Proceedings of the Standing Senate Committee on
Foreign Affairs and International Trade
Issue 24 - Evidence - Meeting of March 25, 2015
OTTAWA, Wednesday, March 25, 2015
The Standing Senate Committee on Foreign Affairs and International Trade met this day at 4:15 p.m. to examine such issues as may arise from time to time relating to foreign relations and international trade generally (topic: trade promotion).
Senator Percy E. Downe (Deputy Chair) in the chair.
[English]
The Deputy Chair: I call the meeting to order. The Standing Senate Committee on Foreign Affairs and International Trade is continuing its study on foreign relations and trade issues.
Today we'd like to welcome Dan Ciuriak, who, among other things, is a research fellow at the C.D. Howe Institute. I understand you have a presentation and afterwards we'll have questions from senators. Please proceed.
Dan Ciuriak, Director and Principal, Ciuriak Consulting Inc. and Research Fellow, the C.D. Howe Institute, as an individual: Thank you very much for this opportunity. It's always a privilege to appear before this committee. This is my first time here in my personal capacity. I was here before as a member of the Department of Foreign Affairs and International Trade.
My name is Dan Ciuriak. I am director and principal of my own consulting firm, a small, rapidly growing firm. Most of our sales are exports. We work with people in Canada, from Halifax to Victoria. We serve major business clients, governments, international development banks and think tanks. We've worked in Canada, Europe, Asia, Africa and the Caribbean, and I'm working 18/7 as a result. As mentioned, I'm with the C.D. Howe Institute as a fellow in residence and was former Deputy Chief Economist at Foreign Affairs and International Trade.
In terms of Canada's trade and trade promotion programs, the background, as you've probably heard from many witnesses, is that Canada's trade performance has been desultory, unsatisfactory generally, and there are probably a lot of reasons why.
In response, Canada has launched a new global commerce strategy. It has tried to reduce the costs at the border. It has entered into new trade agreements and is negotiating more, and it has expanded its trade promotion policy in terms of a diplomatic offensive.
I should like to comment on all of these things. My basic work as a consultant and with C.D. Howe is in quantifying these kinds of effects. I imagine that is what attracted attention to me here.
As background, in a private sector economy, it's not countries that trade but firms. If we want to expand trade, we can either expand the sales by existing exporters or we can expand the number of exporters. Our agreements, the various initiatives to reduce border costs, to reduce trade costs through free trade agreements and to expand our trade promotion activities seek to reduce trade costs for both existing exporters and for new exporters. I will argue that they basically work for existing exporters but do not do so well to bring new exporters into the game.
Trade costs are what keep firms from trading. It's a lot more expensive to trade across borders than to trade within a country. These include the cost of just crossing the border as well as fluctuating currencies. And for this committee, I would urge you to think in terms of unit financial costs of trade. If you have to hedge your currencies, that's a cost to you. It's a profit centre for banks; it's a cost centre for producing companies.
Distance is a factor, which raises transportation costs. There are language and cultural barriers. There are different product standards, and one of the major efforts of modern trade agreements is to reduce duplication so that firms do not have to get duplicate certification of their products.
There are information costs. In trade, we talk about asymmetric information in trade costs. What this means, basically, is that when we go into a foreign country, we know less about it than our partners do. There is a kind of a tourist tax there because we wind up paying more than we should.
There are beachhead costs, which can be expensive. What are beachhead costs? If you want to establish a presence in a foreign market you have to go and acquire knowledge about that market, make partnerships, get on the plane, maybe establish an office there to help with your representation, to help with your after-sales service and so forth. It's an expensive proposition.
The economic literature suggests that these kinds of beachhead costs can range between $500,000 and $1 million to establish a significant presence abroad. It's not cheap to become an exporter.
Many of these costs are fixed. That's important to understand. If you're selling a very large amount, then these fixed costs are spread out over large volume and they become less onerous. But if you're a small firm, you don't get to spread them over a large volume. The small shipments that you send abroad bear the whole cost, and for small firms this can be prohibitive.
What we find as a result is, as a stylized fact of the real world, most trade is conducted by larger companies that also happen to be at the top of their class in terms of profitability, productivity and efficiency. It's because they're the only ones that can handle all the costs of trade and still be profitable. For smaller firms, these are prohibitive.
