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By Glen Hodgson and Danielle Goldfarb
May 6, 2008

The Free Trade Agreement with the United States turns 20 next January. Along with its cousin, NAFTA, it has become the target of protectionist rhetoric from U.S. politicians. Rather than sitting back on the defensive, Canada needs to go on offence to advance its own trade agenda, beginning with a second round of free trade talks with the United States (FTA-2) where reductions in non-tariff barriers should be a top priority.

Canadians now widely believe that we have become deeply integrated with the U.S. economy, based on a privileged position as America's most important trading partner.

However, a new Conference Board report, Stuck in Neutral: Canada's Engagement in Regional and Global Supply Chains, paints a very different picture. When the impact of rising prices is removed, Canada-U.S. trade has actually stagnated since 2000. This trend is much deeper than simply a response to a rising loonie or the U.S.'s current economic troubles. Although U.S.-destined exports have grown (in dollar terms) since 2000, these gains are entirely due to higher prices for commodities and other goods and services.

In addition to the stagnation in Canada-U.S. trade volumes, our research shows that the process of Canada-U.S. economic integration has stopped. No progress has been made since 2000 in terms of the share of Canada-U.S. trade (both exports and imports) used as inputs into each others' production processes. We are on a plateau, which is at odds with the rapidly expanding global opportunities in a world where the very nature of international business has changed. Companies today are breaking their activities into smaller elements, focusing on what they do well, and seeking to make greater use of global inputs (services and parts). For a typical DVD player, to use just one example, Europeans, Americans, Japanese and Koreans create the core technologies and design, Taiwanese and other Asians manufacture the chips, and Chinese workers assemble the final product. But Canadian companies in aggregate are not on the leading edge of these global trends. This matters because the evidence shows that trade integration goes hand in hand with higher living standards.

So what's a country to do? The U.S. market still dominates Canada's trade--around 77% of exports in 2007, down from 87% five years ago -- so Canadian policymakers and businesses cannot afford to ignore the stagnation in trade volumes and integration with the U.S. The plateau in Canada-U.S. supply-chain integration likely reflects the non-tariff barriers between our countries.

For example, there are a host of regulations with similar policy objectives that differ slightly between Canada and the United States (not to mention Mexico). This "tyranny of small differences" adds business costs without a material public-policy purpose. One simple example: In Canada, cheese-flavoured popcorn must contain no more than 49% real cheese; in the U.S., no less than 53%, as Michael Hart notes. Popcorn-makers bear the cost of two production runs, with no added health or safety benefit for consumers. Reducing these types of barriers should be central to a second round of tree trade with the United States (FTA-2) aimed at getting beyond the plateau (ideally, we should even move toward global regulatory standards). And we also need to address long-standing problems under the FTA, such as dispute settlement.

Nevertheless, we cannot afford to ignore other regions, such as Asia, Europe and South America. While trade with these regions is still modest, our study shows that Canadian companies are increasingly taking advantage of opportunities to integrate into those regions' supply chains and benefit from their inputs. In particular, Canadian companies have rapidly expanded their use of imported Asian inputs to make themselves more competitive -- though they have been less successful in supplying Canadian goods and services into flourishing Asian supply chains.

With the Doha multilateral trade round on life support, Ottawa's best options to enable businesses to capitalize further in these regions are unilateral or regional removal of trade barriers. For example, we need a re-energized, multi-track approach to regional trade liberalization, pursuing our trade interests with the U.S. but also seeking freer trade and investment with Asia, Europe and other regions. Businesses can expand their international engagement without government action, but the gains would be that much greater if Ottawa can reduce barriers to globally imported inputs.

As well, we need to remove barriers to domestic competition and trade within Canada, which appear to be costing Canada a leading role in global markets. For example, the U.S. Security and Exchange Commission recently snubbed Canada in favour of negotiating its first-ever agreement on mutual recognition of securities with distant Australia. The United States apparently found it unpalatable to have to negotiate with 13 provincial regulators here.

And Canadian businesses need to do a better job of identifying areas where they are globally competitive, and assessing how to take full advantage of other regions' strengths-- both expertise and inputs.

Taking the offensive offers Canada its best chance to offset disappearing trade with the U.S., and the associated impact on Canadian living standards.

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