Canada is a trading nation

Author: | Published: 5 Sep 2017
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The Canadian economy is highly reliant on the free flow of goods, services, people and capital. One-in-three jobs in Canada relies on trade, and more than one-in-five Canadians were born outside of Canada – with an additional one-in-five with parents born outside of Canada. Over 80% of assets in Canada's eight largest public pension plans (all among the largest one hundred in the world) are in overseas investments.

Canada's current government has been particularly welcoming to refugees and supportive of free trade in a period of global uncertainty. However, being open isn't a new choice – it is who we have been, and who we need to continue to be to remain competitive in a land that is more physically isolated and less populated than most others.

Critical time for engagement

To put it simply, openness and the related concept of globalisation works for Canada. We also have strong evidence that it works for most across the world, with benefits such as increased price stability, reduced poverty and reduced propensity for military conflict.

However, we find ourselves in an unusual period where unconventional points of view are gaining traction. Even if populist movements crest, the impact of recent rhetoric is likely to have a long tail. In such a situation, engagement becomes more important than ever.

Engagement is particularly critical given the unprecedented era of opportunity we find ourselves in today, where three changes could have significant consequences:

  • The economic shift from developed markets to certain emerging markets is accelerating
  • Global trade flows are changing, driven by supply chain strategies
  • International commerce is becoming less about trade

Accelerating economic shift from developed to emerging markets

The shift from developed to emerging economies is no longer theoretical – it has happened and is accelerating. For example, in 2016, India led the GDP charge on a relative basis with real growth above 7%. Though higher growth rates from emerging economies aren't unusual, China more than doubled the US' contribution to global growth on an absolute basis. Absent a major correction, China will likely continue to lead growth globally, even if the US productively invests the enormous sums in infrastructure discussed during the election cycle and manages to achieve 3% real growth.

This pattern is broadly likely to accelerate, as the cost of incremental growth is lower in emerging economies than in developed economies. For example, many developed economies operate with high levels of consumer debt and full employment, requiring expensive and time-consuming innovation to grow. In contrast, emerging economies can often draw on a relatively unlevered and growing middle class, along with productivity opportunities from upgrading skill in the labour base and efficiently deploying capital.

However, not all emerging economies capitalise on this opportunity. Those that diversify beyond natural advantages, address structural issues, limit distractions and remain engaged in the international community have been most economically successful. Further, they may have developed competitive advantages and be well-positioned to export their capability to other growing economies. An instructive example is China's One Belt, One Road strategy, which aspires to leverage available Chinese capacity and world-class infrastructure development to modernise a vast region.

Engagement of this kind has benefits for both developed and emerging economies: the rewards for getting it right are significant, and the cost of getting it wrong could be dramatic – particularly during critical periods of change.

Global trade flows are changing, driven by supply chain strategies

Turning our attention to trade, in 2005 trade among developed economies was roughly double trade among emerging economies. In the decade to follow, almost half of the world's growth in international trade was among emerging markets. Today, trade among developed economies is roughly equal to trade among emerging economies, even despite a recent slowdown in trade in Asia.

Trade in emerging economies is often anchored with China. On the surface, China is becoming much less dependent on international trade; for example, in 2006, trade in China represented 65% of GDP, while today it is roughly 35%. Looking below the surface at evolving supply chain strategy provides a window into China's restructuring, and powerful clues to help understand the recent slowdown in within emerging market trade.

Exports from China were largely stable in 2015. However, imports were down considerably, a seeming contradiction given China's focus on domestic consumption. In fact, a key driver of the change is a diminished reliance on intermediates in Chinese exported products, falling from approximately 72% of exports in 2005 to 50% in 2015. In short, supply chains in China are becoming more vertically integrated, where hubs composed of firms collaborate to manufacture – localising the spillover benefits of exported product (somewhat in the tradition of the German Mittelstand). This is further enabled by an increase in automation technology that reduces the importance of low cost labour in nearby countries. Critics may argue that the way that intellectual property has been transferred into China may discount innovation; but to be a part of China's global growth drive, it is important for firms to either be embedded in the increasingly localised China supply chain, or produce goods and services geared for Chinese consumption.

Looking elsewhere, we see a different supply chain strategy of global integration. For example, in North America, car subassemblies could cross sovereign borders six times during their path to completing the final product. More dramatically, over forty large companies are involved in supplying the main components to the Boeing Dreamliner – a remarkable accomplishment resulting from global ideas and capabilities converging in the United States.

The prerequisite for such an approach is low friction coordination, involving intellectual property, manufacturing and assembly. Successes like the Dreamliner are precisely why it is important for policy makers to consider the context for trade in negotiating agreements. A bilateral approach to trade may encourage vertical integration and localise the benefits of commerce, while a multilateral approach may be better suited to support global supply chain integration for clearing house economies – lowering the price of imports, promoting exports and encouraging innovation.

