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Vehicles assembled in Canada cross into the U.S. at Buffalo, N.Y. Trade between Canada and the U.S. shot up after the free-trade agreement was inked. (David Duprey/AP)
Vehicles assembled in Canada cross into the U.S. at Buffalo, N.Y. Trade between Canada and the U.S. shot up after the free-trade agreement was inked. (David Duprey/AP)

Analysis

Free-trade agreement paved way for future tough decisions Add to ...

Over the past 25 years, the Canadian economy has dealt with a number of transformational issues, such as the introduction of the goods and services tax, government restraint, the interest-rate collapse, the rise in the value of the loonie and the global financial crisis. But arguably, none has had as far-reaching and long-lasting effects as the Canada-U.S. free-trade agreement (FTA) and its 1994 successor, the North American free-trade agreement (NAFTA).

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There are numerous ways to assess the FTA. Because it was fundamentally a trade deal at heart, the impact on trade is probably the best way to start. Bilateral exports shot up from barely $100-billion per year in the late 1980s to more than $350-billion by 2000, an incredible annualized growth rate of more than 12 per cent . It was a broadly similar picture on the import side.

However, Canadian exports to the United States have since flattened; they have actually been below the 2000 peak in the latest 12-month period, even with a significant recovery from the 2009 depths.

There are a variety of reasons for the shift from rapid acceleration to a lengthy lull, such as the tech bust from 2000 to 2002 and border tightening after the terrorist attacks of Sept. 11, 2001. Plus, just as exports of goods and services were beginning to make some headway (again midway through the last decade), they were then restrained by the persistent strength in the Canadian dollar, and then heavily undercut by the global recession in 2008-2009. Export volumes are still struggling to recoup those recession losses, remaining below the 2007 peak, and are even further below the 2000 highs.

Meanwhile, total Canadian trade with the United States rose from just over 31 per cent of GDP before NAFTA, to a peak of 56.7 per cent in 2000, but has since receded to only slightly more than 36 per cent – coming almost full circle.

This retreat is by no means an indication that the FTA hasn’t been a success. The split personality of Canadian exports to the United States in the past quarter-century says as much about the wild swings in the Canadian dollar and the significant adjustments in the U.S. economy, as it does about the underlying strength of trade. When we measure in U.S.-dollar terms, export progress appears much steadier over the first 20 years, aside from the pullback during the tech wreck in 2001.

Beyond increasing trade, the FTA and NAFTA were also aimed at strengthening and improving the environment for cross-border investment, especially foreign direct investment. While there have been some high-profile squabbles in the past 25 years, overall the FTA should be judged a success on this front. Foreign direct investment from the U.S. into Canada averaged just $1.7-billion annually in the six years prior to the FTA and $4.7-billion per year in the first six years of FTA (and just before NAFTA), but then shot up to $19.8-billion per year since 1995.

One of the main positives cited for the initial FTA was that it would serve as a vehicle to help bring down the prices of many goods for Canadians as tariffs fell and competition increased. There is absolutely no debate that inflation has been considerably lower in the past 25 years, averaging just 2.3 per cent versus more than 6 per cent in the previous 25-year period.

Many factors have driven inflation lower, but the FTA did help cut inflation in the early 1990s, contributing to the intense anti-inflation thrust of the Bank of Canada at the time. Notably, average Canadian CPI inflation has been 0.5 percentage points lower than in the U.S. in the past 25 years (2.3 per cent and 2.8 per cent, respectively), while it was 0.6 percentage points higher in the prior 25 years before the FTA agreement. The FTA clearly played a constructive role.

The bottom line is that the FTA and then NAFTA were critical ingredients in helping to modernize the Canadian economy, and have ultimately played a big role in transforming Canada from a relative underachiever among industrial world economies to a relative overachiever.

Canada has made a number of reforms over the years, but in many respects the FTA paved the way for future tough decisions. It sharply clarified trade and investment rules within North America, and likely helped avert serious protectionist measures from arising within the region during the steep economic downturns of the past decade. It has led to a net strengthening in North American trade and foreign investment flows, and the deal helped grease the slide for Canadian inflation.

Douglas Porter is deputy chief economist at BMO Nesbitt Burns in Toronto.

 

 

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