North America

Upstairs, Downstairs

With the US being a 17 trillion dollar economy, it can sometimes be easy to forget that both of its neighbours, Canada and Mexico, are in the trillion dollar club as well. Canada is the 10th largest economy in the world by nominal GDP and 17th by purchasing power parity (PPP)-adjusted GDP; Mexico is the 15th in the world by nominal GDP and 11th when adjusted for purchasing power parity. Outside of the US or EU, Canada and Mexico are already the two largest economies in the world within the same trade bloc. With continued decent GDP growth—both are expected to grow 2-3 percent in 2017—they may soon overtake more EU economies in size too:

trade bloc pairing comparisons

And yet, as the NAFTA renegotitation begins its second round of formal talks this week, the trade bloc shared by Canada and Mexico may to some extent now be on the chopping block. Not surprisingly, the two countries are now attemtping, diplomaticaly, to stand shoulder to shoulder with one another; to present a unified front to the US. But this can be hard to do, especially when those shoulders are separated by a few thousand km of US territory. It may be,  then, that the US will divide and conquer them (economically speaking) and get the best deal for itself.

Read the full article: Upstairs, Downstairs

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North America

Demographics, Drivers, and Dreams

On The Future of the Canadian Auto Sector 

There is a profound difference between Canadians, Americans, and Chinese, both in their demographics and in their dreams.

In the US, the largest population group is 20-35 year olds. Many of these Americans will, in the years ahead, be looking to pursue the American Dream: to buy a home and start a family. Indeed, just like the Baby Boomers before them, many of these Millennial Americans have been moving to suburbs and buying SUVs. 

In Canada, in contrast, the largest group is 50-60 year olds. In the years ahead, many of these Canadians will be looking to cut back their work hours, or retire, or transition from manual labour to less physically strenuous jobs. Many will also pursue the Canadian Dream: having a cottage to host one’s grandchildren at.

In China, the largest group is 40-55 year olds. Most of this group works in physically demanding industrial or agricultural jobs. Most of them, particularly in China’s rural areas and inland provinces, still earn between 2-10 dollars a day. The Chinese Dream is to let these aging manual labourers transition to less strenuous work, while also bringing the country’s impoverished rural areas and inland provinces out of poverty.

Ontario’s Position

These demographic trends are not alien to the auto sector in Ontario. A city like Windsor is, in a certain sense, situated in a delicate borderland, between the vast American consumer market on the one hand, and the smaller domestic market of Canada but larger global market on the other hand. This is a risky, though often rewarding, position to be in. When successful, it has allowed Ontario to attract investment from global firms seeking a way to access to the American market without investing too much in the US directly. In the wake of the recent Valiant deal, such investment is increasingly expected to come from China.

Obviously, however, global firms cannot rely for certain on continued favourable access to the American market, regardless of whether or not these firms have investments just across the US-Canada border within Ontario. It is up to Ontario to determine to what extent it wants to orient its production around markets in the United States, and to what it extent it wants to focus on Canadian or global consumers instead.

Motor Vehicle Production

A Possible Divergence

This is where trends such as demographics become relevant. As a result of such trends, it may be the case that consumer demand in the United States will diverge sharply from that of countries like Canada and China in the years ahead. While Americans continue to buy cars and SUVs, in Canada and in global markets it may be instead that auto sector demand will become increasingly dominated by busses and by trucks:

1. The Supply of Drivers 

The global Baby Boomer bulge, of 50 and 60 year olds in the West and of 40 and 50 year olds in China, is likely to create the largest labour shift in human history: manual labourers transitioning to less strenuous work. In spite of what some politicians may claim, these labourers will not often be retrained to become software engineers. Nor will they all move into retail jobs at companies like Walmart, as out-of-work labourers have often done during the past generation. Too many of these retail jobs are being automated out of existence. Rather, the single biggest job these labourers are likely to switch to is driving a motor vehicle.

Not only is driving a bus, truck, or taxi something that can be done by a person who has, say, a bad back, it is also becoming far less strenuous than ever before, as a result of technological additions to modern vehicles. Driving large busses and trucks has been somewhat difficult in the past, particularly in tasks such as parking, turning, or driving on country roads during challenging weather conditions or in the dark of night. Modern vehicles, on the other hand, equipped with cameras, sensors, and high-tech safety features, are in the process of making the job of driving relatively comfortable and safe even for 60 or 70 year olds.

If the Baby Boomers create a glut of drivers globally, the costs of using trucks, busses, mini-busses, etc., will fall.

2.  The Night Moves

Of course, there has also been plenty of discussion in the media about the possibility of self-driving vehicles. If such vehicle actually do become commonplace anytime soon, they will have the largest impact on places and at times in which there is today a scarcity of human drivers. Namely, they will the largest impact on late-night driving (when human drivers are mostly asleep) and on areas such as, for example, Canada’s far northern regions, where — particularly during long, cold winter nights, or in snow storms, or on dangerous ice roads that require almost constant maintenence  — there are few human drivers around.

Autonomous capabilities would have a much greater impact on trucks than on cars, then; and in particular, on short trucks, where labour costs per unit of cargo are much higher than for heavy trucks or transporters. They would also have a greater impact on places with challenging geographies, such as Canada. And they would be especially useful for slow-moving overnight vehicles, like plows, de-icers, and pavers.

Trucks, finally, may experience the benefits of autonomous driving earlier or more than other vehicles  will as a result of government regulation. While governments may be hesitant to allow autonomous cars in general at first, they are far more likely to allow a truck driver to turn on an autonomous cruise control system late at night, when relatively few cars are on the road, so that he or she can get some sleep.

3. More Time, Less Money 

These two trends we have discussed thus far — demographics and automation — may also lead to a phenomenon in which Canadians’ free time will increase at a much faster pace than will their income levels. This could occur because of an aging Canadian worker entering into full or partial retirement, or it could occur because of a Canadian worker losing his or her job to a software system or machine. Either way, Canadians are likely to have more time to fill up their schedules with leisure activities — say, spending more time in cottage country — but will also have to economize on costs in order to afford them.

