Will CETA Help Tories…Or Hurt Them?

June 18, 2013

With Prime Minister Harper making the diplomatic rounds in Europe, media interest has heightened this week regarding the potential free trade agreement which his government is trying to negotiate with the European Union. Several deadlines to reach that deal have come and gone, but the Conservatives are still heavily committed to reaching a deal as a centrepiece of their economic strategy. The more politically desperate they become to reach a deal, the greater the likelihood of damaging concessions (in areas like foreign takeovers, drug patents, and others).

The Globe and Mail’s John Ibbitson went so far as to conclude that failure to reach an EU deal would actually cost the Conservatives the next election (“Harper’s re-election chances may hinge on trade deal with Europe,” June 10). If that surprising statement is true, it’s only because of the hype that has been created around CETA – and certainly not because of its real-world economic effects. If enough politicians and journalists state gravely that reaching a CETA is crucial to our economic future, then perhaps enough Canadian voters could be convinced and vote accordingly.

But in reality, there is no conceivable way that a CETA, even under the most optimistic of assumptions, could generate any measurable improvement in Canadians’ concrete economic well-being before the next election. More likely, of course, the economic effects of CETA for Canadians will be negative (see my study Out of Equilibrium published by the Canadian Centre for Policy Alternatives, for a detailed review of the economic risks of the proposed deal). But even under the government’s own optimistic projections, the economic impacts would be impossible to measure before Canadians next head to the ballot box.

According to a joint Canada-EU study published in 2008, a bilateral trade deal would provide a one-time boost to Canada’s GDP of about $12 billion, or about two-thirds of one percentage point. (I have criticized that estimate in other work.) That increment would be experienced gradually over a multi-year period (since it requires several years for the deal itself to be phased in, and several more for its effects to be fully felt in the economy). In economic modeling of trade deals, analysts typically assume it takes at least a decade for the effects of a change in trade policy to be fully incorporated into investment, production, employment, and trade outcomes. So even under the rose-coloured assumptions utilized by the government study, therefore (including continuous full employment, no impact from exchange rate adjustments, and no outflows of capital investment), the economic effects of CETA would be impossible to measure, let alone become a significant factor in an election campaign.

Without those unrealistic assumptions, moreover, the effects of CETA are likely to be negative. My simulations for the CCPA predicted a loss in Canadian employment (mostly in the manufacturing sector) of up to 150,000 jobs. We learned in the aftermath of the Canada-U.S. free trade deal in 1989 that the downside of trade (plant closures) is experienced a lot more quickly than the potential upside (incremental export opportunities for the companies that remain). In that case, implementing a CETA (if the resulting job losses are indeed significant) would do more harm than good to the Conservatives’ re-election chances – the exact opposite of Mr. Ibbitson’s judgment. (Despite that, I am still hoping that no deal is reached!)

In response to media inquiries this week regarding the likely effects of a CETA on Canada’s auto industry and other key sectors, I dug out the most recent data on bilateral trade flows between Canada and the EU. They confirm my earlier suspicion that a CETA will make our existing lopsided trade relationship with Europe even worse – both quantitatively and qualitatively. And there are a few surprises lurking in the latest numbers, too.

Here are my findings; most of the data come from Industry Canada’s helpful Strategis on-line database, while data on services trade come from Statistics Canada (CANSIM Table 376-0036). In addition, the last half of this commentary goes into more detail on the impact of the proposed CETA on the Canadian auto industry:

Continuing Bilateral Trade Deficit: Canada imports far more from Europe than we export there, producing a large and chronic trade deficit. Eliminating tariffs and liberalizing trade on both sides will make that deficit bigger, not smaller, for two reasons: European sellers already have a larger platform in our market (from which they can expand their sales more successfully after tariffs are eliminated), and Canada will actually be cutting tariffs more than the Europeans (since our tariffs, on a trade-weighted average basis, are about half-again as high as the EU’s tariffs). Our total merchandise trade deficit in 2012 was just under $12 billion. That’s somewhat smaller than in previous years, but for a surprising reason: gold exports (discussed further below).

Trade Deficit in Services, Too: The quantitative imbalance in bilateral trade extends to services, too – like transportation, business services, and tourism. Canada’s bilateral services deficit with the EU in 2010 (most recent year available) was $4.5 billion, the biggest ever. The impact of the over-valued Canadian dollar on our relative costs is clearly a factor here, as is the continuing economic turmoil in Europe (which has cut deeply into outbound EU tourism). Combining goods and services, therefore, our bilateral trade represents a drain on net demand in Canada of over $15 billion per year. Our overall current account position with the EU is even worse (once we include net outflows of investment income). The EU thus likely accounts for about one-third of Canada’s growing current account deficit (which reached a record $62 billion last year). Especially during times of unemployment, trade deficits represent a direct drain on domestic employment and income (contrary to the assumptions of free-market trade models … which assume, don’t forget, that unemployment never exists!).

