Proceedings of the Standing Senate Committee on
Foreign Affairs and International Trade
Issue No. 9 - Evidence - Meeting of June 2, 2016
OTTAWA, Thursday, June 2, 2016
The Standing Senate Committee on Foreign Affairs and International Trade met this day at 10:31 a.m. to study foreign relations and international trade generally (topic: bilateral, regional and multilateral trade agreements: prospects for Canada).
Senator A. Raynell Andreychuk (Chair) in the chair.
[English]
The Chair: Good morning. The Standing Senate Committee on Foreign Affairs and International Trade is authorized to examine such issues as may arise from time to time relating to foreign relations and international trade generally. Under this mandate, the committee will continue to hear witnesses today on the topic of bilateral, regional and multilateral trade agreements: prospects for Canada.
To date, we have had many excellent witnesses, and today is no exception. I'm pleased to see as a panel before us Ms. Beverly Lapham, Professor of Economics, Department of Economics, Queen's University; Mr. Daniel Trefler, Ruth Grant Canada Research Chair in Competitiveness and Prosperity, Professor of Business Economics, Rotman School of Management, University of Toronto. From Statistics Canada we also have Ms. Beiling Yan, Senior Research Economist; and Mr. John Baldwin, Special Advisor, both of the Economic Analysis Division.
As Senate members will know, we originally had two panels but the witnesses felt that they could work very co- operatively together so we're going to have all the presentations. I suggest that we have taken a shorter time on your extensive backgrounds, but we have done so to give you more time to speak to us and to allow us time for questions.
Ms. Lapham, you are welcome to start with your opening statement. Welcome to the committee.
Beverly Lapham, Professor of Economics, Department of Economics, Queen's University, as an individual: Thank you very much for inviting me here. I'm honoured to have the opportunity to be with the committee. My discussion today is organized around three related points.
Point number one is I feel that the key to understanding the economic impacts of trade liberalization is to emphasize that any change in the trading environment causes reallocations of the factors of production, primarily labour and capital, within a country. The nature of these reallocations and their effects are quite complicated, however I would say a robust result is that these reallocations due to trade liberalization raise aggregate welfare.
The second point is that recent firm-based theory and empirics research have changed the way we think of how these reallocations work. Importantly, that research implies that reallocation generates significant two-way linkages between firm, industry and aggregate-level productivity on the one hand, and firm industry and aggregate-level trade on the other.
Point three is that these factor reallocations have significant individual welfare effects on workers. There are winners and losers by trade liberalization. The costs of adjusting to trade liberalization are significant and unevenly distributed across workers. This implies that worker adjustment programs should be considered closely in conjunction with trade policy.
Let me come back to the first point. In early country-based models of trade, factors are reallocated from producing things that a country is not very good at to producing things it is very good at. This is the source of aggregate gains from trade; this is standard comparative advantage.
In the industry-based models developed later in the 1980s, the emphasis was on the importance of thinking about trade when industries have production technologies such that firms should produce at a relatively high scale of production in order to be cost effective, which is characteristic of many manufacturing industries.
Trade gives exporting firms access to larger markets, and factor reallocations go to these expanding firms and aggregate gains come from them producing at lower average cost. This was at the heart of many discussions leading up to the Canada-U.S. Free Trade Agreement: Canadian firms would have access to the larger U.S. market and they would be able to produce more efficiently at higher scale.
In the more recent models of trade, they are firm-based in their analysis. Those models emphasize that, even within industries, firms can be heterogeneous, especially with regard to their productivity. Increased trade can cause the least- productive firms to be forced out of the market and to contract and the most productive firms to expand to meet the needs of the international market.
Thus, in those models, factors of production leave the low productive firms and are reallocated to the most productive firms, and this in itself can lead to an increase in productivity. This is sometimes referred to as the selection effect of trade.
The newer models tell us that the aggregate welfare-enhancing reallocations resulting from trade are not as simple as resources moving out of contracting import-competing sectors and into export-oriented sectors. This also suggests that the distributional effects of trade are perhaps more complicated than we would think.
My second point is that this recent theoretical and empirical research, which emphasizes firm-level decisions and firm-level heterogeneity, has demonstrated a whole range of links between trade liberalization and productivity.
To reiterate the last link I just described, trade causes factors to be reallocated from the least to the most productive firms within industries, and this leads to an increase in industry and aggregate productivity. Of course, this also means there will be winning and losing firms within industries.
The links between trade and productivity may be even more complicated than this. As emphasized by some of your previous witnesses, such as Joy Nott and Bob Wolfe, firms are also impacted by trade liberalization through their participation in global value chains and as importers of intermediate inputs. If trade liberalization measures enable these firms to reorganize their production structures more efficiently through these channels, then trade can further enhance firm-level productivity.
These reorganizations also involve significant reallocations of the factors of production. Empirical work using firm- and plant-level data from a variety of countries has provided convincing evidence of mechanisms at work, which link trade and productivity. Importantly, many of the members of this panel, along with their co-authors, have documented sizable magnitudes of these types of productivity effects for Canada following the Canada-United States Free Trade Agreement. They may be discussing those studies today.
My final point is that the large body of trade theories and empirical evidence based on worker- and firm-level data makes it clear that there are winners and losers from trade liberalization. Dan Trefler's earlier work makes this point clear.
The costs of adjusting to changes in the trading environment are highly unevenly distributed across workers, and there certainly will be displaced workers. Canadian evidence shows that displaced workers with at least five years' tenure on an old job have an average earnings loss of 25 to 30 per cent, even many years after the initial job separation. In the U.S., we see rising protectionist sentiment and the support for certain types of presidential candidates partially coming from these displaced workers.
There are many other studies that document large losses to displaced workers. In Brazil, for example, there is a study that looks particularly at trade-induced losses, and those estimates based on worker-level data suggest that the loss to some workers is between 1.5 to 3 times annual wages in the period of adjustment.
