Canadian foreign domestic and international policy – some thoughts on two reports

Summary

Two 2012 reports address future directions for Canadian foreign and domestic economic policy. Both stress the importance of a renewed focus on emerging markets, the need to understand the nature and impact of firm supply chains, the productivity of Canadian firms, and the policy towards inward foreign direct investment. This note suggests that future policy needs depend on which will be the growth regions of tomorrow, not just today. Canada has missed opportunities to develop service industries such as education and healthcare.

While industry supply chains are important they are constantly in a state of flux resulting from technological change leading at times to outsourcing to where labour is cheaper, and at other times requiring temporary foreign workers. Immigration policy needs to be integrated with trade and investment policy. At present they are located in different departments of government, and academic study tends to examine migration separate from trade. The delivery of diplomatic services are affected by these changes and are already underway.

 

Two reports published this summer (2012) deal with overlapping but not identical issues in examining Canada’s future economic policy options. Both are available online. The first, Winning in a Changing World, Canada and Emerging Markets, is written by a committee with four chairs – Derek Burney, Thomas d’Aquino, Leonard J. Edwards, and Fen Osler Hampson. Input was provided from a series of roundtables with the participants listed in the report. It is available online at http://www.gowlings.com/knowledgecentre/publicationPDFs/20120626_Winning-in-a-Changing-World-EN.pdf , hereafter referred to as Gowlings.  

A second report, authored by Michael Hart, Breaking Free: A Post-Mercantilist Trade and Productivity Agenda for Canada, is published by the C.D.Howe Institute, available online at http://cdhowe.org/pdf/Commentary_357.pdf , hereafter referred to as Hart. Gowlings lists no references or sources except in the case of several charts. It reflects the work of a committee with something noted for each of the main interest groups involved. Hart reads like a paper authored for an academic policy journal with bibliography and footnotes. By way of disclosure both Fen Hampson and Michael Hart were colleagues of mine. I read and respect their scholarly work. They are persons from whom I have sought comments on my own writings.

Both reports make recommendations for Canada’s future domestic and foreign economic policy and examine similar issues, such as the importance of emerging markets, the extent of and policies for foreign direct investment, the significance of supply (value) chains in different industries, and the productivity performance of Canadian firms. I started by making some succinct comments but when these reached over 5,000 words, I realized this was the “full monty” which no-one wanted to be exposed to or would read. I have shrunk my comments to two aspects of the reports, the nature of emerging markets and the implications of firm supply chains, plus some final thoughts.  

 Gowlings’ findings are summarized as follows:

“Since 2009, nearly all the world’s growth has come from emerging powerhouses led by China, India, and Brazil, and include dynamic economies such as Mexico, Korea, Turkey, Poland, Indonesia, and South Africa · Less than eight per cent of Canadian exports and four per cent of outward investment go to these emerging markets · Canadian participation in non-North American value chains remains low · The U.S. share of Canadian exports of goods and services declined from a high of 87 per cent in 2000 to 75 per cent in 2010 · Global trade volumes will quadruple by 2030 · By 2020, China’s GDP is projected to be the world’s biggest · By 2030, the individual GDPs of Turkey, Indonesia, Mexico, Vietnam, and Nigeria may surpass Canada’s GDP · By 2050, emerging markets will be home to 60 per cent of the world’s wealth and 70 per cent of global trade · By 2050, less than eight per cent of global trade will take place in North America, compared to 15 per cent today · In the next 10 to 15 years, there will be one billion middle class consumers in Asia and Africa.” It concludes with the following, “This report examines these rapidly changing trends and recommends a new approach to our trade and investment strategies for engaging emerging markets.”

Hart (2) states:

“To revitalize its flagging trade and productivity performance, Canada needs to adapt its international trade and investment policies to a world of value chains, evolving trade and investment patterns, and deepening global integration…

Canada should not wait for a hypothetical “payoff” from negotiations with other countries, but instead proceed in its own interest to remove home-grown impediments to trade. The author identifies disruptive anti-dumping and countervailing duty regimes, ineffective subsidies and procurement preferences, tariff restrictions in supply-managed sectors, overabundant regulations and many remaining restrictions on foreign ownership, as areas where less trade-restrictive measures should prevail. Such reforms would generate cost savings for the government, and leave the economy more competitive and with a stronger tax base.

