Going Local in a "Global" World? Principled Free Trade, Mercantilism, and Environmental Protectionism

Going Local in a Global World
by Russ Kuykendall

Since Brian Mulroney and Ronald Reagan's Canada-U.S. Free Trade Agreement (FTA) was signed in 1988, "free trade" has had a kind of rhetorical momentum.¹ The FTA gave momentum to negotiations in favour of free trade in the Uruguay Round (1986-1994) that led to the creation of the World Trade Organization, whose stated "overriding purpose is to help trade flow as freely as possible." The FTA also gave rise to the North American Free Trade Agreement (NAFTA) between Canada, the U.S., and Mexico. This, in turn, signalled the rise or strengthening of trading blocs based on geography: the European Union (EU), the European Free Trade Area (EFTA), the Asia-Pacific Economic Cooperation (APEC) as a promoter of free trade, and, since then, a veritable plethora of free agreements in Europe, the Americas, and Asia.

But while global trade policy has tended to sing from a free trade song sheet, the reality even in countries singing the free trade anthem the loudest is quite different. Political authorities have pursued protectionist trade policy while engaging in free trade rhetoric.

For defence and security contracts, the Government of Canada has a long-standing "Industrial and Regional Benefits Policy (IRB)" that asks companies to "place business activities in Canada at the same value of the contract." Under the policy, Canadian companies are to be afforded "opportunities to develop and competitively sell innovative products and services" with multinational suppliers who win Government of Canada contracts with IRB obligations.

The U.S. Government has a policy similar to the Government of Canada's IRB policy. But on defence and security matters, the U.S. Government also holds to a long-standing policy that significantly constrains which companies qualify as eligible suppliers, and even those that do qualify are limited as to which personnel can work on the contracts. Effectively, this too is a form of protectionism framed as security. And since 9/11/2001, in the U.S. "security trumps trade."

This is a kind of policy adopted by most countries. While it is protectionist on the face of it, we concede that it can be justified under national security concerns.

Even municipalities wade along in this Janus-faced inertia. The City of Calgary, for example, has implemented a "Supplier Code of Conduct" for companies supplying goods and services under contract to the city. The Code of Conduct is focused mostly on labour and environmental practices, and doesn't mention anything like the concerns of the federal IRB policy on obligating suppliers to bring local, economic benefit. The Code effectively bars multinationals from reducing their production costs solely by side-stepping Canadian labour and environmental standards in taking production to jurisdictions without these constraints.

But unlike many municipalities across North America, the City of Calgary has refused to extend tax or regulatory concessions in order to lure businesses to its tax base. So, while the city generally refuses to engage in preferment of local businesses in city procurement, neither does it generally engage in a policy of tax and regulatory concessions in order to lure businesses to its tax base and the local economy. The arguments used to justify a policy of no concessions on one side, and no local favouritism on the other, tend toward what is most advantageous to municipal taxpayers and what will do the most to encourage free market competition.

This brings us to a key tactic for adding caveats to free trade agreements: environmental standards, which were put in place even before the ramp-up of concern in respect to "greenhouse gases" (GHG), "carbon," and "climate change."

Unlike the City of Calgary that generally refuses to offer concessions, the Province of Ontario has aggressively pursued a policy of offering concessions as environmentalism. In January, 2010, the Province of Ontario made a $7 billion deal (renegotiated in August, 2011) with a Korean wind turbine manufacturer in order to expand wind-generated electricity capacity in the province. Meanwhile, Ontario inventor-entrepreneurs struggle to obtain development and pilot funding for "home-grown" wind turbine technology.

The U.S. Government makes wide use of environmental standards enshrined in law and treaties that are configured so as to favour domestic over foreign suppliers. That is, the U.S. Government engages in trade protectionism for its domestic industries under the aegis of environmentalism. We will look at this more later.