The evidence, if you look at Germany, for example, you'll find that about 90 percent of German firms in a study group will be exporting within the European Union. Only about 37 per cent will be exporting to Canada and maybe only about 27 or 28 per cent to India and China. That reflects the difference of not having a border, a currency cost and, of course, distance.
Even the instruments that we use to reduce all of these trade costs come with their own costs. For example, at the border, we institute policies to reduce the cost for trading firms crossing the Canada-U.S. border such as the Trusted Traders Program or the Authorised Economic Operator in the jargon of the world customs organization. But the costs of qualifying for this and complying with these programs are heavy and, as a result, the uptake on these programs is quite low.
Similarly, when we strike free trade agreements to reduce the border costs, and for example the tariffs and non-tariff barriers facing firms, these agreements may be tariff-free but they're not cost-free either. You have to comply with rules of origin in order to access these particular preferential windows. The costs can be high. First you have to get a certificate of origin for every shipment above $1,000. You have to keep the records for seven years. You face potential audit and if a ruling goes against you five years down the line that maybe something you thought was qualifying for originating status and the Canada Border Services Agency decides no, you may face millions of dollars of liability in duty which has not been paid. It can bankrupt you. You may have to hire a professional rules-of-origin specialist to navigate this world.
To give you a sense of the complexity, the NAFTA rules of origin regulations run to 556 pages of dense, legal, technical text. It's not a simple thing to trade.
What we see is that the main instruments that we have to facilitate trade work are basically for the larger firms because they impose costs that only the larger firms can carry.
Trade promotion is a bit different, and this is the interesting feature of it. Trade promotion actually targets SMEs and it doesn't impose costs. It actually reduces costs for SMEs. This is an interesting element for us in terms of thinking about how it works. However, there are some difficulties. What we find when we examine the effect of trade promotion is that the biggest benefit from it comes from establishing an embassy abroad. It's not from having more consulates, more trade commissioners or boots on the ground selling Canadian products, it's from having that diplomatic relationship with the foreign government.
My results from the C.D. Howe study, which I am sure you have seen, are corroborated by other studies, and it's a curious factor. Why do we not get more bang for the buck, as it were, from these additional consulates that we're establishing in China, Chengdu and other places? This is an interesting question because when we study the effect of a firm accessing the trade commissioner services, on that firm's export sales we find there is a significant boost. So if a company makes use of the TCS services, we found in a study of foreign affairs that they get a boost of 18 per cent of exports compared to a very comparable firm, a matched firm — identical as far as we could make it in all characteristics — that did not use those services.
There is almost a 20 per cent boost to trade for using these services. Why do we not get more of a bang from opening more consulates? The contradiction is answered simply. If you look at the number of firms that actually utilize these services, it's quite small. It's on the order of 5 per cent of all the firms that export to the United States, about 10 or 15 per cent of firms that export to Europe and East Asia. Even though most of them are SMEs, the total number of these firms is not large enough that if we were to double or triple or even quadruple it that we would make a serious dent in our export picture.
This is not an easily scalable kind of a program. That is the challenge that we face in terms of mounting a trade promotion policy.
The things we do to promote trade work primarily on one avenue of trade, which is to expand exports by existing exporters. The border costs for reduction work for larger firms, the FTAs work for larger firms, and even the trade diplomacy through the establishment of embassies, government-to-government diplomacy, works primarily with larger firms in countries, again in countries where the government is more engaged in the economy. These are countries like China and Vietnam and so forth.
Typically these are not going to be SME products. It's going to be in things like major wheat sales or other kinds of commodity sales. That's our challenge.
I have some suggestions of avenues we could explore. If I may take the liberty, I will put them forward.
The first thing I would argue is that there is no reason why we should have the kind of border between Canada and the United States that we now have. The Swiss-EU border is a much less costly border than we have. If we could arrange a Swiss-EU type border, and there are no problems of military risk or anything else between Canada and the United States any more than there is between Switzerland and the EU, and they can live with it, we could expand the number of trading firms entering into trade between Canada and the United States substantially.
The second thing I would suggest is that we promote a reform of rules of origin in free trade agreements. I have a proposal that will be coming out from C.D. Howe shortly in this regard. I can explain it to you if you are interested in it.
