Capacity for Choice: Canada in a New North America 9781442672697

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CAPACITY FOR CHOICE:

CANADA IN A NEW NORTH AMERICA Edited by George Hoberg

Drawing together an interdisciplinary group of scholars, this collection of essays - part of the Trends Project of the Government of Canada's Policy Research Initiative - examines North American integration and its potential future impact on Canadian life. It looks at trends in integration, knowledge gaps, and policy implications in economics, culture, and politics. The contributors argue that the consequences of continental integration have not been as formidable as many people believe - the reality turns out to be enormously complex and ambiguous. While Canada has surrendered some policy instruments in exchange for access to larger markets and the pressures for harmonization have probably increased, it still retains significant room to manoeuvre, even in areas of policy most affected by growing economic integration. Canada has formidable capacities for domestic policy choices in a wide range of sectors, as this volume clearly shows. It is up to Canadians and their elected officials to exercise that freedom, and the essays collected here can guide them in their choices, as they help to forge a new North America. GEORGE HOBERG is professor and head, Department of Forest Resources Management, University of British Columbia.

T

The Trends Project Series is a result of the Government of Canada's Policy Research Initiative, an undertaking that seeks to strengthen the Government of Canada's policy capacity and ensure that policy development benefits from the work of researchers and academics. The Policy Research Initiative, in cooperation with the Social Sciences and Humanities Research Council, undertook a new model for academics and government to collaborate on policy research. Teams of academics examined the forces that are driving change in Canada and identified the potential implications for public policy. This collaboration came to be known as the Trends Project. Under the Project, academics, research institutes, and government officials worked in partnership to build a better knowledge base on longer-term issues to support policy development and identify knowledge gaps requiring further research. The Trends Project will result in the following books*: Gordon Smith and Daniel Wolfish, editors, Who Is Afraid of the State? Canada in a World of Multiple Centres of Power

Edward A. Parson, editor, Governing the Environment: Persistent Challenges, Uncertain Innovations

Neil Nevitte, editor, Value Change and Governance in Canada

George Hoberg, editor, Capacity for Choice: Canada in a New North America

David Cheal, editor, Aging and Demographic Change in .Canadian Context

Danielle Juteau, editor, Social Differentiation: Patterns and Processes

*These are working titles and are subject to change.

CAPACITY FOR CHOICE Canada in a New North America

Edited by George Hoberg

U N I V E R S I T Y OF TORONTO PRESS Toronto Buffalo London

www.utppublishing.com University of Toronto Press Incorporated 2002 Toronto Buffalo London Printed in Canada ISBN 0-8020-8407-9

Printed on acid-free paper

National Library of Canada Cataloguing in Publication Data Main entry under title: Capacity for choice : Canada in a new North America (Trends series) ISBN 0-8020-8407-9 1. Political planning - Canada. 2. North America - Economic integration. 3. Social choice - Canada. 4. Canada - Economic policy - 1991- . 5. Canada - Cultural policy. I. Hoberg, George, 1958- II. Series: Trends series (Toronto, Ont.) HN103.5.C36 2001

320'.6'0971

C2001-903552-7

University of Toronto Press acknowledges the financial assistance to its publishing program of the Canada Council for the Arts and the Ontario Arts Council. University of Toronto Press acknowledges the financial support for its publishing activities of the Government of Canada through the Book Publishing Industry Development Program (BPIDP).

Contents

List of Figures and Tables Preface

vii

xi

Contributors

xiii

1 Introduction: Economic, Cultural, and Political Dimensions of North American Integration 3 George Hoberg Part One: Economics 2 Effects of the FTA on Interprovincial Trade 17 John F. Helliwell, Frank C. Lee, and Hans Messinger 3 Making Macroeconomic Policy in an Integrating North America 61 Ronald Kneebone 4 The Integration of Labour Markets in North America Rafael Gomez and Morley Gunderson 5 Checking the Brain Drain 2000 128 John F. Helliwell

104

vi Contents

Part Two: Culture 6 North American Integration and Canadian Culture 159 Gilbert Gagne Part Three: Politics 7 Governance and State–Society Relations: The Challenges 187 Laura C. Macdonald 8 Redefining the Locus of Power 224 Francois Rocher and Christian Rouillard 9 The Scope for Domestic Choice: Policy Autonomy in a Globalizing World 252 George Hoberg, Keith G. Banting, and Richard Simeon 10 Conclusion: Capacity for Choice 299 George Hoberg Bibliography 315

Figures and Tables

Figures 1.1 Exports and imports, total and with the United States, as percentage of GDP, 1926–1998 7 2.1 Ratio of international to interprovincial trade, 1989-1996 30 2.2 Ratio of U.S. trade in 1996 and 1989 31 2.3 Ratio of ROW trade in 1996 and 1989 32 2.4 Ratio of interprovincial trade in 1996 and 1989 34 2.5 Ratio of U.S. trade to interprovincial trade, 1996 36 2.6 Ratio of ROW trade to interprovincial trade, 1996 38 2.7 Duty collected as percentage of imports, 1989-1996 39 2.8 Changes in rate of duty collected for imports from ROW, 19891996 40 2.9 Changes in rate of duty collected for imports from the United States, 1989-1996 41 2.10 Changes in rate of duty collected for exports to the United States, 1989-1996 44 2.11 Effects of FTA on exports, actual versus forecast 45 2.12 Effects of FTA on imports, actual versus forecast 45 3.1 Rates of CPI inflation, Canada and the United States, 1976– 2000 70 3.2 Short-term interest rates, Canada and the United States, 19622000 71 3.3 Unemployment rates, Canada and the United States, 1976– 2000 72

viii Figures and Tables

3.4 Ratios of total government-sector deficit and of debt to GDP, Canada, end of calendar year, 1970-1998 74 3.5 Total government revenues and expenditures, as percentage of GDP, Canada, end of calendar year, 1970–1998 75 3.6 Exports and imports of goods and services, total and with the United States, as percentage of GDP, 1961-1999 77 3.7 Commodity price index, Canada, 1987-1999 81 3.8 The Canadian-U.S. exchange rate, 1973-2000 82 3.9 Stock-market prices, Canada and the United States, 19872000 84 3.10 Indices of labour productivity in Canada relative to that in the United States, 1977-1997 93 3.11 Real per-capita disposable income, Canada and the United States, 1970–1998 97 3.12 Indices of real per-capita GDP, Canada and the United States, 1977-1999 98 4.1 Union members as percentage of non-agricultural paid employment, 1901-1997 112 4.2 Work stoppages involving 1,000 workers or more, 1980– 1997 114 5.1 Canadian-born living in the United States and U.S.-born living in Canada, as percentage of Canadian population, 1900– 1996 131 5.2 Current location of UBC bachelor's graduates from 1950 to 1996, as percentage of graduating class 136 5.3 Current location of UBC PhD graduates from 1955 to 1995, as percentage of graduating class 137 5.4 New UBC bachelors and PhDs relative to BC population, 1930– 1996 139 9.1 Public expenditures on social protection, as percentage of GDP, 1960–1995 258 9.2 Health expenditures and outcomes, Canada and the United States, 1960–1997 259 9.3 Health insurance non-coverage in the United States, 1998 261 9.4 Public expenditures on seniors and poverty levels among seniors, Canada and the United States, 1970s-1990s 263 9.5 Recipients of regular UI benefits, as percentage of unemployed persons, Canada and the United States, 1971-1997 267 9.6a Impact of tax and transfer systems on income inequality, Canada and the United States, 1974-1997 268

Figures and Tables ix

9.6b Change in levels of inequality, as percentage change in Gini coefficients, Canada and the United States, 1974–1997 269 9.7 Trends in air pollution emissions, Canada and the United States, 1980-1994 274 9.8 Trends in concentrations of ambient air pollutants, Canada and the United States, 1975–1996 275 9.9 Air pollutant emissions per unit of GDP, Canada, the United States, and the OECD, mid-1990s 276 9.10 Environmental spending, as percentage of total budgets, Canada and the United States, 1986–1997 277 Tables 1.1 1.2 2.1

The continuum for integration 9 Perspectives on the consequences of economic integration 12 Trends in interprovincial and Canadian-U.S. merchandise trade, 1988-1996 25 2.2 Changes in trade, 1989-1996 28 2.3 Changes in average tariff rates, 1989-1996 29 2.4 Effects of tariff changes on trade flows, 1989-1996 35 2.5 Canadian exports to the United States 43 2.6 Canadian imports from the United States 46 2.A1 Duty rates on imports to Canada from the United States 48 2.A2 Duty rates on Canadian exports to the United States 51 2.A3 Duty rates on imports to Canada from the rest of the world 54 3.1 Ratio of international exports to provincial GDP, 1981-1996 78 3.2 Ratio of international to interprovincial exports, 1981-1996 79 5.1 Estimated Canadian-born population in the United States, 1980– 1999 130 5.2 Canadian population and growth components, 1851-1996 132 5.3 Selected characteristics of Canadian-born in the United States who have entered the United States to live since January 1990 141

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Preface

Exchanging ideas, perspectives, frameworks, and data between academics and government is, at once, necessary for the development of innovative and effective public policy and difficult to accomplish in time of constant change. The Trends Project, a collaborative effort of the Policy Research Initiative and the Social Sciences and Humanities Research Council, was conceived as a means of addressing this difficulty by providing a new model for academics and government to collaborate on policy research that informs the policy-development process. Three goals lie at the heart of the Policy Research Initiative and the Trends Project: • supporting the creation, sharing, and use of policy research knowledge; • strengthening departments by recruitment, development, and retention of people; and • building a policy research community through networks and concrete vehicles and venues. In the past, either the government has commissioned research to address government-identified knowledge gaps or the federal granting councils have funded an academic-led research agenda. Under the Trends Project, academics, think tanks, and government officials worked in partnership to identify the knowledge gaps requiring further research. This collaboration sought to identify opportunities for research and scholarship to inform longer-term policy and societal choice.

xii

Preface

The make-up of the teams themselves was unique. Led by some of Canada's leading academics, the project's eight teams involved more than fifty researchers from universities across the country, chosen through a call for proposals administered by the Social Sciences and Humanities Research Council. These multidisciplinary teams of participants from across Canada brought people together who would not normally have the opportunity to collaborate. The result of this multidisciplinary and cross-Canada approach has been that we now have a greater depth and breadth of understanding on the emergent policy areas Canada is likely to confront in the coming years. The Trends Project research papers were presented on several occasions at workshops and conferences across the country where Canadian researchers and government officials provided insight and feedback. Finally, each of the papers published under the Trends Project underwent anonymous peer review. The Trends Project was also innovative because it provided a means for academics to have their ideas and research circulated widely throughout government. The project was concerned not only with producing papers, but also with the continued process of dialogue and collaboration between thoughtful people engaged in these issues from multiple disciplines and professions, and from the university, government, private, and non-profit sectors. The second annual National Policy Research Conference in November 1999 offered an opportunity for researchers to showcase their work to over 800 policy developers and experts in the federal and provincial governments. Commentaries and research excerpts have been featured regularly in Horizons, the Policy Research Initiative's newsletter. Horizons targets a broad policy audience from throughout the Canadian policy research community, both inside and outside of government, reaching more than 8,000 people. By bringing government and academic communities together on an ongoing basis, the Trends Project exposed these groups to each other's research needs, perspectives, and constraints. The Trends Project has been one part of a large effort to build Canada-wide policy research capacity. It is a model that we would like to build on in the future. Laura A. Chapman Executive Director Policy Research Initiative February 2001

Contributors

Keith G. Banting, Queen's University Gilbert Gagne, Bishop's University Rafael Gomez, London School of Economics Morley Gunderson, University of Toronto John F. Helliwell, University of British Columbia George Hoberg, University of British Columbia Ronald Kneebone, University of Calgary Frank C. Lee, Organization for Economic Cooperation and Development Laura C. Macdonald, Carleton University Hans Messinger, Statistics Canada Francois Rocher, Carleton University Christian Rouillard, Ecole nationale d'administration publique, Universite du Quebec Richard Simeon, University of Toronto

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CAPACITY FOR CHOICE: CANADA IN A NEW NORTH AMERICA

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1. Introduction: Economic, Cultural, and Political Dimensions of North American Integration George Hoberg

Since before Confederation, Canada has defined its national identity partly in terms of its relationship with the United States. In Canada, this relationship has been characterized by divisive tensions between believers in the economic benefits of closer commercial relations with the United States and those who have feared that free trade would 'Americanize' Canada, either literally, in the form of leading to its joining the union, or figuratively, in terms of values and culture. These conflicts have been particularly evident over the past fifteen years, as Canada entered into the Canada-U.S. Free Trade Agreement (FTA) i 1988, which expanded six years later to include Mexico in the North American Free Trade Agreement (NAFTA). Opponents of these agreements argued that they would destroy jobs, lower wages, increase inequality, undermine national identity, and vitiate the capacity to forge distinctive policies. Proponents of free trade claimed that it would foster tremendous economic benefits and vehemently denied that it would lead to Americanization. This volume draws together an interdisciplinary group of scholars to examine North American integration and its consequences for Canadian life. It is part of the Trends Project of the Government of Canada, designed to enlist academics to help assess the major forces influencing Canadian society and their potential impact on future public policy. The chapters in this book address four questions: • How has closer integration of Canada with its giant neighbour to the south affected the things that Canadians care about?

4 Capacity for Choice

• How might changes over the next decade further influence these concerns? • What are the crucial gaps in knowledge? • What are the policy implications - how should Canada maximize the opportunities and minimize the risks in its relationship with the United States? This introductory chapter sets the stage for the volume by providing a brief survey of the history of North American integration, introducing the concept of integration used throughout the volume, and providing a brief overview. North American integration is one part of the more general phenomenon of globalization that has become so dominant of late in both popular and elite discourse.1 Despite the international context, the focus here on continental integration in North America is justified. For Canada, globalization is effectively 80 per cent Americanization - that figure represents the proportion of Canadian exports that go to the United States. Clearly, it is too simplistic to reduce the complex nature of U.S. influence to trade relations, but that figure is an effective representation of the place of the United States in Canada's external relations with the world. Indeed, when one considers the cultural content of the media to which Canadians are exposed, one finds 80 per cent probably an underestimate. The collection brings together academics from diverse perspectives, all of whom present a complex and nuanced view of the implications of North American integration. However, a clear theme emerges from the analysis: the consequences of continental integration have not been as formidable as widely believed. Despite a sharp rise in trade dependence as a result of the FTA and growing American dominance of global media, the border still matters. Admittedly, Canada has surrendered some policy instruments in exchange for access to larger markets. In addition, pressures for harmonization do exist and have probably increased. But Canada still retains significant room to manoeuvre, however, even in the areas of policy most affected by growing economic integration. A Brief History of Continental Integration North American integration - the replacement of the pattern of eastwest relationships on which Canada was founded by north-south

Introduction: Economic, Cultural, and Political Dimensions 5

exchanges with the United States - is certainly not a new phenomenon. According to historian Jack Granatstein, free trade with the United States takes second place only to the Quebec question as an enduring and troubling challenge throughout the history of Canadian politics.2 The issue first emerged in the 1850s, when Britain repealed its corn laws and committed itself to free trade, thus exposing British North America's exports to Britain to U.S. competition. In response, Canada negotiated with the Americans the Reciprocity Agreement of 1854, whereby Canada obtained free access for its resource exports, including grain and lumber, in exchange for granting the United States navigation rights on the St Lawrence and fishing rights off the Atlantic colonies. The agreement lasted only twelve years, however, as growing opposition from U.S. commercial interests and tensions resulting from the Civil War led Congress to abrogate the agreement in 1866. The termination of the agreement contributed to the forces promoting Confederation.3 Repeated attempts to renegotiate a reciprocity agreement failed, setting the stage for the introduction of John A. Macdonald's National Policy in 1878. Avowedly protectionist in nature, the National Policy constructed a tariff wall to promote Canada's fledgling manufacturing sector and an economy built on an east-west axis. It was the first and most explicit attempt in Canadian history to use policy to resist the powerful economic forces channelling trade into north-south flows. In 1891, Sir Wilfrid Laurier's Liberal Party ran against Macdonald's Tories on a campaign to create a commercial union with the United States. Macdonald rallied loyalty to the empire with the cry 'A British subject I was born, and a British subject I will die' and won the first free-trade election. Laurier was eventually elected in 1896 and negotiated a new reciprocity agreement in 1911. However, the same year, in the second freetrade election, the Conservatives appealed to Canadian allegiance to Britain and to fears of being swallowed up by American 'manifest destiny.' The Liberals lost the election, and the agreement died. Another trade agreement with the United States was not reached until 1935, only after the disastrous U.S. Smoot-Hawley tariff of 1930 had taught Americans the harsh consequences of beggar-thyneighbour protectionism. The 1935 agreement, along with another one signed three years later, reduced tariff levels between the two countries to about where they had been in 1920, before the protectionist wave emerged.4

6 Capacity for Choice

The Second World War brought about a sea change in continental relations, as the magnetism of the growing global power to the south overwhelmed Canada's historic affinity for the mother country.5 The armed forces and the economies of the two countries became increasingly linked. After the war, both nations turned to multilateralism with the General Agreement on Tariffs and Trade (GATT), ratified in 1947. At about the same time, Canadian and U.S. officials were negotiating the equivalent of a customs union, but Prime Minister W.L. Mackenzie King killed the idea.6 The next major free-trade development was the Auto Pact (1965), which eliminated duties for Canadian automobiles and parts exported to the United States and dramatically increased sectoral trade. Events of the 1980s brought more comprehensive free trade back onto the political agenda. Pierre Trudeau's National Energy Policy, and rising U.S. protectionism in the wake of the 1982 recession, escalated trade tensions. Supported by President Ronald Reagan, the idea of free trade received greater legitimacy in Canada when the prestigious Macdonald Commission in 1985 urged the country to pursue free trade as a 'leap of faith.' After several years of controversial and heated negotiations, the two countries reached agreement in 1987. Despite the support of the Mulroney government for the pact, the Liberal-dominated Senate delayed passage. This strategy set the stage for the pivotal election of 1988, which, in a reversal of the historic pattern, pitted the profree trade Tories against the anti-free trade liberals, led by John Turner. Despite the mobilization of a nationalist popular sector against the agreement,7 the Tories won the election, and the Canada-United States Free Trade Agreement came into effect on the first day of 1989. Five years later, with some reluctance, Canada entered into a more elaborate North American Free Trade Agreement, extending the free trade area to include Mexico. Meanwhile, both Canada and the United States were active in the finalization of the latest round of GATT negotiations, which gave birth to the World Trade Organization (WTO) in 1995. NAFTA's accession clause seemed to presage its enlargement into a hemispheric agreement. Depsite the support of successive U.S. presidents, negotiations towards a Free Trade Area of the Americas have been stalled by the refusal of the U.S. Congress to provide the president with the 'fast track' negotiating authority provided by U.S. trade law. Figure 1.1 shows the evolution of Canada's foreign trade, both with the United States and with the world. It charts exports and imports as a

SOURCE: Generated by Ronald Kneebone, based on CANSIM.

FIGURE 1.1 Exports and imports, total and with the United States, as percentage of GDP, 1926-1998

8 Capacity for Choice

percentage of gross domestic product (GDP) from 1926 through 1998. As it shows, Canada did have an earlier period of high dependence on exports: for 1926-45, exports ranged from 18 per cent to 37 per cent of GDP. After the Second World War, trade dependence dropped precipitously, and it remained below 20 per cent until 1967. Beginning around 1960, it began to increase gradually, reaching around 28 per cent in the early 1980s. After the implementation of the FTA, it skyrocketed to about 40 per cent in 1998, making Canada one of the most trade dependent nations on the world. The United States has been the dominant actor in Canadian trade at least since the early twentieth century. Up until 1900, trade with the British rivalled that with the Americans, but the U.S. proportion increased up through the Second World War. During this period, Canadian exports to the two countries were comparable, but imports from the United States were much greater than those from Britain. The differential effects of the war on the two economies transformed the relationship, as Canadian trade took on an even stronger north-south orientation. By 1951, 70 per cent of Canada's imports came from the United States, and 60 per cent of Canadian exports went there. The U.S. share of exports continued to increase until it matched the import share of about 70 per cent around 1970. In the wake of the FTA, there was a sharp increase (15 percentage points) in Canada's trade dependence, all because of increased dependence on trade with the United States. In 1998, total exports constituted a staggering 40 per cent of GDP, with the United States accounting for 84 per cent of that total, or 33 per cent of GDP. Thus, while trade dependence was quite high earlier on - when GDP was quite low during the Depression and the war - the current levels of trade dependence, globally and on the United States in particular, are record setting. Conceptualizing North American Integration This volume examines the consequences of North American integration in three spheres of Canadian life: economic, cultural, and political. Generally, we can conceptualize integration as a process, moving along a continuum from 'fundamentally distinct and unrelated' at one end to 'fully integrated' at the other. For each of our three spheres, we can identify the two poles of the continuum, as outlined in Table 1.1, and at any given time it is possible to locate Canada's approximate relation to its external environment.

Introduction: Economic, Cultural, and Political Dimensions 9 TABLE 1.1 The continuum for integration Sphere

Unrelated

Fully integrated

Economic

No international exchanges

Common currency; customs union; economic transactions a function of size and distance (no border effect)

Cultural

Distinctive national values

Identical values resulting from assimilation or some other form of external influence

Political

Autonomous nation states; distinctive policies reflecting domestic conditions

All relevant decision-making authority transferred to supranational authority, or, if there is a continued division of powers, nation-states get full political representation in supranational bodies; uniform policies imposed from without

The phenomenon of integration is perhaps best measured and understood in the economic sphere. At one end would be the unlikely world of economic autarky, where there were no exchanges across borders. At the other, there would be no barriers at all to exchange of goods, services, or capital across borders. Clearly, the Canadian and U.S. economies are highly integrated, but they still have a long way to go before the integrated extreme. Part I of this volume has four chapters (2-5) on the economic sphere - on trade, macroeconomics, labour markets, and migration of skilled workers. John F. Helliwell, Frank C. Lee, and Hans Messinger (chapter 2) analyse the relative volume of trade flows between the provinces and across the border with the United States and how they have changed over time - the so-called border effect. Ronald Kneebone (chapter 3) provides an overview of Canadian macroeconomic performance and policy in the North American context. After comparing Canadian and U.S. performance across a number of indicators, Kneebone examines three key policy choices by Canada over the past dozen years: the Bank of Canada's decision to adopt a 'zero-inflation' target, the cabinet's decision to pursue free-trade agreements, and the fiscal policy choices of the federal and most provincial governments to rein in their deficits and debt. Raphael Gomez and Morley Gunderson (chapter 4) examine

10 Capacity for Choice

the effects of economic integration on labour markets and on the institutions, practices, and policies of the labour market. John F. Helliwell (chapter 5) deals with one of the most important and contentious issues in Canadian policy, the so-called brain drain. He presents a careful analysis of the evidence regarding its magnitude and argues that the extent of the problem is vastly overrated. The cultural sphere (part II) has always been a highly contested aspect of North American integration, and here it is more difficult to identify the extremes of the continuum. At one extreme, there would be distinctive national cultures resulting from historical experience; at the other, identical values resulting from assimilation or some other form of cultural influence. Gilbert Gagne (chapter 6) focuses on Canadian policies designed to protect cultural industries and on how more elaborate and extensive trade agreements, from the FTA to the WTO, have constrained such policies. In the political sphere, we need to distinguish the structures of governance from the content of the public policies that they produce. At one end of the spectrum we would expect to see autonomous nationstates adopting distinctive policies reflecting their own domestic circumstances. The fully integrated end of the spectrum would involve the transfer of all formal decision-making authority to a supranational entity, with perhaps some room left for a federal union, which reserved specific powers for the lower levels of government. In policy terms, complete integration involves uniform policies imposed from outside the domestic entity. In North America, there has been very little formal political integration, but concerns have been growing about the extent of policy integration. Part III of this volume addresses the effects of integration on the political sphere in Canada. Laura Macdonald (chapter 7) examines the impact of economic integration on the relations between the government and various aspects of civil society. Francois Rocher and Christian Rouillard (chapter 8) analyse the effect of North American economic integration on the central feature of Canadian political life: federal-provincial relations. They take issue with the dominant view that integration is 'hollowing out' the central state in Canada. Finally, George Hoberg, Keith G. Banting, and Richard Simeon (chapter 9) consider one of the most troubling concerns in Canada about economic integration - namely, whether closer economic ties with the United States will reduce Canada's capacity to adopt policies that reflect distinctive national preferences.

Introduction: Economic, Cultural, and Political Dimensions 11

Perspectives on the Consequences of Integration While dividing the phenomenon of integration into three spheres is a useful analytical device, what is most crucial about the consequences of integration is the relationship between the spheres. In particular, there is a great amount of concern about the relationship between greater economic integration and the survival of a distinctive Canadian identity or of meaningful capacities for domestic policy choices. The intense political conflicts in Canada concerning free trade have been driven largely by different beliefs about the relationships between the economic sphere and the other two.9 Nationalists have argued that greater economic integration will inevitably lead to the destruction of Canada as a cultural and political entity. Champions of free trade have been dismissive of this view, positing minimal connection between economics and the political and cultural spheres. We can separate the competing views on the consequences of integration into four camps, portrayed in Table 1.2. We can differentiate the perspective both by a person's view of the empirical question of how much international economic integration constrains domestic choices and by his or her view of the normative question of the desirable role of the state in the economy. We place representative authors advocating that view in each cell of the table. Canadian nationalists, represented here by Maude Barlow and her colleagues, claim that international economic integration highly constrains domestic choices, and prevents governments from doing a number of things that nationalists would like to see them do - from protecting Canadian culture to ensuring universal social programs. Not all those who would like to see a prominent role for government believe that international economic integration has been so consequential. There is a strong view emerging, represented by journalist Linda McQuaig and political scientist Geoffrey Garrett, that nations still have room to manoeuvre, and these people want to see countries use that freedom to forge a more active role for government.10 The conservative position also has two camps. Some of its members, such as syndicated columnist and author Diane Francis, champion free trade precisely because they believe that it inhibits government from doing things that they oppose. But not all those who prefer a small government hold that position - for example, William Watson argues forcefully that there is little connection between trade liberalization and domestic policies.11

12 Capacity for Choice TABLE 1.2 Perspectives on the consequences of economic integration Beliefs about the desirable size of government Beliefs about the degree of international constraint

Small

Large

Low

Watson

Garrett McQuaig

High

Francis

Barlow

We do not intend this book to address the normative question of the desirable role for government. But we have designed it to consider the empirical question about the links between international economic integration and domestic policy choices. The analysis supports the conclusion that the consequences of North American integration are exaggerated and that Canada still has the capacity for choice. NOTES 1 The literature on globalization is exhaustive. For a sample of the debate, see Thomas Friedman, The Lexus and the Olive Tree: Understanding Globalization (New York: Farrar, Straus, and Giroux, 1999); Kenichi Ohmae, The End of the Nation State: The Rise of Regional Economies (New York: Free Press, 1995); William Watson, Globalization and the Meaning of Canadian Life (Toronto: University of Toronto Press, 1998); Richard Gywn, Nationalism without Walls: The Unbearable Lightness of Being Canadian (Toronto: McClelland & Stewart, 1995); Gary Burtless et al., Globaphobia: Confronting Fears about Open Trade (Washington, DC: Brookings Institution, 1998). 2 Jack Granatstein, 'Free Trade between Canada and the United States: The Issue That Will Not Go Away/ in Denis Stairs and Gilbert Winham, eds., The Politics of Canada's Economic Relationship with the United States (Toronto: University of Toronto Press, 1985), 11. 3 Ibid., Michael Hart, The Road to Free Trade/ Background paper for the McGill University Conference on Free Trade at 10, Montreal, 4-5 June 1999. Available at http://www.freetradeatlO.com/hart.html 4 Granatstein, 'Free Trade/ 33.

Introduction: Economic, Cultural, and Political Dimensions 13 5 J.L. Granatstein and Norman Hillmer, For Better or for Worse: Canada and the United States to the 1990s (Toronto: Copp Clark Pitman, 1991), chap. 5. 6 Granatstein, 'Free Trade,' p. 42. 7 Jeffrey Ayres, Defying Conventional Wisdom: Political Movements and Popular Contention against North American Free Trade (Toronto: University of Toronto Press, 1998). 8 Data from Historical Statistics of Canada, series G396-400, and G396-395. 9 Kim R. Nossal, 'Economic Nationalism and Continental Integration: Assumptions, Arguments, and Advocacies,' in Denis Stairs and Gilbert Winham, eds., The Politics of Canada's Economic Relationship with the United States (Toronto: University of Toronto Press, 1985). 10 See Geoffrey Garrett, Partisan Politics in the Global Economy (Cambridge: Cambridge University Press, 1997); and Linda McQuaig, The Cult of Impotence: Selling the Myth of Powerlessness in the Global Economy (Toronto: Viking, 1998). 11 Watson, Globalization.

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Part One

Economics

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2. Effects of the FTA on Interprovincial Trade John F. Helliwell, Frank C. Lee, and Hans Messinger

A decade has passed since the signing of the Canada-United States Free Trade Agreement (FTA);1 the successor North American Free Trade Agreement (NAFTA) has been in effect since 1 January 1994. These two treaties were intended to create a more competitive economy in Canada through increased competition and open access to a larger export market. Canada was not alone in forming preferential trade agreements (PTAs). France, Italy, West Germany, and the Benelux established the European Economic Community (EEC), or Common Market, in 1957. One of its objectives was to form a common market within western Europe, which goal was finally realized in 1993. Between 1957 and 1993, there were a series of parallel developments, such as the formation of the European Free Trade Association (EFTA) in I960, to facilitate and strengthen economic links among other nations in western Europe.2 Moreover, there are other regional trading blocs such as the 'Mercado Comun del Sur' (MERCOSUR) or 'Common Market of the South/ formed by Argentina, Brazil, Paraguay, and Uruguay effective 29 November 1991. As with other PTAs, one of its goals is to facilitate movements of goods, services, and factors of production within the region. Aside from any political considerations, all PTAs seek to improve the economic welfare of participating countries. Therefore it is reasonable to ask whether the FTA and NAFTA have indeed benefited Canada. Aggregate economic indicators appear to indicate that the U.S. economy has been their primary beneficiary. It has been outperforming Canada's, despite improvements in 'macro' fundamentals in Canada

18 Economics

after implementation of the FTA in 1988. For instance, Canada's productivity gap with the United States has continued to widen in every major manufacturing industry since 1985. An unemployment gap opened up in the early 1980s and persists today at over 4 percentage points. Canada's share of the world's inward stock of foreign direct investment (FDI) declined by roughly 50 per cent between 1985 and 1996. At the same time, skilled Canadians may be migrating to the United States, attracted by lower taxes, higher wages, and better weather. But these economic indicators cannot assess the impact of the FTA on the Canadian economy, since Canada had problems as well. The recession in the early 1990s in both nations, coupled with the introduction of the Goods and Services Tax (GST) and a tight monetary policy in Canada, left little room for the aggregate economy to expand. In addition, the two economies were already fairly integrated as a result of previous GATT rounds and the Auto Pact of 1965.3 In any case, aggregate economic indicators may not be too helpful here. Wonnacott4 argues that the recession of 1990-1 might have been worse without the FTA. In fact, Canada's export sector has thrived: exports to the United States increased to 79 per cent of total exports, or $281 billion, in 1996, from 73 per cent, or $144 billion, in 1988. Imports from the United States increased from 69 per cent of all imports in 1988 to 76 per cent in 1996. Statistics Canada found that trade flows between the two countries increased in those industries most liberalized by the FTA.5 Since implementation of the FTA, interprovincial trade has declined. As we show in the next section, and in Table 2.1, between 1988 and 1996 volumes of merchandise traded grew 2 per cent per annum less quickly than the growth of provincial GDP over that period would have suggested. The unexplained lack of growth drops to 1 per cent per annum if one factors in the increasing share of services in GDP, and this remaining gap needs explanation. The FTA may have created more Canadian-U.S. trade partly by diverting trade away from interprovincial channels. If the resulting trade diversion is greater than the trade created, this finding could influence assessments of the net economic benefits of the FTA. This shady aims principally to examine the links between FTA-induced increases in Canadian-U.S. trade and changes in interprovincial trade. Did the extra binational trade induce additional interprovincial trade, or did it divert interprovincial trade to the United States? Or was interprovincial trade largely unaffected by the FTA-induced increases in north-south trade?

Effects of the FTA on Interprovincial Trade 19

First, this study reviews some previous work on the effects of trading blocs on trade volumes. Second, it offers aggregate evidence about the links between movements in interprovincial and in province-state trade under the FTA. Third, it presents and analyses new industrylevel data to see whether the observed changes in trade mix are consistent with creation of interprovincial trade, diversion of trade, or neither. Fourth, it summarizes the two strands of evidence and sets some objectives for future research. While the initial results from the industry-based data are interesting, they also suggest that uncovering of the full links between tariff changes and interprovincial trade will require a finer level of classification, since the level of aggregation used here may involve too much averaging of commodity groups that had quite different tariff rates before the FTA. Literature Review Many studies have analysed the effects of trading blocs on internal and external trade. International trade theory has wrestled with this matter as well, as have computable-general-equilibrium (CGE) models of international trade. Apparently the formation of free-trade areas, customs unions, or other preferential trading blocs has uncertain effects on economic welfare. Despite a general presumption that fuller specialization to achieve economies of scale and to match comparative advantage increases trade, diversion of trade may actually reduce trade with non-members, thereby offsetting expected gains from increased international trade. Empirically based CGE models have been used frequently to resolve the theoretically ambiguous effects of trading blocs, and to assess their likely net costs and benefits, usually from the perspective of potential members, but sometimes from a global perspective as well. There were several such studies before the FTA came into effect, followed by several applications to the subsequent NAFTA. Most of the first group of studies showed net gains, despite substantial differences that depended on the assumptions made about competition and unexploited economies of scale.6 Although most CGE models are static, researchers are beginning to consider the dynamic effects of trade.7 There have also been several more recent studies of the effects of the FTA. Gaston and Trefler8 examine its impact on earnings and employment in Canada, using reduced-form employment and earnings equa-

20

Economics

tions. Head and Ries9 prepared a matched sample of manufacturing industries in Canada and the United States and found more shrinkage of production and employment in Canadian industries. What was more surprising to them and to others was the non-increase in output per worker despite such rationalization. One popular model for assessing the impact of PTAs on trade creation and diversion involves import demand. For example, Balassa10 assesses the effect of the EEC on trade flows by comparing internal and external elasticities of import demand before and after integration. He finds that the income elasticities of import demand increased for members but very little for non-members. Thus he finds that the Common Market created trade without diverting much trade. Likewise, Gondwe and Griffith11 estimate income elasticities of import demand to assess the effects of the Caribbean Free Trade Association (CARIFTA) and find net trade creation. In a similar fashion, Wylie12 studies the implications of NAFTA for trade creation between NAFTA partners and trade diversion between North America and the rest of the world. It appears that exports from non-NAFTA members are likely to be diverted away from NAFTA members. But NAFTA-induced growth in trade is likely to dampen the static effect. Another model that has been used widely to assess the impact of trading blocs is the gravity model. It assumes that trade (attraction) flows depend on physical distance and the product of economic size (mass), proxied by real GDP.13 The model has always been the most empirically successful framework for explaining bilateral trade flows.14 However, it was initially suspect because its links to the various theoretical models of trade flows were little understood. The earliest tight derivations from theoretical models were for trade in differentiated products,15 but subsequent research has shown the gravity form to be consistent with the classical Heckscher-Ohlin model as well.16 Its theoretical ubiquity and empirical robustness make it the natural choice for evaluating the effects of preferential trading arrangements on trade volume. Empirical papers have used the gravity model to assess the impact of European PTAs on trade flows. Aitken17 finds that both the EEC and the EFTA experienced creation of gross trade, especially the EEC. Similarly, Bikker18 finds, based on the gravity model, that preference to trade among EEC members increased by 76 per cent between 1959 and 1974. Bayoumi and Eichengreen19 use a modified gravity model to examine the formations of the EEC and of the EFTA. They find that

Effects of the FTA on Interprovincial Trade

21

both arrangements increased trade among members, accompanied by trade diversion in the EECF, and perhaps in the EFTA. Frankel and Wei20 find evidence of de facto trading blocs in Europe, the Western Hemisphere, East Asia, and the Pacific based on the estimated results of the gravity model. These various empirical findings suggest that PTAs do affect trade flows between countries. However, after we control for distance and other relevant factors, we find that home-country residents still prefer to purchase goods produced at home.21 The gravity model has also been applied to the Canadian economy. McCallum22 estimates a simple gravity model using interprovincial trade flows and Canadian province-U.S. state trade flow in 1988 to analyse the effect of the border on trade between the two countries. He finds that Canadian provinces traded twenty times as much with other provinces as with U.S. states of equal size and distance. Helliwell23 uses data for 1988, 1989, and 1990 and confirms McCallum's result.24 Helliwell, however, finds that the border effect rose from 1989 to 1990 for all provinces except New Brunswick. Engel and Rogers25 test the role of border and distance for price dispersion across fourteen North American cities. They confirm that distance and the border help explain price differences in North America and estimate the implicit width of the Canadian-U.S. border to be 2,000 miles. Furthermore, the estimated border effect is larger in the 1989-94 period than in 1978-88. A few studies have attempted to link the FTA with interprovincial trade. Helliwell26 uses OECD trade data to see whether trade links in 1990 between Canada and the United States were tighter than those between other pairs of countries. The results27 show that they were no greater than one would expect between any two countries of the same size and distance sharing a common language but not in any special trading relation with one another. Most empirical studies mentioned above rely on aggregate trade data. They may not be adequate in assessing the implications of PTAs, which often do not treat all industries or commodities equally (as, for example, in special exemption clauses). Therefore, we must analyse the impact by detailed commodity category (or industry). Clausing28 analysed the consequences of the FTA by examining Canadian-U.S. flows of trade for approximately 1,700 commodities from the late 1980s to the early 1990s.29 She found that the commodities with the largest tariff reductions increased most in value of shipments. Aggregating her results, Clausing attributes a substantial fraction of the post-1988 increases in cross-border trade to tariff changes under the FTA.

22

Economics

Aggregate Empirical Results Our aggregate assessment of the FTA's effect on interprovincial trade makes use of the gravity model of trade flows. More specifically, the volume of trade depends in a log-linear fashion on the GDPs of the two trading partners (i and j), on the distance between them, and on whether they are in the same trading bloc: InSij = a0 + (XjlnCGDPj) + a2ln(GDPj) + a3ln(DISTjj) + a4(BLOC) + e^, (1) where S^ is bilateral merchandise trade flowing from i to j, GDPj and GDPj are the GDPs of i and j, DIST^ is the distance between them, BLOC is a variable that takes the value 1.0 for pairs of i and j that are in the same trading bloc, and e^ is a random-error term usually taken to be normally distributed. To get some idea of the FTA's possible aggregate effects, we use extended and revised versions of the data for interprovincial and province-state trade used by McCallum and Helliwell,30 applying a slightly extended form of equation (1). The main extension (also in Helliwell)31 is the addition of variables designed to measure the economic remoteness of both the importer and the exporter from other states and provinces. The remoteness variable measures trade opportunities available for state or province j with states and provinces other than the bilateral trading partner being directly considered. Thus the summation covers all of j's n trading partners excluding i: REMjit = Ek = L.n/nri (DISTkj/GDPkt)

(2)

We fitted the gravity model to merchandise trade from 1988 through 1996 among the ten Canadian provinces and between each province and each of thirty states - the border states plus others with the largest trade links to Canada. If we exclude intraprovincial trade from the data, as we did here, then the maximum possible number of annual observations is 690 - 90 flows between provinces32 and 600 (= 2*10*30) between provinces and the thirty states.33 We also eliminated trading pairs with no trade flows in one or more of the years, reducing the total to 676.^ We fitted the equations in two ways - first, as separate equations for each year, and second, as a system of equations with income, distance, and remoteness effects constrained to have the same values for each year, with the constant term replaced by separate variables

Effects of the FTA on Interprovincial Trade 23

covering interprovincial and province-state trade.35 The variable HOME takes the value 1.0 for all trade flows from one province to another and is zero elsewhere. The variable CUS takes the value 1.0 for all trade flows between provinces and states - i.e., between Canada and the United States - and is zero elsewhere. The results of the first estimation reported for most years appear in Tables 2.1 and 2.2 of Helliwell.36 The coefficients and t- values (in parentheses) for the second estimation appear below for the constrained coefficients: InSjj = 1.18 (InGDPi) + .957(lnGDPj) - 1. 35(1*018^) + .2191n(REMi) (42.2) (33.7) (23.6) (3.2) + .179(lnREMj) + cc4t(HOME) + cc5t(CUS) (3) (2.6) The results of the constrained and unconstrained estimates are very similar. The first two columns of Table 2.1 show the border effects implied by the two versions of the model. The first column represents the antilog of the coefficients of the HOME variable (oc4t) in the equations with unconstrained coefficients.37 The second shows the antilog of the differences between the coefficients on HOME and CUS in equation (3) above both i.e., columns exp(a show, from 4t - a5t). Thusdifferent versions of the same gravity model, interprovincial flows of merchandise trade as a multiple of province-state trade flows, after we adjusted for differences in the economic size, distance, and remoteness of the trading partners. Both estimates show interprovincial trade flows to have been about nineteen times larger than province-state trade flows in 1990, when the FTA was coming into effect. A substantial drop occurred between 1990 and 1993, followed by a subsequent period of rough constancy 1993-6, at a level of about 12, punctuated by a rise to 14 in 1995. Since the relevant parameters are estimated with considerable precision, statistical tests show that the average value of the border effect from 1993 through 1996 is much below that from 1988 through 1990. These results thus suggest very strongly that the FTA, or something simultaneous, significantly increased the provinces' trade with U.S. states relative to their trade with each other. Three other features of these results are also noteworthy. First, the adjustment appears to have been concentrated between 1991 and 1993,

24

Economics

with little or no subsequent trend appearing, at least through 1996. Second, the FTA's relatively small tariff reductions appear to have increased bilateral merchandise trade by more than the accumulated effects over many years of the much larger tariff reductions among the countries of the European Union (EU). Finally, even after a substantial increase in province-state trade, interprovincial trade links remain twelve times as intense as those between provinces and states. We can push these results slightly further, even in the context of the aggregate data for merchandise trade, by assessing whether the relative increase in province-state trade resulted simply from expansion of province-state trade, from diversion of interprovincial trade, or from some combination of the two. This question is easier to ask than to answer. A starting point is to compute how fast interprovincial and province-state trade each grew from 1988 to 1996, relative to what the growth of GDP would have suggested. The results appear in the third and fourth columns of Table 2.1. We calculated the column labelled IPROV by taking the antilogs of the coefficients for each year on the HOME variable (cc4t) in equation (3), and then dividing each value by the 1988 value, to get an index equal to 1.0 in 1988. The column labelled CUS we calculated as the antilogs of the coefficients (oc5t) on CUS - the dummy variable covering all province-state trading pairs - and then multiplying the resulting series by 10.0 and dividing by the 1988 value for IPROV. The IPROV series shows that interprovincial trade actually fell on average between 1988 and 1996, despite the growth of GDP. The CUS series shows that province-state trade showed little trend, although it fell to a low point at the beginning of the 1990s and rose thereafter by about 25 per cent. Why does province-state trade show so little increase, despite the leap in cross-border merchandise trade? The simple answer is that nominal GDP was growing fairly quickly in the first half of the 1990s, especially in the United States, and the equation estimates that trade flows grow on average 20 per cent faster than the exporter's GDP and almost as fast as the importer's GDP. The same reasoning explains why interprovincial trade, through fairly stagnant in normal terms, is shown by the IPROV series to be falling. A first look at these results suggests that whatever trade the FTA induced only offset what otherwise would have been a drop in Canadian-U.S. trade intensity and either left untouched or exacerbated the falling ratio of interprovincial trade to provincial GDP. However, the

Effects of the FTA on Interprovincial Trade 25 TABLE 2.1 Trends in interprovincial and Canadian-U.S. merchandise trade, 1988-1996 Year

B

BSYS

IPROV

CUS

IPROR

CUSR

M

1988 1989 1990 1991 1992 1993 1994 1995 1996

16.91 16.82 19.52 17.07 15.24 12.26 11.43 14.02 11.93

17.02 17.31

1.00 0.97 0.89 0.85 0.83 0.77 0.82 0.80 0.78

0.59 0.56 0.47 0.50 0.51 0.63 0.67 0.57 0.63

1.00 0.98 0.92 0.94 0.96 0.89 0.90 0.89 0.87

0.59 0.57 0.49 0.55 0.60 0.72 0.75 0.64 0.71

0.43 0.43 0.42 0.39 0.37 0.38 0.39 0.39 0.39

18.92 17.18 16.09 12.29 12.13 14.00 12.24

Definitions: B Border effect estimated with all coefficients allowed to vary from year to year. Border effect estimated from a set of nine equations estimated by Zellner SUR BSYS with all coefficients except the border effect constrained to be the same in each year. IPROV Interprovincial trade volume, relative to 1988 level, after adjustment for all growth caused by changes in GDP and remoteness. CanUS Canadian-U.S. trade, multiplied by 10, relative to interprovincial trade in 1988, after adjustment for effects of GDP, distance, and remoteness. IPROR Interprovincial trade volume, relative to 1988 level, after adjustment for increasing share of services in GDP, i.e. IPROR = IPROV/(M/M88). CUSR Same as CUS, after adjustment for increasing share of services in GDP, done in the same manner as for IPROR. M The year's average across provinces in ratio of intraprovincial sales of goods to provincial GDP. Notes: The values of B for 1991 through 1996 are identical to those reported in Table 2.2 of Helliwell, How Much Do National Borders Matter? (Washington, DC: Brookings Institution, 1998). The value for 1990 is the same as that in column (v) of Table 2. Values for 1988 and 1989 are obtained from regressions using the 1990 adjustment factors for province-state trade, as explained by Helliwell. BSYS are from the same data and specification as B, but with all coefficients except those on the border-effect variable constrained to have the same value in all years. IPROV and CUS are obtained from the same data, but with the specification changed to exclude a constant term, but to include instead two variables that sum to 1.0. The first is HOME, covering all observations relating to trade from one province to another, and the other, CUS = 1.0 - HOME, covering all observations of trade between provinces and states. The antilogs of the coefficients on these variables are shown above as IPROV and CUS, respectively, except that IPROV is divided by its own 1988 value, to give an index with a base of 1.0 in that year, and CUS is multiplied by 10.0 and divided by the 1988 value of IPROV. The 1990 value of CUS of .47 thus means that province-state trade flows were .i* .47 = .047 as large as interprovincial flows, after adjusting for the effects of economic size, distance, and remoteness. IPROR and CUSR are adjusted for increases in the share of services in GDP, as described above.

26 Economics

parameters used to estimate the relation between GDP and trade are based on cross-sectional variation among states and provinces, all of which have roughly similar per-capita incomes and economic structures. However, changes over time in the structure of both the U.S. and the Canadian economies affect the relation between GDP and merchandise trade. In particular, merchandise trade by definition excludes services, while GDP includes services, which have been increasing as a share of GDP. We would therefore expect, for a given degree of international economic integration, that merchandise trade would grow at the same rate as total goods production and hence at a lower rate than GDP if services were becoming a larger share of total GDP. To give some idea of the possible size of this service-growth effect, the seventh column of Table 2.1, labelled M, shows the average across provinces, for each year separately, of the ratio of within-province goods sales to provincial GDP. This series has been falling, reflecting the increasing share of services in GDP. To adjust the trade-growth series for this change in economic structure, we show in the columns labelled IPROR and CUSR the original series divided by an index of service intensity.38 The adjusted series for interprovincial trade still displays some reduction, by about 10 per cent, rather than 20 per cent for the unadjusted series, from 1988 to 1996. For province-state trade, the adjustment converts the trendless unadjusted series into one with an early slump followed by an increase of about 40 per cent from 1990 through 1996. One preliminary inference from the adjusted evidence would be that the FTA period saw the intensity of province-state trade increase and that of interprovincial trade decline. Whether these offsetting movements reveal some combination of FTA-related creation and diversion of trade, or reflect some other phenomena in addition or instead, cannot yet be told. Including some measures of cyclical variation in the constrained equations may perhaps further refine the aggregate data, since it is well-established that merchandise trade is more cyclical than is GDP and the first half of the 1990s contained substantial cyclical variance. However, the most promising avenue involves trade data disaggregated by industry. Such data offer at least the possibility of enough cross-commodity variation in tariff reductions to show, for both province-state and interprovincial trade, that sort of tariff-induced changes in growth patterns identified by Clausing39 for province-state trade.

Effects of the FTA on Interprovincial Trade

27

Evidence from Industry-level Data This section employs newly developed matched disaggregated commodity detail for interprovincial, Canadian-U.S., and Canada-rest of world (ROW) trade flows from 1989 through 1996. The new data series, at aggregation levels that initially cover sixty-seven commodities, include nominal trade flows and average tariff rates. The tariff rates on Canadian imports have been compiled by Statistics Canada, and the data for U.S. tariffs on imports from Canada by U.S. agencies at the request of Statistics Canada. The industries and the tariff data are described in the Appendix. Initially, the data are split among sixtyseven commodities, but not by individual provinces and states. Thus the gravity model cannot help us with the analysis of trade between individual provinces and states, although it may be able to later. Our initial studies make use of a fairly high level of industrial aggregation. Further disaggregation would be invaluable, since tariffs can vary considerably within commodity groups at higher levels of aggregation. This probably helps explain why our research does not reveal as much tariff-induced change in trade as Clausing40 discovered with much more commodity detail. Table 2.2 shows the growth of trade from 1989 to 1996, as represented by the ratio of 1996 trade to 1989 trade. The averages are shown across two groupings of merchandise trade, first for all sixty-seven commodity classes, and then for a sub-group of forty-two that excludes food, tobacco, alcoholic beverages, and crude materials. The quantitative results reported in this paper make use of the sub-group, which includes all the manufacturing classes that were the primary focus of pre-FTA tariffs and of FTA-related tariff reductions. We also ran all equations for the larger sample, but they always produced weaker results. The excluded categories were either tariff-free throughout the period (as with crude materials) or were and are subject to additional or alternative trade restrictions (as with most of the agricultural categories, tobacco, and alcoholic beverages). In addition, several excluded categories were subject to very large changes between 1989 and 1996 (for instance, an eighty-fold increase in Canadian imports of natural gas from the United States, starting from a base close to zero). Table 2.2 shows trade with the United States doubling between 1989 and 1996, compared to increases of about two-thirds for trade with the rest of the world and almost no change for interprovincial trade, in

28

Economics

TABLE 2.2 Changes in trade, 1989-1996

Mean Growth of trade, 1996 trade/1989 Imports from United States Exports to United States Imports from ROW Exports to ROW Interprovincial trade

Standard deviation

Minimum

Maximum

trade, averages across 67 commodity classes 3.20 10.37 .30 86.58 2.75 2.03 .35 13.71 2.68 7.24 0 59.43 1.65 .96 0 4.19 1.08 .66 .27 5.34

Growth of trade, 1996 trade/1989 trade, averages across 42 commodity classes (27 through 69) 1.98 Imports from United States .86 .62 4.68 2.75 Exports to United States 13.71 .40 2.05 Imports from ROW .40 .58 3.20 1.61 Exports to ROW 1.79 .29 .96 4.19 .27 .32 Interprovincial trade .91 1.74 Imports from United States

Exports to United States

Correlations of trade growth for 42 commodities Imports from United States 1 Exports to United States .35 1 Imports from ROW .45 .30 Exports to ROW .13 .44 Interprovincial -.22 .12

Imports from ROW

Exports to ROW

Interprovincial

1 .09 .05

1 .09

1

terms of the averages of the increases in the various commodity classes. In terms of total trade for the forty-two commodity groups, exports to and imports from the United States were both about $83 billion in 1989. By 1996, exports were $163 billion and imports $146 billion. Over the same period, for the same trade total, exports to the rest of the world grew from $22 billion to $30 billion, while imports from the rest of the world grew from $37 billion to $65 billion. Interprovincial trade in these same commodities actually fell slightly, from $59 billion to $56 billion. As a prelude to assessing the effects of tariff changes on these growth differences, Table 2.3 shows the average tariff reductions between 1989 and 1996 and the levels of the remaining tariffs. Across

Effects of the FTA on Interprovincial Trade 29 TABLE 2.3 Changes in average tariff rates, 1989-1996

Mean

Standard deviation

Minimum

Maximum

Average changes in tariffs as % of trade, 67 commodity classes Canadian tariffs on imports from United States 2.71 6.97 U.S. tariffs on imports from Canada 1.43 3.11 Canadian tariffs on imports from ROW 1.84 3.43

28.5 13.7 23.5

Average changes in tariffs as % of trade, 42 commodity classes Canadian tariffs on imports from United States 3.90 3.54 U.S. tariffs on imports from Canada 2.06 2.51 Canadian tariffs on imports from ROW 1.66 1.67

15.6 13.7 7.4

0 0.13

Average 1996 tariff levels as % of trade, 42 commodity classes Canadian tariffs on imports from United States 0.75 0.93 U.S. tariffs on imports from Canada 0.60 1.05 Canadian tariffs on imports from ROW 3.48 3.17

0 0 0

4.04 4.68 18.3

Canadian imports from United States Correlation of tariff changes across 42 industries Canadian tariffs on imports from United States 1 U.S. tariffs 3 Canadian tariffs on ROW 0.46

40.6 14.4 0.9

0.9

Canadian imports United States from imports ROW

1 0.37

1

the forty-two commodities, tariffs on imports from the United States fell from an average of under 5 per cent in 1989 to less than 1 per cent in 1996. Tariffs on imports from the rest of the world also dropped, from an average of just over 5 per cent in 1989 to 3.5 per cent in 1996. Average U.S. tariffs on imports from Canada, for the same forty-two commodities, fell from 2.7 per cent in 1989 to 0.6 per cent in 1996. All of the average tariff levels were fairly low in 1989 and are much lower now. As the minimum and maximum values and the standard deviations show, industries varied considerably in 1989, and still do. However, the FTA has clearly reduced the dispersion as well as lowered the average value of tariffs, while imports from the rest of the

30 Economics

FIGURE 2.1 Ratio of international to interprovincial trade, 1989-1996

world still have some high-tariff categories. The industry groupings with the largest FTA tariff reductions are the four commodity classes dealing with textiles and apparel, where Canadian tariffs on imports from the United States fell from the range of 12 per cent to 20 per cent in 1989 to 4 per cent or less in 1996. U.S. tariffs on the same categories fell from the range of 5 per cent to 18 per cent in 1989 to under 5 per cent in 1996. These are also industries with striking trade growth in both directions. For example, the value of trade each way in each of the four categories more than doubled between 1989 and 1996, with the faster growth of southbound trade helping to make the 1996 flows of equal size in the two directions. Figures 2.1 through 2.7 describe the extent to which international and interprovincial trade and tariffs changed from 1989 to 1996 based on sixty-seven commodities listed in Tables A2.1 to A2.3 in the Appendix. By any measure, the Canadian economy has become more trade oriented. Figure 2.1 shows that Canada's trade (exports plus imports) with the United States and the rest of the world (ROW) in relation to interprovincial trade peaked in 1994. The ratio of Canada's trade with the United States to interprovincial trade increased from 0.7 in 1989 to 1.1 in 1996. At the same time, the ratio of Canada's trade with ROW to interprovincial trade increased from 0.3 to 0.4. Figures 2.2, 2.3, and 2.4

Effects of the FTA on Interprovincial Trade 31

19 Flour, Wheat & Oth. Cereals 66 Pharmaceuticals 1 Grains 34 Hosiery & Knitted Wear 50 Boilers, Tanks & Plates

42 Paper Prod

23 Soft Drinks •>0 Breakfast Cer & Bakery Prod. 22 Misc. Food Prod. 18 Feeds 2 Live Animals 1 1 Natural Gas 67 Oth. Chemical Prod. 3 1 Yarns & Man Made Fibres 1 5 Dairy Prod. 1 7 Fruits & Veg. Prep.

32 Fabries

38 Oth Wood Fab. Material 5 1 Fab. Structural Metal 29 Plastic Fab. Prod. 36 Lumber & Timber 25 Tobacco Processed Unmfg. 33 Oth. Textiles Prod. 37 Veneer & Plywood 60 Cement & Concrete Prod. 28 Oth. Rubber Prod. 64 Industrial Chemicals 5 Fish Landings 39 Furniture 59 Oth. Elec. Prod. 69 Oth. Manu, Prod. 35 Clothing 63 Oth. Petroleum & Coal Prod. 52 Oth. Metal Fab. Prod. 47 Copper 62 Gasoline & Fuel Oil 54 Oth. Industrial Machinery 53 Agric. Machinery 24 Alcoholic Bcv. 10 Crude Mineral Oils 14 Meat Prod. 45 Iron & Steel Prod. 4 Forestry Prod. 57 Oth. Trans. Equip. 68 Scientific Equip. 30 Leather 26 Cigarettes & Tobacco Mfg. 43 Printing & Publishing 58. Appliances & Receivers 27 Tires & Tubes 61 Oth. Non-metallic Min. Prod. 55 Motor Vehicles 56 Motor Vehicle Parts 65 Fertilizers 46 Aluminum Prod. 3 Oth. Agri. Prod. 41 Newsprint & Oth. 12 Non-metalic Minerals 49 Oth. Non-ferrous Metal 16 Fish Prod. 8 Oth. Metal Ores 7 Iron Ores 40 Pulp 9 Coal 6 Hunting & Trapping 21 Sugar 48 Nickel Prod.

f

FIGURE 2.2 Ratio of U.S. trade in 1996 and 1989

32 Economics

25 Tobacco Processed Unmfg. 66 Pharmaceuticals 26 Cigarettes & Tobacco Mfg. 51 Fab. Structural Metal 37 Veneer & Plywood 59 Oth. Elec. Prod. 18 Feeds 67 Oth. Chemical Prod. 53 Agric. Machinery 10 Crude Mineral Oils 29 Plastic Fab. Prod. 54 Oth. Industrial Machinery 3 Oth. Agri. Prod. 22 Misc. Food Prod. 55 Motor Vehicles 28 Oth. Rubber Prod. 20 Breakfast Cer & Bakery Prod. 57 Oth. Trans. Equip. 42 Paper Prod. 52 Oth. Metal Fab. Prod. 33 Oth. Textiles Prod. 64 Industrial Chemicals 68 Scientific Equip. 56 Motor Vehicle Parts 16 Fish Prod. 1 Grains 43 Printing & Publishing 35 Clothing 65 Fertilizers 27 Tires & Tubes 38 Oth Wood Fab. Material 36 Lumber & Timber 5 Fish Landings 41 Newsprint & Oth. 69 Oth. Manu. Prod. 24 Alcoholic Bev. 30 Leather 58. Appliances & Receivers 15 Dairy Prod. 34 Hosiery & Knitted Wear 14 Meat Prod. 21 Sugar 61 Oth. Non-metallic Min. Prod. 45 Iron & Steel Prod. 31 Yarns & Man Made Fibres 39 Furniture 7 Iron Ores 32 Fabrics 17 Fruits & Veg. Prep. 9 Coal 49 Oth. Non-ferrous Metal 46 Aluminum Prod. 48 Nickel Prod. 50 Boilers, Tanks & Plates 40 Pulp 8 Oth. Metal Ores 63 Oth. Petroleum & Coal Prod. 12 Non-metalic Minerals 62 Gasoline & Fuel Oil 23 Soft Drinks 47 Copper 2 Live Animals 19 Flour, Wheat & Oth. Cereals 60 Cement & Concrete Prod. 6 Hunting & Trapping 4 Forestry Prod. 11 Natural Gas

FIGURE 2.3 Ratio of ROW trade in 1996 and 1989

Effects of the FTA on Interprovincial Trade

33

show growth rates of trade by commodity class in trade with the United States, ROW, and other provinces, respectively. These figures also indicate that trade with the United States grew fastest, followed by that with ROW. However, only one commodity - pharmaceuticals - appears among the top-ten fastest-growing categories in trade with both the United States and ROW. Similarly, only one commodity cigarettes & tobacco manufacturing - is one of the top 10 fastestgrowing categories in trade with both ROW and other provinces. Thus these figures suggest that trade is becoming more specialized geographically. Despite a tendency towards geographic specialization in trade, the process is not complete yet. Figures 2.5 and 2.6 show the extent of specialization in 1996. Five commodities (nickel products, pulp, scientific equipment, other industrial machinery, and lumber and timber) are actively traded with the United States and ROW in relation to interprovincial trade. In other words, those five commodities that Canada trades actively with the United States it also does so with ROW. Motor vehicle parts and motor vehicles were traded predominantly with the United States, suggesting the effects of the Auto Pact. Figure 2.7 illustrates that duty collected as a percentage of imports from ROW and the United States and exports to the United States have declined steadily since 1989. However, the tariff rates remain highest for imports from ROW and lowest for exports to the United States. A comparison of Figures 2.8 and 2.9 shows that imports of three commodities (alcoholic beverages; boilers, tanks, and plates; and fabrics) from the United States that experienced drastic tariff cuts also underwent tariff reductions for imports from ROW. However, when we compare tariff changes for U.S. imports (Figure 2.9) and U.S. exports (Figure 2.10), we see the impact of the FTA - five commodities (hosiery and knitted wear; fabrics; clothing and accessories; leather; and boilers, tanks, and plates) experienced most tariff cuts by Canada and the United States. Table 2.4 shows the results from regressions attempting a more systematic assessment of the influence of tariff changes on the interindustry differences in the growth of trade flows. The regressions are cross-sectional, with each observation being the growth of trade from 1989 to 1996 in one of the forty-two commodity groups and the independent variables being changes in average tariff rates for the same commodity group. For each trade flow, the primary explanatory variable is the average tariff on that trade flow, except for interprovincial

34 Economics

4 Forestry Prod. 7 Iron Ores 3 Oth. Agri. Prod. 56 Motor Vehicle Pans 55 Motor Vehicles 26 Cigarettes & Tobacco Mfg. 15 Dairy Prod. 2 Live Animals 65 Fertilizers 63 Oth. Petroleum & Coal Prod. 20 Breakfast Cer & Bakery Prod. 23 Soft Drinks 17 Fruits & Veg. Prep. 22 Misc. Food Prod. 62 Gasoline & Fuel Oil 21 Sugar 10 Crude Mineral Oils 19 Flour, Wheat & Oth. Cereals 46 Aluminum Prod. 14 Meat Prod. 50 Boilers, Tanks & Plates 66 Pharmaceuticals 38 Oth Wood Fab. Material 1 Grains 43 Printing & Publishing 45 Iron & Steel Prod. 18 Feeds 49 Oth. Non-ferrous Metal 1 1 Natural Gas 64 Industrial Chemicals 28 Oth. Rubber Prod. 5 Fish Landings 57 Oth. Trans. Equip. 34 Hosiery & Knitted Wear 33 Oth. Textiles Prod. 12 Non-metalic Minerals 36 Lumber & Timber 29 Plastic Fab. Prod. 51 Fab. Structural Metal 27 Tires & Tubes 24 Alcoholic Bev. 52 Oth. Metal Fab. Prod. 69 Manu. Prod 16Oth. Fish Prod.

69 Oth. Manu. Prod

67 Oth. Chemical Prod. 39 Furniture 53 Agric. Machinery 42 Paper Prod. 25 Tobacco Processed Unmfg. 61 Oth. Non-metallic Min. Prod. 60 Cement & Concrete Prod. 32 Fabrics 35 Clothing 47 Copper 68 Scientific Equip. 59 Oth. Elec. Prod. 41 Newsprint & Oth. 30 Leather 31 Yams & Man Made Fibres 8 Oth. Metal Ores 6 Hunting & Trapping 54 Oth. Industrial Machinery 58. Appliances & Receivers 37 Veneer & Plywood 40 Pulp 9 Coal 48 Nickel Prod.

FIGURE 2.4 Ratio of interprovincial trade in 1996 and 1989

Effects of the FTA on Interprovincial Trade 35 TABLE 2.4 Effects of tariff changes on trade flows, 1989-1996 Equation no.

(i)

(ii)

(iii)

(iv)

(v)

(vi)

(vii)

Dependent variable

dlmus

dlxus

dlip

dlmrow

i-iii

ii-iii

i-iv

.040 (2.1)

.019 (1.0)

-.045 (2.0)

Independent variables: CanTarUS

-.032 (2.8) -.117 (4.0)

USTarCan CanTarROW

-.045 (2.4) -.121 (3.9)

-.083

056

(2.1) dlxus RB2 SEE

.141 .260

.270 .470

.347 (2.9) .142 .370

.057 .373

(1.5)

.069 .505

.261 .494

.091 .367

Notes: Absolute values of f-statistics are reported below coefficients. The dependent variables are the logarithms of the ratios of 1996 trade to 1989 trade, with each observation reflecting a different industry. The tariff changes are the 1996 average tariffs (%) minus the corresponding values in 1989. Equations (i)-(iv) are the ratios for the separate trade flows, while the dependent variables for equations (v) through (vii) are differences, with (v) = (i) - (iii), (vi) = (ii) - (iii), and (vii) = (i) - (iv).

trade, for which the explanatory tariffs are those applicable to trade with the United States and the rest of the world. The first equation shows a significant impact of changes in Canadian import tariff rates on the growth of imports from the United States. The estimated effect is very substantial, since the change in tariff rates is measured in percentage points and the growth of trade is as a ratio of 1996 to 1989 trade. Thus a decrease of 1 percentage point in a commodity's tariff rate is associated with a 3.2 per cent cumulative increase in trade between 1989 and 1996. Thus the average tariff cuts of 3.9 percentage points between 1989 and 1996 are estimated to have increased imports by 12.4 per cent. U.S. tariff reductions had even larger effects on the growth of Canadian exports to the United States, as shown in equation (ii), with the tariff cuts averaging 2 percentage points, implying an average export increase of 24 per cent (= .117*2.06). In both cases the proportion of the inter-industry variance in trade explained is small, showing that while the estimated effect of tariffs is substantial, it is far from the whole story.41

36 Economics

68 Scientific Equip. 48 Nickel Prod. 54 Oth. Industrial Machinery 53 Agric. Machinery 56 Motor Vehicle Parts 40 Pulp 36 Lumber & Timber 55 Motor Vehicles 6 Hunting & Trapping 47 Copper 58. Appliances & Receivers 16 Fish Prod. 9 Coal 59 Oth. Elec. Prod. 49 Oth. Non-ferrous Metal 41 Newsprint & Oth. 28 Oth. Rubber Prod. 69 Oth. Manu. Prod. 64 Industrial Chemicals 31 Yarns & Man Made Fibres 27 Tires & Tubes 46 Aluminum Prod. 61 Oth. Non-metallic Min. Prod. 57 Oth. Trans. Equip. 24 Alcoholic Bev. 29 Plastic Fab. Prod. 32 Fabrics 1 1 Natural Gas 52 Oth. Metal Fab. Prod. 37 Veneer & Plywood 39 Furniture 42 Paper Prod. 7 Iron Ores 60 Cement & Concrete Prod. 8 Oth. Metal Ores 30 Leather 63 Oth. Petroleum & Coal Prod. 67 Oth. Chemical Prod. 38 Oth Wood Fab. Material 12 Non-metalic Minerals 50 Boilers, Tanks & Plates 18 Feeds 65 Fertilizers 51 Fab. Structural Metal 10 Crude Mineral Oils 45 Iron & Steel Prod. 2 Live Animals I Grains 43 Printing & Publishing 62 Gasoline & Fuel Oil 3 Oth. Agri. Prod. 33 Oth. Textiles Prod. 66 Pharmaceuticals 35 Clothing 22 Misc. Food Prod. 34 Hosiery & Knitted Wear 5 Fish Landings 17 Fruits* Veg. Prep. 14 Meat Prod. 20 Breakfast Cer & Bakery Prod. 4 Forestry Prod. 23 Soft Drinks 19 Flour, Wheat & Oth. Cereals 21 Sugar 1 26 Cigarettes & Tobacco Mfg. 25 Tobacco Processed Unmfg. 15 Dairy Prod.

