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03/16/2018 12:22 EDT | Updated 03/16/2018 12:22 EDT

Looming Trade War Isn't The Only Problem For Canada's Economy

Unfortunately, nothing was done to try to correct these issues in the recent federal budget.

In collaboration with Alexandre Moreau, Public Policy Analyst at the MEI

U.S. President Donald Trump has just announced that the U.S. will indeed impose tariffs on imported steel and aluminium, while exempting Canada and Mexico at least temporarily. As many commentators have noted, this will hurt the U.S., causing net job losses in their manufacturing sector and increasing prices south of the Canadian border, making U.S. households poorer. And no change in the overall U.S. trade deficit will occur, since a country's trade balance is related to the national levels of saving and investment, not to tariffs.

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The probability of a trade war, in which other countries will retaliate by creating new obstacles to U.S. imports, is now higher than at any time in the past 50 years. The European Union has already selected politically strategic sectors to hurt in a tit-for-tat approach. Notwithstanding President Trump's statement to the contrary, trade wars are never, ever good. The last big one, in the 1930s, made the Great Depression deeper and longer, as every country retaliated against other countries' protectionist policies, and international trade shrank dramatically. That's why countries all over the world have since tried, through the GATT and the WTO, to make trade more orderly and less subject to the whims of national politics.

Even if Canada is safe from duties on steel and aluminium for the time being, as long as the NAFTA negotiations are unfolding in the United States' favour, a lot is at stake, as the Americans are our most important trading partner. And while it is possible that no tariffs will be imposed on Canadian exports, the risk remains real since those negotiations are not exactly going well. We stand to lose even more if a global trade war breaks out.

There is not much the Canadian government can do about these issues, though, other than show our U.S. partners the shared benefits from trade. But there are other areas in which things can be done to improve Canada's situation.

If we continue down this path, Canadians will become poorer and poorer compared to Americans.

Looking at the data from Statistics Canada's Gross fixed capital formation table and the U.S. Department of Commerce's Bureau of Economic Analysis, we can see a worrying trend developping.

Over the past three years, foreign direct investment in Canada has decreased by 54 per cent, whereas Canadian investment abroad (especially in the U.S.) has increased by 36 per cent. This has been happening for a while in the resource industry, as investing in infrastructure becomes more and more complicated in Canada while it becomes easier in the United States. And this problem has now spread to other industries.

In fact, business capital expenditures are down 17 per cent in Canada since the end of 2014, while they are up four per cent in the U.S.over the same period, in constant dollars. This problem will undoubtedly become worse as uncertainty concerning trade will translate into more companies making the safe choice of investing in the U.S. instead of Canada.

THE CANADIAN PRESS/Sean Kilpatrick
Prime Minister Justin Trudeau, left, and U.S. President Donald Trump take part in a joint press conference at the White House in Washington, D.C. on Feb. 13, 2017.

At the root of this major discrepancy between U.S. and Canadian investment lie the favourable changes that have been occurring in the United States regarding business regulations and the corporate tax rate, while regulations have become more cumbersome in Canada. Simply stated, Canada is becoming less and less competitive in many sectors. One sector, Canadian oil and gas, has been hit particularly hard, as many projects have been abandoned in the past three years and new projects are being reconsidered. As a case in point, experts fear it will become close to impossible to have new pipeline projects approved by the refurbished National Energy Board.

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Falling investment is a very big problem, as living standards are directly related to productivity, which is itself closely linked with business investment. If we continue down this path, Canadians will become poorer and poorer compared to Americans.

Unfortunately, nothing was done to try to correct these problems in the recent federal budget. It's not too late to act, but time is running out, especially in our worsening international context. The federal corporate income tax rate must come down, and a real effort to reduce costly regulations has to begin as soon as possible. Our future does not only depend on President Trump; our to-do list is considerable, so we'd better stop sitting on our hands.

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