***EXPORT SPECIAL*** Picking the export markets with the most growth potential

The future of Canadian exporting is bright, but not all foreign destinations glow with the same intensity, according to Glen Hodgson, Vice-President and Deputy Chief Economist with Export Development Canada.

Which markets will prove the most fruitful? Some industry analysts look upon the European market with hope but Hodgson is not one of them.

"Europe would seem an attractive and logical enhanced export destination for Canada, based on economic size, real incomes and a shared political history. However, Europe’s share of Canadian exports has been declining for more than fifty years, and now represents under 5 per cent of Canadian exports," Hodgson says. "Why? A principal factor is the trade impact of European economic integration. When a regional free trade area is created, it has the effect of lowering tariffs and other trade barriers among the members of the area, which promotes greater integration via increased trade and investment. However, depending on the design of the regional trade agreement, lowering barriers for member countries may inadvertently make trade more difficult with outside countries an effect called trade diversion."

In the case of western Europe, he explains, creation of the European common market did not explicitly discriminate against Canadian exports by raising nominal tariffs or other trade barriers, but it did create an economic bias in favour of intra-European trade and, by default, against outsiders like Canada. In other words, Canadian exports face higher relative trade barriers in Europe, if not higher absolute trade barriers. Recent work by the World Bank suggests that the European Union has had one of the strongest trade diversion effects of all regional trade agreements, he continues.

"The forthcoming expansion of the EU single market, with the addition of up to ten countries in Central and Eastern Europe, will give preferred market access to a group of competitors within Europe, many with significant initial cost advantages. Canadian exporters therefore will have to work hard to maintain or grow their market position, notwithstanding the obvious attractions of a larger continuous European market," he cautions.

Nor does he have high hopes for growing trade with Japan, which remains mired in the economic doldrums.

"There is currently little sign of the fundamental policy change needed to shock Japan back into over-drive, although at some point Japan must deal with its morass. Indeed, Japan might need to have a full-blown financial crisis in order to see a reversal of its economic fortunes and a return to growth after which it should become a more attractive market for Canadian export growth," Hodgson says.

But he says there are excellent opportunities for faster Canadian export growth in selected emerging markets. However, some necessary conditions must be met. The country must have its policy house in order economic, legal, regulatory. It must have a degree of political stability and the ability to form a national consensus. And it should be open to foreign private capital, especially direct investment. A number of emerging markets in different regions have met these criteria such as Korea, Hungary and Brazil. Others like Indonesia or Venezuela have some way to go, he says.

Hodgson places Mexico is at the head of the class for Canadian export growth potential pointing out its membership in NAFTA already gives us preferential market access, and the fact that it has made a rapid transformation toward a more open, democratic, pluralistic nation.

"With each passing year, Mexico’s economic management principles are more like those of a mature economy, and less like those of a developing market. Like Canada, it is heavily exposed to a U.S. economic slowdown, but like Canada it will be pulled along by a U.S. recovery and by North American economic integration," he says.

Canadian exports to Mexico have grown by 14 per cent per annum over the past five years, accelerating to 25 per cent in 2001. A key challenge facing Canadian exporters and investors in Mexico will be to establish and nurture long-term business relationships, since there are still perceived differences in business culture

Some countries in South America also hold out promise for substantial growth in Canadian exports and investment. Uninterrupted access to foreign capital, especially equity, will be a critical success factor, Hodgson says.. Chile and Brazil are at the front of the queue. Chile has a bilateral free trade agreement with Canada and has built a stable and attractive climate for trade and investment. Brazil improved its macro-economic management during the 1990s and is gradually shifting from foreign debt to foreign direct investment to finance its current account deficit. Its large domestic market presents tremendous export and investment potential for Canadians, provided that it continues to mature economically, politically and socially.

Canada does not have an explicit market access advantage with the once-tigers of East Asia, but the relative trade barriers are not significant. Indeed, World Bank analysis suggests that the formation of ASEAN (Thailand, Malaysia, Singapore, the Philippines and Indonesia) may have actually catalyzed trade with the rest of the world. These and other East Asian economies like Korea and Taiwan have largely recovered from the crisis of 1997-98 and possess relatively high purchasing power and strong growth potential. Canadian exporters are now much more cognizant of the differences among them, the opportunities that should exist, but should also be wary of believing in "miracles", Hodgson cautions.

Hodgson is high on China, where GDP could double over the next decade, and where WTO accession will improve market access.

"China has by far the greatest untapped trade potential for Canadians — and everyone else," he says. "Even a fraction of China’s 1.3 billion consumers would constitute an attractive market. Country creditworthiness is currently not a major concern, due to a mixture of prudent macroeconomic management, insulation from external shocks and a policy of holding massive foreign exchange reserves. If China is able to sustain its economic growth rate of the past decade of 7-8 per cent per annum; its GDP will double (again) in ten years. At that point it could be close to surpassing the United States as the world’s largest economy."

But Hodgson also cautions that Canada’s recent export performance to China has been dismal. Our exports in 2000 were at the same level as in 1995, C$5.5 billion, and our market share has fallen precipitously from 4 per cent to under 2 per cent.

"Future competition for market share and investment partners will be fierce, since everyone will want a piece of the action," he warns. "The central challenge facing Canadian exporters and investors is our knowledge gap with respect to China’s quickly evolving business culture and values, and the financial and personal cost of building relationships that are needed for long-term success. Are we equal to the challenge?"

Overall, Hodgson sees Canada growing even more reliant on its major trading partner due to NAFTA.

"We are in a world of growing trade regionalism, due largely to the practical reality of negotiating complex agreements with many partners. While export opportunities will be found in many regions, Canadians will have their greatest market access advantage in the Americas, building on the success of NAFTA.

He predicts that, driven by North American integration, Canada’s exports-to-GDP ratio will increase toward 60 per cent in a decade, and exports to the U.S. could reach 92 or 93 per cent of our total exports.