This Selected Issues paper addresses some of the key policy and economic challenges facing the Canadian economy. The paper presents a new approach to predicting the business cycle in the context of the Canadian economy. This approach uses a range of parametric and nonparametric tests to gauge the ability of various indicators to predict turning points in the business cycle. The paper also presents a model that links the inflation rate to the business cycle and the rates of change in the exchange rate and in unit labor costs.

Abstract

This Selected Issues paper addresses some of the key policy and economic challenges facing the Canadian economy. The paper presents a new approach to predicting the business cycle in the context of the Canadian economy. This approach uses a range of parametric and nonparametric tests to gauge the ability of various indicators to predict turning points in the business cycle. The paper also presents a model that links the inflation rate to the business cycle and the rates of change in the exchange rate and in unit labor costs.

X. Developments in Canadian Trade Policy 1/

1. WTO agreement on trade in financial services

Under the Uruguay Round agreement which established the World Trade Organization on January 1, 1995, an agreement on financial services was not concluded. Instead, the parties resolved that an agreement should be achieved by June 30, 1995. Of the 76 WTO members with commitments in the financial services sector, 29 members, including Canada, offered improvements in the negotiations which finally led to the Agreement on Trade in Financial Services on July 26, 1995. The signed Protocol acts as an interim agreement to be implemented for an initial period to November 1, 1997 at which time members will have an opportunity to modify or improve their offers on financial services schedules and to take most-favored nation (MFN) exemptions by sector. The Protocol to which the new financial services schedules are annexed is open for acceptance until June 30, 1996, and will come into force 30 days after that date.

The General Agreement on Trade in Services (GATS) covers all service sectors, including financial services, and has two components. The first is a set of general rules and disciplines that apply to all WTO members, and the second provides schedules of specific commitments analogous to the tariff schedules governing market access commitments in goods. The service schedules contain commitments on individual service sectors and service activities defining the conditions of market access, which are binding undertakings and legally enforceable. The two key principles under the Agreement are: (i) most-favored nation (MFN) treatment, which guarantees that a member will not discriminate among members supplying a service; and (ii) national treatment, which guarantees that governments do not discriminate in favor of domestic service providers. However, specific exemptions from the MFN commitment can be taken and the national treatment obligation is subject to negotiation.

Accordingly, in exchange for the concessions of other countries in the GATS financial services negotiations, Canada agreed to eliminate the foreign ownership and market-share limitations in the federal financial regime. 2/ In particular, Canada has eliminated the following restrictions: (i) the 10 percent individual and 25 percent collective limitations on the foreign ownership of Canadian-controlled federally-regulated insurance companies and trust and loans companies; (ii) the 25 percent collective limitation on the foreign ownership of Schedule I banks; 3/ and (iii) the 12 percent asset ceiling on the size of the foreign bank sector in Canada.

The agreement is expected to improve Canada’s access to a number of markets, notably in Asia and Latin America. Enhanced access reflects, inter alia, improvements in the number of licenses available for establishing foreign financial institutions, and increased levels of foreign equity participation in branches, subsidiaries or affiliates of banks and insurance companies. There will be opportunities for a broad range of Canadian companies in the financial sector.

The United States did not participate fully in the deal and applies an MFN exemption in its GATS schedule for the whole of the financial services sector. The U.S. decision, however, will not adversely affect Canadian companies, as Canada is assured access to the U.S. market, including national and full MFN treatment, under NAFTA.

2. The Uruguay Round Agreement

Ratification of the Uruguay Round agreement by the Canadian Parliament occurred at the end of November 1994 and became effective on January 1, 1995. In total, 24 amendments to Canadian law were required to satisfy the obligations of the WTO. For most products, tariff rate quotas replaced quantitative import controls on January 1, 1995, however, for certain dairy and grain products, the conversion became effective August 1, 1995. 1/ 2/ While prohibitively high over-quota rates ensure that imports are effectively limited to the TRQ quantity, the access commitments have resulted in some expansion of import opportunities. In addition, some modifications to supply management systems have been made to respond to the needs of food processors for competitively-priced dairy and poultry inputs. Significant changes have occurred in chicken, where production quota is no longer tied to historical performance but is more responsive to current market factors. In dairy, the federal subsidy is being gradually phased out for fiscal reasons, and will terminate in 2001. Consultations are to occur in 1996 with a view to developing a longer-term plan for other elements in the federal dairy program.

