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Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue No. 34 - Evidence - February 14, 2018


OTTAWA, Wednesday, February 14, 2018

The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:16 p.m. to study new and emerging issues for Canadian importers and exporters in North American and global markets.

Senator Douglas Black (Chair) in the chair.

[English]

The Chair: Good afternoon and welcome, colleagues and members of the general public who are following today’s proceedings of the Standing Senate Committee on Banking, Trade and Commerce, either here in the room or listening via the Web. My name is Douglas Black, and I am the chairman of this committee.

I would like the senators to introduce themselves, please, to the witnesses who are here with us by video and here in the room, and also to those watching.

Senator Marwah: Sarabjit Marwah, Ontario.

Senator Wallin: Pamela Wallin, Saskatchewan.

Senator Unger: Betty Unger, Alberta.

Senator Tannas: Scott Tannas, Alberta.

[Translation]

Senator Dagenais: Jean-Guy Dagenais from Quebec.

[English]

Senator Stewart Olsen: Carolyn Stewart Olsen, New Brunswick.

[Translation]

Senator Ringuette: Pierrette Ringuette from New Brunswick.

[English]

Senator Tkachuk: David Tkachuk, Saskatchewan.

The Chair: Thank you very much.

As I always point out, we are extremely ably supported by our clerk and the analysts who help us with the important work that we are undertaking.

Today, our committee begins its hearings on new and emerging issues faced by Canadian importers and exporters in relation to their international competitiveness. Some of these issues may include the possible withdrawal of the U.S. from the North American Free Trade Agreement, the recent changes to federal corporate tax in the U.S., interest rate differentials, regulation and innovation.

The committee is interested in learning about the potential impacts of these developments on the competitiveness of Canadian importers and exporters, as well as the manner in which Canadian importers and exporters and the federal government might respond to these developments.

Today, we are going to hear from a number of Canadian economists. May I introduce the first panel?

With us in the room today is Peter Hall, Chief Economist, Export Development Canada; and by video conference we have Jeremy Kronick, Senior Policy Analyst, C.D. Howe Institute.

I would ask each of the panellists to begin with a five-minute opening statement. After those presentations, we will move to questions from the senators.

Jeremy Kronick, Senior Policy Analyst, C.D. Howe Institute: Thank you, honourable senators, for the opportunity to comment on the new and emerging issues faced by Canadian importers and exporters, and what impact they might have on international competitiveness and how the government ought to respond.

I will focus my testimony on the scenario where Canadian interest rates continue their upward march. To contextualize this point, however, it is useful to discuss what a potential NAFTA collapse might look like and how that impacts the role of rising interest rates on Canada’s international competitiveness.

The C.D. Howe Institute has done a lot of work related to these NAFTA negotiations, including a paper by Dan Ciuriak in which he estimates three scenarios should the U.S. walk away.

In the first scenario, the three NAFTA parties revert to WTO rules for trading amongst themselves, and the U.S. additionally walks away from the Canada-U.S. FTA, a precursor to NAFTA.

The second scenario is NAFTA lapses but a Canada-U.S. FTA remains in place.

Third, using the background of this second scenario, Canada and Mexico also continue with bilateral free trade either through a new agreement or through the revised TPP.

In the first scenario, Canadian exports fall by about $20 billion, or 2.8 per cent, over a five-year period, and real GDP falls by $15 billion, or 0.55 per cent. The smaller fall in real GDP reflects some restructuring to the economy that occurs as a result of falling trade.

If the Canada-U.S. FTA remains in place after NAFTA is abandoned, Canadian trade volumes, according to Mr. Ciuriak’s models, remain essentially unchanged as does real GDP. And in the final scenario where Canada and Mexico continue with bilateral free trade, Canada could actually see small increases to both exports and real GDP of a little over $2 billion and $3 billion respectively, a result that occurs due to trade diversion at the expense of the U.S.

These results highlight the importance of the negotiations but also the fact that there are multiple outcomes under the scenario where NAFTA is abandoned. However, none of these scenarios where the U.S. walks away from NAFTA is likely to lead to what I’ll call “good” high inflation, which is inflation that occurs as a result of a robust Canadian economy and that would cause the Bank of Canada to increase the overnight policy rate.

There is, unfortunately, a scenario where “bad” inflation occurs as a result of a NAFTA collapse. Should NAFTA be abandoned, we’re likely to see increases in U.S. tariffs, forcing Canada to increase tariffs as well since we lose the ability to charge the U.S. lower tariffs as a result of having a trade agreement with them.

Should a NAFTA collapse lead to a weak real economy, this puts the inflation-targeting Bank of Canada in a real bind with respect to increasing interest rates. However, in this case, Canada may then liberalize with non-NAFTA countries in order to bring tariffs down worldwide, hopefully counteracting some of the inflationary impact of U.S. tariffs. I think it’s likely difficult, at this point, to forecast how this particular scenario nets out.

So the scenario where interest rates are most likely to rise, in my opinion, occurs from a strong Canadian economy, one that drives up demand such that the Bank of Canada expects inflation to rise above target over the medium term, which only occurs if NAFTA negotiations do not end with the U.S. walking away.

If we assume that’s the case, then we’re starting from a pretty good point, one involving a strong Canadian economy where exports continue to play their crucial role. However, at this point, if Canadian interest rates start rising relative to other countries, the Canadian dollar appreciates relative to these countries as demand for the loonie increases. The question then is: What does an appreciating Canadian dollar do to Canada’s international competitiveness?

If you are a business relying on imports, obviously a more valuable Canadian dollar makes your imports cheaper and profit margins greater, leading to all the good things that come with businesses that find themselves in this scenario.

By contrast, exporting businesses will find this scenario less than desirable as it makes their goods and services more expensive, leading to a drop in demand and subsequent negative macroeconomic effect from the scenario. Of course, if imports are required in order to produce these exportable goods, some of the effects will be offset.

Now, Canada has largely oscillated between being a small, relative to total size, net importer and small net exporter of goods and services since the financial crisis. The fact that Canada does not have a clear, consistent position as a net exporter or net importer makes it difficult to argue for a net outcome in any direction that’s going to come from Canadian interest rates rising faster relative to other countries.

A similar story holds if rising interest rates in Canada are matched or are even outpaced by interest rate increases by the U.S. and/or other countries. In this scenario, the Canadian dollar might depreciate, but, again, given the small size of our net trade outcomes in Canada, it is unlikely to have a significant impact on our aggregate international competitiveness.

My overall view is that rising interest rates are a good thing as it implies NAFTA negotiations have been resolved and the economy is humming at a robust enough pace that the bank sees strong tailwinds on inflation as it looks out over the medium term.

There will, of course, be some restructuring to the makeup of our economy depending on where the Canadian dollar ends up vis-a-vis our trading partners, especially the U.S., but overall the Canadian economy is pretty balanced from an importing-exporting perspective.

The government should, therefore, not overly concern themselves with the impact of rising interest rates, per se, but focus on other things that can improve our competitiveness, including making Canada a more attractive destination to set up headquarters for global companies, improving our middling productivity numbers, and taking the opportunity these forced NAFTA negotiations have given Canada to modernize what has become an outdated trade agreement.

Thank you, senators, for the opportunity to speak today. I look forward to the question and answer following Peter’s presentation.

Peter Hall, Chief Economist, Export Development Canada: Thank you, Mr. Chair, and honourable members of the committee. Good afternoon.

[Translation]

I am truly honoured to be here with you today to share our remarks about international trade and our clients’ concerns.

[English]

It is a distinct pleasure to address the members of this committee. International trade is on the minds of Canadian business people perhaps more than ever. Canada’s domestic economy is fundamentally weak. The global economy is strengthening. Trade diversification is drawing increased attention to the dynamism of less traditional export markets, and a younger generation seems more prone to interacting on a global stage.

At the same time, globalization is facing what might well be its greatest existential threat since its inception. Years of subpar post-recession economic growth have left millions behind. Their ranks have steadily risen to the point that elections have been, in a number of cases, very close to tipping in favour of an anti-globalization stance. Lack of shared prosperity has caused a much larger share of the global population to question current political leadership, post-war institutions, the corporate world and the 1 per cent.

As a trading nation, Canada’s economic fortunes are tied critically to the success of our international trade. As such, planet-wide debates about the very architecture of global trade are of great concern. According to survey work by EDC and anecdotes from multiple conversations with customers, there is, today, no greater concern on the minds of Canadian exporters than the future of the North American Free Trade Agreement. This has been stoked by provocative statements made by the U.S. administration as the successive rounds of negotiation proceed.

