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The declaration of interdependence: Why the U.S. needs free trade with Canada

U.S. President Donald Trump welcomes Canada’s Prime Minister Justin Trudeau on the South Lawn before their meeting about the NAFTA trade agreement at the White House in Washington, U.S. October 11, 2017. (REUTERS/Jonathan Ernst)

United States President Donald Trump fired another shot in the ongoing “who needs who more” trade debate this week, saying that the U.S. has a trade deficit with Canada. The comment, delivered via Twitter, is short on context but raised a few eyebrows.

According to data from the U.S. Trade Representative, goods and services trade with Canada totaled an estimated $627.8 billion in 2016. On the U.S. goods side, there was a $12.1 billion deficit with Canada and on the services side, there was a $24.6 billion surplus with Canada – leading to a total goods and services trade surplus of $12.5 billion for the U.S. in 2016.

But that’s not what made economists and trade experts alike shudder.

“Bilateral current account deficits are almost meaningless once we take into account global value chains,” says Isaac Holloway, an economist and assistant professor at the University of Western Ontario’s Ivey Business School. Bilateral current account deficits illustrate the difference between the value of imports and the value of exports. While one country may import a finished product from another country, the exporter often gets the raw components making up that product from other countries. 

Sui Sui, an economist and associate professor in global management studies at Ryerson University’s Ted Rogers School of Management agrees, says most economists agree a trade deficit isn’t necessarily a bad thing. What’s more relevant, says Sui, is the supply chain integration between Canada and the U.S.

She points to something as simple as a sausage. The pigs may be born and bred in Canada then sent to the slaughter in the U.S., before being shipped back to Canada to be processed as sausage then packaged and sold to the U.S. and throughout Canada. “Before it reaches customers, it’s crossed the border so many times.”

Give and take and give…

Both countries have worked hard to build infrastructure to facilitate the flow of components and byproducts – “intermediate goods” – that will eventually be combined to create products sold both North and South of the border. 

NAFTA-enabled trade accounted for 50 per cent of intermediate good imports as a share of total imports for 2015, according to a Brookings analysis of U.S. Census data.

“Just go to the border and see how many trucks cross – it’s very efficient,” says Sui. “It makes both country’s companies more productive, reduces costs for the customers on both sides and makes products more competitive compared to other countries.”

According to 2017 foreign trade data from the U.S. Census Bureau, 14 states count Canada as their biggest import partner and 36 states export more to Canada than any other country. Some states like Montana, Colorado, Iowa, or Illinois point to Canada as their number one trading partner in both imports and exports.

“Multinationals in the U.S. have put certain products in Canada and certain products in the U.S.… there are supply chains (that) you can’t just turn around and change overnight,” says Peter Clark, one of Canada’s leading international trade strategists. “This isn’t a game of Monopoly, you’re playing with people’s lives and with investments and those investments have been pretty carefully considered.”

American voices

While the official message out of D.C. seems to be a mix of trade war rhetoric followed by back-stepping and tariff exemptions, Clark says industry players are very much interested in protecting their investments on both side of the border.

“I’ve already seen all the U.S. brewers petition [U.S. Secretary of Commerce] Wilbur Ross to make sure that their product is not included,” says Clark pointing out that Canada supplies more raw aluminum than the United States does to its market, predominantly because Canada has access to inexpensive electricity to produce aluminum. “We have arrangements with the [U.S.] defense industries, with the aerospace industry and the aircraft industry to supply aluminum that’s used in their products.”

The Rust Belt – the nickname for the Midwestern states and the Great Lakes region – has been particularly vocal about the importance of NAFTA-enabled trade. John Austin, director of the Michigan Economic Center, points out that the 11 midwestern states together account for 48 per cent of all U.S. exports to Canada, and 21 per cent of all U.S. exports to Mexico.

“When President Trump proposes stuff you get a pretty universal pushback from the business and government and civic leaders on our side of the border, certainly in our state, who know what’s at stake and how the world works,” Austin told Yahoo Canada Finance. “He’s willing to do economic damage to the very region that elected him.”

Exports represent 12.3 per cent of the U.S. GDP, according to Austin, with the Rust Belt generating 26 per cent of export-derived GDP.

“We’re very much export-reliant,” says Austin, also pointing to the highly efficient production system between Canada and the U.S. in the region. In his Brookings thought-piece, he called the bridge and tunnel crossing between Detroit and Windsor the “single largest trading location by value on earth” where more than $100 billion in goods are traded annually.

“If you start throwing spanners in those works – you raise the tariff here, make it harder to cross the border there – you’re throwing the whole thing out of kilter,” he says. “It [sends] us into a scramble to figure out how we can rejigger everything and produce competitively again and you’re potentially throwing people out of work.”

Force of habit

But could the relationship be remixed? Could President Trump’s “Buy America” mandate work?

“It’s a good question,” says Holloway. “Certainly, when it comes to displacing Canadian trade, for the most part they probably could, and the reasons we can say that is because we have a lot of two-way trade in the Canada-US relationship.” He points out that both Canada’s top export and top import category for the U.S. last year was autos.

Tariffs set up by the U.S. government to encourage buying local could eventually prompt states like Montana, Vermont, Wyoming, North Dakota and Maine, all of which get more than 50 per cent of their imports from Canada, according to Holloway’s analysis of U.S. Census Bureau data, to source locally. “It’s presumably going to increase their cost as well, assuming that they’re currently cost minimizing.”

The clutch of the current system, says Holloway, is that automakers, for example, can have factories both north and south of the border specializing on certain vehicle models, which helps them minimize costs through economies of scale.

“There’d be massive one-time adjustment costs to re-tool all their factories, that would be fairly significant, then on an ongoing basis, they’d be producing stuff at lower scale and higher cost,” says Holloway. “Could they (produce a lot) without Canada? Yes they could… and it would cost more and everyone would be poorer for it.”

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