On one side, governments that engage in free trade rhetoric will use environmental concerns as trade protectionism, as with the U.S. Government. Or, framed differently, they will use trade and market access to finance their reputations on environmental protection. Other governments, as in Ontario, will use environmental concerns to justify concessions that favour foreign suppliers over homegrown technology.

What would a principled approach to trade look like, grounded in something other than the idea of a radically free market or corporate and national self-interest?

Both Roman Catholic and Protestant political theorists formulated grounds and principles for the free movement of people, goods, and services just prior to the emergence of modern political theory in the 17th century. Two key theorists are the Spanish Catholic and Thomist Francisco de Vitoria (ca. 1492-1546) and the Dutch Protestant and Arminian Hugo Grotius (1583-1645).

Grounding his thought in the ius gentium, the law of peoples, Vitoria argued that "amongst all nations it is considered inhuman to treat strangers and travellers badly without some special cause, humane and dutiful to behave hospitably to strangers."² In a series of propositions and proofs, he further argued that "travellers may carry on trade so long as they do no harm to the citizens . . . any human enactment which prohibited such trade would indubitably be unreasonable."

And:

If the Spaniards were to prohibit the French from trading with the Spanish kingdoms, not for the good of Spain but to prevent the French from sharing in any profits, this would be an unjust enactment, and contrary to Christian charity. But if this prohibition cannot justly be proscribed in law, neither can it be justly carried out in practice, since an unjust law becomes inequitable precisely when it is carried into execution. And "nature has decreed a certain kinship between all men" (Dig. 1.1.3), so that it is against natural law for one man to turn against another without due cause, man is not a "wolf to his fellow man," as Ovid [actually Plautus, Asinaria 495], says, but a fellow.

That is, the law of peoples in respect of the treatment of strangers obligates political authorities to permit foreigners to engage in trade in their jurisdictions.

Considered by some to be the father of international law, the protomodern political theorist Hugo Grotius argued along lines similar to the Salamanca School founded by Vitoria. In his The Rights of War and Peace (1625), Grotius argued for the relations between people to be governed by treaty and agreements that recognize the freedom of the seas and seaways so that people from other jurisdictions may trade freely.³

So, the general principles are these:

1. Grounded in the law of peoples on the treatment of the stranger, people and goods should be permitted to move freely across political jurisdictions; and

2. In order to guarantee the free movement of people and goods across political jurisdictions, political authorities must engage in treaties and agreements to govern relations across jurisdictions.

Now, we turn to an argument that is suggestive of how reality is structured.

Regarding special concessions to anyone, foreign or domestic, in his Wealth of Nations (1776) Adam Smith argues against them with considerable verve. For centuries, the English Crown had pursued a policy of concessions that even extended to monopolies over certain kinds of trade. As Smith writes, politicians of the day are using the long-standing policy of the Crown's granting trade concession monopolies to enrich themselves. Smith coined the term, "mercantilism," to describe the long-standing practice of concessions and protectionism which held sway not just in England and Britain, but across Europe.

For mercantilists, trade was warfare by other means. That is, under a policy of mercantilism, it was incumbent on countries to pursue a policy of trade interventionism in order to privilege domestic industry and business in the promotion of economic as well as national and political interests. On trade, the mercantilist objective of political authority was to pursue policies that discouraged imports and encouraged exports, in order to, as much as possible, achieve a balance of trade that favoured one's political jurisdiction.⁴

But Smith observed and argued that a law of unintended consequences resulted. Instead of discouraging imports and encouraging exports, mercantilist political authorities tended to pursue policies that discouraged exports and encouraged imports. His arguments suggest that much as nature abhors a vacuum, so the structure of reality overturns the best of mercantilist intentions.