One way to economize on leisure spending would be to forgo car ownership (or at least, to share a car with a spouse instead of owning two cars per couple) and using transit more. Busses, for example, are slower than cars — as they often make stops to pick up and drop off passengers along their routes —  but also cheaper than cars, particularly once you factor in the cost of car ownership. If the cost of bus drivers declines (which, as we have discussed above, we think it will), busses would become cheaper still. As Canadians’ free time increases faster than Canadians’ incomes, busses might therefore see greater use.

4. The Transit Revolution 

Apart from their sometimes being slow compared to cars, another major reason many people do not use transit regularly is because of the “last-mile” problem: how to get from a transit station to one’s destination, without a car. Also problematic is the “first-mile” problem: how to get to the transit station if the station’s parking lot is full, or if you do not own a car.  Yet these “first-mile/last-mile” problems are likely to be solved—or at least, made far less problematic—in the near future, as a result of technological changes.

One technology to overcome the first-mile/last-mile challenge is that of services like UberPool, wherein passengers and drivers easily co-ordinate door-to-door carpools through their smartphones. This same system could be used by busses or mini-busses too, which would make the rides cheaper but also longer—see the More Time, Less Money section above. Systems like UberPool work best in markets that are “liquid”; i.e. big-city markets, where there lots of passengers and drivers around. The US, being highly suburban, may be less suited to this than Canada (where more people live in large cities) or most global markets.

Another way to overcome the “last-mile” challenge is via car-sharing services, such as Car2Go or Zipcar. These allow people to take a car from the transit station to reach their destination. Use of car-sharing services in Canada is growing. It may eventually make it easier for some people to forego car ownership entirely.

As services like car-sharing and ride-sharing advance, then, transit’s “first-mile/last-mile” problems may be overcome.

5. The Canadian Shield 

If transit really does become more common relative to car usage, it will in many places be dominated by rail transit. Similarly, railways will continue to transport more freight than trucks. Trains are, after all, more efficient than trucks and busses. They will remain more efficient even if the cost of hiring a bus or truck driver falls.

Where trucks and busses will be utilized most, then, is in locations where it is difficult for railways to function. We have already mentioned one location where railways are difficult: Canada’s far north, where permafrost impedes rail construction and maintenance, and ice roads are sometimes the only economical option.

Another region where railway construction is expensive is the Canadian Shield, the result of the Shield’s enormous size, exposed rock shelves and over-abundance of lake (the latter being proble  matic given that trains cannot easily make sharp turns to bypass them, as trucks can). If Canadians, armed with more free time than ever before, seek the Canadian Dream in the lakeside cottages of the Shield, they will have to rely on trucks to transport bulk necessities like food (as the Shield is not suitable for agriculture) and fuel.

Canadian Shield .png

Railways networks are also under-built in mountainous areas, as trains cannot handle either sharp turns or steep inclines well. Three of Canada’s four major cities — Vancouver, Montreal, and Calgary — are located a very short distance from mountains, in contrast to US population centres which tend to be located in spatious coastal plains or the even larger Midwestern/Central Plains. It might be expected that, as a result of having more free time to spare, Canadians will spend more time pursuing leisure activities in mountains.

Meanwhile, countries like China are now actively trying to develop their impoverished inland regions, many of which are mountainous and have relatively little access to either railways or to coastal shipping—and will therefore have to rely on trucks and busses for their transportation. Many other developing economies, in South Asia, Latin America, and Africa, are also mountainous and landlocked. The largest city in NAFTA, Mexico City, is the highest-elevation in the world among cities with at least four million residents. Still, it is China which is the king of highlands. China’s Tibetan Plateau and Himalayan region occupies roughly one-fifth of China’s landmass, and is similar to the Arctic in its permafrost risks, sparse population (it has less than one half of one percent of China’s population), low rail access, and resource wealh.

Conclusion — Canada and the World 

Canada typically has one foot in the American market and one foot in the Canadian and global markets. Canadians companies often wonder what trade regulations or barriers the Americans will insist upon, either for Canadian firms or for foreign-owned firms invested in industrial facilities within Canada. But if, also, markets diverge — if Americans continue to use conventional four-seater cars and SUVs and trains, while Canadians and global market players like China increasingly look to buy busses and trucks — then Canada’s auto sector could also have to answer a more basic Canadian question: just how American are we?

As usual, there are no easy answers here, only risks and rewards.

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East Asia

The Geopolitics of Chinese M&A

According to an article in The Economist, the value China’s outbound M&A activity rose sharply in 2016, up approximately fivefold since the summer of 2015 and eightfold above its average rate between 2010- 2015.

The article mentions that this increase could represent a troubling trend for China, of capital fleeing the country in response to its slowing economic growth rate and gradually depreciating currency in recent years.

It then largely dismisses this theory, however, saying, “rather than sparking a stampede [of money] to the exits, it is more accurate to say that these changes [in China’s economic performance] have alerted Chinese firms to the fact that they are still woefully under-invested abroad. China’s share of cross-border M&A has averaged roughly 6% over the past five years, despite the fact that it accounts for nearly 15% of global GDP”.

In other words, the article assumes that, if  a country’s share of global M&A does not exceed its share of global GDP, its M&A is less likely to be capital flight. This assumption is not justified, however. It overlooks other key factors that may determine a country’s propensity for engaging in outbound M&A. Such factors include:

1. A country’s physical proximity to other large economies

In order to have cross-border M&A, you need borders to cross. Economies with large neighbours, for example Canada or the Netherlands, tend to have a relatively high propensity for engaging in international M&A.Canada’s cross-border M&A, for example, has tended to be 25-50% as large as the US’s in recent years, in spite of the fact that Canada’s GDP is less than 10% as large as that of the US. China, unlike Canada, does not border any large economies. This impacts not just its M&A, but also trade: in China trade counts for 37% of GDP, whereas in Canada it is 64% and in the Netherlands it is 151%.

2. A country’s cultural and linguistic affinity with other large economies

Most economies in the world speak European languages; Northeast Asia remains something of a linguistic outlier. This may make Northeast Asian countries less likely than other regions to engage in global M&A.  Japan, for instance, currently accounts for 6.5 percent of global GDP, yet has accounted for less than 1 percent of global inbound M&A in recent years, and less than 4 percent of cross-border M&A in general. Arguably, China too might be expected to have a low propensity to engage in M&A.

