July 2006: NAFTA's Broken Promises

Record shows “free trade” has been detrimental for most Canadians
July 1, 2006

The impact of the Canada-U.S. Free Trade Agreement and the North American Free Trade Agreement should be measured against the only standard that ultimately counts when evaluating public policy: has “free trade” bettered the lives of the people affected by it?

The answer is that not only has NAFTA failed to deliver the goods it promised, but its cumulative effect on the well-being of a large majority of Canadians, and on the social cohesion of our society, has been negative. While personal income growth under free trade has registered its worst performance of any comparable period since World War II, income inequality (after tax and transfers) has increased for the first time since the 1920s.

It is important at the outset to state that NAFTA alone is not to blame. The culprit is the neoliberal—or market fundamentalist—agenda that has dominated policy-making in Canada. NAFTA is a central component and locking-in mechanism of a package of mutually reinforcing policies—including tax and public program cuts, privatization, deregulation, and monetary austerity.

The most striking feature of the growing inequality driven by this agenda has been the massive gains of the richest 1% of income earners at the expense of most of the population. The growth of precarious employment, the undermining of unions as a countervailing power to transnational capital, the erosion of the Canadian social state, and heightened economic dependence on the U.S.—all are additional hallmarks of the free trade era in Canada.

NAFTA is about much more than deregulating trade. It is about removing restrictions on the mobility of capital. It goes way behind the border to the heart of domestic policy-making. It is an economic constitution, conferring enforceable rights on investors, limiting the powers of government, and making it extremely difficult for future governments to change. At its core, NAFTA is about shifting the power in the economy from governments and workers to corporations.

The actual effects of free trade must be evaluated against the claims made by its Canadian proponents. Among the benefits they promises were:

  • increased economic growth, income and employment—rising living standards that would be widely shared across all sectors, regions and income groups;
  • the closing of the long-standing productivity gap with the U.S. and the creation of a more diversified, more efficient, and more knowledge-based economy; and
  • the ability, with the promised stronger economy, to maintain and strengthen the unique features of the more generous Canadian social programs.

Economic integration has deepened in the wake of the CUFTA and NAFTA. Two-way trade and investment flows have grown immensely. Exports as a share of Canada’s GDP grew from 25% to about 40%. Canadian manufactured exports grew from one-third to over one-half of total output. Conversely, almost one-half of the Canadian market for manufactures is now met through imports. One-half of all bilateral trade is conducted between the American and Canadian sections of the same industries—even more in the manufacturing sector.

But expectations that Canada would become a magnet for foreign direct investment (FDI) from companies wanting to export into the U.S. market have not materialized. Canada’s share of inward FDI flows to North America dropped from 17% to 13% during 1993-2004. Indeed, the outflow of Canadian direct investment abroad (including to the U.S. and Mexico) exceeded foreign direct investment inflows by one-third during this period.

Much has been made of Canada’s NAFTA-driven trade success, but the reality does not live up to the hype. Canada’s merchandise trade surplus with the U.S.--which grew from $48.6 billion in 1996 to $124.6 billion in 2005—is less than meets the eye.

According to Statistics Canada researchers, much of the growth in gross exports over the last decade reflected the markedly elevated use by Canadian-based companies of imported inputs in their production, significantly overstating the employment impact of the growth of manufactured exports. (For example, more than one-half of auto inputs are now imported.)

Furthermore, oil and gas exports alone accounted for close to 40% of the rise in exports to the U.S. over the last 10 years, and during the current resources boom (2003-05) accounted for 62% of the increase in exports to the U.S.

Several other inconvenient facts contradict the claims of NAFTA-driven trade success. First, there is no evidence of Canada gaining special U.S. market advantage under NAFTA. In fact, Canada’s share of U.S. imports actually fell after 1994. Second, a federal Industry Department study found that by far the largest factor--accounting for 90% of the 1990s export surge--was the low Canadian dollar. Finally, another Industry Department study found that the import content of Canadian exports increased to the point where, by 1997, more jobs were being destroyed by imports than created by exports.

