Is America bringing us down?

The U.S. is an anchor around Canada's neck, but our best bet might be to grasp it even tighter.

Canada’s economy should be blazing by now. The country this year recouped nearly all the jobs lost during the recession, saw hikes in consumer spending and business investment and had some of the best economic growth in the industrialized world. Things would be going gangbusters, if not for those damn Yankees.

Canada currently finds itself tethered by its southern border to an economic anchor. The United States still grapples with near double-digit unemployment rates, surging foreclosures and sputtering consumer spending. America’s travails slashed Canada’s export market and blocked the chance for “an absolutely rip-roaring recovery,” according to Douglas Porter, deputy chief economist with BMO Capital Markets.

Canada’s largest trading partner is dragging it down. But the United States’ economic woes don’t just mean a weak market for Canadian goods. The dismal outlook has inflamed America’s protectionist tendencies. It took more than a year for Canada to negotiate a waiver of the “Buy American” provisions contained in America’s $787-billion stimulus package. Less than a month after that dispute was resolved, 28 members of Congress introduced a bill calling for the scrapping of the North American Free Trade Agreement. The situation is so worrisome that the Canadian Council of Chief Executives has enlisted Gordon Giffin, the former U.S. ambassador to Ottawa, as its envoy in Washington. The message from the U.S. is clear: Americans can’t afford our goods right now. Even if they could, they’d rather buy American.

“It’s that feeling of—I hate to say ‘attacked’—but that the United States has to look inward for solutions,” says Birgit Matthiesen, a Washington-based adviser to the Canadian Manufacturers and Exporters (CME).

As America pulls up its drawbridge, it seems an ideal time for Canada to pursue other trading partners. Everyone knows that emerging markets like India, China and Brazil are where the future lies anyway, right? But for Canada, the inescapable fact is 73% of our exported goods go to America. Canada’s annual trade with India represents less than two days of trade with the United States. Trade with the European Union, Canada’s second-largest trading partner, is one-ninth of what crosses the U.S. border. Diversification is a good idea, but it doesn’t offer a real alternative to the American market. “Nothing can replace our trading relationship with the United States,” says Peter Van Loan, the federal minister of trade. “Growth in other places is a plus, but an American economic recovery is very, very important for Canada.”

Canada’s interests lie not in divorcing the United States but in wooing it again. There are still too many regulatory differences, too little policy collaboration and too few champions of trade liberalization, business leaders say. Canada can’t cut away the millstone around its neck; it needs to hug it even closer.

This summer, it was nearly impossible to find a story on Canada’s economic performance that didn’t note the United States’ insidious downward drag. From commodity prices to manufacturing sales to currency trading, America’s woes were constantly cited as Canada’s biggest obstacle to full recovery. In many respects, the current situation mirrors the recessions of the mid-’70s and of a decade ago, when Canada’s economic downturn was far milder than America’s. In other cases, notably the early ’80s and ’90s, the Canuck recession was far worse than in the United States. “There is no official recession playbook,” says Porter. But exports to the United States represent 25% of Canada’s GDP. Only 2.2% of American economic activity is linked to Canada. Americans don’t tend to notice when Canada stumbles; when the U.S. tumbles, Canadians are yanked down as well. Consider that Canadian exports to the United States have fallen by 2.2% in the past nine months alone. In December 2008, Canada exported $6.1-billion more goods to the United States than it imported. The surplus has narrowed by nearly $5 billion in less than two years, sitting at just $1.2 billion this July. In the same month, manufacturing sales overall fell 0.9%, while motor vehicle and paper sales, both heavily dependent on the U.S. economy, fell 8% and 5.5% respectively. America’s floundering also kept oil at roughly half of its pre-recession price. It is only thanks to strong domestic demand that Canada has managed to keep grinding upward. “Most of us are very pleased at the extent we’ve managed to keep soldiering along, given the extent of the U.S. recession,” says Van Loan. But as Canada has marched forward, America has found new ways, some intended, most accidental, to trip its neighbours up.