FIGURE 2.5 Ratio of U.S. trade to interprovincial trade, 1996

Effects of the FTA on Interprovincial Trade

37

Our primary attempt to estimate the effects of the FTA on interprovincial trade appears as equation (iii) in Table 2.4. The drop in Canadian tariffs diverted substantial amounts of trade. The coefficient of 0.04 implies that each percentage-point reduction of Canadian tariffs on U.S. imports would decrease interprovincial trade by 4 per cent. The total drop from 1989 to 1996, across the forty-two commodities, was 3.9 percentage points, implying a reduction of interprovincial trade of over 15 per cent (.156 = 3.9*.04, and exp (.156) = 1.15). Equations not reported show that there was no direct interprovincial trade effect evident from the reductions in U.S. tariff rates, although there is some evidence of indirect effects flowing from export volumes, as revealed by the negative sign on exports to the United States in equation (ii). Combining the results of equations (ii) and (iii) implies that the drop in U.S. tariffs created rather than diverted interprovincial trade. The size of this effect is estimated to be large enough to offset about half of the interprovincial trade losses caused by the FTA reductions on Canadian import tariffs. The proportionate increase in interprovincial trade is about .04 (.117*347 = .0406) for each percentagepoint drop in U.S. tariffs. The average drop of 2.06 percentage points would thus have increased interprovincial trade by about 8 per cent (2.06*.0408 = .0836). The FTA tariff changes thus reduced interprovincial trade by about 7 per cent (-.156 + .084 = -.077, and exp(-.077) = .93). How does this compare to the total shortfall of provincial trade in 1996 relative to what the gravity model would have predicted? The service-adjusted calculations of Table 2.1 suggest that interprovincial trade in 1996 was 13 per cent less than expected. Slightly more than half of this shortfall may have resulted directly or indirectly from the FTA tariff cuts, with a 15 per cent diversionary effect from Canada's tariff cuts offset by a 7 per cent additional-trade effect from the drop in U.S. tariffs. How can we explain the result that Canadian tariff cuts reduced interprovincial trade while the U.S. tariff cuts increased it? Many industries had Canadian subsidiaries set up by U.S firms to provide for the Canadian market, with shorter production runs and higher average costs than the parent plants. When the FTA provided for phased elimination of most tariffs - at a time when many U.S. manufacturers were already rationalizing and downsizing their operations - closure of many Canadian branch plants may have followed. Their closure may have increased imports from the United States directly to the province of consumption, thus eliminating some interprovincial trade. Any FTA-induced increases in exports, by contrast, are likely to lead

38 Economics

48 Nickel Prod. 40 Pulp 68 Scientific Equip. 9 Coal 54 Oth. Industrial Machinery 16 Fish Prod. 58. Appliances & Receivers 30 Leather 36 Lumber & Timber 69 Oth. Manu. Prod. 8 Oth. Metal Ores 53 Agric. Machinery 59 Oth. Elec. Prod. 1 Grains 6 Hunting & Trapping 24 Alcoholic Bev. 49 Oth. Non-ferrous Metal 47 Copper 37 Veneer & Plywood 56 Motor Vehicle Parts 32 Fabrics 31 Yarns & Man Made Fibres 41 Newsprint & Oth. 7 Iron Ores 64 Industrial Chemicals 35 Clothing 12 Non-metalic Minerals 61 Oth. Non-metallic Min. Prod. 57 Oth. Trans. Equip. 34 Hosiery & Knitted Wear 27 Tires & Tubes 28 Oth. Rubber Prod. 10 Crude Mineral Oils 52 Oth. Metal Fab. Prod. 65 Fertilizers 25 Tobacco Processed Unmfg. 3 Oth. Agri. Prod. 46 Aluminum Prod. 55 Motor Vehicles 66 Pharmaceuticals 33 Oth. Textiles Prod. 5 Fish Landings 5 1 Fab. Structural Metal 29 Plastic Fab. Prod. 45 Iron & Steel Prod. 39 Furniture 22 Misc. Food Prod. 67 Oth. Chemical Prod. 42 Paper Prod. 17 Fruits & Veg. Prep. 18 Feeds 50 Boilers, Tanks & Plates 14 Meat Prod. 38 Oth Wood Fab. Material 43 Printing & Publishing 62 Gasoline & Fuel Oil 15 Dairy Prod. 63 Oth. Petroleum & Coal Prod. 19 Flour. Wheat & Oth. Cereals 26 Cigarettes & Tobacco Mfg. 21 Sugar 20 Breakfast Cer & Bakery Prod. 60 Cement & Concrete Prod. 23 Soft Drinks 4 Forestry Prod. 2 Live Animals 1 1 Natural Gas

FIGURE 2.6 Ratio of ROW trade to interprovincial trade, 1996

Effects of the FTA on Intel-provincial Trade 39

FIGURE 2.7 Duty collected as percentage of imports, 1989-1996

to some increases in interprovincial trade of intermediate or final products. Any closure of U.S. subsidiary plants by Canadian firms could have led to a drop in interstate trade, but we have no relevant data. Given the much larger U.S. market, it is much less likely that scalebased reasons would have led Canadian firms to close their U.S. subsidiaries, and there are many more U.S. subsidiaries operating in Canada than vice versa. This asymmetry also helps to explain why U.S. tariff rates influence Canadian exports more than Canadian tariffs do. As the various CGE models of the FTA emphasized, once the U.S. tariff is low enough to encourage the entry of Canadian firms, the scale of U.S. sales can be large relative to pre-existing Canadian production, since the U.S. market is ten times as large as the Canadian market. The Canadian tariff reductions on imports from ROW probably help explain the growth of imports from the ROW, as shown by equation (iv). There is also a smaller, and insignificant, trade-diversionary effect of the FTA-related reductions of Canadian tariffs. The 1989-96 reductions in tariffs facing ROW imports to Canada, averaging 1.6 percentage points, increased imports from ROW to Canada by about 10 per cent (.065*1.6 = .104). Combining evidence from the equations for individual trade flows may reveal to what extent the changes in tariffs have influenced the relative growth of international and interprovincial trade. Each of equations (v) through (vii) estimates the difference between the growth

40

Economics

24 Alcoholic Bev. 26 Cigarettes & Tobacco Mfg. 50 Boilers, Tanks & Plates 66 Pharmaceuticals 32 Fabrics 42 Paper Prod. 21 Sugar SI Fab. Structural Metal 31 Yarns & Man Made Fibres 16 Fish Prod. 61 Oth. Non-metallic Min. Prod. 58. Appliances & Receivers 38 Oth Wood Fab. Material 29 Plastic Fab. Prod. 25 Tobacco Processed Unmfg. 59 Oth. Elec. Prod. 64 Industrial Chemicals 39 Furniture 52 Oth. Metal Fab. Prod. 28 Oth. Rubber Prod. 41 Newsprint & Oth. 69 Oth. Manu. Prod. 34 Hosiery & Knitted Wear 47 Copper 18 Feeds 68 Scientific Equip. 37 Veneer & Plywood 67 Oth. Chemical Prod. 20 Breakfast Cer & Bakery Prod. 17 Fruits & Veg. Prep. 33 Oth. Textiles Prod. 35 Clothing 27 Tires & Tubes 54 Oth. Industrial Machinery 14 Meat Prod. 45 Iron & Steel Prod. 57 Oth. Trans. Equip. 22 Misc. Food Prod. 46 Aluminum Prod. 63 Oth. Petroleum & Coal Prod. 56 Motor Vehicle Parts 43 Printing & Publishing 49 Oth. Non-ferrous Metal 3 Oth. Agri. Prod. 23 Soft Drinks L2 Non-metalic Minerals 1 Grains 2 Live Animals 53 Agric. Machinery 6 Hunting & Trapping 19 Flour, Wheat & Olh. Cereals 8 Oth. Metal Ores 10 Crude Mineral Oils 1 1 Natural Gas 36 Lumber & Timber 4 Forestry Prod. 40 Pulp 5 Fish Landings 62 Gasoline & Fuel Oil 65 Fertilizers 9 Coal 7 Iron Ores 30 Leather 15 Dairy Prod. 60 Cement & Concrete Prod. 48 Nickel Prod. 55 Motor Vehicles

percentage points

FIGURE 2.8 Changes in rate of duty collected for imports from ROW, 1989-1996

Effects of the FTA on Interprovincial Trade 41

24 Alcoholic Bev. 34 Hosiery & Knitted Wear 32 Fabrics 33 Oth. Textiles Prod. 35 Clothing 30 Leather 37 Veneer & Plywood 50 Boilers, Tanks & Plates 39 Furniture 29 Plastic Fab. Prod. 42 Paper Prod. 5 1 Fab. Structural Metal 3 1 Yarns & Man Made Fibres 21 Sugar 66 Pharmaceuticals 67 Oth. Chemical Prod. 28 Oth. Rubber Prod. 69 Oth. Manu. Prod. 52 Oth. Metal Fab. Prod. 20 Breakfast Cer & Bakery Prod. 58. Appliances & Receivers 38 Oth Wood Fab. Material 41 Newsprint & Oth. 61 Oth. Non-metallic Min. Prod. 17 Fruits & Veg. Prep. 27 Tires & Tubes 64 Industrial Chemicals 22 Misc. Food Prod. 45 Iron & Steel Prod. 47 Copper 15 Dairy Prod. 59 Oth. Elec. Prod. 23 Soft Drinks 54 Oth. Industrial Machinery 60 Cement & Concrete Prod. 25 Tobacco Processed Unmfg. 55 Motor Vehicles 14 Meat Prod. 48 Nickel Prod. 63 Oth. Petroleum & Coal Prod. 68 Scientific Equip. 43 Printing & Publishing 3 Oth. Agri. Prod. 19 Flour, Wheat & Oth. Cereals 46 Aluminum Prod. 2 Live Animals 16 Fish Prod. 18 Feeds 57 Oth. Trans. Equip. 1 Grains 49 Oth. Non-ferrous Metal 56 Motor Vehicle Parts 12 Non-metalic Minerals 53 Agric. Machinery 36 Lumber & Timber 6 Hunting & Trapping 8 Oth. Metal Ores 65 Fertilizers 9 Coal 10 Crude Mineral Oils 4 Forestry Prod. 5 Fish Landings 7 Iron Ores 1 1 Natural Gas 40 Pulp 62 Gasoline & Fuel Oil 26 Cigarettes & Tobacco Mfg.

percentage points

FIGURE 2.9 Changes in rate of duty collected for imports from the United States, 1989-1996

42 Economics

rates of two trade flows. Equation (v) estimates the growth of imports from the United States less the growth of interprovincial trade and finds a significant effect, equal to the import-creating effect from equation (i) plus the diversionary effect from equation (iii). Equation (vi) shows a slightly larger effect than does equation (ii), suggesting that U.S. import tariffs probably affect interprovincial trade, since the drops in those tariffs have, if anything, reduced interprovincial trade. Finally, equation (vii) asks to what extent the drops in Canadian tariffs influenced the differential rate of growth of imports from the United States and ROW. The effect of the FTA cuts are larger and more significant, with the estimated size of the two effects, per percentagepoint change in tariffs, being similar, but of opposite sign. Since the Canadian tariffs on imports from the United States fell by more than twice as much as those on imports from ROW, the U.S. share of total Canadian imports grew, while both import flows rose relative to interprovincial trade. Finally, we compare the actual FTA growth of Canadian-U.S. trade by sector with what was forecast before the event. Figure 2.11 and Table 2.5 compare the actual growth of exports to the United States with what was projected by the CGE model underlying the Department of Finance's evaluation of the FTA.42 Figure 2.12 and Table 2.6 show the corresponding comparison for Canadian imports from the United States. In both cases, there is a positive correlation between the model forecasts and the actual increases, although in most sectors the actual increases were far greater than those forecast.43 This shows once again how large have been the actual changes relative to what had been expected, since the model embodied relatively high price elasticities for merchandise trade flows (2.8 for imports and 4.4 for exports) and the tariff reductions used in the model's calculations are if anything greater than the average tariff reductions witnessed thus far. Thus the FTA apparently generated much more north-south trade than had been forecast. A second and more troubling element of the puzzle is that although the trade increases have been much greater than anticipated, the productivity gains that were supposed to have been the motivation and the reward for the increased trade have not been evident. The projected changes in the scale and pattern of manufacturing trade were to have led to increases in scale economies sufficient to reduce average unit costs in manufacturing by 2.7 per cent. The much larger actual increases in trade should presumably have led to even larger productivity increases. However, while there is substantial evidence, in this

Effects of the FTA on Interprovincial Trade

43

TABLE 2.5 Canadian exports to the United States

Industry

Actual (1996/1989) -dlnGDP

Forecast (FTA/no FTA)

Agriculture Forestry Fishing & trapping Mining Food - beverages Tobacco Rubber & plastics Leather Textiles Knitting Clothing Wood Furniture Pulp & paper Printing & publishing Primary metals Metal products Machinery & equipment Cars & parts Other transport Electrical products Mineral products Oil & coal products Chemical products Other manufacturing

2.75 1.29 1.56 1.63 1.79 1.07 2.11 1.58 2.69 4.83 1.91 2.19 2.20 1.10 1.52 1.14 2.12 2.06 1.37 1.62 2.04 1.42 2.05 2.20 1.84

0.99 0.93 0.95 0.97 1.23 2.53 1.38 1.58 1.58 1.67 1.75 1.09 1.28 0.98 1.22 1.17 1.26 1.31 1.04 1.03 1.89 1.68 1.04 1.63 1.18

Averages

1.92

1.33

paper and in Clausing,44 that those industries with bigger tariff reductions have seen larger trade changes, there is no cross-industry evidence of corresponding improvements in productivity. One possibility - sketched more fully below in chapter 7 - is that the pre-FTA degree of linkage between the U.S. and Canadian markets was already great enough to permit the major gains from comparative advantage and production scale. More research on productivity in matched Canadian and U.S. industries is needed to see if this is a plausible hypothesis. Alternatively, or additionally, some observers have argued that the pre-FTA gap in measured productivity between Canadian and U.S.

44

Economics

34 Hosiery & Knitted Wear 26 Cigarettes & Tobacco Mfg. 32 Fabrics 31 Yams & Man Made Fibres 17 Fruits & Veg. Prep. 64 Industrial Chemicals 35 Clothing 30 Leather 50 Boilers, Tanks & Plates 67 Oth. Chemical Prod. 33 Oth. Textiles Prod. 29 Plastic Fab. Prod. 66 Pharmaceuticals 27 Tires & Tubes 19 Flour, Wheat & Oth. Cereals 45 Iron & Steel Prod. 22 Misc. Food Prod. 52 Oth. Metal Fab. Prod. 28 Oth. Rubber Prod. 69 Oth. Manu. Prod. 51 Fab. Structural Metal 15 Dairy Prod. 58. Appliances & Receivers 59 Oth. Elec. Prod. 38 Oth Wood Fab. Material 68 Scientific Equip. 42 Paper Prod 39 Furniture 61 Oth. Non-metallic Min. Prod. 3 Oth. Agri. Prod. 37 Veneer & Plywood 60 Cement & Concrete Prod. 54 Oth. Industrial Machinery 1 Grains 2 Live Animals 62 Gasoline & Fuel Oil 47 Copper 57 Oth. Trans. Equip. 14 Meat Prod. 49 Oth. Non-ferrous Metal 24 Alcoholic Bev. 46 Aluminum Prod. 10 Crude Mineral Oils 16 Fish Prod. 18 Feeds 43 Panting & Publishing 41 Newsprint & Oth. 23 Soft Drinks 53 Agric. Machinery 12 Non-metalic Minerals 63 Oth. Petroleum & Coal Prod. 4 Forestry Prod. 5 Fish Landings 6 Hunting & Trapping 7 Iron Ores 9 Coal 1 1 Natural Gas 36 Lumber & Timber 40 Pulp 65 Fertilizers 8 Oth. Metal Ores 48 Nickel Prod. 55 Motor Vehicles 56 Motor Vehicle Parts 20 Breakfast Cer & Bakery Prod. 21 Sugar 25 Tobacco Processed Unmfg.

Percentage point

FIGURE 2.10 Changes in rate of duty collected for exports to the United States, 1989-1996

Effects of the FTA on Interprovincial Trade 45

FIGURE 2.11 Effects of FTA on exports, actual versus forecast (r = 0.15)

FIGURE 2.12 Effects of FTA on imports, actual versus forecast (r = 0.41)

46

Economics

TABLE 2.6 Canadian imports from the United States

Industry

Actual 1996/1989 -dlnGDP

Forecast (FTA/no FTA)

Agriculture Forestry Fishing & trapping Mining Food - beverages Tobacco Rubber & plastics Leather Textiles Knitting Clothing Wood Furniture Pulp & paper Printing & publishing Primary metals Metal products Machinery & equipment Cars & parts Other transport Electrical products Mineral products Oil & coal products Chemical products Other manufacturing

1.00 1.56 0.90 0.80 1.72 1.83 1.56 1.32 1.83 2.30 1.55 1.25 1.30 1.94 1.36 1.39 1.60 1.44 1.25 1.28 1.49 1.37 1.15 1.88 1.46

1.09 1.02 1.06 1.07 1.09 1.25 1.19 1.06 1.19 1.18 1.02 1.07 1.36 1.15 1.09 1.18 1.13 1.10 1.05 1.05 1.16 1.12 1.05 1.17 1.09

Averages

1.46

1.12

manufacturing, which has shown no signs of closing, may comprise measurement error as much as potential for trade expansion. Conclusions Both aggregate and commodity-level data show that interprovincial trade grew significantly less quickly than Canadian-U.S. and Canadian-ROW trade from 1989 through 1996. Tariff changes, especially those associated with the FTA, are able to explain slightly more than half of the shortfall of interprovincial trade in 1996 relative to what the grav-

Effects of the FTA on Interprovincial Trade 47

ity model proposes. The primary role of the FTA appears to have been to increase direct trade flows between Canada and the United States, although the evidence suggest some contribution also from trade diversion. The most likely locus of trade diversion appears to be a shift from interprovincial trade to imports of manufactures from the United States. This pattern of results is likely to be more secure than are the precise numbers, since the statistical power of the estimates is still quite low. To gauge better the size and significance of the FTA's effects on interprovincial trade, it would be desirable to supplement the available data in two ways - first, by disaggregating the commodities to allow a closer match with tariff categories, and hence to provide more differences among the industries in the tariff-reduction experiences, and, second, by adding a number of pre-FTA years to the data sample. Although the disaggregate results are not yet strong enough to permit secure estimates of the effect of the FTA on interprovincial trade, the aggregate results presented above are extremely robust. Interprovincial trade linkages remain twelve times tighter than those between Canada and the United States. The FTA did indeed have a border-reducing effect, since our best estimate, strongly supported by the data, is that the pre-FTA border effect of over eighteen fell to twelve between 1990 and 1993 and has remained on a plateau since. There may be some FTA effects on interprovincial trade still to come, but the border effect's constancy for the last four years suggests that at least the first round of trade adjustments is now complete. In the absence of any appearance of a new downward trend, the Canadian economy retains a strong national structure, with interprovincial trade links more than an order of magnitude tighter than those between provinces and states. Does this tight interprovincial trade network, relative to the international network, imply that Canada is missing out on productivity improvements from expanded trade? Our research, combined with that from studies of productivity under the FTA, would suggest not. The sharp growth in Canadian-U.S. trade, partly in substitution for interprovincial trade, has apparently not led to strong increases in productivity, either in the aggregate or in the industries most subject to FTA effects. Thus the current tight trade links between Canada and the United States, and in general among the industrial countries, is sufficient to permit access to internationally transferable technological progress and to attain adequate economies of scale. If this preliminary conclusion should be supported by continued research, then it is likely that national economies should continue to have much tighter trade and other economic and social linkages than are found in the global economy.

Appendix: List of Industries and Duty Rates TABLE 2.A1 Duty rates on imports to Canada from the United States Calculated rates of duty collected on Canadian imports from the United States 1 Grains 2 Live animals 3 Other agricultural products 4 Forestry products 5 Fish landings 6 Hunting & trapping products 7 Iron ores & concentrates 8 Other metal, ores & concentrates 9 Coal 10 Crude mineral oils 11 Natural gas 12 Non-metallic minerals 13 Services incidental to mining 14 Meat products 15 Dairy products 16 Fish products 1 7 Fruits & vegetables preparations 18 Feeds 19 Flour, wheat, meal & other cereals 20 Breakfast cereal & bakery products 21 Sugar 22 Misc. food products 23 Soft drinks 24 Alcoholic beverages 25 Tobacco processed unmanufactured 26 Cigarettes & tobacco mfg.

1989

1990

1991

1992

1993

1994

1995

1996

1.11 1.20

1.09 1.40 1.55 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.17 0.00 1.86 4.26 0.94 5.62 0.48 2.63 6.35 6.13 5.32 5.08 16.31 4.71 9.40

1.01 0.99 1.45 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.15 0.00 1.45 4.85 0.84 5.52 0.11 2.91 5.94 5.85 4.71 3.75 12.47 3.50 18.32

1.00 1.07 1.24 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.08 0.00 1.23 3.43 0.69 5.01 0.12 1.93 5.18 4.11 3.98 2.15 11.22 2.76 9.39

0.89 0.51 1.02 0.00 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.05 0.00 1.02 3.09 0.48 4.13 0.07 1.47 4.07 3.34 3.09 3.05 10.92 2.20 8.86

0.81 0.37 0.86 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.05 0.00 0.78 2.90 0.33 3.43 0.07 0.95 3.42 3.76 2.40 1.89 9.63 1.50 7.41

0.50 0.29 0.57 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.02 0.00 0.51 1.69 0.22 2.60 0.06 0.94 2.64 1.89 1.97 1.66 11.01 0.87 6.63

0.30 0.16 0.38 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.40 1.51 0.14 1.82 0.04 1.47 1.81 0.45 1.42 1.17 10.06 0.50 4.29

1.59 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.20 0.00 1.78 4.14 1.16 5.00 1.07 2.76 5.90 5.83 4.25 4.28 25.28 4.90 10.16

TABLE 2.A1—Continued Duty rates on imports to Canada from the United States Calculated rates of duty collected on Canadian imports from the United States 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52

Tires & tubes Other rubber products Plastic fabricated products Leather & leather products Yarns & man-made fibres Fabrics Other textile products Hosiery & knitted wear Clothing & accessories Lumber & timber Veneer & plywood Other wood fabricated materials Furniture & fixtures Pulp Newsprint & other paper stock Paper products Printing & publishing Advertising, print media Iron & steel products Aluminum products Copper & copper alloy products Nickel products Other non-ferrous metal products Boilers, tanks & plates Fabricated structural metal products Other metal fabricated products

1989

1990

1991

1992

1993

1994

1995

1996

3.52 5.16 7.66 10.66 6.64 14.67 13.05 20.24 12.27 0.01 8.53 4.65 6.89 0.00 3.72 6.01 1.40 0.00 4.01 1.26 2.96 1.59 0.61 8.23 7.15 4.91

2.73 5.06 8.05 5.87 6.28 13.73 12.64 12.11 5.70 0.00 6.91 4.76 6.92 0.00 3.62 5.39 1.02 0.00 4.37 1.02 3.56 0.93 0.94 6.90 6.37 4.83

2.72 4.65 7.24 5.86 4.49 11.73 11.83 9.53 5.23 0.00 7.22 3.82 4.85 0.00 2.33 4.13 0.97 0.00 3.98 0.72 2.44 0.77 0.75 3.56 6.61 4.13

2.13 3.80 5.90 4.59 4.24 9.83 9.56 9.01 5.31 0.00 4.82 2.73 2.89 0.00 1.31 2.53 0.53 0.00 3.29 0.50 1.57 0.40 0.51 4.23 5.80 3.14

1.02 2.99 4.50 3.46 2.82 7.10 7.67 7.79 4.94 0.00 2.71 1.79 0.58 0.00 0.16 0.94 0.11 0.00 2.57 0.24 1.41 0.19 0.27 1.86 4.23 2.07

0.73 2.58 3.74 3.31 2.15 5.31 6.21 6.91 4.30 0.00 1.45 1.44 0.53 0.00 0.12 0.71 0.12 0.00 2.30 0.16 0.97 0.07 0.17 1.76 3.48 1.49

0.62 1.80 2.75 2.60 1.67 4.04 4.32 6.03 3.47 0.00 1.33 1.04 0.35 0.00 0.08 0.41 0.10 0.00 1.85 0.12 0.54 0.04 0.12 1.03 2.20 1.18

0.42 1.36 1.92 1.86 1.19 2.62 3.00 4.13 2.50 0.00 0.95 0.61 0.27 0.00 0.03 0.29 0.06 0.00 1.17 0.10 0.36 0.02 0.09 0.84 1.40 0.81

TABLE 2.A1— Concluded Duty rates on imports to Canada from the United States Calculated rates of duty collected on Canadian imports from the United States 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 78 93

Agricultural machinery Other industrial machinery Motor vehicles Motor vehicle parts Other transport equipment Appliances & receivers, household Other electrical products Cement & concrete products Other non-metallic mineral products Gasoline & fuel oil Other petroleum & coal products Industrial chemicals Fertilizers Pharmaceuticals Other chemical products Scientific equipment Other manufactured products Electric power Non-competing imports

Total primary goods Total manufactured goods Total primary & manufactured goods

1989

1990

1991

1992

1993

1994

1995

1996

0.15 1.82 1.65 0.51 1.13 5.18 3.20 1.49 3.95 0.00 1.57 3.18 0.00 4.98 4.89 1.58 5.47 0.00 0.06

0.15 1.65 0.48 0.46 1.23 4.72 2.89 1.30 3.90 0.00 1.42 2.63 0.00 3.93 4.65 1.31 4.93 0.00 0.01

0.11 1.33 0.45 0.42 0.87 4.12 2.48 0.92 3.14 0.00 1.26 1.83 0.00 3.64 3.68 0.99 4.46 0.00 0.01

0.09 0.90 0.55 0.26 0.87 3.63 2.05 0.67 2.57 0.00 1.06 1.09 0.00 3.48 2.31 0.72 3.82 0.00 0.01

0.05 0.54 0.51 0.18 0.39 2.97 1.57 0.18 1.66 0.00 0.78 0.34 0.00 2.21 1.23 0.54 2.99 0.00 0.01

0.05 0.48 0.49 0.18 0.32 2.22 1.48 0.08 1.21 0.00 0.66 0.27 0.00 1.66 1.16 0.44 2.52 0.00 0.01

0.02 0.29 0.48 0.11 0.23 1.59 0.92 0.03 0.85 0.00 0.46 0.15 0.00 0.11 0.86 0.32 1.71 0.00 0.01

0.01 0.21 0.31 0.10 0.14 1.01 0.61 0.03 0.56 0.00 0.32 0.12 0.00 0.04 0.59 0.25 1.09 0.00 0.00

0.51 2.57 2.44

0.52 2.31 2.21

0.52 2.09 2.01

0.50 1.78 1.72

0.43 1.22 1.19

0.35 0.97 0.95

0.22 0.68 0.67

0.14 0.50 0.48

SOURCE: Revenue Canada, Customs Import Files. Note: Values for duties collected continue to appear for many commodities after the FTA tariff rates have been eliminated. These amounts represent duties on goods imported from, but not produced in, the United States or on goods that do not meet FTA content rules.

TABLE 2.A2 Duty rates on Canadian exports to the United States Calculated rates of duty collected on Canadian exports to the United States

1989

1990

1991

1992

1993

1994

1995

1996

1 Grains 2 Live animals 3 Other agricultural products 4 Forestry products 5 Fish landings 6 Hunting & trapping products 7 Iron ores & concentrates 8 Other metallic ores & concentrates 9 Coal 10 Crude mineral oils 1 1 Natural gas 12 Non-metallic minerals 13 Services incidental to mining 14 Meat products 15 Dairy products 16 Fish products 17 Fruits & vegetables preparations 18 Feeds 1 9 Flour, wheat, meal & other cereals 20 Breakfast cereal & bakery products 21 Sugar 22 Misc. food products 23 Soft drinks 24 Alcoholic beverages 25 Tobacco processed unmanufactured 26 Cigarettes & tobacco mfg.

0.81 0.75 1.54 0.00 0.00 0.00 0.00 0.00 0.00 0.34 0.00 0.02 0.00 0.60 3.70 0.38 5.74 0.31 2.42 0.20 0.44 2.96 0.20 0.80 8.14 8.77

1.37 0.62 1.39 0.00 0.00 0.00 0.00 0.00 0.00 0.21 0.00 0.02 0.00 0.52 2.77 0.28 4.87 0.29 2.21 0.45 0.03 2.79 0.19 0.93 7.95 6.85

1.08 0.39 1.39 0.00 0.00 0.00 0.00 0.00 0.00 0.17 0.00 0.01 0.00 0.36 2.39 0.21 4.12 0.15 2.34 0.59 1.14 2.97 0.17 0.93 7.56 4.22

1.49 0.21 1.31 0.00 0.00 0.00 0.00 0.00 0.00 0.09 0.00 0.01 0.00 0.10 2.22 0.14 3.50 0.02 2.05 0.35 2.10 2.23 0.09 0.66 6.80 3.63

1.00 0.01 0.81 0.00 0.00 0.00 0.00 0.01 0.00 0.00 0.00 0.00 0.00 0.09 2.08 0.10 2.71 0.03 1.38 0.67 3.05 1.73 0.07 0.65 5.90 3.11

0.82 0.01 0.52 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.05 1.43 0.09 1.93 0.01 1.06 0.56 2.69 1.17 0.09 0.55 5.18 2.58

0.37 0.01 0.42 0.00 0.00 0.00 0.00 0.01 0.00 0.00 0.00 0.00 0.00 0.04 1.28 0.07 1.37 0.00 0.71 0.53 2.46 0.92 0.00 0.32 4.12 1.79

0.14 0.00 0.28 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.03 1.24 0.06 0.90 0.00 0.44 0.47 2.47 0.59 0.00 0.24 3.00 1.25

TABLE 2.A2—Continued Duty rates on Canadian exports to the United States Calculated rates of duty collected on Canadian exports to the United States

1989

1990

1991

1992

1993

1994

1995

1996

27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52

2.82 2.55 3.03 4.96 5.76 8.35 3.99 15.29 8.45 0.00 1.13 1.38 1.91 0.00 0.18 1.40 0.22 0.00 2.80 0.33 0.79 0.01 0.88 2.62 2.22 2.36

2.56 2.81 2.90 5.23 3.87 8.15 3.49 13.38 9.33 0.00 0.85 1.33 1.42 0.00 0.17 1.07 0.28 0.00 2.53 0.20 0.71 0.01 1.01 2.49 1.97 2.34

2.21 2.42 2.63 5.51 3.54 8.89 3.04 12.12 9.15 0.00 0.62 1.25 1.02 0.00 0.12 0.76 0.25 0.00 2.46 0.15 0.57 0.01 0.94 2.07 1.71 1.88

1.85 1.91 2.13 4.12 3.09 7.40 2.47 9.99 7.86 0.00 0.36 0.78 0.59 0.00 0.07 0.44 0.13 0.00 2.10 0.09 0.33 0.01 0.40 1.11 1.28 1.49

1.50 1.24 1.68 3.45 1.77 5.46 2.08 8.20 5.99 0.00 0.12 0.26 0.08 0.00 0.01 0.18 0.05 0.00 1.59 0.06 0.12 0.00 0.43 0.60 1.07 1.04

1.12 0.91 1.26 3.14 1.04 3.37 1.76 6.54 4.99 0.00 0.09 0.20 0.12 0.00 0.01 0.14 0.04 0.00 1.22 0.05 0.46 0.01 0.36 0.38 0.88 0.75

0.83 0.68 0.92 2.62 0.83 2.47 1.74 4.86 4.36 0.00 0.07 0.15 0.07 0.00 0.00 0.09 0.02 0.00 0.90 0.04 0.31 0.00 0.24 0.23 0.64 0.55

0.57 0.67 0.66 1.77 0.62 1.74 1.11 3.44 3.60 0.00 0.07 0.13 0.05 0.00 0.00 0.08 0.01 0.00 0.60 0.02 0.16 0.00 0.19 0.14 0.47 0.42

Tires & tubes Other rubber products Plastic fabricated products Leather & leather products Yarns & man made fibres Fabrics Other textile products Hosiery & knitted wear Clothing & accessories Lumber & timber Veneer & plywood Other wood fabricated materials Furniture & fixtures Pulp Newsprint & other paper stock Paper products Printing & publishing Advertising, print media Iron & steel products Aluminum products Copper & copper alloy products Nickel products Other non-ferrous metal products Boilers, tanks & plates Fabricated structural metal products Other metal fabricated products

TABLE 2.A2—Concluded Duty rates on Canadian exports to the United States Calculated rates of duty collected on Canadian exports to the United States

1989

1990

1991

1992

1993

1994

1995

1996

53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 78 93

0.07 1.04 0.00 0.28 0.59 2.02 1.61 1.05 1.54 0.28 0.06 3.82 0.00 2.24 3.03 1.96 2.11 0.00 0.00

0.07 0.92 0.03 0.48 0.34 2.04 1.19 0.72 1.20 0.18 0.07 2.36 0.00 1.86 2.51 1.33 2.04 0.00 0.00

0.10 0.69 0.06 0.15 0.18 1.67 0.89 0.65 0.94 0.16 0.05 1.55 0.00 2.49 1.96 0.95 1.77 0.00 0.00

0.06 0.44 0.06 0.14 0.11 1.14 0.72 0.23 0.77 0.08 0.04 0.84 0.00 2.45 1.12 0.72 1.54 0.00 0.00

0.08 0.18 0.04 0.12 0.05 0.85 0.57 0.02 0.53 0.04 0.00 0.13 0.00 1.68 0.76 0.63 1.20 0.00 0.00

0.07 0.13 0.02 0.20 0.14 0.74 0.58 0.00 0.53 0.01 0.00 0.12 0.00 1.38 0.62 0.43 0.98 0.00 0.00

0.02 0.10 0.02 0.31 0.14 0.53 0.34 0.00 0.44 0.00 0.01 0.09 0.00 0.01 0.46 0.38 0.58 0.00 0.00

0.01 0.10 0.04 0.35 0.12 0.38 0.29 0.00 0.32 0.00 0.01 0.07 0.00 0.01 0.29 0.39 0.44 0.00 0.00

0.26 0.77 0.71

0.21 0.70 0.65

0.17 0.59 0.54

0.15 0.48 0.44

0.07 0.34 0.30

0.07 0.27 0.25

0.04 0.21 0.19

0.02 0.19 0.17

Agricultural machinery Other industrial machinery Motor vehicles Motor vehicle parts Other transport equipment Appliances & receivers, household Other electrical products Cement & concrete products Other non-metallic mineral prod. Gasoline & fuel oil Other petroleum & coal prod. Industrial chemicals Fertilizers Pharmaceuticals Other chemical products Scientific equipment Other manufactured products Electric power Non-competing imports

Total primary goods Total manufactured goods Total primary & manufactured goods

SOURCE: U.S. Customs Services, Import Files. Note: Values for duties collected continue to appear for many commodities after the FTA tariff rates have been eliminated. These amounts represent duties on goods exported to, but not produced in, Canada or on goods that do not meet FTA content rules.

TABLE 2.A3 Duty rates on imports to Canada from the rest of the world Calculated rates of duty collected on Canadian imports from ROW

1989

1990

1991

1992

1993

1994

1995

1996

1 Grains 2 Live animals 3 Other agricultural products 4 Forestry products 5 Fish landings 6 Hunting & trapping products 7 Iron ores & concentrates 8 Other metallic ores & concentrates 9 Coal 10 Crude mineral oils 1 1 Natural gas 12 Non-metallic minerals 13 Services incidental to mining 14 Meat products 15 Dairy products 16 Fish products 1 7 Fruits & vegetables preparations 18 Feeds 1 9 Flour, wheat, meal & other cereals 20 Breakfast cereal & bakery products 21 Sugar 22 Misc. food products 23 Soft drinks 24 Alcoholic beverages 25 Tobacco processed unmanufactured 26 Cigarettes & tobacco mfg.

0.22 0.14 1.38 0.00 0.00 0.03 0.00 0.00 0.00 0.00 0.00 0.27 0.00 1.64 1.69 3.81 5.75 1.71 6.43 4.75 4.80 3.87 1.71 39.95 5.38 43.00

0.09 0.01 1.26 0.00 0.00 0.00 0.00 0.47 0.00 0.00 0.00 0.26 0.00 1.78 2.30 3.18 6.09 1.04 6.74 5.89 4.93 4.04 6.04 18.61 8.35 45.34

0.17 0.01 1.26 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.58 0.00 1.76 2.24 3.09 6.09 0.98 9.39 5.41 6.20 4.00 7.45 17.33 6.94 12.86

0.60 0.00 1.33 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.21 0.00 1.69 2.04 2.39 5.53 1.06 10.35 5.24 5.98 4.22 2.43 15.18 1.25 12.19

0.04 0.06 1.49 0.00 0.00 0.17 0.00 0.00 0.00 0.00 0.00 0.29 0.00 1.19 1.74 2.14 5.55 0.66 7.80 4.42 5.59 3.93 7.90 12.20 2.45 7.48

0.19 0.04 1.47 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.29 0.00 0.86 1.83 1.94 5.63 0.57 6.15 4.62 4.26 3.83 5.43 14.13 1.08 12.86

0.72 0.13 1.34 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.29 0.00 0.68 1.75 1.60 5.10 0.45 5.78 3.63 2.36 3.53 5.81 14.00 1.76 9.74

0.10 0.00 1.20 0.00 0.00 0.01 0.03 0.00 0.00 0.00 0.00 0.03 0.00 0.56 1.82 0.96 4.21 0.46 6.60 3.45 1.24 3.10 3.02 14.06 2.98 11.22

TABLE 2.A3— Continued Duty rates on imports to Canada from the rest of the world Calculated rates of duty collected on Canadian imports from ROW

1989

1990

1991

1992

1993

1994

1995

1996

27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52

7.82 8.84 8.57 13.11 7.91 15.04 11.27 19.96 13.93 0.00 4.80 4.55 8.93 0.00 3.51 7.54 1.08 0.00 3.79 2.23 2.94 0.32 0.94 9.82 5.87 5.56

9.53 6.74 9.71 17.18 9.70 16.61 15.32 25.81 17.14 0.00 5.08 4.24 11.57 0.00 3.95 7.92 1.10 0.00 5.25 2.69 3.39 0.32 1.30 9.54 6.11 6.69

9.54 5.72 9.55 17.06 9.57 17.17 14.31 25.45 16.84 0.00 5.23 4.01 10.43 0.00 3.41 7.63 1.06 0.00 5.12 2.08 3.33 0.35 1.72 7.83 5.95 7.12

9.36 5.43 9.15 16.82 9.06 15.90 12.31 23.94 16.08 0.00 4.94 3.50 10.93 0.00 3.80 7.32 0.92 0.00 4.14 1.93 3.08 0.10 0.66 6.61 5.88 6.40

8.46 5.62 8.06 14.58 7.10 14.03 10.58 19.62 14.59 0.00 4.67 2.70 8.34 0.00 3.96 7.18 0.92 0.00 3.97 2.11 2.94 0.12 1.02 8.00 5.21 5.62

8.50 5.27 7.62 14.07 6.52 13.35 11.34 19.61 14.43 0.00 4.31 2.94 8.82 0.00 4.03 6.75 0.90 0.00 5.25 1.94 2.12 0.10 0.65 6.45 5.36 5.08

7.37 5.90 6.79 14.33 5.98 12.21 10.64 19.31 13.93 0.00 3.98 2.53 8.11 0.00 3.02 5.09 0.82 0.00 3.91 1.48 1.20 0.36 0.53 4.72 4.33 4.45

6.94 5.78 6.01 13.30 4.89 11.03 9.48 18.17 12.68 0.00 3.41 2.27 6.75 0.00 1.42 4.06 0.65 0.00 2.78 1.45 0.76 0.89 0.45 2.83 3.44 3.41

Tires & tubes Other rubber products Plastic fabricated products Leather & leather products Yarns & man-made fibres Fabrics Other textile products Hosiery & knitted wear Clothing & accessories Lumber & timber Veneer & plywood Other wood fabricated materials Furniture & fixtures Pulp Newsprint & other paper stock Paper products Printing & publishing Advertising, print media Iron & steel products Aluminum products Copper & copper alloy products Nickel products Other non ferrous metal products Boilers, tanks & plates Fabricated structural metal products Other metal fabricated products

TABLE 2.A3— Concluded Duty rates on imports to Canada from the rest of the world Calculated rates of duty collected on Canadian imports from ROW

1989

1990

1991

1992

1993

1994

1995

1996

53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 78 93

0.13 1.86 13.86 1.38 0.87 3.88 3.39 1.37 7.47 0.00 1.31 3.22 0.00 5.87 5.41 3.20 4.98 0.00 0.35

0.16 1.99 15.74 1.60 1.32 4.31 3.89 1.27 7.82 0.00 0.54 4.02 0.00 8.97 6.17 3.42 6.22 0.00 0.57

0.16 1.87 12.78 1.65 1.18 4.36 3.44 2.00 7.99 0.00 0.39 4.09 0.00 8.96 6.03 3.42 6.14 0.00 0.90

0.17 1.66 11.54 1.03 0.56 2.52 3.21 1.04 7.26 0.00 0.41 4.23 0.00 8.83 5.74 2.88 5.90 0.00 0.96

0.10 1.31 8.56 0.84 1.02 2.26 2.73 3.49 6.34 0.00 0.55 4.15 0.00 7.73 5.82 2.66 5.28 0.00 0.34

0.11 1.26 6.54 0.69 0.72 2.02 2.41 2.09 6.19 0.00 1.02 4.07 0.00 7.43 5.93 2.32 5.40 0.00 0.22

0.13 0.87 5.09 0.63 0.36 1.74 1.95 2.41 5.42 0.00 0.82 1.58 0.00 0.09 5.21 1.99 3.94 0.00 0.19

0.09 0.65 4.50 0.65 0.17 1.37 1.41 2.15 4.50 0.00 0.41 1.04 0.00 0.07 4.33 1.58 3.17 0.00 0.04

0.11 5.81 5.22

0.17 6.54 5.65

0.12 6.17 5.49

0.11 5.77 5.13

0.14 4.85 4.38

0.14 4.39 4.00

0.13 3.64 3.30

0.09 3.13 2.76

Agricultural machinery Other industrial machinery Motor vehicles Motor vehicle parts Other transport equipment Appliances & receivers, household Other electrical products Cement & concrete products Other non-metallic mineral products Gasoline & fuel oil Other petroleum & coal products Industrial chemicals Fertilizers Pharmaceuticals Other chemical products Scientific equipment Other manufactured products Electric power Non-competing imports

Total primary goods Total manufactured goods Total primary & manufactured goods

SOURCE: Revenue Canada, Customs Import Files.

Effects of the FTA on Interprovincial Trade 57 NOTES The authors are grateful to Larry Schembri and two anonymous referees for very helpful suggestions. Opinions expressed are the sole responsibility of the authors. 1 The FTA came into effect on 1 January 1989. 2 For a detailed discussion, see Kenneth M. Holland, 'NAFTA and the Single European Act/ in T. David Mason and Abdul M. Turay, eds., Japan, NAFTA and Europe: Trilateral Cooperation or Confrontation (New York: St Martin's Press, 1994), 1-37. 3 Ibid. 4 See Ronald J. Wonnacott, 'Canada's Role in NAFTA: To What Degree Has It Been Defensive?' in Victor Bulmer-Thomas, Nikki Craske, and Monica Serrano, eds., Mexico and the North American Free Trade Agreement: Who Will Benefit? (New York: St Martin's Press, 1994), 163-75. 5 See Statistics Canada, Trade Patterns: Canada-United States, the Manufacturing Industries, 1981-1991 (Ottawa: Statistics Canada, 1993), Cat. 65-504E. 6 See Tim Hazledine, 'Why Do the Free Trade Numbers Differ So Much? The Role of Industrial Organization in General Equilibrium,' Canadian Journal of Economics 23 (1990), 791-801, which surveys most of the pre-FTA CGE models and results, several of which are included in John Whalley, ed., Canada-United States Free Trade (Toronto: University of Toronto Press, 1986), and emphasizes the extent to which the conclusions depend on the assumed costs and competitive structures. 7 See Warwick J. McKibbin, 'Dynamic Adjustment to Regional Integration: Europe 1992 and NAFTA,' Journal of Japanese and International Economics 8 (1994), 422-53. 8 See Noel Gaston and Daniel Trefler, The Labour Market Consequences of the Canada-U.S. Free Trade Agreement,' Canadian Journal of Economics 30 (1997), 18-41. 9 Keith Head and John Ries, 'Market-Access Effects of Trade Liberalization: Evidence from the Canada-U.S. Free Trade Agreement,' in Richard C. Feenstra, ed., The Effect of U.S. Trade Protection and Promotion Policies (Chicago: University of Chicago Press, 1997), 323-42. 10 See Bela Balassa, 'Trade Creation and Trade Diversion in the European Common Market/ in Bela Balassa, ed., Comparative Advantage, Trade Policy and Economic Development (New York: New York University Press, 1989), 109-30. 11 See Derrick K. Gondwe and Winston H. Griffith, Trade Creation and Trade Diversion: A Case Study of MDCs in CARIFTA, 1968-1974,' Social and Economic Studies 38 (1989), 149-75.

58

Economics

12 See Peter J. Wylie, 'Partial Equilibrium Estimates of Manufacturing Trade Creation and Diversion Due to NAFTA/ North American Journal of Economics and Finance 6 (1995), 65-84. 13 See Tamim Bayoumi and Barry Eichengreen, 7s Regionalism Simply a Diversion? Evidence from the Evolution of the EC and EFTA, Working Paper No. 5283 (Cambridge: National Bureau of Economic Research, 1995). 14 See, for instance, Jan Tinbergen, Shaping the World Economy: Suggestions for an International Economic Policy (New York: Twentieth Century Fund, 1962); Peutti Poyhonen, 'A Tentative Model for the Volume of Trade between Countries/ Weltwirtschaftliches Archiv 90 (1963), 93-100; and Norman D. Aitken, 'The Effect of EEC and EFTA on European Trade: A Temporal Cross-Section Analysis/ American Economic Review 63 (1973), 881-92. 15 See James E. Anderson, 'A Theoretical Foundation for the Gravity Equation/ American Economic Review 69 (1979), 106-16; Elhanan Helpman, 'Increasing Returns, Imperfect Markets and Trade Theory/ in Ronald Jones and Peter Kenen, eds., Handbook of International Trade (Amsterdam: North-Holland, 1984), vol. 1,325-65, and Jeffrey H. Bergstrand, The Generalized Gravity Equation, Monopolistic Competition and the Factor Proportions Theory in International Trade/ Review of Economics and Statistics 71 (1989), 143-53. 16 As illustrated by Alan V. Deardorff, Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical World? Working Paper No. 5377 (Cambridge: National Bureau of Economic Research, 1995). 17 See Aitken, The Effect/ 881-92. 18 See Jacob A. Bikker, 'An International Trade Flow Model with Substitution: An Extension of the Gravity Model/ Kyklos 40 (1987), 315-37. 19 See Bayoumi and Eichengreen, Ts Regionalism Simply a Diversion?' 20 See Jeffrey A. Frankel and Shang-Jin Wei, Trade Blocs and Currency Blocs Working Paper No. 4335 (Cambridge: National Bureau of Economic Research, 1993). 21 See Shang-Jin Wei, Intra-National versus International Trade: How Stubborn Are Nations in Global Integration? Working Paper No. 5531 (Cambridge, Mass.: National Bureau of Economic Research, 1996); John F. Helliwell, 'Do National Borders Matter?' Canadian Journal of Economics 29 (1996), 507-22; and John F. Helliwell, 'National Borders, Trade and Migration/ Pacific Economic Review 2 (1997), 165-85. 22 See John McCallum, 'National Borders Matter: Canada-U.S. Regional Trade Patterns/ American Economic Review 85 (1995), 615-23. 23 See Helliwell, 'Do National Borders Matter?' 507-22. 24 See McCallum, 'National Borders Matter/ 615-23. Other studies suggest

Effects of the FTA on Intel-provincial Trade 59

25 26 27 28

29

30 31 32

33

34

that borders may be an important factor in preventing full integration. Alun H. Thomas, Saving, Investment, and the Regional Current Account: An Analysis of Canadian, British and German Regions, IMF Working Paper No. 93/62 (Washington, DC: International Monetary Fund, 1993). Thomas shows that there is no positive relationship between regional personal savings and private investment in Canada, suggesting that personal savings are perfectly mobile within Canada. Boyoumi and Eichengreen, 7s Regionalism Simply a Diversion?, confirm his finding in that their results indicate full capital mobility within Canada but only partial capital mobility between Canada and the rest of the world. See Charles Engel and John H. Rogers, 'How Wide Is the Border?' American Economic Review 86 (1996), 1112-25. See Helliwell, 'National Borders,' 165-85. The results are reported in equation (viii) of Table 2 of ibid. Kimberly Clausing, Trade Creation and Trade Diversion in the CanadaUnited States Free Trade Agreement' (PhD thesis, Harvard University, 1996). Following the harmonized classification system, Clausing uses the six-digit level of commodity detail, which includes approximately 5,000 commodity groups. When she eliminates commodity groups containing less than $100,000 of annual trade (only about 1 per cent of total trade), her sample size drops in half. She further reduces the sample by removing those commodities for which she could not ascertain the liberalization status. See McCallum, 'National Borders Matter,' 615-23; and Helliwell, 'Do National Borders Matter?' See John F. Helliwell, How Much Do National Borders Matter? (Washington, DC: Brookings Institution, 1998). There are ninety interprovincial flows, because each of the ten provinces exports to each of the nine other provinces. In this study we do not consider intraprovincial trade flows. These are the border states plus the largest non-border states - the same sample used by McCallum, 'National Borders Matter/ and Helliwell, How Much Do National Borders Matter? These trading pairs undertake almost all trade between the United States and Canada. We exclude the trade between provinces and the smallest states to reduce the number of zero observations and to minimize the risk that the log-linear results are overly influenced by large proportionate changes in very small trade flows. Since this represents only 2 per cent of the total observations, it was no surprise to find that alternative ways of treating these zero observations made no material difference to the results.

60 Economics 35 The sum of these two variables takes the value of 1.0 for each observation, since we do not have data for interstate trade. Thus constant term must be excluded to prevent singularity in estimation. If the coefficients on both variables may take different values from year to year, as in our estimation, then the results are equivalent to those that would be obtained by including the HOME variable covering interprovincial trade and then permitting the constant term to take a separate value for each sample year. 36 See Helliwell, How Much Do National Borders Matter? 37 For 1991 through 1996 these border effects are thus exactly the same as those shown at the bottom of Table 2.2 of ibid. 38 The index of service intensity is just the series listed as M divided by its 1988 value. 39 See Clausing, Trade Creation.' 40 Ibid. 41 In view of the risk of reverse causation, a referee suggested using reverse regression of these and other bivariate equations, treating 1/P from the reversed regression and p from the original regression as likely bounds for the true (3 in the original regression. 1/fJ from the reversed regressions is in all the bivariate regressions larger than the ps shown in the tables. This test would suggest that the estimates shown in the table are more likely to be underestimates than overestimates of the effects of tariff changes on trade. 42 The sectoral projections came from a Finance Canada paper entitled Modelling the Free Trade Agreement in Finance's General Equilibrium Trade Model (Jan. 1988). The actual growth is represented by the ratio of actual trade in 1996 and in 1989 minus the change in the logarithm of nominal GDP. 43 A cross-sectional regression for exports covering all twenty-five sectors is not significant but becomes so if the first six industries are removed, thus leaving out food, tobacco, and the primary industries. The simple correlations between the actual and predicted series are 0.13 for the twenty-five sectors and 0.40 for the smaller group of nineteen sectors. As we can see from Table 2.5, tobacco was forecast to be a big export gainer, while this has not shown up in the export statistics. For imports the regression is significant using either group of sectors. The simple correlations in these two cases are 0.41 for all twenty-five, and 0.33 for the nineteen. 44 See Clausing, Trade Creation.' 45 See Helliwell, How Much Do National Borders Matter?

3. Making Macroeconomic Policy in an Integrating North America Ronald Kneebone

The goal of this chapter is to review the debate about the effects of increased economic integration on a nation's capacity for independent choice of macroeconomic policy. I focus on Canada and the effects of increased economic integration with the United States and Mexico on its capacity for making macroeconomic policy. I also present data on the recent evolution of macroeconomic variables. While these data help explain the impact of greater economic integration, movements in these data may also reflect structural changes in the Canadian economy since 1988 that relate to technological changes and government policy choices. First, I briefly sketch what macroeconomic policy is and how it is implemented. Then I outline what macroeconomists judge should be its goals. An overview of the recent evolution of key macroeconomic variables follows. The discussion turns next to the impact of economic integration on macroeconomic policy in Canada. Finally, I offer a conclusion and suggest how the economy may evolve in the coming decades. Macroeconomic Policy and Its Implementation Macroeconomics is the study of economy-wide phenomena, including inflation, unemployment, distribution of income, and economic growth. Macroeconomic policy involves a government making choices that affect these phenomena. Macroeconomic policy-making is traditionally defined as involving fiscal policy (the setting of taxes, govern-

62 Economics

ment spending, and debt management) and monetary policy (the setting of monetary growth rates, interest rates, and exchange rates). However, also important to the determination of macroeconomic variables is the very basic policy question of the extent to which government will restrict the free operation of markets - what we might call market policy. Thus policy choices regarding issues such as the choice or blend of socialism versus capitalism and the protection of property rights are key. So too is the choice of whether the nation-state will be relatively open or closed to international trade in goods, services, and capital. The predominant view among macroeconomists is that useful macroeconomic policy, whether it be fiscal, monetary, or market policy, is based on rules rather than on discretion. A useful policy announces specific policy responses to particular types of shocks or situations. Thus the policy-maker announces, 'Whenever I observe economic situation X, I will do Y.' The effectiveness of such policy rules depends on their being clearly announced and consistently obeyed. Policy based on discretion, in contrast, involves responding differently at various times to the same economic conditions; 'Whenever I observe economic situation X, I may do W, or I may do Y, or I may do Z.' Economists do not favour policies based on discretion precisely because they are not predictable. This unpredictability makes it difficult for households and firms to make optimal consumption and investment choices and consequently makes for less than optimal economic outcomes. Policy rules that involve discretionary changes to tax and spending rates also open decision-making to political, as opposed to economic, factors. Thus political business cycles, wherein aggregate demand varies with the nearness of election dates and depends on the political party in power, become possible when discretion rather than rules determines fiscal policy.1 An effective way of implementing a fiscal policy rule is via automatic stabilizers. Such a feature of the tax or expenditure system reduces income fluctuations without the need for changes in tax or expenditure rates. Examples include the income tax and employment insurance. During an economic expansion, income tax revenues increase and employment insurance payments decline; during a contraction, the opposite happens. In this way, income tax revenues and employment insurance expenditures move in a counter-cyclical fashion, acting to reduce fluctuations in consumption and aggregate demand. An automatic stabilizer is a rule in the sense that it is clearly

Making Macroeconomic Policy 63

understood by households and firms and is consistently applied by government. Essentially, governments set tax rates and spending propensities and then do nothing to offset the impact of the business cycle on revenues and expenditures. Since an economic slowdown has the effect of causing automatic stabilizers to reduce tax revenue and increase government expenditures, the use of automatic stabilizers requires that the government have the legal right to allow budget imbalances and to accumulate debt. Using automatic stabilizers to impose a fiscal policy rule is viable over the long term if tax rates and spending propensities are set at levels that cause the changes in total government revenues and expenditures that arise over the course of economic contractions and expansions to more or less balance over the course of the business cycle.2 If this is not the case, then the budget deficits that accumulate during contractions will not balance the surpluses that accumulate during expansions. The result is an accumulation of debt or, less commonly observed, an accumulation of assets. Fiscal policy rules may also involve changing tax rates and spending propensities in predictable and well-known ways in response to changing economic conditions. Thus a policy-maker may announce his or her intention to smooth fluctuations in aggregate demand by decreasing tax rates by x per cent whenever growth rates in gross domestic product (GDP) fall below y per cent. Such policy rules are discouraged by macroeconomists because, unlike automatic stabilizers, they take a good deal of time to implement. That is, a policy-maker seeking to change tax rates or redesign spending programs in response to changes in economic conditions must recognize the need for change, pass legislation to make these changes, and wait for the changes to affect aggregate demand. These recognition, implementation, and multiplier lags can result in the policy prescription's affecting aggregate demand only after the problem has passed. Macroeconomists also favour the use of rules over discretion in the conduct of monetary policy. Although recognition and implementation lags are shorter for monetary than fiscal policy (changes in market interest rates are easily observed, and the central bank does not need to debate and pass legislation), changes in monetary policy affect aggregate demand only with long and variable lags. Thus the cure may take effect only after the economic problem has disappeared. Choosing a monetary policy rule involves making a choice among three considerations -

64

Economics

• the degree to which the domestic capital market will be left open to international capital flows • whether the exchange rate will be fixed or flexible • whether domestic monetary policy will be directed towards meeting domestic policy goals. A country cannot maintain simultaneously an open capital market, a fixed exchange rate, and a monetary policy aimed at affecting domestic economic variables. If it seeks to maintain an open capital market while orienting monetary policy towards domestic goals, it must allow the exchange rate to vary endogenously. Orienting monetary policy towards domestic goals and maintaining control over the exchange rate require closing of the domestic capital market to international capital flows. The fact that the choice of monetary policy rule must involve these three considerations is sometimes referred to as the open economy's 'trilemma.'3 Whichever two of the three choices the monetary policy-maker decides to control - international capital flows, the exchange rate, or domestic economic conditions - it must allow the third to be endogenously determined. Once government has decided how to deal with the open economy's trilemma, it conducts monetary policy like it handles fiscal policy; the policy-maker should allow the economy to respond to the choice and allow the endogenous monetary policy parameter to vary freely.4 Finally, macroeconomists believe it to be important that a government commit itself, as irrevocably as possible, to decisions about market policy. Thus government must decide the extent to which it will respect property rights and the extent to which it will restrict economic choice via government regulation of free markets. Economists feel that policy rules are the best route to these goals. The commitment to market policy choices is particularly important because unless policy-makers can credibly commit themselves to their announced policy, economic agents will not make choices that are consistent with what the policy-maker might expect or hope for. An example is patent policy, where the granting of a temporary monopoly as a reward for the discovery of a new drug or industrial process is intended to encourage firms to risk the very large cost of research and development (R&D) - a cost that has only a small chance of being recovered. Once the new item is discovered, if government reneges on the patent policy in order to permit competition in the item's provision, the firm that made the discovery is unable to recover its R&D

Making Macroeconomic Policy 65

costs. The mere possibility that the policy-maker may renege on the patent policy is enough to prevent firms from committing the R&D expenditures. To minimize this problem, policy-makers must commit themselves as irrevocably as possible to the rule. Another example of the importance of the time-inconsistency problem is the issue of the respect for property rights. If the possibility exists that a government will appropriate or nationalize private property, then the private sector will be hesitant to make the kinds of long-term investments necessary for sustained economic growth and development. The failure of governments in some underdeveloped economies to guarantee property rights goes some way to explaining their economic underdevelopment. The Goals of Macroeconomic Policy To understand what goals macroeconomists favour for macroeconomic policy, it is first necessary to grasp the economist's preference for free markets. Free markets enable individuals and firms to specialize in the work that they do and the products that they produce. This specialization reflects the comparative advantage that economic agents possess. Competition rewards innovation and punishes inefficiency. In this way, competition causes resources and goods to be efficiently allocated and produced. The result is a rate of economic growth that is the maximum that can be achieved, given the availability of resources and technology. This system maximizes returns to labour and capital and increases standards of living. In open economies, capital markets that are open to international capital flows ensure that financial capital finds its most productive use in the world economy. International free trade in goods and services ensures producers the highest reward for their output and gives consumers the widest possible selection of goods and services at the lowest possible cost. The modern view of macroeconomic policy stresses that, in the long run, economic well-being is determined by the setting of tax rates, the design of expenditure programs, the resolution of the open economy's trilemma, and the choice of how much influence the free market has. With respect to international trade, the instinctive response should be to favour free trade, and macroeconomic policy should be designed to minimize interference in trade. In Western economies it has been deemed desirable, for reasons that we discuss below, to allow government institutions to regulate and control certain markets. Thus the goal

66

Economics

of macroeconomic policy is to design tax and expenditure programs that at once enable that role for government while maintaining as much as possible the efficient operation of markets. The modern approach to the conduct of macroeconomic policy is thus to focus on the 'supply side' of the economy, to ensure that markets are working as efficiently as possible, and then to allow those markets to drive economic growth. This view of the proper role of macroeconomic policy is different from that generally held by macroeconomists in the 1950s, 1960s, and 1970s. In those earlier periods, a more activist role was deemed acceptable, and the focus was on the 'demand side' of the economy. If the free market was not achieving high-enough rates of growth or low-enough unemployment rates, it was believed that government could change levels of taxation and government spending to increase the demand for goods and services and in this way spur economic performance. Thus government could lower unemployment by taking resources from the private sector, via either taxation or borrowing, and then spending the proceeds. The current view is that government can do little in this regard to improve economic growth and lower unemployment rates for anything but short periods. Thus the tools of macroeconomic policy-making described above involve establishment of passive rules: setting tax and expenditure rates and setting monetary policy and then allowing economic actors to optimize their behaviour, subject to these settings. Although economists generally favour reliance on markets to allocate resources and goods, they commonly identify reasons why government should interfere with markets. At least three of these reasons have to do with undesirable market outcomes related to perceptions of fairness and equity. First, the efficient operation of free markets implies the reallocation of labour and capital from dying firms and industries to new, more efficient firms and industries. It therefore involves the dislocation of resources, in particular human resources. In the face of such dislocations, government can provide social insurance. Reserving such a role for government sets up a conflict between the efficiency of free markets and what is judged to be the fair treatment of citizens. For example, providing insurance against unemployment creates disincentives to working while funding a period of transition for the person made unemployed by market forces. Second, free markets reward most heavily those whose skills are

Making Macroeconomic Policy

67

most valued in the marketplace and reward relatively little those whose skills are not valued. Thus a system of free markets also produces an uneven distribution of income. Again, the need for fair treatment often results in governments' redistributing income. Once again, because this process creates disincentives for both those who are taxed and those who receive the income transfer, it is usually argued that there must be a trade-off between the efficiency of the market and concerns about equity. Third, free markets allocate goods and services to the highest bidder. For some goods and services, this allocation mechanism is not judged to be fair or equitable. Thus medical services are often deemed best allocated in other ways. Once again, it is generally argued that this bow to equity sacrifices economic efficiency. Everyone must wait for the same length of time for medical treatment, even though some people have higher opportunity costs for their time than others. The implication for macroeconomic policy of these concerns about equity and fairness - the subject of what we might refer to as social policy - would seem rather straightforward; they decrease economic efficiency and hence economic growth and returns to capital and labour. This interpretation suggests a negative trade-off between goals of social policy and the goals of fiscal, monetary, and market policy. This postulated negative trade-off between macroeconomic and social policy has been challenged recently by suggestions that income inequality may reduce economic efficiency.5 Modern theories of endogenous growth, for example, emphasize a positive relationship between growth and income equality. One reason why the distribution of income may be key to economic growth is that it determines the aggregate amount of investment in human capital. Poor people are less able to make this investment, and so societies with unequal income distribution underinvest in human capital.6 A political-economy approach suggests that the greater the income inequality, the more likely the median voter is to favour redistributive taxes. Since inefficiency increases with such taxes, economic growth is slower the more unequal are incomes.7 Lars Osberg concludes that if this theorizing is correct, then increasing income equality will spur long-run economic growth. Indeed, social programs designed to redistribute income, rather than being 'nice things that we can no longer afford/ should perhaps be an integral part of a policy to promote stronger economic growth.8 Similarly, provision of social insurance in the form of unemployment insurance and welfare may be a necessary prerequisite if

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Economics

voters are to accept changes to institutions that facilitate economic growth. For example, Dani Rodrick and Tanguy van Ypersel suggest that acceptance of free trade by voters may be possible only if there are in place social insurance programs to aid the transition to the new regime of those negatively affected by the decision.9 Jeffrey Williamson's review of the historic impact of economic integration on North American and European economies suggests that macroeconomic policy-makers should consider this idea.10 He documents how restrictive immigration policies and tariffs arose as a reaction against the factor price equalization that resulted from increased European and North American economic integration after 1850. This backlash led to a prolonged period of 'deglobalization' between 1914 and 1950, when international trade and global capital flows were small. Williamson concludes that the earlier period of global economic integration planted the seeds of its own destruction, since it created rising inequality in the labour-scarce North American economies and falling returns to landowners in labour-abundant Europe. The powerful interest groups representing ordinary workers in North America and landlords in Europe generated the backlash against globalization. Hence Williamson's review of history supports the hypotheses of Rodrick and Ypersele - that international economic integration requires compensation for those hurt by integration. This new area of research finds that only social insurance and income redistribution can maximize economic efficiency. The goal, however, is not to ensure equal incomes, which would short-circuit the incentives that allocate resources efficiently and would dramatically slow economic growth and lower incomes. Thus there is an efficient amount of social insurance to provide and income to redistribute an amount sufficient for voters to accept more reliance on market solutions and more efficiency in exchange for greater exposure to the market and thus greater individual exposure to risk. Only when this efficient amount of income redistribution and social insurance is available can reliance on markets be maximized. This strain of research makes it clear that if economic growth is a net positive function of a more equitable distribution of income, the introduction and maintenance of such a program should become an integral part of macroeconomic policy. The goal becomes not only to provide social insurance and income redistribution as efficiently as possible, but to protect them from forces that might threaten their existence.

Making Macroeconomic Policy 69

The Recent Evolution of Macroeconomic Variables in Canada Before considering how greater economic integration might affect Canadian macroeconomic policy, we wish to stress that the recent freetrade agreements into which Canada has entered are not the totality of Canada's recent economic history. This section reviews and describes the key determinants of Canada's economic health over the past decade. The recent evolution of macroeconomic variables in Canada has been driven by three key domestic policy choices, by the rise and fall of world commodity prices, and by the unprecedented strength of the U.S. economy since its recovery from recession in the early 1990s. Key Policy Choices Three policy choices of the past decade have had a dramatic impact on the economy: the decision to pursue North American free trade, the Bank of Canada's decision to adopt a target of zero inflation, and the fiscal policy choices of the federal government and the provinces with respect to their deficits and their levels of debt. All three involved choosing a policy rule and thus accord with the judgment of macroeconomists that policy is best expressed in the form of rules. First, in 1988, Bank of Canada Governor John Crow announced the central bank's decision to pursue a monetary policy rule. The bank would conduct monetary policy in a way consistent with a target of zero inflation. Figure 3.1 shows measures of Canadian and U.S. rates of inflation. At the time of Crow's announcement, both nations' rates of inflation were more or less constant, at 4 per cent. The monetary contraction aimed at moving inflation towards the announced target began in 1990 and continued through 1991. Figure 3.2 shows the effect of this policy on interest rates: Canadian short-term interest rates increased both absolutely and relative to comparable U.S. rates. Figure 3.3 shows its impact on the unemployment rate. While unemployment increased in both countries beginning in 1990, it grew substantially more in Canada. The response of the rate of inflation was delayed until the beginning of 1992, when it quickly and dramatically fell to just 1 per cent.11 Since that time, it has fluctuated in a narrow range around 2 per cent. The U.S. figure has fluctuated even more narrowly, but at a somewhat higher rate. Second, Canadian governments decided belately to reduce their

Calculated from monthly, all-items CPI indexes; Canada (CANSIM P100000) and the United States (D139105). Inflation was calculated as the year-over-year rate.

FIGURE 3.1 Rates of CPI inflation, Canada and the United States, 1976-2000

91-day Treasury bill rates; Canada (CANSIM B14060) and the United States (B54409).

FIGURE 3.2 Short-term interest rates, Canada and the United States, 1962-2000

Monthly unemployment rates, seasonally adjusted, both sexes, all ages, Canada (CANSIM D980745) and the United States (B53106).

FIGURE 3.3 Unemployment rates, Canada and the United States, 1976-2000

Making Macroeconomic Policy 73

deficits and to begin on the long road to debt reduction. For many provincial governments, this decision took the form of a policy rule. New Brunswick introduced legislation in 1993 that restricted the size of its deficit. Since 1995 Alberta has passed a number of laws to establish a schedule for deficit and debt reduction. Manitoba, in 1995, established financial penalties for provincial cabinet ministers in the event of a deficit. The federal government has adopted a less formal rule. Rather than introducing legislation limiting the scope for deficits and debt accumulation, it has relied more on promises to meet deficit targets 'come hell or high water/12 It was the last Canadian government to begin taking seriously the need for deficit reduction. It seemed to respond only after an international credit-rating agency downgraded its debt in the spring of 1995.13 Figure 3.4 shows total government deficits and debt (local + provincial + federal + public hospitals + CPP/QPP) expressed as a fraction of GDP. Prior to 1975, surpluses were not uncommon, and so the ratio of debt to GDP was falling. From 1975 to 1996, however, government deficits were consistently positive and large, averaging 4.5 per cent of GDP. The largest deficits naturally occurred during years of recession, as the effects of automatic stabilizers were felt. But even in periods of strong economic growth, particularly 1985-90, deficits never approached zero, let alone a surplus. These consistently large deficits resulted in rapid accumulation of government debt - from 5.6 per cent of GDP at the end of 1974 to a maximum of 70.2 per cent of GDP at the end of 1995. Since 1993, deficits have fallen rapidly and moved back into surplus for the first time since 1975. As a result, the ratio of debt to GDP has started to fall. Figure 3.5 presents total government-sector revenue, expenditures, and program spending, all measured relative to GDP, between 1970 and 1998.14 Note the inexorable increase in the ratio of revenue to GDP from 37 per cent in 1970 to over 46 per cent in 1998. Such growth even during the serious recessions beginning in 1982 and again in 1991 indicates that governments were increasing tax rates in an effort to halt the revenue loss and reduce their deficits. Thus they were short-circuiting automatic stabilizers in an effort to halt the growth in debt and imposed a pro-cyclical influence on aggregate demand. Program expenditures have dropped rapidly as a fraction of GDP since 1993, because of large spending cuts in education, social services, and health care intended to reduce government deficits. In conjunction with the high and steady ratio of revenue to GDP, this reduction in program expendi-

Deficit and net debts of the total government sector in Canada. The sector consists of federal, provincial and local governments, public hospitals, and the Canada and Quebec Pension Plans. Data measure values at the end of the calendar year. Total government deficit comes from Fiscal Reference Tables, Department of Finance, Ottawa, Sept. 1999. Net debt comes from CANSIM matrices 0782, 0783, 0788, and 0789. These data were divided by GDP measured at market prices (CANSIM D22435).

