Geopolitical Futures recently conducted a Deep Dive exploration of the U.S.-Mexico trade relationship. Now, we will examine the U.S.-Canada economic relationship. First, we will take an in-depth look at one commodity upon which Canada is highly dependent: oil. Next, we will look at relative dependence in the U.S.-Canada trade relationship and explore the North American Free Trade Agreement’s efficacy from Canada’s point of view. The report reaches two conclusions. First, Canada’s economy is dependent on the U.S. economy, but despite NAFTA, Canada’s manufacturing industries cannot compete with the lower production costs available in Mexico and China. Consequently, Canada has lost its competitive advantage in the production of goods such as motor vehicles and machinery. Second, renegotiating NAFTA and a selectively more protectionist environment in the U.S. are just as much in Canada’s interest as they are in the United States’.
- Canada’s economy is extremely dependent on the U.S. economy.
- Canada has lost market share of U.S. imports, to China, Mexico and others.
- Canada has an interest in a more protectionist environment in the U.S. that preserves Canada’s preferential trade status with the U.S.
NAFTA is technically a free trade agreement between three countries: the United States, Canada and Mexico. Even so, it is more useful to think of NAFTA in terms of two distinct bilateral economic relationships: one between the U.S. and Canada, the other between the U.S. and Mexico. NAFTA is built around the United States as a consumption engine since the U.S. is not a large exporter – only 12.6 percent of the U.S. GDP comes from exports. The United States economy is also massive in relative terms, and it accounts for 24.3 percent of global GDP. By comparison, Canada has the 10th largest economy in the world and Mexico has the 15th in terms of GDP. Canada and Mexico are not small countries; they are both major economic powers. Even so, both pale in comparison to the U.S. when it comes to size.
The Suncor refinery in Edmonton, Canada, seen here on June 17, 2015 has, according to the company, a capacity of refining 142,000 barrels of light oil a day. It is run entirely on bitumen from the oil sands in northern Alberta. GEOFF ROBINS/AFP/Getty Images
The imbalance between the U.S. and its neighbors is one reason that NAFTA is effective. Because the U.S. does not depend on exports and is such a large consumer, Mexico and Canada grow their economies by relying on exports to their American neighbor. Mexico exports 35.4 percent of its GDP; for Canada, that figure is 31.5 percent (all figures are from the World Bank, 2015). Both countries export primarily to the United States, but not to each other. For instance, the United States is the destination for 76.7 percent of Canada’s exports. Put another way, almost a quarter of Canada’s GDP comes from exports to its southern neighbor. For Mexico, the reliance is even more stark – 81.2 of Mexican exports are to the United States, which means more than a quarter of Mexico’s GDP comes from exports to the U.S.
In comparison, trade between Canada and Mexico is relatively small. In 2015, Mexico was the destination for only 1.3 percent of Canadian exports; Japan, the U.K. and China all imported more Canadian products than Canada’s fellow NAFTA state Mexico. Similarly, only 2.8 percent of Mexico’s exports ended up in Canada. It makes sense, then, to look at the U.S.-Mexico relationship and the U.S.-Canada relationship as separate components when studying NAFTA.
A Microcosm of Canada’s Dependence: Oil
Of the 10 largest economies in the world, none is as dependent on another country as Canada is on the United States. As noted above, a quarter of Canada’s GDP comes from exports to the United States. This dependence is even sharper when viewed in terms of Canada’s most lucrative export: petroleum oils.
The chart above shows that Canadian exports have tripled since NAFTA came into effect in 1994. Before 2005, Canada’s biggest export to the United States was motor vehicles. Oil took over as Canada’s top export in 2006, and in the most recent year for which complete data is available, 2015, total exports of mineral fuels accounted for about 5 percent of Canada’s GDP. Preliminary data show that 2016 was likely the first year since 2005 that mineral fuels were not the most valuable Canadian export; this is due to low oil prices throughout most of the year.