There are, of course, policies in place to assist displaced workers. Preventive policies provide education and skill development, and adjustment assistance policies provide training and EI benefits. The evidence on the effectiveness of these policies in Canada is mixed, it's not my area of expertise and I haven't studied it well enough to make specific recommendations. However, my hope is that the committee will give those studies careful consideration in their discussions on the impact of free trade agreements on Canadian workers.
To conclude, I would argue that recent firm-based theory and firm-based evidence indicates that trade liberalization measures such as CETA and the TPP will enhance Canadian productivity and aggregate welfare. However, it is essential to fully recognize that these measures will create winners and losers within and across industries, and who wins and loses is very complicated. These trade policies should be considered in conjunction with redistributive and worker adjustment programs and policies. Thank you for your attention.
Daniel Trefler, Ruth Grant Canada Research Chair in Competitiveness and Prosperity, Professor of Business Economics, Rotman School of Management, University of Toronto, as an individual: It's an honour to be here. I think all Canadians would be tremendously interested to know that so many senators are engaged in an important public policy issue. I thank you all for being so involved in this.
The committee asked me to talk about trade agreements to put them in the context specifically of trade and innovation; so I'll confine a lot of my comments to that. I'd like to start with the most basic question: What do we actually know have been the effects of past agreements? We want to be on solid ground in talking about future agreements. What we know starts with the very simple fact, which is that exporters are far more productive than non- exporters. Starting with that fact, there are two ways in which trade agreements in the past have had very tangible real impacts that have helped Canadian productivity and innovation.
The first of these is simply that as the U.S. market opened up to us under the Canada-U.S. Free Trade Agreement, our exporters took advantage of that. That meant our most productive firms grew. That's got to be a good thing. It also meant, and I think Ms. Lapham was alluding to this, that our least productive firms were hit hard by American competition. They contracted, exited and shutdown factories. You need to see the data to know, and I first saw these numbers from John Baldwin, that this led to an expansion of Canadian productivity.
The way to think about that is to go back a few years to Grade 10 math. You were in that course and some of your tests were really good and some of them weren't so good. The teacher announced: "I will allow to you drop your worst test.'' What happens to your average? It goes up. That's what happened in Canada too. Our most productive firms grew and got more weight in our productivity calculations and our least productive firms contracted. Average productivity went up.
The second one, which surprised me and has been important in my thinking ever since and informs all my policy thinking about trade agreements, is what happened to innovation. That's extremely important. Bear in mind that when a firm wants to innovate, it needs to incur some pretty substantial upfront fixed costs. The only way that a firm will agree to do that is if it really expects to recoup those costs through being able to sell much more product down the line. What better way to encourage a firm to innovate than to tell them, "We, as a government, are going to give you the opportunity to sell a heck of a lot more in the U.S.'' The response was for Canadian firms to bump up their innovation rates and their technology adoption rates. It's a hard fact.
Let me put a hard number on it. I'm tempted to say that this increased Canadian productivity by 14 per cent. You will then look at me and ask: "Is that a lot or a little?'' Let me put it to you in a simple number. It means that every single year Canada generates $70 billion more in value-added. Given your position in Canadian society, you might want to know a slightly different number, which is that one third of that money goes into our tax base. It means $25 billion to federal and provincial coffers every year. The idea that a simple policy like integrating more closely with the U.S. could raise our productivity and fill our tax base so enormously is just extraordinary to me.
That is my starting point for thinking about trade agreements. We have had much more research since then. Professor Yan and Professor Baldwin have been exceptional in pushing this agenda with fact-based research. The conclusion to me is: In a small country like Canada, we have no option but to be engaged in trade agreements if we want to stay among the most innovative countries in the world. That is certainly my objective.
There are a large number of issues that I'm sure you are confronting. I'm going to second guess a few of them and rattle off some quick ideas and on my thinking on it.
First, we need to ratify CETA and TPP. I understand it's a very difficult decision. There are many voices up against it. We have to ratify CETA, and if the U.S. ratifies TPP we have no choice but to ratify it. We cannot be left outside of major trading blocs. The implications for Canadian innovation are just too dire — no choice.
Does that mean that I'm happy with those agreements? No. I'm not happy with them. Those agreements represent compromises. Nobody will understand compromises better than politicians and senators. What is wrong with these agreements that I would have liked to see changed? This is a wishful thinking moment, and I won't give you too many more of those.
ISDS has many problems with it. I do not like ISDS. The IP provisions of TPP have serious problems: patent locks, patent restoration, patent extensions and biologics. All of these, to me, are significant problems. Finally, the e- commerce provisions, which I don't think anybody fully understands — another reason why we should be worried about agreements. We don't want to sign agreements we don't fully understand. Also, non-localization provisions and privacy provisions are not healthy.
With all of that on the table, do I still think we should ratify TPP if and when the U.S. does? Yes, absolutely. Because there is another side of the story: being part of big trade blocs promotes innovation.
What fixes do we have to think about? If we can get ISDS out of any trade agreements, let's do it. If we can't do it, let's at least put it into the WTO. If we can't do that, then let's follow Europe's current lead on what they are proposing for CETA.
For IP, we have to recognize that U.S. legislators have been captured by special interest when it comes to IP policy. Those special interests are now pushing their agenda worldwide through trade agreements. It's very unhealthy for the world economy. It's very unhealthy for the U.S. It's very unhealthy for U.S. consumers. It follows that it's even worse for Canadians. That's what we're stuck with. Let's see if in future agreements we can do a little better than that.
In conclusion, first, trade agreements have been powerful boosters of innovation and productivity in Canada. Second, we can't afford to be left out of CETA and TPP. Third, let's do a heck of a lot better in the future on our trade agreements when we figure out how to handle things like IP, ISDS and e-commerce. Thank you.
Beiling Yan, Senior Research Economist, Economic Analysis Division, Statistics Canada: I have distributed slides. Thank you for inviting us. As requested, we will begin with a presentation of the main findings of our research on trade and productivity. The summary of the findings is published by the Institute for Research on Public Policy, an article entitled Trade and Productivity: Insights from Canadian Firm-Level Data. We will also refer to other studies outside Statistics Canada in the area.