In response, EDC has studied, as has the C.D. Howe Institute, the impact of the cancellation of NAFTA on the Canadian economy. Our work concludes that Canadian GDP would be affected a little more than in the C.D. Howe Institute study, taking about 1.2 percentage points off of our bottom line over a three- to five-year period.

At today’s growth rates, that’s not enough to tip us into recession, but the impact would definitely be noticeable. Trade flows would be affected. But according to our work, business investment spending would sustain the larger impact. We foresee a decline there of between 4 per cent and 5 per cent or a net decrease somewhere along the lines of $24 billion from our baseline outlook.

Based on our assumptions, the impact would not be equally shared among exporters. Some would be affected much more deeply than others. In fact, some aren’t affected at all under the assumption that we would be moving from a NAFTA situation to a World Trade Organization “most favoured nation” status.

Although our most significant trade agreement is being debated, other agreements are concurrently being pursued. Clearly, there is still interest and willingness to further the global trade agenda. This is a great relief as opportunities in the broader world market are already massive and accelerating.

Hundreds of millions will be added to the ranks of the emerging market middle class in the next decade, according to the report by the Advisory Council on Economic Growth released just about one year ago. This vast group of consumers will be buying much more higher-valued goods and services that their own economies do not have the capacity to furnish. A key example is food, an industry sector wherein Canada has a vast surplus.

Among these markets, China is clearly the most dynamic. As such, it is particularly strategic that Canada embarked on discussions with China to explore a possible Canada-China free trade agreement on December 22, 2016. There have been a number of meetings since, including a multi-ministerial meeting in December of last year.

Meanwhile, on January 23, Canada and the 10 other remaining members of the Trans-Pacific Partnership concluded discussions in Tokyo, Japan, on a new Comprehensive and Progressive Agreement for a Trans-Pacific Partnership.

This was a welcome development because clearly with China being as dynamic as it is, the countries in the region will benefit from that dynamism and further open doors to what is already a very significant trade diversification into non-traditional markets by Canadian exporters. We are seeing this among our community, but we are also trying to address the concerns that the exporting community has.

Now, no one is waiting for the advent of any of these particular circumstances to occur, so I want to emphasize to the committee that investment is already being impacted. The mere threat that our greatest trade agreement could be coming apart is causing an investment hesitation that is already having an impact on industry capacity and on the certainty, or lack thereof, with which Canadian exporters are operating in this space.

Given the extent to which the United States is our vastly and overwhelmingly largest customer, this is of critical importance at this time.

I’m going to terminate my remarks at this point, but I very much welcome questions from the committee. Thank you very much.

The Chair: Thank you very much, Mr. Hall.

We will get under way with questions.

Senator Stewart Olsen: Thank you very much for your presentations. I appreciate the fact that you didn’t go all doom and gloom and you offered options, which was good to hear.

Mr. Hall, I was encouraged to hear you say that food is something that Canada could really be looking at in the way of exports. In that event, perhaps it’s something that the government should be investing in now, which would mean our farmers and our natural resources, as they proceed to wean us from fossil fuels.

Perhaps I can get an answer from both of you: In terms of food, what investments would be very good right now for the government to be making to ensure our economy keeps rolling along?

Mr. Hall: Thank you for that question. Food is of growing importance because at the very front end of the rise in the emerging market middle class, food is almost the first place where an increasingly wealthy economy will go. According to the Food and Agriculture Organization of the United Nations, meat consumption is what rises.

The interesting dynamic there is that for the equivalent caloric intake from meat, it takes 7 to 10 times the same amount of grain to generate that meat as if that grain was consumed for the equivalent caloric intake. I didn’t say that very well, but I think you understand what I mean.

What it does is put exponential pressure on world crops and processed food. This dynamic is illustrated in the 2012 FAO study on this issue, which highlights the fact that due to the rise of demand inside of emerging markets in China in particular, the net dependence on the rest of the world is rising at what we calculate to be somewhere between 10 and 25 per cent a year after adjusting for inflation. There aren’t very many things out there that rise to that extent.

That’s how demand is shifting with the rise in this emerging market, this wealthier middle class and the pressure that it puts on things.

Canada never stopped being a breadbasket nation. That’s what we were referred to in Queen Victoria’s time, and that hasn’t ceased. If anything, we are world leaders in a number of different aspects of the agricultural sector. This is a dynamic that puts pressure not only on crops and not only on meat, but on agricultural science, farm machinery — which we are very specialized in — and fertilizer. So those five aspects of agriculture are all ones for which there would be very hot demand, we would think. This is a near-term, medium-term and long-term opportunity for Canada.

Efforts have already been made to focus on this sector and to examine the sector by ISED in particular, but also by Agriculture and Agri-food Canada, to explore means of accommodating this demand.

The Chair: Mr. Kronick, do you have anything to add to the senator’s excellent question as to where we might be able to focus as a country?

Mr. Kronick: I’m going to take a slightly different tack than Peter. I don’t at all disagree, but I’m going to talk about some of the things I mentioned at the end of my presentation, thinking about making it more palatable for organizations to set up their headquarters here in Canada and continue to grow.

We’ve been very good at generating start-ups. What we haven’t been very good at is keeping them here and allowing them to grow and see the long-term return from growth companies.

There are a few reasons to posit why that might be occurring. One thing is our business lending is lower than some of our largest international peers. You actually see it even more starkly in our lending to small- and medium-sized enterprises, or SMEs. If you look at the interest rate margins, which is the difference in rates for borrowing by SMEs versus large firms, we have the largest margin out of our international peers. That suggests that we’re not providing the incentives or, for whatever reason, we have not seen lending to SMEs to the size they should be in order to generate innovation. We need to think about why that is occurring. That’s one thing I would bring up.

I would also think about the skills we’re developing here. We hear all the time about scientific and engineering skills, and no doubt those are important, but businesses have to grow. We need to invest a little more, thinking about skills in business, skills in marketing and things like that that are going to foster the type of productivity gains and development of companies that we want here in Canada to develop jobs and make us competitive.

We’re going to be coming up against the tax policy changes in the U.S., and that’s going to create a challenge here in Canada, no doubt.

We have the small business tax. The problem with the small business tax as it is currently designed is it actually creates an incentive to stay small. We have done some work at C.D. Howe Institute to see how you can change that tax benefit and move it away from being small, per se, to being young; so young companies get these tax benefits, but there is at least an incentive for those companies to grow.

It’s about thinking holistically about productivity and innovation. I think that is key for the government to be thinking about and for the future of our economy.

Senator Dagenais: The U.S. reduced the business tax rate from 35 per cent to 20 per cent. This reduction will put pressure on Canada. Would this be a difference?

Mr. Hall: That is a very important question, and it’s one of the top questions I dealing with when I’m on the road.

There is a heightened amount of concern among Canadian exporters in terms of this. We have for quite some time enjoyed a business tax advantage over the United States, as you have rightly pointed out. According to certain studies, we are competitive at about the 25 per cent rate. The reduction to 21 per cent is of concern.

This is something that is not yet fait accompli because in the workout of this tax, several changes were made in the United States. There is the absolute change in the tax, but there are exclusions. There are credits that have also been removed as a result of this new bill that mean that it’s not simply a change from 35 to 21 per cent. As a result, there is some dispute about the total effect of this, the final effect on Canadian businesses.

Notably, one of the sectors that is most concerned about the end of NAFTA, and we believe will absorb about half of the impact if the deal were to revert to a WTO basis, is the auto sector. Just a few weeks ago, Ray Tanguay released his report on the auto sector for Ontario that highlighted two very key competitiveness concerns. But when he was asked about the change in the U.S. tax, he was quite dismissive about that because it was unclear at that point that the combination of the change in federal tax and the state taxes in the United States would have a serious impact on the absolute competitiveness on the auto sector in Canada versus the United States. I found that quite significant because it was a great opportunity to highlight that as a concern if indeed it was something that was going to rock this sector that would be precarious in the event of the end of NAFTA.

Studies are still being done on this; it’s still very fluid. I would say when I was in Mexico earlier this year, there was much more concern about it in a Mexico-U.S. context versus the Canadian context because of relative tax rates there.

I’m compelled by the stories that are coming to us from industry on these changes, and that while there is concern, when the facts are actually analyzed, there seems to be more of a calm.

Senator Dagenais: If Canada does not sign NAFTA with the United States for its reasons, can you identify for me the influence of this on Canadian business? What measures will business have to take because we don’t have the NAFTA between the United States and Canada?

