CHAPTER III. Economic Trends and Outlook A. Major Trends and Outlook The Canadian economy grew by 2.2 percent in 1993, its best performance in four years. A lingering recession that began in early 1990 took its toll on every sector, manufacturing in particular. In addition to cyclical factors, the manufacturing sector had to contend with adjustments brought on by the CFTA and an appreciation of the Canadian currency that hurt exports priced in Canadian dollars. Most analysts agree that the restructuring process produced improved Canadian competitiveness, but the immediate costs in lost output and high unemployment were substantial. In addition, job insecurities and implementation of various tax increases sent Canadian consumers running for cover. In the first quarter of 1994, however, a stronger U.S. economy, improved employment, relatively low interest rates and a significantly depreciated currency helped the Canadian economy grow by an annual rate of four percent. Inflation is well under control. Substantial reductions in tobacco excise taxes in early 1994 and a 1.5 percentage point decline in Quebec's provincial sales tax rate even resulted in recorded deflation (the Consumer Price Index declined 0.2 percent in May 1994 from a year earlier). The Conference Board of Canada is forecasting an average inflation rate of 0.6 percent for all of 1994, rising to 1.9 percent in 1995. Such an inflation scenario should sustain low interest rates that in turn would continue bolstering consumer spending, private investment, housing starts, retail sales and employment. However, by mid-1994 in a highly integrated North American capital market, inflationary fears in the United States and heightened fiscal and political uncertainties in Canada contributed to further Canadian dollar depreciation and a resultant upward rise in interest rates. Such conditions sustained for any length of time, combined with an already burdensome debt and tax load, have the potential to threaten Canada's economic recovery. As of mid-1994, the Conference Board of Canada was forecasting real GDP to increase by 3.1 percent in 1994 and 3.5 percent in 1995. B. Principal Growth Sectors Manufacturing is expected to continue to grow since output in this sector is still below its pre-recession peak. Non-energy machinery and equipment investment is promising given the ongoing upgrading of Canadian manufacturing plants and equipment. Services are expected to continue to grow in relative terms, with particular emphasis on tourism, transportation and storage, retail trade (motor vehicles and discount store sales) and wholesale trade (machinery and equipment sales). C. Government Role in the Economy Canada is the world's seventh-largest market economy. Production and services are predominantly privately owned and operated. However, the federal and provincial governments are significantly involved in the economy. They provide a broad regulatory framework and engage in considerable redistribution of wealth from high income individuals and regions to lower income persons and provinces. Federal government economic policies since the mid- 1980s have emphasized the reduction of public sector interference in the economy and the promotion of private sector initiative and competition. Both federal and provincial governments also privatized selected crown corporations. Nevertheless, federal government regulatory regimes affect foreign investment and also U.S. firms in the financial services sector. D. Balance of Payments Situation Canada typically runs a large current account deficit even though its merchandise trade is in surplus; as a traditional importer of services (especially tourism), Canada also hosts a very large amount of foreign investment on which dividends are paid, and more recently, has had to service a large foreign debt. In 1993, Canada's current account deficit was C$30.7 billion, and C$32.4 billion at a seasonally adjusted annual rate in the first quarter of 1994. At the same time, Canada's global merchandise trade surplus was C$9.5 billion in 1993 and C$8.3 billion at a seasonally adjusted annual rate in the first quarter of 1994. The bulk of Canada's current account transactions is with the United States. Canada traditionally records a merchandise trade surplus with the United States, but also has a non-merchandise trade deficit that is more than offsetting. Canada's bilateral investment income account with the United States, composed of dividends and interest, accounts for the single largest deficit within the non- merchandise trade component. This deficit is expected to continue and probably grow. There is a large amount of U.S. foreign direct investment in Canada that results in high dividend payments by Canadian subsidiaries to their U.S. parents, and Canada's large and growing external debt, much of which is held by U.S. residents, gives rise to an outward flow of debt service payments. In the first quarter of 1994, Canada's merchandise trade surplus with the United States was C$21 billion at an annual rate, while its annualized non-merchandise trade deficit with the United States was C$22.3 billion. E. Trade and Investment Barriers As a result of the CFTA, many Canadian tariffs on U.S. products have been, or will soon be, eliminated. The North American Free Trade Agreement (NAFTA) removes some remaining barriers and expands specific provisions of the CFTA. However, non-tariff barriers at both the federal and provincial level continue to impede access of U.S. goods and services to Canada or retard potential export growth. The following constitutes a partial list of areas which will be addressed in 1995 by USG to improve bilateral U.S.