Canada implemented its commitments to reduce export subsidies on grain, oilseeds, and their products by eliminating the program through which these subsidies were granted. Effective from August 1, 1995, the Western Grain Transportation Act (WGTA), which provided subsidies for transportation of grain from the Prairies, was eliminated. An adjustment package of C$1.9 billion has been made available for compensation and to enhance infrastructure in the sector. Under the terms of the Uruguay Round no further reductions in domestic subsidies are necessary, in that they now represent less than 60 percent of their 1986-88 baseline, compared with an upper limit of 80 percent to be achieved by 2000. However, in the context of improved efficiency and the need for additional budgetary restraint, further rationalization of agricultural subsidies remains under review.

Canada, in quadrilateral discussions with the United States, Japan and the European Union (EU), supported further consideration of a number of initiatives, designed to help maintain momentum on market access liberalization, including the possibility of accelerating certain Uruguay Round tariff reductions, examination of zero for zero tariff packages, broadening participation in existing packages, and inclusion of new areas such as information technology products.

3. Tariff system review

In the February 1994 Budget, the Government announced a comprehensive review of the tariff system, and intends to fully implement the recommended changes by 1998. With the growing complexity of the tariff regime, the intention is to simplify the system, making it more transparent and easier to administer.

Reductions in tariffs on a wide range of manufacturing inputs (classified under some 1,500 tariff lines) became effective on June 13, 1995. The competitive disadvantage created by the Canadian tariff levels on manufacturing inputs had traditionally been mitigated by full reimbursement to exporters of their input duties through a duty drawback program. 1/ The tariff reductions on these inputs are at least to current U.S. MFN levels, with subsequent reductions in certain cases to be phased-in over four or nine years in line with the reductions agreed to by the United States under the Uruguay Round agreement. Where inputs are not made in Canada, and additional economic benefits have been identified, tariffs have been eliminated.

The government has recently launched public consultations on an overall draft simplified customs tariff, which incorporates the input tariff reductions and modified proposals on: the elimination or conversion of concessionary tariff codes; the termination of the Machinery Remission Program; the conversion of some specific rates; and the elimination or replacement of tariff regulations, all of which have been the subject of previous consultations. The draft Tariff also incorporates new proposals, including measures aimed at: the modernization and simplification of legislative provisions; the accelerated implementation, in 1998, of the final Uruguay Round tariff reductions scheduled for January 1, 1999; the harmonization of rates on certain competing goods, and the rectification of tariff anomalies; the elimination of rates below 2 percent, and the rounding down of decimal rates to the nearest half percentage point; and, the amalgamation of tariff lines where rates are the same, rate differentials are small or imports are insignificant. Corresponding legislation would be tabled by early 1997, for full implementation in 1998.

4. Trade disputes

Under Canada’s use of Chapter 19 of the Free Trade Agreement (FTA), the U.S. Government revoked the countervailing duty on softwood lumber and agreed on December 15, 1994 to refund approximately $450 million in cash deposits with interest. 1/ At that time both countries agreed to establish a consultative body to create a better understanding to resolve problems and a new forum to mediate disputes in order to avoid future litigation in the sector. After successive rounds, on February 16, 1996, an agreement in principle was reached in which Canadian provinces would make changes to their forest management practices and the United States would agree not to initiate any trade action. The key exporting provinces are Alberta, British Columbia, Ontario, and Quebec. The agreement takes effect from April 1, 1996 and will operate for five years.