On slide two, there is a close relationship between international trade and productivity in Canada. The aggregate productivity performance of the Canadian economy has tracked its overall trade intensity closely over the past three decades. In the 1990s, both grew quickly, coinciding with a weaker Canadian dollar and the implementation of NAFTA. In the post-2000 period, both fell when the trading environment became unfavourable due to the thickening of the Canada-U.S. border after 9/11 and the significant appreciation of the Canadian dollar.
To gain a better understanding of the link between trading opportunities and productivity, Statistics Canada has carried out a set of research projects over the last two decades using business micro-data in manufacturing that are available for research purposes. The following is a summary of our findings.
On slide three, research has found that better access to foreign markets has improved productivity in the Canadian manufacturing sector. Exporters are found to be the dominant source of aggregate productivity growth, accounting for almost 75 per cent of aggregate labour productivity growth in manufacturing in the 1990s. Based on a number of studies, such as those by Professor Trefler, the Canada-U.S. Free Trade Agreement is estimated to have increased the Canadian manufacturing productivity by almost 14 per cent between 1988 and 1996.
Import activity also contributes to Canada's productivity performance. Our research has shown that a remarkable two-thirds of Canada's effective, multi-factor productivity growth came from other countries, with half the total coming from the United States between 2000 and 2007.
Next we will review our findings on the mechanisms through which trade impacts on productivity.
On slide four we find that firm-specific factors matter if firms generate benefits from gains associated with trade. Greater access to foreign markets from trade liberalization allows firms to increase their productivity through three main mechanisms. The first mechanism is the increasing specialization and economies of scale as plants grow. Several studies provide evidence that a free trade agreement is linked to a significant reduction in the diversity of products being produced by Canadian manufacturing plants, and the substantial increase in the production runs for the smaller set of products.
The second mechanism is that trade facilitates the transfer of knowledge. Evidence suggests that new exporters are 37 per cent more likely to use foreign technologies than non-exporters. Exporting is connected to an increase in the incidence of R&D collaboration agreements with foreign buyers, and firms that begin to export are also more likely to begin conducting R&D. Importing can also enhance a firm's productivity by allowing Canadian firms to access foreign inputs and technologies that are unavailable or more expensive when obtained domestically.
The third mechanism is through intensified competition. Trade forces firms to increase efficiency in the face of more competition.
On slide five, these trade benefits do not happen automatically. They require adaptation and investment. Firms that succeed abroad have the following characteristics: They tend to be adaptable and innovative, introducing new products and processes.
They also tend to be those who invest in advanced technologies, research and development and training; all activities that develop their capacity to learn from international best practices.
On slide six, the trading environment also affects a firm's success. Conditions in the macro environment that are beyond the direct control of Canadian firms also matter, such as tariffs and exchange rate movements. Changes in the macro environment, such as exchange rate movements, have had important effects not only on the degree of experimentation, but also the magnitude of market-share gains in foreign markets, and associated gains in productivity. For example, the depreciation of the Canadian dollar served to reinforce the positive performance of Canadian exporters in the 1990s. In contrast, the productivity benefits normally accompanying new exporters were much reduced after 2000, when the Canadian dollar appreciated significantly.
On slide seven, another important way that trade liberalization policies raise productivity is through industrial restructuring, which leads the least productive firms to exit and the more productive firms to expand, and aggregate productivity improves. This reallocation of production between plants is estimated to have accounted for 50 to 60 per cent of productivity gains in Canada's manufacturing sector that were associated with the Canada-U.S. tariff cuts in the 1990s.
On slide eight, in conclusion, the main insight from the firm-level empirical Canadian research is that adapting to new, larger markets promotes productivity growth. A successful expansion into new markets is affected by broader macro-economic conditions as well as firm-level factors such as the ability to adapt, invest and innovate. Thank you.
The Chair: Mr. Baldwin, is there anything you wish to add?
John Baldwin, Special Advisor, Economic Analysis Division, Statistics Canada: No.
The Chair: We use this term "innovation'' so often. It means so many things within departments and within the public discourse. Mr. Trefler, how do you define it in your case studies?
Mr. Trefler: I use narrow definitions that are much inspired by John Baldwin's work. Innovation is something that helps you introduce a new product or helps you improve an existing process.
Firms are asked very specifically if they have spent money, and how much money they have spent to improve an existing process for manufacturing their product. Firms will respond very specifically to that question. Have you introduced a new product? Tell us about your development cost for that new product. Those are the types of very specific questions that Statistics Canada will vet, and then ask on a large-scale basis to firms. But what it means more generally, is that the question?
The Chair: Yes.
Mr. Trefler: It's hard to conceive of humanity without innovation. Anthropologists like Joe Henrich at Harvard look at how we define humanity. Humans are different from all other mammals because we are social learners. We see people improving something, and we run with it. That's been the history of man for 10,000 years at least.
Innovation is anything that will improve mankind's well-being. For me, it's something very, very general. If we ever move away from that definition, I think we're making a mistake.
Businessmen define it more narrowly. It's almost any activity that is new and will increase value in your company. That could be different ways of managing, as well as more high-tech things like finding ways to put a man on the moon. It's the whole gamut.
The Chair: Do you have a comment then on the role of the government in that process of innovation companies?
Mr. Trefler: First, the government is the massively important in innovation. Anybody who tells you there is no role for government, the free market can take care of it all, simply has no idea of how innovation has happened in the world powerhouse for innovation, the U.S. The U.S. has run many programs that improve their innovation. The most famous of these is DARPA. The U.S. Department of Defense said, "We have a specific problem. We don't know how to solve it. We will fund the private sector to solve that problem.''
Sometimes they're egregious things, like how to kill more effectively. Sometimes they're things which are hugely transformative for our society, like the Internet.
The government plays a huge coordinating role. I think the Canadian government can do even more than they already do. The government does a lot of wonderful things, but I think they can do even more. I'm working with various units within the government for that purpose.
At some point the private sector has to play in the game, and I feel that the private sector has not pulled its weight as much as it could.
The Chair: Ms. Yan, do we track the input from our government vis-à-vis other governments' inputs into their industries?