Qualitative Imbalance in the Composition of Trade: In 2012, manufactured goods accounted for 94 percent of all EU sales to Canada. And as we know, European exporters specialize in higher-technology, more expensive niches in manufacturing. In contrast, manufactures account for only 50 percent of Canada’s exports to Europe. Our exports are thus far more concentrated in natural resource and agricultural industries. This is a problem for several reasons. First, EU tariffs on imported raw materials (other than agricultural products) tend to be very low (for obvious reasons), so there will be little benefit to our resource industries from a trade deal. Second, our trade balance will be very sensitive to fluctuations in commodity prices. When prices come down (and where commodities are concerned, this is inevitable), then our existing deficit with Europe will become much larger.

Lopsided Manufacturing Trade: Canada imported $47.4 billion worth of manufactures from the EU in 2012, but only exported $19.7 billion worth. The resulting bilateral trade deficit in manufactures (of almost $28 billion) was the highest in our history. And that imbalance is getting worse, not better. In the last five years (since 2007, through the financial crisis and resulting recession and stagnation), our manufactured exports to the EU declined by 21 percent – while our manufactured imports from Europe grew by over 10 percent. That’s not surprising, given terrible demand conditions within Europe, the sharp depreciation of the euro relative to our loonie, and the growing efforts by European countries to export their way out of recession. A free trade agreement won’t fix that imbalance, and more likely will exacerbate it. Canada’s status as an exporter of resources, which (even during times of high commodity prices) are not quite enough to pay for our imports of high-value manufactures, will be cemented. A good chunk of our manufacturing exports to Europe are themselves resource-based products (things like petroleum products, primary nickel, wood products, etc.). To be fair, there are also some important higher-value manufactures represented among our slate of exports to Europe, including aerospace ($2.5 billion exported in 2012), chemicals ($2.8 billion), and machinery ($2.3 billion). Those are exceptions, however, to the general pattern that defines our bilateral trade: namely, Canada sells resources, and buys back high-tech manufactures. And even in those three sectors, Canada imports more from Europe than we export there.

The Curious Role of Canada’s Gold Exports to the EU: According to the trade data, Canada’s largest export to the EU, far and away, is now gold. The Industry Canada data indicate that Canada exported $11.7 billion worth of gold to the EU in 2012 (accounting for almost 80% of our total gold exports). We import very little gold back the other way. Much of that exported gold, it appears, was actually imported from elsewhere, perhaps processed in some way in Canada, and then re-exported to Europe. (While Canadian-based companies dominate the list of the world’s largest gold-miners, Canada itself is only the 7th largest gold producer in the world; most of the Canadian firms’ major operations are in other countries. In aggregate, Canada imports a lot of gold as well as exporting it, further indicating some kind of trans-shipment trade pattern.) Our gold exports to the EU have exploded by a factor of 100 over the last decade (partly, of course, because of the soaring price of gold, but mostly because of the opening up of a brand new trade channel). This statistic raises some interesting questions. If the price of gold falls (as it surely will), then our trade imbalance with the EU will expand dramatically. And this explosion of gold exports to Europe has masked the underlying structural deterioration in our overall trade with Europe. Indeed, considering all merchandise other than gold, Canada’s trade deficit with the EU last year was $23 billion – the highest in history. So Canada is relying on a temporary surge in value of gold shipments to Europe (much of which was not even produced here) to offset a growing structural imbalance in our other bilateral trade. I would be interested in learning more about the nature of and reasons for Canada’s surging gold exports to Europe, and invite readers to contact me with ideas. (The question of gold exports to Europe was also explored by John Jacobs in another CCPA report, Straightjacket: CETA’s Constraining Effects on Ontario).

Automotive Trade – A One-Way Street: Bilateral EU-Canada trade in automotive products epitomizes, to the extreme, the quantitative and qualitative imbalance of our overall trade relationships with Europe. Canada imported $5.6 billion worth of automotive products (vehicles, parts, and bodies) from the EU in 2012. European companies (especially luxury brands like BMW, Mercedes, and Audi) have significantly expanded their market share in Canada in recent years (some of their products are imported from plants in the U.S.; the $5.6 billion figure applies only to products made in Europe). In return, Canada shipped just $269 million the other way. We import 20 times as much as we export. The resulting bilateral automotive deficit ($5.3 billion) was the worst in history. Canadian automotive exports to Europe have fallen by half in the last five years (reflecting, again, the negative impact of depressed market conditions in Europe and our overvalued currency), while our automotive imports from Europe have steadily grown. During the first four months of 2013, Canada’s auto exports to Europe fell by another 15 percent (year over year). Our bilateral auto deficit with Europe is now almost as bad as with Japan (which used to be our most unbalanced auto trade partner).

