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Less than a year ago, energy giant Royal Dutch Shell PLC and its joint venture partners decided to build an $18-billion liquefied natural gas plant in Kitimat, B.C.

The plan: make Canada a leading LNG exporter by selling the West’s vast gas deposits to buyers in Asia. Shipments are scheduled to start by early 2025. PetroChina, the huge state-owned energy company, has a 15-per-cent stake in the venture.

It’s the stuff of corporate dreams. But the success of the project – and the prospect of more investments similar to it – hinges on finding stable markets. And the project’s partners have pinned much of their hope on China, a country with which Canada is now locked in an unprecedented political clash.

“We’re looking to build long-term relationships with Chinese buyers of LNG,” said Jeff Tonken, chairman of the Canadian Association of Petroleum Producers and chief executive of Birchcliff Energy Ltd. “Now we’re afraid to go over there because we might get arrested.”

Former diplomats who now work as business consultants, such as Guy Saint-Jacques, confirmed that some Canadian companies have put a ban on employee travel to China, although it remains unclear how widespread the practice is. Others have had trouble getting paid, he said. In one case, a Quebec manufacturer saw a contract implode at the last minute because the Chinese buyer was denied an import permit. Customs data show Canada’s exports to China have dropped 5 per cent this year through July.

Is Canada’s top diplomat still ‘a bull on China'?

A single event in December has changed the relationship between the two countries in a way not seen since the 1989 Tiananmen Square massacre: Canada’s arrest of Meng Wanzhou, the chief financial officer of Huawei Technologies Co. Ltd. – and the daughter of its highly connected founder – at the request of the United States.

China’s response has created a mess for many Canadian corporations and has put the federal government in a bind. Canada’s second-biggest trading partner has detained two Canadian citizens without proven cause and has blocked imports of Canadian canola and meat. What was once a big play for Canada – and a key plank in the strategy to diversify away from our economic reliance on the U.S. – now seems to be unravelling.

A middle power by global standards, Canada has become entangled in the bigger trade war between China and the U.S. As the two giants remain locked in deep ideological disagreements over China’s support for state-owned firms and whether Huawei poses a security threat, among other things, Canada’s victimization becomes ever more pointed, with no obvious way out.

The Huawei case will be resolved, eventually. That does not mean China and Canada will resume normal relations. Canada’s business and political elite have spent the past 25 years trying to forge deeper ties with the Middle Kingdom. That strategy now requires a clear-eyed reassessment, especially as Chinese President Xi Jinping consolidates his grip on power.

“It’s a shock to the system,” said Ron MacIntosh, a former foreign affairs officer who helped develop Canada’s economic and commercial overtures to China in the late 1970s. “It’s a harder-edged Chinese leadership now, even by their standards. And it makes it hard to generate much enthusiasm [for China] in the Canadian populace.”

The events since December have permanently altered Canadians’ view of China, observers say. That, in turn, is making it difficult for anyone pushing for more business and engagement with the one-party Communist state.

The China problem hasn’t crept into the federal election campaign, yet. But it ranks as Canada’s biggest challenge on the world stage – and it will loom large for the next government.

Early promise has yielded to the realization that Canada is dealing with an autocratic state that is ever-more inclined to act in its own interests, often to the detriment of its trade partners. Some economic analysts argue Canada doesn’t need China as much as many people might think and should instead deepen its relationships with more trustworthy countries.

Still, ignoring China is not an option. Canada is not ready to decouple from the global superpower, and our corporations are still hungry for the opportunities its 1.4 billion people offer. Canadian firms continue to seek and find business in China, while Chinese students at Canadian universities have never been more numerous. Economic and cultural bonds have not disappeared and, by some measures, are growing. That’s proof, for now, that both sides are getting something from the continuity.

But it’s hardly business as usual.

“I don’t think that things will come back to normal,” said Mr. Saint-Jacques, Canada’s ambassador to China from 2012 to 2016.