Mr. Baldwin: There is data collected in Canada on one of the narrow aspects of innovation contributions that Dan has referred to, and that's the extent to which subsidies for R&D, which is one of the inputs into the innovation process, are effectively supported by the government. We both collect data on research and development, and of course the tax system provides subsidies to a portion of those inputs. So that part of the system is tracked.
I'd like to add an additional, broader answer to Dan's to the question of what governments do to support innovation, and a brief story might suffice here.
I can recall being at a session where we were developing innovation surveys. We had representatives from senior technology companies from across Canada, and there were some discussions as to what governments did to support them. The chief of one of the largest companies in Canada said the reason he developed his innovations in southern Ontario is that he got to call upon the best software engineers in the world from at least 16 different universities that are within half a day's travel.
The educational system is a prime supporter of innovation in this country. Skilled workers are essential to the innovation process, whether they be scientists, commerce students or people who effectively manage companies. That's an incredibly important facet. Statistics Canada has a lot of surveys that deal with the education system, the skill levels of workers and how those interact.
In the innovation surveys that Statistics Canada has conducted, they have questions on the importance of HR practices and how they have effectively contributed to the innovation process. There is recognition by the agency that that part of government support is indeed very important.
The Chair: Thank you.
Senator Johnson: Innovation is quite the topic in our country today, and in the world.
Professor Lapham, you noted in a study last year that Canada needs greater coordination of its traditional trade policies with new initiatives regarding productivity, innovation, investment and industrial policy, and I couldn't agree more. Canada is late in the game and far behind most of our G7 peers.
What should Canada do to catch up and become a strong innovation economy once again?
Ms. Lapham: I think the points raised in response to the last question are right on target. I completely agree with Dan in that the private sector certainly has a strong role because the nature of innovation is that it's a public good and there are externalities associated with it. In those kinds of situations the market doesn't necessarily provide the optimal level of such goods, and innovation is a perfect example of that.
I think there is a strong role for government to step in and encourage innovation. There is an understanding that we now have, based on theory and empirical evidence, that there is a strong connection between trade and innovation that goes both ways, and productivity. Trade policy is one way that governments can encourage innovation, as well as through direct programs and understanding that these policies can be used effectively to work together. I think that is important.
Senator Johnson: Should we take a closer look at the Americans, Germans and Japanese, perhaps, in the promotion of innovation ecosystems?
Mr. Trefler: Each of those has separate things we should be looking at. I've mentioned some things that U.S. government already does. The German government has something called the Fraunhofer, which is a series of institutes whose job is to help give very specific insights to manufacturing firms in their locality. I think it has been a tremendous model and has meant that where manufacturers are now sitting at 10 per cent of employment in Canada, it's at 20 per cent in Germany. They saved their manufacturing through government-sponsored innovative activities.
There is no doubt that the government can play a role like that. I think we have nascent versions of that in Canada. The University of Waterloo serves its local ecosystem. It doesn't serve entrepreneurship in all of Canada; it serves high- tech entrepreneurship in that locale, as does the Université de Sherbrooke, and there are several other less-successful nodes trying in other parts of Canada.
The government could find ways of shaking universities and saying, "We have models that work. We're going to force you to scale them up and provide you with incentives,'' to try to replicate things like Waterloo elsewhere in the country. That would be an example of something government can do.
Senator Johnson: I was taken with your comments about trade agreements, not being left out of CETA and TPP and how we have to do better.
What economic or trade strategies would allow us in Canada to ensure that the implementation of agreements like TPP and CETA provide a net benefit to Canadians?
Mr. Trefler: What can we do on the implementation side of TPP?
Senator Johnson: What economic or trade strategies would be useful?
Mr. Trefler: I think agreements have a little more wiggle room than we recognize. They are complicated texts that even great lawyers in Canada are disputing as far as what the content is. We have wiggle room.
If we have a vision of what it is we want to accomplish, then we can play within the context of these agreements. But we have to have that vision because it will cut across departments: it is going to cut across finance, competition policy, human resource development and immigration. All these things will feed into it so the government has to think holistically about the problem and break down these silos.
I personally think the government has to set out a vision of what a national innovation strategy is going to look like. That strategy is going to be something that all Canadians can agree is important, like remediation of old carbon technologies or opening the North to better economic and social outcomes. Whatever our national vision is, let's pick it and figure out how it becomes part of the innovation strategy.
A simple example is that if we want to better serve northern communities we will need to know about self-piloting aircraft, because we will need to send drones to supply them. We are going to need to know about artificial intelligence to guide them, and we might want to scale up with quantum computing so that we can really push at a low cost and deliver wonderful services.
The point is to identify a vision that not only is important to us as Canadians but which builds on our existing expertise in areas like AI and quantum computing and use it to drive innovation in Canada. Let's combine social vision with innovation and come up with something that's crazy important for this country and will propel it into the next decade.
Senator Johnson: What would be your vision?
Mr. Trefler: My vision? I have a few on my list. I have given you two of them. I have much crazier ones.
Senator Johnson: Let's hear them.
Mr. Trefler: First, the North.
Senator Johnson: The North is critical to the future, isn't it?
Mr. Trefler: The North is critical, and there are other aspects of it I didn't mention. We need to protect the Northwest Passage for many reasons, and not just military — I'm not much of a flag-waver in that regard — but also because this is an important and extraordinarily fragile ecosystem and the track record of shipping and oil companies are not very good on the environment.
We need to protect it, and for that we need the technologies that universities in Halifax are developing on mapping sea beds, naval technologies and so on. These are things that we already have expertise on and, to my mind, they would fit into that vision.
Senator Housakos: This has been a very interesting discussion so far this morning, and I would like to pursue the discussion on the innovation side that Senator Johnson and Senator Andreychuk commenced.
Your perspective is interesting where you say we need to have a bold social vision in order to couple it with an innovation plan.
I have a slightly different view. I have a been looking at the United States and Germany models, but particularly that of the U.S., which I think we all agree is a world leader when it comes to technological innovation. I think we have a lot to learn from them.
I think it will be challenging to compete with a nation where the private sector really invests their capital when it comes to innovation. Somehow, they have figured out that putting money into universities and research has a net benefit on their economy.