Oil is Canada’s most important export, and the U.S. is practically Canada’s only customer. According to Canada’s National Energy Board, 99.1 percent of Canada’s crude oil exports went to the United States. Petroleum oil exports to the U.S. excluding crude were similarly lopsided, accounting for 95 percent of Canada’s exports. Canadian oil exports make up a significant portion of American oil imports, to be sure: Canada accounts for 40 percent of U.S. oil imports. But the oil market is oversupplied, and numerous other sellers would be grateful to entertain U.S. buyers. A comparative study of relative dependence on this commodity also confirms that Canada is more dependent on exports of petroleum to the U.S. than the U.S. is dependent on imports from Canada.
Canada’s dependence on the U.S. for petroleum imports could make it vulnerable in two ways. The first would be if the U.S. either decided to buy its oil from elsewhere or decided to increase its domestic oil production. The former is extremely unlikely, but the latter is probable in the long run. Though such developments are not imminent, their potential effect on Canada is still potent. Either of these scenarios would do significant harm to Canada’s economy. This vulnerability could also manifest with an overall decline in global oil prices. In fact, Canada is currently experiencing this. The recent downturn in oil prices has had a significant negative impact on the Canadian economy. In terms of volume, Canada exported about as much oil in both 2015 and 2016 as it did in 2014. Even so, the value of oil exports to the U.S. in 2016 was about half as much as in 2014. In U.S. dollar terms, from 2014-2015 Canada’s GDP decreased in value by 13 percent because of low oil prices.
Oil is just one commodity, and while it is the most significant Canadian export, it is not the only one. Still, it is a useful case study to show how dependent Canada is on the U.S. economy. In the next two sections, we will elucidate some caveats to this dependence, and we will also trace a broader picture of Canada’s trading relationship with the U.S. Still, it is important to keep in mind Canada’s underlying reliance on the U.S. when thinking in terms of comparative advantage between the two countries.
Not Completely a One-Way Street
Although the U.S. is less dependent on Canada than Canada is on the U.S., Canada is still an extremely important trading partner for the U.S. For instance, Canada is the largest destination for U.S. exports; in 2015, 18.6 percent of total U.S. exports went to Canada. Canada is also the second-largest source of U.S. imports, at about 13 percent of the total; China took over the pole position from Canada in share of U.S. imports in 2007. The fact that the U.S. economy is so massive and is not dependent on exports, however, obscures the importance of the U.S.-Canada trading relationship for the U.S. As Geopolitical Futures has previously noted, the U.S. economy is balanced across different regions. This means that certain U.S. regions are much more dependent on the trading relationship with Canada than national economic data indicate. To get a better sense of the relationship’s importance from a U.S. perspective, it is necessary to drill down at both the regional and state levels.
As noted above, the U.S. consumes essentially all Canadian oil exports. However, these oil exports can be broken down in regional terms. When it comes to energy, the U.S. is divided into five main regions, called Petroleum Administration for Defense Districts. Canada’s National Energy Board reports its export statistics in terms of these regions, which underlines just how important these exports are to Canada. The thing to note from the map above, though, is that the majority of Canadian oil exports to the U.S. – 63.7 percent – go to the Midwest. The Rocky Mountain region is one of the smallest in the U.S. and is a much less wealthy region than the Midwest. However, it imports a large share of Canada’s oil relative to its size.
This makes a great deal of sense considering that these are the two U.S. regions that do not have direct access to either the Atlantic or Pacific oceans. It also is indicative of the current pipeline infrastructure, which is designed to transport oil from Canada into these specific markets. Overall, the United States is not dependent on oil from Canada and could likely find alternate sources, either foreign or domestic. For the Midwest and Rocky Mountain regions, however, this would be more difficult in practice than obtaining oil from Canada, and it would also likely entail greater cost. Neither of these regions would look kindly on a decision made in Washington to shift away from importing Canadian oil.
This analysis holds in two other important factors of the relationship. When considered as a single political entity, the U.S. is not dependent on exports. But not all the states in the union are created equal; the Constitution only guarantees that they are equally free to pursue economic gain. The chart above identifies all the U.S. states for which Canada is the largest export destination of products manufactured in those individual states. It also shows what percentage of individual state GDPs come from those exports to Canada. Michigan, for example, depends on exports to Canada for almost 5 percent of its state GDP. Indiana, North Dakota and Kentucky are all states whose economies have a similar dependence on their trading relationship with Canada. The maps below show which states count Canada as their largest trading partner, both in terms of imports and exports.
