The drive to diversify

Economists and politicians have long advocated the need to diversify Canada’s international trade and investment to avoid overreliance on the U.S. market.

Even though the U.S. economy is performing well, and recent bilateral trade has been surprisingly strong, increased trade protectionism from President Trump has renewed the urgency for some Canadian companies to diversify their international business.

The federal government recently underscored the importance by appointing Jim Carr as the Minister of the newly-named International Trade Diversification portfolio.

In this blog, we analyze historical Canadian trade data and EDC surveys to uncover longer-term and emerging diversification trends.

So far this century, traditional merchandise trade data show a two-speed growth pattern. While Canada’s overall exports grew at 1.5% annually on average between 2000 and 2017, underlying growth with the U.S. was fairly weak at only 0.8%. Growth with the rest of the world was much stronger at 4.1%.

If we narrow the “rest of the world” segment down to emerging markets—which feature the fastest-growing countries such as China and India—the share of Canada’s exports to these destinations grew from 5% of the total to 13% over this period. This diversification has been remarkably broad-based. It occurred in all 10 provinces (see figure). Note that the most diversified provinces of Saskatchewan, Manitoba and British Columbia are all in Western Canada.

Diversification also occurred for 24 of 25 product categories (many of which are shown in the figure). The largest diversification gains occurred for paper products, coal, iron, soybean, oilseed and lentils; the only exception is wheat, which continues to have one of the highest shares destined for emerging markets.

The Herfindahl-Hirschman Index is a common way to evaluate a country’s export market concentration. Concentration is the opposite of diversification: a higher index closer to 1 indicates that a country’s exports are more concentrated, while a lower index closer to zero signifies more diversified exports.

First, the good news: since 2000, Canada’s exports have diversified more than the average OECD country. However, the bad news is that we remain the least diversified among the G7 countries and the second-least diversified among the 35 OECD countries. In fact, the two NAFTA periphery economies stand out in the figure, and only Mexico has more concentrated exports. In both cases, having the world’s largest economy next door and the highly-integrated continental supply chains built up under the North American Free Trade Agreement have exerted a strong gravitational pull—a pull that should endure, even if it is weakened.

In the new context of increased U.S. protectionism, it’s important to take a longer-term perspective, which reveals that Canadian commerce has been slowly but steadily diversifying away from the U.S. in recent decades. We expect this trend to continue as more Canadian exporters and investors increase their efforts to diversify their global operations. For the time being, it looks like many Canadian companies are viewing increased U.S. protectionism as a wake-up call and are responding by focusing on expanding to new markets.