The third thing is we need to expand our economic diplomacy. Based on the results that I have obtained, which the literature confirms, the avenue to go is to expand our diplomatic presence through embassies, government to government, and that is where we gain the big bucks in terms of export revenues. I'm not saying that we should not expand our network of trade commissioners, but the scale at which we would need to do this to make a serious expansion of exports is quite daunting.
That brings me to the bottom line, which is that there is nothing easy to do to boost the number of small- and medium-sized exporters engaged in trade. I think in this regard, we have to then look at the other economic policies that impact on Canada's industrial ecology. We don't have an awful lot of firms in Canada capable of exporting. That is one bottom line. If we expand the cadre of firms, which is to say not the small micro-sized firms, but the larger firms in the SME category that are capable of trade then we will tend to expand the number of exporters also. I think that this points to our innovation and manufacturing policy.
As a final point, I would observe in terms of global value chains, which is a major issue and I'm sure you've heard a lot about this, if you examine the content of global value chains, very little of it is services. Very little of the intermediate inputs in export products are imported services. Almost all of it is imported goods. To participate in value chains you have to be exporting manufactured goods. We will sell more services internationally embedded contained in a manufactured good than we will sell as a stand-alone product into a foreign value chain. So we need to think about manufacturing, not in terms of traditional ways of saying that we're indifferent between manufacturing, services and resources. We have to think of manufacturing as anchoring our ability to participate in global value chains, including our service exporters. I will end my prepared remarks there.
The Deputy Chair: Thank you very much. It was an excellent presentation and has generated a list of questions.
[Translation]
Senator Fortin-Duplessis: Mr. Ciuriak, could you tell us a bit more about the economic diplomacy concept you mentioned? What are the advantages and disadvantages of that approach?
[English]
Mr. Ciuriak: In terms of economic diplomacy, the question is: Can we draw some kind of correlation between where we spend our diplomatic capital and where we get our exports and why is that?
For example, if you look at the extractive industries, oil and gas, and mining products, diplomacy doesn't seem to affect that whatsoever. The main reason for that is all of our extractive products flow into the North American market. We can't test how much diplomacy works there. We know that Canada pulled out all stops on the Keystone Pipeline and it didn't work. But we can't add an embassy in the United States. We already have one and I'm not sure that adding consulates would have changed the story either.
So diplomacy will not always work, but insofar as what we can find from studying the numbers then that is one thing. In the agricultural area, what you find is that these are managed trade areas. What we sell is very similar to what the Americans sell. Canadian, American and Brazilian soybeans are all soybeans. What matters is not necessarily the quality of the soybean, but the quality of the schmoozing.
I have an anecdote: a former friend of mine went to work on executive exchange with Merrill Lynch and he said that the underlying products that we sell and that the competitors sell are the same thing. What counts are the client relationships. Thus the counterpart of economic diplomacy is the quality of the relationships. The interesting part for us as a democratic and a market oriented country is that where economic diplomacy matters most is in the less democratic or market oriented countries where the government is more inclined to interfere with the economy. Our challenge is then to manage our relationships with countries which are less like us, and that can be hard. Does that get to your question, senator?
[Translation]
Senator Fortin-Duplessis: I would like to ask another question, if possible, Mr. Chair.
The Deputy Chair: Yes.
Senator Fortin-Duplessis: I noted that you have vast experience and that you wrote articles for the C.D. Howe Institute. You did a lot of work over several years. You were surely in a position to evaluate the services the federal government provides to small businesses and SMEs.
In your opinion, which federal trade-related services do Canadian businesses find the most useful?
Mr. Ciuriak: Could you repeat the question? I did not understand it.
Senator Fortin-Duplessis: Which federal trade-related services do Canadian businesses find the most useful? In the course of your experience and activities, you must surely have found certain services to be excellent. Which ones were they?
[English]
Mr. Ciuriak: For companies that actually use the federal services, what we find is that the services from our posts abroad are more valuable than the headquarter services. What we find is that the services that help a company to go global, sort of the export starters, are also very valuable. But the information and the ability to make introductions, to break down barriers and to forming relationships with foreign firms, that is what helps our SMEs abroad. In terms of the nature of the things that work for the firms that utilize these services, it is the fact that we've got these people abroad who know the ropes there, who have contacts and so forth. That being said, as I mentioned, in terms of what really seems to impact our exports overall is simply having good diplomatic relationships with countries and that helps us to win the big contracts.