3. Capital availability versus investment opportunity

One of the reasons that Japan’s outbound M&A far exceeded its inbound M&A is that capital in Japan has been cheap (its interest rate is below zero), yet investment opportunities in Japan have been limited (its economic growth rate is 1 percent). Thus, the Japanese borrow money cheaply at home, and often invest it abroad. In China, however, interest rates frequently top 4 percent, while economic growth is estimated to be 6-7 percent. We might, then, expect China to be less M&A-intensive, and generate more of its own investment opportunities domestically rather than seek out ones in foreign markets. Unless, of course, as many economists suspect, China’s true growth rate is much below 6-7 percent.

4. A country’s political relationship with other large economies

Outside of mainland China itself, approximately 45 percent of East Asia’s GDP is generated in Japan, China’s historic regional rival. Outside of mainland China, approximately 29 percent of global GDP is generated in the US, China’s potential global rival. Because China’s relationship with Japan and the US is sometimes a tense one, its investment relationship with Japan and the US may be less than it could otherwise be. For instance, when a territorial spat between China and Japan, over the Senkaku/Diaoyutai islands, heated up (rhetorically) around 2012, cross-border M&A between China and Japan fell sharply. Indeed, in spite of relatively close cultural connections, Japan was not even one of China’s top ten targets of outbound M&A spending in the past decade. China has tended to invest in Europe; Japan in its political ally the US. 43 percent of Japan’s outbound M&A in the past decade went to the US.

5. A country’s relationship to foreign financial hubs

Relatively independent financial hubs, like Hong Kong, Singapore, or Luxembourg, tend to be significant net providers of M&A capital. Their outbound cross-border M&A spending tends to far exceed their inbound M&A, and their global share of cross-border M&A tends to far exceed their global share of GDP. From  2011-2014, for example, Hong Kong’s outbound M&A was about 25-40% as large as mainland China’s, even though Hong Kong’s GDP is only around 2% as large as mainland China’s. (Rightly or wrongly, M&A statistics tend to treat Hong Kong as if it was an independent entity). The fact that the world’s top two financial city-states (Hong Kong and Singapore) are Chinese may suggest that mainland China’s propensity for outbound M&A should be relatively low—just as, for example, US outbound M&A would plummet if (hypothetically) Manhattan were to secede from the US.

The value of China’s outbound M&A as a share of global cross-border M&A should, perhaps, be lower than China’s share of global GDP, then. Yet in 2016 Chinese buyers accounted for an estimated 15 percent of the value of all cross-border M&A, slightly higher than the 14.5 percent of global GDP China had. The Syngenta deal alone, announced in early 2016, was roughly large enough to eclipse all outbound Chinese M&A in any year prior to 2014.  China has kept up its M&A pace thus far in 2017, not counting Syngenta.

The explanation that you often hear for why China’s M&A boom is not capital flight — namely, that Chinese firms are seeking foreign expertise and technology, as China transitions to a more knowledge-intensive economy — may have some merit, but still it ignores the fact that money has also been pouring out of China into other assets in the developed world in recent years. To take the most notorious example, Chinese capital been pushing up real estate values in Pacific cities (Vancouver, Seattle, Sydney, etc.) and hub cities (NY, London, Toronto, etc.). The M&A boom, then, may be part of the greater trend of Chinese capital seeking safe haven. China’s 2016 M&A investment in the global safe haven, the US, was roughly triple what it had been in 2015, 2014, or 2013. It was larger than in every year from 1990-2012 combined.

If much of China’s M&A boom really is a result of capital flight, it is also likely to be unsustainable. In part two of this article we will analyze China’s geopolitical structure, to see when (or whether) this boom will end.

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East Asia, North America

The League of the Overshadowed

It is easy to be small and ignored. But to be large and ignored, it helps to hide within the shadow of an even larger entity. In the realms of economics and geopolitics, there are three very large countries which, though not actually ignored, do not always receive the respect their size demands, as they inhabit the shadows thrown by the world’s colossi, the USA and China. These countries are Canada, Mexico, and Japan.

Japan has by far the third largest economy in the world, by far the second largest developed economy in the world, by far the second largest population among developed economies, and the tenth largest population globally.

Canada is the second largest country in the world, the fourth largest possessor of renewable freshwater, the fourth largest producer of renewable energy, the fourth largest exporter of oil, and the tenth largest economy.

And Mexico has the world’s eleventh largest population, thirteenth largest territory, and fifteenth largest economy. (Only five other nations are top-15 in all three categories: the US and the BRICs). Mexico has 2.5 times the population of the next largest Spanish nation (Colombia), plus a diaspora of 35-45 million in the US. It is also the twelfth largest oil producer in the world. The Greater Mexico Region (including Mexico, Texas, California, Venezuela, and US waters in the Gulf) produces more oil than Saudi Arabia or Russia. This region also has an economy larger than any country in the world, apart from the US or China.

The League of the Overshadowed

At the moment, however, trade between Canada, Mexico, and Japan is quite small. Neither Canada nor Mexico are even among Japan’s top fifteen trade partners. And while Mexico and Canada do trade with one another more often — Mexico recently overtook Britain to become Canada’s third biggest trade partner — trade with Mexico still counts for less than three percent of Canada’s total. Their trade with one another is overshadowed by that of the US. Indeed, California alone trades far more with Canada, Mexico, and Japan than those countries do with one another. There is no League of the Overshadowed… yet.

It may be worth noting, though, that US politics have to a certain extent put trade with Canada, Mexico, and Japan into question. President Trump’s first executive order was to withdraw from the Trans-Pacific Trade Partnership, in which Japan would have accounted for over 60 percent of the twelve member-states’ GDP apart from the US. Trump has also signalled his intention to renegotiate NAFTA, tighten the US-Mexico border, raise tariffs on Canadian farm and forestry products, and keep American fossil fuels cheap.

