bout de papier, Vol. 17, No. 4 (2000-2001) — Winter 2000/2001 // Hiver 2000/2001, pp. 19–23
by Bill Dymond
A distinguished economist from India once observed that many people in his country believe in the doctrine of reincarnation. Applied to his profession, reincarnation would mean that a good and virtuous economist would be reborn as a moral philosopher while a bad economist would be reborn as a sociologist.
If only economists practiced bad economics, the situation would be manageable; however, as David Henderson (Innocence and Design, Oxford 1986) observes, more than two centuries have passed since the publication of Adam Smith’s The Wealth of Nations and trained economists are now well established in government, business and academe. Yet ideas and beliefs which owe nothing to recognized economic theory still retain their power to influence people and events. He describes the phenomenon as “do it yourself economics” (DIYE).
The free practice of DIYE in the Department of Foreign Affairs and International Trade (DFAIT) by trade and political officers from all varieties of intellectual discipline clearly points to sociology rather than moral philosophy as the its members’ next profession. The following is a brief selection of DIYE howlers encountered over many years, to which I have freely contributed.
Exports Create Jobs
The exports-create-jobs howler is omnipresent in our communications on the benefits of trade and trade agreements. It springs from a persistent mercantilist conception of trade as a zero sum game in which exports are good and imports are bad.. Exports then implicitly displace the production and associated employment of other countries not only from export markets but from their domestic markets as well.
There is no theoretical or empirical basis to support this proposition. Trade both creates and destroys employment. Export production draws capital and labour from production destined for the domestic market because the returns from export markets are more attractive. Imports displace the gaps in domestic production to meet domestic needs, and perform the critical function of determining the most profitable enterprises for the employment of capital and labour. Rising levels of both exports and imports engender structural shifts in employment towards higher value jobs. The result is not more employment but more secure and higher paying jobs because the underlying economic basis is comparative advantage and not protection.
The best empirical evidence is found in the economic failure of command and control economies of the former Soviet empire and China. These economies combined full employment with low exports, steadily declining economic performance and deteriorating standards of living. The strong export performances of many of these countries since the replacement of central planning by market-driven economic policies are associated with rising standards of living and increasing levels of unemployment. Try telling the 17 percent unemployed of Germany’s eastern Lander or the hundreds of thousands, if not more, of Chinese workers who are going to get the sack as China adjusts to World Trade Organization (WTO) disciplines, that exports create jobs, then listen for the howls of derision.
Canada’s comparative advantage, derived from our human and natural resource endowment, requires economies of scale and specialization, and implies heavy reliance upon imports and exports. Until the Tokyo Round of multilateral trade negotiations, held under the General Agreement on Tariffs and Trade (GATT, 1973-79), Canada pursued a trade policy which eroded growth and employment performance by seeking market access for resource exports while protecting domestic manufacturing from imports to preserve employment. In the aftermath of the Canada-US Free Trade Agreement and the 1995 creation of the WTO, strong Canadian performance has been accompanied not only by rising exports and imports, but by a rising share of foreign content in Canadian exports. These results are sure signs of the Canadian economy’s growing integration into the world economy. They ought to trigger a shift from the exclusive preoccupation with the terms and conditions of Canada’s access to export markets to the terms and conditions of Canada’s access to imports.
Canada needs foreign investment
The Canada-needs-foreign-investment howler has a long and fallacious pedigree. While none would deny the importance of foreign direct investment (FDI) in Canada, it’s important to situate FDI in its overall economic context. In any given year, new net investment in the economy will be primarily financed by corporate and individual domestic savings. Accordingly, increases or decreases in FDI have relatively modest impacts on yearly Canadian economic performance compared to the sizeable economic impact of modest shifts in domestic savings.