Senator Oh: Thank you for the wonderful information.
We all agree that SMEs play an important role in our economics — 75 to 80 per cent of the economic growth. Are you familiar with the government announcement on March 18, last week, about a new Export Market Development program, which would provide a total of $50 million over five years of direct financing assistance to entrepreneurs seeking to export to emerging markets for the first time? Would you be able to comment on that?
Mr. Ciuriak: Not at this point in any serious fashion because it is a new program. We still have to see how we will work. We have to see what the uptake will be by firms and to see whether or not it actually does impact on their ability.
A lot of this work depends upon execution. So simply throwing money at something is not necessarily going to solve the problem. As mentioned, for example, we've poured a lot of money into the border initiative, but that same initiative generates costs of compliance. To access this new money, I am sure there will be controls and audits and so forth. The question will be whether or not the cost of accessing this will be sufficient to induce firms to actually make use of this and profiling the help that it will provide to firms.
Again, if we look at what history has shown, relatively few small firms make use of the mechanisms that we put in place to promote trade. The reason for that is because the access to these instruments is also costly.
Again, I'll draw a parallel with the rules of origin. If we look at a trade where there are large volumes in the shipment and it's a high tariff, almost 100 per cent of these shipments will utilize the FTA preference window. As the tariff falls, the preference utilization falls. As the size of the shipment falls, the preference utilization falls.
In Canada, for a tariff of 1 per cent, the utilization of NAFTA preferences falls to 17 per cent, so 83 per cent of importers pay the MFN tariff rather than go through the rigmarole of accessing the preferential window.
So it depends upon how much the $50 million will be on a per-exporter basis and what share of the costs of market access that amount of money will cover. That we just don't know. We have to see how this thing works in practice.
Senator Oh: In my many years of experience in trade, I was past president of different trade organizations, and many SMEs came to me for help. Similar to this program, they wanted the government to assist them in the export market. It helped them reduce the costs for going into emerging markets for the first time.
Mr. Ciuriak: I absolutely agree with you. Small firms face high costs and they look for every bit of help they can get. I'm sure it will help with the margin. It will help some firms get into trade.
Again, the real questions are what will be the scale of assistance per firm? How many firms will actually take this up? Will they see this as efficient to induce them to make the sum costs of trying to establish themselves in emerging markets? It will not be easy for a small Canadian firm to establish itself in China, for example, or India.
Right now, I think we have to be agnostic. I think it's a good initiative to expand the resources that we're putting in this area. I think it's important that we study how it works and then make corrections in terms of the mode of delivery, if we see that firms are not taking up this particular new assistance.
Senator Eaton: Thank you very much for your presentation. I'll raise three things and if you could comment on them quickly.
You talked about how the Canada-U.S. border should be more fluid, that there's really no military reason for it not to be, if you think of Switzerland and the EU. We've had other witnesses here who have said to us that as long as the Obama Administration is sitting in the White House, there's not much point. Or do you see the fault on Canada's side?
The second thing I'd like to ask you, when you went through the unit financial costs — i.e., the currency, the distances, cultural differences, product standards differentiations — that SMEs face going to other countries, is there a country like ours — I'm thinking about Australia or New Zealand — or a country in the EU that has managed to jump these hurdles more successfully with small- and medium-sized businesses? Is this a worldwide problem or a Canadian problem?
Lastly, when we went to Indonesia — you're talking about the trade commissioners and how useful they are — we heard that but we heard over and over again in both Indonesia and Singapore that there is nothing like having a company presence there to establish customer relations one-on-one to build up confidence and trust. It's all very well for these trade missions to go and visit them, but they really feel more comfortable and more apt to do business with companies that make the leap and actually have a physical presence.
Mr. Ciuriak: On the Canada-U.S. border, I think very definitely the United States is a difficult partner in this. I think if it were up to Canada, we would probably have a Schengen border, as between France and Germany — i.e., there wouldn't be a border. It's been the target of many Canadian policies, and I don't think we have a concern.
My own personal view — and this is when I was in Foreign Affairs — is that it is so much in Canada's interest to protect America's border, we are their best friends in this regard. They are, however, as I said, a difficult partner in this. This will be difficult, but I think it works two ways. I think it also works for their SMEs. I think it's important that we get across the message that this is debilitating for both economies.