Given this highly unbalanced starting point in bilateral automotive trade, there is no way that bilateral liberalization could produce anything other than a widening of this initial existing deficit. Canada would eliminate its 6.1% automotive tariff (over some unknown timetable), and the EU would do the same with its 10% tariff. The resulting increase in trade flows in both directions will be driven both by the proportional reduction in costs and by the size of the initial starting point. (Arithmetically, economic models calculate the change in trade each way as the product of the decline in tariffs, an assumed elasticity of demand, and the size of the starting trade flow.) Since the initial flow of automotive imports from Europe is so much larger, the resulting increment in additional imports will inevitably dwarf even a large proportional expansion of Canada’s (very small) automotive exports to Europe. (And that assumes that market conditions in Europe recover, reversing the current trend of declining automotive purchases from abroad.) The federal government’s own joint study confirms this finding: that study anticipates that the bilateral deficit ($5.3 billion in 2012) would grow by another $600 million under a CETA. In reality, the damage would likely be greater. Under no circumstances can the auto industry be seen as a “winner” from a deal that liberalizes trade with a larger, more globally-oriented competitor.

Another interesting feature of the auto negotiations at CETA has been the issue of rules of origin. To qualify for tariff-free treatment under a trade deal, a product must embody sufficient content produced in the originating FTA-partner country. (This prevents a country from importing a product from a third party, and then re-exporting it tariff-free to its FTA partner.) This creates a fundamental asymmetry in the Canada-EU case, by virtue of the different sizes of the two parties. Europe is a continent; the auto industry there utilizes a supply chain that includes parts and supplies produced in many different EU countries (even if most of the complete vehicles imported to Canada receive their final assembly in Germany). For Canada, the supply chain is similarly continental – but under a CETA, this would make it very difficult for Canadian-made vehicles to pass an equivalent rule of origin threshold. The apparent solution to this problem (as reported in media stories based on unofficial draft texts) seems to be to allow Canada to export up to a certain quota of vehicles, tariff-free, without meeting the same rule of origin requirement that will be imposed on European-made products. This ad-hoc exemption would disappear if and when the U.S. also signs a trade deal with the EU. While novel, this feature of the CETA will have no meaningful impact on the continuing bilateral trade pattern, which will continue to be dominated by Canada’s large (and growing) vehicle imports from Europe. Indeed, leaked EU memos describing this feature explicitly noted it was motivated purely by the political requirement that the automotive aspect of the deal must be seen to be even-handed.

International vehicle manufacturers are generally supportive of the CETA (as well as the proposed U.S.-EU deal), not surprisingly since most have operations on both sides of the Atlantic and will profit from the additional flexibility it would grant them in production and marketing strategies. From the perspective of Canadian automotive production, however, it is impossible to imagine a CETA doing anything other than incrementally undermining the overall demand for our products (since the loss of sales to new imports will not nearly be offset by potential new exports). In other words, what’s good for the companies (as judged by their global executives) will not be good for the country. The same fundamental reality is true of proposed trade deals with Japan and Korea (either of which could potentially be folded into a bigger Trans-Pacific deal). In all of these discussions, the auto industry has become a bargaining chip to be played off, in hopes of winning concessions in other industries where Canada has more realistic offensive hopes. “Cars for beef,” in essence, is the trade our government is trying to make – and hence the auto industry will be a collateral victim of any of the deals currently on the table.

Imagining an Alternative: The problem here is not trade. The problem is free trade, following the NAFTA recipe (according to which no performance requirements or other safeguard measures are imposed to ensure that trade remains balanced and mutually beneficial). I could imagine a trade initiative with the EU that promoted an expansion of bilateral trade, but in a fair and balanced manner. Targets could be set for limiting the size of the bilateral imbalance in this strategic sector, for instance. Or European car manufacturers (like Volkswagen/Audi) could be required to invest in Canadian manufacturing operations (either directly, or indirectly through their purchases of parts) as a condition of tariff-free access to our consumers. Other countries do this sort of thing all the time. India, for example, is also negotiating an FTA with the EU – but has already made it clear that tariffs (currently as high as 60 percent) will stay in place on vehicle imports to India (instead of exposing the infant domestic Indian industry to the full power of the European car industry). Brazil has many trade agreements, but still imposes requirements on companies to maintain proportional domestic operations in Brazil. Many jurisdictions (including Germany and France) use public equity (in various forms) as a way of enforcing loyalty from automakers. Japan and Korea benefit further from the structural strength of their domestic automakers in their home market, and a spate of direct and indirect subsidies for outbound exports. These are all tools that could be invoked in Canada, too, to promote more balanced auto trade with Europe and other jurisdictions. (The CAW proposed many measures like these in our 2012 auto policy paper, Rethinking the Auto Industry.)

However, they all run counter to the boy-scout adherence to pure free trade which still seems to guide our negotiators. And so for that reason, Canadian negotiators won’t even ask for these things … let alone bring them home in a tentative deal.

Jim Stanford is an economist with the Canadian Auto Workers union and a research associate with the CCPA. This commentary was originally published on The Progressive Economics Forum.