We keep talking about Waterloo as an example in Canada. It is a great example of success: Waterloo has had the success of having some strong private organizations, fund, grow and nurture it, but we don't have many Waterloos in Canada.
If you look at the United States, they have hundreds of institutions like Waterloo. They really do. Look at the endowment funds at MIT, Harvard and Stanford and across the United States. Our operation pales by comparison, and I believe their success in innovation is driven by profit rather than social vision.
I was wondering what we can do in order to overcome the challenge that we face right now, where we have banks and large corporations in this country that have been hoarding billions of dollars through the last decade and have been hesitant and quite conservative when it comes to reinvesting in our institutions, innovation and technological growth. They step back and seem to be saying a lot of what I have heard this morning, which is that the government has to take the lead. They're the ones sitting on the capital right now while provincial and federal governments are strapped and have a lot of demands with limited resources.
My question started with a long preamble, but I think you get the gist of it. Maybe you can comment on that.
Mr. Trefler: Differentially, I would beg to differ on some points. I wouldn't have chosen MIT; I would have chosen Stanford since it is sitting in Silicon Valley, and I would have pointed out that Stanford received enormous amounts of money from the U.S. government. They lived off the Vietnam War.
I'm not advocating that our vision should be a Vietnam War so we can encourage innovation, but we have to recognize that there is interplay between the profit, which is extremely important, and the government. We tend to belittle the government, but in some sense that's quibbling more constructively.
In my view, there is a small number of pockets worldwide of gigantic success. Boston is one of them, as is Wall Street — for them, but maybe not the rest of the nation — and Silicon Valley. Those are the staggeringly successful accomplishments of the United States. There are not that many and we should not underplay what we have going for us here. We were leaders in machine learning. That might not mean very much when you say it in those terms, but let me say it in other terms: we were the ones who invented, here in Canada with government funds, all the algorithms that we now call Google. For everything we think about on the Internet that is innovative — like Uber — and that is going to broadside whole industries, those algorithms first appeared here at the University of Toronto. We missed the boat on them.
The question is: do we want to miss the boat on the next one that is coming along, like quantum machines? I don't want to miss it, and I don't think anybody in this room wants to miss it. We don't have to miss those things, but it's not easy.
Let me rephrase what you're saying is the difficult part: when a firm goes to market with an idea, it's facing two significant problems. The first is that the people with the money are being approached by potential innovators with lots and lots of ideas. It's very difficult to get to the people with money if you have an idea because so many people are knocking at the gate. You need to have a system that allows people in the Bay Area to see what is truly remarkable in Canada. Not what is happening in Canada but what is absolutely outstanding in Canada, so they can come up here and go shopping almost without cost.
The second thing is that to build a company you need to have the expertise on how to run a startup. The way you get that expertise is not by going to the Rotman School of Management; you get it by running a successful company. If we don't have successful companies, we don't have the expertise to manage successful companies.
We're in a negative spiral. We need to find some way of helping to develop some successful Canadian companies who will then develop the expertise that will cascade it into the next generation of startups.
I think the government can play part of that role, and it can play part of the role for the first aspect, which is helping the Bay Area with a shopping list. I think things like the Venture Capital Action Plan are going to help us in that direction.
Senator Housakos: Fundamentally my question is: Without the private sector taking the lead in Canada, do you think the government has the resources to be able to fulfill the requirements when it comes to technology and innovation?
Mr. Trefler: It's clearly a partnership.
Senator Housakos: What do we need to do to encourage the private sector in this country to step up?
Mr. Trefler: We have some programs that I hope will be interesting, like VCAP.
The government, as always, I think, is best when it's providing information and coordinating. If we can articulate a vision around which to hang that coordination and decide what it is we want to push based on both what we feel and what we have expertise in on the ground already, I think that will allow investors to say, "We're trying to get to point A. To get there today, the first bottleneck we face is that we don't have the engineering to solve this particular problem.'' The private sector will then see there's money to be made there. "That's a bottleneck. If we're the first ones to figure out that problem, we will make some money.'' That's the sense in which I mean the government can help to coordinate it.
Senator Cordy: Ms. Yan, you said — and others referenced this earlier — that conditions beyond the control of Canadian firms also matter. You referenced tariffs, exchange rates, global economic conditions and we know 9/11 was part of that. Who becomes President of the United States will also, I think, have a huge effect on our trade.
Mr. Trefler, you made excellent arguments about the importance of TPP because, overall, we have to be part of the bloc if we are going to benefit. But if the United States doesn't ratify TPP, what does Canada do then? Is it as important that we ratify it if the U.S. doesn't?
Mr. Trefler: I haven't read them, but there are provisions in the TPP for what happens if certain players don't ratify. I could be wrong, but I believe you need a minimum of four players. There are some legal issues that might get us off the hook, but if the U.S. does not ratify it I am very happy to bow out.
Senator Cordy: Ms. Yan, you spoke about exporters being the dominant source of productivity growth in relation to free trade agreements, and I think we all understand that. What we heard before and what you mentioned today was that imports also matter for Canada's productivity.
Could you expand a little bit on how imports are going to increase the productivity for Canadian companies?
Ms. Yan: There has been research at Statistics Canada to propose an alternative measure of productivity which takes into account not only the technical progress in one particular industry but also looks at the technical progress and the productivity growth in all upstream industries, both at home and abroad, that supply the intermediate imports to Canada.
Our research shows that, for example, in 2000 and 2007, around two thirds of productivity growth in Canada came from other countries that have supplied the intermediate imports, and the majority is from the U.S.
The reason is that Canada is highly integrated into the intermediate global production process. We import around 23 per cent of intermediate imports, compared to 10 per cent of other advanced countries. In post-2000s, the U.S. has had higher productivity growth and Canada's has slowed down, so the contribution from foreign countries becomes greater in Canada when you calculate productivity growth in producing final products.
That shows that the competitiveness of Canadian industry depends not only on the technical progress within the country, but also on the degree of integration into foreign countries and how they perform so it can transmit to Canada.
