Director, Trade Policy Research
G8 Research Group
November 18, 2004
Predicting the outcome of Super Bowl XXXVIII would have been easier than trying to predict the outcome of the 2004 U.S. presidential election, even though each week someone different seemed to be favoured. There were certainly no shortages of superstitious benchmarks either. At the end of September, The Economist reported a poll from CNN money.com that, according to Buyseasons, a costume company, sales of George W. Bush Halloween masks were outselling John Kerry masks by 57% to 43%.  Sales of the masks have been said to predict the results of the last six elections correctly; thus Bush would be the clear winner. Not so fast, however. Apparently, the Washington Redskins have predicted whether the incumbent president would win since the 1930s. A win during the Sunday football game means that the incumbent will come out on top. Fortunately for Kerry, October 31, 2004, saw the Redskins lose by a score of 2814. But in real-world politics, the outcome of the presidential election would be decided only by the American electorate, and whether they think George Bush is doing a good job or whether they would like to give John Kerry a chance at being their Commander-in-Chief. Either way, this was an election where the whole world was not only watching, but is now trying to figure out what the next four years will bring in relation to their organization, international body or country including, of course, Canada.
This paper examines how the outcome of the election will affect the trade relationship between the United States and Canada. Does it really matter who won the election? Or is it more important that the encumbrance of the election cycle can now be left behind in real decision-making? Can political rhetoric predict who will be the better free trader? And how important is it to control Congress in the overall scheme of things where trade is concerned?
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The Election Cycle
The election cycle plays a strong hand in hindering outward-looking decision making in the year before an election. Re-election campaigns and the appeasement of domestic groups are synonymous. If decisions are likely to alienate any particular group in the short term, avoidance is strategically recommended and exercised. Historically, "while outcomes may be unaffected by presidential elections the process of trying to resolve disputes whether by inducement, persuasion, negotiation, or retaliation is affected by the electoral cycle."  With the election now over, the U.S. can finally start addressing the overarching problems faced by the administration. Where Canadian trade is concerned, these problems include the American current account and budgetary deficits, as well as ongoing trade disputes such as softwood lumber and the reopening of the Canada/U.S. border to Canadian cattle, both of which will be addressed later on in this paper.
The American trade and budgetary deficits are at a critical stage. Both are hovering around 5% of gross domestic product (GDP). Further budgetary deficits will also encourage higher trade deficits through initiatives such as tax cuts, which typically lead consumers to buy more imports. Addressing the unsustainably high deficits, the effects of which are felt the world over, needs to be a priority for the President.
Another factor is the status of the U.S. as the worlds largest consumer of oil, with China standing second. Increasing oil prices, coupled with the increasing trade imbalance with China have driven the trade deficit to record highs. One way to manage the skyrocketing trade deficit is to adopt protectionist policies, which then limit the amount of imports into the country. This is not an attractive option for Bush or for the now regionally integrated American economy.
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A more feasible way to balance the accounts is to continue to allow the U.S. dollar to depreciate. A lower dollar makes imports more expensive and therefore leads consumers either to purchase domestic products or to save. Consumer spending accounts for two thirds of all U.S. economic activity, and this spending rose 4.6% in the third quarter of 2004, despite the increase in energy prices and the approaching holiday season.  Although spending was on a downturn during the first half of 2004, it seems that the American love affair with credit has got them spending once again. Increased consumer credit indebtedness also indicates that any increasing taxes may not necessarily dampen consumer spending. Interest rate hikes may prove to be a better deterrent.
What does this combination of an open American economy, depreciating dollar and sustained U.S. aggregate demand mean for export-driven countries such as Canada, which has long relied on a weak Canadian dollar for its trading surplus with the U.S.? Tougher times ahead, no doubt. With a weaker U.S. dollar, Canada is likely to see imports from the U.S. rise and Canadas trade surplus sink. Canadas reliance on a cheap dollar rather than productivity growth has now come back to haunt exporters. Productivity allows products and not just low prices to compete around the globe. Can something be done in the short term to correct this? Sadly, no, even though a stronger Canadian dollar will allow Canadian firms over time to import more productivity-boosting capital equipment from the U.S. and put it to work at home. Gains in productivity come in the long term, and Canada has neglected the importance of productivity for quite some time. To see the effects, the World Economic Forums recently released Global Competitiveness Report showed that while Canada may have gained one spot this year in growth competitiveness (to rank 15th), it has consecutively slid in the past six years in the business index (falling from 8th to 15th), which many see as the more important indicator of the economys competitiveness.  Thus the commitment to a weaker U.S. dollar, which Bush does not oppose, will help in balancing the U.S. trade deficit, but will simultaneously negatively affect Canadas current account and export-led growth.