For companies calculating the costs and benefits of doing business with China, recent events amount to “a warning," he said. For the Canadian government, it’s a wake-up call that although China has come a long way, it is not the partner Ottawa hoped it would be.

“With the challenges created by the ongoing crisis, I think it would be fair for the government to say, ‘We’re having another look and we’ve come to the conclusion that it’s better to try to diversify our export markets and to try to make better use of other free-trade agreements that we’ve signed,' " Mr. Saint-Jacques said. “[With China], we are more in a context of retrenchment."

It wasn’t supposed to be like this.

When Justin Trudeau arrived in Beijing in December, 2017, to clear a path to formal negotiations for a free-trade deal with China, he was given the red-carpet treatment, with a brass band and official honour guard ceremony.

China was reluctant to commit, but Chinese Premier Li Keqiang insisted his country was ready to work with Canada as long as there is mutual respect, adding: “This is the golden era of Canada-China relations.”

Twenty months later, the relationship looks more like a smouldering pile of rubble – so bad that Foreign Affairs Minister Chrystia Freeland pleaded on public radio in May for the Chinese to return her calls.

In many ways, Mr. Trudeau’s openness to China echoes that of his father. In 1970, Pierre Trudeau was one of the first Western leaders to recognize China’s Communist government, ending a two-decade break in relations. The elder Trudeau’s approach – and appeal – was cemented in 1973 with his landmark visit to Beijing.

Canada was enthusiastic about the market-economy reforms China undertook in the 1970s and 1980s, but business leaders were reluctant. A watershed moment came in 1994 when Canada organized an ambitious trade mission to the Middle Kingdom. In early November, an Air Canada jet filled to capacity with the country’s political and corporate elite – prime minister Jean Chrétien, the provincial and territorial premiers and roughly 400 senior business executives – left for Beijing with an air of excitement and guarded optimism. They came back with $9-billion in deals and a new beachhead onto what has become the planet’s most-sought-after marketplace.

“It gave us an entree into the fastest-growing market in the world,” said former New Brunswick premier Frank McKenna, who was on that trip. “Canada needed a kick-start. … Out of it, the foundation was laid for much more business to develop over a period of time.”

“I went into the job absolutely convinced that we needed to diversify and expand our economic relations beyond the United States,” said author and long-time Canadian diplomat Roy MacLaren, who was Mr. Chrétien’s international trade minister in 1994. “We went to China as the obvious priority for such an initiative.”

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President and CEO of Birchcliff Energy Jeff Tonken in his corporate headquarters in Calgary, Alta., on Sept. 20, 2019.Todd Korol/The Globe and Mail

At the time, Canada had adopted its “Four Pillars Policy” for engaging China: economic partnership; sustainable development; human rights, good governance and the rule of law; and peace and security. Canada believed that engaging China in more open trade – and, most importantly, supporting its accession to the World Trade Organization – would open the floodgates to the huge Chinese market, not just for Canada but the whole world. China joined the WTO in late 2001 – the same year as the second Team Canada mission to the country, which was even bigger than the original.

“To get China into the World Trade Organization was fundamental to our trade policy,” Mr. MacLaren said. “For China to be a partner, accepting the disciplines of a rules-based trade organization was immensely important as a first step.”

While human rights was also one of the pillars, it was generally downplayed in Canada-China relations during the Chrétien years and was all but absent from the Team Canada missions.

“There was some debate even at that time about the Chinese record on human rights. But we didn’t think that human rights and trade promotion/trade expansion/trade liberalization were antithetical,” Mr. MacLaren said. “We [believed that] deepening trade and investment relations with China, not only through the Team Canada mission but the far more important question of getting China into the WTO, would lead – in my view and in Jean Chrétien’s view – to human-rights advances. As the Chinese economy expanded and liberalized, China would be drawn into the liberal international order.

“I have no doubt that the China strategy was the right one. In my view, it worked.”