- Canadian commercial relations. 1. Trade Issues/Barriers (a) Standards The CFTA provided that testing facilities, inspection agencies and certification bodies of each country have access to the accreditation systems of the other country without obligation to establish facilities in the other country. As a result, U.S. certification agencies and testing facilities applied for accreditation to the Standards Council of Canada (SCC), the primary accreditation authority in Canada. After three years of delayed implementation, the first two U.S. organizations were accredited late in 1992, and the process now appears to be open to U.S. applicants. Several other U.S. labs have applications pending before the SCC. Even if accredited, U.S. labs may face reluctance from Canadian and U.S. firms to accept their mark. Beyond obtaining SCC accreditation, in some areas of testing and certification, firms must also be recognized by the provinces. (b) Government Procurement The CFTA roughly doubled the value of Canadian government procurement contracts to which U.S. companies have equal access with Canadian competitors. These increased opportunities for U.S. products expanded upon access already available under the GATT's Government Procurement Code by lowering the GATT Code's qualifying threshold to US$25,000. The NAFTA provides even greater access to the Canadian Government procurement market through expansion of coverage to Canada's remaining federal departments, some government-owned enterprises (crown corporations) and selected services and construction contracts. Coverage of government-owned enterprises and services and construction under the NAFTA represents the first time that such procurement will be subject to international rules of open and competitive bidding. Finally, under the NAFTA all three parties have agreed to further negotiations before the end of 1998 to expand the coverage of the agreement. This will include coverage at the sub-federal levels. (c) Provincial Liquor Boards Canadian provincial government liquor boards have exclusive control over Canada's alcoholic beverage retail pricing, listing, distribution and sales. The CFTA requires Canadian provinces to accord national treatment to U.S. wines and spirits in their listing and pricing policies and, with certain well-defined exceptions, their distribution practices. The United States has questioned several provinces' implementation of these obligations and in 1990 requested consultation under the CFTA Chapter 18. Since 1990, the CFTA dispute settlement consultation has been "set aside" (by mutual agreement) pending resolution of the U.S. case against Canadian provincial beer practices. The CFTA obligated Canada not to worsen the treatment accorded to U.S. beer as of October 4, 1987, and to ensure that any new measures meet a national treatment standard. Canada did not fulfill these obligations. Consequently, in 1991, the U.S. beer industry (Heileman Brewing Company and Stroh's Brewing Company) filed a petition under U.S. trade law requesting an investigation of discriminatory Canadian provincial beer practices. The U.S. government accepted the petition and in February 1992 initiated a GATT dispute settlement case against Canada's beer practices. In October 1992, a GATT Panel ruled against Canada. On April 25, 1992, the United States and Canada signed an Agreement in Principle to resolve the dispute, which called for the elimination of discriminatory pricing of beer by July 1992 and delivery and points of sale access by September 1992. However, on July 9, 1992, negotiations to complete the Agreement were ended when it became apparent that the Province of Ontario was unable to fulfill the Agreement's basic obligations. On July 24, 1992, the United States announced the imposition of a 50 percent ad valorem retaliatory tariff on Canadian beer brewed and/or bottled in the Province of Ontario. Canada counter-retaliated with its own 50 percent ad valorem tariff on Heileman and Stroh products entering the Province of Ontario. On May 27, 1993, the United States and Canada resumed negotiations to resolve the beer dispute. On August 5, 1993, the United States and Canada signed a Memorandum of Understanding (MOU) which settled this longstanding dispute. The MOU committed the Canadian provinces to remove discriminatory provincial practices regarding beer by September 30, 1993. By the end of 1993, the United States was disappointed at the slow and spotty implementation of the MOU. Quebec's announcement of plans to introduce a minimum price regime based on that of Ontario led the United States to request consultations under the MOU's termination clause. Three rounds of consultations in February and March 1994 focussed on the provinces of Quebec and British Columbia. As a result, the United States and Canada reached agreement on April 29 on Quebec distribution issues, codified