Historically, the high levels of Canadian tariffs and other trade protection under the Sir John A. Macdonald’s national policy provided a major incentive for domestic FDI, especially in manufacturing. Production in Canada was frequently the only way open to foreign producers to achieve access to the Canadian market. This type of investment within a small, highly-protected market produced a fragmented, inefficient, uncompetitive industrial base which persisted well into the 1980s. Successful GATT rounds reduced Canadian protection, thereby steadily eroding the investment incentive for domestic market production. The FTA conveyed the National Policy’s tariff component to the dustbin by eliminating tariff incentives to invest in Canada. The inevitable result is that investors no longer need to invest in Canada to sell here. The good old days when Canada, especially Ontario, was dotted with small-scale replicas of European and US plants producing for the domestic market are gone.
The real story is Canada’s transformation from an importer to an exporter of FDI. In 1991, FDI imports exceeded exports by $26 billion; in 1994, the difference was $11 billion. In 1997, outward foreign investment exceeded FDI into Canada by $8 billion. This difference grew to $22 billion one year later. While, by 1999, inward FDI was greater that outward FDI, the long-term-trend seems unlikely to be reversed. This is a good news story all around – it means that Canadian companies are expanding rapidly into global markets — as demonstrated by the rapidly growing share of exports in gross domestic product. They’re following the path blazed by successful European and American companies: mergers, acquisitions, and greenfield investment in other countries to acquire the technology, markets, managerial skills and access to critical imports that are the keys to growth. More power to them.
Notwithstanding these significant changes in the “economy” of investment, Canadian official and political attitudes are stuck in a time warp. Our investment policy prism remains resolutely import-blinkered. Whether the public mood is suspicious of FDI, as during the days of the federal Foreign Investment Review Agency, or welcoming as with Investment Canada, the focus is inward investment: how to control it when we are worried about having too much; and how do we get more when we think we’re not getting our share. The public debate over the late, unlamented Multilateral Agreement on Investment was all about the depredations foreign investors would visit on Canadian innocence; hence our negotiating posture became almost wholly defensive about the sectors of the economy we would keep safe from foreign investors.
The essential point is that capital exports are, in many respects, the matching twin of imports. The logic of free trade (on which successive Canadian governments have embarked) is the reduction of Canadian import protection to zero to provide Canadian producers access to world-priced inputs and technology. Just as Canadian producers need to achieve economies of scale and specialization to compete domestically and internationally, so too they need the freedom to invest in other countries and obtain access to the markets, technology, distribution and supplier networks that foreign investment brings.
The foreign policy implications of shifting the focus from domestic to global investment would be significant. Attracting foreign investment for DFAIT is principally a matter of promotion and consciousness raising, since the fundamental economic determinants lie elsewhere, e.g., tax policy. Protecting capital exports implies an aggressive negotiating strategy towards many countries, notably less developed countries to obtain treaty-bound investment access and protection commitments (that Canada rejected out of hand as unacceptable constraints on sovereign decision making until the FTA).
Country export figures matter
This howler is bred into the bones of every officer of the department. No country or region briefing, no ministerial visit, no press release, no ministerial transition brief is complete without an observation on bilateral trade flows. (No brief on the European Union omits the groundless claim that it is Canada’s second largest trading partner. So what is Japan?) There are at least three reasons why we should dispense with the notion that bilateral trade statistics are relevant measures of economic realities and, even worse, a tool for the making of trade policy.
Firstly, governments have virtually no power to influence bilateral trade (except the residual ability to reduce or prohibit trade for foreign policy reasons, (e.g., Serbia.) Governments have not only abandoned most of the traditional tools designed to regulate trade but bound themselves to multilateral or regional non-discrimination regimes. Governments operate at the margins of bilateral trade by addressing precise trade barriers (e.g., using the WTO to get the Australians to eliminate their illegal prohibition on Canadian salmon exports) or through modest programs of subsidy and market development. But these can only have an infinitesimally small impact on overall trade. To focus on bilateral trade flows is to suggest that governments can or should do something about the state of bilateral trade. The reality is that whatever bilateral trade flows exist, governments are virtually powerless to make them grow faster or to change their composition.
