COMPETITION Why The FTA Will Reverse North America’s Course

April 1 1990 by Chief Executive

Look beyond the trade numbers and it’s obvious North America is coming back. If you divide the industrialized world into three “triad” powers-Asia Pacific, Europe and North America-and look at the trade numbers, they seem to tell us that North America is the “sick man” of today’s world trading system. We might also conclude that Canada and the U.S. are both sinking to the bottom with a sad case of the “British disease.”

But trade figures are laggers, not leaders. What we see behind the trade statistics is a pattern of long-term structural change that is revitalizing our economies. For instance, the Canada-U.S. FTA signed early this year is the most far-reaching trade agreement ever put into effect. Canada and the U.S. are transforming themselves. Managers in the two countries, who preside over two of the most dynamic economies in the world, are creating a manufacturing powerhouse designed to operate in a global marketplace. The strength behind these trends is powerful enough that they will continue to grow, even if there is a temporary downturn in our economies.

The signs are everywhere-except in official trade statistics. They show up in global scale “mega corporations” created by mergers and acquisitions, a resurgence of North American productivity, and recognition by such international scorekeepers as the IMEDE-World Economic Forum report on competitiveness that North America outranks all other countries in most categories.

This doesn’t mean we should ignore the bad news the trade numbers tell us. But we have to interpret them according to what’s really going on, not “hand me down” economics devised for a less interdependent world. In part, the trade deficits we see are caused by imports of capital equipment-new machinery for retooling rundown production facilities.

The influx of foreign investments that excites so many “nationalist” voices in both Canada and the U.S. is a multibillion dollar bet by those in a position to affect outcomes that the world trading system will remain open and that North Americans will play an increasing role in it.

THE CANADA-U.S. FTA

The FTA creates an ever-denser network of trade and investment linkages between Canada and the U.S. It also represents a commitment by both sides to maintain and enhance what has become the world’s largest bilateral trade relationship.

Fundamentally, by eliminating tariffs, seeking to ensure access to markets, and creating a new dispute resolution mechanism, the FTA aims to encourage Canadian and U.S. companies to compete globally without fear of protectionism.

The net outflow of Canadian direct investment reflects Canada‘s desire to expand in the U.S. and to compete globally. The substantial inflows of foreign direct investment reflect the same thinking-not only by U.S. investors, but also British, French, Japanese and West Germans. Given these longer-term trends in cross-border trade and investment, Canadian assets will be revalued upwards in this new environment.

REORGANIZING PATTERNS OF PRODUCTION

We are witnessing the transformation of the branch plant into a facility more closely integrated into parent company strategies. Productive capacity is now being managed on a North American basis, a win-win outcome on both sides of the line.

Isaiah A. Litvak, professor of International Business at Toronto‘s York University and acting director, Institute for U.S.-Canada Business Studies, Pace University, has recently studied several typical examples. Florsheim, the shoe company, is transforming its Canadian plant into a marketing operation. Avon, the cosmetics firm, is now shifting western Canadian production to the U.S. and production for the northeastern states to Canada. North American Philips is currently contemplating a similar reorganization. Chrysler, which has made cars in Canada for 20 years under the Auto Pact, is increasing its reliance on Canadian production. It now sends 80 percent of its Canadian production southward and 75 percent of the automobiles sold in Canada come from the U.S.

Procter & Gamble is another example. It has four Canadian plants as part of its 54 plant North American production system. If you shower with Zest or Ivory, there’s a good chance it was made in Canada.

Other companies have pursued a successful niche strategy within their firm’s multinational distribution network. Among the most successful of these is General Electric. It started preparing for free trade half a decade ago. Now GE Canada sells halogen lamps and large industrial motors for GE worldwide.

Services, too, have reorganized. Canadian banking rules, unlike U.S. rules, have long permitted national branch banking. More recently, financial services deregulation has allowed banks to acquire Canadian investment dealers, deepening their capital and making them more competitive.

Now they and their competition in trust companies are implementing aggressive business strategies in the U.S. while U.S. investment dealers and service providers, such as American Express, open or expand operations in Canada.

Indeed, virtually every traditional business service in Canada, from accounting to public relations, and advertising to real estate and insurance, is now providing more specialized international service. The FTA’s guarantees of national treatment and easier cross-border sojourning will greatly ease the trading of such services between our two countries.

JUDGMENT AT DAVOS

Another sign that shows North America is more than the international basket case the persistent trade deficits suggest is the judgment of experts at the World Economic Forum, in Davos, Switzerland. For nine years, this group has surveyed the industrialized countries of the world and ranked them by competitiveness, which they define as: “The ability of entrepreneurs to design, produce and market goods and services, the price and non-price qualities of which form a more attractive package than that of competitors.”

In recent years, Japan has ranked first in industrial efficiency and innovativeness and along with Switzerland, ranks ahead of the U.S. in sociopolitical stability. But the U.S. and Canada lead Japan in the other seven categories. In the overall rankings, the U.S. and Canada rank third and fourth, respectively, behind Japan and Switzerland, but ahead of 19 other industrialized countries.

Perhaps most indicative of the North American turnaround is that both Canada and the U.S. outrank Japan in human resources. Here’s what the Davos experts have said about this factor: “The U.S. maintains its towering superiority in human resources, owing largely to its large, growing and motivated work force. In addition, the U.S. benefits from a foreign brain-drain, a well-trained managerial class and labor flexibility.” The report went on to say: “Canada has toppled Japan this year, thanks to its growing labor force and important public expenditure in education.”