in an annex to the MOU. British Columbia also made commitments to improve the customs entry system. The two sides agreed to disagree on minimum price. FCS Canada will work very closely with the OOC and other U.S. government agencies to carefully monitor implementation of the MOU. Such monitoring will involve gathering information on provincial beer regulations and procedures, as well as information pertaining to provincial environmental measures which may affect U.S. beer exports or federal/provincial budgetary considerations which may affect the pricing, distribution, and points of sale access of U.S. beer in Canada. (d) Telecommunications Industry sources estimate that U.S. telecommunications firms are denied access to over 65 percent of Canada's US$4 billion equipment market. These concerns have resulted in a Congressional request for the General Accounting Office to conduct a comprehensive assessment of whether or not the Canadian market is closed to U.S. telecommunications equipment exports. In addition, industry groups have called for the Administration to initiate negotiations with Canada to increase market access. (e) Services Services exports constitute the fastest growing component of the U.S.-Canada bilateral trade relationship, producing a US$10.4 billion export surplus in 1992. Given the increasingly important share of our overall exports, greater emphasis should be placed on removing barriers to services trade. The CFTA services obligations, which cover only 150 sectors, are prospective, meaning that restrictions to services trade in existence prior to the Agreement's entry into force were grandfathered. The CFTA also confirmed competence-based licensing and certification requirements and encouraged development of mutually acceptable professional standards for architects and other professions interested in negotiating reciprocity agreements. However, the CFTA did not compel the United States or Canada to change laws and regulations that inhibit services trade, but only to ensure that such measures do not discriminate against nationals of either party. Unless specifically excluded, the NAFTA covers all service sectors and, like the CFTA, applies guiding principles to services trade. A party can retain an existing law, measure, or practice that does not conform to the agreement's principles, by formally lodging an exception or reservation for the measure. All federal government reservations were listed during negotiations and cannot be amended. However, states and provinces must list nonconforming measures within two years after the NAFTA's entry into force. Both the Canadian and U.S. governments will be working closely with their respective sub-federal governments to identify non-conforming measures. This "barrier inventory" exercise provides an opportunity to press for further liberalization in services. NAFTA parties must also remove citizenship requirements affecting the licensing and practice of professionals within two years of entry into force of the Agreement. If a state or province fails to remove citizenship requirements within the allotted time frame, the other countries have the right to maintain equivalent restrictions in their own countries. (f) Prohibition of Special Edition Magazines Special edition U.S. split run publications (using the same editorial content but different advertising content) are prohibited from importation into Canada. Time-Warner, publisher of Sports Illustrated, is avoiding the ban from importation by electronically transmitting the magazine which is subsequently printed in Canada. Customs authorities have no jurisdiction over electronic transmissions. A GOC task force has been set up to investigate the special edition magazines issue as well as all matters of concern to the Canadian magazine industry including, advertising, postal rates, taxation, and the electronic transmission of page proofs. 2. Investment Issues/Barriers Under the Investment Canada Act and related Canadian regulations, Canada maintains laws and policies which restrict new or expanded foreign investment in the energy, publishing, telecommunications, transportation, film, music, broadcasting, and cable television sectors. (a) Investment Canada Act The Investment Canada Act requires the federal government to review proposed acquisitions by U.S. and other foreign investors to ensure "net benefit to Canada". The Act exempts from prior government approval foreign investments in new ("greenfield") businesses and smaller acquisitions (worth less than C$5 million for direct acquisitions and C$50 million for indirect acquisitions). Under the CFTA, Canada raised the threshold level for review of direct acquisitions by U.S. investors to C$150 million on January 1, 1992. The threshold level will be indexed for inflation in subsequent years. Under NAFTA, this threshold would be further increased in line with real economic growth. Screening of indirect acquisitions by U.S. investors was phased out altogether in 1992. The thresholds for reviewing investors' acquisitions also apply to sales by U.S. investors of their Canadian investments to third country nationals. (b) Investments in "Cultural Industries" The exemption from review does not apply to foreign investments to establish new businesses