FIGURE 3.4 Ratio of total government-sector deficit and of debt to GDP, Canada, end of calendar year, 1970-1998

SOURCE: From Fiscal Reference Tables, Department of Finance, Ottawa, Sept. 1999. These data were divided by GDP measured at market prices (CANSIM D22435).

FIGURE 3.5 Total government revenues and expenditures, as percentage of GDP, Canada, end of calendar year, 1970-1998

76 Economics

tures vis-a-vis GDP explains the rapid reduction in the ratio of deficit to GDP observed in Figure 3.4. Third, the federal government decided to pursue free trade agreements, first with the United States (FTA), signed in 1988, and then with the United States and Mexico (NAFTA), signed in 1993.15 Figure 3.6 plots Canada's total exports and imports of goods and services as a percentage of GDP over the period 1961-99. It also presents exports to and imports from the United States alone as a percentage of GDP. It reveals a dramatic increase in the value of trade since the signing of the free trade agreements, and it shows that virtually all of this growth has occurred with the United States. The expansion in international trade has not been experienced in all provinces. Table 3.1 measures, for each province, the ratio of international exports to provincial GDP for 198196. It shows that while Quebec, Ontario, Manitoba, and Alberta have seen their export ratios increase by roughly 50 per cent, the other provinces have experienced much smaller increases. In fact, in the Atlantic provinces international exports have fallen as a fraction of GDP. Table 3.2 presents the ratio of international to interprovincial exports for each province. For Quebec, Ontario, Manitoba, Alberta, and, to a lesser extent, British Columbia, international trade grew much faster than interprovincial trade. What these tables and the figure suggest is that while economic integration of the Canadian economy into the North American16 has increased quite dramatically under free trade, the extent of integration clearly differs across regions, which should not be surprising. Because of differences in industrial structure, regions will realize differential benefits from free trade. To sum up, three policy choices have had a dramatic influence on the Canadian economy since 1988. The Bank of Canada's decision to seek a low rate of inflation imposed costs in the form of higher interest rates and an economic slowdown early in this period. More recently, this choice has gained a firmer footing, and so Canadian interest rates have slipped below those in the United States and the Bank is now better able to use monetary policy to address Canadian policy concerns. Second, government deficits at the beginning of the period forced fiscal policy-makers to slash program expenditures and increase tax rates in an effort to halt the growth of debt. The result has been a very recent reversal in the long and steady growth in the ratio of government debt to GDP. If this new trend continues, it will put government spending on social programs on a more sustainable basis. Finally, the decision to

Annual data. International exports from CANSIM D58001, international imports from D58017, exports to the United States from D58101, imports from the United States from D58117. Divided by calendar-year GDP (CANSIM D22435).

FIGURE 3.6 Exports and imports of goods and services, total and with the United States, as percentage of GDP, 1961-1999

TABLE 3.1 Ratio of international exports to provincial GDP, 1981-1996 Year

Nfld

PEI

NS

NB

Quebec

Ontario

Manitoba

Sask.

Alberta

BC

1981 1982 1983 1984 1985 1986 1997 1988 1989 1990 1991 1992 1993 1994 1995 1996

0.41 0.27 0.26 0.29 0.27 0.28 0.26 0.32 0.31 0.30 0.26 0.26 0.27 0.27 0.32 0.36

0.19 0.13 0.12 0.15 0.14 0.14 0.15 0.13 0.15 0.14 0.12 0.13 0.14 0.15 0.16 0.17

0.22 0.20 0.17 0.18 0.18 0.19 0.20 0.17 0.17 0.17 0.16 0.16 0.17 0.19 0.22 0.22

0.37 0.30 0.29 0.32 0.30 0.31 0.32 0.29 0.27 0.28 0.25 0.24 0.25 0.29 0.34 0.35

0.23 0.21 0.21 0.22 0.22 0.22 0.20 0.21 0.20 0.21 0.20 0.21 0.25 0.31 0.34 0.34

0.29 0.29 0.29 0.34 0.34 0.33 0.30 0.30 0.28 0.28 0.28 0.31 0.35 0.40 0.45 0.46

0.21 0.20 0.19 0.20 0.19 0.17 0.19 0.21 0.19 0.19 0.19 0.19 0.21 0.23 0.26 0.29

0.38 0.38 0.38 0.40 0.34 0.28 0.31 0.31 0.24 0.27 0.27 0.30 0.29 0.36 0.37 0.39

0.26 0.24 0.23 0.24 0.26 0.23 0.23 0.24 0.23 0.24 0.24 0.27 0.28 0.29 0.33 0.38

0.26 0.25 0.25 0.29 0.30 0.30 0.31 0.30 0.27 0.26 0.24 0.24 0.26 0.29 0.32 0.31

Annual interprovincial and international trade flows in goods and services by province (CANSIM matrices 2623 for Newfoundland, to 2631 for Alberta, and 6950 for British Columbia.

TABLE 3.2 Ratio of international to interprovincial exports, 1981-1996 Year

Nfld

PEI

NS

NB

Quebec

Ontario

Manitoba

Sask.

Alberta

BC

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

3.34 2.31 2.30 2.82 2.32 2.57 2.22 2.95 2.88 2.82 2.66 2.86 3.20 3.15 3.27 3.90

0.49 0.38 0.35 0.49 0.44 0.51 0.54 0.49 0.49 0.50 0.48 0.49 0.49 0.56 0.59 0.61

0.81 0.89 0.77 0.81 0.80 0.89 1.00 0.87 0.82 0.82 0.86 0.85 0.90 0.95 1.03 1.00

1.00 1.00 1.02 1.10 1.06 1.11 1.10 1.01 0.94 1.03 1.02 0.97 0.86 0.97 1.18 1.20

0.86 0.84 0.82 0.93 0.90 0.95 0.87 0.89 0.88 0.93 0.95 1.05 1.29 1.53 1.59 1.72

1.04 1.12 1.15 1.44 1.45 1.43 1.37 1.34 1.31 1.33 1.43 1.67 1.87 2.13 2.33 2.26

0.61 0.63 0.62 0.68 0.64 0.59 0.66 0.73 0.67 0.70 0.74 0.73 0.80 0.92 1.00 1.08

1.80 1.69 1.77 1.65 1.39 1.23 1.26 1.25 0.99 1.17 1.24 1.39 1.41 1.63 1.65 1.75

0.77 0.72 0.62 0.66 0.75 0.79 0.77 0.88 0.86 0.92 1.03 1.18 1.24 1.27 1.49 1.57

1.87 1.81 1.83 2.09 2.05 2.00 2.07 2.06 1.90 1.86 1.82 1.75 2.05 2.23 2.49 2.39

Annual interprovincial and international trade flows in goods and services by province (CANSIM matrices 2623 for Newfoundland, to 2631 for Alberta, and 6950 for British Columbia.

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pursue free trade has shifted both the level and the direction of trade. Overall, trade moves increasingly in a north-south direction. However, this change has been much more dramatic for some regions than others. Commodity Prices A large fraction of Canada's exports consists of commodities. For the most part commodity prices are determined in world markets in which the supply of Canadian commodities has relatively little influence on price. Thus fluctuations in world commodity prices help determine the health of the Canadian economy yet lie outside the control of Canadian producers. Figure 3.7 plots an index of a number of commodity prices weighted by the share of each commodity in Canada's exports. The volatility of this index, wherein commodity prices have risen and fallen by over 30 per cent over periods as short as two years, indicates that over the past ten years international commodity prices have played havoc with producers' revenues. Many commodity-exporting industries are regionally based - oil and gas in Alberta, grain in Saskatchewan, lumber in British Columbia - so that fluctuations internationally tend to hurt some regions far harder than others. This situation also affects provincial government revenues. Alberta, for example, saw its revenues fall by over 40 per cent following a crash in the price of oil in 1986. John McCallum argues that over the long term these fluctuations also play havoc with the value of the Canadian dollar.17 Figure 3.8 shows that the dollar has fallen substantially in value against the U.S. dollar since 1973. McCallum estimates that changes in commodity prices are responsible for about 10 cents of the 31-cent drop. If this relationship continues, then the upturn in commodity prices during 1999 suggests a rise soon in the Canadian-U.S. exchange rate. The U.S. Economy The United States is far and away Canada's largest trading partner. As a consequence, how the U.S. economy performs has enormous impact on Canada. Figures above show the strength of the U.S. economy over the past ten years. Most impressive has been the decrease in the U.S. unemployment rate to levels not observed since the late 1960s. Since the rate dropped below 6 per cent, it has been below what most macro-

Royal Bank of Canada, Commodity Price Index. 1981 = 100, in U.S. dollars. This index weights commodity prices by their share in Canadian commodity exports.

FIGURE 3.7 Commodity price index, Canada, 1987-1999

Canadian-U.S. nominal exchange rate, monthly (CANSIM B3400).

FIGURE 3.8 The Canadian-U.S. exchange rate, 1973-2000

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economists would have agreed was the natural unemployment rate the rate below which labour-market tightness should have caused inflation to begin to rise. Yet, as Figure 3.1 shows, U.S. inflation has remained subdued. Figure 3.9 plots stock-market indices for both countries over the period from January 1987 to January 2000. Clearly, stock prices have increased much faster in the United States than in Canada. Another sign of the robustness of the U.S. economy is how quickly the stock market recovered from the slump in prices in August 1998 and then continued to rise. In contrast, the Canadian market took much longer to regain the ground lost in August 1998. While strong U.S. growth has benefited Canada, the current strength of the U.S. stock market has also been a cause of concern. The lofty heights to which the Dow Jones index has soared so quickly caused some analysts to worry that a large correction in stock prices was imminent. If such a correction occurs, it will affect Canadian exports and interest rates.

Increased Economic Integration and Canadian Macroeconomic Policy In this section, we examine how the increased integration of the Canadian economy into the world, especially the North American economy has affected or might affect policy-makers' ability to meet macroeconomic policy goals. We organize this examination around a discussion of three key issues. Can Canada maintain a unique set of social insurance programs? Can it sustain independent fiscal policies? Can, and should, it have an independent monetary policy? Can Canada Maintain a Unique Set of Social Insurance Programs? We reviewed above a literature that suggests an optimal amount of social insurance and income redistribution to maximize reliance on markets. This position raises interesting questions. Do Canada's social programs provide this optimal amount? George Hoberg, Keith G. Banting, and Richard Simeon (below, chapter 9) describe the U.S. system as being less generous, less comprehensive, and less effective than Canada's.18 I present evidence below that shows per-capita disposable income to be higher, and growing faster, in the United States. While suggesting that perhaps Canada's programs have traded too much efficiency for equity, such an interpretation would be ignoring

Stock-market indices. TSE 300 (CANSIM D99956) and Dow Jones (CANSIM B4220).

FIGURE 3.9 Stock-market prices, Canada and the United States, 1987-2000

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Williamson's question about the sustainability of the equity-efficiency trade-off.19 That is, the U.S. choice of a high degree of efficiency and of income inequality may not be politically sustainable. The question pertinent to our discussion is whether substantial economic integration means that Canada must accept the U.S. equity-efficiency trade-off. Thus the issue is not whether Canada can protect and maintain its current set of social programs, but whether it can maintain any set of programs that differ significantly from those in the United States. This becomes an important matter for macroeconomic policy-makers if they believe that the U.S. trade-off is not sustainable. What pressures may be put on social programs by economic integration? Three sources may be identified. First, integration is increasing the demand for social programs, thus making them too expensive. Over the past few years, Canadian governments have cut back on a number of social programs. For example, the federal government has significantly tightened eligibility requirements and the generosity of payments under the Employment Insurance (El) program. Certain provinces, Alberta and Ontario in particular, have substantially lowered welfare payments. These changes have moved Canadian social insurance and income support closer to the U.S. design programs. But to what extent is increased economic integration the cause of these changes? Probably very little. Some evidence to support this conclusion comes from a survey of income dispersion in industrialized countries over the period 197795.20 Whereas income dispersion widened in Britain and the United States, it did not do so in Canada. In fact, the measure was remarkably constant in Canada, while the other six OECD countries in the survey all exhibited much greater variation. Similarly, Eugene Beaulieu shows that the FTA did not affect the relative earnings of skilled and unskilled workers,21 although it reduced employment for unskilled workers. At this time, then, there is little evidence that increased economic integration has noticeably affected the relative wages of skilled and unskilled workers. Thus integration is probably not dramatically increasing the demand for social insurance and is not likely the source of presssure on governments to reduce the generosity of these programs so as to save on costs. Second, integration is benefiting 'have' more than 'have-not' provinces and is thus putting pressure on the system of interprovincial equalization grants. We saw above evidence that pressure to reform Canada's system of interprovincial equalization transfers may be a

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result of increased North American integration. Because of differing industrial composition among regions, integration is affecting some more than others. This is putting Canada's system of equalization payments under greater scrutiny. While its high cost, combined with high tax rates and the high levels of government debt that restrict further financing options, are certainly part of the reason for recent challenges, integration itself is creating questions. Thomas Courchene argues that the system needs to come to grips with the rise in economic integration into world markets.22 At what point does the pursuit of east-west equity begin to impede Canada's ability to compete north-south? If the high cost of equalizing provinces' revenues leaves Ontario, for example, unable to match the public-sector benefits offered in Michigan, then Ontario loses industry and wealth, so that equalizing access to government programs makes Ontario less able to provide them. Third, integration will force a 'race to the bottom' in the provision of social insurance. Trading partners may protest such programs as an unfair government subsidy to private industry, leading to a 'race to the bottom' in provision of social programs. This claim rests on a legal issue: can U.S. firms challenge the existence or design of Canadian social programs under the rules of trade agreements? Can they challenge these programs as unfair subsidies to Canadian firms? The Uruguay Round of GATT negotiations specifically exempted from challenge what it defined as 'non-specific subsidies' (subsidies available to all firms or industries within the jurisdiction of the authority granting the subsidy) and assistance to disadvantaged regions. It also recognized the right of countries to establish their own labour laws and measures to protect the environment. It is only unusually stringent changes in standards that constitute a violation of GATT obligations.23 While what constitutes 'unusually' stringent standards is problematic, the fact that only changes in standards can be challenged means that there is little threat to the labour market and environment standards in place at the time of trade negotiations. In fact, while the GATT agreement encourages countries to use international standards where these are appropriate, it does not require them to change their levels of protection to meet these standards. It is difficult to see how increased integration can result in serious challenges to Canada's labour and environmental standards, its broadly applied social insurance programs, or its system of interprovincial transfers. The only serious source of challenge is to programs that target specific industries. Such challenges have little to do with social insurance and more to do

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with programs that are often motivated by narrow, regionally based political concerns. In that sense, this restriction on domestic policy is not necessarily unwelcome. Can Canada Maintain Independent Fiscal Policies? There are at least two related issues to consider here. First, does greater economic integration make it more difficult for Canadian governments to allow their tax systems and expenditure programs to provide automatic stabilization to aggregate demand? Second, does it limit Canada's options with respect to taxation; in particular, may Canada tax capital and labour at rates different than is done in the United States? Whether or not integration affects automatic stabilizers is important, since, as we saw above, these devices provide counter-cyclical controls on aggregate demand in a way that avoids problems with timing and concerns about political business cycles. For these instruments to work, governments must be free to allow budget imbalances and to allow debt to accumulate. Will further economic integration, by increasing the exposure of Canadian governments to foreign lenders, increase pressure on them to maintain balanced budgets? Will integration force governments to cut spending and raise taxes during economic downturns, thereby short-circuiting the counter-cyclical operation of automatic stabilizers? While the exposure of highly indebted Canadian governments to capital markets restrained their borrowing, there is no evidence that this exposure prevents governments from borrowing. Obstfeld emphasizes that the integration of capital markets limits the use only of unsound financial policies and thus serves a useful function.24 Thus the downgrading of the federal government's credit in the spring of 1995 came only after twenty years of high deficits and rapidly accumulating debt. Since it is difficult to associate twenty such years with the operation of well-designed automatic stabilizers, it is difficult to see how increased economic integration has limited Ottawa's ability to use such devices. Ronald Kneebone and Kenneth McKenzie emphasize that the real threat to these policy instruments is the size of government debts.25 In order to reduce debt loads and reassure financial markets, some Canadian provinces have 'recession proofed' their budgets by passing balanced-budget legislation or offering similar assurances that they will not allow a recession to cause a serious deterioration of finances. In this environment, a recession may force these governments to adopt

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pro-cyclical fiscal stances. That is, they may have to raise tax rates and/or reduce spending in order to offset the fact that recession causes spending to increase, tax revenues to fall, and deficits to grow. In this way, the government budget may exert an influence on aggregate demand that exacerbates the recession. Second, must Canadian governments harmonize their tax systems with the Americans'? The key issue here is the extent to which labour and capital are mobile across international jurisdictions. Financial capital is obviously the most mobile input into production. If capital is freely mobile, then attempts to tax it will be frustrated, as it flees hightax for low-tax jurisdictions. Taxes on capital will be shifted onto less mobile labour as capital flight induces an outflow of investment and a corresponding reduction in the income earned by labour. If capital is highly mobile, then, it is inevitable that Canadian taxes on capital will have to equal those in the jurisdiction with the lowest capital taxes. There is thus a potential 'race to the bottom' with respect to capital taxes as countries competitively offer tax breaks to mobile capital. Jack Mintz suggests a number of possible responses to the problem of a highly mobile capital tax base.26 One is to change the tax mix away from capital taxes and towards taxes on consumption and payrolls that is, to alter the tax mix to emphasize taxing relatively immobile tax bases. A switch towards consumption taxes would also reduce the bias against savings that is inherent in income taxes. Thus in one stroke this policy would stem the outflow of capital to jurisdictions with lower capital tax rates and also encourage savings that provide the foundation for economic growth. Mintz notes that this response to increased integration impedes the use of some tax powers by national governments - especially income taxes, a tax source that governments have been reluctant to eliminate because of their role in achieving fairness in the tax system. But how mobile is capital? Obstfeld observes that it is hard to argue that capital tax rates are anywhere close to equivalent across countries - something that should be observed if mobile capital forces capital tax rates to be the same across tax jurisdictions.27 He notes that even U.S. states, which are much more highly integrated with each other than countries, maintain substantially different capital tax rates. Similarly, Duanjie Chen and Kenneth McKenzie calculate that the marginal effective tax rate on manufacturing investment by large firms in Canada remained, in 1995, significantly higher than in the United States, Britain, or Mexico (25.5 per cent versus 21.5 per cent, 20.2 per cent, and

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16.5 per cent, respectively).28 Between Canadian provinces, they find an even wider range of marginal effective tax rates on manufacturing investment - from a low of 9.7 per cent in Prince Edward Island to a high of 31.1 per cent in Manitoba. The findings of Martin Feldstein and Charles Horioka - a close positive correlation between domestic saving and domestic investment in most countries - also suggest that financial capital may not be as mobile as many believe; most domestic investment is financed from domestic saving.29 Goods and services are also not as mobile as usually thought. John Helliwell, Frank Lee, and Hans Messinger (in chapter 2, above) analyse the effects of free trade agreements on the flows of goods and services across borders30 and conclude that national borders matter a great deal for determining trade in goods and services. Adjusted for scale and distance, trade between Canadian provinces before 1988 was eighteen to twenty times greater than that between provinces and U.S. states. Although the FTA and NAFTA realigned interprovincial versus international trade (recall the calculations in Table 3.2), trade between provinces remained twelve times greater than trade between provinces and states. Lawrence Summers interprets this evidence as suggesting a considerable gap between reality and the free trade model that predicts factor price equalization and the international harmonization of tax rates.31 He speculates that much economic activity depends on social networks, which are strongest where nationality and language are common. Hoberg, Banting, and Simeon emphasize similar points.32 They argue that the forces of convergence must contend with considerable forces favouring non-convergence, including political and social cultures and differences in political institutions across nations. Most important may simply be inertia - intra-national movements of goods, services, capital, and people may dominate international movements for a long time following the signing of free trade agreements simply because the costs of changing the status quo are large. Finally, I noted above that macroeconomic policy has to do substantially with whether or not government will respect property rights and whether or not it consistently follows whatever rules it announces. Until less-developed countries can credibly commit themselves to respecting property rights and the rule of law, they impose a very large cost - uncertainty - on firms considering investing there. This uncertainty surely guarantees that the border effects identified by Helliwell et al. will remain strong for a long time following trade agreements and may affect capital as well as trade flows.

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Can, and Should, Canada Have an Independent Monetary Policy? The third issue consists of two closely related questions having to do with monetary policy. The first question - can Canada conduct a monetary policy different from that in the United States - has recently been examined by Paul Boothe and Douglas Purvis.33 They concluded that the evidence was that there was indeed room for independent Canadian monetary policy. It is useful to update and reconsider their evidence, since their data stopped in 1992. Figure 3.2 shows Canadian and U.S. short-term interest rates, and the difference between them, from January 1962 to April 2000. In general, the two have moved together. The difference, however, has been more volatile. At times the gap has changed sign. It is useful to look at a long time series on Canadian and U.S. interest rates: while from 1975 to 2000 the gap has been positive, this was not always the case. For much of the 1960s the gap was near zero, and in the early 1970s it was negative. The gap has shrunk since 1992, and it turned negative after January 1996. From then to April 2000, the gap shrunk again to almost zero. A gap between the two nations' interest rates reflects the existence of exchange-rate risk. American purchasers of a Canadian financial asset demand a higher interest rate than they can receive on the same U.S. asset if they believe that the value of the Canadian dollar may fall during the time they hold the Canadian asset. If Americans believe that the Canadian dollar may rise in value while they hold the asset, they will accept a lower interest rate than they can receive on the same asset sold in the United States. Under a fixed exchange rate, such as the one that Canada maintained from 1962 to 1970, this risk was minimized but, as Figure 3.2 shows, not eliminated. Under a flexible exchange rate - since 1970 - exchange risk is potentially much larger. Exchange-rate risk arises when market participants doubt the ability of the monetary authority to maintain a rate of inflation equal to that in the country to which the comparison is being made. Many analysts have suggested that the poor fiscal performance of Canadian governments vis-a-vis U.S. governments between 1975 and 1996 helps explain the positive interest-rate gap during this period.34 In particular, high and growing Canadian tax rates and the explosion of government debt caused capital-market participants to question whether the Bank of Canada could maintain the monetary discipline needed to match the U.S. inflation performance. These analysts argue that the recent move

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to balanced budgets in Canada is part of the reason for the elimination, and indeed reversal, of the interest-rate gap. Also important was the Bank of Canada's decision to work towards 'zero' inflation. As this target appears to be below that chosen by the U.S. Federal Reserve, it has contributed to a narrowing of the interest-rate gap. Movements in Canadian versus U.S. interest rates indicate, as Boothe and Purvis concluded, that Canada has at least some scope for independent choices in monetary policy. This is also suggested by Canada's consistently lower rate of inflation since 1992, which means that the Bank has defined and implemented its own monetary policy. More responsible fiscal policy and the increasing credibility of the Bank of Canada's inflation target all increase the Bank's future ability to follow an independent monetary policy. The Bank must always, however, deal with the open economy's trilemma. Thus freedom to maintain an inflation target different from the Americans' while keeping an open capital market means surrendering control over the exchange rate. The larger and more persistent the difference in rates of inflation, the greater the pressure on the exchange rate. A closely related question is whether Canada should direct monetary policy towards independent policy goals. In a recent paper, Thomas Courchene and Richard Harris have argued that the growing integration of the two nations' economies has made it desirable for Canada to fix its exchange rate.35 Whereas Canada currently surrenders control over its exchange rate in order to orient monetary policy towards domestic goals and maintain an open capital market, Canada should now give up the former in order to maintain control over the exchange rate. Courchene and Harris's argument stresses that exchange-rate volatility is a major barrier to trade and thus prevents Canadians from reaping the full benefits of international specialization. Firms must hedge against the possibility of price changes resulting from exchangerate movements, and this is not costless. The greater the amount of trade between Canada and the United States, and the more volatile the Canadian-U.S. exchange rate, the greater the economic cost of the hedge against exchange-rate risk. Given the evidence presented in Figure 3.8 about the volatility of the exchange rate and the results in Figure 3.6 showing the extraordinary growth in Canadian trade, their argument seems to carry some weight. Courchene and Harris also emphasize that the loss of policy independence would be more apparent than real. Adopting a fixed exchange rate would simply mean

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adopting the monetary policy of the U.S. Federal Reserve, which has yielded a low rate of inflation and a high rate of economic growth. What's more, adopting a fixed exchange rate has not compromised Canada's ability to initiate policy changes - most of Canada's key social programs were introduced in the 1960s during a period of fixed exchange rates. Finally, they stress that a flexible exchange rate has protected Canadian firms and workers from international competition. As a result, productivity has lagged behind that in the United States, and Canadian wages have not maintained the flexibility needed for a well-functioning labour market. Among others, John McCallum has taken up the challenge of defending Canada's choice of a flexible exchange-rate.36 While conceding that exchange-rate volatility requires firms to hedge themselves against unexpected price changes, he emphasizes that there is little evidence that this volatility has had a major impact on trade. Indeed, he notes that the apparent increase in trade with the United States that has been used to warn against the costs of exchange-rate flexibility also provides evidence that volatility in exchange rates has not appreciably affected trade! McCallum also cites the empirical work of Jeffrey Frankel, Ernesto Stein, and Shang-Jin Wei, who find no statistically significant effect of exchange-rate volatility on trade.37 Finally, McCallum emphasizes that fixing the exchange rate does not eliminate the need for hedging - fixed exchange rates often become unfixed following periods of speculation. Thus there always remains a small but significant probability of a large change in the exchange rate. This was the experience of Canada (which abandoned a fixed rate of 92.5 U.S. cents in mid-1970) and Britain in the late 1960s, and it was the situation in Brazil and Thailand more recently. For reasons that I outlined above, like any policy choice, the advantages of adopting a fixed exchange rate can be realized only if market participants judge it irrevocable. Paul Fenton and John Murray conclude that the microeconomic benefits of fixed exchange rates are probably small for a country with a sophisticated, competitive financial system, within which hedging costs can be minimized.38 What about the claim that a flexible exchange rate has allowed Canada's manufacturing sector to become 'lazy' and unproductive? This issue has garnered a great deal of attention lately. Figure 3.10 compares the annual rate of growth in labour productivity in Canada relative to that in the United States between 1977 and 1997. While Canadian aggregate productivity remained more or less constant

Source: Data from Table 4 of Andrew Sharpe, 'New Estimates of Manufacturing Productivity Growth for Canada and the United States,' Centre for the Study of Living Standards, Ottawa, April 1999.

FIGURE 3.10 Indices of labour productivity (U.S. = 100) in Canada relative to that in the United States, 1977-1997

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relative to the U.S. figure, Canada has lagged quite seriously in manufacturing. It is this decline that has caused some commentators to suggest that the Canadian dollar's low value over the past six years has dulled the competitive edge of Canadian firms. If not for the low dollar, they argue, Canadian companies would face fiercer international competition, and productivity levels would be higher as a result. Aggregate measures, however, may hide valuable information at the industry level. In a careful analysis of industry-level data in both countries, Andrew Sharpe shows that almost all of Canada's woes in manufacturing productivity come from two industries 'electrical and electronic products' and 'industrial and commercial machinery.'39 Over the period 1989-97, the U.S. lead in the average annual rate of growth in manufacturing productivity (2.90 per cent versus Canada's 2.35 per cent) disappears when one removes these two industries. Indeed, with that adjustment, Canadian growth in manufacturing productivity exceeds American. While Sharpe stresses that more work needs to be done to refine the data, his analysis none the less shows that in the period 1989-97 Canadian productivity growth exceeded that in the United States for fifteen of nineteen industries. Unless the data are totally and dramatically misleading, it is difficult to discount Daniel Trefler's conclusion - namely, that since there is no 'across-the-board' productivity crisis, it is difficult to claim that Canadian manufacturers are lazy and hiding behind an undervalued dollar.40 This argument, then, cannot be used to advocate the adoption of a fixed exchange rate. Summing Up This section has looked at the implications of greater economic integration for macroeconomic policy-making in terms of three issues. Can Canada maintain a set of income redistribution and social insurance programs different from those in the United States? Can it have fiscal policies different from those in the United States? Can and should it maintain an independent monetary policy? What can we conclude? On the first issue, macroeconomists are increasingly sensitive to the idea that social programs are crucial to any lasting adoption of policies designed to increase economic efficiency. Since the political equilibrium arrived at by our trading partners may differ from that which Canadians have adopted, Canada must be able to maintain social programs different from those offered elsewhere. I argued that little of the pressure on Canada's social programs can be identified as resulting

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from external challenges from our trading partners or from an increased demand for social insurance arising from the effects of integration. An exception may involve interprovincial equalization payments. As economic integration increases north-south trade, the east-west transfer of income puts this program increasingly at odds with the goal of economic efficiency and increases pressure from 'have' provinces to limit the program to facilitate north-south competition. On the second issue, Canada can maintain a unique set of fiscal policy choices. In particular, we found little evidence that could be interpreted as threatening Canada's ability to allow government expenditure programs and taxes to perform their roles as automatic stabilizers. I suggested that the major threat was internal - rapid growth of government debt, not economic integration, has threatened the operation of automatic stabilizers. On the freedom of governments to choose tax mixes, I showed how, if capital is very mobile between tax jurisdictions, governments may have to alter their tax mixes in favour of payroll and consumption taxes. However, a review of the literature suggests that the international mobility of capital and labour may not be sufficient to force a convergence of tax rates. But even if mobility is high, the policy response of altering the tax mix away from capital and towards consumption and payroll taxes would not only mitigate this problem but would also provide a much-needed boost to Canadian's incentives to save. Finally, with respect to the third issue, I presented evidence to show that Canada can move interest rates in ways that are at least partially independent from U.S. choices. The Bank of Canada has implemented a monetary rule with respect to inflation that is different from that followed in the United States. On whether Canada should use monetary policy for domestic goals or use it simply to fix the exchange rate, the debate continues. However, the balance of evidence is far from overwhelming in favour of a fixed exchange rate. Thus it is probably wise to rely on the well-known result from macroeconomic theory - given uncertainty about the outcome of policy changes, the prudent policymaker treads cautiously.41 Obeying this adage puts the burden of proof on those who advocate radical change, and at this point it is difficult to conclude that they have made their case. Concluding Comments The purpose of this chapter has been to review and discuss the impli-

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cations for Canadian macroeconomic policy of Canada's closer integration into the North American economy. The conclusion to which I am drawn is that integration has not had, nor will likely have, serious implications for Canada's ability to conduct independent macroeconomic policy. Over the past ten years, the Bank of Canada has proven able to implement a monetary policy rule that is somewhat distinctive from that followed in the United States, and I believe that its ability to act independently will increase as Canadian governments reduce their debt levels. With respect to fiscal policy, the evidence of substantial and persistent differences in international and even intranational tax rates suggests that the mobility of capital and labour is simply not sufficient to force all jurisdictions to adopt the same tax rates and provide the same level of government services. I also believe that one of the effects that increased integration has had on macroeconomic policy - greater pressure on governments to reduce irresponsibly high debt levels - has been a positive one for Canadians. Since it is only by doing so that governments can ultimately safeguard social programs from inexorably rising debt-servicing costs, it is somewhat ironic that integration is sometimes identified as a threat to those programs. Integration is forcing Canadian governments, especially Ottawa, to obey a beneficial rule of fiscal behaviour that they had not previously shown a willingness to adopt. In this sense, then, integration is improving macroeconomic policy. A useful summary measure of the effectiveness of Canadian macroeconomic policy over the past twenty years is to compare real percapita disposable incomes in Canada versus the United States. Disposable income consists of what is left from earned income after all taxes have been paid and after all government transfers have been received. Changes in this measure reflect changes in taxes, government transfers, and changes in earned income. Figure 3.11 presents these figures, along with the gap between them. While per-capita disposable income in both countries increased steadily during the 1970s, Canada's has remained more or less constant since 1980, while that in the United States has continued to grow. As a result, the gap between these two series has widened from an average of $3,500 over the period 1970-81 to an average of $6,000 for 1982-98. We saw above that the level of aggregate productivity in Canada relative to that in the United States has remained more or less constant over the past twenty years. This suggests that the lack of growth in real per-capita disposable income in Canada results from fiscal policy choices affecting taxes and govern-

Canadian personal disposable income (CANSIM D43360 and D28390). U.S. personal disposable income (CANSIM B51115). Nominal values deflated using CPI indices. U.S. figures adjusted using PPP value of the exchange rate (from OECD, National Accounts, Main Aggregates, Vol. 1 (www.oecd.org). Population data from Canada (CANSIM D1) and from the United States (Economic Report of the President).

FIGURE 3.11 Real per-capita disposable income (in 1992 Canadian dollars, at PPP), Canada and the United States, 1970-1998

Canadian GDP (CANSIM D22435); U.S. GDP (CANSIM B51230). Nominal values deflated using CPI indexes. Population data: Canada (CANSIM D1) and the United States (Economic Report of the President).

FIGURE 3.12 Indices of real per-capita GDP (in 1992 dollars; 1977 = 100), Canada and the United States, 1977-1999

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ment transfers rather than from a fall in earned income. In particular, the double-whammy of rising taxes and cuts to social programs has offset the effects of aggregate productivity gains on earned incomes. If this speculation is correct, then both absolutely and relative to its major trading partner, Canadian macroeconomic policy has produced a rather poor outcome. Fortunately, over the past ten years, Canadian policy-makers have introduced three key macroeconomic policies that I believe will eventually reverse the trend observed in Figure 3.11 - free trade, a 'zero' inflation target, and reducing government debt levels. All three policies impose what economists refer to as 'short-term pain for long-term gain.' The adoption of free trade required a substantial adjustment of Canadian industry and created 'winners' and 'losers' among industries, categories of workers, and even regions of the country. It takes time for the country to absorb these transition costs and to realize the full benefits of the reorientation. Similarly, the reduction in government debt levels requires a transition period wherein taxes remain high relative to program spending. Finally, adjusting to the target of zero inflation required a period of transition, during which interest rates increased and output slowed. Figure 3.12 plots indices of real per-capita GDP for Canada and the United States. The adoption of the 'zero'-inflation target and the signing of the.FTA in the late 1980s, along with government cutbacks to spending and increases in taxes in the 1990s, combined to shift Canadian per-capita GDP downward relative to that in the United States. Since that time, however, per-capita GDP in the two countries has grown more or less at the same rate. While the transition costs of adopting the 'zero'-inflation target have probably been fully absorbed, the economy is still adjusting to free trade and dealing with the transition costs caused by the move to lower levels of government debt. Once all these costs are fully absorbed, the full benefits of these three policy choices will be realized, and the economy can start to enjoy the long-term gain of more rapid growth in per-capita output. NOTES

The author would like to thank Eugene Beaulieu for helpful comments. 1 For evidence of the existence of political 'business cycles' in Canadian fiscal policy choices, see Ronald Kneebone and Kenneth McKenzie, 'Electoral

100 Economics and Partisan Cycles in Fiscal Policy: An Examination of Canadian Provinces/ International Tax and Public Finance 8, no. 516 (Nov. 2001), 753-74. 2 The interest rate payable on outstanding government debt and the rate of growth in the tax base are also determinants of the long-run viability of any set of tax and expenditure rates. For a discussion of the determinants of changes in government debt in Canada, see Pierre Fortin, The Canadian Fiscal Problem: The Macroeconomic Connection/ in Lars Osberg and Pierre Fortin, eds., Hard Money, Hard Times (Toronto: Lorimer Press, 1998), 26-38. 3 See Maurice Obstfeld, The Global Capital Market: Benefactor of Menace?' Journal of Economic Perspectives 12, no. 4 (fall 1998), 9-30. 4 Policy-makers often face constraints on the ways in which they implement macroeconomic policy. The limitation imposed by the open economy's trilemma is one example. There are at least four features of the Canadian economy and Canadian fiscal arrangements that impose additional constraints. First, Canada has a federal system of government. In aggregate, the provinces control approximately one-half of all government expenditures. The two levels of government share responsibility for providing and financing many of the same social programs, and they share access to most types of taxation. Second, like the federal government, the provinces are free of any constitutional restriction on their ability to run budget deficits and accumulate debt. Third, Canada's regions do not share a common business cycle, and so movements in real per-capita GDP are not always highly correlated across provinces. Fourth and finally, the Canadian constitution requires a system of equalization payments to ensure all citizens reasonably similar access to government services wherever they live. These features of the Canadian economy pose at least four problems for macroeconomic policy-making. First, because all Canadian governments borrow in the same capital market, they impose interest-rate spill-over costs on one another. If Ontario, for example, borrows a great deal in this market, it increases the borrowing costs of the other provinces and Ottawa. Second, changes in provincial fiscal stances also impose spill-over costs on other jurisdictions in the form of aggregate-demand shocks. Third, at any time a particular monetary policy choice will be more appropriate for some regions than for others. Fourth, equalization payments redistribute income from 'have' to 'have not' provinces and thus add an additional layer of income redistribution along with further economic disincentives. These two sets of factors make it particularly difficult for government to use discretion in macroeconomic policy. However, they render use of monetary and fiscal policy rules and reliance on automatic stabilizers particularly appropriate. Provincial budgets expand and contract according to

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15 16

17

the business cycle unique to their province and thus offer appropriate province-specific stabilization of aggregate demand. For reviews of this literature, see Lars Osberg, The Equity/Efficiency Trade-Off in Retrospect/ Canadian Business Economics 3, no. 3 (spring 1995), 5-19; and Jason Fur man and Joseph Stiglitz, 'Economic Consequences of Income Inequality/ in Income Inequality: Issues and Policy Options (Kansas City: Federal Reserve Bank of Kansas City, 1998), 221-63. This point is emphasized by O. Galor and J. Zeira, 'Income Distribution and Macroeconomics/ Review of Economic Studies 60 (Jan. 1993), 35-52. See, for example, Torsten Persson and Guido Tabellini, 'Is Inequality Harmful for Growth?' American Economic Review 84, no. 3 (June 1994), 600-21. See Osberg, The Equity/Efficiency Trade-off/ 5-19. See Dani Rodrik, 'Why Do More Open Economies Have Bigger Governments?' Journal of Political Economy 106, no. 5 (1998), 997-1032; and Dani Rodrik and Tanguy van Ypersele, Capital Mobility, Distributive Conflict and International Tax Coordination, Working Paper No. 7150 (Cambridge: National Bureau of Economic Research, June 1999). See Jeffrey Williamson, 'Globalization, Labor Markets and Policy Backlash in the Past/ Journal of Economic Perspectives 12, no. 4 (fall 1998), 51-72. The delayed reaction of inflation to the monetary contraction resulted from monetary policy's delayed influence on inflation and from the introduction of the Goods and Services Tax (GST) in 1991. The latter caused a short-lived upward spike in the measured rate of inflation. The quotation is from federal Finance Minister Paul Martin. In April 1995, Moody's downgraded the rating for federal Canadian-dollardenominated debt from AAA (highest level) to AA1. It downgraded federal foreign-currency-denominated debt from AA1 to AA2. Program spending is defined as total government expenditure minus interest payments on outstanding debt. Thus the vertical distance between the lines showing total and program spending measures the interest payments made on debt. Although the FTA was signed in January 1988, it did not come into force until January 1989. While the tables do not identify whether the increase in international trade by province results from increased trade with the United States or with other trading partners, the evidence presented in Figure 3.6 suggests that an increase in U.S. trade is the cause. See John McCallum, 'Government Debt and the Canadian Dollar/ Current Analysis, Royal Bank of Canada, Sept. 1998,1-5.

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18 See Hoberg, Banting, and Simeon, chapter 9, below. 19 See Williamson, 'Globalization/ 51-73. 20 See Anthony Atkinson, The Distribution of Income in Industrialized Countries,' in Income Inequality: Issues and Policy Options (Kansas City: Federal Reserve Bank of Kansas City, 1998), 11-32. 21 See Eugene Beaulieu, The Canada-U.S. Free Trade Agreement and Labour Market Adjustment in Canada,' Canadian Journal of Economics 33, no. 2 (May 2000), 540-63. 22 See Thomas Courchene, Renegotiating Equalization: National Polity, Federal State, International Economy (Toronto: C.D. Howe Institute, Sept. 1998). 23 For a summary of GATT rules on this issue, see General Agreement on Tariffs and Trade, GATT Focus, no. 104 (Dec. 1993). 24 See Obstfeld, The Global Capital Market,' 9-30. 25 See Ronald Kneebone and Kenneth McKenzie, 'Stabilizing Features of Fiscal Policy in Canada,' in Thomas Courchene and Thomas Wilson, eds., Fiscal Targets and Economic Growth (Kingston: John Deutsch Institute for the Study of Economic Policy, 1997), 191-235. 26 See Jack Mintz, Is National Tax Policy Viable in the Face of Global Competition? Working Paper No. 3 (Toronto: Institute for International Business, University of Toronto, 1998). 27 Obstfeld, The Global Capital Market/ 9-30. 28 See Duanjie Chen and Kenneth McKenzie, The Impact of Taxation on • Capital Markets: An International Comparison of Effective Tax Rates on Capital/ in P. Halpern, ed., Financing Growth in Canada (Calgary: University of Calgary Press, 1997), 135-58. 29 See Martin Feldstein and Charles Horioka, 'Domestic Saving and International Capital Flows/ Economic Journal 90 (1980), 314-29. 30 See John F. Helliwell, Frank C. Lee, and Hans Messinger, chapter 2, above. 31 See Lawrence Summers, 'Reflections on Managing Global Integration/ Journal of Economic Perspectives 13, no. 2 (spring 1999), 3-18. 32 Hoberg, Banting, and Simeon, chapter 9, below. 33 See Paul Boothe and Douglas Purvis, 'Macroeconomic Policy in Canada and the United States: Independence, Transmission, and Effectiveness/ in Keith Banting, George Hoberg, and Richard Simeon, eds., Degrees of Freedom: Canada and the United States in a Changing World (Montreal: McGillQueen's University Press, 1997), 189-230. 34 See, for example, McCallum, 'Government Debt/ 1-5. 35 See Thomas Courchene and Richard Harris, From Fixing to Monetary Union: Options for North American Currency Integration (Toronto: C.D. Howe Institute, June 1999).

Making Macroeconomic Policy 103 36 See John McCallum, 'Seven Issues in the Choice of Exchange Rate Regime for Canada/ Current Analysis, Royal Bank of Canada, Feb. 1999,1-10. 37 See Jeffrey Frankel, Ernesto Stein, and Shang-Jin Wei, 'Trading Blocs and the Americas: The Natural, the Unnatural and the Supernatural/ Journal of Development Economics 47, no. 1 (1995), 61-95. 38 See Paul Fenton and John Murray, 'Optimum Currency Areas: A Cautionary Tale/ in The Exchange Rate and the Economy: Proceedings of a Conference Held at the Bank of Canada, June 22-23,1992 (Ottawa: Bank of Canada, 1993), 485-531. 39 See Andrew Sharpe, New Estimates of Manufacturing Productivity Growth for Canada and the United States (Ottawa: Centre for the Study of Living Standards, April 1999). 40 See Daniel Trefler, 'Does Canada Need a Productivity Budget?' Policy Options 20, no. 6 (July-Aug. 1999), 66-71. 41 This proposition comes from William Brainard. See William Brainard, 'Uncertainty and the Effectiveness of Policy/ American Economic Review 57 (1967), 411-25.

4. The Integration of Labour Markets in North America Rafael Gomez and Morley Gunderson

Labour markets throughout North America are becoming more integrated. This integration applies both across borders and within domestic economies. It applies to the workplace practices of firms and their human resource policies and to the external labour markets that link up with the internal labour market of firms. Yet despite these integrating forces, persistent differences in workplace practices and labour market outcomes exist across jurisdictions. Furthermore, integration takes on different forms, including regional trading blocs that may depend less on national or provincial-state borders. This chapter analyses the integration of external and internal labour markets in North America. In keeping with the spirit of integration, the approach synthesizes relevant aspects of labour economics (with its focus on external labour markets), human resource management (which deals with internal labour markets and workplace practices of firms), and industrial relations (with its emphasis on institutions and laws and on the interaction of labour, management, and government). We look first at the various dimensions of integration and interdependence, with respect to depth, breadth, and feedback effects, emphasizing the mechanisms that facilitate - perhaps dictate - integration. Our second topic - given its obvious relevance to integration - concerns the 'new regionalism' within Canada and the nature of 'border effects.' Third, we consider the effects of integration, especially on wages, wage structures, wage inequality, and employment. Fourth, we discuss the impact of integration on institutional features of labour markets such as unions and strikes, as well as on firms' workplace and

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human resource practices. Fifth, we analyse integration's constraining effect on governments ability to deal with the consequences of integration and other changes that affect the labour market. Finally, a policy discussion outlines the elements of appropriate initiatives in labour market policy in the face of integration. Throughout the analysis, we emphasize the extent to which wider and deeper integration exacerbates or mitigates any trade-off that may exist between efficiency and competitiveness, on the one hand, and distributive equity and social access, on the other hand. We also analyse the feedback effects, which run from equity to efficiency. We pay attention also to the implications of integration for countries of different levels of development, as is the case in North America. Dimensions of Integration There are three pertinent dimensions to integration - deepening, widening, and feedback. Economic integration initially has both a deepening and a widening dimension.1 Deepening refers to the expansion of the functional areas that are involved in integration and of the mechanisms and procedures that facilitate integration and exchange. By way of illustration, the European Union (EU) has taken many of the steps towards deeper integration. The EU has not only internal free trade in goods and services, but also open internal labour mobility and a common external tariff (i.e., it is a customs union). It has established common supranational institutions (for example, a parliament, a court, and directives that become law in the member countries), which necessitated members' giving up some sovereignty, and it recently established a common currency. In contrast, the North American Free Trade Agreement (NAFTA) provides for much shallower integration; it focuses on trade and capital flows. It does not call for the deeper integration of a common market (with free labour mobility) or a customs union (with a common external tariff). It requires only minimal coordination of standards and policies and no common currency or direct relinquishing of sovereignty.2 Whether deeper integration follows naturally from the more shallow variant is an open and interesting question. Certainly, integration in one area tends to foster the same in others. Removal of restrictions in some areas often exposes further restrictions in others. As Weintraub stated aptly: The onionskin nature of economic integration has become apparent: another layer of restrictions almost always lurks below

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the one removed.' Or, as Castro-Rea observed: The spillover process will gradually include different economic matters before slipping into the political and cultural realms. Economic dynamics will, sooner or later, put the national governments of the countries involved in freetrade agreements before the challenges of enhanced integration in fields other than the economy.'3 The other main dimension of integration - widening - refers to expansion to other countries or regional trading blocs. NAFTA is an obvious widening of the FTA, and the accession of countries to the original six of the (now) EU is an obvious widening of that bloc. Potential areas of widening of NAFTA include4 the addition of Chile, in large part because it has already undertaken substantial economic restructuring and returned to democracy; of other individual countries such as Argentina and Colombia; and/or of some already existing regional trade agreements, such as MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay), the Andean Pact (Bolivia, Colombia, Ecuador, Peru, and Venezuela), and CARICOM (Caribbean Basin countries). An agreement covering the whole Western Hemisphere could occur, eventually or in a single step - for example through the Enterprise for the Americas Initiative (EAI) proposed by U.S. President George Bush in 1990. There is also a mayor feedback dimension to integration. As Reynolds observed in 1992,5 the concept of interdependence traditionally refers to 'interactions between two or more economies and societies, such that behaviour in one influences conditions in the other leading to and this is the crucial element - feedbacks on the original system.' As we see below, such feedback effects - adjustment consequences and the ability of institutions and governments to deal with those consequences - are crucial elements of North American integration as applied to labour markets. Also as we see below, these various dimensions of integration deepening, widening, and feedback effects - all affect labour markets and their transnational integration. In the field of labour, the process has one other significant dimension - integration of internal and external labour markets. Internal labour markets within a firm or organization pertain to the workplace and human resource practices of firms. They encompass such issues as job classification, employee participation, team production, worktime arrangements, and subcontracting. External labour markets are the loci where labour demand and supply interact to determine wages, employment, and hours of

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work, as well as wage structures, inequality of wage and hours, and unemployment. New Regionalism and Integration Canadians tend to think of integration as integration with the United States - indeed, the phrase 'engulfed by' tends to be more appropriate in the minds of many. Integration involving countries of such different sizes can be problematic, even if they have fairly similar levels of development. A commonality of such factors as language, culture, institutions, and laws fosters the potential for integration, as do proximity and the absence of natural barriers; in North America, the natural barriers tend to run north-south rather than east-west. As Krugman stated, 'Canada is essentially closer to the United States than it is to itself!'6 There is, however, another dimension of integration - the new regional alliances that are forming throughout the world. They can cause the disintegration of traditional borders, especially those associated with the nation-state.7 In Canada, new regional alliances are becoming more prominent.8 British Columbia increasingly looks to the growing commerce of the Asia-Pacific Rim and to the U.S. Pacific Northwest.9 Alberta and Quebec turn more and more to the United States as a market for their energy resources, with Quebec also trying to diversify in case separation occurs. Ontario is also attempting to diversify away from its east-west orientation as a manufacturing centre built up under the earlier protective tariff and subsidized rail lines. It is transforming itself from Canada's industrial heartland to more of a 'region state' with a north-south focus.10 The Atlantic provinces are also forming regional alliances and looking south, especially to protect themselves from isolation from the rest of Canada in case Quebec should separate. Canada's reorientation is illustrated by the redirection of trade from internal east-west towards an external north-south orientation with the United States and Mexico. A number of recent studies, however, have shown that internal trade across provinces within Canada has tended to be approximately twenty times more sizeable than external trade with U.S. states, even after one controls for such factors as distance and size of markets.11 This finding has prompted Helliwell and others to emphasize that national borders do influence trade and investment. This may reflect internal networks of information and

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trust, familiarity, the legacy of provincial dependence, or perhaps subtle costs that are difficult to measure and control for. Adam Smith esteemed this preference for internal exchange within a country: Every individual endeavours to employ his capital as near as home as he can, in the support of domestik industry; provided always that he can thereby obtain the ordinary, or not a great deal less than the ordinary profits of stock. Thus upon equal or nearly equal profits, every wholesale merchant naturally prefers the home-trade to the foreign trade of consumption, and the foreign trade of consumption to the carrying trade. In the home trade his capital is never so long out of his sight as it frequently is in the foreign trade of consumption. He can know better the character and situation of the persons whom he trusts, and if he should happen to be deceived, he knows betters the laws of the country from which he must seek redress. A merchant, in the same manner, who is engaged in the foreign trade consumption, when he collects goods for foreign markets, will always be glad, upon equal or nearly equal profits, to sell as great a part of them at home as he can. He saves himself the risk and trouble of exportation, when, so far as he can, he thus converts his foreign trade of consumption into a home-trade. Home is in this manner the center, if I may say so, round which the capitals of the inhabitants of every country are continually circulating, and towards which they are always tending, though by particular causes they may sometimes be driven off and repelled from it towards distant employments.12

The key, of course, is 'upon equal or nearly equal profits.' Despite the preference for internal domestic transactions, when economic returns decrease relative to returns from international transactions a reallocation follows from domestic to international exchange - as evidenced by the dramatic growth in international trade and investment in recent years. Borders matter, but they are not impenetrable to cost considerations. For example, after the Canada-U.S. Free Trade Agreement (FTA) came into force in 1989, internal trade within Canada fell from being twenty times larger than external trade with the United States to only twelve times greater by 1993.13 In Canada, integration with the United States is most pronounced in the four western provinces, which have the lowest ratio of internal interprovincial trade rela-

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tive to trade with the United States.14 Borders still matter, but they matter much less after liberalizaiton of trade and investment. Direct Effects of Integration on Labour Markets Integration can alter labour market outcomes, including wages, wage inequality, wage structures, employment, and mobility. Deepening of integration, for example, adds pressure from additional sources trade, financial capital flows, and foreign direct investment (both inward and outward). Widening leads to increased pressures from more countries, especially those at different stages of development. Feedback may make governments less able to offset undesirable effects of integration or to have winners compensate losers. This section outlines some of the major labour market effects of integration. Discussion of integration must distinguish average wage levels from wage structures. According to basic trade theory, countries will export goods with which they are abundantly endowed and import goods for which they have scarce factor endowments. Countries with low-wage labour will export labour-intensive goods, and countries with highwage labour will import such goods and export capital-intensive goods (including human capital intensive ones). This process in turn should foster factor-price equalization or wage convergence. Hence the fear that wages in Canada will be set by wages in the maquiladoras of Mexico. Wage convergence, or the 'law of one price/ however, applies to homogeneous inputs. Higher wages in countries such as Canada can be sustained if they embody higher productivity or human capital endowments - thus a high-performance workforce and human capital can sustain high wages in the face of growing international competition from low-wage countries. Integration's impact on wage structure depends on how increased exports and imports affect different types of labour. The import competition from low-wage countries is likely to affect most the low end of the wage structure in countries such as Canada. Increased exports tend to embody higher-wage labour in the form of human capital that is complementary to physical capital and that involves high-end products and services. As well, the resulting internal restructuring probably places a premium on managerial, entrepreneurial, and professional talent. The empirical evidence suggests that trade liberalization has increased wage inequality in high-wage countries, though probably less than technological change, which tends to favour skilled labour.15

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Separating the two factors, however, can be difficult, if, for example, the technological change was a response to competition from lowwage imports. Unemployment has also increased in Canada, although the impact of free trade is probably less than that of other factors such as tight monetary policy, designed to curb inflation.16 How much of the tight monetary policy, however, is a result of pressures from integration, especially to curb inflation to keep Canada competitive in global product markets and to make it appear a stable economy so as to attract investment? The 1990s also saw a rise in the ratio of unemployment rates of youths and adults - a reversal of the downward trend since the mid-1970s.17 This shift in turn is giving rise to anxieties over the job prospects of youths. Feedback is likely to exacerbate the potentially adverse impact on wages, wage inequality, and unemployment. As we saw, governments may be less able to sustain equity-oriented policies as they compete for investment and the jobs associated with it. As well, the shifting of payroll taxes is likely to be largest for the immobile factor of production labour - and especially for less skilled labour. If labour does not quickly absorb the shifting in the form of lower wages, then periods of unemployment may result during the transition to lower wages. While these adverse effects can certainly occur in labour markets, beneficial effects of integration also exist for labour. Goods are cheaper, and labour benefits from lower prices and more choice. To the extent that workers have investments, perhaps through pension funds, labour also benefits from the higher return to capital. The rationalization of production can also increase productivity and so help maintain wages and create more sustainable employment. On the negative side, integration can also foster a 'brain drain,' or exodus of skilled labour. Even though their focus is on trade in goods and services, free trade agreements such as the FTA and NAFTA provide enhanced temporary entry for business persons (business visitors, traders, investors, professionals, and intra-company transfers). Increased foreign direct investment is often accompanied by high-level personnel associated with 'running' that investment. Greater exchange in ideas is likely to increase exchange for the people who generate those ideas. Organizations that operate globally are more likely to have high-level personnel who think globally and are prepared to relocate accordingly. The United States may be particularly appealing to highlevel Canadians because the greater wage inequality that prevails there

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means that such high-level persons are more likely to obtain a highwage job. The lower U.S. tax rates and their lower degree of progressivity may be particularly appealing to high-wage people. The potential for a brain drain is particularly severe for countries that subsidize the higher education of their youths. Such people are sufficiently mobile to move to a country, such as the United States, that does not extensively subsidize their higher education but pays high salaries in return for that education. Privately appropriating the benefits of public investment can be lucrative for individuals.18 Median starting salaries of U.S.$105,000 (over Can.$150,000) for MBAs from top U.S. business schools can be a drawing card. The falling Canadian dollar can make U.S. salary offers very attractive to Canadians and may account for some of the recent success of American universities in raiding top academics from Canadian universities - and for much of the difficulty that Canadian universities are having in competing for new talent. Concern over the brain drain may well be overstated. Helliwell, for example, has found that the number of Canadian-born workers who have migrated to the United States since 1990 and have remained there has averaged only about 10,000 a year, and only about half of them have university degrees.19 Nevertheless, that concern can influence policy, as in its being used as a call to reduce taxes and public expenditures on education.20 It has been cited specifically to recommend harmonizing taxes with the United States.21 Effect on Labour Market Institutions and Workplace Practices The discussion above focused on the effects of integration on labour market outcomes. Integration can also affect labour market institutions and workplace practices, which can in turn alter labour market outcomes. It is well known that there has been a dramatic divergence in the rates of unionization between Canada and the United States in recent years.22 In the mid-1960s rates were substantially the same in the two countries, at approximately 30 per cent of the paid non-agricultural workforce. Since that time they have plummeted continuously in the United States, to roughly half that level, while they have risen slightly in Canada (see Figure 4.1). Differences in the legal environment23 are generally regarded as sustaining that difference, even though (as we saw above) these differences should be endogenous and responsive to

Sources: U.S. data: Bureau of Labor Statistics; Canadian data: Lipset and Meltz (1997).

FIGURE 4.1 Union members as percentage of non-agricultural paid employment, 1901-1997

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the economic imperatives of integration. That is, if the legal environment in Canada is more conducive to the sustaining of unionization, and if that turned out to be more costly in terms of sustaining competitiveness under increased economic integration, then we would expect such policies to dissipate and converge more towards those of the United States. It could be that the results of such policies are not that costly, if, for example, union wage premiums have decreased over time and unions have emphasized their voice more than their monopoly power function and (assuming that adversarial unionism is costly) have become more cooperative and less adversarial. It is also possible that the costs fall more on 'outsiders' - in the form of unemployment or a devalued exchange rate - or that they are offset somewhat by more generous social safety nets, or that there is simply a lag in convergence. The absence of convergence in unionization rates shows that increased integration need not lead to harmonization 'to the bottom' in labour market institutions. Strikes are another notable feature of labour markets. However, unlike the divergence noted above in union density, strikes have dissipated dramatically in both countries in recent years.24 In 1980, for example, the number of major work stoppages (involving 1,000 workers or more) was 135 in Canada and 187 in the much more populous United States. By 1996 the numbers had declined to 35 and 37, respectively (see Figure 4.2). Under increased integration, strikes are simply a less effective weapon, as organizations can often shift production elsewhere. With increased global competition, strikes lead to a permanent loss of market share for both business and labour, since customers can more easily shift to other sources. As well, if prices are increasingly set in world markets, there is simply a smaller zone of disagreement over the distribution of wage offers that a firm can make. There is less asymmetric information over the firm's ability to pay, since global market imperatives now more often circumscribe that ability. Integration is also likely to affect the workplace and human resource practices of firms. Multinational enterprises (MNEs) are more prominent and are more likely to follow a standardized set of practices and foster their international transmission through their transplants. In 1976, the OECD established a set of guidelines for MNEs covering nine areas of internal policy.25 The most comprehensive chapter deals with employment and industrial relations. In many cases, it recommends simply adherence to host-country or international law. However, where laws are absent (as in most internal labour market practices) the

Sources: U.S. data: Bureau of Labor Statistics; Canadian data: Bureau of Labour Information.

FIGURE 4.2 Work stoppages involving 1,000 workers or more, 1980-1997

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guidelines suggest 'best practice' for firms to follow. Integration therefore leads at a minimum to greater exposure to 'best practices' (for example, quality circles and workplace teams 'imported' from Japan). Firms are also under more pressure to emulate these systems, given global competition. Foreign direct investment can encourage transmission of workplace practices in the source country to the host country, with possible feedback following to the source country. The economic pressures associated with external competition have also encouraged Canada to be competitive internally. This can be fostered by enhanced labour mobility (especially through removal of barriers to occupational licensing and certification), preferential hiring, income-support programs, education qualifications, language, and labour standards. Such initiatives as the Internal Free Trade Agreement of 1994 in Canada assist these changes.26 The just-in-time delivery needs of integrated product markets often in different countries have led to a just-in-time workforce, as evidenced by such forms of non-standard employment27 as part-time work, limited-term contracts, temporary-help agencies, and self-employment, as well as greater flexibility in hours of work. According to a 1997 report by the North American Agreement on Labor Cooperation (NAALC), since 1984 non-standard employment has grown throughout North America 'in all segments of the labor markets of the U.S., Canada, and Mexico. And although it is somewhat cyclical, it has continued to increase regardless of economic conditions.' Employers' need for flexibility and adaptability has led to similar pressures on employees - for example, to broader job classifications involving a wider array of tasks and to demands for 'multi-tasking' and 'multi-skilling' to perform such tasks. An emphasis on quality, in part a response to Japanese success in this area, has led to quality circles and workplace teams. Greater outsourcing and subcontracting, with payment contingent on service provided, have increased use of performance-based or contingent pay. These competitive pressures have also begun to permeate the labour market even of the public sector. The competition of governments for business investment and for the associated jobs has pressed governments to restrict not only their laws and regulations, but also their expenditures, or at least to provide a cost-effective public infrastructure. They have introduced performance-based budgeting, privatization, deregulation, subcontracting, and user charges. These practices in turn have increased pressure on wages and employment in the public sector.28

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Feedback to Labour Policy The most powerful feedback effect for labour markets from integration will probably be pressure to reduce costly labour market regulations and policies. Governments will find their hands increasingly tied by the threat of capital mobility and business decisions on investment and plant locations. With globalization and increased economic integration, that threat is now more credible. For example, with trade liberalization, firms can now more easily locate in the country or jurisdiction with fewer costly labour regulations and export into countries that have reduced their tariffs.29 Foreign direct investment, especially in the form of decisions on plant location, can similarly go to countries with fewer costly laws and regulations. Financial capital can move even more quickly. With footloose capital on the move, the world becomes a 'greenfield site.' Joint ventures, alliances, and outsourcing will follow the same pattern. In fact, these can be particularly appealing for firms, since they can involve minimal long-term commitments; they can be terminated if the regulatory costs begin to 'creep up' once the investment is committed. These credible threats may limit governments' power to enforce or implement labour and other regulations. Other constraints include inability to increase expenditures that would lead to tax or deficit increases; growing conservatism; a perception that many regulations are 'captured' by those regulated; and growing mistrust of governments and especially politicians. Governments may want to compete for business investment and the resulting jobs. Reduced labour regulations are one 'carrot' in such intergovernmental competition. The phrases used to describe this phenomenon are revealing 'social dumping,' 'harmonization to the lowest common denominator,' 'regulatory meltdown,' 'race to the bottom,' and 'ruinous competition.'30 Even more colourful are the titles of some books on the topic: The Great Betrayal: How American Sovereignty and Social Justice Are Being Sacrificed to the Gods of the Global Economy?1 One World, Ready or Not the Manic Logic of Global Capitalism;32 Everything for Sale: The Virtues and Limits of Markets;33 Losing Control: Sovereignty in the Age of Globalization,3* and Corporations Are Gonna Get Your Mama: Globalization and the Downsizing of the American Dream35 While the various dimensions of integration will exert pressure in the direction of downward harmonization, there are potentially offsetting factors. Even if we assume, as we have till now, that the forces of

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integration produce a common set of constraints, a common set of efficiency requirements may not follow. As Traxler stated in his analysis of convergence in systems of industrial relations: 'Functional requirements do not necessarily ensure their own fulfillment.'36 Such 'embeddeness theory' posits that economic processes, including labour relations outcomes, exist within social structures.37 Hence certain forms of workplace practices and employment relations may persist in certain economies and not in others because of their embeddeness within supportive power structures, even if a particular set of policies appears inefficient in terms of neo-classical economics. As well, harmonization need not move to the lowest common denominator.38 First, labour regulations need not always impose a net cost on firms. Workers' compensation systems, for example, were part of a 'social bargain' whereby workers gave up their right to sue negligent employers in return for expedited payments on a no-fault basis. Eliminating such compensation would lead to a return to the tort-liability system, with its obvious legal costs to employers. Legislation requiring advance notice in the event of layoffs may impose costs on some employers but benefits on others if that period of notice is used to make effective new matches between displaced employees and employers who have a labour shortage. Government programs that provide a safety net for workers may reduce resistance to otherwise efficient changes. Compensating losers from technological change and trade liberalization can go a long way to reducing their resistance to such changes. Equity and efficiency considerations need not always conflict. Other programs can offer training, mobility, or information on the labour market that may provide valuable human capital infrastructure (for example, education and training) and facilitate efficient changes in labour markets away from declining and towards expanding sectors. Health and safety regulations can reduce costly accidents by providing workers with three fundamental rights - to know or be informed, to refuse unsafe work, and to be represented through health and safety committees. Such regulations may impose costs on firms and impede competition. Some of the costs, however, may be offset by associated benefits to organizations, and such programs could survive under increased global competition. Furthermore, both labour and management in practice often ignore programs that impose excessive costs, and sometimes governments do not enforce them. Ontario's permit system for regulating hours of

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work and overtime is almost impenetrably complex. Aspects of it are often ignored in practice, evoked only in the most egregious of transgressions. Private actions may also 'undo' government policies - for example, if the straight-time component of pay moves downwards to help offset legislated overtime premiums. Employers may also be able to shift at least part of the costs of programs forward to customers or backward to workers. Shifting forward is now more difficult, since trade liberalization and global competition mean that prices are increasingly set in world markets. But shifting back to workers in the form of compensating wages can occur, especially where workers value the benefits associated with the program. In effect, they may ultimately pay for the program, even if the costs are initially imposed on employers. Empirical evidence suggests that workers ultimately pay for such benefits as reductions in workplace risk (perhaps emanating from occupational health and safety requirements), reasonable accommodation requirements (to facilitate the return to work of injured workers),39 or pension benefits.40 Shifting costs back remains feasible under increased economic integration as long as labour is a relatively immobile factor of production and not able to escape the tax by moving to low-tax jurisdictions. According to empirical evidence, for example, approximately 80 per cent of payroll taxes used to finance such programs as workers' compensation, public pensions, and unemployment insurance is shifted back to labour in the form of lower wages.41 Even if there are costly labour policies and programs, there is remarkably little evidence on how important they are relative to other regulations, or to other factors such as access to markets, in influencing decisions on investment and plant locations. Labour cost advantages, including those arising from reduced legislation, may be transitory and only for the short run, if wages and regulations increase as capital moves in and the demand for labour increases.42 Furthermore, it is labour costs relative to productivity that ultimately matter, and countries with high regulatory components of labour costs tend to have highly productive workforces. Jurisdictions - like firms that often use a high-performance workforce even if it is highly paid relative to other firms - often find that a 'slash-and-burn' approach to labour regulation is not always conducive to competitiveness. Governments may discover that cutting labour regulations does not foster knowledge spillovers and interactions of social capital that encourage a highperformance workforce. They may also be concerned about appearing

The Integration of Labour Markets 119

'mean-spirited' by reducing labour protection for the disadvantaged especially since workers are also voters. Governments may also try to develop cooperative strategies to inhibit what they may regard as a 'prisoners' dilemma' that would otherwise lead to a 'race to the bottom' in policy initiatives. The labour and environmental 'side accords' under NAFTA are examples of such a strategy, as is the Social Charter of the European Union. Even if the regulatory component of labour costs influences decisions on investment and plant location, it is unclear how much governments respond in order to attract such investment. On the one hand, McBride and Williams argue that the degree of convergence in employment legislation stemming from globalization has been overestimated.43 Examining OECD data on compliance with recommendations of the OECD Jobs Strategy, they found little convergence in many policies, including early retirement, taxes, social security contributions, wage formation, industrial relations, and active labour market polices. 'Rather than convergence around neo-liberal ideals represented by the Jobs Strategy, several [labour market] models continue to exist/44 By way of contrast, the so-called Michelin Bill of 1979 - when Nova Scotia modified its labour law allegedly to attract a Michelin tire plant • is an example of downward regulatory convergence. Moreover, many southern U.S. states advertise their union-free and so-called right-towork status. 'Open for business' is an image that is now more often cultivated by some Canadian provinces,45 and some have rolled back legislative initiatives established by more interventionist governments. When provinces are revising their labour policies and 'benchmarking' them against those of other jurisdictions, they are increasingly making comparisons as well with U.S. states that are their competitors. Nevertheless, despite the recent work of McBride and Williams and the examples cited above, there is scant evidence on the overall importance of such practices and on how they have changed in response to globalization. For the pressures to downward harmonization to lead to the lowest common denominator in labour regulation, the following four conditions must hold:46 • The labour policies must be implemented and enforced in a manner that would raise costs and deter competitiveness • The costs cannot be offset by benefits emanating from the policies or cost-shifting back to workers

120 Economics

• Decisions on investment and plant locations must be influenced by the regulatory component of labour costs • Governments must respond to such pressures by reducing their labour regulations. A break in any one of these links can sever the connection between the liberalization of trade and capital flows and such a race to the bottom. Multiple equilibria are also possible, with some jurisdictions cultivating a high-performance workforce and others cutting labour costs, including those induced by labour regulation. While these four conditions necessary for downward harmonization do not prevail completely, they are present. Laws are generally enforced. Such laws and policies are costly to business, even if there may be some offsetting benefits and cost shifting. Business decisions are more responsive to such cost considerations. Governments are under considerable pressure to compete for that investment and the associated jobs, with reductions in labour regulation being a potential carrot. Hence liberalization of trade and capital flows is likely to create pressures that lead towards harmonization of policy, which is likely to move towards the lowest common denominator. With towards being the operative word, the question becomes, 'by how much?' While such interjurisdictional competition on the basis of labour regulation may appear undesirable, it should at least reduce costly regulations that do not increase efficiency and competitiveness. Regulations that protect the rents and privileged position of particular interest groups should be under the most pressure. Governments will simply have to look at how their regulations affect costs and competitiveness but this is a desirable pressure. The exception - a crucial one - is that pure equity-oriented policies that do not aid efficiency will be more difficult to sustain. It will be more difficult to be a 'kinder and gentler society,' even if in the past many equity-oriented policies did not protect the most disadvantaged. The irony is that this restriction on such government policies is coming at a time when they may be most needed - to deal with the adjustment consequences of the market-oriented changes, especially when they afflict the disadvantaged. The efficiency gains from such marketoriented policies provide the means to compensate the losers, but market mechanisms obviously do not ensure such compensation. Furthermore, market imperatives are inhibiting the state from playing its role in that area.

