Despite concerns on NAFTA’s future, Ottawa should be wary of pushing for trade diversification with China, writes Duanjie Chen.

By Duanjie Chen, Feb. 15, 2018

Canada has often been stereotyped for its “reliance” on the US economy. Even some decades ago in China, my Harvard-trained economics professor told us an old joke: when America sneezes, Canada catches cold. That joke has long stuck with me, due not least to its humorous medical analogy to disease contagiousness.

But in today’s reality, isn’t it true that when America (or to a lesser degree China) sneezes, the whole world catches cold? And because of America’s economic size and diversity, and its free-market system, who doesn't envy our geographic proximity to the United States and the attendant economic benefits that cannot be matched by any other country farther away? Between that old joke and today’s reality, there is a natural linkage, both geographically and historically, between economic regionalization and globalization.

Because we have grown so accustomed to smooth sailing with our American sibling, however, we easily panic when conditions south of the border go sideways. In addition to the usual economic downturns, recent examples of such troubling developments include the repeated fallout of the Keystone pipeline project under the Obama administration and the current worrisome NAFTA renegotiations forced upon by President Trump.

These are the times when the age-old call for using policy to diversify Canada’s trade sound more natural, or at least harmless. But the current rhetoric of using China as a counterweight to the Trump administration at the NAFTA renegotiation table has gone too far. It becomes imperative for us to defuse the myth of our urgent need for trade diversification.

The current rhetoric of using China as a counterweight to the Trump administration at the NAFTA renegotiation table has gone too far.

In other words, our political leaders need to think logically and speak by the facts.

Fact One: Our close economic ties with America are rooted in our geographic proximity and supported by our shared belief in free-market capitalism, the rule of law, and democratic institutions. This is a blessing rather than curse, since our economic relationship with America is a perfect combination of being “godsend” and “man-made.” Imagine for a moment that we were far away from the US, let’s say across the Atlantic Ocean or even the Indian Ocean. And what if we shared a border with a centralized authoritarian regime that did not afford us an equal say at the negotiation table?  Would we really be rejoicing at our good fortune? Or would we be alarmed by our proximity to a (not-so) good neighbour with which we share little in terms of values or beliefs?

Fact Two: Canada is not an outlier in terms of its trade diversification, if the concentration of its exports is measured at the regional rather than the country level, as argued by two trade economists, Beaulieu and Song. More specifically, they pointed out the following:

  • World trade is extremely regional in nature, with each region trading at least 50 percent within its own boundaries. Geographic trade patterns are determined by the size and proximity of trading partners.
  • In terms of its concentration of trade on a regional level, Canada (within the North American region) is even less concentrated than Australia (within the Asian region) and more diversified than many EU member states including Belgium, Netherlands, Austria, Norway, and Luxemburg.
  • It is Canadian firms – and not governments – that undertake exports and imports. In that sense, the “all your eggs in one basket” argument is fallacious. Aggregate trade patterns reflect the decisions of thousands of firms and markets involving millions of people and are not conducted by countries. (See below for the obvious outlier on this point.)

Of course, the authors who arrived at these findings never meant to be anti-diversification, but they do say that Canada does not have a concentration problem. Policy initiatives may help, but only the decisions made by firms and consumers can lead to the substantial of trade, including trade diversification.

Fact Three: According to the latest report by Statistics Canada, our Canadian exports to the US were not concentrated in any specific state but were rather distributed across US states in a relatively uniform manner.

The implication of this fact is clear. Given the size and diversity of the American economy and the democratic topography of its state governorships, it is safe to predict that neither Mr. Trump nor any individual state could singlehandedly change the orientation of our trading structure with the fifty states. This prediction will be valid even if NAFTA renegotiations proceed along a longer and bumpier road than we would prefer.

Fact Four: The true outlier in the world of free trade is China.

As pointed out recently by David Lipton, the IMF’s deputy managing director, “China should be open to look at its own restrictions on trade and investment, which have generated criticism from some trading partners. It also means protecting intellectual property rights and reducing the distortions of industrial policy, overcapacity, and policies that favor state enterprises.”

It is therefore absurd to promote China as a counterweight to any of our rule-abiding trade partners.

Lipton went further at Davos to urge the rest of the world to listen to the “legitimate” US complaints of “distortive” or “unfair” Chinese trade practices. Despite Trump’s bombshell hurled into the international trading community, the rest of the world knows full well that only China is the intentional and systematic rule breaker.

It is therefore absurd to promote China as a counterweight to any of our rule-abiding trade partners.

Fact Five: Unlike China, politicians in both Canada and the US act in their perceived constituency’s interests, and all of them can be voted out of office if their constituents disapprove of the way they handle or mishandle critical issues. This means that Trump’s isolationist rhetoric and unpresidential mentality should not shake our confidence in America as our trustworthy and leading trade partner.

More specifically, Trump’s performance on the Trans-Pacific Partnership (TPP) stands out. He pulled the US out of the TPP on the first day he entered the White House and then announced his possible accession to it a year later at Davos, perhaps after doing some reluctant soul-searching.  Did not our Prime Minister Trudeau similarly disappoint and then rejoin with our other 10 TPP partners, albeit to a much lesser degree?

But that is democracy: In the free world, politicians are actors in a democratic theatre, and their audiences are always in disagreement but are normally versed in reasoning and persuasion. Trump, like Trudeau, has had to listen to his audience. If they don’t, the electorate will let them know who is in the majority.

On NAFTA, therefore, we should not be overly worried because, in addition to the staunch defense of it by both Canada and Mexico, Americans from all walks of trade have been speaking up against Trump’s misconceptions. A recent academic estimate also put the annual cost to America for leaving NAFTA at $50 billion. Trump the Business Man will not ignore that sum!

To conclude, let us look at the numbers:

Over the past two decades (1998 – 2017), despite the steady growth in the volume of our exports to the US by over 50 percent, the US share in our total exports has dropped by 7.5 percentage points (ppt), from 82.3 percent to 74.8 percent. This drop in the US share was more than offset by the total share increment among our other major exporting destinations: the EU region (up 2-ppt to 7.9 percent), China (up 3.7-ppt to 4.5 percent), Mexico (up 0.8-ppt to 1.7 percent), India (up 0.7-ppt to 0.8 percent), and the rest of the world (1-ppt, from almost nothing).

This is quite an achievement in terms of Canada’s trade diversification. Of course, we should strive for greater trade expansion through deepening existing trade ties and exploring new ones. But lunging at the age-old siren call for trade diversification as an emergency counterweight to Trump and his antics – and doing so with a focus on expanding ties with the fundamentally protectionist China – is illogical, misconceived, and perilous.

Duanjie Chen is a Munk Senior Fellow at the Macdonald-Laurier Institute.