Contrary to the promise of free trade proponents, diversification of Canada's industrial base has been disappointing. Although there was an increase in some high-tech sectors, notably telecommunications (until the 2001 meltdown) and aerospace, the trade deficit in high-tech products remains high, the capital goods sector remains weak, and Canada's poor record in private sector R&D persists. Relative to GDP, Canada’s exports of higher value-added products--including autos, machinery and equipment, and consumer goods--have fallen by one-quarter since 1999. Ironically, NAFTA eliminated many of the policy tools that could help shift competitive advantage to more knowledge-intensive activities.

Restructuring in the Canadian manufacturing sector has been far-reaching. By 1997, 47% of the plants in existence in 1988, accounting for 28% of the jobs, had closed. On the other hand, 39% of all plants in 1997, accounting for 21% of all jobs, did not exist in 1988. The plants that closed tended to be larger, higher-productivity plants, and those that opened were smaller, lower-productivity establishments. This helps to explain the continuing manufacturing productivity gap.

Big business, by and large, has done well under free trade. A study of 40 non-financial member companies of the Canada’s main big business lobby, the Canadian Council of Chief Executives, found that their combined revenues jumped 105% during 1988-2002, while their overall workforce shrank by 15%.

Free trade was sold as a solution to Canada’s persistent unemployment problem. Though there are other factors at play, the record does not bear this out. Average unemployment during the last 15 years has remained about the same as the average rate during the previous 15 years. Canada’s unemployment rate was 6.8% in 2005, modestly lower than the 7.6% in 1989 (1.2 million workers are currently looking for work). This compares with U.S. unemployment, which was 5.1% in 2005, slightly below the 5.3% level in 1989.

Nor has the promise of increased employment quality--high skill, high-wage jobs--under free trade materialized. On the contrary, displaced workers in the trade sectors have moved to lower-skill, lower-wage jobs in the services sector. Precarious forms of employment (part-time, temporary, and self-employment) have also increased, disproportionately impacting women and workers of colour.

As for the productivity gap with the U.S. that was, according to proponents, supposed to narrow under free trade, it has instead widened. Canadian labour productivity (GDP per hour worked) rose steadily in relation to U.S. productivity during the 1960s and 1970s, peaking at 92% of the U.S. level in 1984. Thereafter, it slid to 89% in 1989 and by 2005 had fallen to just 82% of U.S. productivity--below where it was in 1961.

Despite slower (almost flat) wage growth in Canada, labour cost competitiveness (unit labor costs) expressed in Canadian dollars deteriorated significantly compared to U.S. costs. It was only the depreciation of the Canadian dollar that preserved cost competitiveness. Unit labour costs expressed in U.S. dollars fell 19.7% in Canada compared to 7.2% in the U.S. during 1992-2002. Since then, this advantage has been eliminated by the 40% appreciation in the Canadian dollar.

If free trade was supposed to usher in a new era of rising living standards, reversing the sluggishness of the 1980s, the record reveals quite the opposite. Annual growth in average personal income per capita fell to a plodding 1.55% per annum in the 1980s, from the rapid 3.9% annual average gain during the 1960s and ‘70s. During 1989-2005, personal income per capita growth continued its slide to a snail’s pace of 0.63% yearly. What is particularly striking is that GDP per capita was growing almost three times faster--1.57% annually--than personal income. While U.S. GDP per capita grew at an annual rate of 1.80%, slightly faster than the Canadian rate, U.S. personal income per capita grew at an annual rate of 1.05%, almost twice as fast as the Canadian rate during 1989-2005.

Compared to American performance, Canadian GDP per capita fell sharply--from 86% of the U.S. level in 1989 to 81% in 1992. From 1997 to 2002--a period of economic recovery driven in large part by a low dollar and strong U.S. demand for Canadian exports--it rose to 87% of the U.S. level. However, personal income per capita experienced no such recovery. It fell precipitously from 89% in 1990 to 78% of the U.S. level in 2000, where has remained to the present.

The growing divergence between the ability of GDP and personal income per capita to keep pace with American performance after 1996 is explained by the massive cuts to social programs, the increased share of the national income pie appropriated by profits and interest income, and the stagnation of wage income during this period. Only those at the top of the income scale saw significant growth in their earnings. It is dramatic evidence of how NAFTA-driven integration had altered relations of power between labour and capital, between state and market in the Canadian economy.