Mr. Hall: Well, I don’t think anybody in Canada would be in a hurry to abandon the place that accounts for 75 per cent of our exports. I have been known for saying that, in the normal course of business, necessity is the mother of invention. But in this case, we would be talking about crisis as being the mother of transformation, and businesses in Canada would be thinking very creatively about how to address this issue.

When we were doing our analysis — and I’m sure the C.D. Howe’s analysis came up with the same observation — over 46 per cent of Canada’s exports at the moment are already operating under “most favoured nation” tariff rates. Now, we’re not sure exactly why, but, over time, the average “most favoured nation” tariff has reduced to the point that companies have actually elected to pay the tariff as opposed to going through all the machinations, the paperwork and so forth, of complying with this particular free trade agreement. That means that in the event that NAFTA is torn up, it is status quo for that 46 per cent of Canadian exports. It’s really only roughly half that would sustain the impact of the change in the event that that’s the way things worked out and we would revert to WTO “most favoured nation” tariff rates.

That, by no means, causes us to be dismissive about this, but it is instructive that firms have elected to do this and that, in a number of different industries, they might say, “We will absorb this on our bottom lines.”

Where that is most punitive is when we are talking about an industry where the margins are already quite thin. A very competitive industry with low margins is much more affected by a reversion to this.

Our analysis, in looking at industry-by-industry impacts, measured the absolute change in tariff rates against the margins that already exist in the industry. We then looked at that as a share of total Canadian exports, and that’s how we came up with our industry-by-industry impacts.

Mr. Kronick: On the lower corporate tax rates in the U.S., one thing I would suggest is that part of this will depend on what happens to the U.S. economy as a result of these lower corporate tax rates. It’s easy to say they will be lower and will stimulate business, that’s fine, but don’t forget that this budget will add $1 trillion to the deficit. We are talking about significant percentages each year to a deficit that was already quite big. So at some point down the line, one might see tax rates moving back up to pay for some of this deficit spending.

There will be an impact on the real economy that may not be as positive when we look at it long term. Some of the decision on the final impact needs to differentiate between the short run and the long run.

The government spending is likely to stoke further inflation, which is likely to cause the fed to have to increase interest rates, which has a different set of impacts on Canada.

There is a lot to think about. It is not as simple as just the relative competitive tax rates on that front.

Peter mentioned the automotive sector. What is interesting in the work that Dan did for us, he found that the automotive sector in the U.S. would be badly hit if NAFTA were to collapse and the Canada-U.S. FTA doesn’t step in.

Peter is right: This comes down to sectoral change. You have to look at how this is impacted by sector to think about how this then impacts the politics side of this thing. The automotive sector and the farm sector in the U.S. are quite important and politically charged. It might be ironic that at the end of day the people Mr. Trump went after to try and garner votes originally might actually be the ones that cause Congress to step in and say, “No, we’re not going to get rid of NAFTA.”

That’s another thing to think about when we’re thinking about what the impact of the corporate tax rates will be over the long run.

Senator Wetston: JI have a question for Mr. Hall and Mr. Kronick. I’m interested in the notion of rising inflation. I think you both read and studied the Monetary Policy Report of the bank recently and understand what is being discussed there.

This is a two-part question. I think Mr. Kronick indicated that, all things being equal, the economy continues to do what it does and inflation does increase if NAFTA is discarded. I think that was your bottom line. Can you help me on how you came to that conclusion?

Mr. Hall, you may have views as well.

Mr. Kronick: Senator, I think you cut off just at the end in the last line. Do you mind repeating the last line about what you thought my bottom line was?

Senator Wetston: If the economy continues to move in the same direction, which I think you have indicated what that is, and in the event we are no longer in NAFTA, you felt that interest rates would increase. I think that was your bottom line. I wanted to know whether you viewed the Monetary Policy Report in any way supporting that position.

Mr. Kronick: Let me clarify what I meant. If NAFTA is not resolved at the end of day, I do not think there will be sufficient growth in the real economy to generate the inflation that will force the Bank of Canada to increase interest rates. There is a bad inflation scenario in which NAFTA collapses. Peter mentioned the tariffs. Where “most favoured nation” is not already implemented, there will be forced increases in U.S. tariffs, and Canada will be forced to respond. That’s a bad inflation scenario if it slows down the economy.

My scenario, where inflation goes up by enough where the Bank of Canada feels justified increasing the policy rate, is a scenario where NAFTA is negotiated and ends with a solution to the standoff we currently see.

To answer your question about the Monetary Policy Report, yes, I do view it as supporting my position. The uncertainty around NAFTA is a big reason why the Bank of Canada has not further increased the overnight rate. They have said for a long time that they expect we are going to close the output gap, and inflation is basically now at target. If that’s the case, theory and economics suggest you should be at the long-run neutral rate, and the Bank of Canada itself estimates that as to be between 2.5 and 3.5. We currently sit at 1.5. The reason we sit below is the uncertainty that surrounds NAFTA. The Monetary Policy Report makes that one of the major factors why the overnight rate still sits at 1.5.

Mr. Hall: I don’t disagree with a thing that Mr. Kronick has said, which is probably a history-making moment; economists always disagree with each other. I subscribe to all of that.

Where I might differ — we always differ — is in the relative positions of the Canadian and U.S. economies. Our domestic economy is quite fragile, and I mentioned that in my opening comments. We are in a situation, I would say, of surplus supply in our housing market, and we have a highly indebted consumer. In that context, rising interest rates inject fragility into the economy. So on the domestic side, there is a precariousness that we wonder about.

In terms of the conduct of monetary policy, keeping that in mind is something that goes back quite a number of Monetary Policy Reports of the Bank of Canada. I’m sure they have not forgotten their own statements on the need for the housing market to correct and their worries about the level of consumer indebtedness in Canada.

The United States, on the other hand, is in a situation we would consider pent-up demand. It’s quite the opposite to ours. We rarely find ourselves in such different positions. So the reasons for monetary policy increases there are quite different from our own. As such, we would expect in a no-NAFTA situation for our monetary policy to actually vary quite a bit. There is where I would agree with Mr. Kronick’s statements on lower inflation inside of Canada, but the prospect of higher inflation in the United States and our central banks having to do different things.

Senator Wetston: The monetary policy instruments that are available, potentially, if we are no longer in NAFTA are quite limited, and we are going to have to rely on other measures, potentially, to support the economy. To some extent, that was what Senator Dagenais was getting at. Can you comment on that?

Mr. Hall: I would go back to the initial analysis I referred to in my remarks: Yes, we would expect a 1.2 per cent hit to gross domestic product. That would not tip us into recession, and we wouldn’t see a need for the kind of stimulus that, let’s say, we saw in the 2009-10 period when we were enduring the great recession.

I imagine all possible instruments would be investigated at that point in time, but we’re not looking at a full-blown recession-type situation where all the stops are pulled out.

The Chair: Mr. Kronick, have you a response to Senator Wetston’s question?

Mr. Kronick: No. I was actually going to agree with Peter. The analysis we have done also suggests that the size of decline in real GDP is probably not enough to tip the balances back into recession. It will slow down the growth, and the bank likely won’t be increasing their policy rate as a result, but I agree that we are not likely to be in that recession that will require the type of stimulus we saw in 2009.

By the way, we didn’t have to undergo many of the measures the U.S. and Europe had to in terms of the size of quantitative easing. We were able to mostly stick with forward guidance, keeping low rates. And we’ve bought back some of those decreases in the policy rates we saw during the crisis. The governor himself suggested that the lower bound may not be near zero anymore, so there is a little room there.

I agree with Mr. Hall on this one as well.

Senator Marwah: I think we all agree that trade agreements are essential for Canada, as we are a trading nation. Leaving NAFTA aside for a moment, I was under the impression that after we signed these trade agreements — and we’ve signed Peru, Colombia, Korea, to name a few — time lapses, and after a period of five to seven years, we are in a negative trade balance. That implies that those trade agreements are not working as well for us as they are for the other nation. That leads me to believe there are other structural impediments to trade and other non-trade barriers we should also look at besides just signing these agreements. Do you think that is the case?

Mr. Hall: It is excellent question. I will make a number of points in response.

In the intervening period, we had a cataclysmic event in the global economy. We in Canada lost a quarter of our trade almost overnight. Some of the studies that are comparing the effectiveness of trade agreements, even NAFTA, will refer to this period as if it was a normal period of growth. Depending on where you choose your starting and ending points, you can make up a story about the effectiveness of free trade agreements that really misrepresent the situation itself. That would be one caution.