Secondly, the most dominant companies in global markets increasingly operate globally-integrated production, marketing and procurement systems. To enquire into the purely Canadian origin of exports is to suggest that such companies operate as a series of related but nationally-integrated units. The reality is quite different. For instance, Nortel is integrated across product lines, not country lines. IBM has two major factories in Canada, which have little do directly with one another but are part of its global network. The national origin of Bombardier’s Global Express business jet could be legitimately claimed by at least ten countries. Even national symbols like Air Canada earn the majority of their revenues from international travel. Airplanes, their most important asset, are procured from foreign providers, and their prosperity depends on their ability to attract foreign-origin traffic.
Thirdly, there is a trap awaiting anyone so incautious as to rely on bilateral trade figures as indicators of the strength of a given bilateral relationship. To accept the proposition that bilateral trade figures are relevant is to accept, at the same time, that no country but the United States matters to Canada. Even if a portion of the 85 percent of total Canadian exports absorbed by the US are transshipments to Latin America or other destinations, the point is still moot. If recorded exports to Costa Rica were 10 times higher, they would remain marginal to Canada’s economic performance. As used to be said about American attitudes to exports to Canada, our exports to most other countries in the world amount to production on the last shift on Friday afternoon. For all countries but the US, bilateral trade figures are a sign of weakness in the relationship, not strength.
Trade diversification makes economic sense
The trade diversification howler is by no means a candidate for the endangered species list. Its preferred habitat is found in requests for additional resources to expand trade and in the justification for bilateral trade agreements.
The origins of this howler are found in the US share of Canadian trade. The diversification argument — that we rely much too heavily on one market — lacks a basis in economic reality. The American absorptive capacity for Canadian exports is a source of strength, not weakness. The US is the largest, most lucrative and, with a compatible business and legal culture, the most congenial market for Canadian traders and investors. Moreover, the concentration of Canadian trade in only a few regions of the US is indicative of the vast, untapped opportunities for growth. To strengthen Canadian economic performance through trade, we should be focusing our efforts on the US and not chasing the chimera of target-market diversification.
Indeed, other countries to which Canadian trade efforts might theoretically be intensified are often highly dependent on the American market. Mexico’s trade with the US accounts for 80 percent of its total merchandise trade. The US is Japan’s largest destination for exports and source of imports, accounting for 26 percent of total merchandise trade. Japan’s next largest trading partner is China at eight percent. The impact of a decline in the US economy would not only affect Canadian exports to the US but our exports to other markets as well.
Perhaps most importantly, it’s difficult to reconcile the goal of trade diversification with that of market liberalization. Trade liberalization is desirable for several reasons: it facilitates productivity gains to be had from specialization and the exploitation of comparative advantage; it allows enterprises to achieve economies of scale by broadening the market beyond the domestic sphere; and it increases competition in the domestic market, forcing domestic industries to be more efficient. Trade diversification as a policy goal confuses trade facilitation with trade policy and is a potential distortion of the broader policy objective of market liberalization. Bilateral and multilateral efforts to break down specific access barriers to Canadian goods and services are necessary for Canadian exporters. These efforts should be seen as an obvious correlative to trade promotion. Modest trade diversification might well result, but is not central to the purpose of trade liberalization, which is access to export markets and import sources, wherever they may be found.
The need for plain talk
The admixture of economic myth and reality is an occupational hazard for trade policy practitioners and calls for constant vigilance. Separating spin from reality is no less important. The risk is that spin will inform policy, feed protectionist and mercantilist myths, and weaken Canadians’ overwhelming support (shown in polls) for trade liberalization and trade agreements. This is effectively what we do when we argue that trade creates jobs or that Canada is dependent on foreign investment. It is time to strike a new course and argue that the economic future of Canada lies in its continued rapid integration into the global economy.
Look for me to do my part.
0:11 N……
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Originally published in bout de papier, Vol. 17, No. 4 (2000-2001) — Winter 2000/2001 // Hiver 2000/2001, pp. 19–23. Read the rest of this issue →
