North American Convergence: An American Perspective

Remarks at the annual policy conference of the Canadian Association for Business Economics
Washington, DC

March 30, 2001


The Facts of Globalization

  • The evidence is overwhelming that higher trade/GDP ratios, and higher foreign direct investment/GDP ratios raise income. Evidence is mounting that an open economy has a lower non-accelerating-inflation rate of unemployment (NAIRU). The gains from globalization are so large that all countries-especially the United States-can afford a far more generous safety net for losers (e.g., "wage insurance"). See "Globalization: Facts & Consequences".

  • Facts are one thing, sentiments are another. Public sentiment toward globalization ranges from skeptical to hostile.


American Sentiments

  • A recent survey shows that most Americans do not oppose globalization. But they worry about the distribution of costs and benefits. When it comes to growing economic integration, the biggest concerns of Americans are the effects of increased trade on American workers (lost jobs and lower wages) and the environment.

  • At the same time, most Americans do not identify rising living standards with increased trade and investment flows. Unlike Canadians and Mexicans, they do not see economic integration as a growth engine. These two factors explain the difficulty of launching new trade initiatives.

  • These attitudes apply also to the way Americans feel about the North American Free Trade Agreement (NAFTA). A majority of Americans feel that overall the agreement has benefited the United States but increased the income gap, benefited mostly American corporations, cost American jobs, and put downward pressure on US wages.

  • Americans believe that Mexico, far more than Canada, is to blame for the ill effects. In fact, in a Los Angeles Times poll 52 percent of Americans said that the "free trade agreement between Mexico and the United States"-not Canada-"had taken away jobs from the American people." The fact that the US trade deficit with Canada is more than double that with Mexico is unknown and ignored.

  • Americans identify the evils of trade with less developed countries and focus their anti-globalization rhetoric on China rather than Japan, and on Mexico rather than Canada.

US-Canada Economic Integration

  • When Americans think of Canada they do not see a competitor but a partner. Why? Because economically and technologically Canada developed parallel with the United States, and the two countries closely resemble each other in their economic systems, patterns of production, and living standards.

  • The degree of integration and interdependence between Canada and the United States is best illustrated by numbers:

  1. Annual border crossings = 200 million

  2. Percent of Canadians living within 100 miles of the US border = 90 percent

  3. US-Canada trade in 2000 = Over US$400 billion

  4. Percent of Canadian trade involving the United States = 80 percent

  5. Percent of US trade involving Canada = 20 percent

  6. Cross-border foreign direct investment = About US$200 billion


Trade Disputes

  • Considering the level of integration, the existence of friction and disagreement is natural. Numerous disputes have been addressed under the NAFTA (and the previous Canada-US Free Trade Agreement [CUSFTA]) and the World Trade Organization. However, the share of total trade affected by dispute cases is not very significant. Most of the disputes challenge countervailing duties (CVD) and antidumping (AD) measures: the dispute mechanism in Chapter 19 of the CUSFTA and the NAFTA allows private parties to have AD-CVD cases reviewed by binational (trinational for NAFTA) panels instead of by the courts.

  • Between 1989 and 1994, there were a total of 57 disputes under Chapter 18 (5 cases) and Chapter 19 (52 cases) of the CUSFTA. The Chapter 19 (AD-CVD) disputes affected around US$ 7 billion in trade (the lumber dispute accounted for almost US$ 6 billion). On average during this period, the United States and Canada traded US$ 185 billion annually. Therefore, disputes affected less than 4 percent of two-way trade.

  • Under the NAFTA, between January 1994 and 2001, there were a total of 96 disputes (including Mexico) under Chapter 11 (12 cases), Chapter 19 (80 cases), and Chapter 20 (4 cases) of the NAFTA. The Chapter 19 dispute cases involving Canada and the United States between 1994 and 1999 affected US$ 11 billion in trade out of an average annual trade of over US$ 303 billion-again under 4 percent of total trade.