America’s protectionist leanings—and Canada’s frustrations with them—can be traced to the earliest days of the countries’ shared history. In 1878, John A. Macdonald, Canada’s first prime minister, was angered by the United States’ refusal to negotiate a reciprocal trade agreement. He decided Canada needed to impose higher tariffs of its own. “It is only by closing our doors and by cutting them out of our markets, that they will open theirs to us,” he argued. For nearly a century thereafter, pushing for more liberal trade was an unpopular idea. Robert Borden won the 1911 federal election largely thanks to his opposition of a reciprocity agreement with the United States. “That issue of free trade was settled in the election of 1911,” Brian Mulroney said while running for the leadership of the Progressive Conservatives in 1983. “It affects Canadian sovereignty and we will have none of it,” he added. Of course, Mulroney later became Canada’s great champion of trade liberalization. Worried about rising protectionism in the United States and buoyed by the 1985 Royal Commission recommending liberalization, Mulroney signed the free trade agreement in 1988. The North America Free Trade Agreement (NAFTA) followed in 1994, adding Mexico to the trading bloc. Between 1988 and 2000, Canadian exports to the United States multiplied 3.5 times, from $100 billion to $360 billion. Between 2000 and 2002, Americans consumed 87% of Canadian exports. If free trade seemed a success from a Canadian standpoint, it still had opponents south of the border. Roy MacLaren, who served as trade minister between 1993 and 1996, says his efforts to add Chile to NAFTA were rebuffed by the Clinton administration. “They couldn’t get any more trade liberalization through Congress,” he recalls. “That ended any further trade liberalization. Or, put another way, affirmed a degree of protectionism.”

John Manley, a former foreign-affairs minister who now leads the Canadian Council of Chief Executives, says it took the personal advocacy of Clinton and George H. W. Bush to push NAFTA through the American system. “When have we seen that kind of bipartisan approach, believing that liberalized trade is in the interest of the United States? Not since,” he says. “The conversation in the States is a lot more protectionist, and people who speak up against protectionism are less mainstream. And that’s got to be bad for us.”

The rebuilding of Fortress America began with 9/11 terrorist attacks. New security provisions had an immediate effect on Canadian exports. Between 2002 and 2008, merchandise exports to the U.S. fell by nearly 20%. Increased security at the border hiked exporting costs by as much as 15%.

The costs of regulatory compliance for many Canadian companies now exceed the benefits of free trade, according to the CME’s Matthiesen. While border security remains a top priority in the United States, the motivating factor has changed. “In the first few years after 2001, the U.S. response on border management was in response to physical security,” Matthiesen says. “In today’s climate, it’s economic security.”

Evidence of economic turmoil feeding protectionist sentiment is plentiful and varied. Bill White, the Democratic candidate in the Texas gubernatorial race, has released attack ads accusing incumbent Rick Perry of wanting to bulldoze a half million acres of private land and “give it to a Spanish company to build toll roads and let the company set the tolls.” Meanwhile, India’s information technology industry was outraged last month by a U.S. Senate bill that would hike visa application fees for companies that employed 50 or more skilled foreign workers. In an isolationist one-two punch, the proceeds of the visa fees would be used to finance aerial drones and more enforcement agents for the U.S.-Mexico border. “The flares of protectionism reflect both the economic and political environment,” says Matthiesen. “There is that sense in the U.S. that, for the first time in two generations, my future is not as bright as my parents’ future.”

And that sense of financial uncertainty has affected far more than just America’s monetary health. Arizona this spring passed laws making it a crime not to carry immigration documents. Half of Americans now think immigrants are a burden on their country, according to a survey conducted by the Pew Research Center in June. Only 40% of respondents held that view in November 2009, while the percentage of people who feel immigrants strengthen the country has correspondingly dropped to 39% in June compared with 46% eight months earlier. Even the protests against a mosque near the Ground Zero site in New York have their roots as much in economic uncertainty as they do in the aftershocks of the 2001 terrorist attacks, argues Robert Reich, who served as labour secretary under Bill Clinton.

“Ever wonder why the nation is turning isolationist and xenophobic?” he wrote in a recent blog post, adding later, “The practical choice we face is this: either major action to reverse the jobs emergency or years of intolerably high unemployment coupled with demagoguery and scapegoating.”