or acquire existing ones in "culturally sensitive sectors" such as newspapers, magazines, periodical and book publishing and distribution, film and video, audio music recordings, and music in print or machine readable form. As a result, foreign investment in these sectors is potentially subject to review regardless of size or whether the investment is new or through direct or indirect acquisition. This protection for "cultural industries" will continue to be an issue for U.S. investors. In January 1992, Canada announced proposals to amend its book publishing and distribution policies. Under the new guidelines, Canadian firms that fall into foreign hands as a result of indirect acquisitions will not have to be divested to Canadian control, but the foreign investor will have to negotiate specific commitments to promote Canadian publishing if it wishes to maintain control. Foreign investors will be able to acquire directly Canadian book publishing and distribution forms under limited circumstances that also involve providing guarantees of benefits to Canada. The Investment Canada Act also permits special policies on foreign investment in the film distribution sector. Canadian policies provide that: takeovers of Canadian-owned and controlled distribution firms will not be allowed; investment to establish new distribution firms in Canada will only be allowed for importation and distribution activities related to proprietary products; and indirect or direct takeovers of foreign distribution firms operating in Canada will be allowed only if the investor undertakes to reinvest a portion of its Canadian earnings in accordance with national and cultural policies. (c) Energy Sector Investment Investment restrictions that were previously applied to this sector have been eliminated for U.S. investors. Legislation was introduced in 1992 to make U.S. investment in the oil and gas sector reviewable according to the CFTA thresholds rather than the lower Investment Canada thresholds (which still apply to non-U.S. foreign investors). In addition, legislation was introduced in 1992 to allow foreign- controlled consortia to obtain oil and gas production licenses on federal lands (offshore and in the Yukon and Northwest Territories). F. Labor Force The unemployment rate for Canada was 11.2 percent for 1993, and, while improvement is forecast for 1994, it will be slow. Compared to other OECD countries, Canada has the highest or near-highest proportion of both university-educated adults and young adults enrolled at the university level. It is also near the top in proportion of public expenditure on education. However, it has a high school drop out rate of about 30 percent, and there are reports of spot shortages for certain categories of skilled labor. The federal and provincial governments are studying worker education and training to improve the already high quality of the work force. G. Major Local and Third-Country Competitors in Specific Sectors As in most industrialized countries, aggressive third-country competition in Canada tends be concentrated primarily in standardized, labor intensive manufacturing sectors where lower wage rates provide a competitive advantage. These include apparel, sporting goods, household consumer goods and consumer electronics. In Canada, third-country competitors in these sectors are mainly Asian manufacturers. In the higher technology-driven sectors such as advanced machine tools, laboratory instruments and scientific equipment third-country competition stems largely from the European Community and Japan. Sectors where domestic competition in Canada is particularly strong include telecommunications and aerospace. In telecommunications, the long-held preferred supplier arrangement pursued by Canada's telecommunications giant, Bell Canada Enterprises (BCE), has disadvantaged U.S. products. Although BCE's official preferred- supplier policy has recently been abandoned, increased competitive access for U.S. firms remains to be tested. In the aircraft parts sector, Canadian manufacturers have prospered through the current global industry downturn. Adding to this success, the recent decision by Air Canada to modernize its fleet with a major purchase from Airbus will likely advantage Canadian firms which currently supply this market. H. Infrastructure Situation Regarding Goods/Services Distribution in Canada 1. Transportation Canada's transportation systems are highly developed. Canada's most important means of transportation for freight and bulk goods is its railways; however, long distance trucks now carry a substantial share of all merchandise. (a) Railways Railways are Canada's principal means of transport. The two great transcontinental systems, the Canadian National Railway and the Canadian Pacific Railway Company, provide most of the rail transportation. Both systems have extensive supplementary facilities for highway and waterway transport, telecommunications, and storage. Regional lines supplement the transcontinental lines. (b) Motor Freight Aided by an expanding network of paved highways and deregulation, truck transport is generally competitive with rail transport. The provinces have jurisdiction over highways in Canada. Common carriers are required to obtain a license from the Department