On July 17, 1995 the United States requested the establishment of a dispute panel under NAFTA Chapter 20 to examine Canada’s application of WTO tariff equivalents for imports of certain U.S. agricultural products, including dairy, poultry, eggs, and barley. As part of the Uruguay Round Agreement, Canada converted its quantitative import controls on these products to equivalent tariffs. Canada believes that this was fully consistent with its international trade obligations under both the NAFTA and the WTO. As part of the Uruguay Round Agreement, The binational panel was established at the end of January 1996 and is expected to announce its decision in May 1996.

The one-year Memorandum of Understanding (MOU) on Grains agreed between Canada and the United States, including U.S. tariff rate quotas on durum wheat and other wheat, expired on September 11, 1995. 2/ As part of the MOU, a Joint Commission on Grains was established to assess each country’s grain marketing and support systems, and to make recommendations to both governments on long term solutions in the grains sector. The final report was released in January 1996. Generally, the Commission recommended that the United States should significantly curtail its grain export subsidies while the Canadian Wheat Board should be made more responsive to market mechanisms.

In implementing its Uruguay Round market access commitments for sugar, the United States significantly reduced Canada’s access for refined sugar from previous levels. Effective from October 1, 1995 the United States created a new global tariff-rate quota of 22,000 tones for sugars, other than raw sugar, to be administered on a global first-come-first-serve basis. There were previously no restrictions on Canadian exports of refined beet sugar to the United States. In addition to restricting Canada’s access for refined sugar, the United States also reduced Canada’s access in certain sugar-containing products. In total, it is estimated that U.S. measures on sugar and sugar containing products resulted in close to a 50 percent reduction in Canada’s access. At Canada’s request, NAFTA Chapter 20 consultations with the United States were held in March 1995 but the issues remain unresolved. Canada intends to await the conclusions and recommendations of the NAFTA panel on supply managed agricultural products, as the final outcome may have some relevance for the sugar dispute.

On February 6, 1995 the United States Trade Representative (USTR) announced a Section 301 investigation over the decision of the Canadian Radio-Television Telecommunications Commission (CRTC) to revoke the distribution rights of the U.S. firm, Country Music Television (CMT), which had been operating in Canada since 1984. An accord was reached on June 21, 1995 to establish a joint network entity between New Country Network, the Canadian-based network that originally applied to the CRTC, and Country Music Television, to form CMT (Canada). 1/ A commercial deal was reached on March 7, 1996.

In November 1995, the Canadian Parliament approved a law imposing an 80 percent tax on advertising in split-run magazines (those publications where the editorial content is produced abroad and combines with Canadian advertising for sale in Canada). The law was largely aimed at Sports Illustrated Canada, which by electronically transmitting the editorial content into Canada, avoids the prohibition of imports of split-run periodicals which has been in effect since 1965. In March 1996, the United States initiated dispute-settlement procedures against Canada with the World Trade Organization; the United States has complained of discriminatory restrictions on foreign magazines.

On June 30, 1995 Canada requested consultations in the World Trade Organization in response to the European Union’s new system of wheat import duties. 2/ Officials suggested that the EU’s use of reference prices as a basis for duty assessment was inconsistent with WTO obligations. On December 17, 1995 Canadian and EU trade officials reached an agreement, which provided sufficient modifications to the EU regulations on import duties to improve Canadian access by raising the duty rebate on high-quality wheat and lowering the quality threshold for durum wheat. The agreement, to be effective from January 1, 1996 to June 30, 1996, also provides for further discussions during the first quarter of 1996 to examine what measures might be necessary for future marketing years. Canada has presently terminated its request for a WTO panel but retains the right to pursue the matter in the WTO if further discussions do not prove satisfactory.

Canada initiated 11 antidumping investigations under GATT procedures in 1995, and 8 final determinations of dumping actions were issued. Three countervail actions were also initiated and one final determination of subsidization was made in 1995. 1/ The majority of these cases related to refined sugar from six countries. On March 17, 1995 Canada initiated antidumping and countervailing duty investigations following a complaint by the Canadian Sugar Institute. After preliminary determinations announced in July 1995, the final dumping determination made in October 5, 1995 ruled that U.S. sugar exports were being dumped in the Canadian market with an overall average dumping margin of 44 percent. Dumped sugar exports from Germany, Denmark, the Netherlands, and the United Kingdom, with U.S. exports, were found to threaten injury to Canadian production. It was determined that no material injury had as yet been caused to the Canadian industry, but that injury could be caused if the dumping were allowed to continue. No evidence of injury or a threat of injury was found for dumped Korean sugar exports. A final determination of countervailable subsidies was made against exports of sugar from all EU member countries to Canada.