If these policies are followed through on, they could have the effect of driving US trade partners somewhat closer together. Obviously, Canada and Mexico have an interest in showing that they can trade with one another regardless of what Washington intends to say or do about NAFTA. Both also have an interest in exporting more fossil fuels to Asia, where prices remain more expensive than in the shale-rich US. On June 1, in fact, Canadian senator Paul Massicotte wrote an op-ed calling for Canada and Japan to sign a free trade agreement with one another as quickly as possible, given the failure of TPP and risks for NAFTA. Especially as both Canada and Japan have large majority governments right now, such a deal may happen.

An economic relationship between Canada, Mexico, and Japan could turn out to be far more significant, however, than being just a knee-jerk response to Trump’s America-First politics. As we will see, Canada, Mexico, and Japan are in fact complimentary nations, both economically and geographically. Already they have a propensity to trade with one another that is larger than their absolute trade levels suggest (see graph below). So long as Japan’s economic growth remains stagnant, Mexico remains poor, and Canada remains underpopulated, this propensity does not matter much. But if these conditions do not remain, we should expect trade between these three significant, overshadowed countries to grow by a very large amount.

canada propensity to trade

Complimentary Nations

Economists often talk about land, labour, and capital, considering them fundamental inputs of productivity. In the case of Canada, Mexico, and Japan, these inputs are epitomized: Canada has land but not labour, Mexico labour but not capital, and Japan capital but not land. Together, then, they could make a formidable team.

In Canadian politics and business, it has become common in recent years to say that by exporting natural resources to China, Canada can finally reduce the near-monopoly that the US has on buying Canadian exports. This view, however, is based on a false extrapolation of a trend that is now nearing its end: industrial growth in coastal Chinese cities. As China now seeks to rebalance its economy, by investing instead in its service sectors (which are less resource-intensive) and interior cities (which have a lower propensity to engage in trans-Pacific trade), its demand for Canadian resources is unlikely to continue to surge. Most of the resources it does buy will probably continue to come from within its own borders — China only imports 15 percent of the energy it consumes — or from its “One Belt, One Road” partners in Asia.

In Japan, on the other hand, the reverse is true. Japan has few resources of its own, and no Silk Roads to tap. Japan imports 90-plus percent of the energy it consumes, mainly from the Middle East. Its access to the Middle East, however, is imperilled, both from competition with other Asian countries (notably, China and India) as well as from Middle Eastern conflicts. Consider, for example, that Japan accounts for 30-40 percent of LNG imports globally, yet its primary supplier, Qatar, is now in an open feud with Saudi Arabia. Between competition and conflict, Japan could have to rely more on trans-Pacific trade to get resources. It would not be the first time: in the 1930s, eighty percent of the oil Japan consumed was imported from the US.

China-Japan comparisons.png

Even more important may be the impact of labour-saving machinery — robotics — upon Japanese trade. Because Japan has the oldest population in the world by far, it is planning to become a leader in robotics. Even, for example, as soon as the Tokyo Olympics in 2020, Japan is planning to showcase its robotic prowess. Yet robots are highly energy-intensive, and industrial robots resource-intensive. If Japan really does become the leader in robotics, it is likely to start importing lots of energy and other commodities from resource-rich countries like Canada. It may also be likely to start exporting its robotic technologies to countries like Canada, given Canada’s abundance of resources but lack of a large, cheap, human labour force.

Upstairs, Downstairs 

Today, if you exclude the US or Europe, Canada and Mexico have the largest combined economies of any pair of countries which are part of the same trade bloc (see graph 1 below). Yet if you include Europe, Canada and Mexico still rank quite a bit lower than a number of pairings of Europe’s largest economies (graph 2).

trade bloc pairing comparisons

In other ways, however, Canada and Mexico rank ahead of these European pairings. In population they do so (graph 3). In land they do so too (indeed, Mexico alone is larger than any four countries in the EU combined). And in terms of their indirect, second-degree trade (their combined trade with a third country), Canada and Mexico as a pair lead the world (graph 4), a result of their both trading hugely with the US.

canada-mexico indirect trade

 

While Canada’s propensity to trade with Mexico is greater than with any significant country apart from the US, it is still only around half as high as its propensity to trade with the US. The reason for this is simple: Canada and Mexico do not share a border with one another. They are not even very close in proximity to one another. More than 3000 kilometres separate Mexico City from any of the largest cities in Canada.

This separation is also reflected in Canada’s lack of a significant Spanish-speaking diaspora, particularly relative to that of the US. In spite of the fact that 21 percent of Canada’s population is foreign-born, compared to just 14 percent in the US, only 0.3 percent of Canada’s population is Mexican, compared to an estimated 11 percent of the population in the US. Even the state with the smallest share of its population being Mexican or Mexican-American—Maine—has a higher share, 0.4 percent, than Canada does.

But this may be likely to change, for two reasons. First, there is a political faction in the US which is wary of further Hispanic immigration, seeing it as a threat to the singular position held by the English language in America. Second, whereas the population of the US is relatively young, the population of Canada is Boomer-dominated, inching towards old age. This is especially true of the population of Canada’s French-speaking provinces, Quebec and (partially) New Brunswick. These provinces also, because of the far smaller language gap between French and Spanish than between Spanish and English, have a much higher propensity to attract Latin Americans than do other parts of Canada (see graph). Between demographics of this kind and US immigration politics, the next major wave of Latin American emigrants could be to Canada.

canada-quebec comparisons.png

The aging population of Canada’s Baby Boomers, and especially of Quebec’s Baby Boomers, also indicates another area in which Canada-Mexico economic ties—both direct and indirect—are likely to grow: tourism.  Already today, Mexico is the largest destination for Canadian travellers apart from the US, while the areas of the US that Canadians spend the most time in — Florida, the Southwest, and New York — are ones in which Mexican-Americans (or in Florida’s case, Hispanic-Americans in general) inhabit in large numbers. As Canadian Baby Boomers reach old age or retire, they are likely to spend more time in places like Mexico, in order to avoid much of the discomfort (even danger) of dark, icy Canadian winters. This will be most true of Quebec, given its older population, colder winters, and greater ability to learn Spanish.

