Global trade and investment are evolving. Emily Blanchard examines what’s changed and identifies important opportunities and challenges for Canadian trade policy.

Last week, we pre-released the first chapter in the IRPP’s new research volume on Canadian trade policy. In the second chapter, Emily Blanchard (associate professor at the Tuck School of Business at Dartmouth College, United States) dissects the growing complexity of the international trading system.

A more complicated global trading system

In recent decades, globally integrated supply chains, foreign direct investment (FDI) and cross-border portfolio holdings have introduced new and deeper economic connections between trading partners. In the process, countries’ geographic and economic borders have blurred– it’s increasingly difficult to identify where ”national” ends and ”international” begins. Enacting domestic policy reforms can be tricky because these usually require political consensus based on the idea of furthering national economic interests, which have become increasingly elusive.

Emily’s paper simplifies this complexity and re-examines how Canada’s trade policy should be conducted in this new world. While she concludes that some long-standing policy tenets remain unchanged, including the emphasis on market liberalization, she says that global value chains (GVCs) provide new policy opportunities, but also some more emphatic cautions.

New opportunities: Trade/investment-and-policy complementarities

Increased international ownership and longer supply chains can encourage trading partners to strengthen economic ties via preferential trade agreements (PTAs). These deals can be a powerful way to leverage what Emily calls a ”trade-and-investment nexus”– or complementarity– whereby economic links between countries can lead to mutual trade preferences, which then further strengthen GVC- and FDI-linkages. (This only applies to so-called vertical or export-oriented FDI and GVC-links, which are more geared for offshoring than avoiding tariffs in the foreign market.)

For example, Canada might ramp up its FDI in Thailand in plants that exports products back to Canada. This lessens our incentive to maintain high tariffs on Thai imports. Emily’s recent research finds strong empirical support for this effect: countries with more US offshoring enjoy better tariff preferences, particularly developing countries (paper; VOX blog).

Emily says that Canada is in no danger of missing out on trade deals with major and obvious potential trading partners. North America is covered by NAFTA, Trans-Atlantic ties were recently strengthened with the Canada-EU deal, the Trans-Pacific Partnership, TPP, talks are on-going, as are bilaterals with Japan and India.

At the same time, some of the fastest growing emerging markets are also becoming the most integrated into GVCs, which means that Canada’s best prospects for enhanced trade partnerships could include rapidly growing economies in East Asia, Eastern Europe and Latin America (such as China, Thailand, Vietnam, Hungary, Romania, Turkey, Chile and Brazil).

Most of these countries were identified as priority markets in the government’s Global Markets Action Plan (GMAP), but a few in Eastern Europe were not. Moreover, some Canadian pundits are pushing hard for better engagement with China, such as adding a trade deal to build upon last year’s investment deal.

Take a value-added approach to tariffs or eliminate them

The previous chapter by Ari Van Assche established how businesses integrated into GVCs have adopted a supply chain mindset. Emily’s chapter suggests that the thinking and actions of Canada’s trade policy-makers are also generally moving in this direction, but could be bolder.

Tariffs, input trade, rules of origin, and re-exporting are all increasingly important as global production fragments. Longer supply chains magnify the existing inefficiencies of trade barriers. When products cross more borders more often, tariffs " which generally apply to the total value of goods crossing borders rather than the incremental value added in each country " discourage production fragmentation, because the same product can encounter trade barriers multiple times along its journey.

Multinationals with longer supply chains can suffer the most from asynchronous global trade rules, so they’re pushing policy-makers to adopt more open and harmonized trade policies.

Ideally, we’d take a conceptual leap forward and apply tariffs on a value-added basis (rather than the total value of goods). But that’s hard to do in practice, so Emily recommends considering a simpler, more transparent alternative: eliminate remaining tariffs altogether. This would reduce regulatory and customs burdens on Canadian businesses and customers. It would also improve production efficiency by giving our firms cheaper access to the best suppliers of intermediate inputs, regardless of location.

We’ve already taken this step for manufacturing inputs and machinery and equipment (a move that that was phased-in from 2009 to 2015.) This was well-received, so why not go further and proactively remove remaining tariffs?

This proposal also garners support from Dan Ciuriak (former deputy chief economist at DFATD) in this paper and from William Watson (McGill University) in this op-ed who described it as ”new, fresh, bold, forward-looking, evidence-based and on balance, pretty sensible”. Watson acknowledges opposing political pressures, particularly in some protected agricultural sectors, which have been more difficult areas for TPP negotiators.

If Canada’s federal government cut tariffs, they’d forego some revenue upfront–potentially a significant amount, as we collected just over $4 billion in customs import duties in 2013-14 (worth about 1.5 percent of total revenues). But going tariff-free wouldn’t have to be done overnight; it could be phased-in over several years like the manufacturing tariff reductions. And this move needs to be viewed in the context of the long-lasting economic benefits it would provide.

If completely eliminating tariffs is viewed as too costly from a fiscal or political perspective, then extending tariff relief to a broader set of Canadian industries would be a good place to start. Manufacturing shouldn’t be the only industry targeted for this beneficial policy.

Stronger policy warnings

In recent years, efforts have shifted from multilateral trade negotiations at the World Trade Organization (WTO) toward preferential bilateral and regional deals. This focus on PTAs can undermine multilateral efforts and inefficiently divert trade and investment. More deals are not necessarily better as the global economy risks becoming a ”spaghetti bowl” of inconsistent rules from overlapping negotiations.

Emily identifies the potential costs of incongruent global trade policy and raises two distinct concerns. First, recent PTAs have deeper regulatory and behind-the-border provisions that often extend far beyond tariff reduction. These inclusions can serve an important role, but some applications have been heavily criticized for challenging countries’ sovereignty through overzealous investor and patent protections.* As a result, Emily suggests that Canada pursue PTAs selectively, and with careful consideration of behind-the-border clauses.

Her second concern is that more and stronger preferential deals could hurt the multilateral trading system more broadly, by undermining the WTO or excluding other countries. She therefore encourages Canada to maintain an active role in the WTO, including supporting its dispute settlement body.

Emily also urges Canada to not ignore those countries that are currently outside of GVC networks. A stampede toward PTAs with already-integrated trading partners could leave the rest of the world behind, widening the gap between the integrated rich countries and peripheral have-nots. She points out that sub-Saharan Africa receives little attention in Canada’s GMAP, which does not augur well. And she questions if we’re overlooking opportunities there — to the extent that trade preferences can further FDI and GVC links, early leadership could provide rich rewards to first-movers.

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Read Emily’s full paper here. The next chapter to be released is written by researchers at Export Development Canada. They examine Canada’s economic links with the rest of the world based on an analysis of traditional (custom-based) export data, more recent value-added trade data, outward investment, foreign affiliate sales and insights gleaned from interviews of business executives with Canadian operations.


* Controversial cases include when Philip Morris sued Australia’s government for losses that it said it suffered after Australia adopted plain packaging tobacco laws. Closer to home, US company Lone Pine Resources Inc. " which is incorporated in Delaware but headquartered in Calgary " sued the Canadian government after the province of Quebec imposed a moratorium on hydraulic fracking.