Michel Poitevin is a professor in the department of economics at the University of Montreal, and a researcher at CIRANO and CIREQ.
Luc Vallée is a former chief economist at the Caisse de dépôt et placement du Québec and former chief strategist at Laurentian Bank Securities.
Canadian trade statistics for April released on June 4 were disastrous: Imports fell by 25 per cent from their March level and exports decreased by 30 per cent. Such large monthly declines had never been recorded and sent both exports and imports back to levels observed a decade ago. As Canada trades mostly with its southern neighbour, 90 per cent of the drops were attributable to reduced trade with the United States.
Canada’s overall trade balance also deteriorated – the result of a narrowing of our trade surplus with the U.S. and a widening deficit with the rest of world. Some observers see this as a sign that our once very open economy has to become more self-reliant and adopt more protectionist policies if it wants to prosper. But what does the recent deterioration of Canada’s trade balance tell us about how the country is faring from having adopted comprehensive free-trade policies over the past few decades?
Not much, actually. Here is why.
Take, for example, Canada’s trade deficit with the European Union. It has deteriorated since the Canada-Europe Trade Agreement (CETA, or, officially, the Comprehensive Economic and Trade Agreement) went into effect in 2017. European companies seem to have obtained better access to Canadian markets than our companies have to EU markets. However, this deterioration masks many benefits of the free-trade agreement for Canadians.
Canadian consumers are now able to purchase goods that were previously unavailable or more expensive. But what about Canadian businesses? Many observers believe that our companies got the bad end of the deal.
But the deterioration in the balance of trade with the EU only indicates that Canadian businesses’ sales on the old continent grew less than those of European businesses in Canada, not that their sales in Europe have decreased. The diversification of our export markets, even if limited, has certainly made our exporters less dependent on the American market and thus rendered our economy more robust.
Also, the most significant gains of the treaty are probably overlooked. About 60 per cent of international trade relates to the exchange of intermediate goods, used for the production of other goods. It is therefore plausible that, through their purchases of better and cheaper materials and equipment from Europe, Canadian companies increased their sales in the U.S. and their competitive position vis-à-vis their U.S. rivals in Canada. Such gains would not appear in Canada’s trade balance with Europe, but as an improvement in our trade balance with the U.S.
The same reasoning can be used to assert that Canadian consumers have likely substituted part of their American imports by purchasing goods produced in Europe. Again, that helps to improve our trade balance with the U.S. and illustrates how the evolution of Canada’s trade balance with the Europe is meaningless in assessing CETA’s benefits.
More fundamentally, even the evolution of a country’s global trade balance with all of its trading partners is silent as to the economic benefits obtained through trade liberalization.
The balance of trade of any country reflects the difference between sales and purchases made abroad, which are recorded in what economists call Canada’s “current account.” When the current account shows a deficit, Canadians bought more abroad than they sold, and must acquire foreign currencies to finance the gap. In return, foreigners accept to buy our dollar, for example, to invest in Canada. This excess foreign demand for our currency appears in Canada’s “capital account.”
The Canadian dollar exchange rate always adjusts to ensure that the supply of dollars from Canadians wanting to buy foreign goods and services is equal to the demand for Canadian dollars by foreigners. Thus, the sum of two accounts – a country’s balance of payments – is always equal to zero. In other words, a deficit (surplus) in the current account is always equal to the surplus (deficit) in the capital account.
Applying this reasoning to an individual, this amounts to saying that for Sarah to consume more than she earns (current account deficit), she must necessarily be financed by an equivalent in-flow of funds, presumably via a loan (capital account surplus). The same logic prevails for a country.
In the U.S., trade deficits have been chronic for years. This only reflects the country’s success in attracting foreign investment. The continuing in-flow explains the U.S.’s sustained capital account surpluses and the persistence of its trade deficit over the years, whether U.S. President Donald Trump likes that deficit or not.
In summary, trade liberalization benefits both consumers and businesses and, as a corollary, the free movement of capital promotes investment, which further enhances growth.
The deterioration of Canada’s trade balance in April – and likely in the months ahead – should thus not be perceived as a justification for moving toward protectionism and self-sufficiency. Quite the contrary. The novel coronavirus crisis has highlighted the underinvestment by our businesses and governments in technology, health, infrastructure and other important areas.
This should motivate Canadians businesses to increase investment in order to further assert our competitiveness at home and abroad. To do this, Canada’s ability to attract foreign capital to finance investment is crucial. But it will only be possible as long as Canada remains committed to free trade and the free flow of capital.
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