THE 1987 CANADA-U.S. FREE TRADE Agreement is the most comprehensive bilateral trade deal ever struck between the two biggest trade partners the world has ever seen. While in many respects merely confirming the status quo, the FTA remains a landmark in trade history, creating a unified, tariff-free market of 266 million consumers. That it did not succeed in removing all restrictions on the freedom of movement of goods, services, capital, and labour across our border is testament only to the pioneering quality of its efforts in matters previous trade agreements dared not touch.
The agreement frees trade between the two countries in nearly all goods, most investment and many services. It eliminates all existing tariffs by 1998 -- some immediately, some over five years, and some over ten -- and forbids any new ones. Other border restrictions such as quotas and export taxes are similarly proscribed, almost without exception. It establishes the principle of "national treatment" in services and investment, meaning that each country must treat the other's nationals as if they were its own.
That means extending right of establishment on a reciprocal basis, as well as ensuring taxes, product standards, investment guidelines, accreditation systems and other regulations which might be used as non-tariff barriers to trade and capital flows are applied without discrimination. A further provision allows professionals and executives, such as investment managers or after-sales service personnel, to travel back and forth across the border on business trips with a minimum of hindrance.
Of perhaps greatest importance to Canada, the agreement establishes a system of binational panels to adjudicate trade disputes between the two countries, and to hear appeals of each country's application of its own anti-dumping and countervail laws, replacing judicial review. The procedures promise to take some of the politics out of trade remedy law, and to keep decisions marching along a prescribed timetable, offering assurance to exporters they will not be subject to harassment from frivolous "unfair trade" suits. In addition, the agreement exempts Canada from U.S. retaliatory actions aimed at other countries' exports. In the past, as in U.S. restrictions on foreign steel, where such countries as Brazil were the intended targets, Canada was often sideswiped.
The result is to further integrate the markets of two countries that are already each others's largest trade partners, exchanging $200 billion in goods and services last year. The U.S. accounts for 73% of Canada's exports, and two-thirds of its imports. Canada for its part provides 19% of U.S. imports, absorbing 23% of its exports. But these numbers could expand dramatically. Though it is often said that 70% of trade between the two countries was already tariff-free, this is only testimony to the effectiveness of the remaining tariffs, at the time of the treaty as high as 33%, in doing their job: stopping trade. Much trade was also inhibited just by the threat of barriers, and loss of access remained a constant worry for exporters.
The U.S. Commerce Dept. estimates annual two-way trade flows could rise by US$25 billion over five years. The Institute for International Economics in Washington forecasts U.S. manufacturers of machinery, chemicals, rubber and scientific instruments will be among the biggest winners from access to the world's seventh largest market. Computer and telecommunications equipment makers are already smiling: tariffs as high as 18% on their goods were among the first to be removed. There will be losers, too. U.S. producers of energy, pulp and paper and steel must be concerned at the competitive threat from the north. In Canada, furniture, textile and shoe manufacturers have the most to lose from the loss of tariff protection, while a variety of small manufacturers from printers to glassmakers that had previously relied on domestic sales will be forced into export markets to survive.
Competition from lower-cost producers means lower prices for consumers. It means higher wages for workers, by virute of higher productivity levels. But it also means dislocation and layoffs, as companies undergo the adjustment to a unified market free of tariff distortions. The opportunities, and the adjustments, are in general greater for Canada, as the smaller partner in the deal, with the most dependency on the other market and the higher tariffs: 9.9% on average before the deal, versus 3.4% in the U.S. The Conference Board of Canada, a government economic thinktank, estimates the direct effect of the FTA will be to create 250,000 net new jobs in Canada and boost real output by 2.5%, as opposed to U.S. Commerce Dept. forecasts of an increase in U.S. employment of 14,000 and output of 0.x%.
But for business in both countries, perhaps the greatest opportunity -- not captured in the figures -- is the chance to rationalize production on a continent-wide basis to meet the competition from Japan and Europe. For the multinationals that account for 75% of cross-border trade, this will be a matter of reallocating output among existing plants -- locating some products in Canada to serve the U.S. market, while serving the Canadian market in others from the U.S., according to cost and market dictates. For small- and medium-sized businesses, it opens up whole new possibilities: sourcing low-cost suppliers from across the border, or expanding into international markets for the first time, whether directly or -- in a liberalized investment climate -- by acquisition.