If we think about what firms do when they enter into trade — and there's a lot of research on this — once a firm makes that commitment to enter into trade, it makes innovation in process technology; it tends to scale up technology, so that's a driver of productivity. It tends to innovate, and it innovates in terms of products and processes. It engages in much more employee training. Basically speaking, it raises the level of its game across the board.
Now, if the firms along the Canada-U.S. border — and we have one of the longest borders in the world, I think maybe the longest border. We've got firms in every state. Every Canadian city, I think, is closer to a major U.S. city pretty much than it is to the next Canadian city and the same applies to U.S. cities along the border.
So for this region, the removal of the border would be huge in terms of the impact on firms on both sides. That's a cost that keeps mounting year after year for no good public purpose on either side. If we think about the role of firms in trade and what that would do, I think that may be one way that we can start to build up our case for making this border basically disappear from a commercial point of view.
On the unit financial costs and the other cost factors, the facts that emerge from, for example, monetary unions are that monetary unions induce quite a bit of trade. Now, we don't have a very precise estimate of what that impact is, but it's significant. That tells us that currency costs are significant in terms of reducing trade.
The term "unit financial costs" is not used. We talk about unit labour costs, and that rings bells for us in terms of saying "we have to get our unit labour costs down." But unit financial costs are basically a profit centre for banks or a big cost centre for producing firms, and the risk factor of entering into longer term contracts than having your own costs go up because the exchange rate has moved sharply is a major deterrent to trade.
Within the eurozone, you see a big boost in trade amongst countries that don't face that particular risk. You also see a big boost to trade within the Schengen Area from not having a border to cross.
Has anyone done better? Yes. Within the EU they've surmounted these costs. Norway is another good example. Norway is a country much like Canada. It's not part of the EU, so it faces a border and it trades a lot less with the EU than countries inside the EU. These things are quite expensive and it's very hard to get around.
In terms of the question on Indonesia and trade missions versus having a presence there, I think there's no question that — first of all, there has been study on whether missions like Team Canada actually impact on trade, and the jury is out in terms of the econometrics, whether we can actually measure their impact.
We do know that when we compare the impact of services acquired on site in a country compared to services acquired from the Trade Commissioner Service in Canada, the ones acquired on site are more effective. There's no question that establishing this beachhead in a foreign country is vital to improving your ability to access the markets there. That's one reason why these beachhead costs are quite high. To establish that presence is not insignificant. I don't think that there's an easy way around it.
If I just may add one point as an afterthought: If you think about the firms that can afford the capital costs, the outlays to establish that beachhead, again, you're dealing essentially with the larger firms. The best of the best in Canada can do that.
What we really want to do is find ways to get the second tier, the ones that are pretty damn good but are not at the very top of the game. If we can get that tier into trade, that is where we gain a significant boost in terms of the knock-on effects from innovation, investment, productivity gains and so forth.
Senator Eaton: Have several firms thought of doing a beachhead together? In other words, you would go and represent 10 firms somewhere, in China or Indonesia or Jakarta?
Mr. Ciuriak: That is a very interesting concept. There's a paper that I wrote with my colleague John Curtis, who was then the chief economist at Foreign Affairs. We talked about exactly such a strategy. Would it make sense for Canada to establish a platform abroad for the Asia-Pacific, for example, that would make it easier for firms to access? No one's really tried that, so it's kind of an out-there idea. I would be very interested if someone would take a stab at that, actually.
The Deputy Chair: Senator Andreychuk has returned from her press conference and she now has a question.
Senator Andreychuk: I do apologize that I had the other commitment. I caught the last end of what you were saying, and you were saying that the personal relationships are extremely important, that soybeans are the same no matter where you get them from.
I was going to dispute that. Canada's competitive edge has often been, particularly in agriculture, that wheat is not wheat. There are so many types and we have perfected them. We can adapt them to different soils, tastes and cultures. Lentils have been our success story recently.
It seems to me that for a number of years we have said that we have had some unique products. In the oil industry, for example, some of the smaller suppliers have been very innovative and have been able to increase production. While I think anywhere in the world these personal linkages are one of the first things you do, you have to have something unique in your product. Otherwise, you do line up.