Canada‘s ranking at Davos has steadily improved over the years: Canada ranked fourth in the overall scoreboard, up from a disappointing seventh in 1986, reflecting its success in upgrading particular factors, of which human resources was the most significant.

The importance of that human dimension shows up in North America‘s reviving productivity figures. Observers now believe the U.S. work force is the most productive in history.

Science and engineering employment has been growing steadily for more than a decade at more than twice the real rate of GNP growth. Today, the proportion of scientists and engineers in the U.S. work force is higher than Japan’s (2.8 percent vs. 2.5 percent)-an edge that gets substantial leverage from the huge North American lead in computerization.

PROTECTIONIST DANGERS

So why worry about the trade figure “fright night”? Because there exists the very real danger that protectionists will use them to adopt wrong-headed protectionist policies that will quickly destroy the turnaround course we are on. Indeed, concern about U.S. protectionism was one of the chief motivating factors for Canada to push for a free trade agreement which, from our point of view, now “locks in” a trade liberalizing process, at least across the U.S.-Canadian border.

The FTA also liberalizes the other side of trade-investment. In both countries, foreign investment has become a national concern. Recent acquisitions, especially by Japan, such as Columbia Pictures and Rockefeller Center, have sent shock waves through the U.S. similar to those felt in Canada a few decades ago.

What’s happening now in the U.S. is also happening in Canada, where takeovers in the months following the signing of the FTA exceeded in value and number the M&A activity in any previous year.

I do not believe-as some are advocating on both sides of the U.S.-Canadian border-that the huge inflows of foreign investment should be restricted. On the contrary, North American firms are on a roll-and further liberalization of investment flows would be among the best guarantees that the roll will continue.

At stake in these investments is not ownership, but the efficiency of capital. Where these mergers add to the capabilities of the firms or the productive allocation of assets, it is clearly in everyone’s interests that they proceed. Letting the market work freely ensures that the correct judgments are being made.

The conclusion of one of Canada’s leading academic commentators on free trade, professor Alan Rugman, director of research, Ontario Centre for International Business, help put these developments in perspective: “The recent wave of mergers and acquisitions in Canada is part of an efficient process by which the Canadian economy can prepare itself to survive into the twenty-first century….In our integrated North American and global economic systems, Canada’s companies are merging to their efficient relative size. Recent mergers and acquisitions merely reflect the reality of doing business in this environment.”

The fact is, in this new world, size matters. Canadians, even niche players, have to be big enough to count. Size brings greater financial strength, economies of scale and the ability to serve international clients. Our recent agreement with Elders IXL to combine our respective North American brewing operations into a Canadian-based partnership under the name Molson Breweries-by providing the required scale-should ensure Canadian beer a position in the highly competitive North American and world marketplace. The alliance enables us to be cost competitive. This is necessary if we are to preserve a quality Canadian brewing industry in an essentially flat domestic and international market.

The new company becomes the number one brewer in Canada, number six in North America and number 20 worldwide. We will spend more than $220 million in capital expenditures over the next three years to build our breweries. As a result, we will be low-cost brewers, competitive not only in North America, but also in the rest of the world. With the merger, we will be competitive, despite current provincial regulatory restrictions, and in the face of growing competition from U.S. beer in B.C., Alberta and Ontario.

JAPANESE FINANCIAL PERFORMANCE

Although size can confer advantages, biggest is not always best. On the contrary, a look at the world’s biggest firms confirms this and provides strong evidence that North American companies are now more efficient than those in Japan.

Considered on a market capitalization basis, Japanese firms-especially utilities and financial services companies-are the world’s biggest. But Japanese firms come second to last when ranked by return on equity. Canada‘s firms rank just ahead of U.S. firms, with the national composite of its largest firms showing returns of 19.2 percent. Among the world’s largest companies, eight of the top 10 profit performers are North American.

Japanese capital accounts for 47 percent of total asset value reported by the world’s top 1,000 firms. Large U.S. firms, although more numerous than the Japanese (353 U.S. firms vs. 345 Japanese firms) account for only 32.4 percent of total capitalization of the world’s largest firms.

Yet, ranked by sales, large Japanese firms have just 32.7 percent of total market share; U.S. firms have almost 40 percent of the global top 1,000 in sales. Adding Canadian firms to this fractionally increases the North American proportion of assets and sales.

This confirms the turnaround in North American business. North American managers are squeezing out twice the return on assets and a far better sales to assets ratio than the Japanese.

THE FTA AND CULTURAL DISTINCTIVENESS

However, if we accept the view that the transformation of the North American private sector has turned around to become significantly more international and competitive, we have to recognize there may be political limits to what people will accept in the name of free trade.

In Canada, those limits were reached with respect to a sense of national distinctiveness, what Canadians term “culture”-and here misunderstanding lies. For most Canadians, as for most Western Europeans contemplating 1992, national identity remains a significant value, even as transborder economic links become dense.

To Canadians, “culture” is an intangible, reserved space where we talk to each other. And Canada is particularly open to foreign publications and cultural products. The main concern in the FTA negotiations was a reflection of our national openness: some 90 percent of our movie screen space and magazine space, are occupied by non-Canadian productions.

I see the recognition of these limits to the liberalizing process as a virtue of the FTA, not a defect. Because of these differences, the negotiators added to the FTA some common beliefs for settling disputes: manage the agreement as a whole, and protect the interests of the partners. Here, the FTA serves as a model for the multilateral trade negotiations now under way in the GATT Uruguay Round by providing a way to manage our distinctiveness as well as our similarities.