These reforms would leave Canada free to focus on easing passage for secure trade and people at the vital Canada-US border, and on aligning its regulations with the United States and other major trading partners in areas where duplication does not make sense. Beyond the United States, Canada should better use its diplomatic resources by proceeding with trade negotiations only on the basis of clear business support, extensive consultations, and a clearly articulated rationale.”

 

Emerging markets

Nine desirable emerging markets are identified in Gowlings. The facts of their economic growth and trade performance are accurate. The concept of “emerging” has slipped into everyday usage. Some such as the Economist thinks it is time to retire the phrase. It refers to a geographic space defined by artificially created political entities, nation states. If Scotland separates from the rest of the UK and Quebec from Canada, global international trade would increase at the expense of domestic trade. Emerging is measured by a country’s rate of economic growth.

From Canada’s viewpoint, the economic desirability of an emerging market depends on a number of factors, for example the country as a source of raw materials or cheap foreign labour that is allowed to migrate to Canada. Alternatively goods can be shipped abroad, and the emerging market may become a destination for goods and services exported from Canada. Note here, it is firms that export and import not countries, although it may be indicative of future opportunities to focus on countries as these administer policies and negotiate internationally on behalf of firms and consumers.

So what is it that we need to know about emerging markets aside from the fact that some have shown remarkable growth in recent years? I would suggest at least two dimensions in addition to those noted in the reports – population size and GDP/capita, the latter used as a crude measure of wealth. Measures for the nine are shown in Table 1.

Table 1.

               GDP/Cap.$        World Rank           Pop (mil)

China         8,500                  (121)                      1300

Brazil       11,900                  (101)                         199

India          3,700                  (169)                       1200

Mexico    14,800                    (85)                         114

Korea       32,100                   (40)                            49

Turkey     14,700                   (86)                            79

Poland     20,600                    (60)                           79

Indonesia  4,700                  (156)                         248

S. Africa   11,100                  (105)                           49

 

In contrast:

Canada   41,100                      (21)                            34

USA         49,000                      (11)                          314

 

Source: CIA Factbook, accessed online Oct. 2012

The figures show the variation of the nine emerging markets in terms of population size and GDP per capita and where they stand relative to Canada and the US today. These are stock variables which need to be added to the flow variables concerning growth of a country’s GDP and exports.

The highest ranking countries in GDP per capita are Liechtstein (141,000), Quatar, Luxembourg, Bermuda, Singapore, Jersey, Falkland Islands, Norway, Brunei, Hong Kong (49,800). By this measure the wealthiest countries today are very small countries with special attributes. Quatar, Norway and possibly the Falkland Islands have natural resources – the Falklands also has sheep. Singapore, Hong Kong and Bermuda are financial centres. The nine selected in Gowlings vary enormously in population size and GDP/Capita, factors which need consideration as well as their recent export performance. Population size of the nine varies from 79mil. to 1.3bn, and GDP per capita from $3,700 to $32,100. One of the largest India is one of the poorest in GDP terms.

If you are a punter you want to know the horse’s performance to-date, but you are betting on performance in the next race, or the future in the case of emerging markets. Consider China and Australia, the latter not considered an emerging market but used by Gowlings (p.8) as an example for Canada to follow.

“Australia is the only G-20 developed country that experienced growth in its trade during the past decade, nearly doubling its share while Canada saw its portion nearly halved… Much of Australia’s growth came from exports to rapidly growing, emerging economies, as Australian firms nearly doubled their presence in these markets from an already stronger base than Canadian firms…” .

Two reasons to wonder about the future of China and Australia are first, that economic growth in China is slowing down and according to Tyler Cowen and others, China, has picked all the “low growing fruit” with future growth difficult to sustain. It has invested heavily in infrastructure and export oriented industries but with slow growth in the domestic consumer market.   Growing consumer expenditure is needed if China’s growth is to continue. (Cowen developed the term when examining US economic growth from 1700 onwards).

