Extracted from Statistics Canada
The most spectacular manifestation of globalization, which has occurred since 1990, is the increase in foreign direct investment (FDI). In 2001, world FDI (outward flows) amounted to US$ 735 billion, which is 2.3% of world GDP, 10% of the goods and services exports, and 11% of the gross fixed capital formation of the world economies (OECD). This trade in capital has resulted in increased economic integration for those countries and sectors engaged in FDI. One of the major planks of Canadian agricultural policy is the expansion of agricultural and food exports. Growth in exports is believed by the government of Canada to lead to a growth in farm income.
In Canada, increased exports are most often associated with an economic environment of low trade protection, high levels of public and private sector investment in research and development, and a favorable exchange rate with one’s major trading partners. What has not been considered in the policy debate is the relationship between trade and FDI. This report examines three trade and FDI relationships between Canada and the United States. First, we determine the impact of U.S FDI on growth in Canadian agriculture and food exports to the United States. Second, we examine the role FDI plays in determining Canadian agriculture and food imports from the United States. This allows us to measure the impact that U.S FDI has on U.S exports. Finally, we examine the effect of FDI on total agriculture and food trade between Canada and the United States.
Multinational corporations (MNCs) are central to any discussion of economic integration of the United States and Canadian agriculture and food sector because they play a large role in agricultural trade and capital investment. First, approximately 90% of Canada’s total trade involves at least one MNC (Trefler, 2001). A comparable figure has never been estimated for the agricultural and food trade, however, we expect that the percentage of trade associated with MNCs is large. Second, most if not all FDI in the Canadian agriculture and food sector is made by MNCs. A detailed study of FDI in Canada, by Hejazi and Safarian, demonstrated just how important inward FDI has been to the growth in the Canadian economy. The actual investment made by MNCs in the Canadian agriculture and food sector is collected but it is not published as it would compromise the confidentiality of firms providing the data.
The United States and Canada are each other’s largest trading partners, which also holds in the case of agriculture and food trade. In 2002, total trade between the United States and Canada was approximately US$ 2 billion per day (Statistics Canada). This trade relationship makes the Canada-United States border an interesting empirical example of the relationship between product trade and FDI in the agriculture and food sector for at least three reasons. First, the growth in trade has occurred at the same time as U.S. FDI has increased in the Canadian agriculture and food sector. Second, there are several on-going agricultural trade disputes between the two countries including, challenges to the Canadian Wheat Board and dumping charges brought against the tomato and beef industries. One might expect this type of trade action to reduce the level of trade between countries. Third, some parts of the agriculture sector in both Canada and the United States are highly protected from foreign competition through various trade measures. Some of these measures include tariffs on dairy products, sugar, health restrictions on meat products, and restrictions on the volume of Canadian wheat exported to the United States. Given the importance of the trade relationship between the two countries, the level of U.S. FDI in the Canadian agriculture and food sector, and the on-going trade disputes, this sector offers a prime opportunity to empirically test how product trade is related to FDI.
We use trade theory in developing an economic framework to examine the relationship between agriculture product trade and international capital movements. The relationship between product trade and FDI was not established in the early Ricardian or Heckscher-Ohlin trade theory. Mundell (1957) was one of the first economists to address the issue of trade in goods and services and international capital movements. Mundell (1957) demonstrated, within the Heckscher-Ohlin framework, that product trade and international capital movements are substitutes. Later Schmitz and Helmberger (1972) expanded Mundell’s model, through relaxing the assumption of factor immobility, identical production functions, and consumer preferences, to show that product trade and FDI could in fact be complements rather than substitutes.
A second trade theoretical approach, which can be used to explain the linkage between product trade and FDI is due to the work of Bhagwati (1985). Bhagwati (1985) drew a link between the actions of firms that undertake FDI and the setting of trade policy by foreign governments. In his view, MNCs invest in foreign countries with the intent of exporting from the host country as well as the desire to service the local market. Bhagwati’s view was that firms might invest in a foreign country with the expectation that they will convince the host government to lower the level of trade protection. This phenomenon is called the ‘quid pro quo’ of FDI. One can extend Bhagwati’s view to include the effect of FDI on the trade policy of the home country. If a firm makes an investment in a foreign country with the intent of exporting the production of the foreign plant back to the home country, they will lobby both the home and foreign government for policies that make the investment more profitable, such as reduced tariffs. Reducing tariffs will result in a higher level of trade and economic welfare for the firm making the investment.
The majority of empirical studies that measure the effect of FDI on the level of trade contemplate firms having access to final consumer demand, such as the case in the market for automobiles (Blonigen and Feenstra, 1996) and for industrial products (Goldberg and Klein, 1999). However, FDI also occurs for the purpose of securing raw and exporting semi-processed materials. In this case, firms are not only concerned with the size of the consumer market in the host country, but also the ability to export back to their home country raw or semi-processed products, which are inputs for another production process. This suggests that the total volume of trade between two countries maybe effected by FDI rather than just the exports.
United States FDI in the Canadian agriculture and food sector is an example of where investments are made with the intent of re-exporting product back to the home country. Canada has a small domestic market for agricultural and food products, but exports large quantities of primary and semi-processed agricultural products to the United States. Consider the Canadian cattle industry. All of the live cattle exports from Canada go to the United States. In addition, the processing of cattle in western Canada is dominated by two large United States based firms, Cargill Inc. and Iowa Beef Packers Inc., with the majority of the Canadian semi-processed beef (i.e., boxed-beef) exported to the United States market. In 2002, U.S. feeder cattle were moving into Canada to be processed with the semi-processed product reexported to the United States. Once in the United States this product can be re-exported or consumed domestically. This is an industry where the FDI by U.S. companies in Canada affects the total volume of cattle trade and meat trade.
The purpose of this paper is to investigate the relationship between the level of United States – Canada agricultural product trade and U.S. FDI into the Canadian agriculture and food sector. We use FDI as well as other economic variables, such as the exchange rate, to explain product trade rather than Ricardian or Heckscher-Ohlin trade theory. We have two hypotheses. Our first hypothesis is that the level of agricultural trade is positively related to the level of FDI, i.e. trade and FDI are complements. To our knowledge no one has examined the impact of US FDI on Canada-US agricultural and food trade. Our second hypothesis is that the level of agricultural trade is endogenously determined with the level of FDI. The only study we know, which has examined the question of endogeneity is Martinet, Cornell, and Koo (2002).
To test the two hypotheses we construct a panel data set of Canada-U.S trade and FDI in six agriculture and food sectors (3 digit SIC code level), over the period of 1987 to 2001. The United States is treated as one country, which exports and imports products in all six SIC codes and makes FDI in the six code sectors. In addition, we develop a data set of other economic variables, such as exchange rates, GDP levels, and government R&D expenditures.
Based on the econometric results we do not reject the two hypotheses. First, we do not reject the hypothesis that agriculture product trade and FDI are complements. We find that product trade and FDI are complements for all SIC codes. As U.S. FDI increases in a sector the level of trade between Canada and the United States increases. Second, we do not reject the hypothesis that agricultural trade and FDI are endogenously determined in the economy.
The major limitation of this paper is that data on FDI is limited. What is available is reported in terms of net year-end capital positions or the accumulated net stock of FDI since 1987 when the data was first collected and not gross flows between firms. Finally, we were not able to separate merger and acquisition FDI from Greenfield FDI. Therefore, our results are only a first indication of the relationship between trade and FDI. More definitive results will have to wait a more comprehensive data source.