This “structural adjustment” should come as no surprise. It is what NAFTA was designed to do.

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Canada’s social model differs significantly from that of the U.S. Canada has a more equal distribution of earnings, reflecting higher unionization rates, higher minimum wages, and a smaller pay gap between the middle and the top of the earnings spectrum. It has a more progressive tax system and a more generous system of social transfers.

Thus, while the average disposable income in the U.S. is higher than in Canada, the bottom third of Canadians are much better off than their U.S. counterparts. The gap between middle-income Canadians and Americans is small, particularly if adjusted for out-of-pocket health care costs. It is only among the richest third where the disposable income of Americans is much greater than that of their Canadian counterparts. The after-tax-and-transfer income gap between the top and bottom 10% of families is 4:1 in Canada compared to 6.5:1 in the U.S. The poverty rate (defined as less than two-thirds of the median income) is 10% in Canada compared to 17% in the U.S.

That said, however, growing wealth and income inequality and a shrinking Canadian social state have been hallmarks of the free trade era. NAFTA, while adding pressure, does not mandate this kind of harmonization downward to the U.S. social model, nor is it inevitable. But NAFTA competitiveness considerations have provided a pretext for the tax-cut and “smaller government” agendas of our neo-con provincial and federal governments.

After four decades of narrowing the income gap in Canada, after-tax-and-transfer family income inequality has widened during the free trade era. The bottom 20% of families saw their incomes fall by 7.6% during 1989-2004, while the incomes of the top 20% of families rose 16.8%.

The top 1% of Canadian taxpayers--similar to their American counterparts--increased their share of total taxable income from 9.3% to 13.6% during the first free trade decade, 1990-2000. The top 0.1% increased their share even more sharply--from 3% to 5.2%. This development is due in large part to pressure from deepening integration with the U.S., where income inequality is much greater, and where Canadian senior executives can move more freely across the border. Subsequent U.S. tax cuts under the Bush administration for the highest income earners have likely aggravated this situation.

The income comparisons are even starker. While the average Canadian wage increased 8% during 1990-2000, the average earnings of the top 1% of wage earners jumped 64%. Incomes of the top 0.1% soared by 100%. This latter group’s earnings--which were 23 times greater than those of the average wage earner in 1990--had almost doubled to 43 times by the end of the first free trade decade.

Recent research on inequality confirms that, while increases in market income inequality during the 1980s were--in contrast to the United States--fully offset by the tax and transfer system, large increases in market income inequality in the 1990s were not offset to nearly the same degree. Transfers had no effect on reducing market inequality growth, and taxes had only a small effect in reducing the increase. The result is that, in the first free trade decade, overall income inequality increased--for the first time since the 1920s.

Tracking wealth trends in the free trade era is difficult because infrequent Statistics Canada’s wealth surveys preclude precise benchmarks. The latest was in 1999 and before that 1984. Nevertheless, the changes from 1984-99 contrast starkly with the period 1970-84. For example, the bottom 10% of families increased their average wealth 28% during 1970-84, but their average wealth fell 78 % in the 1984-99 period. Meanwhile, the average wealth of the richest 10% of families rose 51% during 1970-84, and continued to rise, by 47%, during 1984-99. To the extent that wealth trends mirror trends in income distribution, the free trade portion of that period would likely have seen the steepest rise in wealth inequality.

Unionization rates also dropped, another sign of the eroding bargaining power of workers in the free trade era. The most trade-exposed manufacturing sector experienced the steepest decline, from 45.5% in 1988 to 32.6% in 2003. This reflects disproportionate closures of unionized plants and a disproportionate concentration of new hiring in non-union plants; it also reflects legislative attacks in key jurisdictions on organizing capability. The decline in union density overall, though not as steep--39.5% to 32.4%--is ongoing and is evident across all sectors of the economy.

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If the first half of the 1990s saw the most intense restructuring of the corporate sector, the second half of the decade saw the “structural adjustment” of the public sector. Federal non-military program spending cuts were the largest in Canadian history, bringing spending down to the level of the late 1940s. Canadian governments collectively reduced their program spending from 41% to 32% of GDP from 1992 to 2005. Governments reduced transfers to persons from 11.5% of GDP to 7.8% of GDP during this period. The cuts were accompanied by a major re-engineering of government—through privatization, deregulation, and decentralization.