Senator Cordy: Mr. Trefler, just to follow up on Senator Housakos' question, I was at another committee and we studied post-secondary education. We found there was tremendous research and good things happening at universities, but there wasn't the private industry interest to bring the knowledge or products to market. How do we deal with the good things happening, which is great, if they're not being brought to market? It's great for the people studying and being innovative, but it's not developing commerce for the country.
Mr. Trefler: That is the $64,000 question. We're not the only jurisdiction struggling with it. If you look at offices of technology transfer throughout the U.S. at major universities, most of them are flops. It's not just us.
My current thinking about some way out of this huge and important difficulty is really part of what I was saying before. We need to create ways to tackle the two problems that these startups are likely to have, which are financing and skilled people. We need to connect university researchers with those two groups of people. I can think of three touchstones.
First, universities are responsive to local entrepreneurs and run internship programs that connect them with those. Second is a model that we're trying to run at the Rotman School of Management called the Creative Destruction Lab, and we've raised several hundred million dollars in seed capital. It's a new program and places like Harvard Medical School are asking if they may emulate our model.
It's trying to hook up researchers with successful entrepreneurs in sort of a "Dragon's Den'' type of environment where we pick some of the best applicants and give them tasks to do to get to the next level of their business. If they don't complete those in very short order, they're kicked off the island. I'm mixing metaphors here because I don't watch television. That's one possibility.
A much longer one where we can make progress — I'm hesitant to say this although I'm a firm believer in early childhood education — is something like SHAD in Toronto, which is a high school with a focus on entrepreneurship. I love high schools that are devoted to the arts, and I don't want our high schools to become centrally focused on business. We could do a little of it if there are interested students and communities. These are ways I think we could funnel it.
At the end of the day the most important thing to get our heads around is that there are tons of small-scale good things happening in this country, some government sponsored and some completely private-sector sponsored. We have to be more flexible and quick on our feet in identifying what works and actually getting the resources to the experiments that are working so they can scale up rapidly.
In today's age of innovation, these cycles are far more rapid than anything we've ever imagined in the past. We need to scale up quickly, identify the successes all over the country and plow money and resources into them.
Senator Cordy: Your presentations were clear, concise and easy to follow. I thank all of you.
Senator Poirier: I agree with my colleague that your presentations were good.
Mr. Trefler, back in January this year you were one of three who wrote an article in The Globe and Mail on the TPP stating that Canada needed the TPP and couldn't be left out. The article ended with a suggestion that Canada should proceed to enter into trade negotiations with China. Since China has the second largest economy, it has been suggested a number of times as a potential trade partner. Is it possible to have a good trade agreement for both countries in the short term? In your opinion, what time frame would we be looking at?
Mr. Trefler: That's a brilliant question. China has a different culture, which we all know. I mention that because negotiations in China are more relational than transactional than they are here. When we go to China we have to think long horizon. My horizon is very long. I'm saying we need to get in now; otherwise we might face the same problems we had with the TPP. By being the last in, we face dramatic problems. I don't want to be in that situation again with China. I want to start the negotiations now. I don't think that I have a firm timeline in mind.
The Prime Minister started off in a great way, but China is not starting off as well as I would like as they are starting negotiations with preconditions. I don't think Canada should be starting negotiations with preconditions about pipelines and so on. We should start the dialogue, which is very important. Right now in Chinese relations we are sitting in the shadow of the U.S. The U.S.-China relationship is becoming increasing confrontational, although not out of control. Canada should get out of the U.S. shadow and be independent in what we think. We should be on every international committee where there are China issues, whether they are military or financial like the Asian Development Bank, which we should have signed onto. We should have been the first ones in on that.
We should get out of the U.S. shadow and have points of contact with China everywhere we can find them and build on that over probably a very long time. I don't think it is going to be anything imminent. We need a starting point. Let's get started.
Senator Poirier: During the Prime Minister's visit in Japan an article stated that having a closer relationship with Japan could hurt our relationship in trade opportunities with China. Is that a fair statement?
Mr. Trefler: There are two dimensions in that statement. One is economic, where it makes no sense. No one is more integrated with China than Japan. It does not make sense on the economic level. Clearly we're talking about something to do with strategic interests and military issues. It's far outside my ken, but my points earlier are germane. We need to make as many points of contact as we can. We can't let China completely control the agenda. We are a sovereign country and we have a sense of what we want to accomplish.
Senator Poirier: On June 23, Britain will vote on whether they will stay in the EU. In your opinion, what will be the impact on CETA?
Mr. Trefler: I haven't thought about that at all. I don't know the answer to that.
The Chair: Ms. Lapham, do you have anything to add on those two points?
Ms. Lapham: Not on the latter point, but on the China issue I completely agree with Mr. Trefler. This is a big player in the world market. They're not going away and they're growing. It's very important that Canada have good relations with China on trade. I'll come back to the last point I made in my presentation: A big part of the concern that Canadians and Americans have is about the impact on the individual in those countries, as people believe that jobs are exported to China and so on.
In order for that kind of free trade agreement to go forward, Canada and the U.S. have to face the issue that certain people are hurt by increased trade with these countries and think about the policy, and the policy reactions to dealing with that I think are paramount. It's a very tricky issue and a huge issue with a country like China.
Could I comment on something raised earlier on the issue of importing that you mentioned? Ms. Yan raised some interesting points about the exchange rate and the depreciation of the Canadian dollar being important for promoting exports and exporters. If we think that importing by firms is important for their livelihood and the connection with productivity, the depreciating Canadian dollar is actually harmful to them if they're buying goods.
If we think that the role of firms as importers is growing, the issues of exchange rate movements and how that affects firms becomes much more nuanced. It's something to keep in mind, as we think that imports are as important, perhaps, as exporting for firms.
[Translation]
Senator Rivard: Almost all of the witnesses who have appeared over the last few months are favourable to free trade agreements like NAFTA, which is almost ancient history, but especially to the agreement with the European Union, and the new Trans-Pacific Partnership Agreement.
