.

The political appeal of signing bilateral free trade agreements outside of North America is strong; however such a strategy is likely to yield only marginal and declining gains relative to the high costs of negotiation and implementation. It will not reduce the risks posed by the U.S. approach, and might divert attention from more important priorities. Businesses have not responded in the past to initiatives to increase economic linkages outside of the U.S. and it is not clear that they will act any differently in the future.

Ottawa could pursue a better, more coherent strategy by focusing its limited resources in areas where payoffs to Canadian interests are likely to be greatest. The expected gains from global free trade will be much larger than from smaller accords and, as a result, Canada should maintain its support for the current round of World Trade Organization (WTO) negotiations and, to a lesser extent, for the stalemated Free Trade Area of the Americas (FTAA) process. Canada's limited influence over these efforts, however, makes it essential that the government concentrate its attention overwhelmingly on attaining secure, predictable access to the U.S. market.

If the U.S. pursues a free trade agreement with a large economy, Ottawa might carefully consider negotiating jointly with the U.S. to reduce overlapping rules and so that businesses in Canada will have free access to two large economies. If Ottawa intends to pursue its own bilateral free trade agreements, it should aim for large or otherwise strategically important markets and press for eliminating barriers to goods, services and investment, while not undermining Canada-U.S. multilateral or regional efforts.

Where We Are Now

This section explores Canada's trade and investment situation, national interests and recent trade policies.

Canada's Situation

Canada's relatively small domestic economy depends critically on international trade for its prosperity. Because of its gradual reduction of tariff rates during many years of multilateral trade liberalization, the country has a relatively open economy. Only a few sectors, such as dairy, textiles and shipbuilding, are still protected by high duties. Despite such an open economy, and the economic expansion of China and other Asian countries, Canada trades little outside of its immediate region. Table I highlights the inescapable fact that Canada's international trade is overwhelmingly directed to and from the U.S. market and that Canada's next largest export destination (Japan) accounted for just over 2 percent of Canadian exports in 2004. The limited available trade data indicate that Canada is not currently a significant part of supply chains outside of North America. (2)

Access to the U.S. market has been mostly tariff-free since the Canada-U.S. Free Trade Agreement came into force in 1989. Still, there are non-tariff barriers between Canada and the U.S. that reduce potential trade gains. Non-tariff barriers that remain include regulatory differences, (3) new security requirements, persistent trade penalties in certain sectors, and rules of origin. (4) Such barriers are inconsistent with the reality of a common economic space, with goods moving across the border in various stages of production. On average, one-third of Canadian exports are imported and then re-exported as part of a more processed good or service (Cross 2002). Such intermediate inputs are subject to barriers each time they cross a border, multiplying the effect of even minor obstructions.

Outside of Canada's immediate neighbourhood, global tariff barriers have declined on average as a result of negotiations within the WTO and predecessor organizations. Canadian businesses have reasonably good access for industrial goods in developed markets, though providers of goods and services still face non-tariff trade and investment barriers, including technical and regulatory impediments. (5)

Foreign direct investment reinforces trade, as multinational companies, operating along global supply chains, set up subsidiaries that trade goods and services. While Canada has maintained its share of the rapidly growing global stocks of direct investment abroad, its share of inward direct investment has fallen steadily over the past 30 years (Hejazi 2004). As well, most two-way flows are with the United States rather than with other large markets that are important for global supply chains. For example, Canada's foreign direct investment in China represents only 1.5 percent of its total and China's direct investment in Canada represents a miniscule 0.1 percent of total direct investment in Canada, as Table 1 shows.