Cutting the budget deficit in half over the next four years is something that Bush has declared himself committed to doing, although he has been far from clear on how he plans to do so. Fred Bergsten, at the Institute for International Economics, states that what is needed is a potent combination of spending cuts, revenue increases, procedural changes and rapid economic growth.  With respect to rapid economic growth, the U.S. economy grew by 3.7% in the third quarter.  Consumer spending has started to rebound. Yet consumer confidence has dropped consecutively over the past three months. Coupled with a weaker dollar, higher energy prices and a lack of exogenous economic shocks, only a marginally different picture will appear in the coming months. The U.S. economy has proven to be resilient over the last half decade, bouncing back from many hard-hitting shocks. But it would be a grave mistake to rely on rapid economic growth alone to help balance the books.
But neither Bush nor his Democratic opponents have credibly committed to the required spending cuts plus revenue increases. Neither has proven to be fiscally prudent. George Bush is a big proponent of tax cuts, which cut revenue, even when rapid economic growth returns. Discretionary spending over the past few years has also increased from 6.3% of GDP in 2000, to almost 8% in 2004.  He has expanded Medicare to cover prescription drugs, which is not only costly in its own right but also will grow exponentially once the nearly 80 million American baby boomers begin to retire in a few years. John Kerrys plan to roll back tax cuts for those income earners making more than US$200,000 and making permanent the cuts for those under US$200,000 would have helped regain some revenue, but is now highly unlikely to be adopted in any form by a re-elected Bush. Even if it were, congressionally negotiated Kerry-like plans for ambitious spending, namely in health care and the National Education Trust Fund which would provide more funding for schools as well as tax cuts for post-secondary education would effectively eliminate the revenue the tax increase would have generated. Thus, it is not at all clear how Republicans or Democrats would have been able to reconcile cutting the budget deficit in half while maintaining ambitious spending. Even with the depreciating dollar riding to Americas double-deficit rescue, painful presidential choices may await.
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In terms of relations between the U.S. and Canada, trade dispute resolution will move forward now that the election is over. The key file is softwood lumber. The softwood lumber industry has remained an area of contention since the 1970s. On August 31, 2004, a dispute panel under the North American Free Trade Agreement (NAFTA) ruled against the U.S. case for punitive tariffs that were based on a claim that Canadas softwood exports were subsidized. The tariff was to be removed and billions of dollars in back tariffs were ordered repaid. Over the past two years, both the World Trade Organization (WTO) and NAFTA have likewise upheld Canadas position.
One would think that an end would be in sight after consecutive, supportive rulings, but this is not the case in an election year. In the U.S., timber prices are set by private contracts or auction because most of the forests are privately owned. This translates into every vote counting, especially in the U.S. South where fast-growing forest plantations and Republican voters loom large. Rather than accept the final ruling two months before the November election, the U.S. decided to file an extraordinary challenge, which would delay final resolution until March 2005. The extraordinary challenge would be the final stage in the dispute, as it cannot be appealed. However, the process of retroactive restitution of the tariffs collected can continue to be dragged out, especially as the U.S. has already implied it would not comply. For Canada, it is good news that Bush is now free to decide to end this battle in March, when he will no longer need to make decisions based on re-election concerns.
Another significant file is the U.S. border closure to Canadian cattle. The U.S. closed its doors to Canadian beef in May 2003 when one case of bovine spongiform encephalopathy (BSE or mad cow disease) was found in Alberta. It has since been reopened to boneless cuts from animals under 30 months old, yet remains closed to live cattle and older beef. Before May 2003, Canada exported 80% of its older cattle to the U.S. Now, with the border closed to older cattle, the run-up in supply has created a severe decrease in price. Older cattle used to be priced at an average of C$800 per head, the current price is approximately C$150. The Canadian Cattlemens Association estimates the cost to the countrys beef industry at more than C$2 billion.  In the U.S. market, prices have soared for U.S. beef producers, so not surprisingly they are lobbying heavily to keep the border closed.