To the point that we would immediately step into a situation where a trade imbalance or a deficit would open up, that really depends on the level of development inside the two economies. America believes at the moment, for example, that they’re exporting jobs to Mexico, it’s very unfair and they point to the yawning trade deficit with Mexico — which is a fraction of the trade deficit with China, I would point out — as being a negative with respect to that. Mexico’s stage of development means its consumers consume different things than America actually produces. Over the long run, you raise the development up, and that trade gets more into balance.

Something natural about that is in the calculus of a free trade agreement at its inception, but what gets forgotten more often than not is that these agreements aren’t just about flows of exports and imports; they’re also about cross-border investment. What gets missed inside of many of the statistics is the installations that we would put in a particular country that are generating foreign affiliate sales. These have become quite significant over time, and they speak to the power of actually having a head office in the domestic economy and controlling business that is happening over a world map.

Our perspective is that that’s a very efficient way of globalizing a business to take good advantage of the comparative advantages of different nations so that we are creating globally efficient businesses that then have the prospect of selling to a much wider audience in the world.

Those are the points that I would raise to that. I’m not concerned by the initial opening up of trade deficits because many good stories can be told around that development.

Mr. Kronick: Senator Marwah, you brought up trade balances, and I think this is a little dangerous in terms of the terminology we’re using here. It’s not necessarily bad to have a trade deficit. You can have a scenario where you have lower exports and lower imports, but exports happen to be greater than imports and you have a positive trade surplus. But if exports go up and imports go up as well, but they happen to create a trade deficit, that doesn’t necessarily mean your economy is doing worse, to the extent that consumption and investment go up as well as businesses that export start to do better, to the extent that those exporting businesses use these imports to export goods. Many good things can come from importing.

I think one of the challenges that the Canadian trade negotiators have with the Trump administration is their exclusive focus on trade balance. I would point out that a lot of the analysis actually shows that the trade deficit would be worse for the U.S. if they were to walk away from NAFTA for the exact reason that I’m talking about — exports and imports will both fall under those scenarios.

Part of why we subtract exports off of real GDP is an accounting reason because we double count it otherwise. So I think some clarity around what it means to be in a trade deficit and what it actually means for the economy is important.

Senator Marwah: Maybe I should reframe the question. Let’s not frame it from a viewpoint of a trade balance surplus or deficit. Let me put it more directly: Are there any non-trade barriers that we’re not paying enough attention to when we negotiate these? Are our countries putting up other non-trade barriers that even though we have a free trade agreement, that’s preventing our exports? Is there anything else? Are there any other structural impediments besides just signing an agreement? Because that affects the study. That’s what’s preventing our exports from being better than they are.

Are there any structural impediments? Are there any non-trade barriers that hurt us?

Mr. Hall: We learn about these from our customers all the time. They will anecdotally raise unfair trade practices.

One that has more recently been on the table is the auto sector opening up a free trade agreement with South Korea, wondering, even though on paper the doors have been opened up for a parts trade between nations, whether there aren’t other cultural and other non-tariff stipulations or practices that in effect freeze them out of that market, whereas we’re opening our market up to those goods and services.

I think this is an iterative process over a number of years where we are steadily refining our approach to free trade agreements. So when TPP was initially tabled, it was hailed as being a next generation free trade agreement because it was precisely dealing with many of the issues that have arisen as non-tariff barrier-type situations; considerations with respect to services, with respect to intellectual property that weren’t even thought of when, let’s say, NAFTA was inked. There are industries that exist now that didn’t exist at that point in time.

I would say this is an iterative process of getting those things tabled to the point where they are actually ensconced inside of new arrangements.

The Chair: Mr. Kronick, could you answer the question that the senator asked as succinctly as you possibly can, please?

Mr. Kronick: Sure.

I completely agree. Services represent 70 per cent of the economy right now. They were not nearly the same thing when the NAFTA negotiations started 30 years. And that has been a problem with the Trump administration, their focus on goods exports, the automotive sector in particular. We need to frame the argument to better reflect the structure of our economy right now, which is dominated by services. This iterative process, where we allow for adjustments to agreements based on the structure of the economy, is going to be key to how we negotiate going forward.

The Chair: I take from your responses to Senator Marwah’s question that your answer is yes, there are other soft barriers to trade that perhaps we need to be alert to.

Mr. Hall: Correct.

Senator Tkachuk: A number of weeks ago we heard the panicked voices of the federal government and others that Donald Trump was going to be walking away from the free trade agreement. I’d like your comments on the main impediments to the free trade agreement we’re trying to negotiate with the United States. Is one of them our marketing boards, our dairy industry, our chicken industry, our egg industry? Could both of you could comment on that?

Mr. Hall: Supply management has certainly been raised as a trade irritant. The dairy industry is one that has obviously come under the microscope, and from what I can tell, individuals in Washington are saying this is not an issue that is going to go away. So, yes, America does look at this and sees a nation that has the ability to produce much more than it consumes, calls itself a trading nation, and yet has these structures in place. They’re not quite sure they add up at this point in time. They don’t understand why it is that they cannot have access to our market.

The approach the administration seems to have taken in a more tangible way is every now and again to talk about tearing the whole agreement up, but in actual practice to focus on particular industries like the auto sector, like the dairy industry, like aerospace, like softwood lumber, and skirmish on those all the while they’re negotiating.

In certain cases, there is a clear structural irritant. In others, we wonder why they have decided to pick on those. Softwood lumber just fell into their lap, so they took that one.

Senator Tkachuk: It would be nice to get some certainty on that piece anyway because it seems every few years we’re dealing with that again.

Mr. Kronick: I agree with Peter. The administration has decided to take this sector-by-sector approach to these negotiations. Usually they focus on the sectors with which they have a deficit or they feel Canada is acting unfairly. That’s the number one challenge for Canada for negotiators here. We’re taking a more holistic approach to looking at trade, and they’re taking a sector-by-sector approach and they’re leaving out services. For example, the U.S. has a surplus of over $4 billion in financial services, and that doesn’t come up very much in these negotiations because it’s an area that the U.S. does quite well in. So this sector-by-sector approach I think is hampering things.

I’ll also mention that the dispute resolution mechanism has been an irritant to the U.S. They feel that they often come out on the losing end in these dispute resolutions, and I think that’s a big sticking point as well for them. I’m not quite sure how we get around that issue other than reinforcing the fact that we need unbiased panels in these trade disputes.

Senator Tkachuk: I’m sure they have subsidies in agriculture in the United States. We continue to hear what the Americans want, but we never hear what the Canadians want. What do we want out of the deal?Where do we think that we’re getting a bad deal, that we’re not getting the access we need? Because I haven’t heard it. I’m wondering if I’m just not listening properly, but it doesn’t seem to be a strategy of us saying, “I know what you want, but here is what we want,” so there is some negotiation. It seems we’re running a defence and there is no offence at all.

Mr. Hall: In response, I would have to say that I’m not privy to the conversations that are happening in the inner sanctum on this, so it’s unclear exactly how we’re positioning ourselves tactically around the table.

There has clearly been an effort to contain the discussion and to approach negotiations by — and the Minister of Foreign Affairs has been quite clear on this — approaching those in the United States who would be most injured by the end of the NAFTA agreement and working through them to get the message through to Washington on the gains from trade. That’s about as far as I can go on this.

Mr. Kronick: I also haven’t heard anything about specifically what we’re looking at. I think the problem is we’ve been spending so much time trying to convince the Trump administration that things aren’t as bad as they make them out to be. When you’re playing that type of defence, you can’t really apply the offence. But, if we try to think of where things could improve, I’ll just reinforce that modernizing an outdated agreement by looking at the services industry is really where we should be spending our energies, if and when we ever get to the point where we’re playing some offence.

Senator Tkachuk: My point is that that’s exactly the problem. They’re going to get what they want, but we’re not going to get what we want because it seems we don’t know what we want. If that isn’t outlined, if that isn’t talked about, if no one is making speeches about it, if no one is talking to governors about it and saying, “Here are some problems that we have,” where are we going to end up?

Mr. Hall: On both sides of the table, the word “modernization” is being used. It’s not clear what that means. One hopes that it means that these things that are being left out are being taken into consideration.

Senator Unger: I have a short question. To what extent, if any, do changes in government impact trade issues? They have to affect it in some way.