Travel by Canadians .png

As the chart above implies, the US reconciliation with Cuba may also lead Canadians to spend more time in Mexico. During the past generation, the US rivalry with Cuba has given Canadians a near lock on the Cuban market. Canadians account for an estimated forty percent of all visitors to Cuba, and Cuba accounts for a disproportionately large destination (given Cuba’s relatively small size) for Canadian tourists. As the US allows its own population to go to Cuba, however, Canadian snowbirds will lose the advantage of having such a cheap, warm country all to itself. Many will re-route to other Latin American beaches.

An even more important pull factor for Canadian snowbirds will be “e-commuting”. The ability for young Canadians to spend time in a cheap, warm country in the winter is likely to increase dramatically as a result of the modern Internet. This is also likely to impact the Baby Boomers. If, for example, it becomes easier for a Boomer’s children and grandchildren to come visit them in Florida or Mexico for, say, a whole month over Christmas, rather than for just a week, then Boomers will be likelier to go in the first place.

And the relationship may not even remain one-way only: Mexicans may begin to visit Canada more often too. Today Mexicans do not go to Canada much, because they lack the disposable income to do so. If and as Mexicans become wealthier, however, they may look to Canada as a place to go in the summer; a place where the summer weather is not too hot, the major metropolises are not too crowded, and a cottage by a northern lake may be rented at an affordable rate. Climate change could, sadly, also play a role in this equation. Mexico — and the Southwestern US, in which tens of millions of Mexican-Americans live — is dangerously arid, whereas Canada is in possession of an abundance of renewable, surface-level freshwater.

Conclusion—The New Drivers of Trade 

Today, the main driver of trade is proximity. Countries which share borders with one another tend to trade a lot — though, of course, there are many exceptions to this — whereas far-away countries tend not to. However as (or, admittedly, if) globalization continues, proximity may no longer matter as much. Complimentarity may matter a lot more. We have seen here various ways in which Canada, Mexico, and Japan may be complimentary to one another. Canada has land but not labour, Mexico labour but not capital, Japan capital but not land. Canada has cold, dark winters but warm, water-rich summers, Mexico warm bright winters but hot, arid summers. All three countries have coasts on the North Pacific Ocean; none are part of the Asian (or Eurasian, or Afro-Eurasian) continent. And all three countries are very large, yet are overshadowed by neighbours that are far larger than they are. They may end up, if only informally, a formidable League.

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Middle East

Peace and Prosperity in Israel’s Future?

In Israel’s last major war, in 1973, 0.08 percent of Israel’s population was killed. During Israel’s last serious financial crisis, in the 1970s and early 1980s, its economy faced hyperinflation. In the four decades since, Israel’s casualty rates have declined while its real income, per capita, has risen. Israeli casualty rates as a result of the Arab-Israeli conflict were 0.03 percent in the 1980s, 0.004 percent in the ‘90s, 0.03 percent in the 2000s, and just 0.001 percent since 2010. Israel’s per capita income has grown from $3,500 in 1975 to $35,000 in 2015. Since the end of Operation Protective Edge in Gaza in 2014, Israel has had a casualty rate of 0.0004 percent. Its economy grew at 3-4 percent annually during this time, twice the average rate of the developed world. Since mid-2015, the Israeli economy has been outgrowing the developing world’s too.

It may be that Israel will continue this success in the years and decades ahead. But it may not. Israel might instead have to face new challenges to its economy and security, which are already becoming visible from afar.

One new challenge Israel may face comes from the development of software and devices that replace human labour. Thus far, labour and technology have been Israel’s twin competitive advantages. Part of the reason that Israel’s economy and tech sector have been growing is that Israel has a labour force that is far younger than those of Europe, Northeast Asia, or the United States. Soon, however, Israel may enter a phase in which, for the tech sector to continue succeeding, it will have to create technologies that will directly undercut Israel’s labour advantage. A glimmer of this future challenge can already be seen, for example in Intel’s 15.3 billion dollar acquisition of a driverless-car technology company, Mobileye, earlier this year. It was the largest windfall in Israeli hi-tech history—yet it could also put Israeli nahagim out of work.

A second threat to the Israeli economy may be climate change. Though it is very difficult to know when, what or even whether the impacts of climate change will be, it is obvious that the Middle East is not a part of the planet one would love to be living in if and when they do occur. As many in Israel must have been thinking during the recent spell of nearly 40 degree temperatures—especially inside Gaza, where electricity has been mostly unavailable—any future warming or drying in the Middle East is a frightening prospect.

Perhaps even more importantly, it is not certain to what extent Israel’s trading partners will decide to enact carbon tariffs in the coming years. Such tariffs could put Israel in a difficult position, as Israel relies on burning fossil fuels, particularly coal, to generate its electricity. Israel has actually benefited from this of late, since fuel prices have plummeted worldwide. But with the possibility of large countries deciding to enact tariffs on carbon (or methane) emissions, these energy sources represent a risk for the Israeli economy.

A third risk to the Israeli economy also comes from its commercial relationships with foreign countries. Israelis do a lot of business in the world; particularly in Europe, where Israelis live and work in countries like Germany while French and British Jews spend tourist and investment dollars in Israel. Israel imports more goods from German-speaking countries than from the United States. Israel also increasingly does business with Asia: Israel exports roughly half as much to Chinese-speaking economies as to the United States.

Today, however, Israel’s economic relationships with both Europe and Asia are at risk, at least in the short term, because of the slow economic growth in both those continents. Europe has barely grown in the past decade outside of Germany, and continues to suffer extreme unemployment in its Mediterranean countries. China, meanwhile, which was growing at over 10 percent just a few years ago, is now growing at just 6.5 percent. And that’s the official rate: most analysts guess China’s real rate is now only 3-6 percent.

Growth in European and Asian economies could bounce back, of course. But until it does, it bodes ill for Israel.