As we see from the China example, shifting supply chain strategies over time is possible. That said, toggling between the two strategies can be expensive, and create unintended consequences.

International Commerce is about more than Cross-Border Trade

On a recent visit to Mexico to meet with companies with interests in Canada, we were often surprised to learn of how little of their business abroad requires goods and services to cross borders – providing insulation to potential disruptions to trade agreements. These Mexican companies refined global-leading capabilities and transplanted those capabilities to other geographies, like Canada. Their 'secret sauce' tended not to depend on supply chain strategy – it could be found in centralised functions like R&D, risk management and financing, and more distributed strategies such as porting tastes from other markets (or adapting to local tastes).

Similarly, we have seen and helped a variety of North American domiciled firms set up subsidiaries in China to access local demand. This is a considerable change from a decade ago, when the prevailing strategy employed by North American firms in China was to produce goods at low cost intended for export to developed markets. This new approach of accessing local demand in foreign markets goes both ways; recently, we saw a Chinese producer win a landmark bid to produce commuter trains in Montreal, beating out an iconic Canadian rail manufacturer with a long history of success in China. Further, to finance the project, that producer may rely on one of the many strong Chinese banks that have entered the Canadian market.

Though it doesn't show up in conventional trade statistics, nor FDI, Mexican companies pursuing local demand in Canada, Canadian companies pursuing opportunities in China and vice versa are examples of a growing form of international commerce. Success in this space is of critical importance for firms, banks and governments participating in the global marketplace in this unique time of opportunity – when old alliances are challenged, and new alliances are being formed.

Keys to success

Doing business internationally is complex and asks a great deal of firms – they need the confidence to take chances, the agility to adapt to local conditions, and the capability to execute. From setting up operating structures in foreign markets with regulatory complexities, to the daunting task of finding customers and suppliers, expanding overseas is complex and fraught with sharp objects. Similarly, with foreign entrants competing increasingly in domestic markets, and new distribution channels putting pressure on margins, it can be a challenging and complicated operating environment for many companies.

Financial institutions can go a long way to reducing complexity. Clients have told us that simplicity is at the core of what they need. They are looking for advice grounded in the competitive and regulatory conditions abroad that is tailored. Our experience is that a local presence is essential to being able to deliver customised insight. We've also learned from observing European banks accustomed to supporting mercantile clients that it is critical to offer services through a familiar interface in all markets – employees that are multilingual, systems that link services in the home market abroad, and an approach to financing in all markets that leverages the broader relationship.

Delivering these services is particularly challenging in a post global financial crisis era where the compliance expectations of financial intermediation have grown, increasing costs and operating restrictions, while helping to prevent money laundering, terrorist financing, and people trafficking. This environment reinforces that banks can't successfully be all things to all people, and certainly can't be all things to all people in all markets. Real and imagined borders that inhibit international commerce are strengthening, reinforcing the value of deep domestic expertise and presenting exciting opportunities for banks to leverage their respective strengths and partner in creative ways.

At BMO, we work with international banks in conventional ways, enabling the flow of funds and working together to finance trade. We have also been exploring more innovative arrangements, such as pilots we have run to connect aspiring exporters in North America with motivated buyers in foreign markets. Our clients want to diversify their client base and grow demand, and our bank partners' clients want access to quality products that can be difficult to source – particularly in agriculture – where Canada's reputation for safety and quality is highly valued. This 'matchmaking' has the potential to not only support existing trade, but to create new trade of net benefit to our respective clients, along with our institutions and economies.

Exciting time for Strategy

As global growth continues to be driven by emerging economies that are structured to thrive and trade concentrates within emerging markets, it is a very exciting time for strategy.

  • As policymakers, we need to consider the competitive context when formulating trade policy and adjust our lens from cross-border trade to the broader concept of international commerce
  • As companies, we need to understand how to be a part of tomorrow's growth – whether we are suppliers tethered to increasingly vertically integrated supply chains in China, partners in globally distributed supply chains, or producers geared to fulfil local demand in foreign markets
  • As banks, we need to provide simple advice and executional capability in key markets; where we aren't best positioned locally, we must partner with peers to deliver solutions that help our clients achieve their objectives

We are in a time of great opportunity – engagement, openness and strategy will help decide tomorrow's winners.

About the author
 

Jeff Shell

Co-Head, Global Trade & Banking
BMO Capital Markets
T: +1 416-359-6544
E: jeffrey.shell@bmo.com
W: www.bmocm.com

Jeff Shell was appointed Co-Head, Global Trade & Banking in 2015. In this role, he is jointly responsible for managing the combined domestic and international relationship management team, corporate banking in China, and overseeing the management of credit lines to foreign countries and counterparties. Previously, he served as lead strategic advisor for BMO Capital Markets.


 


 

 

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