United States-Canada trade and economic relationship: prospects and challenges.(Report)

Summary

The United States and Canada conduct the world's largest bilateral trade relationship, with total merchandise trade (exports and imports) exceeding $429.7 billion in 2009. The U.S.-Canadian relationship revolves around the themes of integration and asymmetry: integration from successive trade liberalization from the U.S.-Canada Auto Pact of 1965 leading to North American Free Trade Agreement (NAFTA), and asymmetry resulting from Canadian dependence on the U.S. market and from the disparate size of the two economies.

The economies of the United States and Canada are highly integrated, a process that has been accelerated by the bilateral U.S.-Canada free trade agreement (FTA) of 1988 and the NAFTA of 1994. Both are affluent industrialized economies, with similar standards of living and industrial structure. However, the two economies diverge in size, per capita income, productivity and net savings.

Canada is the largest single-country trading partner of the United States. In 2009, total merchandise trade with Canada consisted of $224.9 billion in imports and $204.7 billion in exports. In 2007, China displaced Canada as the largest source for U.S. imports for the first time, a trend that has continued since then. While Canada is an important trading partner for the United States, the United States is the dominant trade partner for Canada, and trade is a dominant feature of the Canadian economy. Automobiles and auto parts, a sector which has become highly integrated due to free trade, make up the largest sector of traded products. Canada is also the largest exporter of energy to the United States. Like the United States, the Canadian economy is affected by the transformation of China into an economic superpower. The United States and Canada also have significant stakes in each other's economy through foreign direct investment.

Both countries are members of the World Trade Organization (WTO) and both are partners with Mexico in the NAFTA. While most trade is conducted smoothly, several disputes remain contentious. Disputes concerning the 2006 softwood lumber agreement are under arbitration, and Canada has sought WTO consultations over country-of-origin-labeling requirements. In addition, the United States has placed Canada on its Special 301 priority watch list over intellectual property rights enforcement issues. Canada has also vigorously protested the implementation of the "Buy American" provisions of the economic stimulus package.

The terrorist attacks of 2001 focused attention on the U.S.-Canadian border. Several bilateral initiatives have been undertaken to minimize disruption to commerce from added border security. The focus on the border has renewed interest in some quarters in greater economic integration, either through incremental measures such as greater regulatory cooperation or potentially larger goals such as a customs or monetary union. Congressional interest has focused mostly on trade disputes, and also on the ability of the two nations to continue their traditional volume of trade with heightened security on the border.

Contents

The Economies of the United States and Canada
The Trade and Investment Relationship
    Autos
    Energy
    China
    Trade Deficit
    Services
    Investment
        Canadian FDI Policy.
    Disputes
    Softwood Lumber
    Arbitration
    Country of Origin Labeling
    Buy American Stimulus Provisions
    Intellectual Property Rights
Security and Trade
    Western Hemisphere Travel Initiative (WHTI)
    Action Programs and Initiatives
Prospects and Policy Options
    NAFTA Plus
    Security Perimeter
    Customs Union
    Common Market or Economic Union
    Monetary Union

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September 14, 2011

The Economies of the United States and Canada

The economies of the United States and Canada are highly integrated, a process that has been accelerated by the bilateral U.S.-Canada free trade agreement (FTA) of 1989 and the North American Free Trade Agreement (NAFTA) of 1994. The two countries are natural trading partners, given their geographic proximity and their (partial) linguistic and cultural similarities. Because 80% of the Canadian population lives within 200 miles of the U.S. border and due to the impediments of Canadian geography, trade with the United States is often easier and less expensive than Canadian inter-provincial trade. Both are affluent industrialized economies, with similar (though not identical) standards of living.

However, the economies of the two countries diverge in numerous ways. First, the U.S. economy dwarfs that of Canada. U.S. gross domestic product (GDP) is over 9 times that of Canada in nominal terms and nearly 11 times as large in terms of purchasing power parity. (1) (See Table 1.) This large and historic disparity has presented opportunities and challenges for Canada. NAFTA provides Canada with a large market for its exports at its doorstep, however it has also led to increased import competition for small-scale Canadian businesses. The Canadian economy is also disproportionately impacted by a U.S. economic slowdown or changes in the bilateral exchange rate.

In the past decade from 2001, the average annual real GDP growth rate has been slightly higher for Canada (1.9%) than for the United States (1.6%). Per capita average annual growth rates over the period have shown a similar, if anemic trajectory (0.82% v. 0.62%). Canadian per capita income, in terms of PPP, has remained relatively constant at around 84% of U.S. per capita income. The persistent per capita income gap has proven worrisome to Canadian policymakers as it raises questions about Canadian productivity and competitiveness.

In terms of sectoral components of GDP, the United States and Canada are similar. Over two-thirds of both economies are devoted to the services sector, although the sector is larger as a percentage of GDP in the United States (76.9%-70.9%). The manufacturing sector's composition of GDP has fallen in both countries over time, but it is still relatively more important to the Canadian economy (27.2%-22.2%). Agriculture makes up the remaining 1.9% of the Canadian economy and 1.2% of the U.S. economy.

