Canada has to move towards the new centre of gravity both in terms of geography and technology, writes Dan Ciuriak.

By Dan Ciuriak, March 1, 2021

Global trade is being reshaped by powerful secular trends, geopolitical tensions, and major trade and investment policy departures. These are restoring the premiership of the pre-modern trade routes that linked the Afro-Eurasian world island while relegating the North Atlantic trade system to the second division.

While this upends the traditional perspective of Canada being close to the centre of gravity of global trade, the concurrent digital transformation is shifting commercial activity into the digital and digitally-enabled modes where distance is not so much an issue, but technological capabilities and the geopolitics of the data-driven economy are. Navigating the cross-currents of these contradictory trends represents probably the first truly complex foreign-economic policy challenge that Canada has faced as a nation-state.

This article focuses on the strategic implications for Canada of these parallel trends and underscores two risks – the shifting economic geographical tectonic plates and the accelerating digital transformation change the value of legacy economic assets and drive dynamic changes in comparative advantage.

Economic geography

Historically, Canada has swivelled between continentalism (with the United States), imperialism (with the British empire), searching at times for third options when it struck out with both of its mainstays, and embracing multilateralism – the rules-based framework under the World Trade Organization (WTO), in which goods are “made in the world” by “global value chains.” The last is the option of choice for a small, open economy.

Conventionally, we think of Canada as being in the centre of gravity of the global trading system. As parties to the Canada-US-Mexico Agreement (CUSMA), the Canada-EU Comprehensive Economic and Trade Agreement (CETA) and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), Canada has modern deep and comprehensive trade agreements with the major economies immediately to the south, east and west.

That sense of comfort has been shaken by several factors. First, there is the inward turn that the United States has taken. The Trump administration weaponized interdependence to advance an America First agenda, targeted Canada with Section 232 “national security” tariffs, pushed through a revision of the North American Free Trade Agreement designed to “rebalance” the terms in its favour, and adopted a more restrictive Buy American procurement policy that further militated against Canadian participation in the US economy. The Biden administration, preoccupied with domestic priorities, has left its predecessor’s trade policy in place, and indeed doubled down on the Buy American provisions.

Second, Brexit splinters Canada’s relationship with Europe, leaving both the UK and the remaining EU27 economically weaker as a result. The UK, which was Canada’s largest partner in the EU, is looking west to the United States and east to the Pacific; if successful in negotiating a free trade agreement (FTA) with the United States, that would dilute the value of Canada’s existing preferential access to both the UK and US markets. Canada would be scrambling to turn that into a trilateral agreement (as was the case when the United States and Mexico opened trade negotiations towards a bilateral FTA).

The EU27, meanwhile, is increasingly looking East – for energy (Nordstream II gas pipeline from Russia) and growth (through the EU-China Comprehensive Agreement on Investment), while adopting a “strategic autonomy” stance. These add to the burdens that have been heaped on the EU-US relationship in the last half-decade, such as the stalling of the Transatlantic Trade and Investment Partnership (TTIP) negotiations, four years of relentless attacks by the Trump administration on the EU, trade war over civilian aircraft, differences in the digital domain over cross-border flows of data and the taxation of digital platforms, and frictions over extra-territorial sanctions applied by the United States that erode EU autonomy. For Canada, the prospects of having the CETA dock with a much larger TTIP have receded.

Third, Japan, which anchors the CPTPP, is drawn west and south for production links and markets through the Regional Comprehensive Economic Partnership (RCEP), which includes China and Korea, and  deepens its existing trade arrangements with the Association of Southeast Asian Nations (ASEAN). The introduction of regional rules of origin for accessing the RCEP tariff preferences reinforces the regional supply webs centred on Northeast Asia.

Meanwhile, Canada does not have trade agreements with the three large-population, high-growth economies in the Indo-Pacific: China, India, and ASEAN. With regard to India, Canada has had longstanding but fruitless (to date) negotiations towards a bilateral FTA and now faces a rising economic nationalism in India (boosted by the pandemic and the sharp deterioration of relations between India and China). With regard to ASEAN, the possibility of an FTA has been mooted but obviously, this requires a lot of heavy lifting.

While the Indo-Pacific framing has had more concrete development in terms of geopolitics as opposed to economics (and indeed was weakened in the latter regard by India exiting the RCEP), it complements in the maritime sphere the larger idea of the Afro-Eurasian trading system, which is being refurbished by the natural dynamics of economic geography and the visible hand of the Belt and Road Initiative (BRI) pursued by China. In economic geography terms, the economic tectonic plates are moving – and Canada is starting to look distant from the world’s centre of gravity.