Most worrying for Israel should be Germany, which has thus far been the major exception to Europe’s economic and unemployment crises. Germany has lately shown signs that it may finally be on the verge of succumbing to Europe’s general sluggishness. Germany is an enormously export-driven country, but the economies it exports to are either struggling or, in the case of the United States, have been talking about raising tariffs on imports of German goods. Israel could be hurt if Germany falters, as it is Israel’s largest economic partner by far apart from the US. Lots of Israelis could flow back from Berlin, needing jobs.

Germany also shares a political trend with Israel: long-lasting leaders. Merkel is now in her 12th year as Chancellor and approaching her fourth election. Netanyahu is in his 11th year in office (when counting his previous three-year stint in the ‘90s), approaching his fifth election. As Ruchir Sharma, a top investor at Morgan Stanley, argues in his recent book, The Rise and Fall of Nations, countries with leaders who stay on too long past their “best before date”, like Bibi and Angela are doing, tend to watch their markets do relatively poorly over time.  Time will soon tell whether or not Israel will conform to this rule. It already has done so once before (though perhaps coincidentally), when it struggled in the ‘70s after Labor’s long reign.

Finally, there is Israel’s security challenge. This has declined in the past generation, first because of Israel’s peace with Egypt and then because Israel’s rivals in Arabia and Iran became distracted by their own wars; notably the Iran-Iraq War (1980-1988), the long Iraq war (1991-2017), and now of course the Syrian war (2011-2017). Israel’s smaller but nearer rivals, chiefly Hezbollah and Hamas, have also been distracted of late. Hamas’ supporters—in the Brotherhood, Damascus, and lately Qatar—have weakened. Hezbollah has become directly drawn into the civil war inside Syria. More recently still, in mid-2015, energy prices crashed, weakening Israel’s historic rivals in the Arab world, Iran, and Russia all at once.  Though it is not certain how much these events have caused Israel’s casualty rates to drop, they have possibly played a big part.

But Israel is not the only power in the Middle East that can withstand both cheap oil and crises in the Arab world. The largest economy in the region, Turkey, can also do so. Indeed, Turkey is now facing a power vacuum in every direction. To its east are the oil economies of the Gulf Arab states, Iran, and Central Asia. To its north is another oil economy, Russia, plus a divided nation in Ukraine. To its west, Greece is stuck in a Great Depression, the Balkans are divided, and the European Union has fractured politically. And to its south, Syria, Iraq, and Libya (and more distantly, Yemen) are all at war.  At some point, assuming that oil prices do not rebound, it might be presumed that Turkey will take measures to fill this vacuum.

Turkey’ government, led by Recep Tayyip Erdogan, has been consolidating its own power domestically in the past two years. Erdogan’s three recent victories—in the election of 2015, the coup of 2016, and the referendum of 2017— has put him ahead of rival factions like Turkey’s secularists, Gulenists, and Kurdish parties. While Turkey’s relationship with Israel today is not too bad (they have put the Mavi Marmara incident of 2010 somewhat behind them) there is no guarantee what they will look like in the future. Turkey’s economy is now estimated to be 2.9 times larger than Israel’s, twice as large as Iran’s, 1.3 times larger Saudi Arabia’s, and even two-thirds as large as Russia’s. If oil stays cheap, Israel might soon find itself sharing the Middle East with a significant regional power for the first time since….well, since the Turks, a century ago.

Of course, this is taking a rather negative view of things. There are reasons to be hopeful about Israel’s future as well. The fact, for example,  that fewer Israelis have been killed by Palestinians since 2002 than there were in just two years from 2001-2002, bodes relatively well for Israel and Palestine both. Between this reduction in casualties and the possibility of an eventual cease-fire in Syria (even if it is gained by way of a victorious Iranian-supported regime, or a Turkish invasion of Syria), the region might even find some peace.

More broadly, if the long, slow trend towards global peace, integration, and economic convergence, which began in 1945 and has (contrary to popular wisdom) continued since, is not derailed, Israel could be an  ideal place to live. It is at the crossroads of Africa and Eurasia and of the Atlantic and Indian basins; it can speak English, Arabic, and Russian; it can attract Christian and Muslim pilgrims; and it has Jewish and Israeli connections globally. Israel could do well in a peaceful and equitable world, should such a world come to be.

On the other hand, history may not be so nice. Israel’s past forty years have been pretty decent, all things considered. But new challenges are coming. It is still not clear whether Israel will finally secure the peace and prosperity it has been labouring towards; or instead merely catch a glimpse of them from its current peak.

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East Asia, North America

North Korea in the Next Five Years

The Korean War, fought from 1950-1953, was a result of two earlier wars in the 1940s: the US-Japanese War, which ended with the destruction and occupation of Japan in 1945, and the Chinese Civil War, which ended in a Communist victory (and Nationalist retreat to Taiwan) in 1950. With the Communists and Americans as the only powers in East Asia following these wars, the Korean peninsula was split in two, each side taking a piece for itself.

When the US triumphed over the Soviet Union around 1990, many expected the North Koreans to fix their broken ties with South Korea.  That this did not occur was partly the result of inertia, partly the result of Kim Il Sung’s living until 1994, and partly the result of the 1997 East Asian financial crisis, which kept the South Koreans too poor to want to incur the cost of investing in North Korean infrastructure or labour.

It was also partly the result of a miscalculation on behalf of North Korea in 1987, twenty-four months before the Berlin Wall came down. Seeking to ruin the South’s first-ever Olympics in 1988, the North blew up a commercial airplane. It was by far the deadliest attack on the South since the armistice began in 1953. South Korea’s anger and mistrust of North Korea as a result of this deed persisted during the ’90s.

When the 21st century arrived the situation changed again.  The US, after having fought the bulk of its four major 20th century wars in East Asia—in the Philippines, WW2, Korea, and Vietnam—shifted its focus elsewhere in 2001. This shift was mainly a result of US wars in Afghanistan, Iraq, and Libya. To a lesser extent, it has also been a result of recent Russian interventions in Georgia, Ukraine, and Syria .

In East Asia, meanwhile, China’s GDP surged, while Japan’s continued to stagnate like it had in the ‘90s. Between Chinese growth,  Japanese stagnation, and US distraction, East Asia became again a two-power region: the United States and China now dominate the region. But this may now be ending. In the years ahead, East Asia is likelier to become either a one-power region, like it was in 1990s, or a three-power region (the US, China, and Japan). The two-power status quo could remain in place, but is hardly certain to do so.