Mr. Hall: They seem to make all the difference, actually. Ideologically, where one is placed in terms of one’s beliefs in international trade would have a great determination on how it is that they go about this.

What’s disturbing, I guess, in the post-recession period is that when the economy turned around and everybody was stimulating their economies, even strong advocates of globalization and international trade seemed to do a U-turn, in strange places like heartland Western Europe and China, of all places, issuing protectionist statements that seemed to run counter to where trade had been going up until that point in time.

To answer your question, yes, regimes make all the difference with respect to their view of trade and how it is that they want to pursue it, but even those regimes that back it can change their approach to that with changing economic circumstances.

Mr. Kronick: One the reasons why Canada has been very strong in their response to this idea of putting a sunset clause review into NAFTA every five years or whatever the Trump administration has asked for is for exactly this reason, because governments can change their positions every four or five years. Think about all the uncertainty and disruption that has come out of this threat of NAFTA. Now, imagine that happening every five years. Part of what makes trade agreements successful is the idea that they’re very hard to dismantle once they’ve been put in place. That creates the type of environment for businesses to set up, knowing they’re going to have this type of cross-border relationship with other countries. I think Canada should stand firm on that issue.

The Chair: Mr. Kronick and Mr. Hall, thank you very much. You are a tremendous panel and have given us a lot of information. You’re obviously extremely competent in your area, and we’ve benefited from your knowledge today. Thank you very much for being before this committee.

For our second panel, we welcome, in our hearing room today, Dr. Meredith Lilly, who is Associate Professor and Simon Reisman Chair in International Affairs at the Norman Paterson School of International Affairs at Carleton University; and, by video conference, Dr. Walid Hejazi, Associate Professor of International Business, the Rotman School of Management at the University of Toronto.

Welcome to you both. I would ask if you could each have no more than five minutes of introductory remarks, and then we would ask that you make yourselves available for senators’ questions. Who wants to start?

Walid Hejazi, Associate Professor, International Business, Rotman School of Management, University of Toronto, as an individual: Ladies first.

[Translation]

Meredith Lilly, Associate Professor and Simon Reisman Chair in International Affairs, Norman Paterson School of International Affairs, Carleton University, as an individual: Good afternoon, honourable senators. Thank you for inviting me to join you today.

[English]

It’s my pleasure to share with you my research expertise related to the important issues you’re considering on competitiveness challenges facing Canadian importers and exporters in North American markets.

I can comment on the impact of proposed U.S. tax measures on Canadian competitiveness, but I’m going to focus my opening remarks directly on trade matters, including the potential U.S. withdrawal from NAFTA and the influence on bilateral trade.

First, let me address the broader political and media narrative around a potential U.S. withdrawal. Since last December, I have become less convinced of this likelihood. Although the risk remains that President Trump could trigger a withdrawal at any time — and certainly we have to prepare for that possibility — it’s my assessment that the current risk is lower than it has been since we first started negotiations in August.

Thankfully, since the Montreal round concluded, there is clear public messaging from all three countries that they’re all seeking to negotiate and that no single country is looking to scuttle the deal. I think this is vitally important for Canadian importers and exporters, the vast majority of whom have no particular insight into what goes on at the negotiating table. They rely on media reports for information, and until recently it’s my view that those have only amplified their uncertainty. As we know, uncertainty is bad for business.

With that caveat, I’ll outline several important factors that should be considered in the event of a withdrawal, as well as steps I would recommend the government take to prepare.

The first pertains to Canada-U.S. border crossings of traded goods. Last year I supervised a group of masters students led by Matthew Smith, a former student who is now a graduate, I’m pleased to say. It was focused on the bilateral trade consequences of border thickening between Canada and the U.S. following the 9/11 attacks on the U.S. Obviously the circumstances of 2001 are very different than the circumstances today, but we share the possibility that a U.S. administration may introduce broader processes that could negatively impact trade between our countries.

To better understand the long-term lessons we might learn from 9/11, we conducted a systematic review of 13 years of research on the consequences of post-9/11 security measures on bilateral trade. Overall, we found that Canada was more negatively impacted than the U.S.; sectors that are not very integrated were actually the most damaged; small businesses in Canada faced unique challenges that reduced their ability to trade with the U.S.; and Canada-U.S. passenger car flows were dramatically reduced over this period.

While government-led initiatives such as the Free and Secure Trade program, FAST, mitigated some of these challenges and were quite effective, they overall have been underutilized, largely due to the costs and bureaucracy involved.

I previously submitted to the committee a summary of the findings of that paper, and I’d be happy to answer any of your questions about that.

Before I do that, I would like to raise two other issues about a potential withdrawal of the U.S. from NAFTA. The first pertains to the widely held view that in a post-NAFTA scenario, WTO MFN — most favoured nation — tariffs would come into effect. On most traded goods between Canada and the U.S., these tariffs would be zero, and in sectors such as automotive, they would be 2.5 per cent. Some research on NAFTA rules of origin has also demonstrated how even the current rules we have in place are too onerous, leading many businesses not to even seek to use NAFTA preferences for tariff-free treatment.

But this belief that WTO status quo tariffs would come into effect has led some NAFTA commentators to conclude that the situation would really not be very negative if the U.S. withdrew from the agreement. I have very little confidence that the U.S. administration would simply revert to existing WTO tariff schedules if it were to pursue the nuclear option on NAFTA. It is my recommendation that if it has not already done so, the government should consider other scenarios that would include much steeper tariffs, as well as the imposition of non-tariff barriers between our two countries.

The other issue I’d like to touch on surrounds temporary entry provisions in trade agreements. In the North American context, it’s NAFTA TN visa that allows many Canadian professionals to work in the U.S. rather than having to subscribe to the U.S. H-1B visa that’s used by countries that don’t have temporary entry provisions in place.

Concerns in the U.S. around reforms to both NAFTA and the H-1B program have recently been working in Canada’s favour. Anecdotally, I think we all have heard stories where we appear to have attracted some businesses and U.S.-based workers north as a result, particularly in the high-tech sector. In my view, this is very positive for Canada. However, moving forward, I think it remains to be seen whether our more open immigration system can compete with major changes in the U.S. that increase attractiveness for investment there relative to Canada, such as corporate tax reform. This is an area I’m currently researching.

I would be happy to answer questions around this or other areas regarding the negotiation.

The Chair: Thank you very much, Dr. Lilly.

Dr. Hejazi.

Mr. Hejazi: Thank you for the opportunity to present before the committee. I do apologize that I was not able to come to Ottawa to be there in person, but after all, it is Valentine’s Day, and I have a dinner date with my wife later today.

I agree with Dr. Lilly that the likelihood of a NAFTA withdrawal is much lower today than it has been for some time. I’ll focus my comments broadly and then talk about what I believe the focus of trade policy should be.

We’ve heard it many times that Canada is a trading nation. Much of our prosperity and millions of Canadian jobs are directly tied to links to the global economy. This includes trade with the U.S. and globally, although we know three quarters of our trade is with one partner, the U.S., which leaves us extremely vulnerable to political developments there. I believe an important component of Canada’s trade policy is to enable Canadian companies to be globally competitive in the U.S. and beyond. I’ve undertaken a lot of research on these issues, and I’d like to share with the committee two findings that relate directly to the competitiveness and productivity of Canadian firms and their links with the global economy.

With my colleague Dr. Jianmin Tang at the Strategy, Research and Results Branch of Innovation, Science and Economic Development Canada, we have used detailed information for every company operating in Canada at the firm level to study the competitiveness and productivity of these firms. Attached to my submission is a beautiful graph that looks at productivity of firms, depending upon their engagement in the global economy. As the figure shows for manufacturing, Canadian firms engaged in the global economy are larger in terms of output, are more capital-intensive, pay higher wages and have higher productivity. Stated differently, firms engaged in the global economy are more competitive and more productive relative to domestic firms.

Furthermore — and I want to underline this — these firms have higher productivity ex ante. What do I mean by that? These firms are good firms before they participate in the global economy, and this motivates what I believe to be one of the most important pillars of trade policy: ensuring Canadian companies are enabled to be productive and innovative so they’re able to compete in the global economy. We must ensure the environment within Canada is conducive to allowing firms to be innovative, productive and competitive.

In a second study that is soon to be released by Global Affairs Canada, Professor Daniel Trefler and I demonstrate the significantly negative impact protections on Canadian inward foreign-direct investment have on productivity of Canadian firms. Such protections inhibit the ability of Canadian firms to meet the threshold levels of productivity and innovation needed to compete successfully in the global economy.