Mr. Ciuriak: That's a very good point, and this gets to the issue of branding in particular, and not just the advertising kinds of things but the actual quality of the product.
First of all, you're absolutely correct that there are differences in quality. For example, I believe that the soybeans that we sell to Japan are non-GMO and they're food-quality soybeans, and the soybeans that Brazil sells to Japan are used for feed. There's no question that we have market niches of that nature that are based on quality.
I would not dispute you. I can't dispute you on the issue of wheat since I don't know enough about wheat myself. I would say as an anecdote that there is the question of minimal differentiation between the products. That's the meaning of the term "commoditize." It has become indistinguishable in terms of its general utility. For example, a metal screw is a metal screw. The question becomes: Who gets the sale of these things? In a highly competitive market, if everyone is pricing to the margin, then what may matter in terms of the large sales and procurement, for example, can be the relationships between governments and the amount of diplomacy that is applied.
What we do know, senator, is that where we put our diplomatic capital we do better in exports. It's hard to reconcile that with a firm level view that says we're selling more because our products are better differentiated or because we have a quality edge. It tells us that we sell more because we have a better relationship. There's a significant boost, about a 40 to 45 per cent gain in our exports to countries where we have that relationship being built up. Again, the biggest boost comes from countries where the government is more involved in the economy. When we establish diplomatic relationships and smooth things at the political level, trade seems to flow there.
Senator Andreychuk: We've also said research and development is very important, so we've tried to get some companies to understand that they may be selling something in Canada or the United States, but if they're going to go into Asia or somewhere else, they're going to have to tailor their products.
I think the most famous company doing that was Coke. If the size of the can is different, it sells. If it's going to be the can that's produced in North America, it doesn't. The sugar content changes, et cetera.
Regarding agriculture, I know we've had to adapt, which means the Canadian government needs to understand the market that some of our businesses go into, not on what products but how to sell those products and how to adapt those products.
Mr. Ciuriak: I agree with you fully there. I guess that's the job of our trade promotion organizations of the Trade Commissioner Service, Export Development Canada, namely, to know their markets and to bring that intelligence to bear when they deal with our Canadian clients.
It's hard to look at the world from a small business perspective. Most of your time is spent dealing with things like invoices, personnel relationships, trying to make sure that your inputs are being delivered and the inevitable snafus. In terms of trying to figure out how to get this to market in a difficult and different context, it can be quite bewildering.
You were not present at the beginning, but for myself, I have a small consulting firm and most of our sales are export sales. I find it most easy to deal with the European Union when I subcontract through a German consulting firm than to try to deal with their procurement and their processes myself. The burden of that for my small administrative staff, which is my wife, would be overwhelming, and we haven't managed to penetrate the American market because to take on a consulting contract for something like the U.S. International Trade Commission, there's a 40- to 45-page dense form to fill out of material which is not necessarily at our fingertips.
I know it's difficult to understand these markets. Then, of course, there is the point you mentioned, which is the taste factor. How will the thing that you're producing for the Canadian market actually fare abroad? Again, a huge factor in trade costs is to actually establish that presence abroad, to get your people in your company over there sampling, tasting, if it's food, getting to know the market and perhaps entering into a joint venture with a foreign partner who knows that market. When you enter into a joint venture, you face an additional problem, which is that that partner knows more about their market than you do. You face this asymmetric cost information issue, and you face what I call the "tourist tax." When you travel abroad, you don't get the best deal possible. You pay what is essentially the tourist tax because you don't know the area, the market or what the costs of things really are. The same thing goes for a firm trying to break into a foreign market. Until it is well established there, it pays a tourist tax of its own. These things are just plain difficult.
You do need to have the straight promotion capability out there in terms of your trade commissioner service. You do have to have the diplomacy. It's vital to try to reduce costs that are amenable to be reduced more easily. For example, I was mentioning reducing the cost of complying with rules of origin for small firms. These things we can do. Obviously, with the Canada-U.S. border, it would be wonderful if we could get it to disappear basically. There are many things we can do to reduce costs. There are so many of them, but if we do a good job on only some of them, we will leverage more firms into trade.
The Deputy Chair: I would like to thank you, Mr. Ciuriak, for your presentation and your time here today. Your experience and expertise was obvious in your presentation, and on behalf of the committee, I thank you for that.
(The committee adjourned.)