Closer economic ties to Mexico, U.S. needed to fuel growth in Canada

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After the Brexit shocker of last week, the North American Leaders' Summit with Prime Minister Justin Trudeau, U.S. President Barack Obama and Mexican President Enrique Pena Nieto comes at a time when the United States and Mexico are more important than ever for Canada's future prosperity.

Canada's long-term economic potential has slipped to annual growth of 2 per cent or less due largely to demographic forces, specifically an aging population. Pursuing international opportunities is therefore critical to boosting – or even maintaining – Canadian living standards. Unlike the Brits, we should be seeking ways to engage our regional neighbours further.

Canada's trade with the United States flatlined in the 2000s due to competition from emerging markets, a stronger loonie and uneven U.S. performance. Fortunately, Canada was able to ride the China-driven commodity wave, but the tide has turned and we can no longer rely on high commodity prices. The U.S. economy is now back in gear and is expected to drive most Canadian export gains in coming years. Moreover, we expect Mexico to be Canada's fastest-growing export market over the next few years. In short, our future trade flows look less like the 21st-century period and more like the 1990s, when Canada's trade within North America blossomed thanks in part to NAFTA.

The U.S. economic recovery is led principally by solid consumer demand, brought on by falling unemployment, rising real wages and improving consumer confidence. High-value services sectors, such as financial services and computer and IT services, are expected to see phenomenal growth. A surge in housing starts should drive demand for wood products, metals and minerals, appliances and components. Canadian companies are benefiting from robust U.S. demand, a lower-valued Canadian dollar, and close proximity to the market.

The downside to the weaker Canadian dollar is the increased cost of capital investment. The decline in the loonie means a 25-per-cent increase in the cost of modernized machinery and equipment or other technologies compared with a few years ago. Many Canadian companies failed to invest in boosting their operating capacity when the loonie was strong. As a result, these firms may struggle with inadequate production capacity, perhaps combined with shortages of skilled workers.

But at least the U.S. rebound now provides solid incentives for Canadian firms to invest in capacity. A number of Canadian industries have in fact invested in both machinery and equipment and in their people, and are indeed prepared to seize the U.S. rebound. The sectors include food manufacturing, management services, computer and information services and other commercial services.

(Tariffs with the United States were eliminated decades ago, but a wide variety of subtle non-tariff or regulatory barriers continue to inhibit trade. These barriers are particularly important to trade in high-end services such as finance, IT, computing, media, entertainment and professional services. Canada could be a major global player in services trade with the United States and more globally, building on our strong educational system and cultural and linguistic diversity. Making it easier for Canadians to move back and forth across the border for business is fundamental to delivering high-end services and would be a great place to focus.)

While Mexico's economy, like Canada's, has been hit hard by low oil prices, the economy represents a key future trade and investment market. The Mexican economy rebounded more strongly than both those of the United States and Canada after the 2008-09 recession. The IMF forecasts that it will continue to post stronger economic growth than the United States or Canada. Mexico's median age is 28 (compared with 42 in Canada) and this young population will drive growth in consumer spending.

As Mexico works through reforms in the financial, telecom and energy sectors, Canadian companies can look to sell both their products and expertise. Selling expertise and services requires face-to-face relationships, including Canadians going to Mexico and vice versa. Thus, the removal of the visa requirement for Mexicans coming to Canada will be an important step in seizing these opportunities.

North America fell out of fashion in recent years as the BRIC economies and other emerging markets grew rapidly and the United States and Mexico struggled. Now, some of the best opportunities are closest to home. Leadership will be required from both business and government if we are to invest in Canada's capacity to deliver on the opportunities in our backyard.

Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.