A small reprieve has come by way of U.S. talks with Japan to reopen its border to U.S. beef. Japan is the biggest export market in beef for the U.S., and since it does not have enough domestic supply to meet the incoming demand, it therefore turns to the supply coming in from Canada. It may still be too early for Canadians to celebrate, however, for Japan has only agreed to review the regulations currently in place for importing beef, which state that every cow must be tested for BSE. Japan has committed to a regulatory review, which could take until at least March 2005. The hard lesson here for Canada is to diversify its trading partners.
There may be some reprieve for Canada within NAFTA. Mexican president Vicente Fox has recently completed a three-day visit to Canada and has outlined Mexicos interest in Canadian cattle to fill its need for breeding cattle. But on the broader issue, though, President Bush has shown with his farm bill and other measures that he can be an electoral-cycle protectionist, as well as a free trade ideologue. Farm states such as South Dakota were crucial electoral battlegrounds. Paul Cellucci, the U.S. ambassador to Canada, admitted to a business crowd in the middle of October that "American politics are slowing the process to open the border to live cattle."  Bush himself has stated that he would like the border to reopen as soon as possible, but wants to make sure the herd is clean enough. Indeed, both Canada and the U.S. have increased testing for BSE. Now that the election is over, and the South Dakotan protectionist, Democratic Senator Tom Daschle has been defeated, Bush is free to move swiftly.
On the broad trade liberalization promised by the WTOs Doha Development Agenda, the American electoral cycle also has hindered progress. The WTO had put its trade talks on hold with respect to Doha despite the fact that 147 member countries worked hard to get the round back on track in Geneva in July 2004. Now the process is on hold because of the possibility that a new U.S. trade representative may replace Robert Zoellick. But this important issue should soon be free to move ahead.
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Clear Choice or Hazy Political Rhetoric?
What is the broader meaning of the election for U.S. trade with Canada and free trade in general? In the U.S., the war on terror along with values proved to be the voters most prominent motive in this election, with issues that directly affect the pocketbooks of Americans running behind. Bush is thus now free to give expression to his free trade instincts because the Kerry option proved to have so little traction in the polling booths.
Kerry had positioned himself as a protectionist, promising to review NAFTA and all other trade deals to make sure that labour and environmental obligations were being upheld. Likewise, he stated that he would not sign any new deals that did not include these labour and environmental standards. This may have just been to appease his protectionist support base. But his running mate, John Edwards, voted and campaigned against NAFTA, and believes it needs to be renegotiated so that stronger labour and environmental protections are put in place. Such a renegotiation could cause serious problems when regulatory differences already interfere with the current trading system. Some companies must produce two different versions of the same product in order to meet the regulatory standards in different countries. The question then arises, with regard to labour and the environment, of whose standards will be adopted and who then gets to decide which standards win the day. If U.S. standards reign, is it fair to form agreements only with countries that can live up to American standards? Is there anything fair about diminishing a developing countrys ability to advance economically because it is unable to comply with standards that took decades to form? And if increased trade leads to peace and stability in the world, how can they be reconciled with protectionist measures?
George Bush is not without his own trade problems. He campaigned in the 2004 election, as he had in the election campaign of 2000, on the premise that he is a committed free trader. Yet his record leaves something to be desired. He has been sidetracked from expanding trade and following through on his promises and initiatives by the war in Iraq. He has shown that he too has protectionist tendencies coupled with an inability to stand up to large lobby groups, as seen with the steel tariffs he imposed in 2002 that he later repealed. Other disappointments are the North Americawide electricity system, which has not materialized, and the continuous agricultural subsidies for U.S. farmers. It would be prudent to examine some of the issues more closely to see where the President really stands, both with and now without John Kerry breathing down his political neck.
