Let the trade wars begin, umm, sorta
It has been a volatile week as the on again, off again, on again, but with some carve outs, off again, but only for a month, on again shenanigans of the U.S.-induced global trade war took effect. While Canada’s response has generally been to retaliate for these tariffs in a tit for tat fashion, we would view it as more of an opportunity. For far too long, Canada has been falling behind not only the U.S., but the rest of the world. With the U.S. no longer playing by the same set of rules, the time is ripe for an enormous pivot on the part of Canada and its leaders. Rather than focusing on the tit for tat, we would propose something far more productive.
Let’s start with a chart and then comment:
If one were truly concerned about global trade, one might focus on China, which since it joined the WTO in 2001, has seen its share of global manufacturing go from less than 10% to ~35%. Canada, on the other hand, has seen its manufacturing base go the other direction to the point where Canada’s manufacturing share of GDP is now the lowest in the G7:
Now, there is an economic concept called “Comparative Advantage”, which basically looks at a country’s ability to produce something at a lower opportunity cost than its trading partners. There would be a lot of factors that would go into this including the availability of labor, the cost of labor, the ability of labor, the availability of power, the cost of power, the cost of transportation, the ease of doing business and a myriad of other things. China for its part had access to very cheap labor and a lot of it, which enabled it to leverage its comparative advantage to a massive build-up in its industrial base.
Canada’s comparative advantage would lie in: 1) the ability of its labor – the population is well-educated; 2) the availability and cost of power (more on this in a moment); and 3) the cost of transportation – Canada sits next to the world’s largest economy. Let’s take a look first at the energy side:
Canada enjoys a massive comparative advantage over most of the G7 countries in terms of the cost of electricity and is roughly on par with China and India. This should, in theory, at the very least drive energy-intensive businesses to Canada, but there is no evidence in the data that this has been the case. In fact, ex-energy, Canada has run a trade deficit with the rest of the world since just before the Global Financial Crisis.
Now, a common argument has been - Canada’s push to be a global leader in environmentally friendly policy does not jibe with an expansive industrial base. While we laud these efforts, it ignores the fact that Canada has effectively exported much of its manufacturing base to countries that use electricity that is significantly dirtier than the electricity that would be used to produce the goods in Canada:
Canada ranks second only to France in terms of renewable energy share, while its fossil fuel productive electricity is almost entirely natural gas (i.e. a lot less dirty than coal and oil). In other words, while we can do a victory lap for lowering Canada’s carbon footprint, we have done so, in part, by essentially exporting the production to areas of the world that are going to produce the goods in a much less environmentally friendly manner. If we instead viewed it from a global carbon footprint perspective, it would likely make much more sense to push for as much industrial production as possible in Canada, even if it raised our own carbon footprint. Let’s now pivot to another chart and then comment:
While Canada ranks 23rd amongst all countries in terms of “Ease of Doing Business” (the U.S. ranks 6th), it ranks very poorly in terms accessing that clean energy it produces (124th) and construction permits (64th). In other words, we have the comparative advantage, but we are making no effort to utilize it.
What we would do: While we do not begrudge Canada responding to U.S. tariffs with tariffs of their own, we think and hope there is a much bigger picture opportunity here for Canada. With massive comparative advantages in certain areas and an economy that has largely stagnated for the better part of the last two decades, the time is ripe for a major pivot. As Winston Churchill once said (allegedly) – “never let a good crisis go to waste”.
What we are doing about it: We are generally defensively positioned, so we are not doing anything radical in the face of the current uncertainty. The underlying foundation of the U.S. economy remains strong – credit conditions are benign, consumer balance sheets are clean, corporate earnings growth is good – although, we acknowledge that the day-to-day reversals is not only exhausting, but also could begin to weigh on spending and investment. We have raised some cash in discretionary accounts and may do more depending on how the next several days and weeks play out.