He points to the trade growth between the two countries as evidence. In the year prior to the 1994 mission, Canada’s total two-way trade with China was $4.8-billion. Today, the two countries trade that amount roughly every three weeks.

Canada’s relationship with China took on a different tone under Prime Minister Stephen Harper, who was publicly critical of Chinese human-rights violations. The hard line prompted Beijing to cancel a face-to-face meeting between Mr. Harper and the Chinese president and was considered a serious setback to trade progress.

Mr. Harper tried to re-engage Beijing a few years later, but a proposed takeover of Canada’s Nexen Inc. by a Chinese state energy company in 2012 “really spooked" western members of his party, and interest in a bilateral deal faded, said Queen’s University professor Robert Wolfe, an international-trade policy veteran. The government eventually approved the Nexen deal but introduced new restrictions on deals for Canadian resource companies by foreign, state-controlled enterprises.

Justin Trudeau’s government and Chinese officials reopened exploratory free-trade talks in 2017, but the process stalled again after Mr. Trudeau’s trip to Beijing that December. His desire for a “progressive” trade pact that would include human rights, labour standards and environmental protection rules reportedly put a chill on the discussions.

While trade between the two countries has clearly ballooned over the past three decades, Statistics Canada figures show a deeply uneven trade flow. Canada has imported almost $889-billion worth of Chinese goods since 1988, three times more than the $293-billion it exported to China.

Canada has sold China nuclear reactors, hydroelectric know-how and high-speed trains. It has made inroads in insurance, financial services and other areas. All of Canada’s biggest banks are in China, although Bank of Montreal is the only one with a fully incorporated subsidiary there, which allows it to take deposits. But even BMO views its plans to expand in China as a long game.

China largely still sees Canada as a supplier of commodities. More than three-quarters of Canada’s exports to China last year were raw materials and agricultural products.

And Canada has actually been losing market share in trade with China, even as overall trade has grown. At the time of the 2001 Team Canada mission to China, Canada accounted for 1.7 per cent of China’s total imports, according to World Bank statistics. By 2017, that share had dwindled to 1.1 per cent.

The capacity of Canada’s companies and industries, many of them relatively small by world standards, is a real issue in the vast Chinese market, said Gordon Houlden, head of the China Institute at the University of Alberta.

“The range of goods that we have to offer, and the quantities we have to offer them, doesn’t always fit,” Mr. Houlden said. “When you get a China scale, with provinces that have populations and economies larger than most countries, it makes it a particularly difficult place to do business.”

Perhaps the biggest disappointment is that China’s economy remains far more closed than many had hoped.

In July, China lifted foreign-investment bans on a handful of industries, including oil and gas exploration and development, and next year it will remove ownership caps for life insurers and securities and fund management firms. But access to huge swaths of its economy continues to be limited or outright blocked for non-Chinese firms, including such key sectors as telecommunications, automobile manufacturing, health care and education.

In sum, China has been able to sell and invest much more in Canada than Canada has been able to sell in China, said Charles Burton, a former counsellor at the Canadian embassy in Beijing who now teaches at Brock University. He sees the current political fallout not as the souring of a perfect relationship but as a deeper plunge into lopsided dysfunction.

“The assumption was that as China developed and became more integrated into the global economy, [it] would come into compliance with international norms of trade and diplomacy,” Mr. Burton said. “That has proven not to be the case.”

The momentum of Canada’s complex relationship with China came to a standstill in December.

That’s when the RCMP arrested Ms. Meng at the request of U.S. law enforcement. Currently under house arrest in Vancouver, she faces extradition to the United States on charges of bank fraud connected to the violation of U.S. trade sanctions against Iran.

China’s response came swiftly.

Two weeks after Ms. Meng’s detention, China arrested Canadians Michael Kovrig and Michael Spavor and subsequently charged them with stealing state secrets – a move widely seen as an act of retribution.

Beijing also tightened the economic noose on Canada.

In March, it blocked shipments of canola from Canada’s two biggest exporters because they were allegedly contaminated with pests. Canada insisted they were not, but it fell on deaf ears.

