Ottawa should refocus on Canada’s largest trading partner

Prime Minister Trudeau’s participation in the recent G20 summit in India, which made headlines due to the prime minister’s travel woes, was meant in part to advance the Canadian government’s new Indo-Pacific Strategy (IPS). The IPS initiative aims, among other things, to encourage increased Canadian exports to non-U.S.-based importers, particularly those in emerging markets in Asia such as India and Indonesia, and developed economies such as Japan and Korea.

And yet, despite a long-standing government commitment to reduce Canada’s trade dependence on the United States, which has seen Canada enter multiple trade agreements with Asian and European Union countries, the importance of the U.S. in Canada’s international trade has barely changed over decades. By way of illustration, 75 per cent of Canada’s merchandise exports went to the U.S. in 1990, one year after implementation of the Canada-U.S. Free Trade Agreement, compared to 75 per cent (the exact same percentage) over the period 2017-2020.

The continuing dominance of the U.S. in Canada’s international merchandise trade flows reflects, in part, the important influence of physical distance on geographical trade patterns. The bulk of international trade in goods around the world is primarily intra-regional, and intra-regional trade is becoming even more prominent in the post-COVID period, as companies seek to shorten their supply chains geographically.

The U.S. is also Canada’s dominant partner in services trade. Over the period 2017-2021, approximately 53 per cent of Canada’s services exports, primarily commercial services, went to the U.S. market, down slightly from around 54 per cent over the period 2012-2017. In the case of services, differences in language, legal and regulatory institutions and business practises discourage trade flows between countries. Such differences can contribute to greater “cultural distance,” which is often exacerbated by physical distance.

The importance of physical and cultural distance as determinants of geographical trade patterns underscores the challenges that Canadian-based businesses face in diversifying their exports away from U.S. customers to those in the Indo-Pacific region. In addition, successful exporting to countries in the Indo-Pacific region will likely require Canadian-based companies to integrate into regional supply chains currently dominated by Chinese companies, particularly in the electric vehicle (EV) and components sector, which is a priority IPS export target. The fraught political relationship between Canada and China, and concerns on the part of Canada’s western allies about tighter business linkages with Chinese companies in activities affecting national security, make closer integration into Asia-based supply chains by Canadian businesses problematic for the foreseeable future.

At the same time, the recent and serious escalation of political tensions between Canada and India, pursuant to the Trudeau government’s claim that agents of India’s government assassinated a Canadian citizen on Canadian soil, compromises the likely success of a trade strategy built on an assumption that India is a major market for Canadian exports, thereby reducing the importance of closer economic ties with China.

To be sure, exporting liquified natural gas (LNG) to Asia is a major opportunity for Canada. Unfortunately, Canada has lagged behind other countries (particularly the U.S., Australia and Mexico) in approving and constructing LNG export facilities. Canada’s first LNG export facility being built near Kitimat, B.C. will only come online in 2025. Furthermore, the Trudeau government’s ambivalence to exporting carbon fuels further frustrates the ability of Canadian natural gas producers to sign long-term supply contracts with buyers in the Indo-Pacific region.

So why reduce Canada’s trade dependance on the U.S.?

One argument is that it would reduce the economic and political influence the U.S. exerts in the bilateral relationship. But recent experience suggests that China would leverage closer economic ties to Canada on issues affecting China’s national interests. Another rationale is that the economies of developing countries in the Indo-Pacific region will grow faster than the U.S. economy going forward, so that profitable export opportunities will be increasingly abundant in the Indo-Pacific region compared to the U.S. However, this perspective overlooks the potential for a major expansion of Canada’s services exports tied to the digitalization of services in areas such as health care, finance and entertainment. The online delivery of services will only become more prominent with the roll-out of AI platforms.

Finally, the potential market in the U.S. for Canadian services exports dwarfs those in Indo-Pacific countries. For example, the size of the U.S. service sector was US$18.2 trillion in 2021 compared to US$1.3 trillion in India. Expanding bilateral trade liberalization in the service sector will require agreement between the Canada and the U.S. on sensitive issues such as taxation of digital advertising, privacy protection and protection of domestic suppliers of news and other content, among other things. However, with the Canada-U.S.-Mexico trade agreement scheduled for trilateral review in 2026, the federal government should refocus attention on its trade relationship with its largest trading partner.