Glen Hodgson is a senior fellow at the Conference Board of Canada.
The Trump administration’s disruptive trade policies have been a wake-up call for Canadian policy-makers and exporters, highlighting the risk of being so dependent on a single market. Although Canada’s share of exports to the United States has slowly declined since the early 2000s – when it peaked at more than 85 per cent – a full 70 per cent of Canadian exports of goods and services still go to U.S. buyers.
It is understandable how Canada ended up in this dependent relationship. Canada has had a close economic relationship with the United States for more than two centuries, which only increased with Canada’s diversion away from its historical British trade links from the mid-20th century on. We have had it especially good under the North American free-trade agreement, which made it even easier for Canadian businesses to access the large, affluent and generally open market right next door. Deep economic integration in many key manufacturing, energy and services market segments has ensued. Despite the spectacular rise of China and other major emerging trade partners, Canada’s shift toward other markets over the past 15 years has occurred at only a modest pace.
We see five key elements to greater trade diversification for Canada.
Geography. Most of us think about geographic diversification as a first option. Free-trade deals with the European Union and Asia-Pacific regions were important and necessary policy actions to enhance access to other major markets for Canadian exporters. Policy-makers need to keep going. A second round of negotiations on the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) could bring in countries such as Colombia, Indonesia, Taiwan and Thailand. China is the biggest remaining opportunity for advancing bilateral free trade, but Canada stumbled out of the gate last fall. Trade ambitions with China will have to be recalibrated by focusing on core issues such as reducing tariffs and non-tariff barriers that are keeping Canadian firms from fully accessing the Chinese market.
Sectors. Firms in manufacturing, resources and, in particular, energy have traditionally relied on international trade to build their businesses and enhance their competitiveness; these firms are deeply connected to the U.S. market. Yet services now represent 70 per cent of Canadian gross domestic product. Fostered by direct investment abroad, international trade in services is increasingly possible via digital trade and increased mobility of people with services expertise. A trade diversification strategy should treat services trade as a priority, such as by selling more Canadian financial or professional services internationally. But there are also likely to be limits to services trade. For example, the public sector delivery model for health care will constrain the capacity for Canadian trade in health-care services.
Firms. Size matters in trade. Large exporters have numerous advantages – including economies of scale, deep expertise and larger balance sheets and financial capacity – resulting in their dominant share of Canadian exports. Governments have pushed for greater exporting by small and medium enterprises (SMEs) for decades, and the rise of the digital economy has allowed some SMEs to break out and serve global customers efficiently from a Canadian operating base. Because of their scale, however, many SMEs face internal limitations – management capacity, operating bandwidth and in-house trade expertise – to their ability to engage widely in trade. Governments can only do so much to offset these limitations.
Fit into value chains. The dominant business model today is global value chains. More than 20 per cent of global trade is sales of intermediate goods and services to businesses (not consumers), to help them become more efficient and competitive. The greatest trade diversification opportunity may be for Canadian exporters to fit into the value chains of major firms outside North America. However, the formation of value chains within North America took place over four or more decades, building from a base of historic business relationships. Canadian suppliers will have to be creative to break into the value chains of major firms that are geographically and culturally distant, and already have local or regional value chains in place.
Direct investment abroad. The capacity of Canadian firms to establish facilities offshore is often a critical part of their international trade success. Firms in sectors such as financial services and manufacturing need to invest outside Canada in order to reach and serve foreign customers, and resource firms need to invest abroad to access additional sources of supply. Canadian trade policy often seems to skip over the important role of investment abroad, but it ought to be a core element of a trade diversification plan.
So is greater Canadian trade diversification really possible? The answer is a cautious yes, if the factors identified here are actively pursued. The needless disruption and uncertainty caused by our neighbour to the south provides us with ample reason to act.
Glen Hodgson