It's worth saying what the agreement is not. It is not a customs union: each country remains free to set its own external trade policy. Backstopping this is the FTA's rule of origin -- only those goods with 50% North American content, based on direct cost of manufacturing, qualify for tariff-free trade -- to prevent third countries from gaining free access to either country's market via the "back door."
It is not a common market: except as otherwise noted, labor is not free to move across the border. And there are other specific exceptions: Canada insisted on the exclusion of beer and cultural industries, while the U.S. kept shipping off the table. Agriculture was only partially liberalized, with bilateral tariffs and subsidies dropped, but Canada's marketing boards -- and the import quotas needed to sustain them -- kept in place.
Nor is it an attempt to create a "single market" a la Europe 1992, obliterating all obstacles to trade by establishing a single set of standards and regulations. While the FTA leaves the option open for this sort of "harmonization," it does not require it, relying on the national treatment approach to weed out non-tariff barriers instead. This sacrifices some potential economies of scale, but preserves national sovereignty. "It's a completely different type of situation," says Alan Rugman of the University of Toronto's Faculty of Management, an expert on international trade treaties.
Some other general principles: First, the FTA is embedded in and largely based on the General Agreement on Tariffs & Trade, the body of international trade laws both Canada and the U.S. are already committed to. Applying GATT principles, which both countries have ignored from time to time, in a bilateral setting may make them more binding. Second, except for tariffs, the FTA is strictly forward looking. All existing restrictions in investment and services are grandfathered, unless otherwise specified. But new restrictions are prohibited.
So while Canada has agreed to progressively raise the threshold for review of direct takeovers from $5 million in 1988 to $150 million in 1992 (and to end review of indirect takeovers altogether within the same time frame), it will continue to restrict foreign ownership in oil and gas, uranium, transportation, telecommunications and the cultural industries. One notable absence from this list: banking, where Canada lifted the 25% foreign ownership ceiling. Likewise, only those services listed in an annex to the agreement -- mostly services to business -- are covered by the national treatment provision. Even here, existing regulations are grandfathered.
Third, the FTA applies mostly to national governments. To ease passage, both sides sought to minimize the degree to which the FTA affects state and provincial jurisdictions. While government procurement, for example, has been (partially) opened up to bidders from both countries, this applies only to federal contracts. The national treatment requirement in financial services applies only to federal regulations. And Canada's many interprovincial trade barriers remain intact -- though the absurdity of not applying the same rule of non-discrimination to businesses from another province that the FTA now requires they apply to those from another country may occur to some premiers.
Fourth, the FTA leaves much unresolved. More than twenty separate sets of negotiations are under way, on matters ranging from harmonization of technical standards to the future of the North American auto industry to the makeup of adjudicatory panels. Most contentiously, the two countries failed in their ambition of harmonizing their trade remedy laws (indeed, in the early going there was some talk of eliminating "unfair" trade laws altogether, in favour of domestic competition laws).
Beginning next year, and for the next five years, the two sides will try to negotiate a common definition of what constitutes a countervailable export subsidy. The usual rule is that subsidies that are available to everyone, like Canada's state health insurance, don't count, while subsidies that are aimed at a particular company or industry do. The task for the negotiators will be to decide which of the many subsidies each country makes use of fall under which category. It may be that agreement will prove impossible. In that case the most likely scenario is that the two sides will carry on with the binational panels now in place.
It is difficult to know what impact the FTA might have had to date, given that it has only just begun to be phased in. Moreover, the effects of trade liberalization cannot easily be disentangled from macroeconomic influences on trade flows. Canada has a public debt of $350 billion, of which a growing proportion is financed by foreign capital. That has pushed up the Canadian dollar to a nine-year high of US86¢, three cents higher than it was at the start of 1989. And it has driven Canada's current account deficit to a record $19.7 billion last year, or 3% of GDP, twice what it was in 1988.