In terms of savings and investment, Canada and the United States have diverged. Canada's experience with fiscal profligacy in the 1970s and 1980s caused the country to eschew deficit spending in the 1990s. Parliament consistently passed balanced budgets from 1997-2008, and Canada lowered its ratio of public debt-to-GDP from 100% of GDP in 1996 to 61.3% of GDP in 2008. Yet, deficit spending returned in the 2009 stimulus budget and public debt-to-GDP is now back to 84.0%. The United States has a lower ratio of debt-to-GDP, but it has been trending upwards, reaching 62.9% of GDP in 2010, after years of deficit spending.

Some of the differences between U.S. and Canadian economic performance may be traced to the differences in the role and structure of the government in economic life. While both countries can be identified as generally free-market capitalist economies, at times Canada has adopted more interventionist economic policies. Prior to the FTA with the United States, Canada protected her small-scale manufacturing enterprises that produced solely for the domestic market with high tariffs. While these plants provided jobs to Canadian workers, they resulted in higher prices for Canadian consumers and led to a relatively inefficient allocation of national economic resources. Canada has also provided its citizens with a more generous social safety net including a government-run national health service. Canadian citizens pay higher taxes to receive these benefits, but private industry is relieved of providing health care coverage.

A different relationship between the Canadian federal government and the provinces also affects economic dynamics. Canadian provinces have relatively more power vis-a-vis Canada's federal government than that of states with the U.S. government. For example, natural resources are under the policy control (and in many cases, ownership) of Canadian provincial governments. In the softwood lumber dispute, provincial ownership and management of forests have made the provincial governments key players in the negotiations. Alberta's vast energy reserves may also cause friction between it and other "have-not" provinces without similar resource endowments. The Canadian federal government attempts to provide a uniform level of services across the provinces by providing "equalization" payments to poorer provinces; however, these payments are a source of continuous squabbling between the provinces, on one side, and the federal government.

The Trade and Investment Relationship

Canada is the largest single nation trading partner of the United States. Trade increased in 2010, after dropping in 2009 due to the global economic downturn. In 2010, total merchandise trade with Canada was $481.5 billion (a 12.1% increase from 2009), consisting of $275.5 billion in imports and $206.0 billion in exports resulting in a trade deficit of $69.5 billion. (2) In 2010, $1.3 billion in goods crossed the border each day. Trade with Canada represented 15.9% of U.S. total trade in 2010, with Canada purchasing 18.3% of U.S. exports and supplying 14.5% of total U.S. imports. While Canada is an important trading partner for the United States, the United States is the dominant trade partner for Canada. The United States supplied 50.4% of Canada's imports of goods and purchased 74.9% of Canada's merchandise exports in 2010.

While the absolute value of trade continues to increase between the two nations, each nation's share of trade with the other has decreased in recent years. As a share of U.S. total trade, trade with Canada dropped from 20%-15% since 2003. Conversely, trade with the United States dipped from 74% to 63% of Canada's global trade in the same period.

Trade is a dominant feature of the Canadian economy. While in the United States, the value of trade (exports + imports) as a percentage of GDP was about 20.7% in 2010, the comparable figure for Canada was 49.3%. Canada's goods exports totaled $386.0 billion in 2010, which represented 29.1% of Canadian GDP; Canada imported $390 billion from all destinations, 31.3% of its GDP. In 2009, Canada's merchandise trade balance fell into deficit for the first time since 1975 and this deficit persisted in 2010. Canada is relatively more exposed to the world economy and to the fortunes of other economies, foremost to that of the United States, than most other countries.

Autos and auto parts represent the top U.S. exports to, and second-largest imports from, Canada. Agriculture and construction machinery, computer equipment, general purpose machinery, aerospace product and parts, basic chemicals, pharmaceuticals and medicines, iron and steel, and precision instruments are other major U.S. exports. Primary U.S. imports from Canada outside the automotive sector are energy (natural gas, petroleum products, electricity); pulp, paperboard, and paperboard mill products; aerospace products and parts; nonferrous metal and processing (ex aluminum); and basic chemicals.

That the United States and Canada trade substantial volumes of the same goods bespeaks the economic integration of the two economies. This integration has been assisted by trade liberalization over the past 40 years, beginning with the Automotive Agreement of 1965 (which eliminated tariffs on shipments of autos and auto parts between the two countries), through the Canada-U.S. Free Trade Agreement of 1989 (FTA), and NAFTA. Under the FTA (which was incorporated into NAFTA), bilateral tariffs except for certain agricultural products were phased out over a 10-year period culminating in 1998.

The elimination of tariffs and the reduction of nontariff barriers have contributed to the process of specialization, as each country is able to produce goods for a larger continent-wide market. Thus, firms are able to improve productivity through increased economies of scale and coordinated production. Such specialization led to increased bilateral trade, much of it in intermediate products. One study estimated that about 45% of U.S.-Canadian trade was intra-firm trade, reflecting the substantial integration of the two economies and contributing to increased efficiency and competitiveness of firms on both sides of the border. (5)

Autos

Integration of the U.S. and Canadian automotive industries is an example of the benefits of …