Stephen Gordon: Whatever Trump Metes Out, Canada Will Have to Stomach

 

Pierre Trudeau once described the Canadian relationship with the United States as “like sleeping with an elephant. No matter how friendly and even-tempered the beast … one is affected by every twitch and grunt.” It is now Prime Minister Justin Trudeau’s bad luck – and ours – to be bunking down with a surly and irascible elephant.

It’s worth dwelling on just how asymmetric the economic relationship is between Canada and the United States. It’s sometimes pointed out that Canada is the largest market for U.S. exports, and that’s true as far as it goes. But U.S. dependence on the Canadian export market is an order of magnitude smaller than Canadian dependence on exports to the U.S. Exports of goods and services to the U.S. accounted for 22.8 per cent of Canadian GDP in 2015; U.S. exports to Canada were only 1.9 per cent of U.S. GDP.

There’s not much that could or should have been done to reduce this dependence on the U.S. market. All the factors that determine the volume of trade flows — physical proximity, market size, linguistic and cultural ties, similar legal systems and so forth — all point to the U.S. It’s always been a good idea to promote trade links with other countries, but the U.S. would still be our dominant export market even in a world in which the Comprehensive Economic and Trade Agreement and the Trans-Pacific Partnership were already in place.

So it really doesn’t make sense to think that a Canadian Prime Minister can “stand up” and “fight back” against U.S. sanctions, or that Canada’s bargaining position would be somehow strengthened if another person were running the government. The trade numbers would still be the same.

At this point, the obvious strategy is to try to avoid being hit with sanctions in the first place. Canadian governments, politicians and lobby groups have established an enviable network of contacts throughout Washington, and they’ve already begun working on shielding Canada from the worst of Trump’s protectionist agenda. At the industry level, Canadians are already making the point that that Canada-U.S. production chains are highly integrated, and that disrupting them it would be costly for both sides.

It would be correct to point out to President Trump that his obsession with bilateral trade deficits is misguided, or that his plan to increase the government deficit while simultaneously reducing the trade deficit contradicts the basic rules of national accounting. Correct, but unhelpful: Trump is not going to change his position at this point. In order to persuade Trump, Canada is going to have to use Trump’s logic.

Happily, recent trade data provide Canadian negotiators with the material for a narrative that more-or-less fits into Trump’s view of how international trade should work. For one thing, the current account between the U.S. and Canada is roughly balanced: the small Canadian surplus in the goods and services account is offset by a small U.S. surplus in the investment income account. This bilateral balance with the U.S. is something of a coincidence, but Canadian negotiators can fairly say that Canada and the U.S. are in the same situation: roughly balanced trade with each other, and a deficit with the rest of the world.

Even better, Trump’s focus on trade in manufactured goods makes it easier for Canada to make its case. While the U.S. runs a deficit in manufactured good with countries such as China and Mexico, it exports more manufactures to Canada than it imports in return. Where the U.S. does run a deficit with Canada is in natural resources. A narrative in which the U.S. exports manufactured goods to Canada and imports oil in return is a fair representation of current trade patterns. If Trump’s approval of the Keystone XL pipeline can be interpreted as a sign that he doesn’t object to importing oil from Canada, then Trudeau may have a story to tell that might win Trump’s favour.

At this point, the best-case scenario is that Canada is able to convince the new administration that Canada-U.S. trade already fits the pattern that Trump wants to see, and to win an exemption from protectionist measures. But what if it doesn’t work? What if (say) an across-the-board 10 per cent tax on imports to the United States is brought in, and what if Canada does not succeed in obtaining an exemption?

A recent study by Dan Ciuriak and Jingliang published by the C.D. Howe Institute finds that such a measure would reduce Canadian welfare by 1.86 per cent. The effect on U.S. welfare is also negative, but only slightly. Since the U.S. economy is so large, it has enough market power to force other countries to shoulder some of the burden of the import tax.

At this point, the instinctive reaction would be for Canada to retaliate in kind: this response is probably what most Canadians have in mind when they exhort Trudeau to “stand up” to Trump. It would also be stupid: retaliating in kind would amplify the effect on Canadian welfare from a loss of 1.86 per cent to one of 2.57 per cent, and hardly affect the U.S. The original U.S. import tax would introduce a welfare-reducing wedge between the prices for Canadian imports and exports; adding a Canadian import tax on top of that would only widen it.

This is where we are right now. Our best-case scenario is that Canadians are able to persuade Trump – using the logic of his own, idiosyncratic worldview – to leave Canada alone. Our next-best-case scenario is to simply take whatever hit Trump sees fit to inflict on us.

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