That's wonderful political ammunition for critics of the trade agreement, who are endeavoring, as an opposition finance critic was indiscrete enough to admit, to blame "every sparrow that falls" on free trade. "I can't imagine a worse economic environment in which to implement the free trade agreement than the one we're in now," Gordon Ritchie, the number two man on the Canadian team that negotiated the deal, has lamented. "The adverse impact of the valuation of the Canadian dollar has 20 times the impact of free trade."
Still, the news is hardly all bad. Capital investment in Canada last year, notwithstanding real interest rates in the range of 8%-9%, posted an 11% increase over 1988 levels, marking a three year increase of 38% over 1986 levels. Net new job creation in 1989 was 193,000. Indeed, in March of this year the unemployment rate plunged to 7.2% -- the lowest level in eight years. Preliminary trade figures for 1989 show a 2.6% growth in Canadian exports to the U.S. and a 6.4% increase in U.S. exports to Canada -- much of it machinery and equipment for industry.
The FTA's effects can perhaps best be measured, however, through changes in government policy. In response to hundreds of industry requests from both sides of the border covering more than 2,000 tariff items, the two countries agreed in the first months after the FTA went into effect to accelerate tariff elimination on 400 items covering $6 billion worth of trade. The pattern was repeated this year. Five new Canadian trade offices have been opened, in San Diego, Denver, Princeton, Miami and San Juan. Several American states have in turn opened offices in Canada, the latest being North Carolina.
While trade disputes have continued, the first two to reach the binational panel stage, one concerning Canadian landing requirements for West Coast salmon, the other an appeal of a dumping case against British Columbia red raspberries, have been resolved satisfactorily, with both sides accepting their legitimacy. More than a dozen others are in the pipeline, but less than 2% of trade is now the source of any friction. The success of the panels to date is "very exciting," says the University of Toronto's Rugman. "Canada is now getting special treatment in U.S. trade law." In fact the FTA may prove a model to the rest of the world in this respect. In the current Uruguay round of multilateral trade talks, Canada has unveiled a well-received plan to revamp the GATT into a World Trade Organization, with greater powers to arbitrate trade disputes. The provisions are based on the binanational panels under the FTA.
Other non-tariff barriers are being removed. Both the U.S. Federal Energy Regulatory Commission and the Canadian National Energy Board have given their blessing to massive new natural gas projects that will increase Canadian exports to the U.S. by 7% to 10%, as heightened environmental and security of supply concerns leads coal and oil consumers to switch to gas. In both cases, the regulators cited the FTA in refusing to intervene.
Canada has not only opened bidding for the limited amount of federal procurement covered by the FTA's national treatment provisions (contracts over $31,000 in value, and then only in certain categories, as defined by the GATT), it is listing the contracts on an electronic bulletin board. The last federal budget raised the 10% foreign investment ceiling on Canada's $170 billion in pension funds, unlocking $2 billion-$3 billion more annually to invest in the U.S. and other countries.
Whether due to free trade or not, there are signs of a major reshuffling of corporate assets under way in North America. Last year saw nearly 1,200 mergers and acquisitions in Canada, for a total value of $30 billion. Half of these involved foreign firms, of whom U.S. firms made up about two-thirds. The level of M&A activity in Canada is one-third of that in the U.S., an economy ten times as large, and it far exceeds that of Germany, France and Japan. There has also been a significant increase in Canadian companies seeking listings on the New York and American stock exchanges. Nova Corp. and Norcen Energy Resources Ltd. joined Canadian Pacific Ltd. and Alcan Aluminum Ltd. in the last two years. The Toronto-Dominion and Royal Banks, Dominion Textiles, Four Season Hotels and CAE Industires are all said to be candidates.