The second part of the U.S.-Canada relationship to keep in mind is the number of American jobs that are created by trade with Canada. The website for the Canadian ambassador to the United States claims that almost 9 million jobs in the U.S. are dependent on trade and investment with Canada. It even breaks this figure down at the state level: 259,000 jobs in Michigan, 174,200 jobs in Minnesota, and so on. The numbers are derived from a study commissioned by the Canadian government and published by the Centre of Policy Studies at Victoria University in December 2014. The researchers in that study determined that 8.27 million jobs in the U.S. would disappear if trade between the U.S. and Canada were halted completely. However, Canada has an obvious interest in these figures being high due to its dependence on the trade relationship, so they should be taken with a grain of salt.
The hypothetical situation of U.S.-Canada trade being halted is extremely unlikely, even if NAFTA were to be eliminated or reworked, and even if the U.S. installed various tariffs on goods coming into the U.S. from Canada. Even so, the basic assertion that many U.S. jobs depend on the U.S.-Canada trade relationship is true, even if it is not quantifiable in precise terms. One way to confirm this is to examine data provided by the U.S. Bureau of Economic Analysis (BEA). The BEA tracks employment figures for companies operating in the U.S. but not owned by U.S. citizens. According to the latest figures (2014), Canadian companies employed over 621,000 employees in the United States – only Japan, the U.K. and Germany employed more.
This only represents about 0.5 percent of the total employed civilian labor force in the U.S., but it is also an imperfect measuring stick since it only includes jobs that can be directly tied to a Canadian company. The true figure when accounting for U.S. companies that depend on the U.S.-Canada trading relationship is likely much higher. The important point to keep in mind is that a significant number of Americans are employed because of the U.S.-Canada trade relationship. A precise figure is impossible to obtain, but it probably lies somewhere between the two data points provided above. For all of these reasons, the U.S.-Canada trading relationship is of deep strategic import to the United States even if the U.S. is not as dependent on the relationship as Canada is. It is the countries’ mutual interest in this relationship that initially made NAFTA attractive to both countries.
Canada’s Raw Deal
The U.S. has made a great fuss about wanting to renegotiate the terms of NAFTA. President Donald Trump has done it most vocally, but many major figures on the Democratic side have also expressed a desire to renegotiate NAFTA. When U.S. politicians make these statements, however, they very rarely single out Canada as the problem; it is usually Mexico that gets the bulk of the attention. This is because the U.S. and Canada face similar challenges in the sense that both are losing manufacturing jobs to countries like Mexico and especially China because these countries can produce many of the same products at a much cheaper price. Canada, in fact, has suffered from the hollowing out of American industry because it has lost market share in the United States to China.
At first, NAFTA was a boon for the U.S.-Canada trading relationship. However, Canadian exports to the U.S. have declined in both value and weight since approximately 2000 despite the free trade agreement.
The chart above shows how this situation has slowly developed since 2001. In 2001, Canada had the largest share of U.S. imports of any country in the world, accounting for 18.7 percent of the value of all U.S. imports. In 2007, however, Canada was overtaken by China as the leading exporter of goods to the U.S., and preliminary data for 2016 shows that Mexico has also overtaken Canada. The problem for Canada is not just that China and Mexico have increased their market share, but that these increases have come at the expense of Canada’s market share. The latest 2016 data show that Canada only had a 12.7 percent market share of U.S. imports. China, meanwhile, has increased its market share from 9.3 percent to 21.4 percent since 2001, and Mexico has increased its market share more modestly, from 11.3 percent to 13.2 percent. In addition, Asian countries have also increased their market share of U.S. imports as Canada’s share decreased. Vietnam and India are both examples of countries that had a less than 1 percent market share of U.S. imports in 2001; their shares have now increased to 1.9 percent and 2.1 percent, respectively.