Suddenly, farmers in Western Canada were left largely shut out of a market that previously bought 40 per cent of their crop. Canola is Canada’s largest single export to China, topping $4.3-billion in value in 2018.

When they started planting canola in late April, many farmers believed the issue could be resolved before the fall harvest, said Kevin Serfas, a farmer in Turin, Alta., who sits on the executive of the Canola Council of Canada. It wasn’t. Canada is now challenging the ban at the World Trade Organization.

“Guys now have this crop that they have to sell,” Mr. Serfas said, likely at a discount that will wipe away their profit. “It’s really hitting home for a lot of people.”

China then went further, imposing a near-total ban on shipments of Canadian pork and beef in June, just weeks after having tightened inspections and customs processing for Canadian meat. It also restricted imports of soybeans and peas.

Quebec-based Olymel LP, one of the country’s biggest pork producers, was among the hardest-hit.

The company scrambled in the weeks that followed to find alternatives, said Richard Davies, Olymel’s senior vice-president of sales and marketing. It typically fills between 100 and 125 shipping containers destined to China every week, much of that pig feet and other products that are less valued in other markets.

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Canola farmer Kevin Serfas on his farm near Turin, Alta., on Sept. 19, 2019.Todd Korol/The Globe and Mail

The country is the single biggest importer of Canadian pork – so big that it would be impossible to replace it with two or even three other markets, Mr. Davies said. Olymel has had to tap multiple sales channels to keep its pork moving because it can’t slow down the production cycle – pigs grow regardless of political fights.

“We’re not sitting on product and hoping,” said Mr. Davies, who calculates the dispute is costing the industry $10-million a week. “In the context where we are now, [political resolution is] a coin toss. And we can’t manage this business on a coin toss.”

Some 460 Canadian companies were doing business in China as of 2015, according to data published in a report by Dawson Strategies and supported by the Canadian Council of Chief Executives and the Canada China Business Council. That’s not enough, the report argues, adding that Canada needs a formal economic agreement with China or risks being left behind.

It’s tough to see how that will happen now.

Many of Canada’s biggest companies in China are reluctant to talk publicly about the current dispute. But those who have provided thoughts in recent weeks expressed a mix of anxiety, caution and optimism.

“If we don’t solve Huawei, we don’t have a relationship with China,” said Birchcliff’s Mr. Tonken. Western Canada is “stymied right now" by the dispute, he added.

“We’re very, very careful with our paperwork” to ensure that goods flow smoothly into China, Clearwater Seafoods chief executive Ian Smith told analysts last month. The Halifax-based processor of clams and scallops said that, in many instances, its customers are the ones clearing the food into the country.

A survey conducted this year by the Canada China Business Council found that political and legal tensions between the two countries have resulted in companies on both sides experiencing cancelled or postponed contracts. More than half of Canadian companies polled said they’ve altered their business plans as a result.

Still, there is no shortage of bullishness on China among Canadian business leaders.

“At some point in the next 10 to 15 years, the Chinese economy will become the largest in the world,” Barrick Gold CEO Mark Bristow said. “It stands to reason that any serious business should have a strong relationship with China.”

The ugly rift has come at a particularly delicate time, in the midst of an unusually active period for Canadian brands in China. Canada Goose, Tim Hortons and La Vie en Rose have all opened their first stores in the country since the arrest of Ms. Meng, an event that triggered an outpouring of hostility toward Canada on Chinese social and state media.

But Chinese consumers have paid the political fury little heed.

On Chinese digital platforms, sales of Canadian brands tracked by WPIC Marketing & Technologies rose more than 30 per cent between September-October, 2018, and April-May, 2019. Those brands include Lululemon, Arc’teryx, Jamieson Vitamins, Herschel Supply Co. and Canada Goose, whose revenue in Asia tripled to $18.1-million for the quarter that ended in June.