At the same time, Canadians have been buying up U.S. companies at an astonishing rate. While the names Campeau and Reichman have become well known in the U.S., there are many other smaller acquisitors. In 1988, Canadian investors bought 53 American companies for a total of $13.6 billion, adding another $4 billion in 1989. Canadian investment in the U.S. has grown for the last decade at a rate of 20% per year -- three times faster than U.S. investment in Canada. On current trends, in the early years of this decade, Canadian direct investment in the U.S. will surpass that of the U.S. in Canada. Canada now ranks fourth among foreign investors in the U.S.. As U.S. unease over foreign investment grows, the FTA's requirement of national treatment for Canadian investors looms as a major gain.
The shakeout is not limited to transfers of ownership. Much FTA-driven investment activity also involves reassessing existing production arrangements. So far, this has been dominated by Canadian firms. "American firms are still American companies, whereas the Canadian companies really have a North American focus," says Al Litvak, professor of business at Toronto's York University. Nonetheless, U.S. multinationals are stirring, with plants opening and shutting on both sides of the border. GTE Corp.'s Sylvania unit has closed its U.S. lighting fixtures plant and consolidated production in Mississauga, Ont. Burlington Carpet Mills, on the other hand, is closing its Brampton, Ont. plant to centralize in Georgia. Detroit-based Bachan Aerospace changed its name to Windsor Aerospace when the U.S. parent shut its doors in favour of producing at its Canadian subsidiary across the river. Activity is most frenetic along the border. Last year 68 Canadian firms set up shop in New York state, while 49 U.S. firms opened operations in Ontario.
In many more cases, however, adjustment is less dramatic than opening or shutting a plant. For companies already geared towards a North American market, but with fewer export sales than they'd like, it's simply a matter of expanding. Du Pont Canada increased capital spending last year by 50% to boost capacity at five Ontario plants. The aim is to double U.S. sales by 1991. For others, especially those multinationals with traditional branch plants in Canada, it involves reallocating production among plants, with each specializing in only a few brand lines.
A plant located across the border for cost-competitive and market-sensitive reasons behaves very differently from the classic branch plant set up just to jump a tariff wall. Instead of meekly replicating the parent company's entire product range for sale in the Canadian market, Canadian subsidiaries of multinationals such as IBM, General Electric, and Procter & Gamble are increasingly operating as more or less autonomous corporations, bidding for North American or world product mandates on strictly competitive terms with other units.
The Canadian plants of Procter & Gamble, for example, have won exclusive rights to produce three well-known product lines -- Liquid Ivory hand soap, Always Pantiliners, and Lava industrial bar soap -- for the North American market. The contracts mean an extra $55 million in annual sales and 200 jobs for the company's Canadian subsidiary. Manager of Management Systems and Distribution Tom Gove says Procter & Gamble was in the throes of a radical restructuring anyway. But originally rationalization was intended for the company's U.S. plants only. The free trade agreement helped convince head office to convert that process into a continental exercise. "It was an added incentive," Gove says, "an attitude change, really." While the Canadian plants have emerged as winners, the reallocation of brands is a bonus for both sides. Specialization "drives the waste out of both systems," he says.
There are plenty of reasons to locate in Canada, even at an 86-cent dollar. Wage rates are typically 10-15% higher in the U.S.; on top of that, Canada's socialized health and pension plans reduce the costs of fringe benefits. Yet the workforce is at least as well-educated as that in the U.S. Prices for energy and land are lower. The country has excellent financial, transportation, and telecommunications support structures. Accounting practices are broadly similar to those in the U.S. And little is sacrificed in transportation costs for serving the U.S. market: more than 151 million people live within one trucking day of the border.
Paradoxically, the short production runs which have traditionally made Canadian manufacturing uncompetitive may prove to be their area of comparative advantage in the new era. The ability to manufacture efficiently in small quantities is taking on new importance in an age when economies of scale matter less than adaptability and niche marketing. Instead of making mass consumption goods for a small market, Canadian plants will in many cases make specialty or innovative products for a continental or global market: same scale of production, different products. In other cases, where economies of scale dictate, they will indeed gear up to longer runs of fewer products. The point is, firms will be able to choose how to arrange their production facilities within North America based on economics, rather than politics.