To be charitable to the United States, other countries have similarly tilted toward protectionism over the past three years. Close to 650 discriminatory trade measures were imposed by governments worldwide in the nine-month period between the 2009 G20 summit in Pittsburgh and the organization’s meeting in Toronto this summer, according to Global Trade Alert (GTA), an independent research group based in London. The group’s research suggests China’s decision to offer tax rebates for exports ranging from steel to clothing represented the single largest protectionist measure undertaken during the recession, with a total trade value of $412 billion. Placing second on the list were the Buy American provisions in the U.S. bailout package, with a total value of $337 billion. Canada fared well in the GTA report, which concluded the country created seven measures that discriminate against other nations’ commercial interests since November 2008, compared with 19 imposed by China and 213 from the United States. But even Canada is accused of guarding its interests too closely. Japan recently complained to the World Trade Organization that Ontario’s subsidies for green energy projects favour domestic companies.

The cumulative effect of the various tariffs and other measures imposed during the recession remains a contested point. The World Trade Organization says the new measures will affect less than one-half of one percent of global imports; research conducted by the GTA calculated far greater damage, arguing just the world’s 22 largest trade measures affected 10% of global imports in 2008. Regardless of the actual figure, some say it is remarkable that more protectionist measures were not implemented, given the depth and breadth of the recession. The world appears to have learned a lesson from the Great Depression, when retaliation against high U.S. tariffs eventually cut the country’s exports in half. Even the United States has offered far more rhetoric than actual restrictions, says Porter. “I’m mildly encouraged that we didn’t get even more protectionist pressures, given the depth of the U.S. recession. It could have been worse.”

But even if U.S. trade restrictions failed to fulfill worst-case scenarios, there are still myriad reasons for concern. TransCanada, a Calgary-based energy company, has faced protracted union negotiations and regulatory challenges over its plans to expand an existing pipeline from Montana to Texas. U.S. lawmakers are once again targeting Alberta’s oilsands. Gary Doer, Canada’s ambassador to the United States, this month sent a letter to Congress, warning proposed legislation requiring all import companies to have a U.S. representative will have the “unintended consequences of unduly burdening our bilateral trade.”

In the case of the legislation targeted by Doer, the goal is to ensure companies that make shoddy goods can be served with legal papers. Pitched as consumer-protection measure, the proposed measure stems from the public outcry over hundreds of cases of defective Chinese drywall causing property damage, illness and even death. But in trying to achieve a legitimate public policy goal, U.S. lawmakers may inadvertently burden Canadian businesses with yet another layer of bureaucracy. Canada regularly finds itself contesting protectionist measures aimed at other nations, according to Van Loan. “Congressmen and senators always say the same thing to me: ‘Well, that’s not aimed at Canada,” he told an audience earlier this month at the Toronto Board of Trade. “I have to answer to them: ‘Well, your aim is kind of lousy.'”

Van Loan says the “residue” of the free-trade debate made previous governments unwilling to pursue free-trade agreements, with only three deals—with Chile, Israel and Costa Rica—signed between 1994 and 2008. But in the past two years, Canada had struck agreements with Colombia, Peru, Jordan and Panama. There is also a deal with the trade association composed of Iceland, Liechtenstein, Norway and Sweden. And agreements are pending with countries from the Dominican Republic to the Ukraine. “We’ve stepped up aggressively,” Van Loan told the Board of Trade crowd, noting Canada was also the first G20 country to eliminate tariffs on manufacturing equipment, machinery and other inputs. Achieving free trade with Liechtenstein, which has a population slightly larger than Moose Jaw, will have little effect on Canada’s economy. But Canada has been quietly negotiating a free-trade agreement with the European Union, its second-largest trading partner, which could mean a $12-billion boost to the Canadian economy, according to government projections. With a fifth round of negotiations scheduled for next month, plans called for the agreement to be signed by the end of 2011. Preliminary discussions are also underway on a trade agreement with India, which could similarly prove a major boon for Canadian exporters. “We want more trade with Europe, which is a rich market, and Asia, which is a high-growth market,” says Glen Hodgson, chief economist with the Conference Board of Canada. The goal of these trade talks is to “add to the U.S. market—not replace, not substitute—by seeking opportunities elsewhere,” according to MacLaren, who now serves as Canadian chairman of the Canada Europe Roundtable for Business. Even as Van Loan boasted of his government’s achievements, he conceded the American market still dwarfs all others. “We do want to expand, but we have to be realistic,” he told his audience. “A tiny, tiny amount of growth with the United States represents a huge benefit to us. And a tiny bit of shrinkage has a huge negative impact.”