The Integration of Labour Markets 121

There is also a misconception that a country can sustain whatever level of costly regulation it wants by simply lowering its exchange rate - as Canada has done relative to the United States. This is often stated as if it were a costless policy. But currency devaluation is akin to a fall in the real standard of living - it takes more exports to buy an equivalent bundle of imports. The cost may be spread over the economy as a whole, but it obviously exists.

Policy Discussion The effects of deeper and wider integration - especially from the enhanced flow of goods, capital (financial and physical), people, and ideas and from feedback to government policy - have major implications for labour markets, both external and internal to the firm. Canada's east-west orientation is shifting towards north-south. In a speech in Washington, DC, in 1999, Ambassador Raymond Chretien with Ottawa's approval - asked whether Americans would be willing to talk about a customs union, ways to improve labour mobility, and other initiatives such as a monetary union. New regional alliances are forming, usually with an external orientation. In the short run, at least, these changes have placed Canadian labour in a more precarious position. Manifestations in the external labour market include growing wage inequality, stagnant real wages, unemployment associated with adjustment, and the possibility of a brain drain. Internal labour markets of firms have seen increased nonstandard employment and polarization in hours of work. Feedback to government policy has increased interjurisdictional competition for investment and jobs, reducing governments' ability to deal with the adverse social consequences of integration. This is the negative face of integration, at least for labour markets and labour policy. A more positive face is associated with the conventional benefits of trade liberalization in terms of lower consumer prices and increased choice, as well as higher returns to investments. Furthermore, the restructuring should make Canadian labour better able to deal with the demands of global competition and technological change. As for government regulation, inefficient, rent-seeking regulations should dissipate under the pressures of integration. Governments will be under more pressure to keep their own house in order and to pay attention to the cost consequences of their actions - but these are gen-

122 Economics

erally desirable pressures. Furthermore, they will need to modernize labour policy - much of it established early in the twentieth century to cope with the new world of work as shaped by deeper and wider integration and the feedback effects on governments. Elements of that policy response48 - many of which are being implemented or under consideration - include: • adjustment policies that facilitate reallocation of labour from declining to expanding sectors rather than income maintenance that discourages such reallocation • a focus on the real resource costs of programs (for example, administrative, legal, red tape), which are lost to the system, compared to transfer costs, where one group gains even though another loses • a recognition that the market will 'undo' regulations that hurt private parties • adjustment of policy initiatives designed for traditional work (large fixed worksites with a predominantly male workforce and singleearner families) to suit the new world of work (small establishments, outsourcing, non-standard work, diverse workforces, and twoearner families) • cooperative efforts among governments to mitigate the worst effects of downward harmonization, especially vis-a-vis equity, and to facilitate internal competitiveness so as to enhance external competitiveness • cooperative and coordinated efforts among different functional areas of government (for example, human resources, finance, trade, technology), given their interrelatedness under integration, where international flows of trade, capital, labour, technology, and ideas are growing • government regulation to be a third line of defence, mainly when the mechanisms of the market and collective bargaining fail to deal with the social issues arising from integration • government action, especially with respect to equity for the more disadvantaged, who do not have protections through the market or collective bargaining and who are most hurt by integration and its effects on policy We have mentioned above the lack of research and evidence on many aspects of labour market integration, especially concerning the links necessary for a downward harmonization of labour regulation.

The Integration of Labour Markets 123

Those links involved four elements - implementation and enforcement of labour laws in a manner that would raise costs and deter competitiveness; the potential offsetting benefits and cost-shifting; the impact on decisions on investment and plant location; and those decisions' effects on interjurisdictional competition through reducing the regulatory component of labour costs. While we offered some illustrative evidence, in general there is no systematic, comprehensive evidence on any one of these dimensions, let alone on all four components. The task of compiling such evidence is substantial. For example, the cost and other implications of even a small subset of such policies as workers' compensation and overtime regulations have been the subject matter of royal commissions and task forces. Estimating the effect of labour regulation on investment and plant locations would require separating out their impact from the myriad other interrelated factors that influence such decisions. The task is daunting, but policymakers need such evidence. The deepening, widening, and feedback effects of integration are affecting external and internal labour markets. They are creating incredible challenges and opportunities. The genie cannot - and should not - be put back in the bottle. In such circumstances, governments and policy-makers should be subject to the same pressures to adjust to the forces of integration as are business and labour. NOTES

1 For a thorough discussion of these dimensions see S. Weintraub, NAFTA: What Comes Next? (Washington, DC: Center for Strategic and International Studies, 1994). 2 The NAFTA side agreements on labour cooperation and environmental cooperation are generally regarded not as serious abdications of sovereignty but as attempts to placate labour and environmental groups so as to reduce opposition to NAFTA, although they may also provide the foundation for subsequent social accords. See F. Abbott, Law and Policy of Regional Integration: The NAFTA and Western Hemispheric Integration in the World Trade Organization (Norwell, Mass.: Kluwer, 1995). 3 See Weintraub, NAFTA, 50. See J. Castro-Rea, Towards a Single North American Policy? The Effects of NAFTA on Mexican and Canadian Domestic Politics,' in C. Paraskevopoulos, R. Grinspun, and G. Eaton, eds., Economic Integration in the Americas (Brookfield: Edward Elgar, 1996), 89.

124 Economics

4 See Weintraub, NAFTA, and R. Green, ed., The Enterprise for the Americas Initiative (London: Praeger, 1993). 5 C. Reynolds, The Political Economy of Interdependence in the Americas/ Asian Journal of Economic and Social Studies 11, no. 1 (Jan. 1992), 1-39. 6 See P. Krugman, Geography and Trade (Cambridge, Mass.: MIT Press, 1991), 2. 7 See K. Ohmae, The End of the Nation State: The Rise of Regional Economies (New York: Free Press, 1996). 8 See T. Courchene and C. Telmar, From Heartland to North American Region State (Toronto: University of Toronto, Faculty of Management, 1998); and M. Gunderson, 'Regional Productivity and Income Convergence in Canada under Increasing Economic Integration,' Canadian Journal of Regional Science 29 (1996), 1-24. 9 See M. Goldberg and M. Levi, 'The Evolving Experience Along the Pacific Northwest Corridor Called Cascadia/ in R. Green, ed., The Enterprise for the Americas Initiatives: Issues and Prospects for a Free Trade Agreement in the Western Hemisphere (Westport, Conn.: Praeger, 1993), 99-119; and J. Kazanjian, The Trade and Investment Implications of the Canada-U.S. Free Trade Agreement,' in E. Fry and L. Radebaugh, eds., Investment in the North American Free Trade Area (Toronto: Ontario Centre for International Business, University of Toronto, 1991), 85-92. 10 See Courchene and Telmer, From Heartland to North American Region State. 11 See J. Helliwell, How Much Do National Borders Matter? (Washington, DC: Brookings Institution Press, 1998), and references cited therein. 12 See A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Dublin: Printed for the Messrs. Whitestone, Chamberlaine, W. Watson etc., 1776), 289. 13 See Helliwell, How Much? 14, 21. 14 See M. Gunderson, 'Harmonization of Labour Policies under Trade Liberalization,' in Relations industrielles/Industrial Relations 53 (1998), 92-104, based on calculations from data in Helliwell, How Much? 24-6. 15 See W. Cline, Trade and Wage Inequality (Washington, DC: Institute for International Economics, 1997); S. Collins ed., Imports, Exports and the American Worker (Washington, DC: Brookings Institution, 1996); J.D. Richardson 'Income Inequality and Trade,' Journal of Economic Perspectives 9 (1996), 3355; and A. Wood, 'How Trade Hurt Unskilled Workers,' Journal of Economic Perspectives 9 (1996), 57-80, for evidence and reviews of that evidence. Feenstra and Hanson also find that foreign direct investment from the United States to Mexico exacerbated wage inequality in both countries, by increasing Mexican demand for skilled labour and reducing U.S. demand

The Integration of Labour Markets 125

16 17

18 19 20 21

22

23

24

for unskilled labour. See R. Feenstra and G. Hanson, 'Foreign Investment, Outsourcing and Wages,' in R. Feenstra G. Grossman, and D. Irwin, eds., Political Economy of Trade Policies (Cambridge: University of Toronto Press, 1996), 89-127, and R. Feenstra and G. Hanson, 'Foreign Direct Investment and Relative Wages: Evidence from Mexico's Maquiladoras/ Journal of International Economics 42 (1997), 371-93. See also M. Gunderson and S. Verma, 'Labour Market Implications of Outward Foreign Direct Investment/ in S. Globerman, ed., Canadian Based Multinationals (Calgary: University of Calgary Press, 1994), 179-213. See N. Gaston and D. Trefler, 'Labour Market Consequences of the CanadaU.S. Free Trade Agreement,' Canadian Journal of Economics 30 (1997), 18-41. See M. Gunderson, A. Sharpe, and S. Wald, 'Youth Unemployment in Canada: 1976-1998,' paper presented to the Conference on Structural Aspects of Unemployment. Ottawa, 22-3 April 1999. The extent to which this accounts for some of the indirect feedback effect of rising tuition in Canadian universities is an open and interesting question. See J. Helliwell, 'Checking the Brain Drain: Evidence and Implications/ unpublished manuscript, University of British Columbia, Vancouver, 1999. See H. Grubel, The Effect of the Brain Drain on the Welfare of Canadians: Fraser Institute Conference Paper No. 1 (Vancouver: Fraser Institute, 1998). As indicated by Industry Minister John Manley: The federal government must reduce personal income tax rates and bring them in line with those in the U.S. to stop the exodus of Canadian talent... As much as possible we need to be trying to benchmark ourselves to the United States'; National Post, 2 May 1999, p. A.I See C. Riddell, 'Unionization in Canada and the United States/ in D. Card and R. Freeman, eds., Small Differences That Matter: Labour Markets and Income Maintenance in Canada and the United States (Chicago: University of Chicago Press, 1993), 109^48; and S.M. Lipset and Noah Meltz, 'Canadian and American Attitudes toward Work and Institutions/ Perspectives on Work I , no. 3 (1997), 29-34. Aspects of that legal environment that are more conducive to unionization in Canada include: easier certification through signing of cards rather than the requirement of a vote; stricter enforcement against unfair labour practices; first-contract arbitration in some Canadian jurisdictions; stronger union-security provisions such as the dues checkoff; and stronger prohibitions on the use of replacement workers during a strike. See G. Betcherman and M. Gunderson, 'Canada-US Free Trade and Labour Relations/ Relations industrielles /Industrial Relations 45 (1990), 456. See M. Gunderson, D. Hyatt, and A. Ponak, 'Strikes and Dispute Resolu-

126 Economics tion/ in M. Gunderson and A. Ponak, eds., Union-Management Relations in Canada (Don Mills, Ont.: Addison-Wesley, 1995), 373-412. 25 See Organisation for Economic Co-operation and Development, OECD Guidelines for Multinational Enterprises, available at http://www.oecd.org/ daf/cmis/cime/mneguide.htm, 7 July 2000. 26 See M. Gunderson, 'Barriers to Interprovincial Labour Mobility,' in F. Palda, ed., Provincial Trade Wars: Why the Blockade Must End (Vancouver: Fraser Institute, 1994), 131-54. J. Daly, 'Open for Business/ Challenge (fall 1994), 8-11. 27 See K. Roberts, D. Hyatt, and P. Dorman, The Effect of Free Trade on Contingent Work in Michigan/ in K. Roberts and M. Wilson, eds., Policy Choices: Free Trade amongst NAFTA Nations (East Lansing, Mich.: Michigan State University Press, 1996), 235-60, on the effects of free trade on the use of contingent workers. 28 See P. Warrian, The End of Public Sector 'Industrial' Relations in Canada? (Toronto: KPMG Centre for Government Foundation, 1995). 29 This also applies to services. A call to IBM technical support, for example, can connect the customer to service units in Florida, Dublin, or Toronto. 30 For discussions in the Canadian context, see R. Adams and L. Turner, The Social Dimension of Freer Trade,' in M. Cook and H. Katz, eds., Regional Integration and Industrial Relations in North America (Ithaca, NY: ILR Press, 1994), 82-104; M. Gunderson, 'Labour Adjustment under NAFTA: Canadian Issues,' North American Outlook 4 (1993), 3-21; B. Langille, 'General Reflections on the Relationship of Trade and Labor (Or: Fair Trade Is Free Trade's Destiny,' in J. Bhagwati and R. Hudec, eds., Fair Trade and Harmonization: Volume 2, Legal Analysis (Cambridge, Mass.: MIT Press, 1996), 23166; I. Robinson, 'NAFTA, Social Unionism and Labour Movement Power in Canada and in the United States,' Relations industrielles/Industrial Relations 49, no. 4 (1994), 657-93; and G. Trudeau and G. Vallee, 'Economic Integration and Labour Law and Policy in Canada,' in Cook and Katz, eds., Regional Integration, 66-81 and references cited therein. 31 See P. Buchanan, The Great Betrayal: How American Sovereignty and Social Justice Are Being Sacrificed to the Gods of the Global Economy (Boston: Little, Brown, 1998). 32 See W. Greider, One World, Ready or Not - the Manic Logic of Global Capitalism (New York: Simon and Schuster, 1997). 33 See R. Kuttner, Everything for Sale: The Virtues and Limits of Markets (New York: Knoff, 1997). 34 See S. Sassan, Losing Control: Sovereignty in the Age of Globalization (New York: Columbia University Press, 1993).

The Integration of Labour Markets 127 35 See K. Danacher, ed., Corporations Are Gonna Get Your Mama: Globalization and the Downsizing of the American Dream (Monroe, Me.: Common Courage Press, 1997). 36 See F. Traxler, 'Collective Bargaining and Industrial Change: A Case of Disorganization?' European Sociological Review 34, no. 2 (1997), 34-49. 37 See R. Swedberg, ed., Explorations in Economic Sociology (New York: M.E. Sharpe, 1990). 38 Forces giving rise to sustainable diversity are emphasized in K. Banting, G. Hoberg, and R. Simeon, 'Introduction/ and K. Banting and R. Simeon, 'Changing Economies, Changing Societies/ in Banting, Hoberg, and Simeon, eds., Degrees of Freedom: Canada and the United States in a Changing World (Montreal: McGill-Queen's University Press, 1997), 3-22 and 23-73, respectively. 39 See M. Gunderson and D. Hyatt. 'Do Injured Workers Pay for Reasonable Accommodation?' Industrial and Labor Relations Review 50 (1996), 92-104. 40 See M. Gunderson, D. Hyatt, and J. Pesando, 'Wage-Pension Trade-offs in Collective Agreements/ Canadian Journal of Economics 46 (1992), 146-60. 41 That evidence is discussed in the Canadian context in M. Gunderson, 'Harmonization of Labour Policies under Trade Liberalization/ Relations industrielles /Industrial Relations 53 (1998), 24-52. 42 See A. Verma, 'Labour Markets and the Economic Integration of Nations/ in D. Campbell, A. Parisotto, A. Verma, and A. Lateef, eds., Regionalization and Labour Market Interdependence in East and Southeast Asia (New York: St Martin's Press, 1997), 274. 43 See S. McBride and R. Wiiliimas, 'Globalisation and the Restructuring of Labor Markets: The OECD "Jobs Strategy/" unpublished manuscript, Simon Fraser University, Burnaby, BC, 1999. 44 Ibid., 12. 45 See J. Daly, 'Open for Business/ Challenge (fall 1994), 8-11. 46 For an elaboration of these points, and a discussion of some of the limited empirical evidence, see Gunderson, 'Harmonization of Labour Policies under Trade Liberalization/ 24-52. 47 As indicated by Ambassador Raymond Chretien: 'Most importantly, if Canada were willing, would the United States ... be prepared to consider new treaties and political arrangements that would further codify our future together?' See David Crary, 'NAFTA Currency Unlikely?' Las Vegas Review Journal, 24 Jan. 1999. 48 For an expanded discussion, see M. Gunderson and C. Riddell, 'Jobs, Labour Standards and Promoting Competitive Advantage: Canada's Policy Challenge/ Labour (1995), S125-S148.

5. Checking the Brain Drain 2000 John F. Helliwell

It has been suggested that recent international migration, especially from Canada to the United States, has affected the supply of skilled workers in key sectors of the Canadian economy.1 Referred to as a 'brain drain/ the exodus has been traced to many causes, and it has led to a range of proposals, from exit taxes (to recoup post-secondary education subsidies for the leavers) to major reductions in income tax rates to encourage them to stay. Since the public perceptions and policy discussions may have been based on rather scattered and disparate sources of information, this chapter draws together available evidence on the size and nature of the migration from Canada to the United States. First, I attempt to quantify recent migratory flows from Canada to the United States and to compare them with earlier migration - from Canada to the United States and from other countries to Canada and to the United States. I present extent data for migrants with higher education - a focus of policy interest in Canada and other countries. Second, I survey statistics on the relative importance of factors determining migration, especially for those with higher education and skills. Third, I assess the scantier evidence on how public policies have affected these migrations. Finally, I summarize the key features of the evidence and outline possible implications for future research and policies. How Large Is Migration from Canada to the United States? Migration from Canada to the United States is best estimated from

Checking the Brain Drain 129

the U.S. census and the U.S. Current Population Survey (CPS), since these avoid double-counting while giving full account to the stock of Canadian-born workers employed (or being educated) temporarily in the United States. In this section, I first compare flows of migrants in the 1990s to earlier flows from Canada to the United States, from other countries to the United States, and from other countries to Canada. Second, vis-a-vis highly educated workers, the flows from Canada to the United States and those from other countries to Canada help us to assess the net costs and benefits to Canada from international migration of skilled workers. I try to explain any apparent differences among existing estimates of the 'brain drain' from Canada to the United States. Third, I examine a specific group of university graduates whose whereabouts are documented. Fourth, I consider temporary emigrants. There is a widespread perception that large and growing numbers of Canadians have been migrating to the United States. Because this perception appears to be so widely held, and accepted as fact, one might expect that a review of population statistics would readily confirm it. At least at the aggregate level, however, the numbers do not support it. The past thirty years has seen a steady continuation of the centurylong downward trend in the number of U.S Presidents born in Canada. Table 5.1 shows 843,000 Canadian-born residents of the United States in 1980, 772,000 in 1990, 679,000 in 1994, 660,00 in 1996,542,000 in 1997, 601,000 in 1998, and 662,000 in 1999. Sampling variation may help explain the sharp drop from 1996 to 1997 and the increase thereafter,2 Canadian-born migrants to the United States have not been numerous enough to replace those returning home, dying, or leaving the United States for a third country. The trend covers the century. Measured as a share of the Canadian population in the same year, the number of Canadian-born living in the United States has fallen from more than 16 per cent in 1910 and 12 per cent in 19303 to 7 per cent in 1950, 5 per cent in 1960, 3.8 per cent in 1970, 3.4 per cent in 1980,4 and less than 2 per cent in the late 1990s. Figure 5.1 shows this trend and, for purposes of comparison, the number of U.S.-born residents of Canada (obtained from the periodic Canadian censuses), also depicted as a percentage of the Canadian population. This figure has dropped, too, but not as quickly. However, the Canadian-born living in the United States represent only about 0.2 per cent of the U.S. population, while the U.S.-born living in Canada represent 0.8 per cent of the Canadian population.

130 Economics TABLE 5.1 Estimated Canadian-born population (OOOs) in the United States, 1980-1999

1980

1990 1994 (Census) (CPS)

1995 (CPS)

1996 (CPS)

1997 (CPS)

1998 1999 (CPS) (CPS)

Total

843

772

679

677

660

542

601

Age groups 25-44 45-64 65+

286 268 247

n.a. n.a. n.a.

201 191

208

206 196 175

235 172 183

204 154 131

217 168 138

662

SOURCE: Figures for 1980: from John F. Long, Edward T. Pryor, et al., Migration between the United States and Canada, Series P-23, No. 161 (Washington, DC: Bureau of the Census, Current Population Reports, Special Studies, 1990), A-8. Figures for 1990: The adjusted census number for 1990 comes from A. Diane Schmidley and J. Gregory Robinson, How Well Does the Current Population Survey Measure the Foreign Bom Population in the United States? Technical Working Paper No. 22 (Washington, DC: U.S. Bureau of the Census, Population Division, 1998). Figures for 1994: Data from U.S. Bureau of the Census, Current Population Survey (CPS), are available from www.census.gov.ca. The 1997 age-group estimates are unpublished tabulations requested by Statistics Canada. I calculated the 1998 estimate from CPS survey data from March 1998, applying the same weighting factor as the U.S. Bureau of the Census used for the CPS numbers from 1996 and 1997 for Canadian-born residents of the United States.

Canadian census data allow us to compare immigration and emigration flows, although latter are measured residually and are probably subject to a higher margin of error. As Table 5.2 shows, Canadian census data for the last 150 years present the ratio of emigrants to immigrants, averaged over five- or ten-year inter-census periods, as ranging from a minimum of 20 per cent (1991-6) to a maximum of more than 150 per cent, in the late nineteenth century. During each of the four census decades between 1860 and 1900, emigration exceeded immigration, while for most of the twentieth century (except for the 1930s), immigration exceeded emigration, with net immigration being largest in 1986-91 and 1991-6. In the light of the usual concentration on migration of the highly skilled, it is noteworthy that the 1991-6 Statistics Canada data for university graduates match very closely the census data for total immigration and emigration. People with university degrees are more prevalent among both immigrants and emigrants than among the population as a whole, reflecting their higher mobility. Statistics Canada estimates that the annual flows of university gradu-

Checking the Brain Drain 131

FIGURE 5.1 Canadian-born living in the United States and U.S.-born living in Canada, as percentage of Canadian population, 1900-1996

ates immigrating to Canada are four times or more larger than the number moving from Canada to the United States. There is a similar pattern for higher degrees as well, with immigrants holding master's and doctoral degrees outnumbering emigrants holding bachelor's, master's, and doctoral degrees combined. It is also helpful to compare the trends in Canadian-born residents of the United States with migration from elsewhere to the United States. The declining numbers of Canadian-born are matched by declining numbers of those born in western Europe and increasing numbers of those from poorer countries. For the Canadian-born living in the United States at the time of the 1990 census, as for the German- and Italian-born, more than half arrived before I960, and three-quarters before 1970. By contrast, for those U.S. residents born in Mexico or the Philippines, more than three-quarters arrived after 1970.5 Over the second half of the twentieth century, there was a significant narrowing in the per-capita income gap between the United States and both Canada and the industrial countries, thus lowering the economic incentive to migrate from Canada to the United States or from western Europe to either country. The economic incentives to move from any of

132 Economics TABLE 5.2 Canadian population and growth components, 1851-1996

Period

Net natural increase* Immigrationf

1851-61 1861-71 1871-81 1881-91 1891-1901 1901-11 1911-21 1921-31 1931-41 1 941-51 § 1951-6 1956-61 1961-6 1 966-71 " 1971-6* 1976-61 1981-6 1986-91 1991-6

611 610 690 654 668 1,025 1,270 1,360 1,222 1,972 1,473 1,675 1,518 1,090 931 977 987 987 908

352 260 350 680 250 1,550 1,400 1,200 149 548 783 760 539 890 1,053 771 677 1,199 1,170

Emigrationt

Emigration/ immigration

170 411 404 826 380 739 1,089 971 241 379 184 278 280 427 492 366 360 279 230

0.48 1.58 1.15 1.21 1.52 0.48 0.78 0.81 1.62 0.69 0.24 0.37 0.52 0.48 0.47 0.47 0.53 0.23 0.20

Census population at end of period 3,230 3,689 4,325 4,833

5,371 7,207 8,788 10,377 11,507 13,648 16,081 18,238 20,015 21,568 23,518 24,900 26,204 28,111 29,959

SOURCE: Statistics Canada, Demography Division. *Total births minus total deaths. tStarting with 1 July 1971, immigration figures include landed immigrants, returning Canadians, plus net change in the numbers of non-permanent residents. ^Emigration figures are estimated by the residual method. §Data for the components of growth shown for 1941-51 exclude data for Newfoundland. ''The 1 June 1971 figure is the census count without adjustment for the net censs undercount. The population on 1 July 1971 adjusted for the net census undercount 22,026,000. Starting with 1971, the reference date is 1 July instead of 1 June, and population estimates are based on census counts adjusted for net undercounts.

the richer industrial countries to the United States are far smaller than they were in mid-century, and the flows are themselves correspondingly smaller. As we see below, the greater income inequality in the United States, and a higher wage premium for those with higher education than exists in Canada, may have served to maintain the otherwise declining economic incentives for highly trained Canadian to migrate south.

Checking the Brain Drain 133

The role of sources for migratory flows to the United States and to Canada has shifted from western Europe to poorer countries, for two reasons. The reduced flow from western Europe reflects the faster and greater convergence there to U.S. (and Canadian) standards of living than has occurred in the rest of the world. In addition, changes in Canadian and U.S. immigration policies have reduced the importance attached to ethnicity or country of origin. Canada plays a 'middleman' role in these migratory patterns, receiving even more net migrants (as a share of population) than the United States, while also remaining a net provider of migrants to the United States. Although the aggregate data are helpful, they do not fully address questions about migration of those in highly skilled occupations. Emphasis on the highly skilled, with type and level of education the principal measure of skill, has been at the centre of discussions of the brain drain not only in Canada in the 1990s but in many countries over several decades. Widespread concern about brain drains to the United States in the 1950s and 1960s, from industrial and developing countries alike, led to special research in several countries.6 Such studies provide some data suitable for comparing current and past flows and for placing the Canadian case in a more global context. We can compare data from the 1960s with those from the 1990s for at least some brain-drain categories. Two groups fairly carefully tracked in both decades are scientists and engineers. There were substantially more engineers, in numbers of graduates and of emigrants to the United States, during both periods. DeVoretz and Laryea calculate that engineers migrating south in 1993-4 were 6.3 per cent of the number of Canadian engineering graduates in 1991, with the corresponding figures being 14.5 per cent for scientists and 8 per cent for the two groups combined.7 Grubel and Scott do a similar calculation for the years 1957-61.8 They find the earlier exodus to be more than three times as large as DeVoretz and Laryea's estimate for the 1990s, with the average number of migrating scientists and engineers equal to almost 30 per cent of the number of Canadian first degrees granted in the two fields during the period 1957-61. For engineers, the ratio was even higher, averaging almost 46 per cent - twenty-five times higher than Statistics Canada's estimate for the 1990s. Grubel and Scott calculated comparable emigration ratios for several other source countries vis-a-vis the United States and found the proportions much higher for Canada than for other countries. Between

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1957 and 1961 more than half the scientists and engineers emigrating from Canada to the United States were born in countries other than Canada, while for most other source countries the bulk were born in the country of emigration. However, the flow from Canada to the United States made Canada the number-one source of native-born scientific and engineering graduates to the United States, when measured as a proportion of the source country's population, and third as a provider of source-country students in those disciplines. Grubel and Scott show that these high ranks resulted largely from Canada's being a generally high provider of migrants to the United States, as there was not an unusually large proportion of the highly educated among Canadian-born migrants to the United States,9 compared to migration flows from other countries to the United States. The data presented thus far indicate that recent flows of migrants from Canada to the United States, whether total migration or movements of the highly educated, are less than a quarter as large as those in the 1960s, and in all recent decades they have been much smaller than the inflows from other countries to Canada. It would appear that there is a 'brain gain,' with outflows to the United States still on the century-long downward trend. But what if in fact the best are leaving and are not being adequately replaced by those arriving from elsewhere? This risk forms the basis of DeVoretz and Laryea's calculation of 'churning costs' - the extent to which the skills and wages of migrants to Canada are not as substantial, either per person or in the aggregate, as those of skilled migrants from Canada to the United States. Their aggregate estimate of the present value of these costs is $11.5 billion - almost all of their $11.8billion estimate of the total costs of the brain drain. Their calculations depend on the stated numbers of skilled immigrants and emigrants and their average quality. Statistics Canada finds material problems with the methods adopted by DeVoretz and Laryea. First, it concludes that they use non-comparable definitions for skilled immigrants and emigrants, thus materially undercounting the number of skilled immigrants. They treat U.S. immigration statistics for managerial workers as though the migrants are all highly educated,10 while making no comparable adjustment for immigration to Canada. They also treat all scientists and engineers emigrating to the United States as highly skilled, regardless of whether or not they have any professional qualifications beyond a first degree, while they exclude holders of bachelor's degrees for the matching

Checking the Brain Drain 135

inflows.11 Second, DeVoretz and Laryea use salary differentials that compare salaries of the wider group of immigrant scientists, including those with only undergraduate degrees, with those of emigrants to the United States. Statistics Canada's analysis shows that when comparable methods are employed to value the skills and numbers of immigrants and emigrants, the value and number of immigrants much exceed those of emigrants.12 Even with comparable evaluation procedures, however, the average income of emigrants is likely to exceed that of immigrants,13 reflecting Canada's traditional role as an entrepot for U.S.-bound migrants, as well as the greater relative skill premium in the United States. Useful data come as well from records of the current addresses of most of the living graduates of the University of British Columbia (UBC).14 Helliwell and Helliwell compare the UBC data with national data for the class of 1995 as reported by Frank and Belair, and find the two sources highly consistent. Thus the UBC data can provide some idea of likely trends in the national data, where so far there is only a snapshot of the 1995 grads.15 Figures 5.2 and 5.3 present the UBC data for bachelor's and PhDs living in Canada, in the United States, and in the rest of the world. Figure 5.2 shows that recent holders of bachelor's degrees are less likely to be living in the United States than are earlier graduates. Graduates from all decades are far more likely to be living elsewhere in Canada than in the United States and far more likely still to be in British Columbia. For example, the data for bachelor's degrees show each of the thirty-two U.S. states most likely to be a home to UBC graduates has an average of twelve graduates from the total of 1990-7 graduates, compared to an average of 231 for each of the other Canadian provinces and 32,000 in British Columbia. The thirty-two states are, on average, 10 per cent closer to British Columbia and have economies almost three times the average size of those of other Canadian provinces. When these differences are factored in via the gravity model,16 a UBC bachelor's graduate of the 1990s is about seventy times more likely to be living in another Canadian province than in a U.S. state of similar size and distance. He or she is far more likely still to be living in British Columbia. The UBC data for PhDs show a far more cosmopolitan mix of addresses. This is what would in general be expected, as PhD programs attract students from all over the world, and graduates often migrate - whether home, to a third country, or simply in search of jobs

ROC: Rest of Canada; ROW: Rest of World.

FIGURE 5.2 Current location of UBC bachelor's graduates from 1950 to 1996, as percentage of graduating class

FIGURE 5.3 Current location of UBC PhD graduates from 1955 to 1995, as percentage of graduating class

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that become fewer and more scattered as specialization increases. Figure 5.3 shows UBC PhDs and suggests increasing U.S. residence in the 1990s, though not exceeding the numbers of PhDs staying in British Columbia. The analytical work on these data is just beginning, but the basic trends suggest two things. First, there is no general tendency for graduates in more recent decades to have moved to the United States; indeed, Figure 5.2 mirrors the population-based estimates from the U.S. census, with graduates in more recent decades being less likely to have migrated to the United States than those from earlier decades. Second, there has been sharp growth in the supply of both BAs and PhDs, especially the latter. Figure 5.4 presents the numbers of new UBC BAs and PhDs in relation to the size of the BC population. Both are on a strong upward trend, with PhD production starting later and growing faster, reaching 250 per year in 1996. Tertiary education, especially post-graduate education, has expanded more quickly in Canada than in the United States. Post-graduate education attracts students from around the world, and the recipients of such degrees are also widely distributed. Thus we can anticipate more Canadian-educated PhDs entering the U.S. and other foreign markets, even if the share remaining in Canada should remain high or even increases. The remaining task for this section is to consider temporary workers, whose numbers have grown so much since 1990 and who have spurred recent Canadian public discussion of a brain drain to the United States. DeVoretz and Laryea report the number of non-immigrant professionals admitted to the United States under the provisions of the Canada-United States Free Trade Agreement (FTA) and the North American Free Trade Agreement (NAFTA) as rising from less than 3,000 in 1989 to more than 16,000 in 1993 and nearly 27,000 in 1996.17 They argue that this fast-growing category has become an increasingly popular first step for permanent migration and is thus an early indicator for future migration. There are, however, enough problems - at least five major ones with this series to render it a poor indicator of either temporary or permanent migration to the United States. First, the category that DeVoretz and Laryea report is new under the FTA and NAFTA. It was zero before 1989 and acquired much of its growth by transfers from other categories. Thus the total for all entries of temporary workers from Canada to the United States, including the series used by

FIGURE 5.4 New UBC bachelors and PhDs relative to BC population, 1930-1996

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DeVoretz and Laryea, rose from 46,976 in 1989 to 62,199 in 1996, implying that much of the growth in the FTA-NAFTA series came through transfers.18 Second, the series may contain, even in the same year, more than one entry for the same person. Third, the series captures people who are spending only a few days in the United States, and hence the total will not represent the likely number of Canadians working in the United States at any given time. Fourth, it includes in each year any renewals of earlier visas, as long as the renewal is obtained at a border entry point. Thus a person who comes in one year and stays on the same form of visa, as many are said to do, will appear also in the statistics for each subsequent year. Fifth, the United States has since 1990 strengthened the requirement for temporary professional visitors to have visas if they are to do any business in the United States. This change has increased the number of temporary visas issued, without thereby implying any increase in the actual number of temporary workers. In the light of these large but not yet adequately measured biases in the FTA-NAFTA series, they are not a reliable guide to either current or future emigration numbers. Collaborative efforts between U.S. and Canadian statistical agencies are under way to establish more clearly what these series measure and how they should be related to migration and census data. In any event, the temporary flows should receive less emphasis than figures from the U.S. Current Population Survey (CPS) and census data, which count Canadian-born actually living and working in the United States, including both temporary and permanent migrants. Thus the best estimate of the cumulated flows of Canadian-born migrants to the United States, temporary and permanent alike, in the 1990s is probably that provided by the CPS, with more precise calculation awaiting the U.S. decennial census in 2000. As we can see in Table 5.3, the CPS data show cumulative flows of post-1990 employed migrants to have reached some 125,000 by 1999, for an annual average flow of 15,000. These figures exclude people born in other countries who migrated to the United States through Canada, and they include temporary workers. Highly educated and skilled permanent migrants - the focus of brain-drain discussions - number fewer than 10,000 per year, and not all are in the labour force. Results from the 2000 census will provide more definitive numbers, but the past matches between census and CPS data are close enough that very large surprises are unlikely.

Checking the Brain Drain 141 TABLE 5.3 Selected characteristics of Canadian-born (OOOs) in the United States who have entered the United States to live since January 1990

1994

1995

1996

1997

1998

1999

104

126

105

116

152

185

25-44 16-64

53 99

46 84

54 81

68 91

101 129

101 169

Sex Male Female

45 59

66 60

51 54

68 48

83 69

101 83

Education Number with bachelor's, graduate, or professional degrees

31

34

38

42

80

83

% with bachelor's, graduate, or professional degrees

29.8%

27.0%

36.1%

36.2%

47%

44.9%

Labour force status Employed % Employed of total

46 44.2%

52 41.3%

63 60%

77 66.4%

104 64%

125 69.2%

Total Age groups

SOURCE: U.S. Current Population Survey.

What Triggers Migration? This section reviews the empirical literature on international migration with an eye to seeing what circumstances or policies might be determining current flows. It compares the international flows, in terms of their economic and non-economic determinants, with interprovincial migration in Canada and interstate migration in the United States. The primary economic determinants examined in the literature include income differentials and employment prospects. All the results reveal the extent to which interprovincial and interstate mobility of labour is many times larger than that between countries. As well, those born in Canada seem more willing to move, either to another province or to another country, than are those born in the United States. I have recently estimated interprovincial, interstate, and CanadianU.S. population mobility on the basis of data the from Canadian and

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U.S. censuses. In Canada, respondents report their current province of residence and their province or country of birth. The U.S. census collects similar data for state of residence and state or country of birth. For each of the two countries, one can estimate the relative likelihood of cumulative internal and international migration, after adjusting for the separate influences of distance, size, and per-capita incomes as determinants of migration. The results19 show that for both countries there is a sharply higher probability that a migrant to a state or province comes from another part of the same country rather than from the other country. Figures on all cumulative migration up to the 1990-1 censuses in the two countries indicate that a resident of a Canadian province was 100 times more likely to have come from another province than from the United States, after one adjusts for economic size and distance. The corresponding results for U.S. residents show them to be seven times more likely to have migrated from another state than from a Canadian province of similar economic size and distance. Once again, internal migration is much more likely than international, and Canadians have traditionally been much more likely to migrate to the United States than vice versa. The Canadian-born are more mobile than the U.S.born, whether moving within their country of birth or moving to the other country.20 Also, the border provides a membrane through which northbound information travels much more readily than southbound. The average Canadian has all the U.S. networks on his or her TV set, along with much U.S. information and programming on Canadian channels. The U.S. media, and the U.S. cable systems, carry almost nothing about Canada. Thus Canadians regard the United States as known territory, while most U.S. residents have no reason ever to think what it might mean to live in Canada. Since information and familiarity spur migration, this asymmetry of information may help to explain migration patterns. Canadians' greater familiarity with the United States and its job opportunities may also help explain why Canadian migrants to the United States earn incomes than exceed the U.S. average by more than is true for U.S. migrants to Canada.21 For both countries, however, international migration remains far less likely than internal. Among those who do migrate, whether domestically or abroad, there is a preponderance of the highly educated, who are more likely to have skills in demand, and contacts in and knowledge about possible places to move.22 Studies of Canadian emigration, based on aggregate

Checking the Brain Drain 143

data mainly for the 1960s, confirm the role of economic factors, with employment opportunities, as measured by the inverse of the unemployment rate, dominating relative incomes as the primary economic motivation.23 In the light of the role of relative unemployment rates, and particularly of employment prospects in the target of migration, the 1980s and 1990s, especially 1990-5, should have seen a lot of migration from Canada to the United States. The gap in unemployment rate between the two countries reached 4 per cent in the first half of the 1990s, driven mainly by a reduction in the U.S. rate, indicative of growing job opportunities in the United States. It is possible, using the earlier research on the economic determinants of emigration, to estimate how differing macroeconomic circumstances contributed to migration from Canada to the United States between 1990 and 1995. If we use one percentage point of reduction of the U.S. unemployment rate, averaged for each of the years 1990 through 1996, as a conservative measure of the stronger U.S. macroeconomic performance, and hence of U.S. job creation,24 the implied additional emigration would have been about 10,000 per year. We base this estimate on migratory behaviour in previous decades, and hence it is subject to a large margin of error, but migration in the 1990s was surprisingly small, in the light of a widening gap between job opportunities. At the end of the century, as unemployment rates moved closer together, the gap was lessening, and the incentives to migrate south decreased. To the extent that migration of the highly skilled may be triggered by different factors, survey data reported by Grubel and Scott suggest that job opportunities and challenges are even more decisive for the highly educated. For many such workers, particularly in health care, education, and government-supported fundamental research, the 1990s saw large cuts in government spending induced by budget pressures. As federal and provincial finances in Canada are returning to balance, both levels of government are starting to rebuild their diminished capacities to provide health care, higher education, and research. In addition, job opportunities for new entrants to the knowledge professions, especially those employed by universities, will be enhanced by the large bulge of retirements in the next ten years. The coming retirement surge is the echo of the massive hiring by universities in the 1970s (larger in Canada than in the United States), which almost by itself halted the earlier and much larger exodus of highly educated Canadians in the 1960s.

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Finally, since international migration is such a rare event relative to either domestic migration or staying near one's roots, it probably requires a substantial accumulation of push and pull factors. In addition, because networks of contacts and information either keep people near home or let them follow pathways blazed by others, migration is likely to involve bunching, waves, and very uneven patterns. Why else would so many people from the same rural village in Europe be found decades later in the same census tract of suburban Toronto? Three implications follow from this unevenness and discontinuity. First, migratory flows, especially in their geographical and timing details, are very difficult to predict. Second, anecdotes and small surveys are a problematic source of evidence about the size and nature of migratory flows. Third, the fact that international migration is such an important and unusual decision for individuals and families probably leads them to compare, to the extent they are able, the whole character of life and society in their old and potential new countries. Where the push factors are strong and immediate, as with some refugees fleeing for their lives, details about their place of refuge may matter little - a matter to be sorted out and possibly adjusted by subsequent moves. For those moving from Canada to the United States, the balancing of push and pull factors is likely to be more even, and the choice of the type of community and country more deliberate. However, they typically involve the burning of few bridges, so that experimental and potentially reversible moves may be much more frequent.

How Much Do Policies Influence Migration? The discussion above about the importance and infrequency of the migration decision suggests that narrow comparisons of house prices and personal tax rates, for example, are likely to be subsumed in a larger calculation, based on permanently sustainable ways of life and incomes. However, the increasing frequency of temporary movements under the FTA and NAFTA may encourage more short-term migration aimed at maximizing take-home pay, leaving open future choices about where to raise families and plant roots.26 As Kesselman points out, the fact that geography and political jurisdiction frequently coexist served as the basis for Tiebout's model explaining how jurisdictions can offer quite different packages of services and tax rates, with individuals moving to find the package most suiting their tastes and values.27

Checking the Brain Drain 145

When the choice is among countries, rather than among municipalities, mobility is much less and the fiscal and social packages can be - and are - much more varied, but those who move face not only different tax rates but different patterns and types of public services. Perhaps even more relevant to the study of migration by the welleducated and well-off, countries differ not only in the size and efficiency of their public services and transfer payments, and in their average tax rates, but also in the distribution of those costs and benefits among different groups of taxpayers and beneficiaries. How do these packages of taxes and services look to those deciding whether to live and work in Canada or in the United States? Recent discussions of the brain drain have made bilateral comparisons of income tax rates between Canadian and U.S. cities. These calculations, because they can be easily made, are both natural and compelling. They are problematic, however - income tax rates vary greatly among U.S. states, income taxes are variable proportions of total taxes, and the balance between taxes paid and services received differs greatly between the two countries and among individuals in different economic and social circumstances. Overall, health care and the social safety net absorb about the same share of gross domestic product (GDP) in the two countries, and hence they and their financing would probably not much affect migration decisions. But as the studies in Card and Freeman show, the structure and financing of the two systems differ substantially, as do their efficiency and coverage.28 Health and other parts of the social safety net cost about 16 per cent of GDP in both countries. Yet the health care system costs 4 per cent more of GDP in the United States than in Canada. And other aspects of the social safety net, at least in the early 1980s, cost almost three times as much in Canada as in the United States,29 yet would, if Canadian rules had been applied to the U.S. population, have cut U.S. poverty rates by more than half.30 For a brain-drain migrant, not planning to need social safety nets, and likely to be covered by employer-provided health insurance, the lower tax rates in many U.S. jurisdictions could provide a net fiscal incentive to move.31 Since these studies were undertaken, circumstances have changed social safety nets have been under growing pressure because of increased demands and decreasing funds in both countries, the pre-tax and post-tax distributions of income have become more unequal in the United States, as compared to those in Canada; and the education premium in wage rates has risen in the United States relative to Canada.

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All of these factors may have increased the net attraction of migration among the better educated.32 Recent work by Statistics Canada, as reported by Zhao, Drew, and Murray, does show during the 1990s more higher-income tax-filers leaving Canada, but the researchers are unable to make comparisons with earlier decades.33 Recent PhD research at UBC by Don Wagner has found, using CPS data for those with at least a bachelor's degree, that both taxation rates and income differentials have statistically significant effects on migration from Canada to the United States. However, the overall effect is not large. If tax rates were equal in the two countries, the number of post-1990 migrants would have been reduced by less than 5 per cent. Beyond the overall package of taxes and public services, the structure of education finance has received special attention. Grubel and Scott, Bhagwati and Martington, and DeVoretz and Laryea, among others, have all looked at the fact that brain-drain migrants take with them their own stocks of taxpayer-supported educational capital, and they have considered or advocated some means of recouping some or all of these costs by means of an exit tax or an educational loan that is forgiven only for those who remain to work where they acquired their subsidized education.34 The issue has special relevance to the brain drain between Canada and the United States, since Canadian tax rates are higher than those in the United States, and education, especially tertiary, receives more of its support from taxes in Canada than in the United States. Is the international mobility of the highly educated now substantial enough to threaten this difference in the financing of education? DeVoretz and Laryea's proposal - to tax emigrants for the value of the tax-supported education that they are taking with them is one reaction. Other commentators have suggested that the current pattern is likely to be sustainable, perhaps supported by a continuation of the current move towards higher university fees in the more expensive professional schools.35 There is a final set of policies influencing the brain drain by means of the entry rules for countries receiving immigrants. Such policies are generally intended to combine some skill-based selection with other criteria based more on humanitarian grounds, including especially refugee status. Changes in U.S. and Canadian policies have followed somewhat parallel paths, with country preferences or quotas giving way to systems with more reliance on domestic need for the migrants' skills. Removal of Western Hemisphere preference made it harder for Canadians in general to migrate to the United States, while the increas-

Checking the Brain Drain

147

ing reliance of education and skills has left considerable room to move for the highly skilled, who, as we saw above, were already the ones most likely to migrate. Summary and Implications What can we conclude from the empirical studies of current and earlier international movements of the highly skilled? First, the highly skilled are much more mobile than are those with less education. Second, the data show that even the highly skilled are, by at least an order of magnitude, far more mobile within their country of origin than between countries. In many fields, especially for the higher levels of qualification, international experience is a valuable or necessary part of the training. People exposed to foreign training and experience are probably more likely to migrate than are others who have not made as many such contacts. Third, international migratory flows of the highly skilled seem greater when there are large gaps in job opportunities or living standards between the sending and the receiving countries. These three general conclusions help to explain the main facts of the current migrations between Canada and the United States and to suggest why they are so much smaller than thirty years ago. First, the greater mobility of the highly educated helps to explain their overweighting in migratory flows between Canada and the United States.36 Second, the much smaller size of the 1990s brain drain from Canada to the United States, compared to the 1960s, appears to be the net result of two main factors and two offsetting effects. The two dominant factors are the reduced income gap between the two countries and the greater availability of higher education in Canada. In 1960, per-capita GDP in Canada was 30 per cent below that in the United States; in 1990, it was less than 10 per cent smaller. In the 1960s, graduate studies were far less available in Canada than in the United States, and in many disciplines the standard career track for academics involved obtaining a PhD in another country, most often the United States.37 The situation in the 1990s was dramatically different. For example, among almost 600 active research economists in Canada in 1990, most of whom were also teaching in universities, the percentage with Canadian PhDs rises from 9 per cent for those with 1950s PhDs, through 14 per cent for 1960s PhDs and 35 per cent for the 1970s, to 62 per cent for the 1980s.38 The two offsetting factors are the widening gap in employment opportunities in the 1990s, relative to the 1970s and 1980s, and the gen-

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erally lower costs of international travel and communications. The former factor is most important for medical professionals and academics, who have faced increasing supply combined with declining employment opportunities, driven usually by fiscal retrenchment. Both factors have been evident to some extent in all countries but are much more salient in Canada than in the United States. For example, Murphy, Riddell, and Romer have documented a rising skill premium in the United States compared to Canada and explain it in terms of larger Canadian increases in the supply of skills.39 The main conclusion to be drawn from this chapter's review of the brain-drain data is that the movements of educated Canadians to the United States in the 1990s were surprisingly small, relative to past movements of educated Canadians to the United States, to current perceptions, and to past and current immigration to Canada from other countries. Earlier research suggests that the 1990s' increases in the educational pay premium in the United States, the increasing relative supply of Canadians with higher education, and the lower unemployment rates in the United States should have spurred migration to the United States during the 1990s. Despite greater cross-border movements of goods, services, and temporary workers under the FTA, the number of long-term migrants has been remarkably small. Table 5.3 shows that the number of 1990s migrants to the United States who were still there in early 1999 averaged 15,000 per year, of whom perhaps 9,000 were employed and possessed university degrees. The number is already small relative to previous history and might reasonably be expected to decline further as the gap in unemployment rates continues to narrow. In those areas where the movements have been significant and widely noted - for example, some health care specialists, some high-technology workers, and some university-based researchers - movements are likely to decrease as supply becomes more similar in the two countries, driven by some combination of reduced fiscal pressures in Canada, reduced excess demand in the United States, and a forthcoming retirement bulge in Canada.40 Since the actual flows are modest, the lessons for policy are correspondingly muted. In short, their scale means that it would be a mistake to use the brain drain as a spur for changes to taxes and expenditures that do not otherwise pass the tests of economic and political logic. Migration acts partially to mediate international differences in the balance between the demand for and supply of specialized skills. This is just one more channel in the international transmission of

Checking the Brain Drain 149

macroeconomic conditions, thereby moderating the unemployment effects of domestic shocks while increasing the exposure to shocks originating elsewhere. Since international migration is so small relative to domestic migration, and since all migration is relatively rare, the quantitative effect of migration on the transmission of macroeconomic disturbances is small, even where immigration policies are specifically targeted to helping meet pressing job vacancies. There is some evidence that the availability of a pool of skilled and willing immigrants may have helped to fill job vacancies, and hence to lessen inflationary bottlenecks, in occupations or locations that are less favoured by domestic residents.41 In terms of current brain-drain discussions, the rapid and sustained U.S. employment growth in the 1990s, coupled with a rising U.S. education premium, offered a broader range of better-paying job opportunities for many educated Canadians. Those who have pulled up their roots and set them down elsewhere, however, may be harder to bring back when the domestic needs are greater. The burden of the data examined in this chapter, however, is that the numbers involved are small enough, relative to either existing stocks of skills or the scale of current training, that they are not likely to have a large or long-lasting effect on the availability of skills in Canada. Given the costs of migration, any brain drain of the highly skilled increases the incentive to provide at home a stable and sustainable environment for the training and employment of all workers, but especially those in fields where there are positive national spillovers from domestic employment. The foremost areas include health, education,42 and research and development,43 where governments appear as major employers and financial backers. While there are incentives to take education where it is cheap and then work where wages are high, in the education of PhDs, where post-degree mobility seems to be highest, the financing patterns are quite similar in Canada and the United States and may not involve much subsidy by taxpayers. Almost all PhD students work as teachers and researchers during their PhD programs, and generally produce high-value output for very low wages in both capacities. Thus it might be argued that PhD programs are cost-effective ways of achieving research and development (R&D) and education simultaneously, regardless of where the finished PhDs subsequently work. I am not aware of research that attempts to measure systematically the contributions of PhD students to research and teaching. Since it is clearly relevant to any assessment of directions

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for future R&D support, and of the costs and benefits of migration, it should be a major item on any list of research to be done. There are also obvious gaps in knowledge about the sizes and determinants of migration flows between Canada and the United States. Ideally, filling in these gaps should enrich the data already available from census and labour force surveys. There is also much more to learn from systematic analysis of the movements of sample groups of special interest, such as graduates of various parts of the Canadian educational system. In the meantime, the existing data and analysis provide no evidence of a current crisis or any great cause for alarm. NOTES 1 Department of Economics, University of British Columbia. This is an updated version of the paper presented at the Trends conference. A summary form of an earlier version appeared in Policy Options 20, no. 7 (Sept. 1999), 6-17.1 am grateful for research collaboration from David Helliwell, for data and advice from Statistics Canada and the U.S. Bureau of the Census, and for helpful comments, on this and earlier work, from Don DeVoretz, Herb Emory, Jeff Frank, David Green, Jon Kesselman, Scott Murray, Art Phillips, Elizabeth Ruddick, Derwyn Sangster, Tony Scott, Jeff Simpson, and John Zhao. Thanks to Noreen Russell for editorial assistance with the final version. 2 Despite a 50 per cent overlap in the CPS sample from month to month, country of birth is asked only on the March surveys, so that the sample is changed almost entirely from one survey to the next. See A. Diane Schmidley and J. Gregory Robinson, How Well Does the Current Population Survey Measure the Foreign Born Population in the United States? Technical Working Paper No. 22. (U.S. Bureau of the Census, Population Division, 1998). 3 The data for 1910 and 1930 come from Leon E. Truesdell, The Canadian Born in the United States (New Haven, Conn.: Yale University Press, 1943), 19. 4 The data for 1950 through 1980 come from John F. Long et al., Migration between the United States and Canada, CPR, Special Studies, Series P-23, No. 161 (Washington, DC: Bureau of the Census, 1990), 12. 5 See United States, We, the American Foreign Born (Washington, DC: U.S. Census, 1998). 6 See United Kingdom, Committee on Manpower Resources for Science and Technology, The Brain Drain: Report of the Working Group on Migration, Cmnd. 3417 (London: HMSO, 1967); United Nations, Report of the Secre-

Checking the Brain Drain 151

tary General, Outflow of Trained Personnel from the Developing Countries, A/7294 (New York: United Nations, 1968); United States, Congress, House of Representatives, Subcommittee of the Committee on Government Operations, The Brain Drain of Scientists, Engineers and Physicians from the Developing Countries into the United States: Hearings before a Subcommittee of the Committee on Government Operations (Washington, DC: U.S. Government Printing Office, 1968). 7 See Don DeVoretz and Samuel A. Laryea, Canadian Human Capital Transfers: The USA and Beyond (Toronto: C.D. Howe Institute, 1998), Table 7. Analysis by Statistics Canada suggests that DeVoretz and Laryea's estimates are misleadingly large, since many of the emigrants do not have university degrees. Statistics Canada calculates that average annual emigration of engineers from Canada to the United States 1990-6, at 527, was only 1.8 per cent as large as the annual new supply, as represented by new entrants from the education system, re-entrants to the labour force, and immigrants. For computer scientists, it calculates the corresponding emigrant percentage as 0.8 per cent. 8 See Herbert Grubel and Anthony Scott, The Brain Drain: Determinants, Measurement and Welfare Effects (Waterloo: Wilfrid Laurier University Press, 1977), Table 7.2. 9 Ibid., Tables 9.2 and 9.3, compare the migration of scientists and engineers from various countries to the United States as shares of total students in those disciplines in the source countries and as shares of total migration to the United States. Canada ranked third of forty-eight source countries by the first measure and sixteenth by the second. 10 This is quantitatively significant, as U.S. census data show that 56 per cent of Canadian-born managerial workers in the United States do not have any university degree. 11 This is also an important asymmetry, as DeVoretz and Laryea estimate Canadian immigrants in science occupations 1989-96 at 20,726, while Statistics Canada suggests 64,990, even after removing all those who might be considered technologists and technicians. See DeVoretz and Laryea, Canadian Human Capital Transfers. 12 Ibid. DeVoretz and Laryea base their large estimate of churning costs on evidence that recent immigrant male workers long retain salary profiles below those of Canadian-born workers with similar education levels. Statistics Canada finds no such differential for female workers - an increasing share of the total - and that for many highly skilled groups, such as computer scientists, the salary gap disappears within a few years even for males.

152 Economics 13 Borjas claims that the salary gap for recent immigrants, which also appears in U.S. data, is a function largely of the change in the pattern of source countries, with immigrants from poorer countries generally having skills and education that are less easily transferred to U.S. workplaces. See George J. Borjas, 'National Origin and the Skills of Migrants in the Post-War Period,' in George J. Borjas and Richard B. Freeman, eds., Immigration and the Work Force, 17-47 (University of Chicago Press, 1992). 14 The data shown cover those graduates with addresses in the United States or Canada in the records of the UBC, Alumni Association. From the mid1950s to the early 1990s, these average 72 per cent of degrees conferred. The proportion is over 90 per cent for recent years, because of greater efforts to track graduates, but some locations may still refer to parental homes or student addresses. The gap between the number of addresses and the number of degrees granted reflects graduates with whom UBC has not been able to maintain contact. Deceased graduates are classified at their last known addresses. 15 See John F. Helliwell and David F. Helliwell, Tracking UBC Graduates: Trends and Explanations,' Canadian Journal of Policy Research 1, no. 1 (spring 2000), 101-10; and Jeff Frank and Eric Belair, South of the Boarder, Graduates from the Class of'95 Who Moved to the United States: An Analysis of Results from the Survey of 1995 Graduates Who Moved to the United States, Catalogue No. 81-587-XPB. (Ottawa: Statistics Canada, 1999). 16 For an explanation of the gravity model, and for applications explaining migration between Canada and the United States, see John F. Helliwell, How Much Do National Borders Matter? (Washington, DC: Brookings Institution, 1998). 17 See DeVoretz and Laryea, Canadian Human Capital Transfers, Table 3. 18 Excluding temporary traders for business and treaty traders and investors, whom Arnold H. Leibowitz suggests may be less likely to be workers in the United States. The totals are 26,332 in 1989 and 47,915 in 1996. See Arnold H. Leibowitz, Temporary Entrants: The U.S. Nonimmigrant Structure (Washington, DC: U.S. Department of Labor, 1994). 19 Reported in Helliwell, How Much? chap. 5, especially Tables 5.1 and 5.2. 20 Ibid. In particular, comparing the income coefficients of equation (ii) in Table 5.1 with those of equation (ii) of Table 5.2 shows that income differentials are far more likely to spur interprovincial than interstate migration. Adding immigration from the other country - as in equations (iv)-(vi) does not change this result, but there are few additional data being added, since neither census asks for the state or province of birth of those born in the other country.

Checking the Brain Drain 153 21 For example, Long et al. report that 1970s Canadian-born migrants to the United States had average incomes 40 per cent above U.S. averages in 1980, while the gap for U.S.-born migrants to Canada was 15 per cent. See Long et al., Migration, 60. 22 See Borjas, 'National Origin.' Table 1.8 shows that in 1980 recent migrants from Canada to the United States had on average 2.0 years more schooling and 18 per cent higher earnings than the native U.S. population, as well as a lower unemployment rate. CPS data echo these results for more recent migrants and also show them to be much less likely than other U.S. residents to be in receipt of welfare and other social safety net payments. 23 See John F. Helliwell et al., The Structure 0/RDX2, Bank of Canada Staff Research Studies 7, Part 1 and 2 (Ottawa: Bank of Canada, 1971), Part I, chap. 5, and Part 2, pages 42-3. 24 See the papers and comments in Craig Riddell and Andrew Sharpe, eds., The Canada-US Unemployment Rate Gap,' Canadian Public Policy 24, special issue (Feb. 1998), for evidence that the gap in unemployment rates in the 1990s was substantially determined by macroeconomic differences. 25 The emigration equation in Helliwell et al., The Structure 0/RDX2, used the inverse U.S. unemployment rate to reflect the increasing role of the unemployment rate as a measure of job vacancies as the rate gets closer to zero. Taking a drop from 6 per cent to 5 per cent as a basis for the calculations, we find the implied increase in job opportunities to be .033, which we multiply by the estimated coefficient sum of .3713 to get a quarterly emigration effect measured as a percentage of the labour force population. Using 20.3 million for the 1996 size of the Canadian population between 15 and 64, we find an annual migration flow of .3713*.033*4.*.01*20300000. = 9,950. The standard error of this estimate is about 4,300. 26 International tax competition, especially for capital income, raises the possibility, more tangentially related to brain-drain issues, that incomes once saved will be transferred to a tax haven or other low-tax jurisdiction. The implied pressures on national tax systems, and the policy issues thereby raised, are the focus of the recent Mintz report on business taxation in Canada and of the subsequent panel discussion published in the Canadian Tax Journal. Analysis by Statistics Canada shows an increasing trend of emigrating tax files during the 1990s, from 14,450 in 1990 to 26,600 in 1997, averaging 21,300 per year. These figures include retirees as well as people currently employed and cover moves to all countries. The proportion of tax filers moving to the United States may be more or less than the typical U.S. 50 per cent share of Canadian emigrants 27 See Jonathan R. Kesselman, Policies to Stem the Brain Drain - without Ameri-

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28

29 30

31

32

33

34

35

Economics

canizing Canada, Fraser Institute Conference on the Brain Drain, Paper No. 7 (Vancouver: Fraser Institute, 1998); and Charles M. Tiebout, 'A Pure Theory of Local Public Expenditures/ Journal of Political Economy 64 (1956), 416-24. See David Card and Richard B. Freeman, eds., Small Differences That Matter: Labour Markets and Income Maintenance in Canada and the United States (Chicago: University of Chicago Press, 1993). Ibid. See Rebecca M. Blank and Maria J. Hanratty, 'Responding to Need: A Comparison of Social Safety Nets in Canada and the United States,' in Card and Freeman, eds., Small Differences, 191-231. However, as the studies in Miles Corak, ed., Governmental Finances and Generational Equity (Ottawa: Statistics Canada, 1998), demonstrate, it is important, especially for migrants who intend to stay, to think not just about current tax rates and public expenditures, but also about what those policies will look like in future decades and for future generations. While noting the absence of an upward trend in permanent migration to the United States, Steven Globerman argues that the greater inequality of the pre-tax and post-tax incomes in the United States is likely to increase the incentives for the highly paid to move from Canada to the United States. See Steven Globerman, NAFTA and Labour Markets, Fraser Institute Conference on the Brain Drain, Paper No. 4 (Vancouver: Fraser Institute, 1998). Borjas finds a similar effect of income inequality on overall migration patterns to the United States. See Borjas, 'National Origin.' The underlying theory, outlined first by Andrew D. Roy, is that countries with more egalitarian distributions of income are likely to offer lower returns to those at the top end of the distributions of income and education, so that skilled migrants are more likely to be drawn to countries with unequal distributions of income. See Andrew D. Roy, 'Some Thoughts on the Distribution of Income/ Oxford Economic Papers 3 (1952), 135-46. See John Zhao, Drew Doug, and T. Scott Murray, Brain Drain and Brain Gain: The Migration of Knowledge Workers from and to Canada, Catalogue No. 81-003 (Ottawa: Statistics Canada, 2000). See Grubel and Scott, The Brain Drain; J.N. Bhagwati and M. Martington, eds., Taxing the Brain Drain: A Proposal, vols. 1 and 2 (Amsterdam: NorthHolland, 1976); and DeVoretz and Laryea, Canadian Human Capital Transfers. Robert C. Allen argues that on average the higher personal incomes of those with higher educations lead them to pay Canadian taxes that are higher by enough to repay the existing levels of tax support for higher education. This repayment does not take place for emigrants, of course, and

Checking the Brain Drain 155 that is the basis for the exit-tax proposals. See Allen, Paying for University Education, UBC Department of Economics Discussion Paper 98-07 (Vancouver: University of British Columbia, 1998). J.C. Herbert Emery argues that taxpayers' subsidies are especially high only in second-entry professional programs and business schools, so he prefers, instead of an educationbased exit tax, an extension of current moves in several provinces to higher tuition fees in such courses. See Emery, The Financing of Higher Education and the Brain Drain, Fraser Institute Conference on the Brain Drain, Paper No. 5 (Vancouver: Fraser Institute, 1998). 36 This result is often attributed to immigration rules that favour the highly skilled, and such an influence is clearly in evidence in some periods. However, the higher mobility of the more educated shows up also in studies of interprovincial migration, where the decisions are entirely in the hands of the migrants. 37 The fact that PhDs produced in Canada are likely to seek and find employment nearby is shown by analysis of the place of residence of UBC PhDs of different vintages. As the annual number of PhDs produced has grown rapidly over the past twenty-five years, the number employed and living in British Columbia has grown even faster. 38 The data are from John F. Helliwell, 'What Have Canadian Economists Been Doing for the Past Twenty-five Years?' Canadian Journal of Economics 26, no. 1 (1993), 42. The increased size and stature of graduate programs in Canadian universities will also have increased at least the gross number of highly trained migrants from Canada to the United States, since Canadian programs now attract high-level candidates from around the world, including the United States, and these foreign students may be more likely than Canadian-born to search for and accept positions outside Canada on receipt of their graduate degrees. The re-export of foreign-born graduates may represent a large part of the total emigration. For example, the National Graduates Survey of 1995 shows that in science and engineering the proportion of foreign-born students is as high as the proportion of graduates who are living and working in other countries, suggesting that any loss of Canadian-born graduates emigrating is at least offset by foreign students in Canadian universities who subsequently settle in Canada. 39 See Kevin W. Murphy, Craig W. Riddell, and Paul M. Romer, Wages, Skills and Technology in the United States and Canada, Working Paper No. 6638 (Cambridge, Mass.: National Bureau of Economic Research, 1998). 40 The bulge is likely to be larger in Canada than in the United States. The more concentrated growth of Canadian universities produced a greater bulge in the numbers of those approaching sixty-five, while the absence of

156 Economics mandatory retirement in the United States will be likely to smooth the echo effect in new hiring. 41 Examples might include the high proportion of immigrant doctors in northern Canada, and evidence that immigration to Australia in the 1960s helped to match job vacancies with willing workers and hence to reduce frictional unemployment. 42 The benefits of higher and more equally distributed standards of health and education extend beyond the returns accruing to those in better states of health and knowledge, since both health and education appear to several intangible features of community health sometimes referred to as social capital. For example, John F. Helliwell and Robert D. Putnam use U.S. survey data to confirm a robust linkage between education and measures of trust and community participation, and Stephen Knack and Philip Keefer, as well as John F. Helliwell and Robert D. Putnam, have found some evidence that these measures of social capital in turn improve aggregate economic performance. See John F. Helliwell and Robert D. Putnam, 'Social Capital and Economic Growth in Italy,' Eastern Economic Journal 21, no. 3 (1995), 295-307; Stephen Knack and Philip Keefer, 'Does Social Capital Have an Economic Payoff? A Cross-Country Investigation,' Quarterly Journal of Economics 112, no. 4 (Nov. 1997), 1251-88; and John F. Helliwell and Robert D. Putnam, Education and Social Capital, Working Paper No. 7121 (Cambridge, Mass.: National Bureau of Economic Research, 1999). 43 Research by D.T. Coe and E. Helpman, 'International R&D Spillovers,' European Economic Review 39 (1995), 859-87, shows that R&D in the OECD countries has valuable domestic and international spillovers, while calculations in Helliwell, How Much? Table 6.1, show that Coe and Helpman's estimates imply strong border effects for R&D. Thus research done in Canada has a much large effect on domestic productivity than does the same amount of research spending in the United States.