“It hasn’t affected our business momentum or brand positioning, either in China or at home,” Arc’teryx president Jon Hoerauf said. “Our focus when it comes to China is finding the common values across cultures that we can tap into versus focusing on what makes us different.”

La Vie en Rose began actively planning its first corporate store in China just weeks before Ms. Meng’s arrest. It ignored the political noise that ensued and opened in Guangzhou on Aug. 30, in addition to launching on several Chinese online stores. “For us it was the right time. The market was ripe. There’s a lot more lingerie stores in China. There’s more disposable income,” said Aurélie Daoust-Lalande, vice-president of strategy and development. Being Canadian has not been “an issue at all,” she said.

The diplomatic fray may have even done businesses some good, said WPIC president Joseph Cooke. With little high-level conversation taking place between Ottawa and Beijing – no federal cabinet minister has come to China this year – Canadian companies appear to be “stepping up and saying, ‘If we’re going to do this, we need to do it on our own. Maybe we can’t rely on trade commissioner offices,’ ” said Mr. Cooke, whose firm’s digital analytical tools are used by Ford, Accenture, Huawei and others.

China remains welcoming to Canadian companies that bring global best practices and deliver expertise and local jobs that align with Beijing’s priorities, according to executives and analysts interviewed by The Globe and Mail. As China’s economy slows from its previously blistering pace, the government knows foreign firms can help fuel future growth.

“The demand for what we do has been enormous as millions of people move into the middle class,” said CEO Dean Connor of Sun Life, which operates with a Chinese partner. “Most of the companies I speak with continue to want to engage with China and see the need and opportunities there.”

China in 2019 is not the same country it was even a decade ago. And its current path will force some hard choices on its trading partners.

But what exactly Canada can do to secure the release of the two Canadians, what it should do in the years ahead, has no clear answer because there’s no precedent.

“We’re being treated like a bad child” at the moment, said Wendy Dobson, a professor at the University of Toronto’s Rotman School of Management, adding the Chinese are acting like we insulted them by detaining Huawei’s CFO.” It’s certainly unique in our experience, in our 40 years of bilateral relationship with the Chinese.

“The Chinese side is so opaque, and they’re resorting to some foreign-policy spokesperson scolding us all the time,” she said. “It’s very, very difficult to know what the variables are – other than the Americans withdrawing their extradition request.”

Step one to fixing the mess is re-establishing diplomatic relations by naming ambassadors, and that’s been done, said Jean Charest, a former premier of Quebec. Step two is cooling off. “We need to stop this escalation, give the relationship a bit of a rest,” he said. Then re-engage by starting to talk.

Whether Canada has any control over that process is another question.

The nomination this month of Canada’s new envoy to China, business consultant Dominic Barton, signals a desire by Ottawa to mend fences. But it won’t magically resolve the impasse, Mr. Saint-Jacques said. No matter how much hope Canada has placed in him and his contacts in the country, Mr. Barton faces a monumental task, he said.

“If people in Ottawa feel that Mr. Barton is the man of the hour, and will help resolve the crisis, they are kidding themselves,” Mr. Saint-Jacques said. “It has always been difficult to do business in China. Now, this crisis is adding a new level of risk.”

Some experts say Canada has very little leverage over China. The argument is that China has other supply options for much of what Canada sells here. Meanwhile, introducing new tariffs on Chinese goods would make such a small dent in China’s factory output that it would barely register.

Except, of course, for Canadian companies that depend on “intermediary goods” imported from China to produce their own finished products. In that sense, any retaliation could likely hurt the Canadian economy instead of helping it, even if it might be morally satisfying. The bottom line: Canada needs China but China doesn’t need Canada, said Sarah Pittman, a policy analyst with the Canada West Foundation.

“It’s such a mismatch,” Ms. Pittman said. “They’re still going to need what we produce. But they don’t necessarily need us to produce it.”

But economist Duanjie Chen of the Macdonald-Laurier Institute rejects the view that China holds all the cards.