New issues, however, may prove to be more revealing. Canada does not typically get much mention during the U.S. election. Yet in the 2004 campaign, the importation of prescription drugs and flu vaccine from Canada proved to be a relevant issue in the presidential debates. The Bush administration recently announced that Medicare premiums would go up next year by 17.4%, the biggest annual increase ever, and that Medicare coverage would expand to include prescription drugs. The problem lies with almost 45 million Americans that do not have health insurance and must bear the full cost of prescription drugs themselves. Even before all the baby boomers have reached retirement age, one in six Americans are currently over the age of 65. Only 12% of Americans earn over US$200,000, which means that the overwhelming majority are faced with prescription drug costs that are a high percentage of their annual income.
Thus the argument is about pricing and the fact that the pharmaceutical industry is a US$180 billion industry that can charge different prices in different countries for the same drug. In real terms, taking into account the exchange rate, Americans are charged 3060% above what Canadians pay for the same drugs. The industry claims this premium covers political lobbying, research and marketing. Another factor in the pricing differential is the difference in buying systems between Canada and the U.S.; the Canadian system buys in bulk in order to negotiate lower prices. It is currently illegal to bring drugs from foreign countries into the U.S., but many Americans are willing to risk confiscation for the cheaper prices, and the Internet pharmacy business in Canada is more than happy to comply, as at present it enjoys approximately US$1 billion in annual sales.
When asked about his stance on drug importation in the second televised debate, Bush said he wanted to ensure that the drugs were safe and were in fact coming from Canada rather than some developing country. The rationale is that the ban on drugs protects Americans. In the third debate, the unequivocal evidence of the hindrance of the electoral cycle in policy making could not have been made any clearer than when Bush said that in December he might well declare that there could be a safe way to import drugs. He must tread lightly on this issue because, on one side, many Americans feel that drug coverage is inadequate and, on the other side, the big pharmaceutical corporations, or Big Pharma, tend to pour massive amounts of money into lobbying and political donations. Bush has tried to address this problem by expanding Medicare, but most of the changes do not take effect until 2006. The only pre-election carrot the voters received was a temporary drug discount card, which provided a discount on prescription drugs and gave poorer Americans a US$600 credit. There is a significant flaw in the program, however, as the sole means of registering for the card is by the Internet, which most elderly and poor do not use. So in a country with a population nearing 300 million, only 4.3 million Americans now have this card.  The Presidents promise to lower American medical costs through tort law reform offers little comfort here.
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Will the president move easily to adopt John Kerrys promise to allow Americans to buy cheap drugs from Canada? This would surely be good news for the Internet pharmaceutical companies. However, Big Pharma has told Ottawa that if it does not curb sales to the U.S. then they will not ship enough drugs to cover Canadian needs. If Bush ignores Big Pharma and their political contribution money, he will be leaving it up to Prime Minister Paul Martin and his minority government to take on the pharmaceutical industry by turning to the generic drug companies to cover shortages. This will have repercussions for Canadas healthcare system. Unless generic drug companies can manufacture copycat versions of the needed drugs overnight to respond to the length of time it will take Big Pharma to make good on their promise, it means higher costs for an already strained healthcare system, which is clearly not in the best interest of Canadians. More to the point, will Bush be able to move as he feels the pressure from this giant industry, even if he does not have to worry about being elected for another term?
Another hot election issue was job outsourcing. John Kerry brought it to the foreground. Many believe that this is a new phenomenon, yet most of the outsourcing in the world currently takes place in developed countries, including Canada, and is a practice that corporations have been engaged in for decades. Just how big an impact will outsourcing have in the U.S.? Forrester Research estimates that as many as 3.4 million jobs will be outsourced by 2015.  Although this may sound daunting, the U.S. economy not only downsizes yearly by approximately 30 million jobs, but it also creates enough jobs to cover that number. 