  • When the softwood lumber case is finally resolved, the caseload of disputes will probably drop below 1 percent of total trade.


North American Convergence?

  • When negotiations for a Canada-US Free Trade Agreement started in 1985, trade between these two countries was US$ 116 billion. Exchange between Canada and the United States reached US$ 408 billion in 2000. A conservative estimate is that permanent GDP gains are at least 25 percent of incremental trade.

  • Investment as well as goods flow freely across the US-Canadian border. In 1999, Canadian direct investment in the United States reached US$ 80 billion (over 8 percent of total FDI in the United States). At the same time, almost 10 percent of total US investment abroad was in Canada (US$ 112 billion). Conservatively, a 1 percent increase in the ratio of FDI to GDP increases GDP by 0.3 percent.

  • Trade and investment are mechanisms for transmission of information and technology, and income convergence. An advanced degree of economic integration is evident in some sectors already; the North American automotive industry, for instance, operates as it would in the absence of national boundaries.

  • In the last five years, output per hour in the US business sector has grown at 2.7 percent. Due to the strong links between Canada and the United States, forces that produced such acceleration in US productivity (IT innovation and adoption by user industries) are now beginning to show in Canada. The integration trend is likely to continue as globalization forces countries to team up to compete in world markets.

  • That said, integration has a long way to go. In terms of trade density, we have come from John McCallum's famous 20-to-1 ratio to perhaps 10-to-1. In terms of price divergence, the US/Canada border is still the equivalent of 100 million miles of distance!

  • If deeper integration is to be fostered by policy (in addition to market forces), Canada will have to take the initiative. Eliminating rules of origin and freeing agricultural trade would be good short-term objectives. But the agenda will have to move beyond trade ministries to bilateral negotiations (and cooperation) between other ministries-both at the federal and provincial/state level. Transportation is a good place to start. Health systems should pay for care in the other country. Consolidated corporate tax returns should be possible. Common environmental and pharmaceutical standards should be on the agenda. On a low-key basis, Canada should have a nonvoting representative attending Fed meetings and vice-versa.

  • That said, we should avoid any attempt to build an institutional superstructure. NAFTA is not the European Union. The boldest attempt to build institutions within NAFTA-those on the environment-have not been a stunning success (see Hufbauer, et al, NAFTA and the Environment, 2000). New institutions will only set off a round of turf battles with existing bureaucracies.


The Softwood Lumber Agreement (SLA)

Entered into force in 1996

Expires March 31, 2001

Dispute dates back to 1992. A Chapter 19 arbitration panel was requested in May 1992 after a USITC countervailing duty determination. The arbitration panel invalidated the CVD order in August 1994. The United States requested an Extraordinary Challenge Committee (ECC) to review the panel's decision; the ECC affirmed the panel's decision.

1994 imports of softwood lumber from Canada = US$ 6 billion.

SLA imposes fees on imports in excess of 14.7 billion board feet, restricting Canadian share of the US market to 34 percent when it could be significantly higher.

CATO estimated these trade restrictions add US$50-80 per thousand board feet to the price of lumber. The method of estimation probably overstates their effect.

In any event, Canada is not interested in renewing an SLA type of agreement and is prepared to fight another subsidy case in the United States.

The Canadian government has proposed an "eminent persons" panel to study the dispute and make nonbinding recommendations. Their proposed deadline for this panel to conclude its work is 31 May 31 2001. The United States has not yet accepted the proposal.

US industry favors a solution that shifts from restrictions on volume to an approach focused directly on keeping prices up.

US Trade Representative Robert Zoellick has signaled he would support negotiating an export tax to restrict softwood lumber from Canada, but only after the US Commerce Department has made a finding in AD and CVD cases brought by US industry.

Like trade disputes in many other industries (autos, semiconductors, civil aviation), this one will be ultimately "settled" through cross-border investment and industrial consolidation. Forestry policies that give high priority to the environment can help-if they are implemented through a transparent fee structure.