Tiny improvements may be all Canadians can hope for in their trading relationship with the States, where the Buy American rhetoric will likely continue past the mid-term elections in November. “‘Trade’ is a four-letter word in the United States,” says Matthiesen. “Buy American is going to continue to be with us. It has attracted a lot of political appetite. It is something that is easily understood at the constituent level and equally hard to argue or debate in an environment where unemployment hovers in the double digits.”

There is an undeniable case to be made that U.S. protectionism hurts American workers just as much as it does Canadians, in several ways. To begin with, supply chains now flow across international boundaries, making it difficult to determine the homeland of any particular product. As a recent Conference Board reported noted, RIM’s BlackBerry is made using components from across Asia, Europe and the United States and then assembled in Hungary and Mexico. “The old paradigm was that one country makes something and sends it to another country, and that’s an export,” says Manley. “It still happens, but increasingly you’re really talking supply chains and interconnecting design, manufacture, sales and marketing operations.”

Equally troublesome for the United States is the fact that protectionism begets protectionism. A study conducted by the Peterson Institute for International Economics, a Washington think-tank, suggested the Buy American provisions in the U.S. stimulus bill would create roughly 9,000 jobs but could cost between 6,500 and 65,000 jobs if America’s largest trading partners retaliated. “There is little bang for the buck,” the report said. “The Buy American provisions could well cost jobs if other countries emulate U.S. policies.”

Observers warn any further protectionist measures will damage President Barack Obama’s efforts to double U.S. exports within the next five years, creating two million jobs in the process.

But convincing Americans that protectionism doesn’t really protect them is a tricky mission for Canadians. For one thing, it would require the U.S. to actually pay attention to its milquetoast northern neighbour. “The problem for us is always getting on to the U.S. agenda,” says Manley. “It’s a complicated political system, and there are a lot of actors. And we don’t usually matter to very many of them.”

Hiring Gordon Giffin, who was born in Massachusetts but raised in Toronto and Montreal, represents Manley’s effort to bring Canadian concerns to the attention of American lawmakers. Manley argues trade liberalization efforts need a “champion,” like Reagan or Clinton, in Washington to succeed. “You don’t see or hear many champions for liberalized trade,” Manley says. “We want to gain better access in Washington, to the U.S. business community, build allies and see if we can devise a plan around what we can do.”

For the moment, any plan will likely be incremental rather than revolutionary. For example, 95% of the safety regulations in Canada and the United States are identical. But differences remain. Air bags are not mandatory in Canada but are required in the United States; the opposite is true of daytime running lights. Addressing small issues like these could mean significant benefits for Canadian manufacturers. “If you reduced some of the regulatory barriers, it would reduce costs for exporters,” says Hodgson. “You can maintain the same levels of trade and your profits would go up.”

Such small steps are unlikely to ignite nationalist passions on either side of the border. As Matthiesen says, “Regulatory collaboration is not sexy.” But there are some optimists who envision trade reforms that might make an exporter’s heart rate quicken. When they allow themselves to daydream, proponents of trade liberalization envision joint green energy programs between Canada and the United States, and the creation of a “regional secure space,” where cargo could move between countries without inspection. Regardless of what the next big idea actually is, it will likely come from Canada. America does not have enough invested in the relationship to spend its time fussing over ways to improve it. “As the junior partner, it is incumbent upon us to keep going to the U.S. with offers,” says Hodgson.

In separate interviews on different days, both Manley and Van Loan said they expected America will remain Canada’s top trading partner for the rest of their lives. The rhetorical coincidence emphasized how long-term Canada’s thinking about the relationship must be. The United States economy is currently a drag on Canada; its policies decidedly protectionist. But by geographic imperative, the relationship will far outlast the few years of an economic downturn. “We’re not floating in the middle of the Pacific Ocean,” says Manley. “We’re joined at the hip with the United States.” Canada can dream of rich new trade with distant lands, but our future remains linked to the United States. If not by choice, than by the imperative of geography.