Part Two

Culture

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6. North American Integration and Canadian Culture Gilbert Gagne

North American integration, or continentalism, has generally been considered as a threat to Canadian culture. The simple fact of living next to the United States, Canada's giant neighbour, has proven a source of concern in terms of the viability of the Canadian polity. In such conditions, 'free trade is as much about identity politics as it is about economic relations between sovereign states.'1 For almost as long as Canada's existence, there have been attempts to foster a genuinely national culture and identity in the face of pervasive U.S. influence. However, policies to protect and promote national culture and identity entail restrictions that contravene principles of liberalization, which a trade-dependent country such as Canada has otherwise benefited from and strongly promoted. This conflict largely explains why Canadian authorities, while seeking a free trade agreement with the United States, have also insisted on exempting the cultural sector. Despite U.S. objections, Canada secured a 'conditional' exemption for culture in the Canada-U.S. Free Trade Agreement (FTA) of 1988, which was incorporated into the North American Free Trade Agreement (NAFTA).2 Because of the economic and political significance of cultural industries, the United States has continued, indeed with more insistence, to denounce and threaten to retaliate against Canadian cultural initiatives. In the context of North American integration, cultural policies have proven one of the main problems for Canadian sovereignty, as well as one of the main 'irri-

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tants' in Canadian-American relations. As far back as the 1960s, John Kenneth Galbraith argued that the critical issues in sovereignty were not economic but cultural.3 This chapter looks at Ottawa's ability to promote and protect Canadian cultural industries before and since the inception of the FTA. Canada's constraints in culture are severe when compared with those in most other economic and political spheres considered in this book. Yet Canada may have more policy autonomy in culture than is commonly assumed. It may possess some leeway to ensure the required conditions for the pursuit of meaningful national cultural policies. Canada should skilfully capitalize on its 'special relationship' with the United States to obtain crucial concessions, as it did in the bilateral agreement of 1999 that settled the dispute over the protection of Canadian periodicals. It should also continue to build strategic alliances to have the specific character of culture recognized within international economic regimes, especially the World Trade Organization (WTO). Here also, the United States may have to compromise for fear of jeopardizing its whole liberalizing agenda, as exemplified by the controversy over culture that helped undermine negotiations for a Multilateral Agreement on Investment (MAI). This chapter first reviews briefly the central questions about Canadian culture and its development of cultural policies in the light of U.S. influence and North American integration, as well as about the motives for the Americans' hostile stance on national, especially Canadian, cultural policies. Second, it examines the FTA and NAFTA's provisions on culture, along with the conflicts that have accompanied them. Third, it looks at culture and the issue of cultural exception at the international/multilateral level, particularly at the Canadian-U.S. dispute over periodicals, which was addressed within both NAFTA and the WTO, and proved a test case. The conclusion returns to the broader question of North American integration and Canadian culture. Canadian Culture, U.S. Influence, and North American Integration This section considers the challenge to Canadian culture and identity from North American integration before looking at the evolution of Canadian cultural policies. It later discusses culture policy in Quebec, before concluding on the modern challenge to cultural policy.

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The Challenge to Canadian Culture and Identity When considering issues and trends pertaining to culture, one has first to clarify its meaning and/or one's perspective. In the most general, anthropological sense, culture refers to 'a given people's particular set of preferences, predispositions, attitudes, goals, its particular way of perceiving, feeling, thinking, and reacting to objective reality/4 In this chapter, culture consists of 'the works and practices of intellectual and especially artistic activity.'5 In North America, while Americans tend to think of culture in terms of fine arts, literature, opera, ballet, and classical music ('high' culture), for Canadians it also includes books, magazines, newspapers, movies, video and music recordings, radio, and television. What corresponds to mass or popular culture in Canada is seen merely as an 'industry' in the United States. The notion of identity relates to the tendency of individuals and groups to develop a sense of who they are in relation to their shared psychological, sociological, and political attachments to each other.6 The concept of national identity embraces a very broad sociological and anthropological vision of culture - defined in terms not only of language, social and family institutions, specific traditions and mores, artistic and literary achievements, and popular entertainment, but also of 'lifestyle/ which encompasses all aspects of human activity, be they social, religious, aesthetic, cultural, political, or economic.7 Canadian culture and identity have most often been studied in the light of national values and political culture.8 Drawing on the comparative method, Canadian analyses have almost invariably contrasted Canadian with U.S. culture and identity. The most common line of argument has been that Canadian institutions, beliefs, and behaviour are more British, elitist, deferential, bureaucratic, state-oriented, collectivist, orderly, and conservative; are lacking heroes and founding myths; and are preoccupied with national unity in a binational political setting. For their part, Americans are more individualistic, anti-statist, selfabsorbed, moralistic, egalitarian, religious, ideological, and imperialistic. Some recent scholarship has attributed some Canadian key values, such as toryism and socialism, to anti-Americanism and defensiveness.9 Such analyses, as David Thomas points out, often leave us none the wiser about the details that make possible useful comparisons. Canadian-American differences need be assessed at the 'mid-range' level, where operational comparisons are easier and more precise and may cast light on broader generalizations.10 Studies have focused on

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the extent of the two societies' value convergence (or divergence), as well as on related issues and trends.11 As Bernier emphasizes, there has been little serious reflection on the cultural dimension of economic integration - a very controversial issue. National culture and identity can hardly escape the effects of free trade, which tends to limit state intervention in the economy and to impose the same commercial mould on the myriad activities of citizens. Yet it is difficult to gauge precisely how the FTA and NAFTA have affected Canadian national identity, which would require fairly accurate pictures of Canadian national identity at the incepton of the FTA and since.12 Changes brought about by free trade, when considered individually, hardly seem likely to affect Canada's national identity. But viewed as a whole, they reveal a shift of attitude about the role of state intervention in the economy and the comparative importance of individual rights versus the public interest.13 It is difficult, however, to isolate changes resulting from free trade from changes caused by other seemingly unrelated factors. Lipset claims that the adoption in 1982 of a Charter of Rights and Freedoms has done most to Americanize Canada.14 Since the early twentieth century, Canada has sought to encourage a national culture and to further a feeling of identity among its citizens. If such initiatives on the part of states are nearly universal, they have taken on a particular importance in the Canadian case, in view of the weight and influence of its American neighbour. Federal and provincial governments have adopted a whole series of policies and measures to promote and protect Canadian cultural industries. They hoped thereby both to preserve the necessary space for the dynamism of Canadian culture and the development of cultural industries and to address threats from foreign cultural exports, especially from the United States. Statistical figures are quite eloquent: 95 per cent of films featured in Canada, 85 per cent of retail sales of sound recordings (including 70 per cent of French-language retail sales), 83 per cent of newsstand magazines, 70 per cent of radio music, 70 per cent of books, and 60 per cent of television programs (33 per cent in the case of French-language television) come from abroad, overwhelmingly from the United States.15 Yet, save for the appearance of new technologies, similar figures and problems have prevailed since the 1920s. Hence, despite the active promotion and protection of its cultural industries, Canada has long been a largely open market for foreign cultural products. From this perspective, continentalism could hardly appear a threat to Canadian culture and distinctiveness. In addition, some say that Canadian

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cultural policy has had an overly narrow definition of culture - as the promotion of cultural industries, such as magazines and the performing arts - at the expense of more locally rooted and informal expressions of culture.16 International integration does not affect all aspects of national cultures and identities in the same way and to the same extent. It relates primarily to trade and investment in cultural goods and services, as well as to governments' ability to promote and protect cultural industries. Canadian culture in a wider, anthropological sense is much less directly affected by such an external process. Furthermore, the impact of integration on culture would be much more difficult to assess when considered so broadly or in all its aspects. In this chapter, I focus on cultural sovereignty, understood as a government's ability to control the operation of cultural industries.17 Although this is only one aspect of culture, it is a crucial one. It has been at the centre of government efforts to foster Canadian culture. More fundamentally, cultural industries are the means through which Canadians can most clearly express and project who and what they are. Finally, as the aspect most directly affected by North American integration, it is also the one where external constraints are principally felt. Evolution of Cultural Policies Government policies to foster Canadian culture fall into two broad categories - protecting Canadian cultural industries with regulatory or tariff barriers and promoting indigenous Canadian culture through subsidies to individual artists and creators or through governmentsponsored creation of cultural infrastructure. Canada's cultural policy has been oriented towards two main goals - development of Canadian cultural content and assured domestic access to it. Government cultural policies and measures have usually begun with investigations reports by royal commissions, task forces, and special committees. The main ones have been the Aird Commission in 1929 on radio broadcasting; the Massey-Levesque Commission of 1949-51 on national development in the arts, letters, and sciences; and the Applebaum-Hebert Committee in the early 1980s on federal cultural policy.18 For purposes of analysis, we can divide the cultural interventions of the Canadian government into two distinct periods - 1867-1956, focused mainly on establishment of public institutions, and 1957 onwards, with development of a set of instruments.19 The first era centred around state institutions, first in heritage and later in broad-

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casting. Among the principal instruments are the National Gallery of Art (established in 1880), the Public Archives (1912), the National Film Board (1939), and the National Library (1953). The report of the Aird Commission in 1929 led to creation in 1936 of the Canadian Broadcasting Corporation (CBC). The second era saw adoption of the activist approach recommended by the Massey-Levesque Commission, whose report proved the most influential document in Canada's cultural history. It led to creation in 1957 of the Canada Council (now the Canada Council for the Arts), still the key institution for the promotion of Canadian visual, performing, and literary arts. In 1963, the portfolio of Secretary of State (now the Department of Canadian Heritage) was created to oversee the federal government's initiatives for arts and culture in Canada. In 1968, Ottawa set up the Canadian Radio-television and Telecommunications Commission (CRTC), which now regulates the broadcasting, cable, and telecommunications industries, and the Canadian Film Development Corporation (now Telefilm Canada), to direct federal involvement in the film industry. Ottawa promotes and protects Canadian cultural expression through the major publicly financed institutions, by grants, tax credits, tariffs, and quotas, and through a whole array of programs, funds, laws, and regulations. The laws and regulations pertain to, among other things, reviews of foreign investment in the cultural sector. The Investment Canada Act contains specific provisions to review scrupulously foreign investment relating to Canadian 'cultural heritage and national identity.' This legislation, adopted in 1985 to replace the Foreign Investment Review Act of 1976, was otherwise meant to liberalize investment by reducing the number of operations to be screened. Any foreign investment in the cultural field greater than $5 million is to be examined.20 Culture Policy in Quebec With one-quarter of the country's population, Quebec has a set of specific traditions and customs; as North America's only predominantly French-speaking society, Quebec is significantly distinct culturally.21 In the 1980s, whereas free trade faced strong opposition in English Canada, it was generally well received in Quebec and was not perceived as a threat to its culture.22 Quebec has a less defensive attitude to U.S. cultural influence, owing to its language, which slows and lessens that influence. Quebec has also been more willing to assert its North Americanness,

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partly to gain leverage with the federal government.'23 As Roger Gibbins observes, 'the Quebecois ... have used the Quebec provincial government as an instrument of cultural survival' - much as English Canadians have used the federal government.24 Quebec's governments, whether federalist or sovereigntist, have insisted on their role in fostering francophone culture. Domestically, this relates to a fight about federal and provincial jurisdictions over culture. Although both governments have similar views on culture, notably with regard to cultural exception, Quebec has insisted on having its own voice in international forums, particularly given the ambiguity of the Constitution Act as regards provinces' ability to conduct external relations in their spheres of jurisdiction.25 Quebecers continue to fear the further grip of the 'Canadian nation,' denying their identity, more than U.S. cultural influence.26 Overall, this is translation of Canada's 'constitutional' problems into the crucial issues of national culture and identity. As for constraints on cultural policy resulting from a hostile U.S. stance, problems and trends have been essentially the same as Ottawa's. U.S. interests have been equally critical of Quebec's proposed or actual cultural initiatives and of the federal government's. Its proposed policy on film distribution in 1983 met with the same fate as a similar federal proposal in the late 1980s.27 The Modern Challenge to Cultural Policy What has come to be known as the Canadian model of cultural affirmation is facing challenges from emerging technologies, globalization, and the application of international trade rules. Certain instruments to foster Canadian culture will likely have to give way to others, or be revised, to better conform to prevailing or coming conditions. For example, subsidizing individual creators, producers, or distributors may certainly continue (subject to conformity with international provisions), but new technologies may well render moot other instruments. Hence border measures are increasingly irrelevant or illicit. Notably, in the early 1990s electronic transmission bypassed a ban on the import of foreign magazines' split-run editions. Soon afterwards, WTO panels declared measures such as the import ban of 1965 on split runs incompatible with the rules governing international trade.28 Also, in publications, and in cultural industries more generally, concern may switch from ownership to content and control, as indicated by the 1999 Canadian-U.S. agreement on periodicals.29

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Morever, for new technologies, such as the internet, satellite communication, cable and multimedia programs, and interactive programming, present forms of regulation are problematic. In 1999, the CRTC renounced any form of content regulation for the internet. A new approach centred on promotion is likely to emerge, to foster Canadian content and ensure its availability, both in Canada and abroad.30 Opportunities for Canadian cultural policy have surfaced in the increasing success abroad of Canadian cultural goods and services. One challenge is to relate cultural objectives more effectively to trade and investment objectives. Despite Canada's expertise and advantage in multimedia and telecommunication, domestic restrictions may inhibit export of such cultural goods and services. The recent WTO agreement liberalizing telecommunication services may offer an opportunity in this regard. U.S. criticism of Canadian cultural policy has varied in strength, focusing most harshly on protection. Measures of protection, such as investment reviews, regulations, and quotas that limit the power of U.S. enterprises to penetrate foreign markets, have received systematic denunciation from U.S. firms and governments. American authorities clearly identified the Investment Canada Act and the Canadian Broadcasting Act as barriers to U.S. exports.31 Bill C-58, a 1976 amendment to the Income Tax Act, disallowed deductions for advertising costs to Canadian businesses that attempted to reach their domestic market via U.S. radio and television stations or periodicals.32 It has proven a major irritant in bilateral relations. In contrast, measures for the promotion of cultural industries, mainly in the form of public institutions and subsidies, have not been considered to affect significantly the interests of U.S. firms and have generally been tolerated. Yet the United States, in the periodicals dispute of 1996-7, denounced before the WTO the postal subsidies benefiting Canadian magazines - an issue debated during the FTA negotiations. This development may signal a worrying trend, threatening a much larger segment of Canadian cultural measures. Many Americans see any actions perceived to interfere with such cherished principles as the 'free flow' of information as intrinsically wrong. Also, and perhaps more important, the U.S. publishing and entertainment industries represent one of the most profitable U.S. export sectors. The information and communications industries now have a central role in the U.S. economy. American cultural industries have expanded in foreign markets in order to increase profits and/or

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to amortize ever more costly investments, particularly in the audiovisual sector. Furthermore, Canada, for both geographical and linguistic reasons, has been their single largest export market - sometimes called the 'candy store.' In 1989, Canadians bought about 40 per cent of all U.S. books and about 80 per cent of all U.S. magazines sold abroad, worth more than U.S.$1.4 billion - not to mention American movie and broadcast exports to Canada.33 If Americans really believe in the virtues of free trade, John Meisel pointed out, 'this ideological position often miraculously coincides with crass self-serving economic interests/34 More fundamentally, the communication industries have long been a crucial element in ensuring American hegemony in the world, and therefore have proven a central pillar of U.S. foreign policy.35 U.S. authorities have aggressively voiced and defended the concerns and interests of American cultural industries.36 FTA and NAFTA on Culture and Disputes Canada's cultural policies have long constituted an irritant in its relations with the United States. Almost any initiative of Canada's to protect its culture has met with criticism, accompanied by pressures on its authorities, often leading to bilateral disputes. It sought to exclude the cultural sector from the purview of the FTA in the late 1980s. Despite U.S. objections, it insisted that culture is not merchandise and in fact touches on a country's fabric and very identity. Article 2005, paragraph 1, of the FTA specifies that 'cultural industries are exempt from the provisions of this Agreement.' Yet certain specific commitments in the FTA pertain to these industries.37 This broad and outright exemption for the cultural sector was incorporated into NAFTA and extended not only to enterprises, as in the FTA, but also to individuals working in the cultural industries.38 However, the United States reserved a right to retaliate. The second paragraph of FTA's article 2005 stipulates that 'a party may take measures of equivalent commercial effect in response to actions that would have been inconsistent with this Agreement but for paragraph 1.' As Bernier points out, if Canada is ready to pay the price, it can maintain measures incompatible with the FTA.39 This so-called retaliatory clause is quite significant. The language of the FTA and NAFTA's provisions on culture much reflects U.S. market views on culture. Take the notion of 'measures of equivalent commercial effect.' If what is at stake (Canadian culture) is part of a nation's

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soul, how can this notion be understood unless culture is assimilated to a tradeable commodity? Moreover, the significance of the retaliation clause stems from the great and ever-increasing Canadian dependence on the U.S. market. Foreign exports already accounted for 24 per cent of Canada's GDP in 1991, and by 1998 the proportion had reached 40 per cent. The U.S. share of those exports grew from nearly 75 per cent in 1988, the last year before free trade, to nearly 85 per cent in 1998, or 33 per cent of the country's GDP. In 1988, Canadian exports to the United States amounted to just over $102 billion, and in 1996, nearly $218 billion.40 Thus the very success of North American integration has exposed Canadian cultural policies ever more to U.S. retaliation. The FTA and NAFTA's provisions on culture are now recognized as being inadequate to enable Canada actively to promote and protect its cultural industries. U.S. power politics and continuous threats of retaliation seriously jeopardize the viability of Canadian cultural policies, as exemplified by a series of bilateral disputes within the past few years. Canada and the United States have had different interpretations of the FTA and NAFTA's cultural exemption. Whereas Canada sees retaliation as permissible only in cases of non-compliance with the explicit cultural commitments included in the FTA, the United States has considered that it is entitled to retaliate against any new measures affecting its cultural industries.41 Neither party has been willing to test the meaning of the provisions. Moreover, the United States has had the latitude to determine the economic sectors subject to trade sanctions. Almost systematically, it has targeted numerous, unrelated sectors, sensitive for Canadian interests, the list of which it could modify at any time. This so-called carousel approach, clearly aimed at affecting various important interests, intensifies pressure on Canadian authorities. In the Canadian-U.S. periodicals dispute, the Americans threatened in early 1999 to apply punitive tariffs against Canadian exports of steel, wood products, plastics, and textiles.42 U.S.-threatened sanctions were also far in excess of the equivalent commercial effect of the proposed Canadian policy on periodicals. However, in case U.S. sanctions were excessive, Canada could resort to either NAFTA's general dispute settlement procedure (NAFTA chapter 20) or the WTO's. The exemption clause has indeed not led to any improvement in Canadian-American 'cultural' relations, which have remained acrimonious, but with greater frequency and tension. The United States objects to such restrictions in a context of economic globalization, especially within NAFTA, which gives Canada privileged access to the

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American market. In the absence of bilateral agreement on the treatment of culture, the exemption could not dispose of this most serious threat to Canadian cultural policies. Learning its lesson, Canada has secured an unconditional exemption for culture - i.e., the absence of any retaliation right - in its recent bilateral free trade agreements, with Chile and Israel. Both before and since signing of the FTA, a clear pattern has been noticeable in 'cultural' talks with the United States. Canadian authorities have tended to bow to U.S. pressure. Proposed policies, notably on film distribution, have been watered down considerably, and existing policies, as on Canadian ownership in publishing, have been applied leniently - many would argue, to the extent of being rendered meaningless.43 A report by the United States Trade Representative in 1984 made special mention of Canada for its trade barriers erected under the guise of cultural concerns;44 of all the measures singled out there as trade irritants, only two are still in place.45 Despite the policy changes, the pressure continues. Within the past few years, the United States has criticized both Canada's measures to encourage the development of Canadian services for the transmission of television programs by satellite and the Investment Canada Agency's refusal to authorize establishment of the U.S. bookstore chain Borders in Toronto, although neither matter developed into an overt trade dispute. However, in cases where the Canadian government appeared determined to resist despite persistent U.S. objections, open trade disputes ensued, as with the CRTC's decision to remove from Canadian television cable the U.S. channel Country Music Television in favour of the Canadian New Country Network and, more important, with measures to protect Canada's periodicals industry.46 In periodicals, an accumulation of bilateral tensions over Canadian cultural protection prompted a strong American reaction. Setting a precedent, U.S. authorities took their grievances to the WTO in the most formidable challenge ever launched against Canada's cultural policies. Many countries followed the conflict closely and fear for their cultural identity if Americans continue their attacks on national cultural policies. Cultural Exception and Periodicals At the international level, national cultural policies, such as the ones pursued in Canada, have been the object of a major controversy

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between proponents of two opposite perspectives. For one, although cultural goods and services have commercial value and are a component of trade circuits, they cannot be assimilated to 'merchandise' as they carry symbols and values and therefore touch on the very fabric and identity of a political community. Hence, culture should be subject to an exception to the rules and principles of trade liberalization. This consideration gives rise to the notion or principle of cultural exception, which has been advocated primarily by the governments of Canada and France. From the other perspective, culture represents an economic sector like the others, and public measures to promote and protect cultural 'goods' constitute another unacceptable form of trade protectionism. Such a view has been asserted principally by the United States. This economic perspective has prevailed at the international level as a result of U.S. power and influence, as well as the overwhelming competitive advantage enjoyed by its cultural industries. The prevalence of general principles of liberalization in international economic negotiations and decisions has resulted in a disregard for concerns such as cultural identity. No multilateral regime provides a general exemption in favour of culture like NAFTA's or recognizes the specific character of the cultural sector, despite efforts by Canada and France. Thus the United States is not restricted to pressures and possible retaliation, as within NAFTA, but can attack the very legitimacy of any measure that may affect the interests of its cultural industries. In its WTO challenge to Canada's measures in favour of periodicals, the United States sought to set a precedent in a world forum. During the Uruguay Round of multilateral trade negotiations, Canada made no commitments regarding cultural services in the General Agreement on Trade in Services (GATS).47 At least in theory, it could maintain its current policies and further its programs and regulations for the promotion and protection of its national culture.48 The principle of cultural exception was debated also during the MAI negotiations under the auspices of the Organization for Economic Cooperation and Development (OECD). The ensuing controversy among national delegations and, increasingly, among their citizens, was one of the main reasons that France withdrew from the negotiations in autumn 1998, marking their end, at least within the OECD.49 With the primary objective of strengthening its position, the Canadian government took the lead in the creation in 1998 of the International Network on Cultural Policy (INCP), a broad-based grouping of culture ministers in favour of diversity (Cultural Policy Network). By

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2001, this network had forty-five members, including Mexico and member states of the European Union (EU) such as France and the United Kingdom. Only this - especially an effective alliance with the EU - seems likely to make the United States compromise on the principle of cultural exception. Indeed, the United States fears that this group could prove a forum for the promotion of a form of cultural exception in coming multilateral trade negotiations. The combination of Canada's stance internationally and its domestic cultural policies has infuriated the United States. That is why that country took its grievances over periodicals to the WTO. The conflict proved a test case on typical issues and tensions between the two nations over cultural sovereignty, as well as on the very principle of cultural exception. Its recent resolution in a bilateral setting may foreshadow a new era in Canadian-U.S. cultural relations. U.S. irritation over protection of Canadian magazines dates back to the 1920s and the first measures in favour of Canadian culture and periodicals. Tension recurred in 1955-65, in 1976, and 1993-9.50 The most recent and serious episode started with the launch in April 1993 of a split-run edition of the U.S. magazine Sports Illustrated, now part of the America On Line-Time Warner conglomerate. As the magazine's content was transmitted electronically to a printing plant in Ontario, the periodical, technically speaking, did not materially cross the border, circumventing the nearly thirty-year-old ban on import of split runs. Again, new technology challenged traditional instruments of cultural policy. In addition, the Ontario printing plant was owned by Quebecor, a Canadian communication conglomerate. Ottawa responded quickly with the establishment of a task force on the Canadian magazine industry. The task force's report, repeating the concerns already expressed in the Report of the Royal Commission on Publications of 1961 (O'Leary Report), emphasized - a contested argument - that in the absence of a complete editing operation in Canada, split runs can offer cheaper advertising inserts and then deprive Canadian periodicals of their main source of revenue. Domestic periodicals then risk disappearing, depriving Canadians of access to their own information and ideas through genuine home-grown publications.51 The task force's recommendations led to the adoption, in December 1995, of new federal legislation that imposed an 80 per cent excise tax on the value of advertisements in split runs distributed in Canada, payable per issue by the publisher.52 Making split runs unprofitable, this measure kept them out of the Canadian market.

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In its WTO challenge, the United States contested the recent excise tax, the 1965 import ban, preferential postal rates granted by Canada Post to certain types of periodicals and funded by Heritage Canada, and differential rates applicable to foreign periodicals. WTO authorities found these practices incompatible with Canada's international trade obligations.53 The Canadian government decided to comply with the WTO's rulings and by October 1998 had removed the excise tax and the import ban. It has equalized postal rates for domestic and foreign publications, and postal subsidies now go directly to publishers. On this last aspect, the terms of WTO rulings gave Canada another means to pursue the same objective. As the General Agreement on Tariffs and Trade (GATT) does not contain any provision allowing flexibility to accommodate national cultural policies - except for article IV on national quotas for cinematic film - the periodicals dispute led to an interpretation of international trade rules that ignored the cultural dimension and considered only the principles of liberalization. Yet in its report the WTO dispute panel stressed that its mandate was to determine whether the treatment of imported periodicals was compatible with GATT rules - hence to judge the 'instruments' used by Canada to reach its objectives - not to decide the power of WTO members to adopt measures to preserve their cultural identity. This, the first dispute relating to the cultural sector to be addressed under the WTO, raised observers' worst fears as to the incompatibility of national cultural policies with the international trading regime. The revised policy on periodicals that Canada proposed still infuriated the United States, as it would have forbidden foreign publications from including Canadian advertisements. It was submitted to Parliament in October 1998 but had not yet been adopted by the Senate when the two countries reached an agreement settling the dispute.54 Ottawa has insisted that its policy was consistent with international obligations. Whereas the previous instruments were examined under the GATT,55 applying to trade in goods, the new policy relates to advertising 'services' under the GATS, within which Canadian authorities made no commitments on advertising and cultural services as a whole. Yet Canada had already argued unsuccessfully before WTO panels that its previous measures had to be examined under the GATS obligations. Moreover, WTO authorities have indicated that the relationship between GATS and cultural services, on the one hand, and GATT, on the other, can be determined only case by case, taking into

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account the nature and effects of the measures at issue. Hence, it is not at all certain that the new Canadian magazine policy would be permissible under the WTO, as this again raises the issues of the treatment of culture and the relationship between GATT and GATS. Repeating the standard pattern, the United States bullied Canada with trade sanctions but this time announced that it would resort to NAFTA provisions, as these allow more latitude than WTO rules to determine the timing and conditions for retaliation. Following a year of arduous bilateral negotiations, the two sides reached a compromise in May 1999 in order to avoid a trade war. These talks considered not only Bill C-55, but all the Canadian measures in favour of periodicals, including restrictions on foreign ownership. In short, the agreement provides that foreign magazines can include up to 18 per cent of Canadian advertisements. To have full access to the Canadian advertising market, foreign publishers must, subject to a review by Heritage Canada, set up a new business in Canada and ensure a majority of Canadian content. The federal government also announced a subsidy program to help domestic publications that may face difficulties because of the new competitive conditions. The Canadian government stressed that this agreement marked a precedent, as the United States explicitly recognized the right of a country such as Canada to protect its cultural industries, agreeing to conditions regarding Canadian content in periodicals. As is often the case in such bilateral deals, the United States committed itself not to attack the new Canadian magazine policy, as amended, in international forums or under its trade legislation.56 The bilateral agreement could lead to recognition within the international trading regime of the specifics of culture, beyond its market dimension. The agreement revealed some U.S. flexibility on cultural issues. Yet the U.S. government had also sought to avoid offering any recognition of a certain form of cultural exception and feared more than anything else to set a precedent with implications in the multilateral regime, particularly in its relations with the EU. Thus it remains to be seen whether this more accommodating U.S. approach will translate to the multilateral framework.57 At the time of the WTO ministerial meeting in late November 1999, which ended in failure for reasons other than culture, Canada's strategy was to seek recognition of cultural diversity, including the creation of a new international instrument allowing states to maintain cultural policies.58 Also, Sergio Marchi, Canada's ambassador to the WTO and

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former minister of international trade, was in 2000 appointed chair of the WTO's Council for Trade in Services and so will oversee the negotiations on services. Canada relies on the Cultural Policy Network for the leverage to secure international acceptance of the principle of cultural exception. Like-minded governments have struck alliances in order to influence the development of international trade provisions.59 Similarly, multilateral negotiations on culture could take place in more than one forum. Canada has considered the United Nations Educational, Scientific and Cultural Organization (UNESCO) as a forum in which to build consensus over its idea of an international instrument on cultural diversity. Yet discussions on culture within UNESCO can serve also to develop a consensus that could be taken to trade negotiations. Canada should continue its efforts, alongside its partners in the Cultural Policy Network, to obtain recognition of the specific character of culture within international economic regimes, primarily the WTO, so as to make national cultural policies permissible under international provisions. On the cultural front, a dilemma for Canada is that even though it pursues both the continental and the multilateral approaches, one may jeopardize the other. Washington has tended to view the multilateral approach as a betrayal of its 'special relationship' with Canada. Yet recent multilateral developments suggest that Canada may strengthen its position by forging alliances with states sharing similar views on culture. The pervasive influence and dominance of U.S. culture throughout the world, particularly in Europe, may well lead to further resentment, which in turn could stall the globalizing process. In 1998, culture proved a key factor in the failure of the U.S.-sponsored MAI. U.S. cultural imperialism is also one of the main factors stimulating opposition to the globalization process among ever-growing numbers of people around the world. As a result, U.S. authorities are likely to need to compromise on cultural exception to avoid a 'globalization backlash' and to preserve their overall liberalizing agenda.60

Conclusion Has North American integration had any significant impact on Canadian culture? As a result of U.S. imperialism, the FTA and NAFTA could hardly have improved the difficult situation traditionally confronting Canadian culture and cultural policy. U.S. influence is as

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pervasive as ever, U.S. attitudes to Canadian policies are as hostile as ever, and U.S. pressure even seems to have increased. These tensions are the result of the combination of developments in communications industries with U.S. views and interests. Canada's vulnerability to U.S. threats has inevitably grown as a result of free trade. However, the world's liberalizing or globalizing trend, of which Canada is a strong supporter, also leads to opportunities in the cultural field, mainly from technologies where Canadians possess assets. Fostering a national culture has been a constant and a traditional reason to oppose continental free trade. Now, in the context of North American integration, should Canada accede to cultural convergence, and therefore to the failure of Canadian policy to ensure a genuinely distinctive culture? Given all the dimensions of culture, it is almost impossible to reach a definitive answer. There may or may not be convergence in some fields. Although Canadians, as North Americans, are heavily influenced by the United States, this does not make them Americans; a certain level of distinctiveness persists. In this sense, the border has an effect and still matters. A recent study commissioned by the Canadian government concludes that issues related to globalization and identity will emerge as the dominant national debate over the next five years.61 What is primarily at stake as a result of continental integration and globalization is cultural sovereignty - a nation's ability to promote and protect it cultural industries, which in Canada represent the main vehicle through which citizens can express and project themselves. As cultural policies inevitably entail restrictions on international exchanges, they contradict general liberalizing principles and trends, which Canada has otherwise strongly promoted and which underlie the U.S.-led processes of economic regionalization and globalization. Unless and until there are compromises to accommodate both free trade and principles of cultural policy, U.S. pressure and retaliatory threats against Canadian cultural initiatives will raise the issue of the sustainability of these policies in a context of growing North American integration. In addition to instances of power politics, U.S. cultural imperialism has been reflected in the provisions and principles of the world trading regime. WTO rules offer no recognition of the specific character of culture. Not only the WTO's provisions but its decisions have clearly revealed the predominance of liberalization over culture and identity. For the past few years, there has been a growing contradiction between

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Canada's WTO and its NAFTA obligations with regard to culture. How can Canada preserve its cultural policies, exempted from NAFTA, while remaining committed to a multilateral regime that makes no exception for culture? An exemption clause, such as NAFTA's, does little to protect national cultural policies when the United States, towards which Canada has become ever more dependent under free trade, enjoys considerable latitude to retaliate. On the international scene, a raging debate pits the United States and proponents of all-out liberalization against Canada and France and supporters of a general principle of cultural exception. Between these two positions, more and more governments favour a more or less pronounced form of cultural exception. It is essential to secure recognition in the world economic regime of the specific character of culture. Canadian authorities have proven inclined to allow culture to be part of multilateral rules if its unique character is recognized or subject to specific provisions. Despite inevitable concessions, such recognition at least would allow the specification of which cultural measures could be acceptable and under which conditions. In turn, this arrangement should enable states to pursue (some) cultural policies without fear of trade retaliation or at least limit U.S. freedom to attack cultural measures. If necessary, this strategy could be pursued not only in the WTO framework, but in other forums such as UNESCO, where all aspects of culture, not only its market dimension, are more likely to be considered. Following a broad consensus within UNESCO, international negotiations on culture can be taken up to the WTO. Canada should continue to capitalize on its 'special relationship' to secure crucial concessions - the bilateral agreement of 1999 that settled the dispute over periodicals has revealed a certain U.S. flexibility on cultural issues, at least vis-a-vis Canada. Concurrently, Canada should work with its allies in the Cultural Policy Network for an effective translation of the principle of cultural exception at the multilateral level. This two-pronged strategy, if cleverly pursued, should put Canada in a position to ensure the required conditions for the preservation of meaningful national cultural policies. For Canada, the challenge is to play skilfully on the international scene to secure its national culture and cultural sovereignty, despite increasing economic integration. Maclean's magazine asked readers to complete the phrase 'As Canadian as ...' Deservingly, the winner and his or her answer was: 'As Canadian as possible under the circumstances.'

North American Integration and Canadian Culture 177 NOTES 1 Mildred A. Schwartz, 'NAFTA and the Fragmentation of Canada/ American Review of Canadian Studies 28, nos 1-2 (spring-summer 1998), 12. 2 Canada, External Affairs, The Canada-U.S. Free Trade Agreement (Ottawa, 1987); Canada, North American Free Trade Agreement (Minister of Supply and Services, 1992). The FTA came into force in January 1989 and was superseded by NAFTA, effective January 1994. NAFTA's members are Canada, Mexico, and the United States. 3 As quoted in R.P. Bowles et al., Canada and the U.S.: Continental Partners or Wary Neighbours (Scarborough: Prentice-Hall, 1973), 88-9. 4 Raymond Gagne, 'French Canada: The Interrelationship between Culture, Language and Personality,' in Bruce Hodgins and Robert Page, eds., Canadian History since Confederation: Essays and Interpretations (Georgetown, Ont.: Irwin-Dorsey, 1972), 526. 5 Raymond Williams, Keywords: A Vocabulary of Culture and Society (London: Fontana, 1983), 90. 6 Janine Brodie, ed., Critical Concepts: An Introduction to Politics (Scarborough: Prentice-Hall, 1999), 409. 7 Kim R. Nossal, 'Economic Nationalism and Continental Integration: Assumptions, Arguments, and Advocacies,' in Denis Stairs and Gilbert R. Winham, eds., The Politics of Canada's Economic Relationship with the United States (Toronto: University of Toronto Press, 1985), 80. 8 Among studies on what it is to be Canadian from a philosophical or otherwise reflective perspective, a classic is: Vincent Massey, On Being Canadian (Toronto: J.M. Dent & Sons, 1948). A recent essay on English-Canadian identity in the face of today's pluralistic discourses and societies and a globalizing world is Ian Angus, A Border Within: National Identity, Cultural Plurality, and Wilderness (Montreal: McGill-Queen's University Press, 1997). 9 David Thomas, 'Introduction/ in David Thomas, ed., Canada and the United States: Differences That Count (Peterborough, Ont.: Broadview Press, 1993), 13,17. Leading figures in this stream of inquiry are Louis Hartz, The Founding of New Societies (New York: Harcourt Brace, 1964), and Seymour Martin Lipset, especially Continental Divide: The Values and Institutions of the United States and Canada (New York and London: Routledge, 1990). 10 Thomas, 'Introduction/ 13. 11 See, notably, Allan Smith, Canada: An American Nation? Essays on Continentalism, Identity and the Canadian Frame of Mind (Montreal: McGill-Queen's University Press, 1994); Ronald Inglehart, Neil Nevitte, and Miguel Basanez, The North American Trajectory: Cultural, Economic, and Cultural Ties

178 Culture among the United States, Canada, and Mexico (New York: Aldine de Gruyter, 1996). The latter study is based on the idea that as 'transactions' between the peoples increase as a result of integration, so will values converge. Not surprisingly, this issue has also attracted the attention of the Canadian government. Notably, a long-term research agenda has been set on comparing Canadian and U.S. attitudes and values in a context of North American integration. A recent draft report focusing on key socio-economic indicators, commissioned by the Applied Research and Strategic Policy Branch of the Department of Human Resources Development, is meant to be a starting point. 12 Ivan Bernier, 'Opening Markets and Protecting Culture: A Challenging Equation,' Forces, no. 117 (1997), 85-6. For a pre-free trade discussion of these issues, see Charles Pentland, 'North American Integration and the Canadian Political System/ in Denis Stairs and Gilbert R. Winham, eds., The Politics of Canada's Economic Relationship with the United States (Toronto: University of Toronto Press, 1985). 13 Graham Carr, Trade Liberalization and the Political Economy of Culture: An International Perspective on FTA, Canadian-American Public Policy, no. 6 (June 1991), 38. 14 Lipset, Continental Divide, 225-6. 15 Victor Rabinovitch, 'The Social and Economic Rationales for Canada's Domestic Cultural Policies,' in Dennis Browne, ed., The CulturefTrade Quandary. Canada's Policy Options (Ottawa: Centre for Trade Policy and Law, 1998), 30. This study also provides a more comprehensive discussion of Canadian cultural policies. 16 For a related, holistic analysis of culture, see D. Paul Schafer, Canada's International Cultural Relations: Key to Canada's Role in the World (World Culture Project, 1996). 17 John Herd Thompson, 'Canada's Quest for Cultural Sovereignty: Protection, Promotion, and Popular Culture,' in Stephen J. Randall and Herman W. Konrad, eds, NAFTA in Transition (Calgary: University of Calgary Press, 1996), 394. 18 Report of the Royal Commission on Radio Broadcasting (Aird Commission), 1929; Report of the Royal Commission on National Development in the Arts, Letters and Sciences, 1949-1951 (Massey-Levesque Commission), 1951; Report of the Federal Cultural Policy Review Committee (Applebaum-Hebert Committee), 1982. 19 Rabinovitch, 'Social and Economic Rationales,' 33-5. 20 Investment Canada Act, LRC (1985), (1st Supp.), c. 28, art. 15. 21 See, among others, Yvan Lamonde, 'American Cultural Influence in

North American Integration and Canadian Culture 179 Quebec: A One-Way Mirror/ in Alfred O. Hero, Jr, and Marcel Daneau, eds, Problems and Opportunities in U.S.-Quebec Relations (Boulder, Col.: Westview, 1984), 106-26; Louis Balthazar and Alfred O. Hero, Jr, Le Quebec dans I'espace americain (Montreal: Quebec Amerique, 1999). For an excellent analysis of Quebec's cultural policy, see Kevin V. Mulcahy, 'Public Culture and Political Culture/ in Guy Lachapelle, ed., Quebec under Free Trade: Making Public Policy in North America (Quebec City: Presses de 1'Universite du Quebec, 1995), 335-62. 22 For an analysis of the differences between Quebec and English Canada on free trade, see Peter Bakvis, 'Free Trade in North America: Divergent Perspectives between Quebec and English Canada/ Quebec Studies 16 (spring and summer 1993), 39-^48. 23 See, among others, Guy Lachapelle and Gilbert Gagne, 'L'americanite du Quebec ou le developpement d'une identite nord-americaine/ Francophonies d'Amerique, no. 10 (2000), 87-99. 24 Roger Gibbins, Regionalism: Territorial Politics in Canada and the United States (Toronto: Butterworths, 1982). 25 For more on this and a discussion of Canadian cultural diplomacy, see Andrew Fenton Cooper, ed., Canadian Culture: International Dimensions (Waterloo, Ont.: Centre on Foreign Policy and Federalism, University of Water loo/Wilfrid Laurier University, and Canadian Institute of International Affairs, 1985); Kim Richard Nossal, The Politics of Canadian Foreign Policy, 3rd ed. (Scarborough: Prentice-Hall, 1997), 292-331. 26 Balthazar and Hero, Le Quebec, 208. 27 See, notably, Christine Beeraj, Le dilemme de I'Etat quebecoisface a I'invasion culturelle americaine: une redefinition du protectionnisme culturel au Quebec (Quebec City: Institut quebecois des hautes etudes internationales, June 1995). 28 Customs Tariff, RSC 1985, c. 41 (3rd Supp.), s. 114, sch. VII, item 9958. A split run is an edition of a magazine sold with the same (or substantially the same) content as the original foreign edition but with advertisements directed at a national audience. 29 For proponents of this approach, see Bernard Ostry, 'Culture and Trade: One Policy/No Options/ in Dennis Browne, ed., The Culture/Trade Quandary. Canada's Policy Options (Ottawa: Centre for Trade Policy and Law, 1998), 17-24; Dennis Browne, 'Canada's Cultural Trade Quandry. How Do We Resolve the Impasse?' International Journal 54, no. 3 (summer 1999), 373. 30 On the challenges faced by Canadian cultural policy, particularly as a result of new technologies, see, among others: Herve Dery, 'Telecommunications and Information Technology/ in Lachapelle, ed., Quebec under Free Trade 363-93; Sheridan Scott, 'The Impact of Technological Change on Canada's

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31 32

33

34

35

36

37

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Cultural Industries/ in Browne, edv The Culture/Trade Quandary, 54-94; Liss Jeffrey, The Impact of Globalization and Technological Change on Culture and National Identity: A Call for Visionary Pragmatism/ in Browne, ed., The Cultureflrade Quandary, 155-86; Keith Acheson and Christopher Maule, Much Ado about Culture: North American Trade Disputes (Ann Arbor: University of Michigan Press, 1999), 23-38. Office of the United States Trade Representative, 1997 National Trade Estimate Report on Foreign Trade Barriers. Section 19 of the Income Tax Act (Bill C-58), Isaiah A. Litvak and Christopher J. Maule, 'Bill C-58 and the Regulation of Periodicals in Canada/ International Journal 36 (1980), 70-90. The next largest market is Britain, with 8 per cent of U.S. book exports and 5 per cent of U.S. magazine exports; U.S. Department of Commerce, International Trade Administration, 1991 U.S. Industrial Outlook (Washington, DC: Government Printing Office, 1991). John Meisel, 'Escaping Extinction: Cultural Defence of an Undefended Border/ in D.H. Flaherty, ed., Southern Exposure: Canadian Perspectives on the United States (Toronto: McGraw-Hill Ryerson, 1986), 165. U.S. scholar Herbert I. Schiller has been arguing this point for years and very convincingly. See, among others, 'Cinquante ans d'horreur mediatique. La communication, une affaire d'fitat pour Washington/ Le Monde diplomatique (Aug. 1997), 20-1. A recent illustration has been the immediate and strong U.S. response to piracy of the internet, with meetings grouping the U.S. president, top government and industry executives, and computer and intelligence experts. On the essentials of U.S. views, interests, and strategies regarding culture, see Graham Carr, 'Culture/ in Duncan Cameron and Mel Watkins, eds., Canada under Free Trade (Toronto: Lorimer, 1993), 203-13,310-12. These relate to the elimination of tariffs for goods that are inputs to cultural industries (art. 401), to the requirement that any foreign company having to divest itself of assets in Canada because of ownership restrictions in cultural industries is to receive fair market value (art. 1607), to the removal of the requirement for a (Canadian) magazine or newspaper to be typeset and printed in Canada in order for advertisers to deduct expenses for advertising space (art. 2007), and to copyright payments for cable retransmission of U.S. signals (art. 2006). FTA, art. 2012; NAFTA, art. 2107, annex 2106. Ivan Bernier, 'Cultural Goods and Services in International Trade Law/ in Browne, ed., The Culture/Trade Quandary, 123. See also Gordon Ritchie, Wrestling with the Elephant. The Inside Story ofCanada-U.S. Trade Wars

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46

47 48 49

(Toronto: Macfarlane, Walter & Ross, 1997), 215-38, which includes an account of the FTA negotiations on culture. Statistics Canada. For a more thorough discussion on the FTA and NAFTA provisions pertaining to culture, see Carr, Trade Liberalization; Bernier, 'Cultural Goods/ 122-6, 132-^4,139-40,143-6; Keith Acheson and Christopher Maule, International Agreements and the Cultural Industries (Washington, DC, and Ottawa: Centre for Strategic and International Studies and Centre for Trade Policy and Law, 1996), 5-9; Much Ado about Culture, 76-9. Globe and Mail, 13 March 1999, Al. For more on this, and an analysis of Canada's record in the effective pursuit of cultural policies, see Jamie Portman, 'And Not by Bread Alone: The Battle over Canadian Culture,' in David Thomas, ed., Canada and the United States: Differences That Count (Peterborough, Ont.: Broadview Press, 1993), 343-63; Thompson, 'Canada's Quest/ 393-^410. Services Policy Advisory Committee of the United States Trade Representative and CBS Inc., Trade Barriers to the U.S. Motion Pictures and Television, Prerecorded Entertainment, Publishing and Advertising Industries (Sept. 1984). These were section 19 of the Income Tax Act, not allowing Canadian firms to deduct advertising expenses incurred in foreign magazines and broadcasts; postal rates discriminating against foreign publications; postal subsidies benefiting Canadian magazines and newspapers; the lack of copyright provisions for retransmission of U.S. signals by Canadian cable companies; the simultaneous substitution rules requiring Canadian cable companies to replace American broadcasts of a particular program with the Canadian version if they are scheduled at the same time; and ongoing proposals to reduce the power of U.S. motion picture distributors in Canada. The two measures still in existence are the simultaneous substitution rules and section 19 of the Income Tax Act. Yet the latter now applies only to broadcasts as a result of a Canadian-U.S. agreement reached in 1999 to put an end to their clash over magazines. For further discussion on these Canadian-American cultural tensions and disputes, see Ritchie, Wrestling, 224-38; Bernier, 'Cultural Goods'; Acheson and Maule, Much Ado, 185-348. 'General Agreement on Trade in Services/ in Final Act Embodying the Results of the Uruguay Round of Multilateral Trade Negotiations, 15 April 1994. For more on GATS negotiations, see Bernier, 'Cultural Goods/ 110,126-32. On the MAI negotiations and culture, see Bernier, 'Cultural Goods/ 137-9; and the excellent chapter by William A. Dymond, Canada's chief MAI negotiator, 'The MAI: A Sad and Melancholy Tale/ in Fen Osier Hampson,

182 Culture Michael Hart, and Martin Rudner, eds, Canada among Nations 1999. A Big League Player? (Toronto: Oxford University Press, 1999), 25-53. 50 For a history and a more thorough analysis of the political and legal aspects of the long-standing and latest tensions over the protection of Canadian periodicals, see Thompson, 'Canada's Quest'; Bernier, 'Cultural Goods'; Stephen Azzi, 'Magazines and the Canadian Dream. The Struggle to Protect Canadian Periodicals 1955-1965,' International Journal 54, no. 3 (summer 1999), 502-23; Acheson and Maule, Much Ado, 186-205; Ted Magder, 'Franchising the Candy Store: Split-Run Magazines and a New International Regime for Trade in Culture,' Canadian-American Public Policy, no. 34 (April 1998); Gilbert Gagne, 'Liberalisation et exception culturelle: le differend canado-americain sur les periodiques/ Etudes internationales 30, no. 3 (Sept. 1999), 571-88. 51 Canada, Report of the Royal Commission on Publications (O'Leary Report) (Ottawa: Queen's Printer, 1961). Canada, Task Force on the Canadian Magazine Industry, A Question of Balance (Ottawa: Minister of Supply and Services, 1994). 52 Act Amending the Excise Tax and the Income Tax Act, Bill C-103, SC 1995, c.46. 53 The import ban was examined under GATT article XI, which forbids all prohibitions or restrictions other than duties, taxes, or other charges; the excise tax and the postal subsidies were examined under article III, relating to national treatment in matters of domestic taxation. Canada - Certain Measures Concerning Periodicals, Panel Report, WT/DS31/R, 14 March 1997; Appellate Body Report, WT/DS31/AB/R, 30 June 1997. 54 Foreign Publishers Advertising Services Act, Bill C-55. For a Canadian critic about the soundness of Canada's revised policy on periodicals, see Dennis Browne, 'Our Flawed New Magazine Policy,' Policy Options 20, no. 1 (Jan.-Feb. 1999), 49-55. 55 'General Agreement on Tariffs and Trade' (GATT 1994), in Final Act... of the Uruguay Round. 56 For more on the terms of the Canadian-U.S. periodicals agreement, see Canada, 'Ottawa and Washington Agree on Access to the Canadian Advertising Services Market/ News Release P-05/99-29 CC990205,26 May 1999; 'Canada and United States Sign Agreement on Periodicals/ News Release P-06/99-31 CR990249,4 June 1999. On issues pertaining to this agreement, see Globe and Mail, 27 May 1999, A1-A3, Bl, B4; Inside U.S. Trade, 28 May 1999,1,22-3; 4 June 1999,3-4; Ottawa Citizen, 20 Nov. 1999, A3. 57 The Centre for Strategic and International Studies, a Washington-based think tank, has launched a study program called 'U.S. Trade Strategy and

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58

59

60

61

Canadian Culture' to find ways to escape the confrontational approach and improve a generally harmonious and mutually beneficial relationship. This proposal is based on a report from the Cultural Industries Sectoral Advisory Group on International Trade (SAGIT), Canadian Culture in a Global World: New Strategies for Culture and Trade (Feb. 1999). In July 1999, at the WTO headquarters in Geneva, Canada highlighted the report and circulated it to state delegations. For example, with regard to the Uruguay Round negotiations on agriculture, two such alliances played a key role. For one, a consensus-building exercise within the OECD generated the political will to address agricultural trade, and the concepts developed in the OECD came to underpin the WTO Agreement on Agriculture. As for the other, the Cairns Group, made up of thirteen small and middle powers seeking more open markets for their agricultural products, played an active role in the negotiations and significantly influenced the shape and content of the agriculture agreement. See Browne, 'Canada's Cultural Trade,' 370-1. Gilbert Gagne, 'Mondialisation, regionalisation et questions identitaires: le Canada, le Quebec et 1'exception culturelle/ Paper presented at the Annual Meeting of the Societe quebecoise de science politique, University of Ottawa, 12-14 May 1999. Ekos Research Associates Inc., Exploring Perceived and Comparative Differences in Canadian and American Values and Attitudes: Continentalism or Divergence? Draft Report, Presented to Human Resources Development Canada, 21 March 2000.

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Part Three

Politics

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7. Governance and State-Society Relations: The Challenges Laura C. Macdonald

Regional integration in North America involves changes that are not purely economic, but also profoundly political.1 While Canada's close relationship with the U.S. economy is not new, its intensification under the Canada-U.S. Free Trade Agreement (FTA) of 1989 and the North American Free Trade Agreement (NAFTA) of 1994 has affected statesociety relations in Canada, which in turn impinge on the democratic system of governance.2 The political changes associated with regional integration have exacerbated existing problems in democratic representation and state-society relations. As the massive popular protests against trade talks in Seattle in 1999 and Washington, DC, in 2000 show, earlier models of state decision-making on trade, based largely on elite accommodation, are no longer feasible or desirable. A review of statesociety relations concerning trade with the United States in the 1980s and 1990s can illustrate some of the dilemmas faced in developing new models of decision-making. As this review shows, the Canadian state has responded to the crisis of representation during this period by instituting new mechanisms that allow for close consultation with business but exclude large sectors of the population. This response has allowed the state to control its environment in order to negotiate trade deals but has long-term implications for social cohesion and democracy. Remarkably, the implications of economic integration have been the subject of little systematic analysis either by proponents or even by opponents of the FTA and NAFTA. This chapter addresses this gap. This issue has received little attention partly because of the difficulty in separating the political impact of regional integration from that of

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broader forces of globalization.3 For Canadians, however, globalization means largely greater integration with the United States. The lack of attention relates also to problems of evaluating political change. Democracy is an 'essentially contested' concept, and, as we see below, positions in the debate over the implications of integration relate to different readings of the meaning of democracy. In this chapter, I outline three different models of democracy: elite competition, group theory, and participatory models. The first, I argue, is democratic in only the most limited sense. However, this model is congruent in many ways with the neoliberal philosophy that underlies the FTA and NAFTA. I show how Canadian democracy has been threatened by the institutionalization of a form of decision-making in trade policy that privileges one sector of civil society - business - at the expense of others. In trade policy, as part of its negotiating strategy for the FTA, the Canadian government instituted a system of closed consultation through the International Trade Advisory Committee (ITAC) and the Sectoral Advisory Groups on International Trade (SAGITs). These groups were heavily weighted toward business involvement, partly because of the decision of the Canadian Labour Congress (CLC) not to participate. This system of consultation, combined with the prior ideological convergence between business and the state, produced a new relationship. While private-sector consultation created temporary stability in one facet of state-society relations and facilitated negotiation of the FTA and NAFTA, it is unsatisfactory in the longer term for two, converging reasons - instrumental and normative. First, the Canadian government's failure to manage relations with non-business sectors led to a new 'popular-sector' coalition (particularly in English Canada) hostile to free trade. This coalition ultimately failed to prevent the FTA and NAFTA but has created a potentially powerful new actor in trade policy that feels (with considerable justification) completely excluded from existing consultation mechanisms. The inclusion of these groups might result in different types of trade agreements, including concerns about labour rights, the environment, and human rights, but the alternative may be the complete derailment of future international trade agreements if these voices are not listened to, as with the recent failure of the Multilateral Agreement on Investment (MAI). Second, existing structures of consultation are based on the systematic exclusion of significant sectors of the population, contrary to inclusionary and democratic norms of decision-making.

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More participatory modes of governance have traditionally been limited to local politics, while decision-making on macroeconomic issues has traditionally been highly exclusionary. Globalization, however, means that all areas of Canadians' lives are increasingly affected by international forces. The strengthening of democracy in Canada requires a move away from more restricted to more expansive understandings of democracy and the inclusion of both individuals and groups in all realms of decision-making, from local to global. In developing new forms of democratic inclusion, however, North America will probably not, in the near to medium term, follow the model laid out in the European Union of transferring political decision-making to supranational institutions. North Americans concerned about the relationship between democracy and economic liberalization, and about the loss of some policy tools previously under state control, will therefore have to develop new ways of addressing this 'democratic deficit.' The chapter begins with an overview of three competing models of democracy. Then it looks at debates concerning connected issues - the relationship between economic and political liberalization and liberalization as a threat to democracy in Canada. Third, it considers how economic integration affects the state's relations with both business and the so-called popular sector, examining organizational and ideological changes in each sector, as well as their links with the state and international actors. Finally, it notes encouraging signs for the implementation of a more inclusionary process of decision-making on trade policy. It outlines alternative models for consultation and citizens' engagement which have been applied, particularly in environmental policy. It shows also how Canada's federal Department of Foreign Affairs and International Trade (DFAIT) has promoted greater consultation with the public as part of the preparation for a Free Trade Area of the Americas (FTAA). This represents a move towards a new model of democratic governance in international policy. In the light of increasing concerns about the political implications of globalization, now may be a propitious time for analysing existing forms of consultation in trade policy and for seeking more inclusionary forms of statesociety relations. Globalization and Models of Democracy The process of globalization has led to a revival of debates about the

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meaning and practice of democracy that date back to classical Greece. Of course, not everyone agrees that democracy is indeed the best form of government. But after the fall of the Berlin Wall, the 'third wave of democratization'4 has seemed to indicate a growing worldwide consensus about this idea. Fundamental differences remain, however, about the definition of democracy. As democratic theorist David Held notes: 'Not only is the history of democracy marked by conflicting interpretations, but also ancient and modern notions intermingle to produce ambiguous and inconsistent accounts of the key terms of democracy, among them the proper meaning of "political participation," the connotation of "representation," the scope of citizens' capacities to choose freely among political alternatives, and the nature of membership in a democratic community.'5 Even in established democracies such as Canada, economic restructuring has destabilized inherited ideas about democracy and citizenship and rekindled age-old debates about governance. And globalization has contributed to this intellectual and political turmoil by undermining the fundamental assumption that nation-states are the appropriate focus for democratic practice because it was there that real power was largely concentrated. This tenet seems increasingly unrealistic, since globalization tends to shift power 'upwards' towards supranational institutions such as NAFTA and the General Agreement on Tariffs and Trade (GATT), and downwards towards local or regional authorities. As I argue below, the nation-state still holds considerable power. However, globalization is transforming the relationship between the international and the national, the state and society, and private and public, thereby challenging the practice of democracy. How we evaluate these trends depends on how we define democracy. Table 7.1 outlines three models of democracy.6 Model I: Competitive Elitism One prominent strand of democratic theory, which Held terms 'competitive elitism,' is concerned not with promoting popular participation in governance, but with limiting it. The classical version emerged with the extension of the franchise in the late nineteenth and early twentieth centuries to all adult males. Writers such as Max Weber and Joseph Schumpeter were guided by a pessimistic view of mass politics and by an awareness of the unpredictable consequences of political action. This position involves 'a very restrictive concept of democracy,

Governance and State-Society Relations 191 TABLE 7.1 Models of democracy Model

Main variants

Mode of consultation

ICompetitive elitism

a) Classical liberal democracy b) Neoliberalism

Bipartite

IIa) Classical pluralism Group theories b) Corporatism c) Social capital IIIParticipatory democracy

Multipartite or tripartite

a) Citizens' engagement Broad-based individual participation: b) Deliberative democracy participatory action research, referenda, legislative hearings, surveys, polls, town hall meetings, focus groups, policy conferences, roundtables, study circles, citizens' juries, and so on

envisaging democracy, at best, as a means of choosing decision-makers and curbing their excesses/7 It sees competitive political parties as inevitably, and desirably, the sites of political practice, and regularly scheduled elections as guaranteeing the selection of strong leaders to resist bureaucratic domination of the political process. Citizens play a minor role, limited largely to voting. This view supposes that the public is largely apathetic about politics and that mass mobilization can lead to dangerous political instability as cynical populist leaders manipulate a gullible populace. This model has undergone a resurgence in recent years with the rise of neoliberal economics and its underlying 'public choice' perspective.8 It understands politics as an application of liberal economic theory individuals act in the political arena as they do in the marketplace, pursuing their individual material self-interest. In economic policy, individuals and groups may lobby for the rents created by tariffs, rather than recognizing the collective benefits to be gained from free trade. The neoliberal approach thus overlaps with the competitive elitist argument for democracy by shielding policy-makers from the democratic excesses of self-interested 'special interests' so that they may pursue 'rational' economic policy. In macroeconomic policy, government makes decisions behind closed doors via bipartite consultation with business. Alexandra Dobrowolski notes that in Canadian

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political discourse: 'Increasingly, ... interest groups are not viewed as filling representational lacunae by providing an alternative to parties; rather they are described as having a singular or "special" focus and this, in turn, calls into question their democratic credentials. In fact, in some accounts, interest groups have become the scapegoat for broader representational deficiencies/9 This model then is democratic only in the most limited sense. Since many Canadians have rejected this elitist theory, any attempt to restrict decision-making to a bipartite format is likely to run into trouble. As well, public choice theorists overlook the obvious implications of their own analysis - namely, that pro-free trade business organizations are as much a special interest as any other group. The idea that a state insulated from other pressures can somehow, through an apolitical, rational process, determine the collective interest of society as a whole is at odds with the philosophical underpinnings of the model. This, however, as we see below, is the viewpoint that characterizes Canada's decision-making in trade. Model II: Pluralism While model I views individuals as the fundamental political unit, model II focuses on 'intermediary associations' located between individuals and the state and on their role as aggregators of individual interests and as a countervailing power to public and private elites. The proponents of classical pluralism, such as American political theorist Robert Dahl, were much more optimistic than the competitive elitists about human nature and worried less about the destabilizing potential of democratic involvement by citizens. They believed that the problem of determining the collective interest of society could be resolved through the process of competition between different group interests. A neutral state then would arbitrate between these interests. It was hoped that individuals' membership in multiple and overlapping groups would prevent state bias and excessive group conflict. In his later work, however, Dahl recognized that the state could be hijacked by the more wealthy and organized groups at the expense of the poorer, more marginalized members of society. The most fundamental challenge to democracy comes not from an excess of democracy, but from inequality, and from a socioeconomic system that grants a 'privileged position' to business interests.10 Accordingly, Canadian public policy in the 1960s and 1970s funded non-business interest

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groups such as women, Aboriginal people, and ethnic minorities. While this approach did not create an 'equal playing-field/ it did provide non-elite actors with resources and helped open up the policy process.11 In this approach, citizens' groups are not just 'special interests' but help to determine the collective interest. This model resembles 'multi-stakeholder' consultation processes: 'an ongoing dialogue among affected stakeholders, including government, aimed at obtaining all the relevant information, evaluating the available options and their related consequences, and providing an objectively balanced perspective to each stakeholder's decision making. A primary objective is to obtain consensus at each stage of the process.'12 Corporatism is another strand of group theory, which sees society as composed of two main groups - capital and labour - rather than of multiple, overlapping groups. This approach, popular in social democratic states in Europe, advocates tripartite decision-making. The collective interest, particularly the interest of the working-class majority, is assured best when the state, capital, and labour work together to set policy. This version, by integrating labour, counteracts the tendency in classical pluralism for wealthier groups to dominate. However, both visions share a fundamental problem: do interest groups represent the interests of their members or, increasingly over time, the interests of their relatively comfortable staffs?13 More recently, writers such as Robert Putnam have expanded on group identification and the role of the voluntary sector, particularly when the forces of globalization and modern technology appear to be dissolving the ties between individuals. Theories of social capital argue that group membership is good in its own right, apart from its beneficial effects on public policy, because it counteracts social disintegration by creating 'social capital.' Model HI: Participatory Democracy A final theory rejects the politics of representation (either by a benevolent state elite or by interest groups) and promotes the direct participation in governance of as many people as possible. Participatory democrats emphasize the benefits to both society and the individual of political participation by citizens. This involvement includes voting and membership in interest groups, but also a range of other activities, particularly at the local level. Rather than accepting the view implicit in the other two models that most individuals are too apathetic and ill-

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informed to participate in the public sphere on a regular basis, participatory democrats believe that individuals can gain the skills and knowledge to participate in making decisions of national scope. One version - deliberative democracy, or 'decision making by discussion among free and equal citizens' - has been undergoing a revival in recent years.14 It contests the liberal assumption that individuals' interests and beliefs are relatively fixed and that democracy therefore merely involves the aggregation of preferences. Deliberative democrats claim instead that discussion, debate, and dialogue can transform individual perspectives, making a consensus possible in unlikely situations. Proponents argue that open and broad-ranging discussion of policy options: • • • • • • • • •

reveals private information lessens or overcomes the impact of 'bounded rationality' forces or induces a particular mode of justifying demands legitimizes the ultimate choice is desirable for its own sake makes for Pareto-superior decisions makes for better decisions in terms of distributive justice promotes consensus improves the moral or intellectual qualities of the participants15

A wide range of mechanisms exist to facilitate this form of deliberative democracy or citizen engagement. For example, the Canada West Foundation has promoted a consultation process that combines the opinion poll, policy conferences, and policy roundtables. Participants are chosen at random, and their opinions are surveyed both prior to and after the conference and roundtable.16 The deliberative model, however, focuses on the participation of individuals, not groups, in a return to the individualism of the competitiveelitism model. The legitimate and valuable role that groups can play in the policy process is thus eclipsed.17 A model that combines citizens' engagement with multi-stakeholder consultation may thus optimize the benefits of models II and III. Liberalization and Democracy As we saw above, the extensive and heated debate on North American integration has concentrated on economic issues, and the issue of

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democracy is rarely mentioned, either by proponents of the process or by opponents (although the impact of NAFTA on democratization in Mexico has received considerable attention). Consolidated democracies cannot afford to be complacent about their political systems, particularly given the rapid political and economic changes associated with globalization and regionalism. There are two main theoretical approaches to the relationship between economic liberalization and political change. The first, which we can link to model I democracy and neoliberalism, conceives this relationship as essentially positive - i.e., economic liberalization leads almost automatically to political liberalization. The second, which is closer to model II or model III, argues that greater liberalization, unmediated, tends to undermine the foundations of democracy. I outline below the ways in which these two positions have been applied to the Canadian case. Economic and Political Liberalization as Mutually Reinforcing Proponents of integration have paid little attention to the political impact of integration, but we can assume, given their commitment to liberal analysis, that they would subscribe to this perspective. The striking absence of analysis related to this theme may be the result perhaps of three factors: the equation of democracy with formal liberal democratic institutions; the separation of the political from the economic sphere in liberal thought; and political motivations. The first factor implies that Canada, unlike Mexico, possesses democratic institutions entrenched so firmly that democracy is hardly an issue. The second relates to the third, in that government has a motive to maintain this fiction of the separation of the economic and the political spheres because it has wished to present the FTA and NAFTA to Canadians as purely economic arrangements, with no broader implications for culture, politics, or sovereignty.18 There are, however, a few writers who have defended, from a liberal perspective, Canadian governments' approaches to decision-making in international trade. Mexican political scientist Gustavo Vega Canovas explains the inclusion of the private sector in the consultation process in all three NAFTA countries, despite their distinct political systems, by arguing that this process provides stability and legitimacy by creating domestic support for such trade policies.19 Despite the cooptive logic behind this statement, he still sees an 'inclusionary poli-

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tics' that 'conformed to democratic ideology by giving the private sector a place at the table of global riches'20 and reinforced 'democratic ideals and values.' This argument may be reasonable in the Mexican context, where even the business sector had been largely excluded from decision-making by an authoritarian regime, but is less convincing for Canada, given extensive business influence in its political system21 and the fact that a consolidated democratic regime would probably include non-business as well as business sectors. Alan Rugman and Alan Anderson's analysis offers more insight into such liberal logic. They claim that the creation of the International Trade Advisory Committee (ITAC) and the Sectoral Advisory Groups on International Trade (SAGITs) in the late 1980s was necessary in the light of the fragmentation of decision-making as the result of federalism in both the United States and Canada: 'Business needs to speak with one mind in order to shore up the breakdown of political power to sub units.' Significantly, in his discussion of the ITACs and SAGITs, Gilbert R. Winham refers to republican theorist James Madison's insistence on the need for the state to control the 'evils of faction' in order to function.22 These writers reflect a view of democracy similar to model I: mechanisms for widespread consultation risk paralysing the capacity of the elected governments to perform their legitimate role as representative of the interests of society as a whole, not of 'special interests.' Strikingly, this approach rarely identifies business as a 'special interest.' It is understandable that state actors want to be able to govern without the interference of disgruntled constituents, especially if voters' beliefs and demands are radically different from those adopted by the state. Exclusion of their voices, however, in the name of efficiency is not only anti-democratic, it may also be counter-productive. Writing in 1987, even Rugman and Anderson noted that the lack of union participation in the consultative bodies left labour out of the process. They predicted, correctly, that this exclusion might 'create more dissension through outside lobbying and publicity than if these groups were legitimized by being included in the talks.'23 Liberalization as Threat to Democracy Believing that ongoing political participation is essential for the health of the democratic system, critics of NAFTA present a different version of the relationship between economic and political liberalization. As we saw above, Canadian opponents of the FTA and NAFTA, like sup-

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porters, based much of their criticism on economic factors. However, they did include concerns about social rights, culture, and sovereignty in their critique and also denounced the failure of government to take into account input from non-elite actors. The briefs in The Other Macdonald Report, collected from non-business people who felt that their views were not reflected in the royal commission's report, contain no explicit reference to the implications of regional integration for democracy. This silence may be attributable to the scepticism of the traditional left about formal democratic mechanisms. Nevertheless, since the end of the Cold War, leftist discourse has displayed increasing concern with democracy, especially with the dangers associated with globalization and regionalism. While these worries tend to originate with the left, more recently other actors from a wide range of perspectives have begun to note the potentially harmful effects of untrammeled liberalization on social cohesion and democracy. For example, the OECD, one of the main international proponents of liberalization, has warned about the possible political fallout from neoliberal economic restructuring: For over a decade, OECD countries have been committed to a cluster of economic policies aimed at encouraging macroeconomic stabilization, structural adjustment, and the globalisation of production and distribution. Although these policies have been generally successful in supporting economic growth, combating inflation and reducing current-account imbalances, there is now pressure on many governments to take stock of the longer-term societal implications that are beginning to emerge. In part this is because of a growing political disenchantment arising from the increasing income polarisation, persistently high levels of unemployment, and widespread social exclusion that are manifesting themselves in varying ways across North America, Europe and the OECD Pacific. The diffusion of this malaise threatens to undermine both the drive towards greater economic flexibility and the policies that encourage strong competition, globalisation and technological innovation.24

Canadian critics of integration often depict the FTA and NAFTA as representing not the interests of society as a whole, but one manifestation of the triumph of a 'corporate agenda' in Canadian politics.25 This critique is often vague and polemical. However, it raises important issues about the changing nature of democratic representation. As Keith Banting observes, in a world increasingly defined by global eco-