The issue is not just one of market share. The value of Canadian exports to the U.S. has also declined. In absolute terms, the U.S. imported $220.1 billion from Canada in 2001 and $284.6 billion in 2016. At first glance that seems promising, especially considering that 2016 figures account for the low oil prices that have hurt Canada for the past two years. But adjusted for inflation, Canada’s share of U.S. imports was worth more in 2001 than it is today. In terms of 2016 dollars, U.S. imports of Canadian goods in 2001 were valued at $298.2 billion, meaning the value of Canada’s share has declined by almost 5 percent. Meanwhile the value of China’s exports to the U.S. has tripled, and Mexico’s has almost doubled. Even when oil is removed from the equation, there is still a similar drop in the value of U.S. imports of Canadian goods.
In part, this happened because Canada shifted its economic focus to developing oil production capabilities when manufacturing jobs were lost. This was at a time before the shale revolution in the United States. For a few heady years, high oil prices were a boon for the Canadian economy. At the same time, however, Canada lost overall market share to Mexico and China, and its manufacturing capacity began to erode. The International Monetary Fund noted this in a June 2016 report on Canada’s economy. It is also shown in the chart below, which examines the value of Canadian exports by industry classification. The chart clearly shows a large increase in oil exports while many industries, like furniture and electric machinery, have declined.
This decline is not just registered in terms of value but also in terms of weight. The data, which is reported yearly by the U.S. Census Bureau, shows that the absolute volume of trade has slowly decreased over the last decade. In 2005, the total weight of U.S. imports from Canada was approximately 158,304 million pounds. In 2016, that number had fallen to 108,944.3 million pounds, a decline of over 30 percent.
Canada is in a difficult position, a situation that NAFTA has been unable to prevent. It has prioritized the development of its oil sector only to see the bottom fall out of oil prices. Prices have stabilized for now, but the market is oversupplied and prices are likely to fall again. Canada has also lost significant market share in its most important trading relationship with the United States; China, Mexico and other countries that produce similar goods at lower costs have absorbed this market share.
The U.S.-Canada trade relationship differs from the U.S.-Mexico relationship in that there is less direct competition between Canada and the U.S., both in terms of job market and type of economic activity. The U.S. and Canada face similar problems in the hollowing out of their industrial capacities. However, U.S. jobs are not leaving Michigan for Saskatchewan; jobs are leaving both Michigan and Saskatchewan for Guangdong or Chihuahua. The same phenomenon that has led to the loss of many middle-class jobs in the U.S. has also led to job losses in Canada’s manufacturing sector. In practical terms, this means that a selectively more protectionist U.S. would be beneficial to Canada if the general terms of NAFTA remained in place. The protectionist measures would lend protection not just to the U.S. but also to Canadian manufacturers in such a scenario, making countries such as China and India less competitive. In the current environment, however, even with the preferential trade agreement in place, Canada is not as competitive in U.S. markets as other nations are.
This is one of the reasons that Canada has pursued a free trade deal with the European Union; after a touch–and-go political process in Europe, the deal has finally passed the European Parliament. The EU is an attractive free trade partner for Canada because of the symmetry it offers. One of the original concerns about NAFTA was that it is asymmetrical because it brings together two developed countries and a developing country. The concerns about asymmetry have turned out to be justified but are avoided in the EU deal. The deal is also attractive because Canada needs to find new markets to which it can export since over 30 percent of its GDP comes from exports. With political uncertainty in the U.S. and no way to change its reliance on exports overnight, Canada must find new markets. If renegotiating NAFTA serves to level the playing field between Mexico and Canada by making Canadian goods more competitive when it comes to exporting to the U.S., it would benefit Canada.
Ultimately, Canada has few options. It cannot turn its back on NAFTA because the relationship with the U.S. is too important. Even in a trade deal with the EU, Canada will struggle to find importers for its goods. In the EU, for example, Canada will compete with Germany. Unlike NAFTA, which is built around a massive consumer (the United States), the EU is built around Germany, a massive exporter, which limits the potential gains Canada can make in terms of market share. The good news for Canada is that its free trade relationship with the U.S. is not at stake because the U.S. already is the more significant beneficiary of that relationship. The bad news is that as long as oil prices stay low, there is very little Canada can do to jump-start its economy. For that, Canada needs the U.S. to consume Canadian exports like it did prior to 2000, and that is outside of Canada’s control.