Canadian Interests

Enhancing Canadian prosperity is a vital national interest because the well-being of its citizens depends on it. Canada also has an interest in a prosperous and stable world. As a result, Canada has a large stake in an open economy with barrier-free, secure, predictable, rules-based access to foreign markets, particularly to the U.S. Canada has a strong interest in participating in exercises that improve rules for simple, predictable, freer market access for goods, services, capital and people. It has a large stake in being at the bargaining table when such rules are created. Unlike the U.S., Canada's interests in trade policymaking are primarily economic rather than geo-political. (6) A broader trade deal with one set of rules is far preferable for Canada than being caught in an overlapping set of agreements with different requirements.

Canada has limited expertise and political energy to devote to negotiating and implementing trade accords. The country therefore has an interest in pursuing strategies that will yield large payoffs in terms of advancing its interests. Though multilateral negotiations are moving slowly, economic gains from multilateral trade liberalization will always be superior to those from preferential trade arrangements. (7)

Canadian Trade Policy

Gaining secure, predictable, rules-based access to the U.S. market motivated Canada's signing of the original free trade agreement with that country in 1988 as well as joining Mexico-U.S. negotiations that led to signing NAFTA in 1993. Canada's interest in common trade and investment rules that create predictability have motivated the country's historically strong support for multilateral trade liberalization and also for the FTAA process. That support for multilateralism and western hemispheric free trade continues, as does attention to securing access to the U.S. market. The latter includes the March 2005 announcement of the trilateral Security and Prosperity Partnership of North America and its related June 2005 progress report. It is still not clear how ambitious this initiative is or will eventually become.

During the 1990s and early years of this decade several countries or sub-regional groupings approached Canada to seek free trade agreements. As a result, Canada either opened, or publicly announced it was considering opening, negotiations with nine countries, adding to an incoherent and unfocused list that did not seem to coincide with major Canadian economic interests. Table 2 compares proposed and negotiated bilateral and sub-regional free trade agreements for both the U.S. and Canada. Outside NAFTA, Canada concluded only three agreements--with Israel, Chile and Costa Rica. These three countries together accounted for about 0.25 percent of Canadian goods exports in 1996 (before the agreements were signed), and they buy even less today (0.20 percent in 2004).

Three other negotiations have stalled. Canada launched free trade negotiations with the European Free Trade Association (Iceland, Norway, Switzerland and Lichtenstein) in 1998 and with Singapore and the Central America-4 countries (El Salvador, Guatemala, Honduras and Nicaragua) in 2001. The European Free Trade Association and the Central America-4 negotiations are stalled over Canada's unwillingness to lower shipbuilding and textile tariffs, respectively. The reasons for the delay in completing the Singapore agreement have not been made public. Canada is apparently holding out for an agreement commensurate with the U.S.-Singapore free trade accord (Box 1 examines the U.S.-Singapore agreement and selected other U.S. agreements). In the 2005 International Policy Statement, Canada committed resources to concluding these agreements soon, though the government has not yet scheduled any official negotiating rounds. These three groupings accounted for less than three-quarters of a percent of Canadian exports in 2004, though this does not include services or sales by foreign affiliates, nor does it reflect potential future exports.

Box 1: Selected U.S. Free Trade Agreements (a) Australia The U.S.-Australia agreement, which came into effect in 2005, is the first U.S. free trade pact with a developed country since the Canada-U.S. free trade agreement. Australia is unlikely to see major overall benefits because the two countries are geographically distant, the agreement has exemptions, and both countries were relatively open to each other for manufactures before the free trade agreement. U.S. duties on sugar and some dairy products will not be eliminated at all. Tariffs on textiles and some other items will also be phased out over 10 years, similar to the length of phase-out periods under the Canada-U.S. agreement and NAFTA. Unlike NAFTA and the other new U.S. deals, at Australia's insistence its agreement does not permit investor-state suits in the event of disputes. The U.S.-Australia deal is also the first to include specific provisions for pharmaceuticals, requiring Australia to increase the transparency and accountability of its Pharmaceutical Benefits Scheme, a move intended to benefit U.S. pharmaceutical companies. Singapore Trade...



NOTE: All illustrations and photos have been removed from this article.



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