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nomic constraints and the partial loss of economic sovereignty, it is difficult for governments to appear responsive to citizens' demands: 'In a world of tightened international constraints, there is a danger that public consultations will heighten, not reduce, cynicism about the responsiveness of our political institutions/26 How exactly does the internationalization of public policy through the FTA and NAFTA threaten democracy? Some have argued that the FTA and NAFTA were based not so much on economic motives (since liberalization had already progressed substantively in both Canada and Mexico, and since the economic impact of the agreement is minimal) as on political motives. Ricardo Grinspun and Robert Kreklewich27 call them 'conditioning frameworks/ designed to reassure transnational business that future elected governments in Canada and Mexico would not retreat on these neoliberal reforms.28 Stephen Clarkson argues, 'As a conditioning framework, NAFTA becomes an external addition to each country's political constitution: it limits the power of governments; it defines rights for (corporate) citizens; it provides adjudicatory procedures for resolving disputes; and it contains means for ratification and amendment of the document. In terms of societal values, it represents an attempt to entrench the practices of neo-conservatism in the United States' neighbors and so permanently to change the balance of political forces within these two countries/29 In his comparison of European and North American regional integration, Clarkson notes that concerns about the 'democratic deficit' raised by critics of the European Union relate to the demos (people), not to kratia (power): Tower has been shifted to supranational and intergovernmental institutions whose processes are so complex and inaccessible that the people can neither observe, understand, nor affect what transpires in them. In North America the democratic deficit has less to do with demos than with kratia: institutions have not been erected at the continental level with enough clout to manage the amounts of power that have been shifted out of the hands of governments towards the market/30 Clarkson claims that NAFTA's dispute-settlement mechanism may aggravate democratic deficiencies, since 'in most cases it is only the federal governments and corporations that can seek redress; sub-national governments, NGOs, and citizens need not apply.31 The most blatant example of NAFTA's democratic deficit relates to chapter 11, on investment rules. The current mechanism severely reduces the sovereign power of governments to regulate in the public good, countering any policy that might be perceived as an infringe-

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ment on investors' rights. The six major investor-to-state cases currently filed against NAFTA governments (four against Canada) have challenged environmental regulations, commodity trade arrangements, and the civil justice system, with combined claims for damages of over $1.3 billion.32 Ian Robinson argues that NAFTA has serious implications as well for the 'structural determinants' of democratic quality. Since, he argues, North American integration leads to corporate and state competitive strategies based on lowering wage and environmental costs and reducing corporate taxes and regulations, it will exacerbate income inequality and undermine labour rights. High levels of income inequality corrode democracy because democratic regimes are legitimized by providing equal citizens' rights, equal political participation, and equal opportunity. A strong and consistent relationship thus exists between low levels of income inequality and democratic stability and between high levels of inequality and instability.33 The Implications of Regional Integration for State-Society Relations in Canada Globalization and the State As the discussion above suggests, any reflection on the implications of economic integration for democracy must look at the impact of globalization and regionalization on the role of the nation-state in the economy and the political system. An extensive literature, containing widely divergent positions, exists on this subject.34 This section outlines the implications of the main theoretical positions for democracy. First, liberal writers tend to associate globalization and regionalization with the decline of the nation-state, which retreats in the face of the 'inexorable' expansion of market forces.35 Since much of liberal political theory presents the nation-state as the primary threat to individual liberties (as well as to economic efficiency), it sees this shift as strengthening democracy. This is not only an abstract philosophical position, but also resonates with the stand of Canada's official opposition, the Reform Party/Canadian Alliance, which supports North American integration, but also advocates its own version of 'direct democracy' and the devolution of state power. Strategist Rick Anderson outlines his views:

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My perception is that the trends around government and politics are twofold and they are in opposite directions. At one level, the trend that people have generally accepted and generally support - although they are worried a little bit about some parts of it - is the trend towards globalization, the trend towards some of the more big picture things getting determined at the super-national level... I think the opposite thing that the public is pushing for, is that the things that matter most in their daily lives be brought under local control, which is where you get democratic accountability. Even as they are saying 'look I understand that our level of taxes and the way our currency moves, the big picture things, are going to be set or influenced heavily by supranational agreements' - the question of whether the park has swings in it, or whether the school has a computer lab, or whether to do French immersion here, or whether the hospital has a burn treatment unit, these decisions - that most people perceive to affect their daily lives - they want under the most local authority possible.36

Second, nationalists agree that globalization and regionalization have led to the decline of the nation-state but argue that globalization has occurred not because of autonomous market forces, but because states (particularly powerful states) have actively promoted this process, and that they could still reverse it if they wished. States, in this view, are thus the agents of their own decline.37 These writers, of course, view this as a profoundly negative process, both for economic reasons and because of its implications for democratic governance. Third, and in contrast to both of the preceding approaches, some deny that globalization necessarily involves a weakening of the state. Robert Cox sees the 'internationalization of the state' with 'the state becoming stronger and more autonomous in relation to both its domestic population and individual market actors, but only by participating in global institutions, practices, and discourses, of which the neo-liberal consensus is a fundamental expression. At the same time, the nature of this participation is affected by the character of the state, including its institutions and its capability in relation to other states. Overall, however, if we define sovereignty territorially, as is conventional, then globalization involves paradoxically the strengthening of the state and the erosion of sovereignty.'38 This perspective shares the nationalists' pessimism about the democratic character of the process. The analysis of changes in Canadian trade policy presented in this chapter supports this third position by showing how the state, by institutionalizing corporate participation in decision-making, has increased

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its control over business, while simultaneously exerting its power to exclude other actors. North American integration has thus empowered state agencies responsible for international trade and allowed them better to co-ordinate and control business inputs into decision-making. Since broader notions of democracy require greater participation by civil society in decision-making, greater state autonomy is antithetical to democratization of the policy process. Below, I outline the differential effects of regional integration on specific sectors of Canadian society and their relations with the state, paying special attention to the structural effects of trade integration on civil society's actors, to changes in their form of organization, to their ideas about trade, and to the impact of regionalization on their international links.39 Business-State Relations In any capitalist economy, business enjoys considerable power and influence as a result of government's reliance on it to generate the majority of jobs, as well as goods, services, and taxes.40 Apart from this broad generalization, however, the degree and form of its influence over decision-making will vary across time and space. The Canadian government has developed new institutional mechanisms vis-a-vis international trade in response to changes in business-state relations in the 1970s, as well as to economic changes that transformed the business community's views on economic integration. In the period after 1945, business and government officials worked closely together, united in a consensus on state policy,41 as described by model I, or elite competition. Canada: A Nation on the March reflects the tone of this era; it portrays business-state relations as characterized by 'a degree of intimacy and informality that is desirable, and helps to foster a feeling of partnership and mutual respect/42 Elite accommodation also occurred in foreign policy, particularly in international economic relations, but in most cases the state controlled decision-making, perhaps even more than in other countries.43 Widespread consensus existed against more formal economic integration with the United States and on GATT as the proper focus for trade liberalization. Trade policy was thus effectively depoliticized.44 According to James Gillies, this system began to unravel as government became more complex, until, under Pierre Trudeau, it 'came to an abrupt end and was replaced by an era characterized by "mutual

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misunderstanding/"45 Business saw his government's National Energy Policy and Foreign Investment Review Agency as the nadir of business-state relations. The liberalization of the Canadian economy in the 1960s and 1970s under successive rounds of the GAIT, and the recession of the early 1980s, altered business's view of international trade and how it related to the Canadian state. The formation of the Business Council on National Issues (BCNI) in 1976 reflected the desire by business (particularly big, transnational firms) for a more unified voice on macroeconomic policy. The decision of both the BCNI and the Canadian Manufacturers' Association (CMA) to support a comprehensive free trade agreement was the pivotal event in the road towards free trade.46 The BCNI launched an intense lobbying campaign to convince Ottawa to pursue this option. Canadian chief negotiator Simon Reisman consulted almost daily with the BCNI and CMA heads throughout the talks on free trade - a degree of access greater than that given to other business groups, including the banks and energy companies.47 David Langille argues that the Mulroney government's eventual decision to seek an agreement indicates that the Canadian state has lost its relative autonomy and that business, as represented by the BCNI, has assumed much more direct control over the political system.48 However, the Canadian government did not just cede power to the private sector, it also established an elaborate series of mechanisms for consultation with business designed as much to discipline it as to seek its advice. The new system of consultation, introduced soon after the 1985 announcement of the decision to enter into bilateral trade negotiations with the United States, built on this earlier experience and had two components. First, the International Trade Advisory Committee (ITAC) was to focus on the macroeconomic environment, with its members expected to 'serve in their individual capacities, not as representatives of specific entities or interest groups/49 Second, fifteen sectoral advisory groups on international trade (SAGITs), set up along industry lines, were to focus on sector-specific concerns. The ITAC and SAGITs reported directly to the Trade Negotiator's Office (TNO).50 The degree of authority vested in the TNO was another sign of the centralization of power that occurred during the process of negotiating the FTA. A list of the membership of the various committees reads like a 'who's who' of the Canadian corporate elite, as well as a scattering of representatives of small business, other interests, and a few academics.51 Because the Canadian Labour Congress (CLC) refused to partici-

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pate (see below), only a few labour representatives participated.52 In 1987, 70 per cent of the SAGIT members came from the business sector, nearly 18 per cent represented boards, associations, or co-operatives, 8 per cent were individuals or other representatives, and just over 4 per cent represented unions.53 Helen Moroz calls this model 'elite tripartism' - the federal government, business, and the provinces took part, to the virtual exclusion of non-elite sectors. This format contrasts with the corporatist or tripartite model of consultation that involves the state, business, and labour as formally equal participants.54 The state decided to institutionalize corporate and provincial involvement in decision-making throughout the negotiation process and afterwards. First, trade policy had become an increasingly technical matter, and industry's direct participation furnished valuable (and inexpensive) advice on the specific concerns of each sector affected by the FTA.55 While this function corresponds fairly well to traditional pluralist models of representation, Winham shows how the U.S. consultation system on trade - the model for Canada's system - contradicts this view. He argues that the U.S. federal executive created the Sector Advisory Committees (SACs) and the Advisory Committee on Trade Negotiations (ACTN) in order to bypass the heavily politicized congressional system, allowing Tokyo Round GATT legislation to pass, against all expectations, a hitherto highly protectionist Congress without a fight, 'bureaucratized' the process of constituency relations, delegating liaison with lobby groups to the trade bureaucracy. More important, however, 'Congress bureaucratized the constituency groups themselves.'56 The SAC system ensured a co-ordinated and well-organized effort to sell the agreement to constituents and guaranteed that potential trouble spots could be identified quickly and accommodated whenever possible. This symbiotic relationship gave the members of the SACs a stake in the agreements and made eventual compliance more probable. As one officer with the U.S. Trade Representative (USTR) elegantly put it, 'When you let a dog piss all over a fire hydrant, he thinks he owns it.' Winham notes that the SACs took this traditional logic of co-optation a step further; by consulting with associational groups, the executive 'carried the hydrants to the dogs.'57 Private-sector consultation on international trade thus offers business privileged access to decision-making on economic integration, but it also fuses business and state interests, making it difficult to distinguish where the state ends and civil society begins.58 Business interests have also undergone other substantive changes in the last ten to fifteen

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years as the result of both North American integration and globalization more generally. Corporations have become increasingly transnationalized, or at least continentalized. This process proceeded the FTA and NAFTA and helps explain business's conversion to free trade in the mid-1980s after a long history of support for protectionism. Rugman, Kirton, and Soloway argue that Canadian-based business is now integrated into North American business networks, or clusters: Tn short, there is no longer any such organization as a Canadian business; now it is a North American business.'59 Canadian business's access to these transnationalized networks proved useful to Ottawa's negotiating strategy during the FTA talks.60 BCNI meetings with U.S. CEOs helped shore up their support for free trade, which in turn put pressure on the U.S. government to reach an agreement.61 Overall, as a result of the economic crisis of the early 1980s and the move towards economic integration, Canada's business community has undergone a fundamental realignment. In addition to the ideological shift towards free trade, it has also become more unified and more capable of speaking with a single voice on broad issues of macroeconomic policy.62 The ideological convergence between business and the state (which has continued and intensified under Jean Chretien's government) has led to the creation of institutions that support greater state influence over business in trade policy. This is a process far removed from the picture of the retreat of the state portrayed by both liberals and nationalists. Moreover, both business and the state have also become increasingly internationalized (both as a cause and as an effect of integration). This twin merging of the state and business and the state and international actors has increased the gap between elite actors and the majority of Canadians.63 In the process, model I democracy has been institutionalized, with elite participation in decisionmaking formalized and non-elite participation strictly curtailed. Popular Sector-State Relations Equally dramatic changes have occurred within the so-called popular sector in English Canada as a result of Canada's move towards North American economic integration. Use of the term 'popular sector' - to refer to a wide range of non-elite groups, ranging from trade unions, women's groups, social agencies, Native peoples, and farmers to the churches - is itself probably a product of the free trade debate, since

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these interests had been even more fragmented and diverse than business. Just as business became more unified under the BCNI, these groups, feeling excluded by the state and the dominant economic model, came together with nationalist organizations in opposition to the FTA and subsequently NAFTA. The Pro-Canada Network (PCN), formed in 1987, which became an anti-free trade umbrella for thirty national organizations and ten provincial coalitions, and included organizations representing working-class and marginalized Canadians, saw itself as the popular counterweight to the BCNI and the Mulroney government.64 Its formation required the forging of a cross-class alliance unprecedented in Canadian politics. The 1985 report of the Macdonald Commission, according to Jeffrey Ayres, cemented this popular-sector alliance, symbolizing closure of the policy process to its concerns.65 One major factor permitting emergence of this alliance was the ideological change in organized labour in the preceding years. As I indicated above, the post-war compromise on the welfare state led to a depoliticization of the relationship between labour and the state. Labour leaders felt themselves largely excluded from the system of elite accommodation. However, unions resigned themselves to the new policy model and concentrated on winning better wages and benefits through collective bargaining.66 Individual sectors in the labour movement did lobby government along the lines implied by interest group pluralism. Although the CLC attempted to represent the interests of the labour movement as a whole, the decentralization of the system of collective bargaining, and its own failure to incorporate all unions, particularly those in Quebec, weakened its claims to represent workers and its ability to deliver labour's support for state policies. The CLC supported liberal, continentalist policies. This stance reflected the prosperity that the country had enjoyed in the 1950s and 1960s, during the expansion of U.S. investment, and the fact that workers had shared in the benefits. The Liberal government legislated wage controls in 1975, after the failure of the negotiations with labour on wage and price guidelines. Pressure from angry affiliates pushed the CLC to adopt a more militant posture towards the state and a more radical economic doctrine. In 1976, the CLC officially embraced a nationalist-interventionist discourse and embarked on a path towards greater political activism, through its alliances with both the New Democratic Party (NDP) and other social movements.67 Actions by the Mulroney government forced the CLC into a more intransigent pos-

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ture and pushed it into the arms of the emerging popular-sector alliance. By this time, the CLC had developed a comprehensive critique of free trade, which it saw as removing many of the traditional tools of Keynesian economic management employed by the Canadian state to improve economic welfare and as lessening national independence and sovereignty.68 Influenced by its experience of consultation on wage and price controls, the CLC rejected the government's invitation to participate in the ITAC, fearing being co-opted by a system that it believed, with good reason, to be dominated by business. Although business and labour had been the main focus in mechanisms of consultation until the 1970s, the popular-sector alliance against free trade reflected a new factor in Canadian politics - the explosion of non-class-based organizations, reflecting the fragmentation and specialization of interests and identities.69 In fact, impetus for development of the coalition came from the women's movement, one of the most prominent of these new identity-based organizations. Women's opposition to free trade flew against the complete genderblindness of almost all the literature on trade. The National Action Committee on the Status of Women (NAC) argued that women, particularly poor and working-class women and women of colour, would be disproportionately affected by free trade, since they were more likely to work in the labour-intensive industries where jobs would be eliminated. NAC was also concerned that the burden associated with the trend towards privatization of functions formerly performed by the welfare state would again fall disproportionately on women. As with labour, the women's movement's adoption of a more radical discourse and a more confrontational stance towards the state also represented a dramatic shift. The women's movement that emerged in the context of the welfare state was pro-statist.70 In the 1970s, the federal Bureau of the Status of Women developed close links with feminist groups. This 'clientele' relationship began to break down in the 1980s with the proliferation of groups seeking policies on the status of women, and with the change of government in 1984.71 Like labour, the women's movement became radicalized in the mid-1980s in response to political and economic changes in the country. In addition to its role in bringing the alliance together, NAC also promoted a coalitionbuilding strategy within the PCN, forging cross-sectoral alliances by persuading groups to see beyond their own parochial concerns. The democratic and horizontal organizational traditions of the women's movement, like those of the churches and other new social move-

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ments, differed from the more hierarchical structures of the CLC,

which had prevented alliance building72Like business and the labour

movement, the Canadian women's movement is fragmented, and NAC's reliance on government funding weakened its independence; more recently, dramatic cutbacks in state funding and internal dissension have led to its dramatic decline. The PCN mounted a highly effective campaign in English Canada, culminating in the 'free trade election' of 1988. Through this period, the PCN was successful, in alliance with the Liberal Party and the NDP, in highlighting the political, economic, and cultural implications of what the government and business had hoped to portray as a noncontroversial technical matter. Popular support for the agreement gradually declined throughout English Canada, apart from Alberta. Despite the best efforts of the state, politics had escaped the narrow bounds of elite accommodation. Nevertheless, the PCN's fatal flaw was perhaps its inability to make headway in Quebec. Its weaknesses there were, according to Jeffrey Ayres, both symbolic and political. Symbolically, even the name 'Pro-Canada' Network showed an insensitivity to the nationalist sentiments of most popular-sector actors in Quebec. Quebecers were less likely to be moved by appeals to protect Canadian cultural identity, strengthen Canadian sovereignty, and preserve the powers of the central government. As well, politically, ties between popular-sector actors in Quebec and the rest of Canada were weak, and the fact that both major parties in Quebec - the Parti Quebecois and the Liberals - supported the agreement with the United States meant that the political environment for contesting the FTA was considerably less propitious there than elsewhere in the country.73 Despite the PCN's successes in the early phases of the 1988 campaign, anti-free trade activists lost momentum because of a wellfinanced business counter-response, its own continued failure to convince people in Quebec and Alberta, and the opposition's division into Liberals and the NDP.74 Mulroney's Progressive Conservatives won the election (with less than half of the popular vote), and the FTA entered into force in 1989. The PCN survived (as the Action Canada Network), even gaining more member groups, but its capacity to mobilize Canadians declined because of the lack of a supportive political context.75 The debate over NAFTA was thus much less heated than that over the FTA, partly because Canadians viewed Mexico as less of a threat to their economy and sovereignty than Mexico. Nevertheless, the addition of the 'third amigo' to continental free

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trade created the opportunity for new political strategies, based on the continentalization of the popular-sector movement. While, as we saw above, business and the state had become increasingly internationalized, such links had been largely absent within the popular sector. Mexico's entry into NAFTA helped politicize trade policy in the United States. Trinational alliances of the anti-free trade coalitions in the three countries emerged, and both Mexican and U.S. coalitions borrowed from the PCN's coalition-building tactics.76 Sectoral links emerged between groups of women, workers, environmentalists, and others in the three countries.77 The U.S. congressional system was more responsive to lobby groups than the parliamentary system in Canada and the authoritarian regime in Mexico. Pressures on President George Bush from the Democratic U.S. Congress forced the administration to demand the expansion of the NAFTA negotiations to include side deals on labour and the environment. Although Canadian activists largely dismissed these side agreements as ineffective because they lacked enforcement mechanisms, they still represented a victory for 'citizen diplomacy.'78 The labour and environmental institutions set up under NAFTA represented at least symbolic recognition that the impact of continental integration goes beyond economics. The inclusion of Mexico has also encouraged some members of the popular sector to re-examine their assumptions about the benefits of protection. Mexican anti-NAFTA activists rejected NAFTA as being based on a neo-liberal model that failed to take into account such issues as immigration, human rights, labour rights, and the environment. However, they did not oppose a continental agreement per se, and favoured opening of northern markets to Mexican exports. Transnational alliances are an important aspect of popular-sector politics under NAFTA, and the tension between internationalism and nationalism will continue to characterize popular-sector debates about the future of trade and investment policies. Democratizing Trade? Towards Hemispheric Free Trade As we saw above, institutionalization of North American integration in the form of the FTA and NAFTA affected state-society relations in Canada, transforming the politics of international economic policy. Both elite and non-elite sectors became more unified and more attached to rigid and diametrically opposed ideological perspectives on economic liberalization. The state helped create this polarization by

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establishing mechanisms of consultation geared essentially to business and by failing to draw in other actors. This situation, I have argued, is corrosive of democratic governance, since it has consolidated the most restricted form of democracy - elite competition. Despite this gloomy picture, there are grounds for hope that future developments in North American integration will lead to greater democratization and that more inclusive decision-making can and will be (indeed to some extent have been) devised under NAFTA. The politicization of trade policy and the mobilization of a wide range of groups and individuals on complex issues of trade and investment laid the basis for a more inclusionary model. One encouraging sign is the growing move towards model-II- and model-III-style consultation mechanisms in other areas of public policy. Another is DFAIT's wider consultation in the run-up to a proposed Free Trade Area of the Americas (FTAA). Multi-Stakeholder Consultation and Citizens' Engagement First, the elite-competition model established by the Canadian state in trade policy is an anomaly. According to Susan Phillips,79 the federal government is seeking new, generally more inclusive, ways of relating to organized interest and identity groups because of the following changes in Canadian politics: the increasing fragmentation and specialization of interests and identities; the growth of a rights-oriented political culture as a result of the Charter of Rights and Freedoms, so that each identity group feels that it has a right to be heard in the policy process; and growing popular unease with elitism and increasing unwillingness to leave policy to elected leaders. Other factors relate to global changes in the role of governments vis-a-vis states and societies: the greater complexity of policy issues and recognition that the state does not have a monopoly on expertise; the diminishing availability of financial resources to undertake policy, hence the greater reliance on society; and the sense that governments and business must be more competitive - the state must promote economic restructuring by seeking new relationships with both society and the market. All these forces for change have led Canadian governments to put more emphasis on partnership with 'stakeholders' in most areas of public policy. They have adopted more inclusionary and transparent forms of consultation even in an area as traditionally closed to public view as the budgetary process.80

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For example, until fairly recently, environmental policy, like trade policy, was made behind closed doors, with consultation limited to affected industry officials. As George Hoberg notes, the policy style that dominated the environmental policy network in Canada until recently could be described best as 'bipartite bargaining' and was 'characterized by closed, co-operative negotiations between government departments and industry.'81 It excluded representatives of environmental non-governmental organizations (ENGOs), which were seen as lacking the expertise, organizational sophistication, and political influence necessary to participate in official talks. In recent years, however, as a result of growing environmental concern and NGOs' activism, governments have acquiesced to public pressure and devised new instruments of governance that involve ENGOs and other interests (labour, consumers, and so on) in multi-stakeholder consultations.82 According to Hoberg: 'As governments began to feel more pressure to produce new environmental policies, multistakeholder forums became a standard operating procedure of the policy process at both the federal and provincial level. They have been, or are being, used in virtually every policy initiative, the most prominent being the Canadian Environmental Protection Act of 1988, the pesticide registration review ... the federal pulp and paper effluent regulations, Ontario's overhaul of its water pollution control regime ... and the federal government's showpiece "Green Plan."'83 Similarly, Tim Dorcey and Tim McDaniels report that in the environmental field 'citizen involvement' (models II and III) has almost replaced policy analysis as a means of gaining insight into policy issues.84 Even in the traditionally closed area of foreign policy, the Liberal government has committed itself to viewing democracy as both a domestic source and an overseas objective of Canadian foreign policy.85 DFAIT's approach to the negotiation of an international treaty on the global ban of landmines is a dramatic example of the ability of state and non-state actors to work together on issues of common interest. In the Ottawa Process, DFAIT worked closely with the International Campaign to Ban Landmines, which has been called a good example of 'global civil society.' As Cameron, Lawson, and Tomlin point out, the emergence of a global civil society 'holds the promise of making existing international institutions more democratic, transforming them through innovation and experimentation, and anchoring them in world opinion/86 But in order for government-civil society partnerships to be effective, 'both sides must overcome their mutual ambiva-

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lence about working together.'87 The role of global civil society has become particularly prominent in the environmental field. For example, thousands of ENGOs from both North and South participated in the Global Forum at the Environmental Summit in Rio de Janeiro in 1992. UNCED Secretary-General Maurice Strong reported that he was hopeful because the summit's decisions had been made 'not behind closed doors but in the full glare of publicity, before the peoples of the world who have been watching, people who hold their leaders accountable.'88 Within the NAFTA regime, the Commission on Environmental Cooperation (CEC), established as part of the side accord on the environment, provides a slightly more inclusionary form of politics. In recognition of the leading role that U.S. ENGOs played in the campaign against NAFTA (and the fact that many of them, unlike their labour counterparts, eventually supported the revised treaty), mechanisms for participation by ENGOs were built into the CEC structure. Critics argue that the CEC has processed very few complaints about member countries' failure to enforce their environmental policies and that citizens and ENGOs have limited access to NAFTA's institutions, as compared to private-sector actors. None the less, the Joint Public Advisory Committee (JPAC) - a trinational body set up to ensure that citizens can contribute to North American environmental policy - does include strong representation from the NGO and Aboriginal as well as the business communities. Listed within its mandate is the goal of promoting transparency and public participation in environmental regulation.89 Two of the CEC's intergovernmental processes - on birds and on improving environmental compliance - include both NGOs and business. John Kirton argues that, as a result, the CEC 'is both deepening its societal and governmental roots' and 'broadening its relevance beyond the North American community to the expanded partnership now being forged with Chile and prospective members of the Free Trade Agreement of the Americas (FTAA).'90 Unfortunately, the Border Environmental Cooperation Commission (BECC), the NAFTA institution that offers the most opportunities for non-corporate participation, includes only Mexico and the United States, not Canada, because it focuses on the U.S.-Mexican border. Nevertheless, it too provides a possible model for incorporating civil society's participation in a 'deepened' (and perhaps 'widened') North American community.91 However, for such participation to take on real meaning, the text of any future trade agreement would have to

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incorporate workers' rights and environmental standards, along with appropriate mechanisms for enforcement. Civil-Society Participation in the FTAA Process Finally, a potentially promising area for civil society's involvement is the process of talks on the proposed FTAA. The launching of the FTAA initiative at the Miami Summit of the Americas in 1994 by President George Bush was not particularly propitious. According to the CLC, business leaders, empowered by their success in shaping NAFTA, 'were invited to play an even more direct role in defining the direction of the proposed new initiative.'92 The result was creation of the Business Forum of the Americas, whose recommendations have been tabled in official declarations. In response, the hemisphere's labour movement has insisted on democratization and greater transparency for the FTAA process. The Inter-American Regional Workers Organization (ORIT) has held a Labour Forum at annual meetings of FTAA trade ministers. In 1997, ORIT's efforts to broaden its ties with other civil actors and social movements on trade led to the formation of a Hemispheric Social Alliance, grouping unions, ENGOs, and womens,' human rights, and development groups. The alliance sponsored a Peoples' Summit of the Americas in Santiago, Chile, at the same time as the official summit and developed an alternative platform, 'Fair Trade in the Americas.'93 Within Canada, it seems that the government has learned from the problems of the FTA and NAFTA processes and has encouraged broader consultation. Prior to the Santiago Summit, DFAIT sponsored a series of three consultations across Canada, organized by the Canadian Foundation for the Americas (FOCAL). Although business had but a limited presence and only junior state officials were present as observers, the forums represented a first step. More recently, under pressure from the NGOs, Canada and the United States persuaded the other countries to establish a Committee of Governmental Representatives on Civil Society Participation. However, some of the other governments, including Mexico, resisted calls for active face-to-face talks with the NGOs, instead issuing an invitation to NGOs to mail in their 'constructive' views. Submissions had to refer directly to 'the trade aspects related to the FTAA process.' Dick Martin, former secretary-treasurer of the CLC and president of ORIT, dismissed this option as nothing more than a post office for alternative views.94

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While this solution is clearly inadequate and illustrates the problems of democratizing a system composed of many regimes, some of them still quite authoritarian, Canada's support for the NGOs' position represents a real advance. Given the U.S. Congress's refusal in 1998 to grant President Clinton 'fast-track' authority, under pressure from the anti-free trade forces that mobilized during the NAFTA debate, the prospects for hemispheric free trade currently appear dim. The politicization of U.S. trade policy signifies that future progress may depend on the real, not just token, inclusion of civil-society actors in an active process of consultation. Former Canadian Trade Minister Sergio Marchi recognized this political reality and stated that trade talks can no longer be conducted in secrecy because the process of negotiating such pacts has become as important as their substance. Marchi added that this lesson was demonstrated by the successful grassroots campaign against the Multilateral Agreement on Investment and that Foreign Affairs learned some valuable lessons: 'Secrecy serves no one and risks alienating everyone.'95 Canada's role as host of the Summit of the Americas in 2001 put it in an ideal position to continue to offer leadership on this issue.96

Conclusion Replacing the old 'elite tripartite' model for consultation on trade policy with multi-stakeholder and citizens'-engagement models will not do away with anti-democratic tendencies in governance. As Phillips points out, non-elite stakeholders often see consultation as a charade, designed to legitimize state policy. The logic of co-optation vis-a-vis business hardly represents an encouraging precedent. According to Phillips, these problems occur partly because the federal civil service lacks a consultative culture: 'Little premium is placed on consultative skills and few government departments have any established machinery through which ongoing consultation can proceed. Consultation tends to be an afterthought, rather than a first thought, and, all too often, an exercise in window-dressing.97 Changes are necessary, including a receptive organizational culture, an ethic of openness and interpersonal skills, and principles of fairness and equity of representation. Funding for less-wealthy interests would create a more 'even playing field.' If they wish to be consulted, popular-sector groups must also reexamine their nationalist assumptions and discover points of convergence between their social justice platforms and state and business

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interests. In trade policy, economists must also recognize the political dimensions of economic restructuring and the negative implications both for democracy and for effective policy-making of ignoring popular-sector perspectives. Despite these obstacles to effective consultation, governments, business, and NGOs must find ways to make it work. As Doern and Tomlin point out, in an era of globalization, Canada needs to address 'human-capital' and labour market issues. To do so, government has to deal with unions and organized labour, but labour's alienation from the state prevents this.98 Canada's rising strike rate is also a sign of the failure of existing labour market policy. The dynamic nature of comparative advantage in a global economy requires that the Canadian state play an important role in this area, but it cannot do so without the active and consensual involvement of civil society. From a political perspective, as well, new forms of governance are essential. The growing gap between rich and poor, and Canadians' lack of confidence in existing systems of representation, especially in political parties, are disturbing signs. A 1995 study of public views by Ekos Research Associates found evidence 'of relative discontent with the narrow and unsuccessful pursuit of prosperity and competitiveness which characterized the eighties ... Most Canadians now want to reengage in nation building with a human face.'99 Real consultation not only encourages the representation of a wide range of interests, it also promotes citizenship - the empowerment of individuals and organizations - through their participation in the decision-making process.100 Broadening the existing model of consultation will not ensure democracy in trade, for it does not overcome the 'democratic deficit' - the shift of power and authority away from elected governments to unaccountable international bodies. This shift, however, may increase pressure on governments to share information and to make their decisions in an open and transparent fashion, and it may also provide more space for actors from civil society to contest states' and international decisionmaking. Nowhere is the need for greater accountability and participation more evident than in international economic policy. NOTES 1 I produced this chapter with the support of the Social Sciences and Humanities Research Council of Canada and the Policy Research Secretariat. I

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2

3

4

5 6 7 8 9

thank Laura Ritchie for her able research assistance and Maxwell Cameron, George Hoberg, Sheila Katz, Chris Rosene, and participants in the conference on North American integration held in Edmonton 14-15 May 1999 for their helpful comments. Note that some approaches to state-society relations would include subnational governments as part of 'society.' This chapter does not analyse this area, since chapter 8, below, covers it. In a study for the Macdonald Commission, Charles Pentland similarly noted the methodological problems stemming from the following issues: '!) "North American economic integration" refers not only to a wide variety of arrangements ... but also to a more general process - international integration - to which scholars have found it notoriously difficult to attach precise measures; 2) in the complex set of institutions and behaviour that constitutes the Canadian polity, it is by no means clear where to look for the significant effects of integration, and 3) because of the lack of available literature on Canada, we are forced to look to theoretical literature and to other regions, such as Europe, where processes of integration may not be comparable.' See Charles Pentland, 'North American Integration and the Canadian Political System,' in Denis Stairs and Gilbert R. Winhan, eds., The Politics of Canada's Economic Relationship with the United States (Toronto: University of Toronto Press in co-operation with the Royal Commission on the Economic Union and Development Prospects for Canada, 1985). See Samuel Huntington, 'Democracy's Third Wave,' in Larry Diamond and Marc F. Plattner, eds., The Global Resurgence of Democracy, 2nd ed. (Baltimore: Johns Hopkins University Press, 1996), 3-25. See David Held, Models of Democracy, 2nd ed. (Stanford, Calif.: Stanford University Press, 1996), xi. This section draws heavily on the work of ibid. See ibid., 157. I am indebted to Max Cameron for this insight. See Alexandra Dobrowolski, 'Of "Special Interest": Interest, Identity, and Feminist Constitutional Activism in Canada,' Canadian Journal of Political Science 31, no. 4 (Dec. 1998), 707-42.

10 See Held, Models of Democracy, 214-15. 11 See Jane Jenson and Susan Phillips, 'Regime Shift: New Citizenship Practices in Canada/ International Journal of Canadian Studies 14 (fall 1996), 111-36. 12 Niagara Institute, quoted in George Hoberg, 'Environmental Policy: Alternative Styles/ in Michael M. Atkinson, ed., Governing Canada: Insti-

216 Politics tutions and Public Policy (Toronto: Harcourt Brace Jovanovich Canada, 1993), 317. 13 This is the critique made by the former Reform Party. See Jenson and Phillips, 'Regime Shift/ 124-5. 14 See Jon Elster, 'Introduction,' in Elster, ed., Deliberative Democracy (Cambridge: Cambridge University Press, 1998), 1. 15 Ibid., 11. 16 See Frances Abele, Katherine Graham, Alex Ker, Antonia Maioni, and Susan Phillips, Talking with Canadians: Citizen Engagement and the Social Union (Ottawa: Canadian Council on Social Development, July 1998), 17. 17 See ibid. In their definition of citizens' engagement, Abele et al. do not exclude participation by organized groups, but they emphasize that the participation of 'ordinary citizens' - i.e., individuals who are neither delegates nor representatives of governments, associations, or interest groups - is essential. 18 Richard Simeon, one of the scholars charged with political science studies for the Macdonald Commission, reflected on the disciplinary separation of knowledge within the commission's structure, which rigidly separated economics from political science; the former discipline appeared to offer a coherent alternative to the country's malaise, while the latter did not. See Richard Simeon, 'Inside the Macdonald Commission,' Studies in Political Economy 22 (spring 1987), 167-79. See also Glen Williams, 'Symbols, Economic Logic and Political Conflict in the CanadaU.S.A. Free-Trade Negotiations,' Queen's Quarterly 92, no. 4 (winter 1985), 659-78. 19 See Gustavo Vega Canovas, 'Private Sector Trade Advisory Groups in North America: A Comparative Perspective/ in Gustavo del Castillo V. and Gustavo Vega Canovas, eds., The Politics of Free Trade in North America (Ottawa: Centre for Trade Policy and Law, Carleton University, 1995), 46. 20 See ibid., 50. 21 See Hugh G. Thorburn, The Focus of the Study: Two Overlapping Dynamics/ in Hugh G. Thorburn, ed., Interest Groups in the Canadian Federal System, Royal Commission on the Economic Union and Development Prospects for Canada, Vol. 69 (Toronto: University of Toronto Press, 1985) 9, and William D. Coleman and Grace Skogstad, 'Introduction/ in Coleman and Skogstad, eds., Policy Communities and Public Policy in Canada: A Structural Approach (Toronto: Copp Clark Pitman, 1990). 22 See Gilbert Winham, International Trade and the Tokyo Round Negotiation (Princeton, NJ: Princeton University Press, 1986).

Governance and State-Society Relations 217 23 See Alan M. Rugman and Andrew D.M. Anderson, Administered Protection in America (London: Croom Helm, 1987), 117. 24 Cited in Jane Jenson, 'Mapping Social Cohesion,' Backgrounder - Speech Presented at the Policy Research Secretariat's Conference, 'Policy Research: Creating Linkages/ 1 Oct. 1998, Ottawa, at http://www.cprn.com/ back_press/bmsc2_e.htm, 6 June 2000, 2. 25 See, for example, Linda McQuaig, The Quick and the Dead: Brian Mulroney, Big Business and the Seduction of Canada (Toronto: Viking, 1991). 26 See Keith G. Banting, 'Social Policy/ in G. Bruce Doern, Leslie Pal, and Brian Tomlin, eds., Border Crossings: The Internationalization of Canadian Public Policy (Toronto: Oxford University Press, 1996), 45. 27 See Ricardo Grinspun and Robert Kreklewich, 'Consolidating Neoliberal Reforms: "Free Trade" as a Conditioning Framework/ Studies in Political Economy 43 (spring 1994), 33-61. 28 Rugman, Kirton, and Soloway, supporters of the agreement argue that NAFTA's ultimate significance lies in the fact that it provides 'assurance of policy continuity to investors and traders under a generally predictable set of rules/ See Alan M. Rugman, John Kirton, and Julie A. Soloway, 'Canadian Corporate Strategy in a North American Region/ American Review of Canadian Studies (summer 1997), 199; the citation is from Sidney Weintraub and Jan Gilbreath, 'North American Trade under NAFTA/ NAFTA Effects Working Paper Series, No. 2 (Montreal: Commission for Environmental Cooperation, 1996), 1. 29 See Stephen Clarkson, 'Fearful Asymmetries: The Challenge of Analyzing Continental Systems in a Globalizing World/ Canadian-American Public Policy (occasional paper series of the Canadian-American Center, University of Maine), No. 35 (Sept. 1998), 14-15. 30 See Ibid., 28. 31 Ibid. 32 See Canadian Labour Congress. Submission by the Canadian Labour Congress to The Honourable Sergio Marchi, Minister for International Trade and the Department of Foreign Affairs and International Trade regarding the Free Trade Area of the Americas (FTAA) (Ottawa: CLC, 30 April 1999), 6-7. 33 See Ian Robinson, The NAFTA, Democracy and Continental Economic Integration: Trade Policy as If Democracy Mattered/ in Susan D. Phillips, ed, How Ottawa Spends: A More Democratic Canada ...? 1993-1994 (Ottawa: Carleton University Press, 1993), 338; see also Edward Muller, 'Democracy, Economic Development and Income Equality/ American Sociological Review 53 (Feb. 1988), 50-68.

218 Politics 34 See the chapters by Rocher and by Banting, Hoberg, and Simeon in this volume for other statements of this position. 35 William D. Coleman and Tony Porter, 'Banking and Securities Policy,' in Doern, Pal, and Tomlin, eds., Border Crossings, 55. For an extreme statement of this position, see Kenichi Ohmae, The End of the Nation State: The Rise of Regional Economies (New York: Free Press, 1995). A similar perspective is presented in the Canadian context by Thomas Courchene, Rearrangements: The Courchene Papers (Oakville: Mosaic, 1992), and Renegotiating Equalization: National Polity, Federal State, International Economy (Toronto: C.D. Howe Institute, Sept. 1998). 36 Cited in Stephen Dale, Lost In the Suburbs: A Political Travelogue (Toronto: Stoddart, 1999), 118-19. 37 See, for example, Manfred Bienefeld, 'Financial Deregulation: Disarming the Nation State,' in Jane Jenson, Rianne Mahon, and Manfred Bienefeld, eds., Production, Space and Identity: Political Economy Faces the 21st Century (Toronto: Canadian Scholars' Press, 1993), 347-70. 38 See Coleman and Porter, 'Banking and Securities Policy/ 55-6. 39 This discussion is very general and does not adequately take into account the diversity of experiences within each sector. 40 See G. Bruce Doern and Brian W. Tomlin, Faith and Fear: The Free Trade Story (Toronto: Stoddart, 1991), 109. 41 See James Gillies, 'Where Business Fails Revisited,' in V.V. Murray, ed., Theories of Business-Government Relations (Toronto: Trans-Canada Press, 1985), 144. 42 Cited in Neil Bradford, Commissioning Ideas: Canadian National Policy Innovation in Comparative Perspective (Toronto: Oxford University Press, 1998), 55. 43 See John Kirton and Blair Dimock, 'Domestic Access to Government in the Canadian Foreign Policy Process 1968-1982,' International Journal 39, no. 1 (winter 1983-4), 69. 44 See Doern and Tomlin, Faith and Fear, 60-2. 45 See Gillies, 'Where Business Fails Revisited/ 144; see also D. Wayne Taylor, 'An Interpretive Approach to Understanding and Improving BusinessGovernment Relations/ Canadian Journal of Administrative Science 4, no. 4 (Dec. 1987), 353-66. 46 See Doern and Tomlin, Faith and Fear, 46. 47 Ibid., 105. 48 See David Langille, The Business Council on National Issues and the Canadian State/ Studies in Political Economy 24 (autumn 1987), 41-85.

Governance and State-Society Relations 219 49 See Helen Moroz, 'The Changing Constellation of State-Societal Relations in Canada: A Case Study of the Domestic Consultations Leading to the Canada-U.S. Free Trade Agreement/ PhD thesis, Queen's University, May 1996, 7-8. 50 Gustavo Vega Canovas draws out interesting comparisons between the U.S., Canadian, and Mexican systems of private-sector consultation. Although the Canadian system was modeled on the U.S. SACs, and the Mexican system on the Canadian ITAC, subtle differences reflect the different character of state-society relations in the three countries. Both the Canadian and U.S. groups are appointed by government, but in Canada they are financed by government and sworn to secrecy, while in the United States they are self-financed and their documents are public. In the Mexican case, members are appointed by the private sector, reflecting the historic lack of relationship between the private and public sectors. Also, the U.S. system was more politicized, since the ACTN was appointed directly by the president. Gustavo Vega Canovas, 'Private Sector Trade Advisory Groups in North America: A Comparative Perspective,' in Gustavo del Castillo V. and Gustavo Vega Canovas, eds., The Politics of Free Trade in North America (Ottawa: Centre for Trade Policy and Law, Carleton University, 1995), 34; Gilbert R. Winham, International Trade and the Tokyo Round Negotiation (Princeton, NJ: Princeton University Press, 1986). 51 According to Smythe, in 1996 the ITAC consisted of twenty-five members, sixteen drawn from the corporate sector, including major banks and business associations such as the BCNI and the CMA, three from trade unions, four academics, one farmer, and one consumer representative. Three new task forces (dealing with trade policy, international business development, and trade and the environment) and the SAGITs were even more heavily business-oriented. See Elizabeth Smythe, 'Investment Policy,' in Doern, Pal, and Tomlin, eds., Border Crossings, 208. 52 See Moroz, The Changing Constellation/ 11-12; and Rugman and Anderson, Administered Protection in America, 126-7. 53 Ibid., 117. 54 Moroz, The Changing Constellation/ 19. 55 See ibid., 17-18. 56 See Winham, International Trade and the Tokyo Round Negotiation, 314. 57 See ibid., 314. 58 Alan Cairns wrote about this symbiosis of state and society in Canada in 1985, but it has become more intense since.

220 Politics 59 See Rugman, Kirton, and Soloway, 'Canadian Corporate Strategy in a North American Region/ 215. 60 See Doern and Tomlin, Faith and Fear, 105-8. 61 For example, when Reisman broke off the talks in September 1987, the BCNI called American Express CEO Robinson to meet with its members in Toronto. Robinson was told that BCNI members supported Reisman's decision because of U.S. failure to deal with the issue of trade remedies, and that there could be serious consequences of the failure of the talks, including the defeat of the Mulroney government. Robinson delivered the message to Reagan and Bush, and the negotiators returned to the table the next month. Doern and Tomlin, Faith and Fear, 107. 62 This apparent unity is to some extent artificial, and important differences still exist among different sectors of business on issues of free trade. Several of the SAGITs, for example, came out critical of the free trade agreement. 63 Banting, 'Social Policy/ 39. 64 See Doern and Tomlin, Faith and Fear, 210. 65 See Jeffrey M. Ayres, Defying Conventional Wisdom: Political Movements and Popular Contention against North American Free Trade (Toronto: University of Toronto Press, 1998), 42. 66 See Bradford, Commissioning Ideas, 55. 67 See Miriam Smith, The Canadian Labour Congress: From Continentalism to Economic Nationalism/ Studies in Political Economy 38 (summer 1992), 35-60; and Bradford, Commissioning Ideas, 106. 68 See Smith, The Canadian Labour Congress/ 51-4. 69 See Susan D. Phillips, 'How Ottawa Blends: Shifting Government Relationship with Interest Groups/ in Frances Abele, ed., How Ottawa Spends: The Politics of Fragmentation 1991-92 (Ottawa: Carleton University Press, 1991), 183-227. 70 See Janine Brodie, Politics on the Boundaries: Restructuring and the Canadian Women's Movement (North York: Robarts Centre for Canadian Studies, York University, March 1994), 29. 71 See Sandra Burt, 'Organized Women's Groups and the State/ in William Coleman and Grace Skogstad, eds., Policy Communities and Public Policy in Canada: A Structural Approach (Toronto: Copp Clark Pitman, 1990), 191-211. 72 See Ayres, Defying Conventional Wisdom, 55-6. 73 Ibid., 111-14. The Quebec political parties' support for free trade with the United States reflected the view of a majority of Quebec's francophone

Governance and State-Society Relations 221

74 75 76 77

78

79 80

81

82 83 84

business and political classes that they would benefit most from decreased governmental intervention in the economy. The strength of nationalism among Quebec's popular-sector actors means that they are less likely to challenge Quebec francophone elites than are popular-sector actors in the rest of the country. See Francois Rocher, 'Continental Strategy: Quebec in North America/ in Alain Gagnon, ed., Quebec: State and Society, 2nd ed. (Toronto: Methuen, 1993), 450-68; and Andre Turcotte, 'Uneasy Allies: Quebecers, Canadians, Americans, Mexicans and NAFTA/ in Guy Lachapelle, ed., Quebec under Free Trade: Making Public Policy in North America (SainteFoy: Presses de 1'Universite du Quebec, 1995), 239-90. Ayres, Defying Conventional Wisdom, 93-116. Ibid. Ibid., 128. For an analysis of trinational women's networks, see Christina Gabriel and Laura Macdonald, 'NAFTA, Women and Organizing in Canada and Mexico: Forging a "Feminist Internationality/" Millennium: Journal of International Studies 23, no. 3 (1995), 535-62. The CLC's ability to criticize the practice of labour rights in Mexico was initially constrained by the fact that the main union federation in Mexico, the state-run Confederation of Mexican Workers (CTM), was a fellow member of the International Confederation of Free Trade Unions (ICFTU), so the CLC was reluctant to criticize it. The CLC has become increasingly openly critical of the CTM, however, in recent years, and closer to independent Mexican trade unions. See Jorge G. Castaneda, 'Beyond Terms of Trade: The Broader Social and Political Supranationality and Grass Roots Coalitions/ unpublished document, n.d. See Phillips, 'How Ottawa Blends.' See Evert A. Lindquist, 'Citizens, Experts and Budgets: Evaluating Ottawa's Emerging Budget Process/ in Susan D. Phillips, ed., How Ottawa Spends, 1994-95: Making Change (Ottawa: Carleton University Press, 1994), 91-128. See Hoberg, 'Environmental Policy: Alternative System/ in Atkinson, ed, Governing Canada: Institutions and Public Policy (Toronto: Harcourt Brace Jovanovich Canada), 314. Ibid., 310-11. Ibid., 318-19. See Tony Dorcey and Tim McDaniels, 'Great Expectations, Mixed Results: Trends in Citizen Involvement in Canada/ draft paper prepared for Social

222 Politics

85

86

87 88 89

90

91

92

93 94

95 96

Sciences and Humanities Research Council Trends Project, Environment Theme, 13 April 1999,5. See Maxwell A. Cameron and Maureen Appel Molot, 'Introduction: Does Democracy Make a Difference?' in Cameron and Molot, eds., Canada among Nations 1995: Democracy and Foreign Policy (Ottawa: Carleton University Press, 1995), 9; and Tim Draimin and Betty Plewes, 'Civil Society and the Democratization of Foreign Policy/ in Cameron and Molot, eds., Canada among Nations 1995,63-82. See Maxwell A. Cameron, Robert J. Lawson, and Brian W. Tomlin, To Walk without Fear,' in Maxwell A. Cameron, Robert J. Lawson, and Brian W. Tomlin, eds., To Walk without Fear: The Global Movement to Ban Landmines (Toronto, Oxford, New York: Oxford University Press, 1998), 13. Ibid. See Third World Economics, special issue on the Rio Summit, 43/44 (16 June15 July 1992), 6. See Stephen Mumme, 'Environmental Management on the Mexico-United States Border: NAFTA and the Emerging Bilateral Regime/ American Review of Canadian Studies (summer 1996), 211. See John Kirton, 'The Commission for Environmental Cooperation and Canada-U.S. Environmental Governance in the NAFTA Era/ American Review of Canadian Studies (autumn 1997), 461. For a discussion of the concept of a North American community, see John D. Wirth, 'Advancing the North American Community/ American Review of Canadian Studies (summer 1996), 261-73. See Canadian Labour Congress, Submission by the Canadian Labour Congress to The Honourable Sergio Marchi, Minister for International Trade and the Department of Foreign Affairs and International Trade regarding the Free Trade Area of the Americas (FTAA) (Ottawa: CLC, 30 April 1999), 3. See ibid., 4. See Heather Scoffield, 'Activists Say Mexico Blocking Groups' Participation in Trade Talks/ Globe and Mail, 7 Nov. 1998, B4, and Department of Foreign Affairs and International Trade, 'Canada's Trade Agenda: The Road Ahead in 1999,' www.infoexport.gc.ca/section4/agenda_ftaa-e.asp, Jan. 1999. See James Baxter, 'Government Will Seek Public Input in Future Trade Talks, Minister Says/ Ottawa Citizen, 10 Feb. 1999, B4. For a more up-to-date analysis of civil society and the FTAA, see Laura Macdonald and Mildred Schwartz, "Political Parties and NGOs in the

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97 98 99 100

Creation of New Trading Blocs in the Americas/ International Political Science Review 23, no. 2 (2002), 135-58. See Phillips, 'How Ottawa Blends.' See G. Bruce Doern and Brian Tomlin, Trade-Industrial Policy/ in Doern, Pal, and Tomlin, eds., Border Crossings, 180. See Bradford, Commissioning Ideas, 170. See Phillips, 'How Ottawa Blends.'

8. Redefining the Locus of Power Frangois Rocher and Christian Rouillard

Ten years after the signing of the Canada-United States Free Trade Agreement (FTA), which, with the inclusion of Mexico, later became the North American Free Trade Agreement (NAFTA), other Latin American countries are hoping for hemispheric free trade.1 What is the effect of this continental process on the capacity of governments to regulate their own social and economic development? Continental integration inevitably affects all levels of government in a federal state such as Canada, thus challenging the division of powers between the central and provincial governments. Is it compatible with the very principle of federalism? In other words, does this multinational process threaten not only the state's sovereignty, but also its federal structure? To the extent that it does so, which level of government benefits the most? Is continental integration a centrifugal or a centripetal force in the Canadian federation? Continental economic integration is only one facet of globalization, which is now well under way. This process is transforming the rules governing international exchanges of all kinds, be they economic, cultural, or political. Globalization has implications of particular significance to Canada, which adopted a federal system in order to manage cultural and regional diversity. Federalism may make it possible to reconcile two conflicting trends: the lightning-fast rise of globalization and the inevitable role of national and cultural specificity. Globalization favours greater economic, political, social, and cultural uniformity. Because of its emphasis on the market economy, discourse and practices relating to the rights of producers and consumers chal-

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lenge the role traditionally accorded to the state. Nations must distinguish themselves from each other on the basis of their historical heritage and their identity, while seeking to forge broader alliances for mutual benefit. While globalization may result in economic advantages, individual citizens belong to a singular community that confers on them a sense of self, a language, and a heritage; opens up the world to them; and helps shape their destiny. Andre Burelle asked: To what extent can globalization be reconciled with human beings' need for community and territorial roots?'2 Similarly, how can individual and national identities be reconciled with the universal, without gradually destroying local allegiances that ground individual identity? Federalism is an open, flexible approach that is sensitive to the complexity of allegiances and values. If properly applied, it can reconcile the seemingly conflicting currents of globalization and integration with the preservation of national and regional identities. This spirit is the inspiration for the European Union, for example.3 Beyond the structures inherent in federal states, federalism is also founded on a number of basic principles. Both the spirit that must inspire a federal state and the types of arrangements for the social relationship that it claims to champion are equally important.4 Denis de Rougemont has expressed these principles: • A federation must stem from the renunciation of any idea of organizational hegemony exercised by one of its components. • Federalism must stem from the renunciation of any spirit ofsystematization. • Federalism does not experience problems of minorities. • The purpose of federalism is not to eliminate diversity and meld all nations into a single entity, but, on the contrary, to safeguard their inherent characteristics. • Federalism is based on a love of complexity, in contrast to the brutal simplism that characterizes the totalitarian spirit. • A federation is formed gradually, by individuals and groups, not by a centre or by governments. • A federation is not created in order to counter an external threat, nor for imperialist purposes, but, on the contrary, to further the survival of the communities of which it is composed, so that together they can exercise functions beyond the individual capacities of each.4 In other words, federalism must conform to and respect a number of

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fundamental principles, which must inform its institutional arrangements. Rougemont defines federalism as 'the policy of seeking the guarantee of autonomies within union, or of autonomies seeking their guarantee within union/5 It is thus a dual dynamic, neither of whose elements can be subordinate to the other. By its very nature, this dynamic excludes any hierarchization among the federating entities, be it economic, political, or cultural. The unity sought must not be a 'national' unity, referring to some sort of homogenizing idea of identity, but must rather be expressed in terms of common interests and shared advantages, through an agreement by mutual consent. It cannot be imperialist or unitary. Inspired by such considerations, Andre Burelle, a constitutional adviser to the Trudeau and Mulroney governments, outlined the key principles of federalism as: subsidiarity, non-subordination, and management of interdependence.6 It is not within the scope of this analysis to identify the problems associated with each of these principles. First, subsidiarity is not merely a method of governance. It is part of the broader individualist current, in that it seeks to empower individuals with respect to their immediate environment and is biased in favour of local governments. This principle is not merely an operational technique designed to delimit more effectively the responsibilities that would normally fall under the purview of each order of government.7 Efficiency is not the essential requirement posed by the principle. It is the individual, rooted in the community to which he or she belongs, who is at the centre of this philosophy, rather than the efficient operation of the social and economic structures for their own sake. A managerial interpretation of subsidiarity would thus not be in keeping with the spirit of federalism. Second, the principle of non-subordination refers to the very nature of federalism itself, which is based on the autonomy inherent in each order of government. Finally, interdependence means that the partners of the federation must consult one another and decide freely and jointly on opportunities for, and limitations on, joint decision-making within their respective jurisdictions. This partnership is all the more necessary at a time when globalization no longer allows each order of government to hold powers exclusively. These three principles are indissoluble. Interdependence must be managed in partnership within a federation, taking into account the other two principles. This approach excludes any subordination of one order of government to another and rejects in particular any unilateral

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imposition of standards and rules of procedure by the central authority. While there are many federal states, they have come into existence and evolved as a result of very different causes. Although Canadian federalism has respected these principles only very imperfectly, the federative model was chosen over the unitary state favoured by a number of Fathers of Confederation, including John A. Macdonald. The unitary model was rejected in order to preserve Quebec's exceptional and unique position in North America.8 Canadian federalism was born of the desire to protect the inherent diversity of the new Canada. This key dimension cannot be ignored. This chapter first looks at how the dynamic of globalization/economic integration and decentralization has been perceived and offers an overview of the literature and of how some authors have emphasized the decentralizing effect of continental integration and globalization. Second, it examines how the 'continental agenda' has developed and has led to a challenge of provincial trade practices in Canada. This issue has entered the public debate, and proposals for constitutional change have sought to take this aspect into account. Third, the chapter shows that, despite the failure of the Meech Lake and Charlottetown accords, the provinces and the federal government reached an agreement on gradually eliminating a number of barriers to internal trade. Finally, it looks at the 'lost meaning of federalism' and the many challenges that economic integration poses to Canadian federalism. This chapter claims that the continental integration process, with its emphasis on economic efficiency, appears to be antithetical to federalism. The search for economic efficiency calls for greater harmonization of economic, fiscal, and social policies, which all become increasingly blurred. It calls for a 'level playing field' that can come only through greater national or pan-Canadian uniformity and through greater homogenization of regional and provincial distinctiveness. The irreducible opposition between continental integration and federalism becomes all too evident - the former presses towards uniformity, while the latter is synonymous with diversity. Greater economic integration can come only at the cost of federalism itself. Globalization and Decentralization: Complementary Logics? The globalization of national economies, which produces bilateral and multilateral agreements (NAFTA, for example, and the World Trade

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Organization, or WTO), makes factors of production increasingly mobile, thus reducing states' capacity for autonomous industrial and commercial policies. Moreover, states gradually transfer part of their sovereignty to these new mechanisms, further sacrificing flexibility in sectors that they previously controlled. In addition, policies for supporting less-developed regions are also called into question. Business mentality and economic reasoning favour regions with high growth potential, which can attract capital from transnational corporations. The free domestic movement of factors of production allows individuals, companies, and capital to locate in regions where they can optimize their growth. Underdeveloped regions compete directly with regions seen as having high potential for growth. In Canada, moreover, regional development policies benefited the wealthier provinces, which contributed to a market oriented along an east-west axis, of which Ontario was the centre point. A commercial system more oriented north-south undermines this rationale. Finally, globalization exerts irresistible pressures on welfare-state functions exercised by governments. Whereas wealth redistribution spreads opportunity within the national economic space, thus indirectly reducing labour's mobility, the 'denationalization' of economies accentuates the need to create wealth, while moving it further from the ethic of redistribution. As Courchene points out, 'the process of globalization is clearly undermining the nation-state as one of the principal ways of ordering relationships, of locating authority, and of channeling power.'9 Taking a strictly economic viewpoint, Kenneth Norrie asks: 'Why is there pressure in Canada and elsewhere to strip the central government of much of its authority over economic management? The argument ... for enhanced political integration ran from the fact of globalization to the incentive for increased market integration, to the need for increased political integration, to the need for a new governance structure, to federalism as an appropriate model. If the reasoning is at all robust, the explanation for the interest in devolution must be that one or more of these links must be broken.'10 Norrie explains such an interest in devolution. First, globalization tends to reduce the gains achieved through market integration. It is thus possible to eliminate trade barriers more quickly at the global level vis-a-vis internal trade. As a result, 'if the economic structures of the members differ enough, the costs of the trade diversion may be borne unevenly, leading to regional dissatisfaction with the terms of the union.'11 As well, globalization can reduce the desire for policy harmo-

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nization. While this statement runs counter to the economic and political theories advocating more extensive harmonization of policies, Norrie points out that labour is the least mobile factor of production so that a region's comparative advantage depends even more decisively on it. In addition, the provincial authorities can control their immediate environment and thus encourage savings and investment, improve job training, and ensure flexibility. In short, 'the ability to influence comparative advantage in this manner raises the question of where responsibility for the policies should reside.'12 When labour is relatively immobile, the gains associated with devolution of powers are considerable. Finally, decentralization also reflects the centre's inability to redistribute wealth. As Norrie points out, 'if the terms of these transfers are being altered significantly ... it is natural that members will begin to question the legitimacy of the federal arrangement more generally.'13 This is what happened in Canada following changes to federal-provincial transfers after the 1995 federal budget. Accordingly, decentralization is the direct result of federal spending cuts, notably since the imposition in the 1995 budget plan of the Canada Social Transfer, later renamed the Canada Health and Social Transfer in the 1996 budget. This process hurt provinces' programs, as their revenues declined. Is this a demonstration of greater flexibility, in that, as Courchene notes, the new transfer 'increases substantially the ability of the provinces to design more comprehensive approaches to social policy'?14 Or does it represent a challenge to the state's role in redistribution among regions and social classes, aimed at facilitating response to market forces - most notably, globalization? Decentralization is not so much a political choice to deal with the identity crises within the Canadian federal system15 as a response to the powerful forces associated with globalization and to the pressure exerted by the massive accumulated federal debt and the integration of the Canadian economy into the continental economy. The Literature: Beyond the Hegemonic View of Economic Integration The academic literature on economic integration has stressed the added competitiveness and the greater efficiency thought to result. Few authors have explored its consequences for intergovernmental relations and/or for federalism. Most agree that economic integration is a decentralizing factor. From an economic perspective, it has been hypothesized that market

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integration may entail a transfer of power from the federal government to supranational institutions and/or to provincial governments.16 Either way, economic integration threatens the nation-state, more specifically the federal government, which is not necessarily a problem in terms of economic efficiency. Using Williamson's transactions-cost approach,17 Norrie suggests that a transfer 'upwards' is most likely under the following conditions: an increase in the potential real output gains to market integration; a need for further harmonization of policies (to take advantage of the increase in the potential gains); a hierarchical governance structure replaces ad-hoc bilateral or multilateral negotiations between states; and, finally, a possibility exists to conclude fiscal and other transfers, as required, between members of this governance structure. Norrie's four conditions differ substantially. Only the first is a potential incentive for market integration. The second is a constraint on economic integration. The third is nothing but the end result of a highly institutionalized process of market integration, which leads to a given form of political integration - namely, federalism. The fourth is more of an answer to the unequal distribution of wealth between and within countries that comes with integration than a sine qua non for the latter. Whereas Norrie assmes optimal conditions, devolution of powers can follow from these conditions' absence. Economic integration in its most efficient form, leads to a transfer upwards, and suboptimal integration leads to devolution towards provincial governments. Therefore Norrie's analysis suggests that economic integration need not lead to decentralization in Canada. As the author seems to acknowledge, the transaction-cost approach neglects the inherent difficulty of knowing whether market integration produces real output gains, just as it is difficult to predict which levels - the supranational or the provincial - would better fulfil the central government's redistributive function. This function - embedded in a sense of common citizenship and shared values and essential to equity between regions and individuals - is likely to suffer from the rise of suprnational institutions, which have yet to construct shared values. Accordingly, the optimal scenario of integration seems the most antithetical to redistribution. Norrie concludes: "Thus the main casualties of globalization will likely be residents of poorer countries, or poorer regions within countries, who do not have the skills to benefit from globalization, who lack the ability to migrate to regions where they might acquire them, and who are less and less a part of a sharing society.'1

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Given these perverse effects of the optimal scenario, greater economic efficiency appears to be quite elusive, even though proponents of integration invoke it constantly. Evidently, its meaning is problematic.19 Courchene, whose perspective complements Nome's, speaks of 'glocalization' - economic powers are shifting from central governments to supranational and regional/local institutions.20 He believes that continental and global economic integration will displace Canada's east-west economic axis towards a north-south one, entail greater regional economic diversification, decentralize Confederation, and empower individuals and international cities.21 National governments have become simultaneously too big and too small to be efficient in the new economy. This Gulliver effect22 suggests that only supranational institutions can deal effectively with an economic space that transcends existing political boundaries, while regional and local institutions, empowered by the information revolution and the concomitant economies of scale and scope, can now deal most efficiently with economic integration. National governments are too small for the larger issues, yet too big for the smaller ones. The macro-institutional co-ordination needed between national governments to protect and further develop economic integration can come only, according to this viewpoint, from supranational institutions, pushing upwards elements of states' sovereignty. To the same extent, and in accordance with subsidiarity, regional and/or local institutions, more reactive in the knowledge economy than bureaucratic federal institutions, pull downwards other elements of the sovereignty. All in all, the Gulliver effect hollows out central governments, for reasons of institutional co-ordination and economic efficiency. Thus hollowing out relates to global governance as well as to economic decentralization for federal states. In this scenario, Canadian decentralization has more to do with Ottawa's inefficiency, indeed obsolescence, than with redistribution of powers (albeit informal) to the provinces. It embodies Ottawa's decreasing capacity to foster regional economic development. Courchene's view also emphasizes a strategic network of international cities, such as Montreal, Toronto, and Vancouver, which have become 'not only critical growth nodes but the essential connectors outwards to cities such as New York, Tokyo and London and inward to their regional hinterlands.'23 Decentralization, which clearly benefits local institutions, could also indicate the growing obsolescence24 of the provincial governments - also victims of the Gulliver effect.