of Highways and Transport of the province in which travel occurs. In January 1988, the Motor Vehicle Transport Act went into effect, easing entry into the Canadian market for U.S. firms. Truckers who wish to cross provincial and international borders no longer must prove that their service is consistent with public convenience and necessity. Until 1993, existing trucking companies could block new entrants. Beginning in 1993, new firms may enter the market or existing firms may expand if they are fit, willing, able, and meet basic insurance and safety requirements. U.S. firms may ship goods of their own manufacture to destinations in Canada in their own trucks. However, they may not carry other goods, back haul to the United States, or act in any way as a common carrier. However, some states have reciprocal arrangements with some Canadian provinces to do so. To determine what arrangements are in effect, contact the local office of the U.S. Interstate Commerce Commission (ICC) or the appropriate Canadian provincial department or ministry of transportation. Where no arrangement is in effect, the trucker will be required to purchase a one-trip license at the first weigh station after crossing the border. However, note that some provinces have more limited truck size requirements than the United States as a safety measure, which effectively prevents many U.S. trucks from operating in Canada. (c) Water Transport Although seasonally restricted by frozen waterways, water transport is widely used as a consequence of Canada's unique geographical position. Canada is bordered by the Atlantic and the Pacific Oceans. The St. Lawrence Seaway extends inward for more than 2,000 miles along its southern border. U.S. firms carry about 25 percent of all Canadian water transported exports and about half of its water transported imports. Canada has 25 large deep-water ports and about 650 smaller ports and multipurpose government wharves on the east and west coasts, along the St. Lawrence Seaway and Great Lakes, in the Arctic, and on inland lakes and rivers. Transport Canada is responsible for planning and providing adequate public port facilities. The leading Canadian ports listed in approximate order of tons of cargo loaded and unloaded are: Vancouver, British Columbia; Sept- les-Pointe-Noire, Quebec; Montreal, Quebec; Port Cartier, Quebec; Thunder Bay, Ontario; Halifax, Nova Scotia; Saint John, New Brunswick; Quebec City, Quebec; Prince Rupert, British Columbia; and Hamilton, Ontario. Container traffic can be handled at a number of these ports, including Montreal, Halifax, St. John, and Vancouver. (d) Aviation Air connections between the United States and Canada are extensive, with well-developed facilities for freight and passenger traffic. Air transport on U.S. carriers from the United States and Canada is provided by several companies. The two largest Canadian carriers are Air Canada (a crown corporation) and the privately- owned Canadian Airlines International, Ltd.. Domestic service is offered by a number of airlines. Other small carriers provide regular, irregular, charter, contract, and specialty services. Despite the extensive network, connections to non-major hubs in the United States and Canada can require several time consuming stops and changes of aircraft, and have been the source of irritation to business travelers on both sides of the border. 2. Telecommunications Infrastructure Communications are highly sophisticated in Canada, comparable with those of the United States. Canada is integrated with the U.S. direct long-distance dialing system (dial 1, area code and number). All forms of communication are possible (including voice, text, data, and video), and worldwide telegraphic services are available. Cellular and satellite communications are also possible in Canada. I. Major Infrastructure Projects Underway The federal government recently announced the creation of the Canada Infrastructure Works (CIW) program, the primary objective of which is the upgrading of Canada's physical infrastructure in local communities. Funding for the CIW program will include a federal government contribution of approximately US$1.5 billion which will be matched by an additional US$3 billion from provincial and municipal governments, for a total of approximately US$4.5 billion. The CIW program will be administered by the federal regional agency responsible for each province and provincial government departments. Other notable major projects currently underway in Canada include: the Grand Baleine hydro electric project in the province of Quebec valued at US$10 billion over ten years; a national fiber optic data network (CANARIE), to be tendered in three phases, with a total value of approximately US$1 billion; and, a department of defense tactical command control and communications system with an estimated value of over US$600 million. International market insight (IMI) reports generated by US&FCS Canada on major regional projects such as the Hibernia off-shore oil platform, the Prince Edward Island fixed-link bridge and the Vancouver Airport privatization are routinely undertaken and made available through the National Trade Data Bank (NTDB), which may be accessed through any District Office of the U.S. Department of Commerce.