In my last editorial, I wrote about the potential for a free trade market between Canada and the European Union. I got quite excited about the possibility, both for personal reasons and because I believe there is an excellent economic reasoning behind the deal.
Open and free economies participate in international trade because they have realized one of the few constants in the global economic realm: resources and skills are unequally distributed. In order to alleviate these global production balances, open economies load up on goods and services that produce the best, create surpluses in excess of domestic demand, and export those surpluses to countries where there is yet unmet demand. Once satisfying terms of trade are achieved, goods and services are exchanged and money pocketed, hopefully netting trade surpluses rather than deficits.
So, what could Canada have that the EU might want? Well, our greatest exports are natural resources, forest industries, electric power and equipment, consumer products, telecommunications, and above all, skilled people. This is where our competitive advantage lies. But how is competitive advantage among global economies established? Simply, the country that produces specific goods or services at the lowest opportunity cost has the competitive advantage in that area over its trade partner.
International trade comes with a basket of benefits (besides the obvious monetary ones). For starters, international trade fosters production specialization, which in turn increases productivity and leads to expansion of production worldwide. In other words, specialization allows for economies of scale, at the bottom line of which are lower costs, higher efficiency, and higher incomes.
Also, as trade incomes increase due to having competitive advantage in certain production areas, imports become cheaper, heating up the competition both abroad and domestically. As incomes from trade increase and prices due to competition decrease, our overall standard of living improves.
At this point, I should mention a couple of foreign trade fallacies, often argued by producers whose products lack international competitive advantage. The first argument against foreign trade is that it produces unemployment, which is true in the short run. But we are talking about structural employment caused by the labor market demanding different sets of skills and training. In the long run, as workers are retrained and redeployed, the long-term aggregate supply of labor returns to its equilibrium position on the demand curve.
The second argument is that free trade reduces wages. Again, this is true in the short run, and only for certain types of jobs. However, in the long run, as free trade creates more productivity, prices fall, and resources are employed more efficiently, the overall economy actually ends up with higher real wages.
Now, let’s go back to what establishing a free trade market with Europe could mean to Canadians. Historically, economically, geographically, and politically, it made perfect sense for Canada to have the U.S. as the country’s largest trade partner. In the past, there has been a high correlation between our respective economies. However, lately, our economic fates seem to be diverging due to a large number of macroeconomic factors getting in the way of that snug and comfortable relationship. It is simply time for Canada to look into expanding more aggressively into the next natural choice of markets — Europe!