In a one-power or three-power region, the powers involved may have less to gain from the continuation of poor relations between North and South Korea. There will be much less reason to split Korea in two, as it has been for 67 years now, when East Asia as a whole is not split between two major powers, as it is today.

The move towards a one-power East Asia, or towards a three-power East Asia, is plausible for three reasons:

First, the US has been drawing down from the Middle East. It had 150,000 soldiers fighting in Iraq and Afganistan in 2011, but now has fewer than 15,000.  Unless it decides to wholly reverse this process — Trump has announced the addition of 4,000 soldiers to Afghanistan, but that is a far cry from the Obama-era surge—the US will have the ability to focus on other regions, like East Asia, more than it could during the 2000’s.

Second, China’s GDP growth has slowed, from 10-15 percent growth during the 2000s to 3-7 percent (depending on whether you believe its official growth rate, 6.7%) last year. In order to keep up with 2.5 percent US growth, China must grow around 4 percent. China’s challenge in doing this is that its labour is now much costlier and older than it used to be, while its resource wealth, most notably its coal, has led to pollution.

China may struggle to keep up with US power. As it is, the US economy is an estimated 1.6 times larger than China’s. [The US-Canada-Britain-Australia alliance, meanwhile – which, unlike China itself, more or less speaks a single language – has a GDP 2.2 times larger than China’s]. The US GDP alone is larger than that of East Asia as a whole.

Third, the economy of Japan, which today is an estimated 37 percent as large as China’s and 18 percent larger than Germany’s, is likely to benefit from the crash in oil and other natural resource prices that began in mid-2015. Unlike China, Japan has few resources of its own, and so depends on imports to fuel its economy.

relative trade northeast asia

While Japan’s aging population continues to be a challenge — Japan’s largest age cohorts are 40-45 year olds and 65-70 year olds — it may be able to address the challenge via automation, immigration, and a labour force dominated by technically skilled 50-80 year olds. Japan is already planning to advance its robotic prowess in the near term, as it wants to showcase them at the 2020 Tokyo Olympics.

Japan’s robot drive is likely to have consequences not just for the Japanese economy, but also for the Japanese military. Japan has already begun to rebuild its military of late, first in response to China’s rise and then in response to Donald Trump’s rhetoric that US allies should “stop freeloading, and pull their own weight”.  Already today the Japan ranks 8th in military spending, despite devoting just one percent of its GDP to it. Should Japan double this, to reach the 2 percent of GDP that France and Britain spend, it would then become the third largest military spender in the world, and move far ahead of the next largest, Russia. (Were Japan to spend 5 percent of GDP on its military like Russia does, it would move far ahead of China).

Even if Japan does not re-emerge, East Asia might not remain a two-power region. Rather, China could fall behind the US sufficiently that, in effect, it will be a one-power region again, like it was in the 1990s. US power is rising not only due to its withdrawal from the Middle East, but also because its rivals, most notably Russia, are being hurt by the fall in resource prices. As in the ’90s — when oil prices were at all-time lows — cheap oil works in the US’s favour. And if US power in the region does rise, the North Koreans might be less willing to resist its demands.

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Source: http://gypsyscholarship.blogspot.ca/2013/06/bye-bye-north-korea.html

There is an additional reason for improving relations between the North and South: it may benefit the South’s economy.  Unlike in the 1990s, South Korea is now a relatively wealthy country. Yet because of its rapid growth, it has become dependent on imports of natural resources and exports of manufactured goods. South Korea has been importing resources mainly from the Middle East, and exporting mainly to China.

The Middle East, however, remains unstable. Qatar, for example, the world’s largest LNG exporter, sells more to South Korea than to any other country. But Qatar is now in open conflict with Saudi Arabia. Uncertainty of this kind threatens South Korea’s GDP growth. In addition, as China tries to shift from coal to gas, and as Japan tries to shift from human labour to fuel-powered robots, South Korea may have to deal with rising competition from its own enormous neighbours when importing fossil fuels from the Middle East.

Similarly, South Korean exports have been limited by the slowing Chinese economy. China accounts for a quarter of all South Korean exports, more than the US and Japan combined. South Korea has also been hurt by its own success: its labour is no longer so cheap like it was in previous decades, when it was still a poor country.  For these reason, South Korea has already grown more slowly in the past two years that at any time since 1997 (excepting the global financial crisis in 2009).

These economic troubles are occuring at a bad time for the South. South Korea will host the the first-ever Winter Olympics in continental Asia this year. It wants the world’s perceptions of itself—namely, that it is a remarkable country, with remarkable companies like Samsung and remarkable economic prospects in general—to endure. It also does not want the North to cause trouble this time, as occured in 1987.

Trading with North Korea could help address both these concerns. North Korea has an extremely cheap, Korean-speaking labour force; a labour force that includes cousins, and in some cases even siblings, of the South’s. It represents a potential Korean-speaking market for South Korean exports, both of media and manufactured goods. It even, if ties improve enough, offers opportunities in tourism. And it offers access to natural resources. The North Koreans are rich in coal; the South Koreans are top coal importers. More importantly, the North offers a land route by which South Korea can access resource-rich Manchuria and Siberia.

China_topo

It is possible, of course, that the Korean issue will be addressed by war rather than by trade. In the past year alone, the US has prepared for such a war. It is also possible that the North will not be addressed at all; that the tyrannical staus quo will endure. But for the reasons outlined above, I believe reconciliation is the most likely, and the status quo the least likely.

Dennis Rodman, who played on the the 1990s Chicago Bulls (Kim Jong Un’s favorite basketball team) has lately met with Un. Do not be suprised if Rodman’s Celebrity Apprentice co-star, Donald Trump, follows suit.

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North America

Talking Trade With Trudeau and Trump

NAFTA stands for the North American Free Trade Act, but President Trump does not. After campaigning on a promise to repeal the Act, then adapting his position to that of merely supporting the Act’s renegotiation, Trump recently announced that he would no longer tolerate the status quo arrangement for American imports of dairy and forestry products originating from Canada.