A question that has always been asked in our history is: Are Canadians hewers of wood or drawers of water? Canadian exports can be commodities or undifferentiated goods and services, or Canadian exports could be much more innovative and differentiated. When the Canadian dollar appreciated from 62 cents U.S. to parity between 2002 and 2007, it was the least differentiated, least innovative products that Canada exported that took the biggest hit. The most innovative products served as a more robust source of Canadian prosperity. Canadian firms and the Canadian economy more generally must embrace a more innovative stance.

With respect to the three points you asked us to consider directly — possible withdrawal, recent changes in U.S. federal corporate taxes, and rising interest rates — I wrote an op-ed in the Hill Times just a few weeks ago, and there are five issues still front and centre in the dispute.

Obviously, the preference for us is for NAFTA to survive, but Canada cannot stay under any circumstance. This view is further supported by recent U.S. tax changes. Those tax changes along with, for example, the sunset clause would be detrimental to the Canadian economy and would encourage companies to move their facilities outside of Canada into the U.S. I would argue that a sunset clause or eliminating the dispute-settlement mechanism from NAFTA — in my opinion, Canada should walk away.

In summary, to enhance the competitiveness of Canadian firms and ensure they’re able to compete in the global economy, Canadian trade policy must ensure Canadian companies, one, are not tax-disadvantaged; two, have access to talent, technology and innovation; and, three, have access to export markets not only in the U.S. but globally.

Thank you very much.

The Chair: That’s very helpful. Thank you very much, professor.

We’ll go to questions, starting with our deputy chair.

Senator Stewart Olsen: I have a brief question to both of you.

You’ve both mentioned “if the worst happens,” but even if the worst doesn’t happen, where should Canada start to encourage our own innovation and increase our productivity? I know it’s a big question, but I’d love to hear a few bullets on it.

Ms. Lilly: I’d like us not to focus a lot on “if the worst happens.” Where Canada should be focused is certainly around innovation. It is really important, as are skills training and retraining and lifelong learning. I know that the G7 will be focused on this in the coming year and it is a priority of the government, so that is a good thing.

I think some of the difficulties that we have seen with our relationship with the United States stem from a group of citizens who have been left behind either through trade or through technological change. I honestly think that this requires a fundamental shift in the way we think about skills and training and education. That is something I think we should focus on.

There are also certainly areas from a straight trade perspective we could focus on now. One of the things I think is important to look at is the FAST program, which allows those who are qualified to cross the border very efficiently and it allows cross-border trade to improve much better for those individuals.

Qualifying for that program is difficult, onerous and expensive. You have to do things like have a zero criminal record check if you are a truck driver. They were born out of a security-heavy period following 9/11. I see us moving towards that again on the U.S. side, where there is a security-focused government and administration, whether that is an evidence-based view.

I think that on the Canadian side we could certainly do more to help streamline processes of crossing the border, which would help enhance productivity and trade.

Mr. Hejazi: To add to that, we have to think of the mindset of corporations in Canada and why they do so much trade with the United States; as we know, it is 70 per cent of our trade. The profit-maximizing strategy for any company in Canada is to go into the U.S. because of its size, proximity and similarity, and I could go on and on.

The first point is that as the cost to do business in the U.S. goes up, that would hurt Canadian companies. Most importantly it will force Canadian companies to go to another alternative that’s on a lower level of profit, so it will hurt Canadian companies. The question is: How much?

I think we need to be doing the following.

First, Canadian policymakers, and Canadian trade policy, need to open more markets for Canada. We need to have more market access in China, India or wherever it is that we can be. It is currently so costly to operate in those markets that that leaves the U.S. as the profit-maximizing place to do business. We have to bring down the costs of doing business in these other markets, making market access number one.

Number two is innovation, and I can’t stress this enough. Even if you look at our exports of unprocessed and processed natural resources, Canada has an enormous trade surplus in unprocessed natural resources. We export a lot of stuff directly out of the ground, but we have a huge trade deficit when it comes to processed resources.

We need to change the mindset in Canada, I would argue, away from this notion of hewers of wood and drawers of water to a more innovation-based mentality. I could speak to that extensively, but I want to make one more point which I think is very important.

On Monday, I was in Oakville at a company that exports chemicals to 50 countries around the world. The question I put to the CEO was: What was the most difficult part of your challenge as a Canadian company in Oakville, Ontario, trying to penetrate global markets? His response was that among all of the people with whom he interacts with in government to try to help him get access to these markets or to help with our patents and protecting intellectual property, there is no sense of urgency.

I want to quote from a report from the World Economic Forum:

The survey suggests that Canada’s business community views inefficient government bureaucracy as the single most problematic factor in doing business. This is not an area that any major government is currently addressing in an assertive way.

To go back to my opening statement, I would argue the Canadian government needs to open more markets for Canadian companies, and it needs to enable Canadian companies to be more innovative and allow them to get into these foreign markets.

Senator Tkachuk: Ms. Lilly, I was reading a tweet that quoted you:

America first doesn’t concern me . . . . America alone is the more dangerous sentiment.

I’m sure you must have been relieved at the Davos statement by President Trump, but you had said you were initially concerned that President Trump would be tearing up the free trade agreement, as the government a couple of weeks ago was on a quite a media effort to convince Canadians that that was going to be the case. I thought that was a horrible strategy, but nonetheless they were doing it.

What evidence did you have at that time? I never got the impression they were going to tear up the agreement. Some people did, but no one ever said it.

Ms. Lilly: I have fairly strong views about this because in January, when we started to hear a lot of talk that possibly the Americans were ready to withdraw at any moment, I started to fact check and there was no evidence that that was going to occur. I got calls from many media organizations. I said to some of them that I didn’t think this is a story and to others I said, “If I come on your show, I’m going to explain why this isn’t a story,” and many of them didn’t even want to carry that message. It is not sensational and it doesn’t get head lines: no story here.

There was an anonymous story — well, it was written by a real person whose name is known — that cited unnamed officials on the Canadian side who said that withdrawal by the Trump administration was imminent. The same day, U.S.-based journalists who take their jobs very seriously went to the White House and said, “This is what is happening in Canada; what do you say about this?” And the White House immediately denied the story.

I have been quite concerned by this narrative that has been out there publicly because at least for the last couple of months I haven’t seen any evidence beyond a journalistic desire in Canada to push forward with this story.

Senator Tkachuk: I will ask you both the same question I asked the other two panellists. What do you think are the main impediments to the agreement with the Americans in negotiation?

I haven’t seen or heard any statements about what we want in the agreement. It’s basically about what the Americans want. It’s not only them saying it; we’re also saying it. Are there any areas we should look for to get a better deal with the Americans while they are negotiating with us on getting a better deal?

Mr. Hejazi: I’ll start with the second question about how one-sided this has been, and I really think it speaks to the weakness of the Canadian position.

I agree with Dr. Lilly regarding this entire renegotiation threat. When you look at this from a rational perspective and from a game-theory perspective and you look at repeated games, all of the theory would say that the two parties would come together and make a decision that’s in their best interests over the long term.

In my opinion, if the NAFTA were to be cancelled it would hurt the Americans a lot more than if they were to leave the status quo. If you went at this with a purely rational game-theory perspective, I wouldn’t worry.

The problem is that Donald Trump is really thinking about this from a political perspective. In my opinion, he wants to be able to say to his electorate, “Here is another campaign promise I delivered.” He wants to get past the next election. I think he’s willing to give up a lot of economic gains if he can get the political games.

I’m disappointed that really the whole focus has been on what the Americans want: The Americans want to get rid of dispute settlement; the Americans want to have a sunset clause. While admirable, all of the Canadian proposals are to have sort of a next generation, progressive type of policy. They are admirable, but I don’t think they have legs. That’s more about the narrative and the DNA of the government. I don’t think we’re going to get a chapter on gender rights or indigenous communities, and so on.

The weakness is that this has been an American aggression against Canada vis-à-vis the negotiations. The only impediment to getting a deal for Canada is the political calculations in the U.S., which is outside of our hands.

Ms. Lilly: I would agree with all of that. I would add a couple of things.

The areas of real difficulty moving forward we know are going to be around dispute settlement. Certainly auto rules of origin will be a major issue. There are two parts of that. There is the 50 per cent country-specific rule of origin, which is a non-starter and not something that Mexico and Canada should agree to. Then there is the 85 per cent regional rule, which is complicated and difficult for its own reasons but is something the countries can negotiate on.