One Asia-based analyst notes that Australia  “ …has dug up its outback (literally) to ship to China. Now, China has significant overcapacity in areas like steel, as well as mountains of commodities like iron ore sitting idle in its ports, Australians are feeling a bit insecure, having tied their fortunes so closely to that country’s development. In any case, diversification of trade partners should always be the policy aim, as targeting export destinations by government planners is bound to be sub-optimal. The US pays well, on time, and you don’t have to ship the products very far, so that’s a hard-to-beat combination.” In Canada, there are already concerns about the future demand for energy resources like oil and gas, and few expected that its wine and clothing industry would prosper after the introduction of the FTA and NAFTA.

A recent paper (April 2012) helps to show the underlying changes taking place in the US, supporting in part the two reports’ conclusions, but suggests other directions for further analysis:

http://www.iie.com/publications/interstitial.cfm?ResearchID=2220 and http://conversableeconomist.blogspot.ca/ for Oct. 3, 2012. The paper states:

“The business service sector accounts for about 25 percent of the US labor force—two and a half times the size of the manufacturing sector. Moreover, the business service sector is growing. Over the past decade or so, manufacturing sector employment has decreased by about 20 percent, while business services have increased by about 30 percent. And business service jobs are good jobs: Average wages in business services are more than 20 percent higher than average wages in manufacturing.

Many people hold an outdated view of the US economy. Just as an example, consider the relative size of one service industry, engineering services, relative to two important manufacturing industries: the automotive industry (including assembly and parts) and the aerospace industry. It might surprise you to learn that engineering services is the largest in terms of employment. Engineering services (NAICS 541330) employed 980,000 people in 2007—more than the automotive industry (910,000), and more than twice as many as aerospace (440,000), according to the most recent economic census. Average earnings in engineering services ($73,000) are significantly higher than in auto production ($52,000) or even in aerospace ($68,000).

… the U.S. trade surplus in services has been was running about $5-6 billion per month for much of the 1990s and first half of the 2000s–call it $60-$72 billion per year. But since early 2011, the monthly trade surplus in services has been more like $15 billion per month–call it a services trade surplus of $180 billion per year.”

There is a similar view in Canada that there are good paying jobs in manufacturing and poor paying jobs in services, and that the loss of manufacturing jobs can somehow be brought back. The NDP talks about the Dutch Disease as depressing manufacturing exports from Canada, but as the US example shows there are good and poor paying jobs in the service sector as well. Not all are low paying Tim Horton jobs. It depends on what sector you are talking about.

I doubt Canadian manufacturing employment will return to its previous levels. It will undergo further change due to technology, as took place earlier for employment in Canadian agriculture, which has declined massively since the turn of the century, while output has blossomed due to research leading to the substitution of capital for labour.

What then is happening today which may affect industry competitiveness tomorrow? One example in manufacturing is the research underway on the production of 3D parts on computer operated equipment, similar to desktop printers for publishing. If some parts production can be done on a small scale with the further substitution of capital for labour, it will change the nature and location of parts of the supply chain. This may repatriate some production which is presently outsourced abroad. (Check MakerBot Industries in Wikipedia for details – I have not thought through all the implications as I am not sure about the details of these changes and how they might affect specific industries.)

In services, information technology has already altered the publishing industry (newspapers, books and magazines), the audiovisual industry (films, television and music), the financial industry (banking and trading) as well as other industry sectors. It is coming to education, especially higher education.  This will increasingly go online for certain disciplines, and is already doing so and referred to as MOOCs, massive open online courses, with no or low charge for taking the course, but payment required to write the final exam and methods designed to assure that the exam is taken by the person who will receive certification. One instructor, the stars, will be able to teach massive worldwide audiences in their homes, or smaller audiences around the world interested in esoteric topics and small language groups. The pros and cons of MOOCs are discussed in Wikipedia, with Athabasca University as one pioneer in Canada. Many years ago Carleton University introduced courses on TV (camera in the classroom with blackboard and chalk), but was slow to undertake the opportunities made possible with evolving technology.

I expect that there will be a vastly reduced need for classrooms and instructors for courses which require no lab work or face-to-face interaction between teacher and student. Why Canadian provinces would go ahead with financing further university buildings is a mystery to me; governments experiencing budget deficits and rising debt will be able to cut expenditures for buildings and salaries, and perhaps sell off some land. This is good news for those alarmed at rising university tuition fees and student debt. The medical care industry is another area where Canadian industry could have developed by training more foreign medical personnel and treating foreign patients. Instead we have problems in treating Canadians. ( I am grateful to Don McFetridge for pointing this out to me.)