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Such a process has very little to do with decentralization of powers.25 Courchene envisions the empowerment of individuals, who 'can now access, transform, transmit and manipulate data and information in ways that governments are powerless to prevent. This will make old-style governance more difficult for governments of all stripes.'26 He also speculates: 'This [globalization and the information revolution] is turning the original British North America Act on its head. Some of the line functions, such as forestry, fishing, mining, and energy, can and probably should be devolved to the provinces (in any event, they will continue to be driven by global imperatives) and some of the traditional provincial areas, such as education and training, will have to take on national, if not federal, dimensions. Since not all provinces will be able or willing to take down these areas, asymmetry will likely increase/27 In other words, decentralization refers here to powers, except in the fisheries, already under exclusive provincial jurisdiction.28 Courchene would centralize other exclusively provincial areas - namely, education and training29 - thereby accepting, at least in principle, additional federal activity in these increasingly strategic areas. The inability or unwillingness of some provincial governments to 'take down' these areas can also be understood as an argument for greater federal intervention, by way of norms or spending. All in all, economic integration seems to entail little decentralization of Confederation. Simeon is less optimistic than Courchene. He suggests that the impact of economic integration will vary with an economy's regional differentiation and will tend to increase regional economic disparities while reducing trade and economic links between the provinces in favour of continental or global links.30 This all leads to greater fragmentation, with each region and province increasingly seeing itself as autonomous, pursuing its own economic and social policies, tailormade for the globalizing context. Meanwhile the federal government, facing an increasingly complex situation, is less able to deal efficiently with these exacerbated regional disparities. Simeon sees economic integration as inherently decentralization. Increased competition between provinces for private and public investments and resources is already generating intergovernmental conflict.31 Brown, Fry, and Groen also conclude that global economic integration decentralizes federal states.32 But in contrast to Simeon, they conclude that 'these developments will not in themselves imperil [Canada's] existing federal structure.'33 McBride and Shields, from a critical per-

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spective, emphasize the shrinking public and expanding private spheres that accompany this process.34 NAFTA, embedded in neoliberalism, seems to them synonymous with a significant loss of sovereignty for Canada, which in turn translates into reductions in progressive public spending, erosion of the social safety net, and growing economic dependence on the United States. The continental process, by advocating the primacy of the market and a laissez-faire attitude, undermines Ottawa's role in regional development, and indeed all federal schemes for interregional equity. McBride and Shields see integration as fostering the sovereigntist movement in Quebec and regionalism everywhere else. In this respect, integration threatens national unity. Like many others, they conclude that integration has decentralizing effects because it dissolves the policy capacity of the federal government. Adapting Garth Stevenson's discourse, they conclude: 'Continentalism undermines the very raison d'etre of the Canadian federal government. A central government that exercises only minimal powers over the economy may not be controversial, but it runs the risk of being irrelevant.'35 Federal irrelevance is one thing, decentralization quite another. Neoliberalism, as these authors obviously know, attempts not to undermine Ottawa's legitimacy, but rather to reduce the policy capacity of all governments, including the provinces'. The significant reduction in federal transfers to the provinces - part of the contraction of the public sphere that accompanies neoliberal economic integration - is likely not only to increase federal-provincial conflict, but also to disempower provinces, as would any other loss of revenue.36 The provinces are not beneficiaries at all, but rather victims of this process. Norrie is the only author who does not rely on the Gulliver effect to explain the assumed obsolescence of the federal government in the global context.37 His distinction between optimal and suboptimal scenarios contradicts the common view that economic integration necessarily entails the Gulliver effect - for him, it can come only with a suboptimal scenario. The proclaimed need for supranational institutions to manage the larger issues more efficiently in a globalized context assumes that each member nation is a relatively unitary actor, not a fragile coalition of eclectic and conflictual regional/provincial interests. Co-ordination between members assumes prior-co-ordination of their subnational parts. In Canada such co-ordination, like everything else considered national or pan-Canadian, is usually thought possible only by way of

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federal intervention. How can this simultaneously lead to decentralization within nation-states? Clearly this use of the term 'decentralization' appears misleading. Even under the best-case scenario, with provincial participation paramount, such an institutional dynamic involves deconcentration 'the dynamic process expressing power relations between central and provincial governments, in such a way that the participation of the latter in the decision-making process ... can be improved without the prerogatives of the former really being affected.'38 Neither provincial participation nor diminished federal intervention constitutes true decentralization. The assumption of a federal government as unitary actor is also implicit in the argument that it is simply the wrong size. But the federal bureaucracy is composed of numerous and eclectic subunits that operate according to functional and territorial principles. Nothing prevents the federal government from picking and choosing its own size in any given area of activity. Territorial decentralization, for example, enables it to be as small and as regionally distinctive as it wants for a specific policy purpose. The size of the overall federal bureaucracy is irrelevant; only the unit involved in a given policy area matters. All in all, the presumed death of the nation-state, the alleged obsolescence of the central/federal government, and the concomitant disintegration of national economies are premature, having more to do with rhetorical outbidding than with sound empirical analysis.39 The nationstate is the facilitator of continental or global economic integration rather than its victim and is not obsolete or irrelevant. It is typical of the neoliberal doctrine to hide the state's determining role in the development of the comparative advantages needed to benefit fully from NAFTA and globalization. The Continental Agenda: A Quest for Uniformity40 Although our critical review of the literature has challenged certain interpretations of the impact of continental integration on governance in Canada, a discourse developed during the 1980s to justify a greater role for Ottawa in managing the 'economic union/ justified partially by Canadian integration into the continental economy. This reality led to a challenging of trade barriers, which government and business circles claimed were hurting the economic union. The deepening of continental economic integration presupposed a

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sea change in management of the Canadian economy. Trade liberalization therefore affected not only identity, culture, and political autonomy, but also the division of powers and government's ability to act. A close and complementary relationship emerged between the continentalist option and adjustment to the new global economy, on the one hand, and the bolstering of the Canadian economic union, on the other. The federal system would arguably inhibit a co-ordinated approach to industrial and trade policy. Observers tend to see federal-provincial relations in terms of their conflictual and inefficient nature, which drains political resources and prevents consensus (between the private and public sectors as well as between the different levels of government) on a common development strategy to respond to foreign competition. The federal state multiplies the sites of decision-making and hence the possibilities for confrontation. Shared jurisdiction limits the impact of Ottawa's economic policies. Commentators often note that planned economic development and a federal state are incompatible.41 The Canadian state's decision-making processes vary with respect to level of intervention and increase the possibilities of confrontation. The federal-provincial negotiating process seeks to bring together conflicting regional interests rather than identifying common problems and articulating policies that address national or pan-Canadian priorities. Thus, in so far as they may, provincial governments try to restrict trade, thereby balkanizing the country. The predominance of regional interests prevents a unified approach to the management of economic development.42 The Constitution Act, 1867, did not create weak provinces, for although the act clearly recognizes federal jurisdiction over international and interprovincial trade, it is not always easy to challenge provincial laws that impede trade. Provinces can adopt a wide range of measures, and it is difficult for courts to judge whether a government is protecting the local market or benefiting the economy as a whole. Yet, Richards concludes, on the basis of the relevant jucicial decisions, that 'there are some definite prospects for expanded federal power in the realm of international trade and economic management.'43 Although judicial interpretation, especially from the Supreme Court of Canada, is unlikely to favour Ottawa in this area, such litigation is a centralizing process. The complexity of levels of intervention and the multiplication of programs at each level of government creates distortions by introducing barriers to trade. However, not all such policies spring from a

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deliberate attempt to discriminate against producers from other regions, even though they usually favour local producers of goods and services. Nevertheless, provincial measures to limit competition and factor mobility are considered undesirable. Some distortions are justifiable to the extent that the same rules apply to producers in the internal market. However, outright discrimination - as in language policy, preferential procurement policies, and subsidies to local businesses - run counter to the economic union or formulation of a new trade policy. Although the proliferation of non-tariff barriers (NTBs) and their incompatibility with liberalization of trade policy suggest that they impose too high a price on the Canadian economy, economic analyses have estimated the cost of these distortions at between 0.11 per cent and 1.54 per cent of gross national product (GNP).44 Thus the mobility of factors of production in Canada is not in jeopardy. A study by Proulx, Dulude, and Rabeau in the late 1970s found a high degree of mobility for financial and physical capital, both within Canada and between it and other industrialized countries.45 However, the mobility of foreign capital is directly related to direct foreign investment by firms that enjoy a technological advantage. Similarly, the international mobility of non-renewable resources often depends on a network of multinational firms. Labour is the least mobile factor of production, particularly because the linguistic and cultural differences of Quebec francophones limit the movement both of English-Canadian and foreign managers into Quebec and of francophones from Quebec. However, interprovincial trade barriers have a greater impact on monopolistic firms, especially those under foreign control, that operate in more than one region. As the Macdonald Commission reported, echoing the Canadian Manufacturers' Association, 20 per cent of large manufacturers encounter difficulties in selling their products because of provincial restrictions.46 Despite the apparently minimal costs associated with barriers, they slow the growth of interprovincial trade, make business dependent on government, deprive small businesses of incentives to become competitive, and hamper development of large, internationally competitive firms. Additionally, market fragmentation produces costs such as those arising from differing labour codes and non-portability of pension plans. It is said that these factors may inhibit development of new markets in Canada. In short, criticisms of provincial NTBs are based more on the potential, and therefore uncertain, benefits of general trade liberalization than on a quantitative estimate of the actual limits that they create.

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Furthermore, the liberalization of trade within Canada is animated above all by political objectives. The quantitative effects of trade restrictions are not large enough to justify sweeping reforms. Political arguments instead invoke the fears raised by trade barriers. First, there is concern about their potential expansion - always a potential threat. Second, and just as important, the building of economic links seeks to strengthen pan-Canadian identity. This task is assigned to the only institution that can respond to the needs of all Canadians - that is, the federal government. Political logic speaks to unquantifiable factors that often lie in the realm of symbolism.47 The central government lays claim to a preponderant role in the protection of the economic union: 'This role involves federal leadership in fostering a developing pattern of national standards and common treatment for Canadian citizens in matters within provincial, as well as within federal, jurisdiction.'48 Besides justifying this position in terms of its greater sensitivity to Canadian problems, Ottawa claims that its greater involvement on the international scene makes it more aware than the provinces of global problems. This general philosophy, which emanates from the Macdonald Report and embraces all areas of state intervention,49 expresses the central state's desire to confine provincial activities to sectors of marginal economic importance. This political project should transcend the division of powers. In short, the functions of each level of government should not be identical, and the mechanisms for reinforcing the economic union or for implementing free trade need to be based on this diagnosis.50 Efficiency ought to be the guiding principle here, not federalism, which becomes but an institutional obstacle to greater efficiency. Federalism, however, is much more than that, much more than an institutional design, regardless of its relative merits in terms of efficiency and efficacy. Championing the principles of efficiency, the federal government sought to include the theme of the economic union in constitutional negotiations. In 1980, it put forward a proposal to amend section 121 of the constitution so as to prevent measures that might damage the economic union. It wanted to claim the right to continue its equalization and regional development policies despite their potentially negative effects on the economic union. In a discussion paper released in July 1980, it raised five aspects to be considered: first, the current economic union is first and foremost a customs union; second, Canada is an imperfect common market with respect to the movement of goods, since section 121 does not prohibit non-customs barriers to interpro-

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vincial trade and the courts have limited the federal power with respect to trade and commerce; third, the current common market does not adequately ensure the movement of capital, in that the provinces can limit the movement of companies and of certain financial assets; fourth, Canada is made up of distinct markets that can adopt protectionist measures with respect to labour and services; and fifth, none the less the Canadian economy is integrated because of federal powers that apply to the entire territory.51 Although the provinces rejected this position, fearing a greater capacity for intervention by Ottawa - in regional development, for example - this concern found its way into the Constitution Act, 1982. The new Charter of Rights and Freedoms guarantees the same freedoms and the same basic rights to all Canadian citizens.52 The Charter guarantees all Canadian citizens the right to move to and work in any province, unhindered by any distinction based on province of residence - except for provinces with an employment rate below the Canadian average. But the Charter guarantees the movement only of individuals, while neglecting goods, capital, and services. This concern resurfaced during the negotiations leading up to the Charlottetown Accord in 1992. That document strengthened Ottawa's powers in management of the economic union. It amended section 121 so as to prohibit governments from interfering with the free movement of individuals, goods, capital, and services, while ensuring that the federal government could continue with equalization and regional development. In addition, the accord confirmed Ottawa's jurisdiction over any matter that it declared relevant to the effectiveness of the economic union.53 The defeat of the Charlottetown Accord in 1992 did not, however, end pressure from the business community to eliminate internal trade barriers. But the acceleration of continental economic integration following the signing of NAFTA led governments to adopt other means for limiting such barriers.54 The Agreement on Internal Trade: Entrenching the Status Quo The defeat of the Charlottetown Accord, which would have increased the de facto powers of the federal government while moving towards deconcentration, did not obviate the need to co-ordinate the economic union. On 1 July 1995, an Agreement on Internal Trade (AIT), reached on 18 July 1994 between the premiers, came into effect. The AIT is like

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international trade agreements (such as the World Trade Agreement and NAFTA) - it guarantees the free movement of goods, services, labour, and capital; invokes the general rule of reciprocal non-discrimination, the right of entry and exit, the absence of obstacles, legitimate objectives, reconciliation and transparency.55 The AIT creates obligations in government procurement and labour and investment mobility and sets out measures to streamline and harmonize standards and regulations concerning, for example, transportation and consumer protection. It also establishes a ministerial-level Committee on Internal Trade to determine the areas and timetable of future negotiations on the elimination of trade barriers. If disputes arise, a special impartial panel can be struck. In the event of a disagreement, retaliatory measures can still be taken. Nevertheless, the AIT allows many exceptions - to preserve health and/or public order and security and to protect plants and animals, consumers, workers, and groups benefiting from affirmative action programs. Bryan Schwartz maintains that 'the overall tenor of the AIT is cautious and tentative; it does not characterize itself as legally binding, it is limited in scope and replete with exceptions and qualification.'56 Similarly, the dispute-resolution mechanism favours an essentially political, rather than legalistic approach. According to Schwartz: 'Actually, given its limited scope of application and many exceptions, the AIT is a smallish and rather mild-mannered tiger. When it becomes clear that the terms of the agreement are offended, the guilty party is expected, as a matter of honour, to mend its ways. If it does not do so, the agreement may be cited to bring public attention to the offender's shameful conduct. If the offender is still unrepentant, the agreement can provide no further relief except that the victimized party is authorized to retaliate/57 However, this interpretation is not unanimous. Although the document lacks enforcement mechanisms, governments have formally pledged to conform to it. In addition, as is true of international treaties, its very existence, its enumeration of obligations and administrative mechanisms, and its symbolic value make people conscious of the need to strengthen the economic union, so that they may press governments to respect it. For Katherine Swinton, 'this is a document that will probably have significant effects on governmental action, whatever its technical legal status.'58 Indeed, if the agreement had been legally binding, its signatories probably would have watered down its provisions. The new agreement is in effect a renewal of the status quo; it has

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come under fire because, being modelled on international treaties, it treats the provinces as sovereign, so that 'it is appropriate for them to make mutual concessions on interprovincial barriers comparable to concessions made by governments in the GATT and NAFTA.'59 The elimination of barriers to internal trade (integration and harmonization) benefits Canada, but, as Albert Breton remarks, 'it is not possible to provide a rationale for, or a defense of, federal states that do not give pride of place to differences in the preferences of citizens and, to the extent that these preferences are catered to and habit formation ... exists, to growing differences in preference patterns.'60 In other words, there is need of a balance between the demands of the economic union and those of federalism. Those who focus on elimination of internal trade barriers forget the context of federalism. Federalism must not only adapt but must also recognize the preferences and requirements of each province, especially in regional development. The notions such as efficiency and the free flow of factors of production tend to overshadow provincial autonomy and diversity, which are distinct from 'provincial' interests.61 Recent evaluations indicate that the agreement has increased economic integration, even though it has not fulfilled all of the hopes that it raised, because of its slow implementation, among other things.62 Nevertheless, Knox maintains that it has established certain parameters for trade. Moreover: 'It achieves its results through a complex intergovernmental agreement that is still stymied by the consensusonly decision making of Canadian intergovernmental relations. Yet it also achieves its results with diversity and flexibility and in a way that does not appear to interfere with the sovereignty of the federal and provincial legislatures, which is the federal balance in Canada.'63 The AIT illustrates how co-operation on interprovincial trade does not have to increase federal powers. It has not reduced pressures for greater federal intervention, which might violate the principles of partnership. As Albert Breton puts it: 'It is a balancing act; in general, provincial governments will not be able to accept a federal government agenda that may, in some circumstances, tend to suppress federalism.'64 And as long as the path to greater economic integration is neoliberal, the precarious balancing act between unity and diversity, between partnership and autonomy, will be ignored in the name of greater efficiency. In the end, it is the very essence of federalism that is being sacrificed - in silence, if not in ignorance - by the pursuit of the continental/global agenda.

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The Lost Meaning of Federalism An institutional design as well as a dynamic process, federalism is first and foremost the political project of accommodating within a common state two or more distinctive communities that wish to live together yet separately. Federalism involves a difficult compromise between a single unitary state and sovereignty. It seeks an equilibrium between centripetal and centrifugal forces. It rests on the non-hierarchical fragmentation of sovereignty between the central and the provincial governments, which makes it also distinctive from confederalism, with which it is too often confused.65 This non-hierarchy is an essential feature of federalism. Anything that suggests or rests on the hierarchical ordering of the two orders of government is in clear violation of the federal principle. Inherently respectful of regional diversity, anxious to preserve, promote, and further develop the defining characteristics of its communities and member states, it is the opposite of uniformity imposed by the central/ federal government.66 Federalism 'is born and grows in a space of liberty, democracy and pluralism, in the multiplicity of ideas, cultures, parts and regions, as well as in a complex and diversified social tissue.'67 Federalism presupposes a flexibility committed to deep diversity, under changing circumstances. Federalism and efficiency were never meant to go hand in hand in the Canadian case. Talking about the political necessity of a federal state, John A. Macdonald observed: 'I have always contended that if we could agree to have one government and one parliament, legislating for the whole of these peoples, it would be the best, the cheapest, the most vigorous, and the strongest system of government we could adopt.'68 Not the best, the cheapest, the most vigorous, nor the strongest form of government, federalism was still the preferred option. As Noel succinctly sums up: The objective [of federalism] is not to be efficient nor to guarantee that everyone be treated identically, but rather to allow the constituent parties to continue to do things in their own manner. The results will perhaps prove to be less satisfying with regard to certain objectives or values, but, as Pierre Elliott Trudeau pointed out in 1961, "at certain times and in certain places" the maintenance of the federal principle is "a fundamental value."'69 Being itself a value, and not necessarily an overriding one at that, efficiency poses a threat to federalism, in much the same way it does to democracy. Whereas democracy rests on increasingly numerous and

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sophisticated forms of popular participation, federalism, by multiplying the sites of decision-making, not only increases the number of governmental and bureaucratic actors, but also allows citizens and community groups to participate. Possibilities for articulating divergent interests, for counter-discourses, and for confrontation, open conflict, and deadlocks also increase. Obviously, none of this is synonymous with greater efficiency.70 Economic efficiency implies, among other things, the harmonization of fiscal and budgetary policies and the increased mobility of goods, services, and individuals; federalism emphasizes diversity and different preferences and sensibilities, provincial or communitarian, as well as the possibility for distinctive communities to come together and create associations in given areas of activity. For federalism to remain true to its original meaning, its associative dimension can never come at the expense of its autonomous one. In other words, federalism must resist uniformity of policy capacities and the greater homogeneity of the socioeconomic environment.71 It has been suggested that the FTA is, all in all, a good deal for Canada, given the vast discrepancy in size of the two trading partners, as well as the options available at the time.72 Both the FTA and NAFTA were a strategic response to a difficult situation. Such an assessment, however, fails to recognize the trade-off between economic integration and federalism. Economic integration threatens federalism inasmuch as NAFTA is the quasi-exclusive responsibility of the federal government.73 Even though provincial participation in international agreements has increased since the Tokyo Round of 1973 and was rather intense preceding the FTA, there is no lasting consensus between federal and provincial governments.74 In fact, the federal government led the way at the critical stages of the FTA negotiations.75 And NAFTA most significantly affects areas of exclusive provincial jurisdiction.76 As Bernier explains: "The provinces see their areas of competence being more and more affected by these negotiations, which are generally out of their reach and out of their control, be it collective or individual. This is all being made more difficult by the economic impacts of these international agreements which are directly felt on their territory.'77 The author suggests that the obsession with economic efficiency may lead not only to demands for a redistribution of powers but also to the recognition that the federal form inhibits efficacy and efficiency.78 The federal government believed that any steps taken to bolster the

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Canadian economic union in the context of economic integration necessitated greater uniformity of economic policy and of the regulatory environment. It wanted to play a predominant role, despite the division of powers. It based all its attempts at constitutional and administrative reform in the 1980s and 1990s on this approach. Demonstrating the flexibility of Canadian federalism, or renewing it, would find little support in this philosophy.79 Why, since the mid-1980s, have all the successive governments of Quebec, be they Liberal or Parti Quebecois (PQ) strongly supported economic integration if it does indeed lead to greater uniformity? For federalist Liberals, neoclassical economic theory stresses comparative advantages and long-term prosperity. As well, open markets deter federal intervention. For the PQ, the relevance of the Canadian internal market for Quebec's goods and services has long been declining. Openness to continental and global markets can enhance Quebec's sovereignty. In the meantime, Quebec remains a 'distinct society' within an increasingly homogenized federation.

Conclusion Far from being a decentralizing factor, market integration, be it global or continental, rests on the participation of the federal government. The Gulliver effect is problematic in many ways. Economic efficiency, which may include harmonization or homogenization of fiscal and budgetary policies, is antithetical to federalism, which is synonymous with diversity. Nevertheless, continental and global integration proceed apace, even though the federal form is the framework within which Canada's continental agenda emerged. How much more of the federal principle are Canadians willing to negate in the name of greater economic efficiency and efficacy? How much more diversity - regional, provincial, or local - should they homogenize in the name of competition? Ten years after the signing of the FTA, these questions remain virtually unasked. NOTES 1 Joseph A. McKinney, Created from NAFTA: The Structure, Function, and Significance of the Treaty's Related Institutions (Armonk, NY: M.E. Sharpe, 2000);

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2 3

4 5 6 7

8

9 10

11 12 13

14 15

David R. Davila Villers, edv NAFTA on Second Thoughts: A Plural Evaluation (Lanham, Md.: University Press of America, 1998); Victor Bulmer-Thomas and James Dunkerley, eds., The United States and Latin America: The New Agenda (Cambridge, Mass.: Harvard University Press, 1999). See Andre Burelle, Le droit a la difference a I'heure de la globalisation: le cas du Quebec et du Canada (Montreal: Editions Fides, 1996), 13-14. See Dusan Sidjanski, 'Federalisme (et neo-federalisme),' in Denis de Rougement, ed., Dictionnaire international du federalisme (Brussels: Bruylant, 1994), 66, and L'avenirfederaliste de I'Europe (Paris: Presses Universitaires de France, 1992). See Ronald L. Watts, Comparing Federal Systems in the 1990s (Kingston: Institute of Intergovernmental Relations, 1998), 7. See Fabrizio Frigerio et al., 'Federalisme (chez Rougemont),' in Rougemont, ed., Dictionnaire, 203^1. See Andre Burelle, Le mal canadien: Essai de diagnostic et esquisse d'une therapie (Montreal: Editions Fides, 1995), 127-8. Criticism has already surfaced of the use of this concept in the Canadian context. See Francois Rocher and Christian Rouillard, 'Decentralisation, subsidiarite et neoliberalisme au Canada: lorsque 1'arbre cache la foret,' Canadian Public Policy /Analyse de politiques 24, no. 2 (June 1998), 233-58. See Burelle, Le mal canadien, 34-5; Samuel LaSelva, The Moral Foundations of Canadian Federalism (Montreal: McGill-Queen's University Press, 1996); and James Tully, Strange Multiplicity: Constitutionalism in an Age of Diversity (Montreal: McGill-Queen's University Press, 1995). See Thomas J. Courchene, Celebrating Flexibility: An Interpretive Essay on the Evolution of Canadian Federalism (Toronto: C.D. Howe Institute, 1995), 20. Kenneth Norrie, 'Is Federalism the Future? An Economic Perspective,' in K. Knop, S. Ostry, R. Simeon, and K. Swinton, eds., Rethinking Federalism: Citizens, Markets, and Governments in a Changing World (Vancouver: UBC Press, 1994), 148. Ibid., 149. Ibid. Ibid., 150. See also Kenneth Norrie, 'Intergovernmental Transfers in Canada: An Historical Perspective on Some Current Policy Choices,' in P.M. Leslie, K. Norrie, and I.K. Ip, eds., A Partnership in Trouble: Renegotiating Fiscal Federalism (Toronto: C.D. Howe Institute, 1993), 87-129. See Courchene, Celebrating Flexibility, 39. See Francois Rocher and Miriam Smith, The New Boundaries of Canadian Political Culture,' Journal of History and Politics 12, no. 2 (1997), 36-70; see also Kenneth McRoberts, Misconceiving Canada: The Struggle for National Unity (Toronto: Oxford University Press, 1997).

Redefining the Locus of Power 245 16 See Norrie, 'Is Federalism the Future?' 135-53. 17 See Oliver E. Williamson, Market and Hierarchies (New York: Free Press, 1975), and The Economic Institutions of Capitalism (New York: Free Press, 1985). 18 See Norrie, Ts Federalism the Future?' 151. 19 For more details on the polysemical nature of the concept of efficiency, see Rocher and Rouillard, 'Decentralisation,' 233-58; and David John Farmer, The Language of Public Administration: Bureaucracy, Modernity, and Postmodernity (Tuscaloosa: University of Alabama Press, 1995), 178-209. 20 See Thomas J. Courchene, 'Glocalization: The Regional/International Interface,' Canadian Journal of Regional Science 17, no. 1 (1995), 1-20. 21 Ibid.; see also Thomas J. Courchene, Social Canada in the Millennium: Reform Imperatives and Restructuring Principles (Toronto: C.D. Howe Institute, 1994); 'Presidential Address: Mon Pays, c'est 1'Hiver: Reflections of a Market Populist,' Canadian Journal of Economics 25, no. 4 (1992), 759-91, and 'Canada in the 1990s: Coping with Internal and External Economic Change,' in Douglas M. Brown and Murray G. Smith, eds., Canadian Federalism: Meeting Global Economic Challenges? (Kingston: Institute of Intergovernmental Relations and Institute for Research on Public Policy, 1991), 43-52. 22 See Gilles Paquet, 'Institutional Evolution in Information Age/ in Thomas J. Courchene, ed., Technology, Information and Public Policy (Kingston: Queen's University, John Deutsch Institute for the Study of Economic Policy, 1994), 197-229. 23 See Courchene, 'Glocalization,' 6. 24 Arguably at a slower pace than that of the federal government, if only because all municipal institutions are an area of exclusive provincial jurisdiction (Constitutional Act, 1867, see 92. 8) and are thus creatures of the provincial governments. 25 For a conceptual clarification of decentralization and other related terms, see Francois Rocher and Christian Rouillard, 'Using the Concept of Deconcentration to Overcome the Centralization/Decentralization Dichotomy: Thoughts on Recent Constitutional and Political Reforms,' in Patrick C. Fafard and Douglas M. Brown, eds., Canada: The State of the Federation 1996 (Kingston: Institute of Intergovernmental Relations, 1996), 99-134. 26 See Courchene, Social Canada, 239. 27 Ibid. 28 Constitution Act, 1867, sections 91 (12) and 92A. 29 Ibid., sec. 93. 30 See Richard Simeon, 'Canada and the United States: Lessons from the North American Experience/ in Knop, Ostry, Simeon, and Swinton, eds., Rethinking Federalism, 250-72, 'Globalization and the Canadian Nation-

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31 32

33 34 35 36 37 38 39

40

41

42

State/ in G. Bruce Doern and Bryne Purchase, eds., Canada at Risk? Canadian Public Policy in the 1990s (Toronto: C.D. Howe Institute, 1991), 46-58, and 'Concluding Comments/ in Douglas M. Brown and Murray G. Smith, eds., Canadian Federalism: Meeting Global Economic Challenges? (Kingston: Institute of Intergovernmental Relations and Institute for Research on Public Policy, 1991), 285-91. See Richard Deeg, 'Economic Globalization and the Shifting Boundaries of German Federalism/ Publius: The Journal of Federalism 26, no. 1 (1996), 27-52. See Douglas M. Brown, Earl H. Fry, and James Groen, 'States and Provinces in the International Economy Project/ in Douglas M. Brown and Earl H. Fry, eds., States and Provinces in the International Economy (Berkeley, Calif.: Institute of Governmental Studies, 1993), 1-22. Ibid., 17. See Stephen McBride and John Shields, Dismantling a Nation - The Transition to Corporate Rule in Canada (Halifax: Fernwood Publishing, 1997). Ibid., 167. See Ian Robinson, The Multilateral Agreement on Investment and Provincial Government Powers (Ottawa: Canadian Centre for Policy Alternatives, 1998). See Norrie, 'Is Federalism the Future?' See Rocher and Rouillard, 'Using the Concept of Deconcentration/ in Fafard and Brown, eds., Canada: The State of the Federation 1996,105-6. See Linda Weiss, 'Globalization and the Myth of the Powerless State/ New Left Review 225 (Sept.-Oct., 1997), 3-27; Paul Hirst, The Global Economy: Myths and Realities/ International Affairs 73, no. 3 (1997), 409-25; Kevin Cox, 'Comment: The Politics of Globalization: A Sceptic's View/ Political Geography 11, no. 5 (1992), 427-9. This section reviews assertions that have been made elsewhere. See Francois Rocher, 'Economic Partnership and Political Integration: Recasting Quebec-Canada's Economic Union/ in Roger Gibbins and Guy Laforest, eds., Beyond the Impasse: Toward Reconciliation (Montreal: Institute for Research on Public Policy, 1998), 111-44. See Frederick J. Fletcher and Donald C. Wallace, 'Federal-provincial Relations and the Making of Public Policy in Canada: A Review of Case Studies/ in Richard Simeon, ed., Division of Powers and Public Policy, Royal Commission on the Economic Union and Development Prospects for Canada, Study No. 61, (Toronto: University of Toronto Press, 1985), 125-205. Ibid., 141. Fletcher and Wallace summarize the impact of provincial governments on economic policy: it has 'fostered interprovincial competition for investment, which has, in turn, limited provincial tax rates [and] weakened the federal government's capacity to deal with foreign corporations ...; lim-

Redefining the Locus of Power 247

43 44

45

46 47

ited the capacity of the federal government to reduce regional disparities; made economic planning difficult, thereby weakening the country's capacity to meet international competition; inhibited the development of trust between governments...; limited the policy choices open to both levels; and increased lobbying and monitoring costs and uncertainty, including the risk of being caught in an intergovernmental cross-fire.' See ibid., 143. See Robert G. Richards, The Canadian Constitution and International Economic Relations,' in Brown and Smith, eds., Canadian Federalism, 62. See Royal Commission on the Economic Union and Development Prospects for Canada (Macdonald Commission), Report, vol. 3 (Ottawa: Ministry of Supply and Services, 1985), 120. These figures also take into account barriers imposed by the federal government, barriers which have an even greater impact than those imposed by the provinces. See John Whalley, The Impact of Federal Policies on Interprovincial Activity,' in Michael J. Trebilcock, et al., eds., Federalism and the Canadian Economic Union (Toronto: University of Toronto Press, 1983), 201-42. More recently, other analysts have reached the same conclusions: 'We should ... not exaggerate the potential gains to be realized from eliminating the remaining internal barriers to trade. Most estimates put the potential gains in the range of 1.0 to 1.5 percent of gross domestic product (GDP), or about $1000 per year for a family of four. Nevertheless, at the present time, interprovincial trade flows are almost as great a value as foreign exports and imports, and to the extent that internal barriers are distorting or truncating these trade flows, clearly it is useful to do something about them.' See Michael J. Trebilcock and Rambod Behboodi, The Canadian Agreement on Internal Trade: Retrospects and Prospects,' in Michael J. Trebilcock and Daniel Schwanen, eds., Getting There: An Assessment of the Agreement on Internal Trade, Policy Study No. 26 (Toronto: C.D. Howe Institute, 1995), 22. See P.P. Proulx, L. Dulude, and Y. Rabeau, 'Etude des relations commerciales Quebec-USA,' in Quebec-Canada - options et impacts - craintes et potentiels (Quebec City: Ministere des Affaires inter-gouvernementales, Editeur officiel, 1979), 216-43. See Macdonald Commission, Report, vol. 3,121. The commissioners observed: The previous reference to a political concern of provincial/regional economies and communities makes it clear that the political criteria applicable to the evaluation of barriers and distortions differ from economic criteria in supporting two distinct perspectives. These perspectives reflect the values that Canadians place on the national community, on the one hand, and on provincial communities, on the other. From the perspective of the national community, barriers which may be

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48 49

50

51

52 53

54

trivial in economic terms may be politically significant it they offend against our sense of Canadian citizenship. From the provincial perspective, barriers which many would oppose for economic reasons because they generate significant economic costs for Canadians may be considered politically desirable by other because they strengthen provincial communities. These alternative political criteria not only differ from economic criteria in the policies to which they lead, but also differ from each other. This tension between national and provincial political criteria with respect to evaluating the economic union is inherent to federalism.' See ibid., 113-14. See ibid., vol. 1,18. We use the term 'economic union' in the widest sense, for it also embraces social policy, education, government spending, and so on. It refers simultaneously to economic, political, and social aspects of Canadian federalism and thus leaves nothing outside its ambit. The Macdonald Report argued that the federal government should have 'a predominant role in the negotiation and ratification of treaties, in coordinating federal and provincial activities abroad, and in managing the domestic adjustments that follow from international activities. Secondly, the federal government must be the advocate and catalyst for the effective functioning of the economic union ... Thirdly, the federal government is primarily responsible for stabilization policy. Fourthly, the federal government is primarily responsible for redistribution between regions and provinces, between social and economic interests, and among individual citizens. Thus the federal task is to provide a unified national framework for private economic activity and provincial initiatives to encourage economic development.' See ibid., vol. 3,149. See Government of Canada, Powers over the Economy: Securing the Canadian Economic Union in the Constitution, Discussion Paper 830-81/036 (Ottawa: Ministry of Supply and Services, 9 July 1980). See Government of Canada, Charter of Rights and Freedoms, Discussion Paper 830-81/028 (Ottawa: Ministry of Supply and Services, 5 July 1980). See Privy Council, Shaping Canada's Future Together: Proposals (Ottawa: Supply and Services Canada, 1991), 27-8. The accord did provide for a policy mechanism, however, to govern federal intervention in this field. Its initiatives had to be approved by two-thirds of the provinces with at least half of the country's population, in accordance with the general constitutional amending formula. Dissenting provinces would have had a right to opt out for three years, provided that they obtained approval from 60 per cent of the members of their legislative assembly. See Robert H. Knox, 'Economic Integration in Canada through the Agree-

Redefining the Locus of Power 249

55 56

57

58 59 60 61

62

63 64 65

ment on Internal Trade/ in Harvey Lazar, ed., Canada: The State of the Federation 1997. Non-Constitutional Renewal (Kingston: Institute of Intergovernmental Relations, 1998), 142. For a detailed analysis, see Trebilcock and Behboodi, 'The Canadian Agreement.' See Bryan Schwartz, 'Assessing the Agreement on Internal Trade: The Case for a "More Perfect Union/" in Douglas M. Brown and Jonathan W. Rose, eds., Canada: The Sate of the Federation 1995 (Kingston: Institute of Intergovernmental Relations, 1995), 202. Ibid., 221-2. Robert Howse is even more critical, pointing out that the refusal to use a legalistic approach will prevent the adoption of standards and principles of interpretation allowing governments and individuals 'to rely with confidence on the agreement.' See Robert Howse, 'Between Anarchy and the Rule of Law: Dispute Settlement and Related Implementation Issues in the Agreement on Internal Trade/ in Trebilcock and Schwanen, eds., Getting There, 194. See Katherine Swinton, 'Law, Politics, and the Enforcement of the Agreement on Internal Trade/ in ibid., 205. See Armand de Mestral, 'A Comment/ in ibid., 97. See Albert Breton, 'A Comment/ in ibid., 91. On this question, see Donald G. Lenihan, 'When a Legitimate Objective Hits an Unnecessary Obstacle: Harmonizing Regulations and Standards in the Agreement on Internal Trade/ in ibid., 98-118. See the detailed analysis by Daniel Schwanen, 'Canadian Regardless of Origin: "Negative Integration" and the Agreement on Internal Trade/ in Lazar, ed., Canada, 169-202. See Knox, 'Economic Integration in Canada/ in ibid., 164-5. Breton, 'A Comment/ in Trebilcock and Schwanen, eds., Getting There, 91. As Leslie explains: 'Both are complex political structures, in which two or more orders of government co-exist, each with a range of powers and activities that the other cannot unilaterally take from it. In a federation, neither order of government is subject to the effective control of the other; the touchstone of a federal system is that each order of government, besides having more or less clearly defined powers or responsibilities, has its own electoral and fiscal base. In a confederation, the central power is effectively controlled by the members states, and financially dependent on contributions from them (its taxing powers being non existent, or inadequate to its purposes); representative institutions are relatively weak.' See Peter M. Leslie, 'Asymmetry: Rejected, Conceded, Imposed/ in F. Leslie Seidle, ed.,

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66 67 68 69 70

71

72

73

74

Seeking a New Canadian Partnership: Asymmetrical and Confederal Options (Montreal: Institute for Research on Public Policy, 1994), 67. See Sidjanski, Tederalisme (et neo-federalisme).' Ibid., 73. See John A. Macdonald quoted in P.B. Waite, ed. The Confederation Debates in the Province of Canada/1865 (Toronto: McClelland and Stewart, 1963), 40. See Alain Noel, The Federal Principle, Solidarity and Partnership,' in Gibbins and Laforest, eds., Beyond the Impasse, 242. As critical management studies suggest, efficiency - even when reduced to its simplest expression, input - output, is never a mere technical concept. The elements to be included have more to do with ideological preferences and preconceptions than with so-called objective or expert knowledge. See Walter R. Nord and John M. Jermier, 'Critical Social Sciences for Managers? Promising and Perverse Possibilities/ in Mats Alvesson and Hugh Willmott, eds., Critical Management Studies, 202-22 (London: Sage Publications, 1992). Distinguishing neoliberal economic integration from another possibility namely, communitarian economic integration - Robinson suggests that only the former, the one embedded in NAFTA, is highly incompatible with the principles of federalism. See Ian Robinson, Trade Policy, Globalization, and the Future of Canadian Federalism,' in Frangois Rocher and Miriam Smith, eds., New Trends in Canadian Federalism (Peterborough: Broadview Press, 1995), 234-69. See Peter M. Leslie, The Peripheral Predicament: Federalism and Continentalism/ in Peter M. Leslie and Ronald L. Watts, eds., Canada: The State of the Federation 1987-88 (Kingston: Institute of Intergovernmental Relations, Queen's University, 1988), 3-36. See Robinson, Trade Policy' and The NAFTA, the Side-Deals, and Canadian Federalism: Constitutional Reform by Other Means?' in Ronald L. Watts and Douglas M. Brown, eds., Canada: The State of the Federation 1993 (Kingston: Institute of Intergovernmental Relations, Queen's University, 1993), 193-227. Insisting on the dominant federal role in the negotiation of the agreement and its ongoing management, Robinson sees NAFTA as a most centralizing force. See Douglas M. Brown,' The Evolving Role of the Provinces in CanadaU.S. Trade Relations,' in Brown and Fry, eds., States and Provinces in the International Economy, 93-144,' The Evolving Role of the Provinces in Canadian Trade Policy,' in Brown and Smith, eds., Canadian Federalism: Meeting Global Economic Challenges? 81-128, 'Canadian Federalism and Trade Policy: The Uruguay Round Agenda/ in Ronald L. Watts and Douglas M. Brown,

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75 76

77 78 79

eds., Canada: The State of the Federation 1989 (Kingston: Institute of Intergovernmental Relations, Queen's University, 1989), 211-35; and 'The FederalProvincial Consultation Process,' in Leslie and Watts, eds., Canada: The State of the Federation 1987-88,77-93. See Brown, 'The Evolving Role of the Provinces.' See David Barrows and Gordon Jansen, 'International Trade and the Management of Federal-Provincial Relations/ in Brown and Smith, eds., Canadian Federalism, 147-50. For that very reason, these authors suggest this simple guiding principle: the greater the expected consequences for the provinces, the greater their participation, from the start, in the decisionmaking process. See Ivan Bernier, 'LTmpact de 1'internationalisation sur le fonctionnement de 1'etat: le partage constitutionnel des competences,' in ibid., 66. Ibid., 67. It is surprising to hear praise for the mechanisms for federal-provincial co-operation. See Stephane Dion, 'Collaborative Federalism in an Era of Globalization/ an address to the Institute of Public Administration of Canada, Ottawa, 22 April 1999. This agreement rides roughshod over the principle of non-subordination mentioned above. For a more detailed criticism of the agreement, see Andre Burelle, 'Union sociale: mise en tutelle des provinces; comment caracteriser autrement que de federalisme de tutelle 1'action d'un gouvernement qui se sert de sa marge de manoeuvre financiere pour faire signer par des provinces une entente ou elles echangent leur droit d'ainesse centre un plat de lentilles?' Le Devoir, 15 Feb. 1999, A7.

9. The Scope for Domestic Choice: Policy Autonomy in a Globalizing World George Hoberg, Keith G. Banting, and Richard Simeon

In this age of international economic integration, a great deal of concern, both in popular and in academic discourse, has focused on the unrelenting forces of harmonization and the diminution of governments' capacity to choose policies in the pursuit of national aspirations. For Canada, a small, open economy overwhelmingly dependent on the world's largest and most dynamic national economy, this anxiety is particularly acute. Indeed, concerns about 'Americanization' have been a part of Canadian identity, politics, and public policy since before Confederation. Trade liberalization has intensified these fears. Many Canadians worry that they have forfeited - either through international agreement or through economic and technological change the ability to make choices that protect and promote a distinctive Canadian way of life. Instead, they find themselves forced down a path of policy harmonization with the United States.1 Not everyone bemoans these developments. Some conservatives embrace arguments about the constraining effects of globalization to justify their arguments for more limited government. More important, many sceptics have questioned the globalization thesis, arguing that nation-states still have significant room to manoeuvre in domestic policies. This view spans the traditional ideological divide, articulated not only by those on the left, who seek to buttress their view that more expansive redistribution is not incompatible with globalization,2 but also by those who support a significant reduction in government.3 This chapter examines existing tensions between economic integration

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and domestic policy autonomy and anticipates coming trends. How much convergence has taken place? Are pressures towards convergence likely to increase? Building on the literature in comparative policy studies, including our own previous work, we first develop a framework for assessing the pressures for convergence and divergence. Next we apply it to social policy and then to environmental policy, comparing policy in Canada and the United States and outlining the underlying patterns that emerge from our research. In environmental policy we also look at international influences. Concerns about harmonization in each of these areas were central to the debate over the Canada-United States Free Trade Agreement (FTA) in 1988 and the North American Free Trade Agreement (NAFTA) in the early 1990s. Many commentators concluded that these agreements spelled an end to Canada's distinctive social contract and to policy choices that many Canadians consider more egalitarian than those in the United States. Finally, we move to a more general level of analysis, reviewing several recent studies that examine a broader range of policies in the European Union and across a wider range of OECD countries. Our analytical framework gives us some leverage in assessing the potential impacts of various trends. Our general conclusion is that Canada, despite increasing economic integration and some notable examples of policy convergence, retains far more capacity for distinctive policy choice than many people believe. Analytical Framework Our framework of analysis, which we developed in previous work,4 focuses on two essential questions: how much policy convergence is there, and why? Convergence is a measure of the relative similarity or difference in policy objectives, instruments, and consequences across political jurisdictions. It is a dynamic concept that asks whether policies are becoming more alike over time. There are three major causes of convergence - parallel domestic pressures, emulations, and international constraints.5 Growing similarity in programs is not necessarily an indication of constraints emerging from the external economic environment.6 First, in the case of parallel domestic pressures, convergence results from the existence of similar domestic pressures in different nations, without any direct influence running from one country to another. Thus, quite independently, countries that have experienced similar

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patterns of urbanization and industrialization, the simultaneous impact of new technologies, increased ethnic diversity, the emergence of similar social movements, or common difficulties with debt and deficit will face similar policy challenges and may develop similar responses to them. Second, in instances of emulation, policy making can reflect a process of cross-national learning, where governments choose to adopt policies similar to another country's because they find them attractive.7 The medium of transmission here is ideas. Some international institutions, such as the OECD, facilitate this exchange of ideas. In the CanadianU.S. context, U.S. size and influence ensure that most cases of emulation involve the northward flow of ideas. Third, when convergence results from international constraints, policies converge because aspects of the political and economic relations among countries limit the capacity for autonomous choice. Legal agreements, such as treaties, can entrench a particular policy stance, preclude the use of certain policy instruments, or create supranational decision-making bodies. Such enforceable international agreements involve some voluntary surrender of national sovereignty. Economic integration increases the mobility of capital, creating concerns that any policy that may raise the cost of production in one country will need to be harmonized with lower-cost countries, threatening a 'race to the bottom' in policy. Inherent in this process is some shift of domestic power from the state to global private actors and, within domestic politics, from relatively immobile factors such as labour to mobile factors such as capital. This involves not a loss of formal sovereignty, but perhaps a diminution of the state's autonomy vis-a-vis financial markets and global capital. Distinguishing among these causal relationships is important, because convergence does not necessarily imply constraint; it can also flow from autonomous policy choices. Relationships become ambiguous, especially when the analysis incorporates the potential indirect effects of economic integration. If economic integration leads over time to greater cultural integration and convergence in values on either side of a border, then domestic pressures may be less separate than they appear. As well, international economic constraints can operate by altering the distribution of influence among different domestic actors,8 which may be hard to discern. None the less, distinguishing between the diverse sources of convergence helps to clarify the dynamics at work in an increasingly integrated world.

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Moreover, our normative reactions to these paths vary greater. Parallel responses to the same challenges should raise little concern, unless they are simply spillovers across the border. Emulation is more ambiguous. To the extent that it represents the one-way dominance of economic, political, social, and cultural values from the hegemonic power to smaller ones, it is indeed problematic, even if little or no overt coercion is employed. But to the extent that it permits citizens and policymakers in a given country to become more aware of policy innovations and possibilities in other jurisdictions, it is much more positive. And the fact that a country can learn from the experience of many others, rather than just one, can mitigate fears of cultural domination. Convergence stemming from international agreements may constrain domestic policy, but the individual country remains largely free to choose whether the costs of accession outweigh the costs of autonomy. It is pressures from international economic constraints that are the most troubling, as they may undermine the capacity of governments to respond to the preferences of their citizens. While these forces for convergence are powerful, formidable countervailing forces promote continued national distinctiveness. First, political cultures shape nations' ideas about the role of government in various facets of economic and social life. As a result, even if countries face common problems, national values can produce dinstinctive interpretations of trade-offs and different policy responses. Analysis of how Canadians and Americans differ is something of a national pastime in Canada.9 To the extent that they do - for example, on the relative role of government in health care and other policy areas10 - they will press for distinctive policy responses. Second, domestic political institutions can refract common pressures in different ways. The United States has constitutional checks and balances, and Canada, a parliamentary system; there are weak U.S. parties and highly disciplined parties in Canada; the United States has a centralized federation, and Canada, a decentralized one.11 Many scholars have argued that institutions powerfully influence strategies, distribution of influence among societal interests, and even actors' interpretation of their own objectives.12 Institutions do matter; and they are highly resistant to change, especially from external forces. The simple incentives facing politicians reinforce this inertia. While politicians will be judged in part by their ability to manage their country's role in the international political economy, they are elected by and accountable to their domestic electorates, not to international ones.

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Third, existing public policy can also shape nations' responses to new pressures. The different U.S. and Canadian program structures embody the values in place at the time of enactment. The policies cast their shadow over the present because they structure the costs and benefits of altering the status quo. Once organizations and instruments become institutionalized, they are costly to alter fundamentally. This 'path dependence' means that policy alternatives that may have been feasible at one point in history become less so over time.13 Policy legacies can thus inhibit harmonization. As a result, more traditional policies, such as pensions or health care, may be less likely to converge than newer policies, such as environmental protection or rules about electronic privacy. How then to weigh the balance between the forces for convergence particularly through international constraints - and the forces for divergence? The impact of international constraints varies significantly from sector to sector. For instance, trade agreements limit the use of policy instruments such as selective industrial subsidies.14 In these cases, governments voluntarily surrender their policy autonomy in exchange for what they hope is greater benefits - typically more access to export markets. In other areas, the effect of trade pacts is either indirect, through increased competitive pressures, as in the case of environmental regulations, or non-existent, as in the case of rights policies. Moreover, even international economic constraints are not a straitjacket; they are a cost that citizens and politicians may or may not be willing to pay.15 The stronger the constraints, the more it costs to adopt distinctive policies; the weaker the constraints, the lower the costs of divergence. The costs vary significantly from sector to sector, depending on the mobility of the factors of production affected. For example, the relatively free mobility of financial capital may increase the costs of maintaining different corporate tax rates, whereas the more limited mobility of labour makes distinctive income taxes less costly. The current controversy over the role of higher Canadian marginal tax rates in the alleged 'brain drain' actually reinforces this point: the high-income, skilled professionals in question are the most mobile segment of the labour force. Our earlier study uncovered a number of areas of policy convergence in the two countries, but parallel domestic pressures and emulation, not international constraints, appeared to be the most common pathways to convergence. Environmental policy and policies related to

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equality rights are good examples: the study revealed a considerable amount of convergence, but more because of common political pressures and the international transmission of ideas.16 Even in areas where international economic constraints were the strongest - namely, monetary policy - Canada did find room to carve out a distinctive, albeit costly, policy.17 In social policy, our research found substantial policy divergence that was sustained even in the wake of the intensive economic integration of the 1970s, 1980s, and early 1990s.18 Social Policy19 The issue of the scope for choice is probably most significant in social policy. The Canadian welfare state that emerged after 1945 has been a central part of Canadian identity and distinctiveness, as was revealed in the intense debates in 1988 over the FTA. Fears that economic integration would render medicare and other Canadian social policies unsustainable fuelled much of the opposition. This section provides a comparative analysis of broad trends in social policy in the two countries. It concludes that, despite convergence in several programs, overall patterns of persistent differences remain. Moreover, where convergence has occurred, it is difficult to link it in a simple, direct way to economic integration, or to the FTA and NAFTA. Comparisons The two nations' social policy regimes differ in three dimensions. First, Canadian policy is more comprehensive, in the sense that it covers a broader range of the population than does U.S. policy, with health care being the clearest example. Second, despite the national perception that it is more committed to universality in social programs, Canada has actually been more effective in providing transfers to the poor through a stronger set of selective programs that target benefits to the neediest. Third, and partly as a result of the first two differences, Canada's programs have had a greater redistributive impact than U.S. programs, a difference that has grown more noticeable over time. As Figure 9.1 suggests, both countries have relatively modest welfare states when viewed from the European perspective. Nevertheless, the differences between these two liberal welfare states are significant. As Figure 9.1 also shows, in terms of aggregate spending on social policy,

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SOURCE: OECD, New Orientations for Social Policy. Figures for 1995 from http://www.oecdwash.org/PRESS/CONTENT/socspend.pdf.

FIGURE 9.1 Public expenditures on social protection, as percentage of GDP, 1960-1995

Canada diverged from the United States about 1980 and stayed significantly higher into the 1990s. Moreover, a comparison of key components of the welfare state and their impact on inequality confirms national distinctiveness. We look at health care, pensions, social assistance, child benefits, unemployment insurance, and redistributive impact. Health Care Health care policy represents the area of greatest difference between the two countries. Figure 9.2 presents two measures - total health

Total (public and private) health expenditures, 1960-1997

Infant mortality, 1961-1996

SOURCE: Applied Research and Analysis Directorate, Health Canada, adapted from OECD, Health Data, 1999.

FIGURE 9.2 Health expenditures and outcomes, Canada and the United States, 1960-1997

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expenditures as a proportion of gross domestic product (GDP) and infant mortality. The two systems tracked each other closely until the early 1970s, when major policy changes during the 1960s began to be felt. Canada's medicare program, which was phased in between 1968 and 1971, provides coverage for basic hospital and medical services on a universal basis, without deductibles, co-payments, or user fees. Private health care plans cover other services, and such expenditures are rising in Canada, but they still represent a minority portion of total health spending. U.S. government programs cover only specific groups of the population: the elderly, through Medicare (which involves premiums, deductibles, and co-payments); disabled veterans, through the Department of Veterans Affairs; and welfare recipients, through Medicaid. Other citizens can rely only on private health insurance. Because of the expense of private coverage, a significant fraction of the U.S. population goes without any health coverage at all. In 1999, 16 per cent lacked health insurance, and, as Figure 9.3 indicates, fully 32 per cent of poor Americans lacked coverage. Differences have also grown in health care delivery. Traditionally, both countries relied heavily on non-profit hospitals and doctors who were independent practitioners remunerated on a fee-for-service basis. Despite changes at the margin, this model continues to dominate in Canada. In the United States, however, the commercial sector of the hospital industry has expanded rapidly, and the pervasive spread of health maintenance organizations (HMOs) has transformed the status of physicians and their relationships with patients. Canada, in contrast, has represented an island of relative stability. When thinking about the future, however, we should remember that the differences are greatest within the traditional model of physician services and hospital treatment. In other areas - such as long-term care and the provision of prescription drugs outside hospitals - the two approaches are much more similar. A mixed market of private coverage and supplementary public coverage for the poor and elderly dominates. Although these areas command a minority of current health dollars, they do represent growing sectors in health care and represent a source of increasing convergence. Moreover, the Canadian health care system is under considerable fiscal and technological pressure, and advocates of a larger role for private health insurance have become more vocal. Whatever the prospects for the future, however, the dominant pattern today is divergence.

SOURCE: U.S. Census Bureau, Health Insurance Coverage, 1999.

FIGURE 9.3 Health insurance non-coverage in the United States, 1998

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Pensions There are more similarities between the two countries in the provision of public pensions. For the average senior citizen, the major government programs - Social Security in the United States and the Canada and Quebec Pension Plans and Old Age Security in Canada - provide comparable levels of support. As Figure 9.4 indicates, the United States actually devotes a larger portion of its national resources to the elderly. However, there is a critical difference in the programs designed to protect low-income pensioners. The Guaranteed Income Supplement (GIS) is far more widely available in Canada than the Supplemental Security Income (SSI) in the United States. Whereas close to half of all seniors in Canada receive some benefit from the GIS, the SSI program provides support to less than 10 per cent of the U.S. elderly population. As a result, the Canadian pension system has a significantly more redistributive character, and poverty among the elderly is much lower. Social Assistance Capturing the trends in social assistance is a more complex task because of changes on both sides of the border in the mid-1990s. Historically, Canada provided much greater support for the poor. Under the Canada Assistance Plan (CAP) - a shared-cost federal-provincial program existing from 1965 to 1995 - provinces were required to provide support to all those in need. U.S. coverage was far more limited. The Aid for Families with Dependent Children (AFDC) program was restricted largely to single-parent families. Only some states provided support for two-parent families, and single parents and childless couples were ineligible. Income support for people in these latter categories was limited to Food Stamps, a federal program, and General Assistance, a poorly funded state program that did not exist in many states. In addition to the greater coverage in Canada, historically benefit levels were significantly higher there.20 These differentials grew throughout the 1980s and early 1990s because of the steady erosion of U.S. support for welfare.21 Since that time, both countries have altered social assistance through decentralization, block funding, and restrictions on benefits. Canada folded the Canada Assistance Plan into a block grant, the Canada Health and Social Transfer (CHST). As a result, it placed all federal money for welfare, health, and postsecondary education in the same

Public expenditures on seniors, 1970-1995

SOURCE: HRDC, Statistics Canada, U.S. Census Bureau.

Level of poverty among seniors, 1971-1994

Poverty is measured as 50 per cne t of median disposble income. SOURCE: Timothy M. Smeeding, Financial Poverty in Developed Coutries: The Evidence from US, Luxembourg Income Study, Working Paper No. 155, 1997.

FIGURE 9.4 Public expenditures on seniors and poverty levels among seniors, Canada and the United States, 1970s-1990s

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block grant and eliminated all federal conditions attached to social assistance, except for a prohibition on provincial residence requirements. In addition, fiscal pressures on social assistance programs intensified. Federal funding under the CHST dropped substantially, and social assistance programs were now in direct competition for the remaining funding with more popular programs such as health care and postsecondary education.22 In this context, benefit levels were cut in several provinces. The U.S. story contains important parallels. In the United States, after a protracted conflict between President Bill Clinton and the new Republican majority in Congress, the AFDC, born in the New Deal and extended in the Great Society programs of the 1960s, was terminated in 1996 and replaced by Temporary Assistance for Needy Families (TANF). The entitlement status for welfare that existed under AFDC disappeared, and TANF was created as a block grant to the states, but with significant federal regulations attached. States cannot reduce funding below 80 per cent of historic levels; they must provide Medicaid for particular classes of people; and they must require recipients to work after two years of receiving benefits and enforce a five-year lifetime limit on welfare benefits.23 There are thus important parallels between the two countries, especially in the decentralization implicit in the shift to block grants. Nevertheless, the responses of lower levels of government suggest salient differences. Although in Canada some provinces have reduced benefit levels and all have adopted versions of 'workfare' or 'learnfare/ often under the influence of American examples, more have implemented time limits for welfare support - a policy now imposed on all U.S. states by federal legislation. The gap between the two systems may well be growing. Child Benefits Child benefits represent an area of seeming convergence. In the mid1970s, there were substantial differences in programs. Family Allowances in Canada were universal, and the United States was the only major industrialized country without such a program. Since then, Canada has slowly shifted towards a selective program, culminating in the creation of a single, income-tested Child Benefit delivered through the tax system. Meanwhile, the United States in 1975 created the Earned Income Tax Credit (EITC) for working poor families with children and

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through the early 1990s expanded it significantly in several increments. The convergence in basic program structure - with both countries using the tax system to deliver benefits to low-income families - is thus clear. Beneath these similarities, however, important differences reflect distinctive political cultures. The U.S. EITC drives a wedge between two categories of poor families - the working poor, who receive the benefit, and the welfare poor, who do not. By increasing the income of the working poor, the United States seeks to make work more attractive than welfare. In Canada, child benefits are a much more inclusive program, in that all poor families receive the payments. A recent co-ordinated federal-provincial initiative has also sought to make work pay. The federal government has repeatedly enriched child benefits in recent years, and provinces have simultaneously reduced welfare payments for children by an identical amount, reinvesting the savings in other services for children. The goal, which is now within sight, is to float children off welfare and on to child benefits completely. At that point, welfare benefits, which will be payable only for adults, will be similar to the income provided by minimumwage jobs, thereby eliminating the 'welfare trap' criticized by many. But all low-income families would continue to receive child benefits. Thus the two countries have very different approaches to 'ending welfare as we know it.' Unemployment Insurance Unemployment insurance is an area of remarkable convergence in social policy. Until the mid-1990s, the differences in the programs were significant. The Canadian program is an exclusively federal initiative, financed by contributions from employers and employees. U.S. unemployment insurance is a more decentralized, federal-state program, financed solely through a payroll tax on employers. The federal government imposes a tax on employers, which it then rebates if states establish a program meeting federal standards, thereby eliminating the dangers that some states will simply not act. The states establish qualification periods and set benefits levels and their duration, although the federal legislation produces considerable convergence in qualification periods and duration of benefits. The differences between the two programs were most dramatic in the 1970s and 1980s. The Canadian program was expanded dramatically in 1971. The federal government became a contributor, joining

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employers and employees in funding the program. While benefits were not significantly higher than in the United States, they lasted longer, and eligibility requirements were less stringent, especially in regions with higher levels of unemployment. Canada also expanded coverage to include maternity benefits, which do not exist in the United States. The divergence in programs that emerged in the 1970s grew in the 1980s because of U.S. program changes and funding cutbacks during Ronald Reagan's presidency.24 The policies began to converge, however, in the 1990s as a result of program changes in Canada. Ottawa terminated government contributions, increased qualification periods, shortened the duration of benefits, and reduced benefits levels. Over the decade, Canada withdrew significant resources from the program, especially in affluent parts of the country, and the reduction of support for the unemployed was dramatic. Figure 9.5 shows the the percentage of Canadian and U.S. unemployed who receive regular unemployment insurance benefits. In the late 1980s, the two countries were over twenty percentage points apart on this measure, and in 1997 they were virtually identical. The proportion of unemployed Canadians receiving assistance dropped from over 80 per cent in the late 1980s to about 40 per cent in 1997. The programs are not identical, especially in regions with high unemployment, but the convergence has been dramatic. Redistributive Impact The final and most comprehensive indicator of the distinctiveness of Canada's social policy regime is the overall redistributive impact of the state in the two countries. The steady pace of economic and technological change is generating greater inequality in earnings in both countries, more dramatically in the United States. Despite the restructuring of social benefits in Canada and the convergence with the United States in several programs, however, the Canadian state plays a dramatically more powerful redistributive role. Figures 9.6a and 9.6b compare the distribution of market income (what families derive from the economy) with the distribution of disposable income (what they have after taxes and income transfers). The contrast is clear. In the United States the growth in inequality in market income is strong, and government has not offset the change. In Canada, government has offset the polarization of earnings. Indeed, despite considerable social and political commentary about growing inequality in Canada, the distribution

FIGURE 9.5 Recipients of regular UI benefits, as percentage of unemployed persons, Canada and the United States, 1971-1997

Gini coefficients Canada

United States

SOURCE: Special Tabulations, Statistics Canada.

FIGURE 9.6a Impact of tax and transfer systems on income inequality, Canada and the United States, 1974-1997

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SOURCE: Special Tabulations, Statistics Canada.

FIGURE 9.6b Change in levels of inequality, as percentage change in Gini coefficients, Canada and the United States, 1974-1997

of disposable income was more equal in 1997 than in 1974. Moreover, the contrast with U.S. experience would be even greater if health care were incorporated in the comparison. This broad conclusion is confirmed by Statistics Canada's comparative analysis, which summarizes the distinctive outcomes: 'Canada and the United States have remained politically and socially distinct, notwithstanding the more open border/ and socio-political differences 'have had greater impacts than economic forces. The 49th parallel does appear to have a significant impact.'25 Explaining the Patterns in Social Policy The pattern of social programs is thus complex in both Canada and the United States. Some, such as unemployment and child benefits, have witnessed substantial convergence. Others, such as pensions and especially health care, reveal persistent differences. Overall, the Canadian welfare state continues to provide greater protection for the poor and to have a more redistributive impact on the inequalities generated by the modern global economy. How can we explain this pattern? There are three main reasons why Canada developed a more expansive welfare state than the United States - the pattern of social divi-

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sions in the two countries, the structure of their political institutions, and their relationship to the wider global economy.26 In terms of social divisions, the historical pressure for a more activist welfare state has been stronger in Canada, partly because of its stronger labour movement. Although both countries have weaker labour movements than exist in Europe, union density is significantly higher in Canada than in the United States. Moreover, unions in Canada have played a more active political role in pushing social legislation, through their links with the New Democratic Party (NDP), than have their American counterparts. A second critical social difference concerns the role of race. Scholars have long argued that the more homogeneous a national population is in terms of race, ethnicity, and language, the stronger support is likely to be for redistributive programs.27 The main political division in Canada has always been linguistic, but this has not created a major cleavage over social policy, because dependence on social benefits is not significantly higher in Quebec than in the rest of Canada.28 Despite the increasingly multicultural nature of Canadian life, the politics of social policy has yet to be cast in racial or ethnic terms. In contrast, racial conflict has been a core feature of welfare politics throughout the history of the U.S. welfare state. During the New Deal period, resistance by southern members of Congress to extending benefits to cover large number of African Americans limited the growth of the welfare state. As Great Society policies expanded welfare programs, the fact that racial minorities constituted a disproportionate share of the caseload led to increasing resentment by working-class whites. In combination with civil rights reforms of the same era, welfare policies contributed to a new politics of race that reshaped the entire electoral alignment, giving Republicans a new advantage in presidential politics and transforming the U.S. south from a Democratic stronghold to a Republican-dominated region.29 One result was a reduction in political support for anti-poverty programs. Differences in political structures reinforce these differences in social structures. The exceptionally fragmented nature of the U.S. institutional structure gives opponents of government action powerful tools. Those multiple veto points have been effectively exercised by southern conservatives opposed to more expansive welfare policies. The defeat in 1994 of Clinton's health care proposals - which would have produced greater convergence with Canada - is one more example of the triumph of institutional conservatism over policy activism. In Canada, federalism has had a less decisive impact. At times, it has been a bar-

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rier to policy development; but in the case of health policy it actually facilitated change as social democrats captured provincial governments and enacted path-breaking legislation, which then influenced federal legislation. The structure and ideological predisposition of political parties have also had a differential impact in the two countries. The presence of an active social democratic party in Canada is perhaps the most important difference. Not only has the NDP held power in several provinces; it was also influential at the national level in key periods - 1963-8 and 1972-4 - when the Liberal Party formed a minority government. During the retrenchment of the 1980s, the ideological inclinations of the conservative parties in power in the two countries also led in different directions. The U.S. Reagan administration's reforms left middle-class programs virtually unscathed, while cutting programs for the poor. In Canada, the Mulroney government took a different tack, targeting social spending more tightly on the poor.30 Canada's greater openness to the international economy may also have contributed to a stronger tradition of collective response to social needs. As comparative international studies have shown, small, open economies have been more, not less, likely to develop expansive welfare states because social programs help cushion workers from the turbulence of international markets.31 This logic should see pressures develop for Canada to have a more comprehensive social policy. How should one interpret the convergence in some social programs, such as child benefits and employment insurance? Does it signal the impending triumph of international economic pressures? These developments are as much a result of parallel domestic pressures as of international constraints. Certainly the partial convergence in child benefits resulted from similar domestic concerns about low-income families and the relationship between welfare and work. Moreover, convergence in that area resulted in part from the introduction and expansion of the U.S. EITC, which has clearly not been driven by closer economic integration with Canada. The dramatic convergence in unemployment benefits, with Canada moving sharply towards a less-generous U.S. norm, is more complex. However, it is difficult to see this change as a simple response to integration. The change reflected a lethal combination of fiscal pressures to eliminate the deficit and a broad concern to generate a more flexible labour market, which was shared with many OECD nations. Examples of emulation and the trans-border flow of ideas have left their mark on

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social policy, to be sure. Experiments on both sides of the border with workfare and training programs have been avidly studied and have influenced social assistance and other labour market programs in both countries. But concerns over the deficit were the major force driving convergence in programs such as employment insurance. What of the future? The durability of the social policy divide will depend on a variety of forces, including labour mobility and pressures for harmonization of tax levels. The mobility of labour is crucial to Canada's capacity to maintain its distinctive welfare state. Mobility of low-income labour could lead jurisdictions to tighten eligibility criteria to avoid becoming 'welfare magnets.' In the absence of fundamental change in Canadian-American relations, this is unlikely to happen. Far more pressing is the so-called 'brain drain.' The alleged loss of highly skilled professionals has created pressure in Canada to reduce marginal tax rates. If such pressure inhibits generation of sufficient tax revenue to pay for the welfare state, more convergence is likely. The extent of the brain drain is intensely debated, and many of the claims are exaggerated.32 Understanding the political economy of labour mobility will be critical to anticipating the future of distinctive social policies in Canada. Environmental Policy As with social policy, in environmental matters, potential harmonization and a 'race to the bottom' helped shape the debate over the FTA and NAFTA and continue to be a concern vis-a-vis the World Trade Organization (WTO) and the proposed Multilateral Agreement on Investment (MAI). Unlike social policy, however, environmental protection involves international agreements, as may international economic constraints. There is more evidence of policy convergence in this area, much of it resulting from parallel domestic pressures and emulation rather than from international constraints. But international constraints, both legal and economic, have in most cases in Canada led to more stringent environmental protection, not less. This section begins with a survey of three major indicators in environmental policy. It then examines international influences and analyses their effects on Canadian environmental policy and the capacity for distinctive policy choice in Canada. Finally, the section explains the patterns observed in environmental policy and offers an analysis of future trends in the area.

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Comparisons: Policy Indicators Our earlier work presented a wide range of policy indicators, displaying a complex pattern that we described as convergence under U.S. leadership.33 In some areas we discovered convergence; where there were differences, U.S. policies were more stringent in more cases. Here we update some of the indicators, and the pattern seems to be similar, despite some indication of divergence in spending, which may prove to be critical. Here we look at three indicators - automobile emissions, air pollutants, and spending. Automobile Emissions In the case of controls on automobile emissions, the story is one of U.S. leadership and Canadian 'catch up/ Historically, U.S. standards have been far more stringent than those in Canada. Prior to 1988, Canadian standards were between three and seven times less stringent, depending on the pollutant in question. New standards that went into effect in 1988 made Canadian regulations equivalent to U.S. standards. The United States jumped ahead again with its 1990 amendments to the Clean Air Act, which required much more stringent standards to be implemented between 1994 and 1996. Canada eventually brought in new regulations for 1998 to match the 1990 U.S. standards. A number of states have now moved beyond U.S. federal standards, however. Auto-emission standards in California are considerably more stringent than the 1990 federal requirements, and by 1994 twelve eastern states had followed suit and adopted California standards. As a result, 37 per cent of the U.S. population will be covered by standards significantly more stringent than those voluntarily agreed to by Canadian manufacturers. Thus, despite considerable convergence in air pollution regulations, U.S. standards are still somewhat more stringent than Canada's. Air Pollutants Some of the best quantitative evidence available on the environment appears in data on trends in air pollutants and ambient levels (the concentration of pollutants in the surrounding air). While differences in measurement complicate comparisons of levels in the two countries, comparisons of rates of change give us some indication of the impact of efforts to reduce air pollution.

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SOURCE: OECD.

FIGURE 9.7 Trends in air pollution emissions, Canada and the United States, 1980-1994

These measures show a complex pattern. Figure 9.7 shows trends in emissions for six pollutants. Canadian progress has exceeded U.S. for one pollutant (sulphur dioxide); U.S. progress has exceeded Canadian for three pollutants (particulates, carbon monoxide, and volatile organic compounds); and performance is virtually the same for two pollutants (carbon dioxide and nitrogen oxides). Figure 9.8 shows trends in ambient concentrations of air pollutants. Here there is a clearer pattern of convergence, as each country has substantially reduced concentrations. Emissions per unit of GDP (Figure 9.9) can reflect either the relative pollution intensity of industry in the two countries or regulatory stringency. While its implications are uncertain, the pattern is clear: Canada emits more pollution per unit of GDP in all five of the pollutants measured. Overall, in air pollutants, the United States appears to have achieved more success. Spending

Changes in government spending reveal important areas of divergence. Government spending is both an indicator of government commitment to a policy area and a measure of its capacity to develop,

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E3 Canada

H United States

SOURCE: CEQ Annual Report, Environment Canada.

FIGURE 9.8 Trends in concentrations of ambient air pollutants, Canada and the United States, 1975-1996

monitor, and enforce policy. Our previous study revealed convergence on spending: spending on the environment as a percentage of total budgets was roughly equal, and both countries seem to have responded to the burst in environmental concern around 1990 with similar increases in spending between 1986 and 1991. Figure 9.10 updates these figures and shows marked divergence. Whereas the U.S. budget figure increased again in 1997, the Canadian figure declined from 1991 to 1997 and dipped below that for 1986. Breaking the spending down by governmental level points to part of the explanation for divergence. The major increase in U.S. spending occurred at the state level. The U.S. system involves a great deal of federal regulation implemented by state governments. When federal environmental concern declined, states continued to implement regulatory programs. Canada has much less regulation generally, and certainly much less at the federal level.34 When concerns about deficits put pressure on environmental spending, nothing required the provinces to keep spending on environmental programs, and they were able to cut back. For example, from the 1994-5 budget to the 1997-8 budget, Ontario reduced environmental spending by a staggering 43 per cent.35

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SOURCE: OECD Environmental Statistics.

FIGURE 9.9 Air pollutant emissions per unit of GDP, Canada, the United States, and the OECD, mid-1990s

Again, domestic institutions and the ideology of governing parties matter. International Influences Five types of international factors influence environmental policy in Canada, and they all tend to promote convergence with the United States - international environmental agreements, increased trade, international trade agreements, emulation, and cross-border lobbying.36 International Environmental Agreements While international problems such as ozone depletion, declining biodiversity, and climate change received attention in the 1990s, Canada and the United States have a long history of environmental disputes and collaboration, dating back to the Trail Smelter conflict early in the twentieth century. While all nations share the biosphere, Canada and the United States share a land mass, an air mass, and waterways and oceans. In the west, conflicts over shared salmon habitat have been

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SOURCES: For Provinces: Public Accounts of Ontario, Quebec, BC, and Alberta; for Canada: Public Accounts of Canada; for U.S. Federal: budgets for EPA and NPS from OMB, Historical Tables; for U.S. states: Council of State Governments, Resource Guide to State Environmental Management, 1998.