John Kerry said he wanted to close tax loopholes for companies that move jobs abroad, in order to create good-paying jobs for Americans at home. He called the CEOs of these companies "Benedict Arnolds" for giving jobs to workers outside the U.S. Closing tax loopholes is one thing, preventing jobs from exiting the U.S. is clearly a protectionist idea that does not make much economic sense. The United Nations Conference on Trade and Development (UNCTAD) has produced a study that shows that a savings of up to 40% can be realized for companies that outsource.  This is a substantial percentage in its own right because of the amount of capital it frees. Yet this number becomes even more significant in the context of a globalized world. Disincentives to American companies render them less competitive against other international companies that can capitalize on cheaper labour for a portion of their services. When a companys costs and pricing are less competitive, they and their employees ultimately lose out. Companies are then forced to choose between outsourcing a percentage of their jobs at a higher cost than before disincentives were introduced or shutting down altogether because their ability to compete has been impeded. Kerrys policy would have the reverse effect to what he claimed he wanted to achieve. Jobs would be lost due to company closures, which in turn would pull much-needed revenue out of the economy. The absence of taxes paid by workers and corporations would decrease revenue for the budget account, consumer and business spending would decline, and social spending would increase to compensate the newly unemployed to name just a few of the cyclical economic repercussions. More importantly, Kerry had overlooked the fact that outsourcing is not a one-way street for jobs leaving the country. The U.S. also gains many jobs that enter the country; for example, the French drug company Aventis SA is manufacturing flu shots in its Pennsylvania factory to help fill the shortage in flu vaccines in the U.S. this year. To assume that there will not be retaliation from countries and corporations from abroad is narrow sighted.
The implications for Canada are not insignificant either. Canada is a major beneficiary of U.S. outsourcing. In computer and data processing, Canada has attracted 72% of American outsourcing.  Hindering this process would not affect India and China alone; Canada would also lose jobs, which would then lead to the cyclical economic repercussions outlined above.
George Bush, on the other hand, would like to tackle the issue from a different angle. He is focusing on tax cuts, which include tax relief to companies that return their overseas profits to the U.S. Although there is no guarantee that companies would not use the capital to make their balance sheets more attractive to shareholders, his policy is growth oriented rather than one of forced hindrance.
What all developed countries, especially Canada and the U.S., should note is that India is graduating between 500,000 and 600,000 engineers per year.  This is an impressive number, despite the size of the countrys population. As developed-country economies become more oriented toward services, governments need to focus on the education of their citizenry in order to compete on the world stage. Addressing the effects of a particular situation is not the most prudent or sustainable course of action. The root causes must be identified and addressed in order to ascertain an effective and resilient solution.
The dozen swing states also inspired American politicians political instincts in ways that would have harmed Canada. One example lies in headlines at the beginning of September, when John Kerry vowed to stop Ontario trash from going to Michigan. Ontario has been sending its trash to Michigan since January 2003, with an average of 150 trucks a day. Upon closer inspection, one can see that Kerry was simply campaigning in the swing state of Michigan when he promised to halt the trash, a state he won by a slim margin. There was a clause in his statement that said it would be contingent on Canada notifying the United States Environmental Protection Agency (EPA) for each shipment of waste entering the U.S. However, Mike Levitt, the EPAs administrator, made it clear that this was only necessary for hazardous waste.  Kerrys office later clarified that he had misunderstood the agreement. Did Kerry really misread the document or was this simply political rhetoric in a swing state where news of the "misreading" would only reach those interested north of the border? With the election now over, Canadian garbage bound for Michigan is free to flow, to generate jobs in the waste-processing industry there.
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Who Controls Congress?
In the mid 1990s, the Republicans captured the House of Representatives. Coupled with current control of the Senate, the Republicans now control Congress. The November 2nd election has significantly strengthened their majority in both chambers. This matters for the easy passage of bills into law. A Republican Congress will make life easier for a Republican president, especially as re-election is paramount in the minds of politicians, and Bush has proven to be a powerful electoral draw.
According to the The Economist, of the 435 seats in the House of Representatives, fewer than 30 were earmarked as "competitive," up slightly from 50 in the 2000 election.  This shows the power of incumbency in the House: only four incumbents lost their seats to challengers in 2002, despite the fact that the U.S. redrew the districts that year, which should have made the races more competitive. Yet four out of five races saw two-to-one victories or higher.  The geographic location of party support also plays a role in Congressional control. Democratic support is stronger in big cities, whereas Republican support is spread out through the suburbs and countryside. Considering the safe number of seats in this election, coupled with the fact that 68 seats remain uncontested, it is all the more remarkable how well the Republicans did on November 2nd.