The future for numerous industries is unknown. What appears to be a growth market today may evaporate if a closer look is taken at underlying conditions. Prospects in various emerging markets may not be as rosy as anticipated. Each one needs separate analysis and added data such as population size and GDP per capita. Although not around to see the outcome, I would make a small bet that by 2050 Switzerland, the US and Canada will still have a notably higher GDP/capita than any of the nine chosen countries.

 

Supply chains

Both Gowlings and Hart argue that the growth of industry supply chains (a new word for an old concept, the extent of vertical integration) which cross borders may alter how we analyze world affairs. Supply chains have always existed, there are now more of them in total because of economic growth, and more within particular industries because of technology and changing cost conditions. Transportation and communications costs have fallen and there is increased crossborder movement of persons. For example, immigration and supply chains illustrate that work can be sent to foreign workers with or without FDI, or the workers can be brought to Canada as permanent residents and/or temporary foreign workers employed in domestic or foreign owned firms. Firms will seek the cheapest alternative taking into account things like investment risk and taxation abroad and at home. Where FDI occurs, firms will contract so as to reduce risk, for example by renting rather than owning facilities in Canada and abroad.  

 

Some Examples of supply chains

  1. In the past, Alcan’s supply chain was fairly simple. It mined bauxite in places like Jamaica and Guyana, imported it into Canada and processed it into alumina then into aluminum and different primary manufactured products, which were used in the aircraft, beverage, construction, and other manufacturing industries at home and abroad. It had far more smelting capacity than could be sold in Canada. It might do some manufacturing itself extending the chain, or sell metal and manufactured parts to third parties. Over time it would decide whether to modify the supply chain to do more or less manufacturing.  All of this would be done with whole or partial ownership of an operation. Today since Rio-Tinto acquired Alcan, the supply chain is more complex. See for example http://www.riotintoalcan.com/index_ouroperations.asp which maps the world wide operations of Rio Tinto Alcan’s global operations.
  2. For an automobile manufacturer, the supply chain has to deal with the large number of parts that make up an assembled vehicle. These might be produced in-house in a wholly or partially owned subsidiary in Canada or abroad, or perhaps contracted out to an arm’s length supplier. Falling transportation and communication costs, foreign ownership policies at home and abroad, and protection of intellectual property are among the considerations in determining the nature of the supply chain which will change over time.
  3. In services, some firms have outsourced their call centres to firms in Canada and abroad and at times reversing previous decisions regarding ownership and location.
  4. My thesis supervisor Basil Yamey at LSE argued that the grammar for analysis of markets consisted of four factors, market size, firm size (scale and scope economies), firm diversification and vertical integration. In my mind, these factors remain the basis for understanding the present and future competitiveness of markets and the type of policies a government should consider.  

Canada with a declining share of US imports, and the US as a declining market for Canadian exports is a bad and good news story. It means that the US is a less important market for Canadian exports, thus diversification of export markets is taking place, but it may not be considered enough, or the non-US market for Canadian exports is still the same old markets and not where the report thinks exports should go.

Gowling’s analysis supports the view that there is a separation between what are domestic and international affairs. With the growth of the number of countries, population, trade and investment, this separation may no longer be the case, or the form of separation is changing. I am not sure what all the consequences are, but this needs further thought and may alter the way policies are administered domestically. Will this change the functions and conduct of diplomacy? Canada is proposing to locate some diplomatic activities in the embassies abroad of other countries, a form of foreign outsourcing. The existing diplomatic community will be reluctant to give up their current perks but these resources might be better deployed. Academics have tended to deal with trade and investment as separate from migration. These topics need to be integrated in analysis and in policy management at home and abroad.  

Finally, there are a number of Canadian economists who could provide expert input into trade policy options for Canada especially regarding emerging markets – Frank Flatters of Queen’s University presently living in SE Asia, John Chant of Simon Fraser University, and John Whalley of Western University amongst others. A glance online at their research and publications will indicate their areas of expertise.

Enough said here. There are other issues to discuss, perhaps at a later date. I would appreciate comments, rude or otherwise, on the above.

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One Response to “Canadian foreign domestic and international policy – some thoughts on two reports”

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