There is also the sunset clause, which has been discussed already. It’s my view that Canada shouldn’t sign a trade agreement that includes a five-year sunset clause. However, the compromise put forward by Mexico, which Canada supports, is a good one and will be the best the Americans will get. I’ll be surprised if the Americans don’t take it because they’ve been told by their own side. It is a negotiating position and not a deeply held interest.

Procurement will be difficult and will get ugly. I think dairy, at least on the Canadian side, will be difficult.

With respect to what Canada wants, there is the modernization agenda. We were signatories to TPP and continue to be. Many of the things that we got out of TPP we want to see a modernized NAFTA. That’s good.

However, some specific things Canada would like from the United States that don’t get a lot of play — and it’s my view that certainly behind closed doors these positions would be advanced — include making gains on procurement. We really do want to make gains on procurement. The difficulty is that the United States wants to be more retaliatory in that area.

Sugar does not get discussed. Canada has almost no access to the United States sugar market, but, problematically, Mexico and the United States signed a separate sugar agreement which essentially took sugar off the NAFTA table. What would Canada like? Our sugar beet farmers would really like sugar.

Temporary entry would have been one of Canada’s number one asks. We didn’t get it in TPP. It has not been listed by Robert Lighthizer in his consultation document to Congress. The consultation document is important because it forms a legal requirement in the United States that’s part of their consultation phase. If you don’t see something in that 17-page document that was released in August and updated in October, it means the United States, from their perspective, has no mandate to negotiate these issues. Within the United States they are saying this is off the table. That’s something Canada really wants, but I’m not optimistic we are going to get it.

Those are a few things that I know we want.

The Chair: That is very helpful. Thank you very much.

Senator Marwah: Dr. Hejazi, you made a comment that I agree with completely, namely, that the control and management of our IP is absolutely crucial. In my judgment, if we don’t control and manage that, we run the risk of becoming what I call a colony of the countries that do control it in the future.

What are we not doing in that regard? What can we do more in terms of managing IP? I worry about encouraging the “Googles” to come here rather than encouraging all entrepreneurs to grow and become bigger. What should we be doing? I’d like both your views on that.

Mr. Hejazi: This is the million dollar question and is something we have been working on for years and years: What explains Canada’s lack of innovative capacity. There are lots of hypotheses that we could go through, but what is really important is Canadian companies need to be incented to be much more global beyond the U.S. — operating in the U.S. is relatively easy — I’m not saying it’s easy, but it is easier relative to going to other markets. Whenever companies are doing global strategy, they need to be pushed to create products that they can sell in those foreign markets. We need to create an environment that gets Canadian companies to do more innovation.

To your point directly, Canadian universities, for example, do very little in terms of commercializing IP. Many people are shocked when they hear that the University of Toronto does $1 billion a year of research and development, and little of it gets commercialized. We have put a whole infrastructure here at the university around something called the Creative Destruction Lab. Ryerson has the DMZ, but the whole idea is to help Canadian companies create new innovation.

However, there are all kinds of challenges. First, there is little incentive for Canadian companies to grow because of the small business tax rate.

Second, there is a huge incentive for Canadian companies to have as their exit strategy to sell out to a big American company. There is a very difficult environment within Canada for Canadian companies to create innovation and successfully commercialize that innovation internationally. There is a whole host of reasons around that. Much of it stems from the inability or the difficulty to commercialize technology.

I’ll go back to my comment of a few minutes ago. When I was at the company if Oakville, Ontario, a few days ago, he said he has patents in 15 or 20 countries. He exports to 60 countries. He had real difficulty with the Canadian government helping him deploy strategies globally that would allow him to benefit from those patents and even to get new patents. He said there was no sense of urgency.

I believe this difficult situation with NAFTA should be a wake-up call for Canada. The United States is our number one market. The best solution is for NAFTA to survive, but we don’t want to be in this situation again in 5 or 10 or 20 years, where we are beholden to the U.S. market. We need to enable Canadian companies to be innovative, to create IP and to create platforms for Canadian companies to deploy that globally.

Senator Marwah: Do you have any thoughts on managing IP?

Ms. Lilly: I’m not an IP expert, but I will make a couple of points about some of the stakeholder dynamics around IP with respect to the trade negotiations.

In some respects, it is difficult for the Canadian government to take any one position on IP partly because within the pharmaceutical industry we have brand name pharma and generics, and they have different interests. Similarly, there are different interests with respect to IP in the creative industries. There are digital interests versus things like copyright where you’ve got some innovators who think we should be loosening up copyright and others who want much longer periods. Whenever you have split sectoral interests, it becomes difficult for a country to take a particular view. That’s the only thing that I would add around that.

It is important to note that a number of the very strong IP provisions negotiated in TPP have now been suspended. Those provisions were United States asks, particularly around biologics in pharmaceuticals. This will be an area to watch to see how Canada and Mexico handle it without another nine countries supporting us.

Senator Dagenais: Dr. Hejaz, you talked about transformation and our deficit. How important is the fact that some Canadian businesses should be attracted to cross the border and produce in the United States?

Mr. Hejazi: I don’t know if I got the whole question, but I’ll try to answer what I understood.

If you look at the data on foreign investment, once the Canada-U.S. Free Trade Agreement was signed in 1989 and NAFTA in 1994, the amount of foreign investment in Canada from the U.S. fell dramatically because many companies that were in Canada to supply the Canadian markets had to be here in order to avoid paying the tariff coming into Canada. Once those tariffs came down between Canada and the U.S., we saw a movement of FDI out of Canada and into the U.S.

I would argue that with the recent tax changes in the U.S., it made the U.S. much more attractive. Companies that were on the margin and thinking about whether to locate in Canada or the U.S., they will now locate in the U.S. rather than in Canada.

In my opinion, once we have these tax changes, we’re going to see more companies moving from Canada into the U.S.

One of the challenges for trade policy is the following, and it’s definitely true with CETA, the Canada-European Union Comprehensive Economic and Trade Agreement. I was there when former Prime Minister Harper made the announcement in downtown Toronto that we had signed a deal. He then said, “Now it’s time for companies represented in this room to take advantage of this free trade agreement.” But we need to prepare Canadian companies so they are innovative and competitive and are able to do business in these foreign markets.

We can’t take our eye off of that one fundamental principle, which is to ensure our companies can be innovative to enable them to cross borders to do business abroad. That’s an important source of prosperity for Canada.

Senator Dagenais: Dr. Lilly, Canada is great and a large country, but I want to focus on something without NAFTA. Do you have any information that will provide us a picture of the impact in different areas of our country?

Ms. Lilly: With respect to NAFTA?

Senator Dagenais: Yes.

Ms. Lilly: I have a bit information about the post-9/11 consequences of cross-border trade. We found that Ontario and Quebec fared the best following 9/11. The reason for that was because their economic interest was there. Governments saw a real and serious emergency and worked very quickly to sign the Smart Border Declaration and put a number of processes in place to help ensure that the blockages we saw in the days and months following 9/11 didn’t become permanent problems.

British Columbia, on the other hand, experienced a great deal of difficulty and was more damaged than other provinces. The reason for that, we believe, is because while there is a lot of trade going back and forth across the border in B.C., it’s not highly integrated. In Quebec and Ontario, the trade is global value chains and pieces going back and forth in a just delivery-time model. In British Columbia, it’s entire trucks of trees going once across the border one time. It is not as integrated an industry. So there was a huge drop in Americans coming north, and there was also a drop in Canadians going south.

We saw this with respect to firm size as well. Basically, the bigger firms across the board did better because they were more integrated and there was a greater business case for them to keep trading; but small companies, British Columbia, small provinces where there were fewer benefits to deal with all the headaches of getting it back across the border, dramatically reduced what they were doing at the border.

Senator Wetston: Thank you both for joining us today. I want to ask a couple of general questions, mostly because I think trade policy is very technical. Just like we always talk about Canada being a natural resource economy — I’m not going to use “hewers of wood and drawers of water,” but it constantly comes up — the issue of an innovation economy has been on the radar for years, and it looks like we have not done enough about that.

I often think that competitive markets are really important to driving an innovation economy. Is the lack of competition in Canada, in some of the sectors that we have been discussing, one of the reasons we do not have a more innovative economy or more innovation in our firms? Second, do you believe trade policy is important to incenting an innovation economy?

Ms. Lilly: I’m going to be brief because I think I’m going to defer most of this.

I would agree with a comment made earlier. There is a joke in Canada that a small business’s big dream is just to get big enough to get bought by an American company. Certainly we do have challenges. To some extent — and this is a general comment; I don’t have expertise in this area — there is a “small country” perspective on a lot of our business goals.