Reversing its pre-free-trade promise, the big business lobby pushed hard for personal and corporate tax cuts on the grounds that they were necessary to maintain competitiveness, attract investment, and fuel growth. The federal government complied with major tax cuts, which shrank federal revenue as a share of GDP from 17.2% in 1997-98 to 15.4% in 2004-05, representing a loss to the federal Treasury of $20 billion in the latter year. Provinces also cut taxes, the combined effect of which was a loss to provincial treasuries of $30 billion in 2005. The benefits of the tax cuts were tilted to high-income groups and to the corporate sector, despite the fact that lower-income groups had borne the brunt of the program cuts. Canada has dropped in the OECD ranks from a middle-level taxation country to the bottom third of OECD countries in terms of overall taxation level.

Business also changed its tune around social programs once CUFTA was passed, arguing that cuts--especially welfare and unemployment insurance--were necessary to create a level playing field of competition. The largest of the unemployment insurance cuts were made by the Liberal government under cover of deficit elimination, but were also part of a strategy to increase labour market “flexibility.” This was done by reducing the eligibility criteria and by reducing the duration and amount of benefits. The proportion of unemployed people who qualified for unemployment insurance dropped from 75% in 1989 to 38% by 2002, about the same level as in the U.S. Hardest hit were the most vulnerable workers: part-time, casual, and seasonal--mainly women.

The federal government also slashed welfare transfers to the provinces, breaking its 50-50 cost-sharing commitments under the Canada Assistance Program. Most provinces, in turn, slashed welfare support payments and bumped hundreds of thousands of people off the welfare rolls altogether.

Canadian governments still spend significantly more on social programs and public services than their American counterparts, but the difference has been shrinking rapidly. A federal Finance Department study found that Canadian governments’ (non-military) program spending fell from 42.9% of GDP in 1992 to 33.6% of GDP in 2001. This compares with U.S. (non-military) program spending, which increased marginally from 27.7 to 27.9% of GDP during this period. The gap in non-military spending between the two countries--5.7 percentage points of GDP in 2001--is down dramatically from a gap of 15.2 points of GDP in 1992. Thus, if Canadian governments were still spending at 1992 levels, they would have spent an additional $103 billion on programs and public services in 2001 alone.

Canada now spends proportionately less than the U.S. on public education, and only slightly more on health care (though more efficiently because of not-for-profit delivery and a single payer Medicare insurance system.) It continues to spend substantially more on income security and, though the gap has shrunk in half, more on housing and community services.

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Canada’s economic and political élites promised that “free trade” would usher in a golden era of prosperity for Canada. It clearly has not delivered the goods. Nevertheless, these élites simply disregard the “inconvenient facts” presented here as they push for even deeper forms of continental free market integration. NAFTA, they claim, has greatly increased exports and investment; Canada’s trade surplus is up, unemployment is down, inflation is low, wages are flat, business is experiencing record profits, growth is steady. Therefore NAFTA has been a success. What is there to re-examine? Let’s just move forward, they say, and build on our success.

Instead of continuing down this road, however, it is time to look back at the road already travelled. We should undertake a comprehensive assessment of NAFTA’s costs and benefits, and take a hard-headed look at the advantages and disadvantages of withdrawing from NAFTA. It is time to stand back and ask: is NAFTA working for us? Do the benefits outweigh the costs? Is it serving our needs? It is time to reconsider whether NAFTA is contrary to the well-being of Canadian workers (and indeed of workers in all three NAFTA countries) as the overarching framework for managing North American economic relations.

(Bruce Campbell is Executive Director of the Canadian Centre for Policy Alternatives. He based much of his critique of NAFTA on research developed by Andrew Jackson, chief economist at the Canadian Labour Congress. This article is adapted from a paper Bruce delivered recently in Washington at a tripartite—Canada, U.S., and Mexico—conference on NAFTA sponsored by the CCPA’s U.S. counterpart, the Economic Policy Institute. The complete text, with all sources and references will be available in late September.)