5. The North American Free Trade Agreement (NAFTA) and the Free Trade Area of the Americas (FTAA)

While it is difficult to isolate the effects of lower trade barriers at this early stage, the Canada-U.S. Free Trade Agreement (FTA) and NAFTA are believed to have had a positive impact on intra-regional trade. Canadian merchandise exports to the United States have grown by 83 percent over the six year period to 1994, and trade with the United States now accounts for over 80 percent of total exports, compared with 71 percent in 1988 (the year prior to the FTA). Canadian exports to Mexico increased by 28 percent in 1994 and imports rose by 21 percent. Trade in services and investment flows have also increased within the NAFTA region. Canadian direct investment in Mexico doubled in 1994 to $1.2 billion and direct investment in the United States reached $67 billion.

Overall, the vast majority of trade between the NAFTA countries has been without problems. The implementation of NAFTA and the conduct of trade under its provisions has been facilitated by regular meetings of the NAFTA Trade Commission and the ongoing work of the Commission in the various committees and working groups created under the NAFTA. With regard to the dispute-settlement provisions of the NAFTA, to date there has been only one request for a panel under the dispute settlement mechanism in Chapter 20. The review mechanism for antidumping and countervailing duty in Chapter 19 has been more active. There are currently 14 active panel reviews under Chapter 19, of which three are reviewing determinations made by Canadian agencies.

Under NAFTA a trilateral working group was established to recommend a new system of rules governing antidumping and countervail. The focus has been primarily on antidumping (AD) with the group waiting to see how the new WTO disciplines on subsidies operate. While a deadline of December 31, 1995 had been set, a number of protracted issues remained unresolved and discussions have been extended. However, the group is expected to issue interim recommendations to provide for changes in administrative practices and regulations governing AD cases, and to reduce the administrative burden associated with the process, increase its predictability, and enhance transparency.

Canada fully supports the commitment made at the December 1994 Summit of the Americas held in Miami to create a “Free Trade Area of the Americas” by 2005 in a manner fully consistent with WTO provisions. The FTAA is viewed as a complementary initiative to NAFTA and other subregional trade agreements to assist in the elimination of barriers to trade and investment through agreed disciplines.

At the FTAA Trade Ministerial Summit held in Denver on June 30, 1995, a preparatory framework was put in place with the establishment of seven working groups. 1/ Each group will provide recommendations within their assigned areas to facilitate a program for negotiations. 2/ At the end of March 1996, a Trade Ministerial meeting will be held in Cartagena, Colombia, to assess the working groups’ recommendations, and to set up four additional working groups on government procurement, intellectual property rights, services and competition policy. Depending on the outcome of these preparations, formal FTAA negotiations could be launched at the subsequent ministerial meeting sometime in 1997.

Formal negotiations on Chile’s accession to NAFTA were initiated in Toronto on June 7, 1995. Pending passage by the U.S. Congress of fast-track negotiating authority, Canada and Chile have begun negotiations on an interim bilateral trade accord, which is consistent with the ultimate aim of NAFTA accession. The intention is to provide a stand-alone, interim accord which will integrate easily into four-way NAFTA accession discussions. Three working groups have been established, covering market access, services and investment, and legal questions and dispute settlement.

