Too Many Eggs in One Basket? Evaluating Canada’s Need to Diversify Trade

The Study in Brief

Commentators and politicians alike continue to argue that Canada should diversify its trade away from the United States, by far its largest trading partner, reasoning that dependence on the US leaves Canada vulnerable. This Commentary represents a modest start at evaluating whether the current state of affairs is an economic problem and whether the government can, and should, attempt to diversify trade for economic reasons. The intention is to provide policymakers and commentators who contemplate geographic diversification — for either political or economic reasons — with a better awareness of the economic implications of such a strategy.

The findings might surprise the proponents of diversification. By loosely borrowing from investment portfolio theory, using export volatility and growth as measures of risk and return, the study assesses Canada’s geographic trade mix from both a trade growth and stability perspective. The study does not uncover any evidence that the mix is economically problematic, on either grounds. It finds that concentration in the US market has not been associated with greater export volatility. Canadian exports to the US are relatively stable, have lower overall risk relative to other markets, and have relatively high records of growth. And Canada already benefits from lower risk through diversification across US regions, whose imports from Canada do not behave perfectly in parallel. Moreover, diversifying away from the US is unlikely to reduce overall risk significantly, since US import performance tends to move in parallel with those of Canada’s other major trade partners. Policy-led diversification could even increase volatility and lower exports and income, making Canada worse off in economic terms.

Though Canadian businesses overwhelmingly trade and invest in the US market, Canadian trade and investment are less concentrated in the US than is commonly cited — official statistics overstate the concentration, and the share of US exports in overall Canadian production is much lower than their share of Canadian trade. Further, Canada-US trade as a share of Canada’s total trade is declining, as trade with other countries rises faster than trade with the US. For example, 79 per cent of Canada’s exports of goods and services now go to the US, down from 81 per cent in 1999, and 67 per cent of Canada’s imports of goods and services now come from the US, down from 75 per cent in 1999.

The study points out that individuals and businesses — not governments — determine trade patterns. Instead of trying to orchestrate or change their decisions, Ottawa should turn its attention to providing market information not easily accessible to businesses, and addressing barriers to trade and investment where Canadian firms are already significantly engaged — and payoffs are likely to be greatest. Then businesses can expand opportunities, both in the US and in other regions. However, removing remaining barriers to Canada-US trade must remain the top priority for Ottawa, since trade volumes with the US will continue to represent the majority of Canadian trade.