I’m a bit careful about the role of trade policy to incentivize innovation. Certainly trade policies should be negotiated for the future. In the case of NAFTA, the future of trade is in services, not goods. So insofar as innovation is the future, yes, we should be spending a lot of time and energy thinking about to what extent are these individual technical provisions we’re negotiating relevant for the future.

I have written a bit about this with respect to the rules of origin. The digital iPhone is one example. Rules of origin around autos is something the Canadian government is advancing right now in NAFTA negotiations. But I would also say that it’s important not to overstate the role in trade policy versus technological innovation generally on some of this.

One of the conversations in the United States is around how NAFTA is responsible for a bunch of job losses. Well, NAFTA is responsible for a handful of job losses. There is evidence that some companies moved to Mexico and other cheaper jurisdictions, but the widespread agreement among experts is that’s it’s largely technology that has taken away those jobs rather than trade.

If you take that argument and look at trade policy writ large, I certainly think we should incentivize trade for the future, but I would be careful about over-promising what trade policy will do for our economy generally.

Mr. Hejazi: In terms of competition, I encourage the committee to get the report that Global Affairs Canada will release in the coming month or so.

This is work I did with Professor Trefler at the University of Toronto. We looked at the impact on productivity and prosperity in the Canadian economy that results from protection in Canada for foreign investment. Let me give an example: the telecom sector — and I could go on and on. But when you look at the impact of protection on the telecom sector in Canada and the impact it has on productivity and prosperity to the Canadian economy, these are significant numbers, and they inhibit innovation and productivity in the most data-intensive industries.

We know that two of the emerging sources of competitive advantage in Canada are artificial intelligence and machine learning. These are big data where you really need broadband, and I’m disappointed to report that investment in broadband in Canada is one half of what it is in the U.S. per capita. We need to have more competition in telecom. I can’t understand why we continue to protect that industry.

When it comes to fintech adoption rates across the world, Canada is one the lowest countries when it comes to fintech adoption.

The open API environment proliferated in Europe. It means that fintechs are able to take an individual’s data from their financial institution and integrate it into fintech services. With regard to the Canadian banking system, we’re revisiting the Bank Act, and we’re talking about 5 to 10 years before Canada catches up to the rest of the world.

When it comes to trade policy, the academic literature says that we need to get Canadian companies access to bigger markets because on the margin we need larger markets to spread the fixed cost of R&D, and we need to get to very sophisticated markets which help discipline Canadian companies to create the kinds of innovation that are the sources of prosperity in the next century.

Senator Wallin: I have a comment and then a question.

I know your work on the post-9/11 world. This is what troubles me. Canada actually said no to a perimeter deal at that time to be inside the embrace. Consequently, the border thickened and thickened, and then there was the double whammy of SARS. I hope we don’t do this again and respond to rhetoric rather than reality when it comes to security issues. I would like to hear your comment on that, Dr. Lilly.

Last night I was at an event where the new U.S. Ambassador to Canada and Pete Sessions, a congressman forever, out of Texas, and Laura Dawson were talking about free trade, of course, about NAFTA. They kind of looked at us and said there are midterm elections coming up and there is the Mexican election. We’re not going to resolve this until those things are done. The negotiations are proceeding apace. The stuff is getting done and initialled. And to both your points, the issues are really domestic decision-making here in Canada that has much more of an impact on whether our economy grows, whether we need the same kind of NAFTA deal that we did at the time that we signed it. We’re in a different time and place. I’ll just throw those two things out.

Ms. Lilly: On the first issue around the securitization of American policy following 9/11 and whether we’re returning to that, I think to some extent we are. I think Canada will take an evidence-based approach to this.

I’m not sure that this U.S. administration would put on offer a perimeter security proposal that it might have in the past. The comment that I made yesterday, the America first versus America alone, my real concern is if the United States believe that the Mexican border is leaky and the Canadian border is leaky, I don’t think they’re going to be looking to us for a perimeter solution anyway. So we’ll have to respond and react, but hopefully we can also prepare and try to avoid scenarios that increase concerns around our border security.

On the timing of NAFTA, the Mexican election is coming up in July. If we don’t have a deal by March, I anticipate that the rhetoric in Mexico will become very anti-Trump in a way that will be difficult to advance the discussions. The way that the presidential calendar works in Mexico means that while the president is elected in July, they don’t fully assume office until December. So you’re talking about a long timeline there. And you mentioned the U.S. midterms. So I think there is a very real likelihood that a NAFTA deal will be punted down the road.

The one real concern I have about that is the ongoing uncertainty that it creates for the Canadian business environment and foreign investment in Canada. Anecdotally as well as through evidence — and I think that you either will have or have had the Bank of Canada in to talk about these issues — there is a real chill in investment in Canada, and I don’t see it going away until NAFTA is settled. That’s bad for all three North America countries. It’s not just bad for Canada.

With some of the actions that the U.S. administration is taking to lure companies back to the United States, I think the risks for Canada are real. So I do have concerns about thinking everything will be okay if we just hang on for a really long time.

Mr. Hejazi: Just to add to that, I completely agree with the drawn-out timetable for renegotiating NAFTA and the uncertainty. I think some reports have come out from some of the banks. I think TD released something yesterday that said there is a real chill on foreign investment. This is going to hurt the Canadian economy.

There is one additional point I want to add. We had Edward Luce from the Financial Times present here at Rotman today. He wrote a book called The Retreat of Western Liberalism. I think why that is important for this discussion is that many people you talk to think that if Trump loses the next election, there will be a snap back to normality. His book and research conclude that Brexit, Trump and the rise of far-right parties across Europe — he calls Trump a symptom, not a cause of this retreat of liberalism.

Why do I raise that? I raise it to say that we don’t know if the U.S. is going to return to an evidence-based decision model where you say, “NAFTA is beneficial to both sides, win-win, so we can tweak it, but shutting it down would be bad for both sides.” We can’t say when we’re going to go back to that world, and that really concerns me. That’s why I continue to stress that we want NAFTA to survive. That’s our first choice. That’s the profit-maximizing strategy. That’s where we can create prosperity. But I believe we need to help Canadian companies become much larger and more innovative. Help them develop their IP and deploy strategies globally so we’re not as focused on the U.S. economy and, therefore, really held hostage to the political calendar. It’s pretty sad.

Senator Tkachuk: I don’t know about NAFTA, but I’ve given a lot of thought to Brexit. The problem with the European Union was it became more than a trade agreement. It became an attempt to politicize Europe into a one-nation state, which the British weren’t happy with. I think that’s part of the problem.

You mentioned the bureaucracy in Canada having no sense of urgency. We had the same issue. We had a look at the copyright report for the same thing, where intellectual property, one of the most important things in driving an economy, and these guys were doing nothing and were taking years to get things done.

These things frustrate business. People blame it all on trade, but it isn’t trade. It’s other stuff. All trade is is no tax. That’s what it means. It means I can sell something to an American and no one is going to tax me. It’s not that complicated. But we’ve made it so and the bureaucrats have made it so. People rebel against that and don’t like it. I think that’s the danger in Europe, and that’s part of the problem with Canada-U.S. too.

Mr. Hejazi: We’re in the final stages of writing a book. The title is Canada at 200. I ask my students every year what country they would rather live in other than Canada. And we know Canada is the place to be, but if you look at the sources of our prosperity over the last 50 years, these are not necessarily going to be the sources of prosperity going forward. So when someone is looking in the backwards mirror thinking they have nothing to worry about because we’re one of the best countries in the world, if they look at the data, we continue to slide in the rankings on many different dimensions.

I believe that this is a threat to some of the fabric — I don’t want to be alarmist, but we need to help Canadian companies and enable them to be innovative — copyright, IP — because the sources of prosperity going forward are not going to be the same sources we have relied on for the last 50 years.

Senator Tkachuk: Get that guy from BlackBerry who took a dead company that had barely a pulse and is turning it around. How did he do that? Innovation.

The Chair: I have the opportunity and the privilege to thank you both. This has been a tremendous panel. It’s only the second panel in our study, and it has helped us very much frame where we need to go.

As Senator Tkachuk has pointed out in his extremely effective way, trade matters, but there is other stuff. This committee, over the next number of weeks, is going to be looking at the other stuff that is potentially creating obstacles to competitiveness. I don’t want to prejudge it.

You have been extremely helpful, both of you, and you may very well hear from us again.

(The committee adjourned.)