When we talk about free trade agreements, exclusions or quotas should be discussed. For instance, with the European Union, cheese imports are limited. However, once these guidelines have been established, we expect the see the free circulation of goods and services. In other words, there are no countervailing duties, in the form of taxes or other things. That is what free trade is. That is how I understand free trade.
An increasing number of American states are adopting restrictive measures and inserting conditions in calls for tender, such as for the construction of interstate or in-state bridges, that advantage certain parties unduly and basically exclude Canadian entrepreneurs. The Americans triggered expensive litigation on softwood lumber that lasted many years, the pretext being that the Canadian forestry industry was subsidized too heavily.
Now, given the possible nomination of a certain candidate to the American presidency, who states that he can build walls at the borders of certain neighbouring countries, and force companies like Apple or other telephone manufacturers to bring production back to the United States through legislation, and since the market will always prevail, do we not have cause for concern?
Also, when states introduce protectionist provisions regarding the construction of a bridge or a stadium, for instance, the steel must be produced in the United States, and the skilled installers must be American. Those are the concerns that I wanted to share with you concerning the situation with our neighbour. How could the current situation get worse?
[English]
Mr. Trefler: Your concerns are well placed. As trade agreements have become deeper, one of the important provisions that we have added to them is sub-national clauses on procurement policies. That is certainly an issue. It has come back to bite us in Canada, I think the Ontario government on some of its clean initiatives.
One has to keep things in context. These trade agreements are not perfect, so we're balancing interests here. To date I don't think these procurement issues have been the most important. I would love to have been able to deal better with them in agreements, but that's one of the costs and one of the downsides.
I understand from your question, though, that you're looking forward to what might be a spate of buy-American policies under Donald Trump. I have sort of a strange view of Trump which is not, I think, the way most people see it. I am not a follower of American politics, but I see two things we should bear in mind.
The first is to remember that Bill Clinton was against NAFTA, but he signed it. He put up cosmetic dressing with three side accords and then he passed it. I don't know what Trump will do when he is in office, partly for that example, but partly because I don't know who will pull him more: the extreme right of the Republican Party or whether he'll find something that is a little more to the left of that.
This will sound very odd, and I just don't know how the world will play out, but I mention it because it's relevant to future trade agreements. The other thing that I think we should bear in mind is that Trump is playing heavily to the media in a way that politicians perhaps haven't done as successfully in the past. We can pooh-pooh that or we can celebrate it, and there are reasons to do both.
When I think about writing future trade agreements, we are going to run into the same dilemma. Do we want the negotiators to be out there in the limelight on social media justifying what they are doing? In and of itself it might be the right thing, but for a small country like Canada, pushing up against some very large corporations in foreign countries, it might solidify the government's position. The government would be able to say they have massive discontent on this particular provision of the agreement and can't possibly sign it. That will lead either to the failure of agreements, or to better agreements. I'm not sure which.
We should at least start thinking about whether there is another way of negotiating trade agreements in which there is more of a democratization of the process. Will that help agreements and not hurt them?
Mr. Baldwin: I'm not going to comment on whether the presidential election will change matters, but we were called to come and report on a very specific set of research, which has to do with how firms adapted to trade in the past.
There is another body of research that has been conducted in the economic analysis group that doesn't use firms per se but uses trade flows. It asks to what extent those trade flows, both across Canadian provinces — across Canadian states — and across the border show that the system has opened up, and all of those barriers that Mr. Rivard referred to have become less important.
The research is about to be published and it shows that, unfortunately, we haven't made as much progress as I might have thought as an economist post-NAFTA and the reduction in so-called import barriers to the United States. That is, the height of the barrier offered by the border has effectively not diminished very much. I think that's of importance in consideration of where you need to go in the future. Those things should have fallen, I think, but they haven't and policies can be directed in those particular areas.
[Translation]
Senator Rivard: I would like to reply to Mr. Trefler's comment concerning Mr. Clinton.
[English]
The Chair: I'm told that we have to end this at 11:45 because one of our panelists has to catch a plane. I have two other questioners. Go ahead.
[Translation]
Senator Rivard: Mr. Trefler, you reminded us that Mr. Clinton was not in favour of free trade. We must remember that it was Brian Mulroney who concluded the free trade agreement in Canada. His successor had stated that he would ax it, which was not done. What I find encouraging is your comment is that as you reminded us, there was a president on both sides of the border. Consequently, if Mr. Trump takes power, it is possible that he may realize that it is not a good idea to meddle in the free trade dossier.
[English]
Senator Ngo: I would like to follow up on the responses from Mr. Trefler and Ms. Lapham.
You mentioned Canada should take every opportunity to connect with China. You know China is one of the main violators of human rights in the world. How would Canada prioritize human rights versus economic ties with China?
Mr. Trefler: You're putting me on the spot for a very difficult question. First of all, I would not say that China is the worst abuser of human rights on the planet. I think there are a large number of jurisdictions in this world where very sorry things are being perpetrated against civilians in the name of ideals. We could name many places. I don't want to single out China for that.
The question becomes an impractical one: whether engagement leads to better human rights outcomes or lack of engagement. I don't think I have the answer to that, but lack of engagement with China feels to me literally like the metaphor "water off a duck's back.'' I don't think the Chinese care one iota about what we say. I'm not sure that "punishing them by disengaging'' will have any impact to help citizens of that country, as compared to engagement and capacity building to help them think it through.
I was in Beijing a few months ago. I was asked to a Beijing forum to talk about corruption. They are prepared to talk about abuses in the right language. We have tremendously successful ways of dealing with corruption in this country. We face corruption and we deal with corruption. Being engaged with the Chinese to see a model of how you can deal with those things is helpful. I understand it's a very difficult question.
Ms. Lapham: I like to think that economic prosperity lowers corruption. It's not necessarily the case, but I like to think that engaging in these kinds of trade agreements and integrating economies raises welfare and leads to less corruption. That's a naive view potentially. I agree with Mr. Trefler that this is a huge issue, but I certainly don't think closing doors and isolation will help. It will only harm.