Proposing, on April 24, to add a 24-percent tariff on US imports of Canadian softwood lumber, Trump kept up the pressure on Canada the following day, tweeting “Canada has made business for our dairy farmers in Wisconsin and other border states very difficult. We will not stand for this. Watch!”.

Watch! indeed: the value of the Loonie fell sharply the week of the tweet, as investors worried how Canada will fare when it comes to the broader renegotiation of NAFTA Trump continues to promise.

Trump’s targeting of Canada in this way is not likely to have been random. Nor was it entirely economic in its intention. Rather, Trump brought up the issue in order to prove his anti-NAFTA bona fides to his political base, yet in a way that manages to avoid the hairier subjects associated with NAFTA’s other signatory, Mexico, such as immigration, racism, or The Wall.

Trump has admittedly been careful to direct attention to goods of lesser importance, like dairy products and softwood lumber, rather than to Canada’s key exports of oil (from Alberta) and auto parts (from Ontario). Still, he has been far tougher on Canada—at least in his rhetoric—than has any other recent president. To use a Trumpian phrase: Canada has now been put on notice.

Obviously, this may worry Canada’s Prime Minister, Justin Trudeau. Elected with a rare majority government in 2015, Trudeau’s “political honeymoon” now finally seems to be nearing its end. The NAFTA/Trump issue was just one of four indications of this to occur this spring. The other indications were the election of a new federal opposition leader, Conservative Andrew Scheer, on May 28; the expectation of an NDP-Green minority government forming following an election in British Columbia in May; and the continuing decline in oil prices that has occured thus far in 2017.

Of these, the price of oil is likely the most troubling sign for the Canadian economy, and by extension for the approval ratings of Trudeau. West Texas Intermediate crude oil prices crashed in mid-2015, hitting lows of 26 dollars a barrel in February 2016 but staying mostly within a range of 40-55 dollars since then. They began 2017 at 54 dollars, and remained there until mid-April. However in recent weeks they have fallen again, so that as of this writing (June 21) they are at just 43 dollars a barrel. The Western Canadian Select oil price, which is the price that Canadian oil tends to sell at, is barely over 30 dollars. This does not bode well for the Canadian economy.

The biggest political news in Canada, meanwhile, has been the victory of the new Conservative leader, Andrew Scheer. Scheer narrowly (and quite unexpectedly) defeated Quebec MP Maxime Bernier at the Conservative Party convention, and so will now replace the party’s interim leader Rosa Ambrose as Canada’s leader of the opposition.

The impact of Scheer’s victory is likely to be twofold. First, Trudeau now finally has to face a real political opponent in parliament, rather than a mere interim leader as he has faced until now. This may draw some media attention away from political narratives created by Trudeau, instead giving his Conservative opponents some more air time. Indeed, Trudeau may now no longer be the only golden boy in Ottawa. Scheer is just 38, seven years younger than Trudeau.

The second impact of Scheer’s victory is that, unlike Trudeau, Scheer is not from Quebec. Bernier, who had been expected to beat Scheer, would have been the first Conservative leader from Quebec since Brian Mulroney, who was Prime Minister from 1984 (the year Trudeau’s father left office) until 1993.

In every election since then, the Conservatives have trailed behind the Liberals, NDP, and Bloc Quebecois in Quebec. This is not a trivial fact: Quebec is home to 23 percent of Canada’s population, and tends to vote for home-grown politicians. Given that Quebec has tended to be anti-Conservative, and western Canada pro-Conservative, Scheer’s victory over Bernier could mean that the next national election in Canada will be decided in Ontario. This fact could influence Trudeau and the Liberals during NAFTA negotiations, given that Ontario depends far more on trade with the United States than do any of the other Canadian provinces (apart from New Brunswick).

The month of May also saw a shakeup in Canadian politics at the provincial level. In British Columbia, the third largest of Canada’s ten provinces, the incumbent Liberal government failed by just one seat to hold on to a majority government. The NDP and Green parties have now announced that they plan to form a minority government in BC instead. This announcement has already had consequences for Trudeau, as the new provincial government is not expected to support the planned expansion of Kinder Morgan’s Trans Mountain pipeline from Alberta to BC’s coast.

Indeed the BC election, which was held on May 9, just a few weeks before Kinder Morgan held what it had expected to be the fourth largest IPO in Toronto Stock Exchange history, caused Kinder Morgan’s stock to plunge. If Alberta cannot export its fossil fuels to world markets via BC, then it will probably remain more dependent on sending them to refineries in the United States. Obviously this would be likely to reduce Canada’s leverage in any trade negotiations with the US.

If and when these negotiations do occur, it is difficult to know what the details of any new NAFTA agreement will be. Canada is obviously at a disadvantage relative to the US when it comes to trade negotiations. Not only is the Canadian economy much smaller than that of the US, and more dependent on trade with the US than the US is dependent on trade with Canada, but Canadian politics are also—contrary to popular wisdom—more internally divided than those of the US.

To give only one relevant example of this, there is the division between Canada’s provinces in to the extent to which they depend on US trade. The value of Ontario’s trade with the US is equal to an estimated 49 percent of Ontario’s GDP. In contrast, in Canada’s other major provinces — Quebec, BC, and Alberta — trade with the US accounts for just 23, 16, and 31 percent of GDP.

With these figures varying so widely, it could be difficult for Trudeau to present a unified front during negotiations. On the other hand, the political interests of the US are global in scope, so the US cannot afford to spend as much of its political capital haggling with Canada as Canada can afford to devote to haggling with the US. Thus it is always difficult to know which country holds the more leverage in the Canadian-American relationship.

What is obvious, though, is the importance of the relationship. Canada may appear small when compared to its southern neighbour, but it is the tenth largest economy in the world, and has growth prospects that out-rival most other wealthy economies. The US and Canada have the second largest trading relationship in the world, trailing only (for now) trade between the US and China.

Now that they are both finally settled into office, it will be fascinating to watch how these two countries’ utterly different leaders, Trudeau and Trump, will steward and steer this relationship going forward.

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