The Republicans also went into the November 2nd election controlling the Senate, but by a mere 5149 seats. Only one third of the Senate was up for election, which meant that there were 34 Senate races and only a dozen considered up for grabs. Of those 12, the top eight races were taking place in states that were won by Bush in 2000, and five of them were being defended by Democrats.  The Senate race was important because, should the contest have ended in a tie, it is the Senate that chooses the Vice-President. Regardless, the Republicans now have firm control of the Senate as well as the House.
How will Canada fare? Under John Kerry, the border would have remained closed to Canadian cattle for as long as he could have sustained it. Trade disputes would have been hampered by his efforts to maximize the gain for American workers. Future trade agreements would have become increasingly more difficult as commendable, yet unrealistic, regulatory standards were sought. And Kerrys "Made in America" disincentives would have negatively affected markets where Canada is already a big beneficiary.
In sharp contrast, the Bush presidency will bring expanded trade agreements, as it will continue on the current path as scheduled. Likewise, dispute resolution as well as new policies will move forward without the constant appeasement factor that afflicts anyone seeking re-election. After November 2nd, the world can finally move out of the holding pattern that comes with a U.S. election year. With George W. Bush in the White House, and in firm control of Congress for the next four years, Canada-U.S. trade is free to flow, as the two countries are positioned well to build their common economic community in the years ahead.
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1. The Economist (2004), "The Electoral Week: On the Trail," September 25.
2. Kim Richard Nossal, (19801), "Does the Electoral Cycle in the United States Affect Relations with Canada," International Journal 36 (Winter): 220.
3. United States Department of Commerce, Bureau of Economic Analysis (2004), "BEA News, Personal Income and Outlays: September 2004," <www.bea.gov/bea/newsrelarchive/2004/pi0904.pdf> (October 2004).
4. World Economic Forum (2004), Global Competitiveness Report 2004/2005, <www.weforum.org/pdf/Gcr/Growth_Competitiveness_Index_2003_Comparisons> (October 2004); World Economic Forum (2004), Global Competitiveness Report 2004/2005, <www.weforum.org/pdf/Gcr/Business_Competitiveness_Index_Porter> (October 2004).
5. The Economist (2004), "The Risks Ahead for the World Economy," September 11.
6. United States Department of Commerce, Bureau of Economic Analysis (2004), "BEA National Economic Accounts, Gross Domestic Product (GDP)," <www.bea.doc.gov/bea/dn/home/gdp.htm> (October 2004).
7. The Economist (2004), "Paths to Prosperity," October 9.
8. Kate MacNamara (2004), "Mad Cow's Toll Keeps Mounting," Financial Post, October 25, p. 1; Canadian Cattlemens Association, personal correspondence, November 2004.
9. Dave Ebner (2004), "Canada Hopeful after U.S.-Japan Beef Deal," Globe and Mail, October 25, p. B7
10. The Economist (2004), "Grandmas Little Helper," September 25, p. 40.
11. John C. McCarthy (2004), "Near-Term Growth of Offshoring Accelerating," Forrester Research Including., Table 4-3, p. 5, cited in Forrester Research (2004), "Trends" <www.forrester.com/Research/Document/Excerpt/0,7211,34426,00.html> (October 2004).
12. The Economist (2004), "Economic Focus: Trade Disputes," September 18, p. 80.
13. United Nations Conference on Trade and Development, (2004) "E-Commerce and Development Report 2003," <www.unctad.org/en/docs/ecdr2003ch5_en.pdf>, p. 136.
14. Financial Post (2004), "Canada a Big Winner of U.S. Outsourcing," October 9.
15. Kevin Restivo (2004), "Job Fear Misplaced: India Businessman," Financial Post, October 28.
16. Alan Freeman (2004), "Kerry Says Hed Halt Trash from Toronto," Globe and Mail, September 8.
17. The Economist (2004), "Pyongyang on the Potomac? The Congressional Elections," September 18.
18. The Economist (2004), "Pyongyang on the Potomac? The Congressional Elections," September 18.
19. The Economist (2004), "Pyongyang on the Potomac? The Congressional Elections," September 18.
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