Ms. Chen contends that Canada has long lived under the shadow of Chinese bullying and that recent events have only made that clear. She says Canada has some significant advantages it can use to further its interests, while China is taking some serious risks with its own actions.

Most of Canada’s exports to China are commodities that are either scarce or rapidly being depleted in China, Ms. Chen says in a paper published this month. She says China’s ban on Canadian agricultural products won’t change the global demand for these products and, in fact, could backfire. China can find replacements for Canadian canola, for example, but those producers will need to vacate their non-Chinese markets to do so. Such reshuffling of suppliers of any given commodity will take time, but the market will find a new equilibrium, Ms. Chen says.

“China’s disruptive play in the global agriproduct market will only cause growing distrust among its trading partners, which in turn will adversely affect China’s long-term security in food supply.”

On the flip side, almost all of Canada’s imports from China are manufactured goods that are easily replaceable from suppliers in other markets, albeit at possibly higher prices, Ms. Chen says. She says seven of Canada’s top 10 imports from China are telecoms equipment and electronic gadgets, which used to be made by Nortel, “our national pride” less than two decades ago.

Cultivating more reliable suppliers for such goods will benefit Canada economically in the long term, she says. More generally, Canada should be taking every measure available to diversify its trade beyond China. She also advocates banning Huawei from building Canada’s 5G telecommunications network, as well as registering and scrutinizing all research and development funding sources from China.

“Doing nothing but waiting for Xi Jinping’s mercy is not an option,” Ms. Chen said. “It is a failure that has invited, and would keep inviting, more trouble for our country.”

Canadian farmers have become too reliant on China and they’re now paying the price, says Neil Townsend, chief market analyst at Winnipeg-based consultancy FarmLink Marketing Solutions. As he puts it, the prevailing view on the Prairies about China has always been: “They’re going to buy what you produce. Just keep doing it.”

Mr. Townsend also believes Canada needs to expand its trading options away from China, not only to escape its political whims but also because it won’t be a big market for Canada 20 years from now. He sees China emerging as a rival to Canada as it industrializes its agricultural processes further.

In the near term, Canada needs to cultivate like-minded allies and work toward building a bigger block of countries that have been at the receiving end of China’s forceful behaviour, says Lynette Ong, a professor of political science at the University of Toronto. That includes Norway, Japan and Australia.

The bigger question is what happens once the extradition of Ms. Meng is resolved.

“My feeling is that there still is a high degree of respect between Canada and China, notwithstanding our current situation,” said Roy Romanow, a former premier of Saskatchewan, who was on the 1994 trade mission. “It’s a long-standing relationship. I can’t help but believe that it will withstand the current pressures.”

Prof. Ong said businesses will likely resume their previous activities because they are largely driven by profit. But she said China’s actions will have a lasting effect on its relationship with Canada, marking a “miscalculation” on the part of the Chinese government.

A survey of Canadians by polling group Angus Reid this year found that almost two-thirds of respondents agreed that China’s record on human rights and the rule of law should be a more important consideration than trade and investment opportunities. A plurality (44 per cent) said they would like to see the Trudeau government take a tougher approach to the conflict.

“Public opinion in this country about China has fundamentally changed,” Prof. Ong said. “The Canadian public is seeing another side of China which a lot of people did not see, or were not aware of, or did not care about before.”

That won’t necessarily affect current contracts and business relationships. But it could affect future ones, as this country’s political and business elite absorb the attitude shift of ordinary Canadians, she said.

“I think it would be difficult for any government that comes in place after this election to say that we want to have a policy that courts Chinese investment, that we want to push another 10 big investment projects, government-related projects, into China,” Prof. Ong said. “Even if the two Michaels are released, I think it would be difficult for the public to support that.”

Editor’s note: Editor's note: (September 21, 2019) An earlier version of this story misspelled the name of WPIC president Joseph Cooke.

With files from Brent Jang, Nathan VanderKlippe and James Bradshaw.

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