The digital transformation

Canada’s existing trade agreements were optimized for the knowledge-based economy of the late 1900s and early 2000s. This economy featured highly competitive markets for industrial goods and value capture mainly in the intangible assets at the front end of the value chain (research and development, patents) and at the marketing end of the chain (branding etc.). While Canada participated in the technology-driven economic boom of the period, it ended this era with the collapse of its innovation sector in the Great Financial Crisis (GFC) of 2008-2009. This historic collapse saw the technology share of Canada’s equity markets essentially wiped out, including the demise of Nortel Networks.

Coming out of the GFC, the technological basis was in place for a new economic era – that of the data-driven economy. This transition was the result of several key technological breakthroughs in the 2000s: the development of “deep learning” techniques based on stacked neural networks by Geoffrey Hinton in 2006; the application of parallel processing computer chips to neural networks by Stanford’s Andrew Ng in 2009; and the steep acceleration in data generation with the advent of the mobile era. These breakthroughs combined to power rapid advances in machine learning and the commercial application of artificial intelligence (AI).

The digital transformation is now moving very rapidly, accelerated by the pandemic. What does this mean for Canada? In the first instance, there are plenty of risks but also opportunities.

First, there are no oceans or littorals in cyber space and Canada is not necessarily so distant from this new Afro-Eurasian/Indo-Pacific system. That is a positive feature for Canada.

Second, Canada has a number of strengths, including an established position in the nexus of AI, machine learning and big data. Canada’s big weakness has been scaling up its many promising start-ups – this, however, can be corrected by policy. Moreover, Canada has been a prominent contributor to the development of the policy framework for the data-driven economy. And it has a tradition of good governance and trust. In digital space, Canada has growth opportunities that are for all intents and purposes unbounded.  The trade agreement that may be most critical for Canada, in this regard, is the Digital Economic Partnership Agreement (DEPA). There are, however, major issues to be addressed in keeping the flow of data going – free flow with trust, as outlined in the G20 proposal developed in Japan’s time as G20 chair, is threatened by national security and sovereignty concerns. The DEPA is very thin at this stage in developing the new language that will update trade agreements for the data driven economy.

Third, the digital economy is a world of superstar firms. These are concentrated now in North East Asia – China, Japan, Korea and Taiwan between them have hundreds of Fortune 500 companies. These firms draw energy and scale from the integrated North East Asian economy.  As noted, RCEP will work to further deepen these networks. Canada has only one significant entry of note: Shopify, which is making great strides as the pandemic raises demands for its services in building virtual companies. However, technological decoupling and the more general trend toward technological “sovereignty” may constrain Canada’s ability to build on this foothold in the digital economy of the future.

Fourth, the infrastructure that shapes international connectivity in digital space is undersea cables and satellites. These systems are subject to fragmentation along security lines. For example, the US has its GPS, China its BaiDou, and Europe its Galileo satellite network. There are some 400 undersea cables; these have been laid by a range of state and private actors such as Facebook and Google. With the outbreak of the technology conflict between the United States and China, the latter’s main cable suppliers – Huawei and ZTE – are being excluded from laying cables connecting US security allies. Canada appears to be largely absent from this activity as it lacks production capacity in the hardware of the digital economy (how things might have been otherwise with Nortel in place!). Accordingly, Canada must focus on the soft infrastructure of the data-driven economy.

Whither Canada in an Indo-Pacific world?

Wayne Gretzky famously said that the secret to his success was to move to where the puck was going. In economic terms, the world is moving and Canada has to move towards the new centre of gravity both in terms of geography and technology. I offer three concrete suggestions in this regard.

First, Canada must re-visualize how it fits in the world. This will be no easy task since both of Canada’s traditional international policy anchors – the United States and the United Kingdom – are unmoored in terms of their relationships with the other major powers, the EU and China. Both allies are not at all clear about how their relationship with the Indo-Pacific will develop.

Second, Canada should pursue an FTA with ASEAN. As smaller trade-dependent economies playing in a world of giants, ASEAN and Canada have similar interests in maintaining a smoothly functioning multilateral system, open supply lines, and minimal disruption of cross-border flows of medical and other critical goods. The engagement in negotiations would strengthen the hand of both.

Third, Canada entered the pandemic with one of the best fiscal positions among the major economies. While that position has been badly damaged by the downturn, Canada will still exit the pandemic in better shape than most to invest in its digital future. The data-driven economy is built on an economic asset with strong public good characteristics – and plenty of potential for public bad. The role of the state expands in this context and Canada must be prepared to step up.

Dan Ciuriak is Director and Principal, Ciuriak Consulting Inc. (Ottawa), Senior Fellow with the Centre for International Governance Innovation (Waterloo), Fellow-in-Residence with the C.D. Howe Institute (Toronto), Distinguished Fellow with the Asia Pacific Foundation of Canada (Vancouver), and Associate with BKP Development Research & Consulting GmbH (Munich).

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