Certainly this was the experience following implementation of the Canada-U.S. Automotive Products agreement, commonly known as the Auto Pact, in 1965 (the pact has been incorporated into the FTA, with additions). The agreement provided for tariff-free trade in original autos and parts, provided the Big Three met Canadian production and local content quotas. Canada needn't have worried: the industry has in every year but one exceeded these requirements by wide margins. Investment, employment and output in Canada soared, as the auto manufacturers took advantage of lower labor and materials costs in Canada to engage in a massive rationalization of production for the suddenly unified North American market. Canadian plants had previously produced some of everything. General Motors of Canada manager of public relations Nick Hall recalls, "it was dogs and cats, a few of this, a few of that: Buicks, Oldsmobiles, everything." With the tariffs gone, GM built three new plants in Windsor, Oshawa, and Ste. Therese, Que., while other plants were expanded, modernized, and specialized. Cross border trade in autos and parts, negligible under the 17.5% tariff, increased 20 times over in just four years. It now accounts for one-third of all trade between the two countries
The Auto Pact is a reminder that this is not the first time the two nations have struck a deal on free trade. The issue has dominated Canadian history, returning again and again. Confederation itself, the 1867 union of the colonies of British North America which marks the birth of modern Canada, was in part a response to American abrogation the year before of the "reciprocity" treaty then in existence. Several attempts were made to negotiate a new treaty in the late 19th century, both before and after the high-tariff National Policy was enacted -- originally as a bargaining tactic. That policy attracted its own constituency, however, so that by the time the U.S. was interested enough to sign a new agreement in 1911, the government that negotiated the deal was unable to carry the issue at the polls.
From then on no further attempts were made, at least in public (a deal was negotiated secretly in 1948, but was scrapped). Instead, trade barriers were lowered gradually. Canadian tariffs fell, slowly but steadily, from about 30% on average in 1945 to about 9% by the mid-1980s. Several events conspired to make this steady progress insufficient. For one, the protectionist danger in the U.S. Congress was growing. While tariffs were falling, non-tariff barriers, especially the "contingent protection" of trade remedy actions, were on the rise. The GATT seemed an ineffective way to maintain Canadian access to U.S. markets, much less to make any further progress. As it was, locked into the small domestic market by the very domestic tariff that was supposed to keep foreign competitors out, Canadian manufacturing productivity, at 85% of U.S. levels, had not only stopped catching up, but was starting to fall back.
Meanwhile, the political credibility of free trade was growing, on the strength of several official and private reports advocating a bilateral trade deal, culminating in the mammoth 1985 Royal Commission on the Economy chaired by former finance minister Donald Macdonald. Canadians were by that time receptive to the worldwide trend toward free markets, and were less fearful of foreign investment -- partly as a result of the Trudeau government's disastrous adventures in economic nationalism in the 1970s and 1980s, and partly because foreign ownership of the Canadian economy had declined markedly, from a high of 37% of non-financial assets in 1970 to 23% in 1986.
Most important, the Canadian business community, which had in earlier times supported protectionism, realized they had come to the end of the road with this strategy in the age of globalization, preferring the opportunity to develop new markets to the shaky security of their own. Their almost unanimous support was critical in the new Conservative government's decision in 1985 to seek negotiations with the U.S. administration. So was the rise of bilateralism and trade blocs around the world as an alternative to the GATT process. There are more than a dozen free trade agreements now in existence, involving 72 nations, including the European Community, the European Free Trade Association, and the Australia-New Zealand Free Trade Association.
Nonetheless, Canadian nationalists remained a potent political force, and despite the public's basic receptiveness to the logic of free trade, the emotions that feed nationalism -- fear, hatred, envy -- were almost enough to undo in three weeks what had taken three arduous years to negotiate. The 1988 election was one of the wildest, fiercest campaigns in Canadian history, with opponents warning the agreement heralded the annexation of Canada, or at the very least its redrawing into a caricature U.S. Still, whether because of or in spite of free trade, the Conservatives were re-elected. The election seems to have cathartized the issue: polls since show free trade ranks at the bottom of public concerns. Even if the Conservatives should lose the next election, as now seems likely, the rival Liberals are almost certain not to seek to abrogate the treaty, despite their passionate rhetoric to the contrary in the last campaign.