6. Asian-Pacific Economic Cooperation Forum (APEC)

On November 17, 1995 the 18-member nations of APEC endorsed an “Action Agenda” to achieve “free and open” trade and investment by the year 2020. 1/ The Action Agenda includes two parts. Part One provides for a framework to facilitate and liberalize trade and investment, including actions in specific areas. Part Two covers increased economic and technical cooperation, through, inter alia, infrastructure development, human resource development, and finance and exchange rate coordination. 2/

As a first step, each country submitted “initial actions” on tariffs and non-tariff barriers. In most cases, these initial actions represented a restatement or acceleration of previous commitments undertaken either unilaterally or under the Uruguay Round. 3/ Each member country is expected to submit more substantive proposals during the 1996 APEC Ministerial Meeting at Subic Bay in the Philippines. 4/

The intention at this stage is to build “consensus through consultation” rather than to achieve commitments through negotiated agreement. The approach, which comprises concerted unilateral undertakings as well as collective and multilateral actions where possible, remains a mechanism to a more open regional trading environment for member countries.

7. Trade preferences for developing countries

The General Preferential Tariff (GPT), originally implemented in 1974, was designed to promote economic growth within developing countries and more recently within transitional economies. Until recently, GPT rates were generally two-thirds of MFN rates. However, as MFN rates are reduced under the Uruguay Round, the GPT margin of preference would be eroded and Canadian officials sought to reconsider appropriate preferential tariffs. Consequently, following a review of the scheme, a new schedule of GPT rates became effective from January 1, 1996 which provides for the phased reduction of many GPT rates on over 3,000 products. In addition the GPT product coverage was broadened by 219 tariff lines (primarily in the agriculture and electrical machinery chapters of the Customs Tariff).

Duty-free entry is extended to all GPT eligible imports from the least developed of the developing countries (44 countries are eligible for LDDC tariff treatment). During 1996 the Government is seeking consultations with industry to propose an extension of the special preferential tariff treatment for LDDCs across most of the Canadian tariff schedule, regardless of whether an item is eligible for GPT treatment.

8. Foreign investment

The Communique issued at the Ministerial meeting of the Organization for Economic Cooperation and Development (OECD) in Paris, on May 24, 1995 endorsed the immediate start of negotiations to reach a Multilateral Agreement on Investment (MAI) by the 1997 Ministerial meeting. The intention is to provide a broad multilateral framework for the liberalization of investment regimes, with effective dispute settlement procedures. The agreement will be a free-standing international treaty open to all OECD members and to accession by non-OECD member countries. Such an agreement is expected to prepare the ground for multilateral discussions on investment within the context of the WTO. In September, 1995, the OECD Negotiating Group began the task of formulating a draft agreement to establish the procedural arrangements for negotiations and created a Drafting Group on Selected Topics to prepare specific investment protection provisions, and a dispute settlement mechanism.

Canada will continue to negotiate bilateral Foreign Investment Protection Agreements (FIPAs) however, until a universal multilateral investment agreement is in place. Currently, Canada has FIPAs with Russia, the Czech and Slovak Republics, Hungary, Latvia, Poland, and the Ukraine. Agreements are expected to be reached over the coming year with a number of other countries, including India, Kazakstan, Peru, and Venezuela.

9. Internal trade

On July 1, 1995 the Agreement on Internal Trade, signed by the Prime Minister and the premiers of the 12 provinces a year earlier, came into force. While the constitution mandates a customs union with no tariff barriers across provinces, in fact there have been substantial nontariff barriers to internal trade in the form of government procurement restrictions, and general standards and regulations. The agreement provides for the elimination of these barriers to trade, as well as barriers to investment and labor mobility within the country. The intention is to promote a more open, efficient and stable domestic market.

Liberalization of government procurement is considered to be one of the most important facets of the agreement, covering contracts with a market valuation of C$50 billion per annum. Provincial governments are no longer permitted to discriminate against suppliers from another province through use of local price preferences, imposing unfair registration requirements or setting unreasonable time constraints. Also included in the agreement are provisions for labor mobility and investment. The labor mobility chapter restricts the use of residency requirements and establishes a process for harmonizing worker occupational qualifications and standards across the country. The investment chapter limits the imposition of local presence and residency requirements and restricts the use of local content and purchasing requirements. The agreement also has a formal dispute-settlement mechanism patterned on NAFTA to deal with grievances.