Senator Ngo: The question I'm asking is not whether we would like to isolate China. We know that China is a human rights violator. We are sure about that. Do we try to prioritize human rights over economic considerations? Which one is ahead of the other? To be sure, you have to know that the majority of the company is sponsored by the government. Basically, you are not doing trade with private enterprises but with the government, the work of the Crown ownership.
Mr. Trefler: A lot of the issue in your mind is about state enterprises. That sort of narrows it down.
There are specific things that engagement brings us. I have concerns about state-owned enterprises, absolutely. Engagement brings us very specific things. When we start writing contracts with state-owned enterprises, China is just beginning to develop its contract law. Looking at a small number of decisions by things like the Supreme People's Court, you sort of shake your head and ask, "Did they really think this out?'' If we have Canadian-based lawyers arguing about jurisdictional issues, law of laws, and saying, "Hey, you got it wrong. You cannot make these arbitrary decisions. You have to abide by an international standard,'' there is a chance for the Chinese legal system to start sort of incrementally rethinking.
Do I have evidence of that in the historical past? Yes, in fact I have written several papers and am trying to write a book on the impact of international trade on legal systems. I'm writing a paper now on the impact of FDI into China on the development of patent courts. I don't want to overstate this case, but there is certainly something that engagement brings you. There are advantages to engagement. Of course these will ultimately be political decisions, so I defer to the Senate and to the House of Commons on where we'll draw the line.
Senator Oh: I've travelled to China since 1978 and subsequently. I have seen the improvement of life of many Chinese. Do you agree with me that the lifting of human rights for 600 million people who improved their lifestyles in China, from poverty to a much better life today, not only helps the Chinese people but also helps other countries in trade and world economics? It benefits countries throughout the world. Do you agree?
Mr. Trefler: I certainly agree that we especially, as Canadians, have to be cognizant that trade agreements are not just about us; they are about the planet. Trade agreements have brought prosperity, and they have also brought harm, to literally a couple of billion people. I don't think we should soft-pedal that.
Senator Oh: Talking about SOE you couldn't find any big company in Asia that is not SOE. It covers almost everywhere in Asia, and in Africa too.
Mr. Trefler: Alibaba is going through my mind.
The Chair: I'm not sure that's the point I wanted to end on with you, Mr. Trefler, but you have to leave. You can see that you have engaged the committee successfully. We thank you for your input.
I have one further question that the researchers have asked me to put. It's one that we have been tracking for the other panelists, perhaps more StatsCan. We have been told along the way that perhaps our model of gathering statistics around trade agreements and economic factors may be outdated because it's more skewed to information about goods, where in fact we are tending more to services. Do you believe that you're covering, in Statistics Canada, the issues that are extremely important to the new-wave economy?
Perhaps you could identify yourself, sir.
Éric Boulay, Assistant Director, International Accounts and Trade Division, Statistics Canada: My name is Éric Boulay.
There is a fair amount of information that we collect and publish already. It's on a quarterly and annual basis. We have international trade and services available quarterly by some 25 partner countries that we publish as part of our conceptual framework that we call balance of payments. A number of categories of services are available in terms of services like transportation, government services, commercial services and travel. This is kind of the framework in terms of the work that we do on services.
Just recently we launched some new products in terms of foreign affiliate trade statistics, both inward and outward foreign affiliate statistics. One of the key highlights, for example, of that new product we launched back in December in terms of activities in Canada of foreign, majority-owned Canadian affiliates. As a key highlight, they are responsible for a total of 50 per cent of all our Canadian exports, for example.
The importance of these affiliates in the country is growing. In recognition of that, StatsCan has launched this new product. At the international level, all the major countries are producing such statistics as well. For example, those affiliates in Canada generate 1.9 million in terms of employment. That represents about 12 per cent of total employment in Canada. That is the information that is shedding some light on the importance of that kind of service industry as part of the Canadian economy.
The Chair: That's very helpful. We also hear about the global networks and chains of the world now. This is one piece; the foreign portion.
A widget comes into Canada and is put into something that's being shipped out somewhere else. Are you starting to track all of our activity — because it is very global now — both intellectual and product-wise?
Mr. Boulay: Basically, we have a product called value-added exportsthat actually adjusts the import content of our exports. This is an annual product that is released by another division called the Industry Accounts Division, so that's kind of in line with the question that you asked.
There is further research being undertaken in terms of what we call manufacturing services called goods for processing. We have goods actually coming through our customs and recorded as regular flows when they are being brought into Canada only for some transformation or manufacturing services to then be sent back to foreign countries.
We can't actually isolate that type of information, but there is an ongoing initiative to try to measure those flows, remove them from our gross flows and then just show, as a service, the difference between the import and export values in terms of these goods. Because of the global value chain, we are seeing more of those kinds of movements in terms of goods being sent abroad for processing or being repatriated back into Canada for processing.
Danny Leung, Director, Economic Analysis Division, Statistics Canada: My name is Danny Leung, and I'm director of the economic analysis division at Statistics Canada.
I would like to add that there is ongoing work in improving our capacity to track the movement of these goods. Beiling Yan already alluded to work where we used what we call the input/output tables to look at how importing inputs from the United States and other countries led to productivity improvements in Canada.
That project was a first pass at trying to get at the issues that you have mentioned here. I say "first pass,'' because linking all those production factors across the different commodities is a large task. What has to be done is to make sure that the accounts we have in Canada actually correspond and balance with the ones in different parts of the world.
In the study done by Beiling and her co-authors, assumptions had to be made so that all these things would add up. A current project we have is to take one step back to try to look at a more limited set of connections between Canada and the U.S. and Canada and Mexico, who are our principal trading partners, to make sure we have those connections correctly measured in the sense that we make fewer assumptions to make that system balance.
All that is to say we are aware of the need to create these statistics and we are in the process of improving on what has been done already.
The Chair: Thank you. Thank you for coming, Ms. Lapham, and everyone from Statistics Canada. Your input is extremely valuable. It helps us understand in more depth some of the initiatives at Statistics Canada and some of the perspectives on the topic as we presented it today.
Senators, we're to go in camera on two issues. That will be rather quick, and we can adjourn for the day after that.
(The committee continued in camera.)