FIGURE 9.10 Environmental spending, as percentage of total budgets, Canada and the United States, 1986-1997

simmering for years, and in central and eastern Canada, crossborder water and air pollution, most of it flowing northward, has been a source of friction. On a polluted day in the Windsor-Quebec City corridor, up to half of the ambient smog comes from south of the border. There have been successful instances of collaboration. The two nations set up the International Joint Commission (IJC) in 1909 to address shared environmental concerns and the Migratory Birds Convention in 1917 to protect habitat. They signed the Great Lakes Water Quality Agreement in 1972. Recent agreements on trans-boundary air

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pollution are reducing emissions. The Canada-U.S. Air Quality Agreement (signed in 1991) became possible when the United States was able to commit itself to substantial reductions in acid rain (sulphur dioxide and nitrogen oxides) after the 1990 amendments to its Clean Air Act. Both countries agreed to approximately 50 per cent reductions from major sources, although the deadline was 1994 for Canada and 2000 for the United States. The United States agreed to a reduction of 10 million tons per year from 1980 levels by 2000 and a permanent cap of just under 9 million tons annually from its electric utility industry (its largest source) by 2010. It appears to be making good on its commitment. By 1997, reductions in sulphur dioxide emissions had exceeded the initial target level by 23 per cent. By 1997, Canada had exceeded the national cap promised for 2000.37 Acid rain is a case of relative convergence, with Canada exercising leadership.38 In the late 1980s and early 1990s, global climate change and threats to biodiversity moved to the forefront of the environmental agenda. The agreement in the Montreal Protocol of 1987 to reduce ozonedepleting substances represented a significant collaborative achievement. Canada and the United States exercised leadership in this case, which resulted in policy convergence. Both countries were quite reluctant to agree to significant reductions in emissions of greenhouse gases. The Kyoto Protocol, approved in December 1997, commits both to similar reductions: Canada's target is to get 6 per cent below 1990 levels by 2008-12; the U.S. target is 7 per cent. Given substantial increases since 1990 and projected increases over the next decade, they will have to reduce emissions about 25 per cent.39 In an increasing number of cases, Canada has bound itself to international environmental agreements, some bilateral with the United States, others multilateral. In all cases, Canada has chosen to sacrifice policy sovereignty for gains in environmental protection. In acid rain, stratospheric ozone, and greenhouse gases, substantial convergence has resulted. Increased Trade

Economic globalization may also transform environmental policy, although the direction of its impact is not yet clear. There are two broad categories of effects - those that result from greater flows of goods and services and the increased mobility of capital and those that relate more directly to the mechanisms of international trade agreements.40

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First, pressures towards harmonization of standards may follow because of the costs that environmental regulations impose on firms competing in international markets. In the case of 'product standards' that control the characteristics of the product itself (such as limits on the quantity of a particular chemical contained in a product), firms have an interest in uniform regulations across nations so that they can take advantage of the economies involved in producing the same product for a larger market. In 'process standards/ which control production (such as effluent controls on a chemical plant), firms may suffer a competitive disadvantage if their costs of complying with environmental regulations exceed those of their competitors. Firms in such a situation are likely to lobby their governments to reduce regulatory burdens, creating the potential for a 'race to the bottom' in which each nation attempts to create a competitive advantage for its firms by weakening environmental standards. Environmentalists worry about this trend; policy-makers seem to embrace it. Empirical studies show little evidence of such an effect, however; study after study finds no significant evidence of this effect.41 One explanation is that the available data are poor, but even analyses with solid data have failed to find the expected effect.42 The other, more plausible explanation is that environmental control is relatively inexpensive compared to other factor costs. According to a U.S. government study, 'compliance costs are not a major share of total costs for any industry, and are only one of many factors determining competitive advantage.'43 There may be cases where control costs may actually be high enough to affect plant location, and some areas in Canada, which still relies on pollution-intensive commodity production such as pulp and paper, mining, and smelting, may be vulnerable to this phenomenon. But the evidence suggests that concerns of both environmentalists and politicians about this problem are exaggerated. In environmental policy, there seems instead to be a 'race to the top.' David Vogel refers to this as the 'California effect,' after the state that has led the way in U.S. environmental regulation. Powerful and wealthy 'green' jurisdictions may promote a regulatory 'race to the top' among their trading partners. Thus, just as California's relative size and wealth helped drive many American environmental regulations upwards, so have Germany's strengthened the European Union's.44 Which dynamic will tend to win out depends on the context. Can-

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ada's largest trading partner tends to have relatively stringent standards. If the balance of trade flows within NAFTA changed, and 80 per cent of Canada's exports went to Mexico rather than the current level of 3 per cent, the balance of pressures would obviously be quite different. While strong U.S. standards have mitigated the downward pressures on Canadian policy, economic integration has improved environmental controls. For instance, the Canadian forest products industry is being forced into more environmentally 'friendly' practices as a result of market pressures from foreign consumers. American states and municipalities require newspapers to contain a certain percentage of recycled fibres, forcing Canadian exporters to increase their capacity to supply recycled newsprint. Demands from European governments and consumers for chlorine-free paper products and more environmentally sensitive forest practices have encouraged the industry to adopt expensive controls to reduce emissions of dioxins and furans and the province of British Columbia to overhaul its regulatory regime.45 Trade Agreements Specific trade agreements may encourage the harmonization of environmental standards and open countries' environmental policies to challenge by competitors on the grounds that they provide unfair subsidies or are a non-tariff barrier to trade.46 Many environmentalists in Canada were highly critical of the FTA and NAFTA because they feared that they would weaken Canadian standards.47 Some U.S. environmentalists expressed similar fears about NAFTA and the GATT/ WTO. Public Citizen, a prominent U.S. public interest group, has a 'harmonization alert' on its website.48 Nothing in the three agreements explicitly requires harmonization of environmental standards; in fact, they all recognize the right of countries to have different standards. The environmental side agreement to NAFTA explicitly addresses the issue; but even it focuses on the enforcement of each country's own laws and contains no requirements that those laws be changed.49 There are some measures that are designed to encourage harmonization. For instance, section 7 of the FTA establishes a binational group to 'work towards equivalence' in pesticide regulation, discussed below in more detail. NAFTA's sections on sanitary and phytosanitary standards, as well as on standards-related measures, encourage adoption of international standards, but the measure is intended to promote upward harmonization. Parties are urged

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to 'pursue equivalence' and use international standards, but 'without reducing the level of protection for the environment/ Countries are explicitly allowed to exceed international standards.50 Despite these assurances, these agreements may constrain environmental policy in five ways. First, the principle of national treatment explicitly permits countries to adopt their own regulatory rules but also requires that the same rules apply to domestically produced and to imported products. Second, the ability of countries to use trade measures, such as import bans, on products produced according to environmentally damaging processes is limited. In a landmark 1991 case, a GATT dispute-resolution panel ruled that the United States could not ban tuna imported from Mexico because of fishing practices that threatened dolphins.51 In March 1998, the WTO rejected a U.S. ban on shrimp imports from nations that did not adequately safeguard sea turtles.52 U.S. environmental groups have begun a campaign to press for trade sanctions against Canada for its failure to adopt federal legislation protecting endangered species. Third, the NAFTA side agreement on the environment may make it more difficult for a country to engage in routine non-compliance with its own environmental standards, although the procedural hoops to invoke sanctions are quite daunting.53 Some environmentalists have used this section to challenge the non-enforcement of Canadian laws, but thus far they have not succeeded.54 Fourth, NAFTA's chapter 11, on investment, has a novel provision (article 1110) that allows corporations to sue member governments for compensation for expropriating or reducing the value of their investment. The MMT case is an example of this measure being employed against Canadian environmental policies.55 While this provision remains untested, in a worst-case scenario it could be interpreted as giving corporations a right to compensation for 'regulatory takings' by governments seeking environmental protection. If this were to occur, it would indeed have a chilling effect on autonomy in regulatory policy. Fifth, policies that distort trade are subject to challenge or retaliation by competitors. The WTO exempts policies aimed at conservation and environmental protection from these challenges under article XX, but whether or not the environmental justifications are legitimate is a matter of interpretation and subject to the dispute-resolution process.56 Under NAFTA, if trading partners believe that standards exceeding the international norm are a barrier to trade, they can challenge the standard. NAFTA does require the standards to be 'based on scientific prin-

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ciples' and 'not maintained where there is no longer a scientific basis/ The party challenging the regulation bears the burden of proof. According to leading trade experts, 'placing the burden on the challenging party effectively creates a presumption that the environmental regulation is valid.'57 Environmentalists remain concerned that requirements for scientific support will make it harder to enact precautionary measures in the face of scientific uncertainty. Because there is no case law under NAFTA on these issues, perceptions about their implications boil down to how one thinks future dispute-settlement panels will decide.58 Overall, economic globalization is a force for convergence, in terms of both economic integration and trade liberalization. But it is important not to overstate the magnitude of this factor. The trade agreements do impose some limits on national regulatory sovereignty, but they still provide a great deal of room for regulatory divergence. Much of their impact will depend on interpretations by dispute-resolution panels. One major study up through 1994 concludes that trade liberalization had improved environmental standards.'59 Emulation Another potential force for convergence is emulation.60 In North American environmental policy, this phenomenon is pervasive, and virtually uni-directional, from the United States to Canada.61 Canadian emulation usually occurs through one of two primary modes. The first is elite driven, when officials or policy specialists evaluating policy alternatives are attracted to the American experience. Officials may learn about U.S. policies through the media, specialized publications, or participation in transnational policy communities. In many cases, formal meetings are scheduled between government officials in the two countries to share information and discuss common concerns. The second mode of emulation involves activists who use the existence of an American program or standard to support their argument for policy change in Canada. In this case, activists try to 'shame' government into acting - 'if it is good enough for them, it is good enough for us/ This dynamic is facilitated by the penetration of U.S. mass media into Canada. When an issue of importance emerges in the United States, it is often picked up by Canadian policy activists or the media themselves, forcing the government to respond.62 The emulation dynamic goes beyond U.S. influence on Canada.

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Indeed, much of the strategy of nascent international environmental institutions relies less on making binding international rules than on publicizing comparative information about the policy performance of different nations. Although the Rio conference in June 1992 did not yield much in the way of substantive agreements, it did set in motion an institutional process whereby national governments submit reports to a new Sustainable Development Commission.63 Similarly, NAFTA requires reports to the new Commission for Environmental Cooperation. Exposing the performance of different national governments may 'shame' laggards into improving their efforts. Certainly Canada, and Ontario in particular, were not pleased when the Commission on Environmental Cooperation released statistics showing Ontario to be one of the largest polluting jurisdictions in the region. In some cases, Canada's own efforts to show international leadership have been used against it. Seven years after leading the push for a Biodivesity Convention, Canada still has not enacted national legislation on endangered species. Cross-Border Lobbying Interest groups from one country increasingly engage in efforts to lobby the government of another country.64 Cross-border lobbying has occurred in several areas of environmental policy in North America. U.S. environmentalists have tried to block further hydroelectric development in northern Quebec; Canadian environmentalists attempted to get the U.S. Congress to adopt controls on acid rain in the 1980s. In the 1990s, the B.C. forest sector was the main target of these efforts. Environmentalists, led by Greenpeace, have become increasingly sophisticated at combining cross-border lobbying with market pressures as a way to influence corporate environmental behaviour.65 This is a case where economic integration has promoted, not dampened, environmental protection - much to the dismay of the provincial government and industry. There is a fine line between activist-driven emulation and crossborder lobbying. The former refers to tactics of domestic groups; the latter, of foreign groups. These days, with close ties between national groups and international groups within the environmental movement, it is frequently impossible to make the distinction. In fact, domestic groups try to increase their influence by soliciting support from sympathetic groups outside the country. These tactics can shift the political balance of power working on policy-makers.

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Explaining Patterns The patterns in environmental policy are complex. Unlike in social policy, however, here the more dominant pattern seems to be convergence. While there are several instances of Canada's having stronger policies (on pesticide residues, acid rain), the pattern of convergence under U.S. leadership still appears to hold. The one potentially significant departure is the shift in spending during the 1990s. Environmental spending as a fraction of total government spending continues to increase in the United States; in Canada it has fallen back below 1986 levels. In our earlier shady, we stressed parallel domestic pressures and emulation, rather than international constraints. The first two are still powerful dynamics. The latest directly comparable public opinion polls come from 1992 and show remarkably similar attitudes in the two countries.66 Since then, a common pattern seems to have held. Despite strong support for environmental protection on both sides of the border, it has not been a 'top of the mind' issue in either country since 1990. International constraints on Canadian environmental policy are growing. International commitments, especially the Kyoto Protocol, are going to create real challenges for Canadian policy-makers. International environmental campaigns in the forest sector are creating significant political and economic pressure for change. There is no evidence that trade agreements have had any significant impact, but they have yet to be tested. The area of greatest concern is the potential for the investor-suit provision of NAFTA to be used to create a chill against new regulations that may affect the value of foreign investments. If water were to be interpreted as a tradeable commodity, the implications for Canadian sovereignty and culture, if not ecosystems, could be significant.67 Yet these pressures clearly cut both ways: if some trade agreements may constrain environmental regulation, environmental treaties create a strong incentive for public action. Compared to social policy, Canadian environmental policy is more constrained by economic integration with the United States. In general, however, integration has not posed a threat to Canadian policies of environmental protection, largely because U.S. regulations are at least as stringent as Canada's. A prominent example is automobile emissions. The North American auto market is highly integrated and U.S.-

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dominated. If Canada had sought to impose emission controls beyond those in force in the United States, it would have faced strong resistance from automakers who would have had to produce a different product for a relatively small portion of the market. In fact, because the United States was far ahead of Canada in emission controls, it was much easier for Canada to harmonize its regulations with the United States once it decided to do so.68 In the case of pesticide residues, where U.S. standards were less stringent than Canadian ones, U.S. environmental pressures have relieved potential pressures for downward harmonization.69 Again, the pressures are double-edged: lobbying from U.S. interest groups can counterbalance criticism of tough environmental policy from U.S. business. All five aspects of internationalization - environmental agreements, increased trade, trade agreements, emulation, and cross-border lobbying - are likely to intensify. The balance of these pressures on Canada is unlikely to change in the foreseeable future, unless there is a fundamental shift in U.S. environmental politics or a major shift away from the United States as the dominant trading partner. The former is only slightly more likely than the latter. While many environmentalists remain very apprehensive about deeper economic integration, the major economic powers seem to agree on the importance of environmental values in trade agreements - witness the outgoing suggestion by the WTO's president for the creation of a parallel 'World Environment Organization.' Four other major trends pose challenges for Canadian policy-makers in the environmental sector - one from without and three from within. Chapter-11 investor suits - an apparently unforeseen implication for regulators70 - could pose a significant constraint on policy autonomy if it is interpreted expansively. None of the NAFTA countries has compensation for regulatory takings enshrined in their own jurisprudence; it seems mysterious that they should choose to create one in this manner. More worrisome are the trends of decentralization, and especially de-funding, from within. Both Canada and the United States have fragmented policy-making institutions, but along different dimensions. The particular combination of features in the United States - a legalistic regulatory framework that forces action even on reluctant policymakers - makes the system more resistant to retrenchment than the

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Canadian system.71 The combination of pressures for decentralization resulting from intergovernmental politics and the fiscal pressures on all levels of government has led to a reduction in funding for environmental programs. While the consequences are not yet measurable, this cannot help but affect the capacity to develop, implement, monitor, and enforce environmental policies. The saviour may well be the increasing popularity throughout the developed world of voluntary, non-regulatory instruments for sustainable development that place greater reliance on the private sector.72 These sorts of tools, however, require the credible threat of government coercion to work. Thus, when implemented within a highly regulatory environment such as the United States, they may be a welcome innovation. In the Canadian context, however, where there is a tradition of negotiated agreements and cautious government enforcement, they may not result in the desired behavioural changes. One particularly formidable trend for Canada will be the combination of increasing international agreements and decentralization. Conflict between the federal government and the provinces became palpable at Kyoto when the prime minister committed Canada to more than he had agreed to with the provinces. But that disagreement will pale in comparison to the coming conflict over implementation. Balancing international negotiation, which favours centralization, and effective implementation, which favours intergovernmental cooperation and consensus, will be a great challenge for Canadian governments. There are significant differences between social and environmental policy in the patterns of convergence and divergence. In both there is a complex interplay between the factors promoting convergence and those sustaining difference. Convergence is clearly more dramatic in the environmental case, for several reasons. First, relative to social policy, the environment is a new policy area. The legacies of historically distinctive policies, such as health care and income transfers, are thus more powerful in social policy. Second, environmental policy is clearly much more a worldwide issue that can be dealt with only through global co-operation. While rates of poverty and social distress are clearly influenced by international forces, social policy is far more 'contained' within each country. Third, and closely related, there has emerged a global environmental policy community and set of networks. In social policy, domestic social programs and foreign ones, such as aid and relief programs, are in quite separate policy communities.

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International Comparisons: The EU and the OECD Our initial study, and this update and extension, focus on the CanadianU.S. context. How do these findings relate to other comparative studies? Fortunately, several recent policy studies survey a broader range of cases, including the European Union (EU). The EU provides an excellent comparative vantage point because of its much tighter economic and political integration. In addition to the presence of supranational institutions beyond anything contemplated in North America, there is a monetary union, a common currency, and free labour mobility. In Convergence or Diversity? Internationalization and Economic Policy Response, edited by Brigitte Unger and Frans van Waarden (1995), the authors compare a wide range of policies over a number of countries, with a focus on the EU. They develop an analytical framework similar to that in Banting, Hoberg, and Simeon, Degrees of Freedom, and emphasize international influence occurring through three forces: market forces of exchange, trade, and the mobility of factors; imitation; and enforcement, either by multinational corporations or by foreign governments through international agreements. They argue, as we do, that the balance of forces between convergence and divergence differs from sector to sector. The policy areas most likely to be affected are those, such as macroeconomic policy, where capital mobility is most important. Where it is less important, different national cultures and policy legacies (or what they refer to as 'institutionalization') push for divergence.73 In the EU, many regulatory policies are also influenced by international agreements that tend to promote harmonization. Nevertheless, the survey by Unger and van Waarder shows that the forces entrenching divergence tend to win out over the forces promoting convergence. Indeed, they are surprised by the amount of divergence that their analysis revealed, even in monetary and fiscal policy. The pattern is even more marked in policies less dependent on capital mobility, where asymmetries in factor mobilities (whether natural or the product of political or social processes) and institutional differences make for persistence of policy differences.74 In cases where they did find convergence, such as environmental policy, it involved not a 'race to the bottom/ but a convergence on higher standards. In one case that raises concerns about 'convergence towards the worst' in social policy, the authors blame them not on European integration but on 'the rightward shift in the ideological and political center' occurring everywhere.75

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Similar conclusions flow from an analysis by economist Nancy Olewiler of national tax rates in OECD countries. Olewiler notes the globalization hypothesis - that 'it will be harder to sustain significant tax rate differentials for mobile factors. Tax rates will have to converge. Mobile factors such as portfolio capital and highly skilled labour will be more difficult to tax/76 Her results are striking. Effective marginal tax rates on high-income earners were no lower in 1995 than in 1978. There has been a decline in the dispersion in high-income tax rates, suggesting some convergence in marginal tax rates, and tax rates for low-income people increased, providing some support for 'the hypothesis that with globalization, less mobile labour will face higher marginal tax rates. However, when she expands the analysis to include a broader range of tax policy instruments, including payroll and consumption taxes, she finds 'no conclusive evidence that globalization significantly alters the tax mix' from mobile to non-mobile factors.78 The most remarkable result of Olewiler's analysis is the absence of any significant change in corporate tax rates. Corporate taxes should be one of the policy areas most affected by globalization. Capital mobility would lead one to expect that any country imposing higher taxes on capital than its trading partners would be punished by capital flight. It is the most clear-cut case for the 'race to the bottom' and the need for policy harmonization. But, remarkably, the globalization hypothesis fails the test. Among G-7 nations, the average corporate tax rate stayed constant between 1983 and 1997, and the variation among countries actually increased. In 1996, seven years after the implementation of the FTA, the effective tax rate on large Canadian business was 80 per cent higher than the U.S. rate.79 The most important study of the implications of globalization on domestic policy choice is Geoffrey Garrett's article 'Global Markets and National Politics: Collision Course or Virtuous Circle?'80 Garrett smashes a number of persistent myths about globalization. He agrees that economic integration has constrained governments' ability to run budget deficits. Given the mobility of financial capital in international markets, governments that run deficits are forced to pay an interestrate premium.81 Nevertheless, this phenomenon has not yet had any apparent effect on the size of government in OECD countries. Garrett shows that from 1960 to 1994 there was a steady upward trend in total government outlays as a percentage of GDP.82 He also provides a broader measure of corporate tax changes than Olewiler, examining the entire OECD rather than just the G-7. The trend in effective rates of capital taxation, including changes in both

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the marginal rates and the tax base, 'has been upward, strongly so.'83 Whether one examines rates of change in total government spending, deficits, or corporate taxes, one finds that the 'descriptive data can only support one conclusion: fiscal policies among the OECD countries have not converged in recent years.'84 Countries with large public sectors and high corporate tax rates did not experience significant capital flight. There was some correlation between size of government and higher interest rates, but deficits are far more important than size of government in influencing interest rates.85 Garrett turns much of the current rhetoric over globalization on its head. While greater mobility increases 'exit options' for capital, it also exacerbates the sense of economic insecurity among certain segments of the population, leading to greater political demands to use government to cushion society from market-generated dislocations. While that argument has had academic proponents, with strong empirical support, for several decades,86 Garrett also argues that government can be good for business in a global economy. He claims that too much attention is paid to the economic costs of government intervention and too little to the fact that 'numerous government programs generate economic benefits that are attractive to mobile finance and production.'87 These studies provide powerful support for the argument that, at least as of the mid-1990s, the data simply did not support the argument that globalization was producing policy convergence.88 The most striking finding is the continued divergence of corporate tax rates, where one would expect the strongest pressures for convergence. Economic integration does impose costs. It makes it more costly to run a budget deficit. But the cross-national data suggest that countries can afford to increase their tax burden without suffering the dire consequences that many alarmist accounts of globalization have promoted.

Conclusion This analysis shows that, despite all the rhetoric about globalization and its impact on domestic policy autonomy, there is still significant room for manoeuvre. Our analyses of social and environmental policy reveal two distinct patterns. In social policy, Canada has been able to maintain a distinctive welfare state in many areas. In comparison to many European countries, the distinctions are not significant, but in the North American context, in the words of one pithy book title, they are Small Differences That Matter.89 Fiscal pressures have strained and

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will continue to challenge Canada's ability to maintain this distinctiveness. But blaming fiscal pressures on international economic integration is too facile. Cross-national evidence from the OECD reveals that governments that run deficits do pay a penalty, but governments that have larger government sectors without deficits do not. The biggest constraint on Canada's ability to maintain a distinctive welfare state is not globalization or Americanization but the willingness of the Canadian people to pay the taxes to support it. The pattern in environmental policy is different. There is both more convergence and more constraint. American influence is felt first and foremost in the export of pollution across the boundary, making it more difficult for Canada to manage its own environment. Trade agreements do limit the use of some policy instruments and open regulatory measures up to potential challenges, but thus far the latter has not been a significant issue. Canadians concerned about the 'race to the bottom' in the environment are fortunate that the United States has a relatively strong track record of environmental protection, which has obviated many of the downward pressures on standards that might otherwise be present. In some cases, U.S. pressures have helped push Canadian standards up. Indeed, environmental policy-makers at times are uncomfortable with constraints in the continental relationship that push them to be greener - witness B.C. forest policy-makers or federal and provincial officials grappling with endangered species legislation. Concerns about globalization and Americanization are driven both by ideological concerns about what it means to be Canadian and empirical beliefs about the nature of constraints created through economic integration. The research that addresses the empirical questions is quite powerful.90 Canada has maintained distinctive social programs and has done a more effective job at caring for its needy. In the broader picture, perhaps the most striking findings come from the research on comparative corporate tax rates. In the policy sector most susceptible to downward harmonization, corporate tax rates across OECD countries have increased and diverged. It is not our purpose to deny that international pressures of many sorts have a critical effect on Canadian policy and on governments' capacity to address these matters. Nor is it our intention to deny that governments are not everywhere and always constrained. Of course they are. But external pressures constitute only one set, among many, of the constraints facing citizens and policy-makers, and domestic pressures remain a potent force in shaping the policies of nations.

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Our purpose has been rather to use the evidence of two major policy areas, together with a broader literature, to argue that crude generalizations about the impact of globalization on policy autonomy are not very helpful. We are simply suggesting a more nuanced view, one that recognizes that international constraints: • vary across policy sectors, time, and countries • should not be confused with policy convergence as a consequence of common domestic pressures and emulation/learning/transfer of ideas • may promote a 'race to the top' as well as a 'race to the bottom' • are counterbalanced by powerful forces sustaining policy difference and divergence • are best seen as costs to be weighed rather than as walls or straitjackets • are often chosen by domestic policy-makers rather than imposed from without. What about the future? Are global constraints likely to increase or to decrease? Are we witnessing simply the beginning of a trend whose full effects are likely to be far greater than we have suggested, or will the interplay of similarity and difference that we have described persist? We have no definitive answer. But 'globalization' has been a focus of attention now at least since the 1970s, and North American integration is even older. So we have had considerable time for their effects to become apparent. Most fundamentally, the capacity to retain autonomy in a globalizing world depends on domestic understanding about fundamental values and priorities and a sense of self-confidence and conviction about them. The most severe constraints imposed by globalization may be more in the mind than in a reality that is enormously complex and ambiguous. Canada has formidable capacities for domestic policy choices in a wide range of sectors. It is up to Canadians and their elected officials to choose how to exercise that freedom of choice. NOTES

1 See, for example, Richard Gwyn, Nationalism without Walls: The Unbearable Lightness of Being Canadian (Toronto: McClelland and Stewart, 1995). For a

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useful critique, see William Watson, Globalization and the Meaning of Canadian Life (Toronto: University of Toronto Press, 1998), chap. 2. 2 See Geoffrey Garrett, Partisan Politics in the Global Economy (Cambridge: Cambridge University Press, 1997); and Linda McQuaig, The Cult of Impotence: Selling the Myth of Powerlessness in the Global Economy (Toronto: Viking, 1998). 3 See Watson, Globalization. 4 See Keith Banting, George Hoberg, and Richard Simeon, edsv Degrees of Freedom: Canada and the United States in a Changing World (Montreal: McGillQueen's University Press, 1997). 5 A fourth type of pressure, lobbying by foreign interest groups, can also act as a force for convergence. As described below, this mechanism is quite important in environmental policy, but because its influence tends to be confined to a narrow range of policy areas, we do not elevate it to the status of the other mechanisms. 6 One of the casualties of globalization rhetoric has been conceptual precision. Some scholars have made effective distinctions, but there is little terminological convergence. In their book on the internationalization of Canadian policy, Doern, Pal, and Tomlin distinguish between globalization as an economic force and internationalization, which includes trends in ideas and international social movements. See G. Bruce Doern, Leslie A. Pal, and Brian W. Tomlin, eds., Border Crossings: The Internationalization of Canadian Public Policy (Toronto: Oxford University Press, 1996). Milner and Keohane restrict 'internalization' to the 'processes generated by underlying shifts in transaction costs that produce observable flows of goods, services, and capital.' See Helen Milner and Robert Keohane, 'Internationalization and Domestic Politics: An Introduction/ in Helen Milner and Robert Keohane, eds., International and Domestic Politics (Cambridge: Cambridge University Press, 1996), 4. While we deploy a different set of distinctions, we agree that it is essential to make clear the mechanism of internationalization to which one is referring. 7 See Colin J. Bennett, 'Review Article: What Is Policy Convergence and What Causes It?' British Journal of Political Science 21 (1991), 215-33; and Richard Rose, Lesson Drawing across Time and Space (Chatham, NJ: Chatham House, 1993). 8 See Milner and Keohane, 'Internationalization,' 2-24. 9 One scholar has been impressed with the enduring differences. See Seymour Martin Lipset, Continental Divide (New York: Routledge, 1990). For very different perspectives in more popular books, see, for example, Gwyn, Nationalism, and Watson, Globalization.

The Scope for Domestic Choice 293 10 See George Perlin, The Constraints of Public Opinion: Diverging or Converging Paths?' in Banting, Hoberg, and Simeon, eds., Degrees of Freedom, 71-149. 11 See Richard Simeon and Elaine Willis, 'Democracy and Performance: Governance in Canada and the United States/ in ibid., 150-86. 12 See, for example, Sven Steinmo, Kathleen Thelen, and Frank Longstreth, eds., Structuring Politics: Historical Institutionalism in Comparative Analysis (Cambridge: Cambridge University Press, 1992). 13 See Paul Pierson, Dismantling the Welfare State? (Cambridge: Cambridge University Press, 1994). 14 See G. Bruce Doern and Brian W. Tomlin, 'Trade-Industrial Policy,' in Doern, Pal, and Tomlin, eds., Border Crossings, 165-87. 15 See Banting, Hoberg, and Simeon, eds., Degrees of Freedom. 16 See George Hoberg, 'Governing the Environment: Comparing Canada and the United States,' in Banting, Hoberg, and Simeon, eds., Degrees of Freedom, 341-85; and Christopher Manfredi, 'The Judicialization of Politics, Rights and Public Policy in Canada and the United States,' in ibid., 310-40. 17 See Paul Boothe and Douglas Purvis, 'Macroeconomic Policy in Canada and the United States: Independence, Transmission, and Effectiveness,' in Banting, Hoberg, and Simeon, eds., Degrees of Freedom, 189-230. 18 See Keith Banting, The Social Policy Divide: The Welfare State in Canada and the United States,' in ibid., 267-309. 19 This section provides an update of ibid. 20 See R. Blank and M. Hanratty, 'Responding to Need: A Comparison of Social Safety Nets in the United States and Canada,' in D. Card and R. Freeman, ed., Small Differences that Matter: Labor Markets and Income Maintenance in Canada and the United States (Chicago: University of Chicago Press, 1993), 191-231. 21 See Banting, The Social Policy Divide/ 298. Another recent study concludes: The Canadian social assistance complex in the contemporary period extends considerably more generous assistance to a range of individuals and families in need who receive only minimal assistance across the border.' See Gerard Boychuk, 'Are Canadian and U.S. Social Assistance Policies Converging?' Canadian-American Public Policy 30 Quly 1997), 3. 22 See Canada, Department of Finance, Facts Sheet: Budget 1995, available at http://www.fin.gc.ca/budget95/facte/facte.html, 31 May 2000. 23 See R. Kent Weaver, 'Ending Welfare As We Know It/ in Margaret Weir, ed., The Social Divide: Political Parties and the Future of Activist Government (Washington, DC: Brookings Institution, 1998), 361-418. 24 See G. Burtless, The Tattered Safety Net/ Brookings Review 9 (1991), 38-41.

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25 M.C. Wolfson and B.B. Murphy, 'Income Inequality in North America: Does the 49th Parallel Still Matter?' Canadian Economic Observer (July 2000). 26 See Banting, The Social Policy Divide.' 27 See, for example, Harold Wilensky, The Welfare State and Inequality: Structural and Ideological Roots of Public Expenditures (Berkeley: University of California Press, 1975). 28 See Banting, The Social Policy Divide,' 276. 29 See Thomas Byrne Edsall and Mary Edsall, Chain Reaction: The Impact of Race, Rights, and Taxes on American Politics (New York: Norton, 1991); and Edward Carmines and James Stimson, Issue Evolution: Race and the Transformation of American Politics (Princeton, NJ: Princeton University Press, 1989). 30 See Banting, 'The Social Policy Divide,' 283. 31 See David R. Cameron, The Expansion of the Public Economy/ American Political Science Review 72 (1978), 1243-61; and Peter Katzenstein, Small States in World Markets (Ithaca, NY: Cornell University Press, 1984). For a more qualified view, see Dani Rodrik, Has Globalization Gone Too Far? (Washington, DC: Institute for International Relations, 1997). 32 See Helliwell, chap. 5 in this volume. 33 See Hoberg, 'Governing the Environment.' 34 See Kathryn Harrison, The Origins of National Standards: Comparing Federal Government Involvement in Environmental Policy in Canada and the United States,' in Kathryn Harrison and Patrick Fafard, eds., Managing the Environmental Union (Kingston: Institute for Intergovernmental Relations, Queen's University, 2000). 35 See Canadian Institute for Business and the Environment, 'Ontario Environmental Budget Cut 43%,' Canadian Institute for Business and the Environment Newsletter, 21 July 1997. 36 See Hoberg, 'Governing the Environment.' For another perspective on the internationalization of Canadian environmental policy, see Glen Toner and Tom Conway, 'Environmental Policy,' in Doern, Pal, and Tomlin, eds., Border Crossings, 108-44. 37 International Joint Commission, Canada-United States Air Quality Agreement -1998 Progress, available at http://www.ec.gc.ca/special/airqual.html, 31 May 2000. 38 The two countries are in the process of developing an agreement on ground-level ozone. 39 See Environment Canada Website, http://www.ec.gc.ca/climate/fact/ challopp.html. 40 For an overview, see Pierre Marc Johnson and Andre Beaulieu, The Environ-

The Scope for Domestic Choice 295

41

42

43

44 45

46

47

ment and NAFTA: Understanding and Implementing the New Continental Law (Washington, DC: Island Press, 1996). For comprehensive surveys, see Adam Jaffe et al., 'Environmental Regulations and the Competitiveness of U.S. Manufacturing: What Does the Evidence Tell Us?' Journal of Economic Literature 33 (1995), 132-63; and Arik Levinson, 'Environmental Regulations and Industry Location: International and Domestic Evidence,' in Jagdish Bhagwati and Robert Hudec, eds., Fair Trade and Harmonization: Prerequisite for Free Trade? (Cambridge, Mass.: MIT Press, 1996), 429-57. For a theoretical assessment of the relationship between trade and the environment, which 'yields a somewhat surprising conclusion: freer trade appears to be good for the environment,' see Werner Antweiler, Brian Copeland, and M. Scott Taylor, Is Free Trade Good for the Environment? (Cambridge, Mass.: National Bureau of Economic Research, 1998), Working Paper No. 6707. See Arik Levinson, The Missing Pollution Haven Effect: Examining Some Common Explanations,' in Environmental and Resource Economics 15, no. 4 (April 2000). See U.S. Office of Technology Assessment, Industry, Technology, and the Environment: Competitive Challenges and Business Opportunities (Washington, DC: Government Printing Office, 1994). See David Vogel, Trading Up: Consumer and Environmental Regulation in a Global Economy (Cambridge, Mass.: Harvard University Press, 1994), 6. See Kathryn Harrison, 'Ideas and Environmental Standard Setting: Environmental Regulation of the Pulp and Paper Industry in Canada, the United States, and Sweden,' paper presented at the annual meeting of the American Political Science Association, Boston, Mass., 1998); and Stephen Bernstein and Benjamin Cashore, 'Globalization, Four Paths of Internationalization and Domestic Policy Change: The Case of Ecoforestry in British Columbia, Canada,' Canadian Journal of Political Science 33, no. 1 (March 2000), 67-99. See Daniel C. Esty, Greening the GATT: Trade, Environment, and the Future (Washington, DC: Institute for International Economics, 1994); Daniel C. Esty and Damien Geradin, 'Market Access, Competitiveness, and Harmonization: Environmental Protection in Regional Trade Agreements/ Harvard Environmental Law Review 21 (1997), 265-336; and Johnson and Beaulieu, The Environment and NAFTA. See Steven Shrybman, 'Trading Away the Environment/ in Richard Grinspun and Maxwell Cameron, eds., The Political Economy of North American Free Trade (New York: St Martin's Press, 1993), 271-94; and Marchak, 'Environment and Resource Protection.'

296 Politics 48 See Harmonization Alert Home Page, available at http://www.harmonizationalert.org, 5 June 2000. 49 An expert on trade and the environment denounces this provision as 'retrogressive': 'An international obligation based on each government's own standard is the weakest conceivable form of international agreement... The three governments resorted to an atavistic, uninspiring approach aimed at the wrong target.' See Steve Charnovitz, The NAFTA Environmental Side Agreement and Its Implications for Environmental Cooperation, Trade Policy, and American Treatymaking,' Temple International and Comparative Law Journal 8 (1994), 22. 50 See Esty and Geradin, 'Market Access/ 310. 51 See Esty, Greening the GATT, 27-32. 52 See Martin Crutsinger, 'WTO Rules against U.S. in Turtle Case/ Associated Press, 14 March 1998, available at http://www.citizen.org/pctrade/ gattwto/Cases%20&%20Tribunalists/turtle.htm, 30 May 2000. 53 See Charnovitz, 'The NAFTA Environmental Side Agreement.' 54 For a registry of cases, see http://www.cec.org/english/citizen/ index.cfm?format=2 55 Details about the MMT case and its significance for regulatory autonomy appear in a previous version of this paper, available at http://www.arts. ubc.ca/polisci/hoberg/north.htm. Another case that has emerged recently is a suit by U.S.-based company Sun Belt Water Inc. against Canada over a BC ban on bulk exports of water. For an overview of this provision, see Howard Mann and Konrad von Moltke, NAFTA s Chapter 11 and the Environment: Addressing the Impacts of the Investor - State Process on the Environment (Winnipeg: International Institute for Sustainable Development, 1999). 56 See Esty, Greening the GATT. 57 See Esty and Gerdin, 'Market Access,' 312. 58 For an intensive analysis of the Canadian-U.S. dispute with the EU over growth hormones in the context of WTO dispute resolution, see Vern Walker, 'Keeping the WTO from Becoming the "World Trans-Science Organization": Scientific Uncertainty, Science Policy, and Fact-finding in the Growth Hormones Dispute,' Cornell International Law Journal 31 (1998), 251320. 59 See Vogel, Trading Up, 5. 60 See Hugh Heclo, Modern Social Policies in Britain and Sweden: From Relief to Income Maintenance (New Haven, Conn.: Yale University Press, 1974); and Bennett, 'Review Article.' 61 See George Hoberg, 'Sleeping with an Elephant,' Journal of Public Policy 11 (1991), 107-31.

The Scope for Domestic Choice 297 62 For a case study involving the pesticide Alar, see Kathryn Harrison and George Hoberg, Risk, Science, and Politics: Regulating Toxic Substances in Canada and the United States (Montreal: McGill-Queen's University Press, 1994), chap. 4. 63 See P. Haas, M. Levy, and E. Parson, 'Appraising the Earth Summit: How Should We Judge UNCED's Success?' Environment 34 (1992), 6-11,26-33. 64 See Margaret E. Keck and Kathryn Sikkink, Activists beyond Borders: Advocacy Networks in International Politics (Ithaca, NY: Cornell University Press, 1998). 65 See Bernstein and Cashore, 'Globalization.' 66 See Alan Frizzell and Jon Pammett, Shades of Green: Environmental Attitudes in Canada and Around the World (Ottawa: Carleton University Press, 1997). 67 See, for example, Marchak, 'Environment and Resource Protection.' 68 See Hoberg, 'Sleeping with an Elephant' 107-31. 69 This dynamic is explained in more detail in the case of pesticide residues in an earlier version of this paper, available at http://www.arts.ubc.ca/ polisci / hoberg / north.htm 70 Early environmental criticisms of NAFTA and the major law treatises on the environmental implications of NAFTA ignored the provision. See Michelle Swenarchuk, 'Environment,' in Duncan Cameron and Mel Watkins, eds., Canada under Free Trade, 196-202 (Toronto: James Lorimer, 1993); Esty and Geradin, 'Market Access'; Charnovitz, The NAFTA Environmental Side Agreement'; and Johnson and Beaulieu, The Environment and NAFTA. 71 See Hoberg, 'Governing the Environment.' 72 For a recent survey and critique, see Kathryn Harrison, 'Talking with the Donkey/ Journal of Industrial Ecology 2, no. 3 (1998), 51-72. 73 See Brigitte Unger and Frans van Waarden, 'Introduction: An Interdisciplinary Approach to Convergence,' in Brigitte Unger and Frans van Waarden, eds., Convergence or Diversity? Internationalization and Economic Policy Response (Aldershot, England: Avebury, 1995), 21-2. 74 Ibid., 29. 75 See Hugh Mosley, The "Social Dumping" Threat of European Integration: A Critique/ in Unger and van Waarden, eds., Convergence or Diversity? 194. 76 See Nancy Olewiler, 'National Tax Policy for an International Economy: Divergence in a Converging World?' paper presented to the conference 'Room to Manoeuvre? Globalization and Policy Divergence,' Queen's University, Kingston, Ont., 5-6 Nov. 1998), 2. 77 Ibid., 5. 78 Ibid., 8.

298 Politics 79 Ibid., 7. See also the studies cited by Watson, Globalization, 59-9. 80 See Geoffrey Garrett, 'Global Markets and National Politics: Collision Course or Virtuous Circle?' International Organization 52 (autumn 1998), 787-824. 81 Ibid., 788. 82 Ibid., 813. 83 Ibid., 814. 84 Ibid., 815. 85 In a more recent analysis, Garrett has expanded his data set to include most of the world. Its findings are consistent with the OECD article, except for showing a stronger link between size of government and the interest-rate penalty, which, it notes, governments have been willing to pay. However, it does not separate out the effects of size of government from government deficits, so it does not draw the sort of distinction made for the OECD data set. See Geoffrey Garrett, 'Globalization and Government Spending around the World,' available at http://pantheon.yale.edu/~gmg8/, 30 May 2000. 86 See Cameron, 'Expansion,' 1243-61. 87 See Garrett, 'Global Markets,' 789. 88 Again, this conclusion is supported by Watson's survey of the evidence. See Watson, Globalization, chap. 4. 89 See D. Card and R. Freeman, eds., Small Differences That Matter: Labor Markets and Income Maintenance in Canada and the United States (Chicago: University of Chicago Press, 1993). 90 While coming from quite distinct ideological perspectives, the authors of two influential recent books reach the same basic conclusion about the magnitude of constraints. See Watson, Globalization, and McQuaig, The Cult of Impotence.

10. Conclusion: Capacity for Choice George Hoberg

The preceding chapters in this volume provide detailed research findings from economics and political science about a number of significant aspects of North American integration and its implications for Canada. As the introductory chapter explained, the key questions involve what happens within each of the three spheres that we examined - economics, culture, and politics - but also the links between those spheres. This concluding chapter summarizes the findings of the research presented in this volume (as well as some related studies) and outlines a number of research priorities and policy recommendations. Economics North American integration is in large part an economic phenomenon. The economic chapters (2-5) in this book examine four areas: trade flows, macroeconomics, labour markets, and the migration of skilled workers (the 'brain drain'). Trade and Investment Chapter 2, by Helliwell, Lee, and Messinger, analyses the relative importance of trade flow between the provinces and across the border with the United States and how they have changed over time - the so-called border effect. Raw figures such as Canada's overall trade dependence on the United States (about 33 per cent of gross domestic product, or GDP, in 1998 as measured by exports) can be misleading,

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because they do not take into account geography, the effects of distance from markets, and the size of the export market. Elaborating and updating Helliwell's earlier work,1 their chapter uses the 'gravity model' to control for distance and size. The analysis yields two striking findings. First, the implementation of the Canada-United States Free Trade Agreement (FTA) led to a substantial reduction in the border effect, as trade between the two countries grew far more rapidly than trade among the provinces within Canada. Second, interprovincial trade links none the less remain far more powerful than international trade links - by an order of magnitude. Controlling for size and distance, we find that the ratio of interprovincial to international trade dropped from around twenty prior to the FTA to around twelve after its implementation. Just how integrated then is the Canadian economy with that of its southern neighbour? Even with the virtual elimination of trade barriers, Canadians still strongly prefer to trade among themselves rather than with other countries, including the United States. All else being equal, the border still matters. We need to square this finding, based on the gravity model, with trade statistics showing that one-third of Canadian GDP consists of exports to the United States. Because Canada is so geographically dispersed, and the U.S. market is both so large and so close to many Canadian centres of commerce, the gravity model creates a very large disparity between its results and actual trade flows. As economist Paul Krugman quipped, 'Canada is essentially closer to the United States than it is to itself.'2 Both results are very important. The factor-of-twelve border effect shows that despite the exceptionally strong pull of (north-south) geography, there is still a very powerful bias towards trading with fellow Canadians. The causes and consequences of this 'home bias' are important subjects for future research. None the less, the aggregate trade-dependence effect is arguably more useful in explaining the consequences of economic integration for other spheres of Canadian life. Because of the exceptionally strong pull of geography, one out of every three Canadian economic transactions is with an American. This research shows the dramatic increase in trade flows between the two countries over the last several years, but it does not address investment flows. The United States also dominates foreign investment in Canada, but not by as much as it does trade. In 1995, the U.S. share of stock in foreign direct investment in Canada was 67 per cent.

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This dominance has declined over the past several decades - in 1966, the U.S. share was 82 per cent. While it has continued to increase over the past decade, it has experienced nothing like the growth witnessed in trade. These diverging trends in trade and investment flows suggest that 'firms are expanding output at their most efficient sites and phasing out smaller facilities that were once required by trade barriers/3 Macro economic Policy Chapter 3, by Ronald Kneebone, provides an overview of Canadian macroeconomic performance and policy in the North American context. In terms of broad indicators of performance, the results are generally poor for Canada. The one bright spot has been Canada's success at reducing inflation - since January 1992, the Canadian rate of inflation has been consistently less than the U.S. rate. Unemployment rates have been considerably higher in Canada. The rates diverged in the 1980s, and that divergence increased in the 1990s, when the gap averaged about 4 percentage points by standard measures.4 Canada has experienced higher interest rates for most of the past several decades, but that situation was reversed for 1997 and 1998. Perhaps most discouraging for Canada, per-capita income - in terms of both absolute amount and growth - has lagged that of the United States. There has been intense controversy over Canada's productivity performance, since international reports and politicians of various stripes claimed that Canada's poor growth was causing the lagging standard of living. However, the data show that Canada's growth has not been poorer than the U.S. performance: productivity has grown more slowly in the manufacturing sector, but multi-factor productivity growth has been comparable. While the news. on productivity growth is good, Canadian productivity levels still are significantly below the Americans'. The fact that Canadian productivity growth is not faster means that Canada is not catching up to the United States as quickly as some other countries are.5 In terms of macroeconomic policy, Kneebone describes three key policy choices by Canada over the past dozen years: the Bank of Canada's decision to adopt a 'zero inflation' target, Ottawa's decision to pursue free trade agreements, and the fiscal policy choices of the federal and most provincial governments to rein in their deficits and debt. Each has had substantial, measurable consequences. Tighter monetary policy has considerably reduced inflation, which since 1992 has been

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lower than U.S. levels. Originally, this policy choice imposed costs in terms of higher interest rates, but then Canadian interest rates were below U.S. rates from 1996 through 1998. The FTA and NAFTA intensified Canada's international trade with the United States - a phenomenon discussed in more detail in chapter 2. Canada has been slower than the United States in getting its government deficits and debts under control, despite substantial progress in deficit reduction in the late 1990s. Kneebone (chapter 3) also addresses the critical issue of whether and by how much economic integration has imposed limits on Canada's ability to forge its own social, fiscal, and monetary policies. I report his results below. Labour Markets In many ways, the most intense worries about free trade have concerned jobs and wages. Gomez and Gunderson (chapter 4) examine the effects of economic integration on labour markets and on their institutions, practices, and policies. Given the complexity of economic forces at work, it is difficult to disentangle the effects of free trade from other phenomena, such as tighter monetary policy, technological change, and business cycles. A recent survey concluded: 'Overall, I don't think that we know whether the FTA led to a rise or a fall in total jobs/6 A recent study by Daniel Trefler looks at the effects of free trade during the period 1989-96. Trefler estimates that the FTA reduced jobs in manufacturing by 4 per cent overall, and by 18 per cent in the most affected industries. These figures suggest substantial adjustments. However, he also notes that the rebound in manufacturing employment since 1996 probably reflects the reallocation of resources from inefficient ones. As well, that the reductions in tariffs actually slightly increased wages. Because earnings of more poorly paid production workers increased more than those of better-paid non-production workers, the tariff cuts slightly reduced income inequality.7 This result is surprising, because evidence from the United States and elsewhere supports the argument that trade liberalization tends to increase wage inequality.8 In another Canadian shady, Beaulieu finds that up through 1996 the FTA had slightly reduced manufacturing employment, particularly in sectors with less-skilled workers. His study shows no effect on earnings.9 Gomez and Gunderson also analyse the implications for the labour

Conclusion: Capacity for Choice 303

market's institutions, practices, and policies. Divergence between the two countries continues in rates of unionization among workers. After quite similar rates continuing for decades, there was a sharp divergence after 1964, with unionization in the United States declining sharply and Canadian unionization remaining relatively high. By the 1990s, the Canadian rate was double the American. In contrast, strikes have shown a clear pattern of downward convergence. The 'Brain Drain' One of the most potentially troubling consequences of economic integration has been the potential loss of highly skilled Canadian workers as a result of a combination in the United States of lower taxes, higher wages, greater opportunity, and easier immigration rules.10 Over the past year the Canadian media have been filled with stories about the loss of Canada's best and brightest, and many have used the issue to promote cuts in marginal tax rates. The C.D. Howe Institute claimed that the brain drain cost Canada $7 billion between 1982 and 1996 in lost subsidies to higher education and an additional $12 billion from 1989 to 1996 in 'churning' costs to replace better-trained and -paid emigrants to the United States with immigrants to Canada.11 John Helliwell's chapter 5 presents a careful analysis of the evidence regarding the brain drain and argues that its extent is vastly overrated. First, Helliwell shows that the present rate of migration of skilled workers is quite small compared to earlier periods - the flow during the 1990s was less than one-fourth of that of the 1960s. Moreover, the movement of highly educated immigrants into Canada from other countries far exceeds the net loss of highly educated Canadians to the United States. Helliwell identifies serious methodological flaws in the 'churning cost' estimates presented in the C.D. Howe study, suggesting that its cost claims are grossly exaggerated. One major area of uncertainty is the apparent dramatic increase in 'temporary workers,' a new status created under the FTA and NAFTA. The number of highly skilled temporary workers going to the United States is much higher (by about a factor of ten) than the number of permanent emigrants, and many may choose to emigrate permanently. Helliwell points to some serious measurement problems with this group of workers and urges that we should await more solid census data before sounding the alarm. A recent shady by the Conference Board of Canada argues that the data are strong enough to merit seri-

304 Capacity for Choice

ous concern.12 Given its importance, this is a high priority for future research and analysis. Helliwell also believes that the drain is small compared to what one would expect, given that the U.S. job market has been much tighter and that there is a higher wage premium for skilled workers south of the border. He concludes: "The burden of data examined in this paper, however, is that the numbers involved are small enough, relative to either existing stocks of skills, or the scale of current training, that they are not likely to have a large or long-lasting effect on the availability of skills in Canada.' Finally, because he believes that the data 'provide no evidence of a current crisis, or any great cause for alarm,' 'it would be a mistake to use the brain drain as a spur for changes to taxes and expenditures that do not otherwise pass the tests of economic and political logic/ Culture One of the great Canadian pastimes is musing about what, if any, relevant differences there are between Canadians and Americans. One of the most enduring concerns about continental economic integration has been whether it threatened Canada's distinctive, if elusive and fragile, national identity. These anxieties intensified with the advent of modern media technologies of radio and television, and the Canadian government has sought to promote a distinctive Canadian culture and to promote and defend the cultural industries that it sees as contributing to that distinctiveness. These policies have been sharply contested by the United States, which considers cultural products one of its most important exports. Cultural policy is one area where economic integration, and trade agreements in particular, have placed undeniable constraints on Canadian domestic policy. While Canadian proponents of the FTA made much of the 'cultural exemption,' the agreement did allow for U.S. retaliation on culture. Gilbert Gagne (chapter 6) examines these constraints. He explores the tensions between Canada's pursuit of a liberal trading regime and its desire to use trade measures, as part of a broader cultural package, to protect its vulnerable cultural sector. The difficulty of this balancing act has been revealed recently in rulings by the World Trade Organization (WTO) striking down Canadian policies for protecting magazines and in the strident American threats of retaliation when Canada began an effort to re-enact the policies in question. Despite the intensity of

Conclusion: Capacity for Choice 305

this controversy, Gagne sees reason for hope in the resulting settlement and recommends exploring new ways of protecting Canadian cultural industries. He proposes a two-pronged strategy - one oriented towards getting concessions for culture within the bilateral relationship with the United States, and a broader, multilateral initiative to secure a cultural exemption in any future revisions to the global trade or investment regimes. Politics In addition to the economic and cultural aspects of continental integration, there are also major political dimensions. Thus far, Canada has experienced very little continental political integration; it has transferred few policy-making powers to supranational institutions. In comparison to the European Union (EU), where supranational executive, legislative, and judicial institutions have emerged, political integration in North America has been quite limited. The NAFTA side agreements created trilateral commissions on both labour and the environment, but their powers are extremely limited. None the less, continental economic integration does have political dimensions and implications. Two chapters look at the implications of economic integration for domestic politics - chapter 7, state-society relations, and chapter 8, federal-provincial relations. Chapter 9 addresses the implications for Canada's capacity for distinctive policy choice. Challenges to State-Society Relations Laura Macdonald (chapter 7) examines the effects of integration on relations between the government and various aspects of society. She argues that the manner in which the FTA was negotiated privileged the business sector, at the expense of others. The consultative mechanisms, particularly the Sectoral Advisory Groups on International Trade (SAGITs), were 'heavily weighted toward business involvement/ However, labour unions, which were invited, declined to participate. Macdonald is critical of this mode of consultation in principle and on instrumental grounds. Past, restrictive structures of consultation are inconsistent with modern 'inclusionary and democratic norms of decision-making.' A powerful 'popular sector' has emerged, which it is no longer politically practical to ignore. The FTA itself seems to have

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fomented political forces that necessitate revisions to the process of domestic consultation on such agreements. Macdonald defines this popular sector as a diverse array of 'non-elite groups ranging from trade unions, women's groups, social agencies, Native peoples, and farmers to the churches/13 She argues for the more 'multi-stakeholder' style of consultation that has characterized various aspects of Canadian domestic policy, and points to models from international environmental agreements. Federalism Chapter 8, by Rocher and Rouillard, analyses the impact of continental integration on federal-provincial relations in Canada. It surveys the literature, most of which argues that integration will make the federal government less relevant. Some policy options are stripped away by trade agreements, others shift to supranational institutions. Many supporting functions transfer to local or regional governments, leaving Ottawa with fewer functions. Thomas Courchene has referred to this process as 'glocalization.'14 Rocher and Rouillard take issue with this dominant view. They claim that the harmonization of policy that, they assume, inevitably follows integration is inimical to the very essence of federalism. "The emphasis on economic efficiency, which includes a harmonization and homogenization of fiscal/budgetary policies, and indeed of the larger socio-economic environment, is antithetical to federalism, which, by definition, is conducive to deep diversity and to the recognition of regional and provincial distinctiveness.' Their assumption that integration inevitably produces harmonization is challenged by evidence from several of the other chapters in this volume. Policy Autonomy Will closer economic ties with the United States reduce Canada's capacity to adopt policies that reflect distinctive national preferences? Hoberg, Banting, and Simeon (chapter 9) emphasize the distinction between policy convergence - the process of policies across countries become increasingly alike - and the effects of international integration. The chapter identifies four major forces behind convergence: parallel domestic pressures, emulation, international legal constraints, and international economic integration. Convergence is not necessarily

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a manifestation of constraints emerging from the international economic environment. Unfortunately, these distinctions are not clear-cut, with the most troubling potential link being that between the Canadian and U.S. cultural spheres. Parallel domestic pressures may in fact be the result of some more subtle process of American influence on Canadian values. These convergent forces meet with countervailing pressures from divergent forces: distinctive national values, different political institutions, and the legacy of past policies. What is the net effect of the convergent and divergent forces? The impact of international factors varies among policy sectors. In some areas, Canada has entered into international agreements that eliminate its ability to use particular policy tools, in exchange for their conferring benefits such as market access. This affects certain sectors - for example, industrial development and magazines - but leaves others unaffected. With international integration, constraints Vary significantly from sector to sector, depending on the mobility of the factors of production that the policy is seeking to influence.' The chapter examines the degree of Canadian-U.S. policy convergence in social and environmental policy. Canada has been able to maintain distinctive social programs: on balance, they are more generous and have been more effective at reducing inequalities. These differences result from differences in values and institutions and from lack of labour mobility across the border. Environmental policy reveals more convergence and more constraint. Relatively strong U.S. environmental protection has reduced some of the downward pressures on standard. In some cases, pressure from south of the border has actually helped raise Canadian standards. Other chapters in the book address policy autonomy in various policy sectors. Perhaps the sector most constrained by economic integration has been cultural policy. But even there, Gagne (chapter 6) argues that the Canadian government still has powerful instruments at its disposal. Kneebone (chapter 3) assesses Canada's ability to forge its own social, fiscal, and monetary policies. He shows that Canada still has considerable autonomy, even in areas such as macroeconomic policy, where one would expect it to be most constrained. The integration of capital markets clearly places limits on any country's macroeconomic policy. In what Obstfeld refers to as the 'open-economy trilemma,' a nation must choose two of the following three options: a fixed

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exchange rate, open capital markets, or the ability to use monetary policy for domestic objectives.15 Within these constraints, however, it still has room to manoeuvre. In recent decades, Canada has chosen open capital markets and allowed its exchange rate to float, permitting macroeconomic policy to pursue domestic objectives such as fighting inflation. I address below the question of whether Canada should continue to float its exchange rate. Economic integration does seem to have increased the pressure to reduce deficits and debts. Kneebone argues that it does not prevent governments from borrowing, but just necessitates that they do so responsibly. For social policy, it may increase the resistance of Canada's 'have' provinces to continuing equalization payments. In monetary policy, Canada has chosen an inflation target different from the United States, and has achieved lower inflation. The interest-rate premium that Canada paid from 1975 to 1996 was reversed in 1996, partly because of the monetary discipline imposed by the Bank of Canada and the growing fiscal restraint of Canadian governments. Gomez and Gunderson (chapter 4) also explore the potential feedback between economic integration and labour market policies. They examine the prospect that capital mobility might pose pressures to reduce costly labour market policies and regulations. Despite a number of countervailing forces, they find reason to believe that the net effect is pressure towards downward harmonization. However, there is no empirical research yet, and the authors have seen 'remarkably little evidence' on how labour market regulations 'influence decisions on investment and plant locations.'16 Hoberg, Banting, and Simeon (chapter 9) also report results from new, broader cross-national research on the links between economic integration and policy autonomy. The research tends to downplay the threat that globalization poses to countries' ability to forge distinctive policies. One would expect to see the most direct impact on corporate taxes. In a world of high capital mobility, any country that increased taxes on capital would presumably see capital flee, leading to a 'race to the bottom.' Remarkably, the evidence shows just the reverse. Over the last several decades, corporate tax rates across OECD countries have actually diverged somewhat.17 In social spending, not only has globalization failed to produce a 'race to the bottom,' but there is actually a positive correlation between openness to trade and the size of the public sector.18 Studies of OECD countries have not detected a statistically significant link between social spending and several crucial indicators

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of international economic integration: imports from low-wage countries, the amount of foreign direct investment, and mobility of financial capital.19 One study closely examines the intensive integration among the Benelux countries and Germany. It shows divergence in tax structures as integration advanced and confirms that the smaller countries were able to create and maintain a far more expansive welfare state. The study finds 'no reason why economic convergence by itself should force Canada to the mode of lower taxes and reduced public spending preferred by the United States.'20 Cross-national quantitative studies do reveal some clear constraints related to economic integration. Governments cannot so easily run budget deficits: those that do so pay interest-rate premiums.21 A recent finding in an unpublished study raises special concerns for Canada. Levels of social spending and levels of trade dependence are positively correlated, but greater trade dependence has a statistically significant link with lower social spending.22 Given Canada's increase in trade openness over the past decade, this area of research is worthy of careful attention. The preponderance of evidence, however, challenges the constraints of integration on domestic policy capacities. There is still significant room to manoeuvre. As chapter 9 concludes, 'The biggest constraint on Canada's ability to maintain a distinctive welfare state is not globalization or Americanization but the willingness of the Canadian people to pay taxes to support it.' Research and Policy Implications The chapters in this volume identify a number of areas where more research is essential to understanding the implications of Canada's relations with the United States. • Chapter 2 reveals the remarkable persistence of a 'home bias' in trade; the causes and consequences of this phenomenon need to be better understood. • The productivity issue, linked to North American integration through its implications for trade flows and macroeconomic performance, has perplexed both economists and policy-makers and should receive high priority in research. • The material in the volume on both labour (chapter 4) and environ-

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mental policy (chapter 9) reveal that we know remarkably little about the determinants of plant location in Canada - a vital ingredient in possible constraints on regulation posed by 'footloose' capital. • We know surprisingly little about the effects of integration on basic infrastructure, such as transportation and energy. • Chapter 7 calls for a new model for consultation on international agreements. Assessing the experience of other countries and other areas of international collaboration would be extremely valuable. Canada has challenging choices ahead. The momentum is certainly in the direction of increasing rather than decreasing international economic integration, despite resistance in the U.S. Congress. The Free Trade Area of the Americas is under negotiation, and another round of WTO revisions is beginning. Given the geography of trade, it seems unlikely that, even if these agreements go forward, the close integration of the Canadian and U.S. economies is likely to change in any fundamental way. Some commentators have argued that it would be desirable to intensify integration by having Canada abandon its floating exchange rate, as proposed by Thomas Courchene and Richard Harris.23 This move would involve Canada's surrendering a valuable policy instrument; would the benefits gained outweigh the loss to sovereignty, in both economic and political terms? Chapter 3 weighs some of these costs and benefits. It concludes that nothing in the evidence about the costs of exchange-rate volatility or about Canadian productivity appears to warrant such a momentous change. Another major controversy relates to marginal rates of personal income tax, which have been linked to the 'brain drain.' The migration of skilled, high-income personnel is a crucial issue, not just because Canada may be losing too many of them, but because the dynamic may put pressure on government to reduce the higher taxes that fund Canada's more generous social programs. Chapter 5 maintains that the available evidence does not justify 'changes to taxes and expenditures that do not otherwise pass the tests of economic and political logic.' This major issue needs to be monitored carefully. While this volume has emphasized Canada's room to manoeuvre, Canada cannot afford to be complacent. International relations have always involved complex and delicate choices between potential gains from agreements and losses in autonomy. To maximize opportunities and minimize risks, Canada must recognize that international con-

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straints, like the economic concept of comparative advantage, are not so much fixed, or given, but variables. This insight allows us to ask what steps citizens and governments can take to maximize their degrees of freedom - their capacity to make and implement autonomous policy choices. Steps that this task might require Canada to make include: • minimizing its vulnerability to international capital markets, as it has done and is doing by eliminating deficits and reducing public debt • using its influence in international forums not only to pursue its global goals but also to ensure that the rules do not impose unnecessary constraints on domestic policy • exploring new policy instruments and exploiting existing ones to minimize constraints • maintaining and enhancing its domestic capacity for autonomous policy debate and policy analysis, so that when it borrows or emulates, it does so on its own terms and in accord with its own values • enhancing the openness, transparency, and quality of government participation in international forums • enhancing intergovernmental co-operation, so that Canada can speak with one voice abroad, present unified domestic resistance to international forces, and make policy more effectively24 The consequences of continental integration have not been as formidable as many people believed. While Canada has surrendered some policy instruments in exchange for access to larger markets and pressures for harmonization have probably increased, it still retains significant room to manoeuvre, even in areas of policy most affected by integration. We should not be deceived by the illusion of false necessity. NOTES

1 John Helliwell, How Much Do National Borders Matter? (Washington, DC: Brookings Institution, 1998). 2 Paul Krugman, Geography and Trade (Cambridge, Mass.: MIT Press, 1991), 2, as cited in chapter 4, above. 3 Gary C. Hufbauer and Jeffrey J. Schott, 'North American Economic Integra-

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4

5

6

7 8

9

10 11

12

tion: 25 Years Backward and Forward/ Paper No. 3, Canada in the 21st Century, Industry Canada Research Publications, Nov. 1998,14. There is evidence that the gap in unemployment is overstated because the two countries count 'passive' job-seekers differently. One estimate is that this difference explained 17 per cent of the gap. See Craig Riddell and Andrew Sharpe, 'The Canada-U.S. Unemployment Rate Gap: An Introduction and Overview/ Canadian Public Policy 24 (Supplement, Feb. 1998), SlS37. For a clear summary, see Andrew Sharpe, 'New Estimates of Manufacturing Productivity Growth for Canada and the United States/ Centre for the Study of Living Standards, Ottawa, 13 April 1999. For a recent study suggesting that productivity growth has been significantly better in Canada than in the United States since implementation of the FTA, see Daniel Trefler, The Long and the Short of the Canada-U.S. Free Trade Agreement/ paper prepared for the Micro-Economic Policy Analysis Division, Industry Canada, 21 June 1999. John McCallum, Two Cheers for the FTA: Tenth-Year-Review of the Canada-US Free Trade Agreement/ Royal Bank of Canada, Economics Department, presented at the Conference on Free Trade at 10, McGill University, Montreal, 4-5 June 1999,8. Trefler, The Long and the Short.' There is dispute over the relative importance of trade liberalization and 'skill-biased technical change' in promoting this inequality. For two recent surveys of the literature, see Susan Collins, 'Economic Integration and the American Worker: An Overview/ in Susan Collins, ed., Imports, Exports, and the American Worker (Washington, DC: Brookings Institution Press, 1998); and William R. Cline, Trade and Income Distribution/ International Economics Policy Briefs, No 99-7, Institute for International Economics, Sept. 1999. Eugene Beaulieu, The Canada-U.S. Free Trade Agreement and Labour Market Adjustment in Canada/ Canadian Journal of Economics 33, no. 2 (May 2000), 108-36. For an overview of the debate, see the various articles in the September 1999 issue of Policy Options. Don DeVoretz and Samuel Laryea, Canadian Human Capital Transfers: The United States and Beyond, Commentary 115 (Toronto: C.D. Howe Institute, 1998). Mahmood Iqbal, 'Are We Losing Our Minds? Trends, Determinants, and the Role of Taxation in the Brain Drain to the United States/ Ottawa: Conference Board of Canada, July 1999.

Conclusion: Capacity for Choice 313 13 For more detail on the emergence and role of this popular sector, see Ayres, Defying Conventional Wisdom. 14 Thomas Courchene and Colin Temler, From Heartland to North American Region State: The Social, Fiscal and Federal Evolution of Ontario (Toronto: Centre for Public Management, University of Toronto, 1998). 15 Maurice Obstfeld, 'The Global Capital Market: Benefactor or Menace?' Journal of Economic Perspectives 12, no. 4 (fall 1998), 9-30. 16 For studies on the determinants of U.S. plant location, see Arik Levinson, 'Environmental Regulations and Manufacturers' Location Choices: Evidence from the Census of Manufactures/ Journal of Public Economics 61, no. 1 (1996); and Robert Crandall, Manufacturing on the Move (Washington, DC: Brookings Institution Press, 1993). 17 Geoffrey Garrett, 'Global Markets and National Politics: Collision Course or Virtuous Circle?' International Organization 52 (autumn 1998), 787-824; Nancy Olewiler, 'National Tax Policy for an International Economy: Divergence in a Converging World?' paper delivered at the conference 'Room to Manoeuvre? Globalization and Policy Divergence,' Queen's University, Kingston, Ont., 1998. 18 Garrett, 'Global Markets'; Duane Swank, 'Funding the Welfare State/ Political Studies 46 (1998): 672-92; Dana Rodrik, Has International Economic Integration Gone too Far? (Washington, DC: Institute for International Economics, 1997). 19 Geoffrey Garrett and Deborah Mitchell, 'Globalization and the Welfare State/ unpublished manuscript, July 1999, available at http://pantheon. yale.edu / ~gmg8 / research. 20 Hufbauer and Schott, 'North American Economic Integration.' 21 Garrett, 'Global Markets.' 22 Garrett and Mitchell, 'Globalization.' 23 The options range from pegging the Canadian dollar to the U.S. dollar, through adopting the U.S. dollar as the official Canadian currency, to creating a new 'North American Monetary Union.' Thomas Courchene and Richard Harris, 'From Fixing to Monetary Union: Options for North American Currency Integration' (Toronto: C.D. Howe Institute, June 1999). 24 I am indebted to my colleagues Keith Banting and, especially, Richard Simeon for their assistance in formulating these strategies.

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