The agreement is viewed as an initial step toward eliminating internal trade barriers. It also prevents new barriers from arising while establishing a framework for further liberalization. The work program envisages further discussions on the energy chapter to allow the free flow of electricity across provincial borders as well as increasing transparency in pricing. In agriculture, issues to be considered are inspection standards and other technical barriers, as well as a review of the supply managed commodities. To increase labor mobility a reconciliation of occupational standards is to be concluded by July 1, 1996.

10. Other measures and issues

Since March 1994, Canada has been participating in the negotiations for a successor regime to the Coordinating Committee on Multilateral Export Controls (COCOM). The main focus of the arrangement under discussion is on the non-proliferation of weapons and will encompass both arms and dual-use goods and technologies, including the establishment of a control list. Working groups are in the process of reporting their progress and a concluding agreement is expected shortly.

Canada maintains restrictions on payments and transfers to Iraq (since August 1990) and Serbia and Montenegro (since June 1993 and April 1993, respectively).

1/

Prepared by Susan Prowse.

2/

These restrictions had already been lifted under the North American Free Trade Agreement (NAFTA).

3/

Schedule I banks are “widely held”, that is, no one party may hold more than 10 percent of its shares. The 25 percent rule limited aggregate foreign ownership of Schedule I banks to 25 percent.

1/

The tariff-rate quota consists of (i) a minimum-access commitment with a relatively low tariff rate for a product and (ii) a much higher tariff rate for all imports in excess of the minimum commitment.

2/

For further information see “Canada - Recent Developments and Policies,” SM/95/81 (4/20/95).

1/

NAFTA provisions require that duty drawbacks be reduced on products exported to the United States, effective January 1, 1996 and on products exported to Mexico, effective January 1, 2001.

1/

Chapter 19 of the FTA covers provisions for dispute settlement for antidumping and countervail. Chapter 18 contains general provisions for all other dispute settlement. NAFTA extends the dispute-resolution provisions detailed in Chapter 18 and 19 of the FTA, to Chapters 20 and 19 of NAFTA, respectively.

2/

For details on the tariff rate quotas see “Canada - Recent Developments and Policies,” SM/95/81 (4/20/95).

1/

For further information see, “United States - Background Papers,” SM/95/18, (7/26/95).

2/

A request for consultations is the first step in the WTO’s dispute-settlement procedures under Articles XXII and XXIII of GATT (1994).

1/

During the last year, Canada has not taken any safeguard actions as governed by the WTO Agreement on Safeguards (as provided in Article XIX of GATT 1994) or any safeguard actions as provided by NAFTA, Chapter 8.

1/

The working groups are to cover: market access; custom procedures and rules of origin; investment; standards and technical barriers to trade; sanitary and phytosanitary measures; subsidies, anti-dumping and countervailing duties; and a “smaller economies” group.

2/

For further information on the work program of the groups see “United States - Background Papers,” SM/95/181 (7/26/95).

1/

At the APEC meeting in Bogor, Indonesia on November 15, 1994, member countries issued a “Declaration of Common Resolve” to achieve “free and open trade and investment” by 2020, and for the more industrialized countries by 2010.

2/

For further details see “Declaration for Action and The Action Agenda - The Implementation of the Bogor Declaration,” APEC Economic Leaders’ Meeting, Osaka, Japan, November 19, 1995.

3/

Canada listed a number of measures undertaken over the last year, as “initial actions” including, enlarging preferential tariff treatment to 219 new lines and reducing preferential tariff rates on some 3,000 items, and extending to all WTO members preferential treatment under the Investment Canada Act previously reserved for investors under NAFTA.

4/

Members will submit unilateral liberalization plans in 15 specific areas; tariffs, non-tariff measures, services, investment, standards and conformance, customs, intellectual property rights, competition policy, government procurement, deregulation, rules of origin, dispute mediation, mobility of business persons, Uruguay Round implementation, and information gathering. Following an initial comparison, these “Action Plans” will be tabled at the Philippine Summit, with implementation and review to begin in 1997, when Canada will chair APEC.