Smith points to the centuries-old concessions given to the makers of wool textiles. One might have expected that a made-in-England mercantilist policy would have discouraged wool imports and encouraged wool exports. But the various concessions tended to bar exports of wool in order to give wool weavers (owners of the looms) a secure supply of wool at a favourable price. Also, the weavers were guaranteed few obstacles to imports of uncarded wool fibre from off-shore, which would further tend to depress the price of wool. Imports of "wool cards" that were used to process wool into wool fibre that could be spun into wool yarn were banned, which tended to limit entry into the weaving business. Importation of any foreign wool textiles was prohibited. Export of English sheep, lambs or rams was prohibited to avoid the propagation of English varieties off-shore, under pain of forfeiture, imprisonment, cutting off the offender's hand, or even on pain of death. Finally, buying and selling of wool within ten miles of the English coastline of Kent and Sussex was severely constrained.

In short, the various wool concessions favoured the weavers over sheep farmers and over the consumers of wool textiles (the English population).

The stated objective of mercantilist policies on English wool was to give English weavers a global monopoly on the wool trade. But Smith points out that the finest wool textiles were made from Spanish wool which would be degraded if mixed with English wool. As a result, Smith argues, the price of wool was artificially depressed far below what it had been in the time of Edward III, centuries before. When Scottish wool was brought under English wool mercantilism by the Union of England and Scotland, the price of Scottish wool fell by one half.

That is, Smith argues that the unintended consequence of mercantilist policies on wool, intended to bolster the price of English wool, severely depressed the price of English wool "generally below what wool of a very inferior quality commonly sells for in the market of Amsterdam." Further, the artificially induced price depression, Smith argues,

must have reduced very much the annual produce of that commodity . . . below what, in the present state of things, it would probably have been, had it, in consequence of an open and free market, been allowed to rise to the natural and proper price.

Smith goes on to argue that, over time, wool mercantilism also tended to lead to a degradation in the quality of English wool, and to an increase in smuggling of wool to markets with higher wool prices, thus depriving the English treasury of revenue.

Smith's zeroing in on wool production for his arguments against mercantilism is not accidental. The significance of wool production to the English economy is indicated by the prominence of "the wool sacks" in the House of Lords chamber at Westminster, even today. A contemporary parallel—particularly for Canada—is energy production and, especially, the production of oil. So, do Smith's anti-mercantilist arguments in respect of England's 18th  century wool trade stand up when applied to Canada's oil trade?

Four mercantilist policies on the oil trade are particularly notable. Two of these have already been tried and we can see the effects: Canada's National Energy Program (NEP) in the 1980s and the U.S. leaded-gasoline standard to which Canadian policymakers agreed in the 1970s. The other two are widely discussed but not implemented and parallel the two earlier policies: the Canadian policy against the export of raw bitumen and the so-far-not-implemented U.S. cap-and-trade policy, as described under the Waxman-Markey bill which appears to have died.

The stated intent of the NEP was "a made in Canada" price for each barrel of oil produced in Canada. One unstated consequence of this policy was a revenue windfall to the federal Canadian treasury from oil exported and sold at the world price which at the time was approximately double the NEP price or more. A second unstated consequence was to give Canada's industrial heartland in Ontario and Quebec a source of cheap and plentiful oil. However, the over-arching unintended consequence of this policy was to bring development of known Canadian oil reserves, let alone exploration, to a screeching halt. Directly linked to this was the unintended consequence of severely shrinking the Alberta oil economy, turning a boom economy into a "bust."

As a result, exploration, drilling, and service equipment left Canada for climes whose oil industry had access to the world price for oil. As Canada's oil industry activity ground to a halt and the flow of investment was stanched, secondary suppliers to the industry no longer had a market for their goods and services. The loss of ongoing investment in Canada's oil economy affected industrial, commercial, and residential construction as well as demand for all kinds of retail goods and services.

The unintended consequences for the Canadian economy were not limited to the oil economy. Canada's manufacturing economy was affected as well. Elsewhere in the world, manufacturers made capital investments in improved equipment, manufacturing processes, and more sophisticated marketing in order to increase productivity and to grow market demand for their products and, by extension, to increase sales, revenues, and profitability. Canada's domestic manufacturers, initially at least, realized increased profitability, not from higher productivity and market demand, but because they could sell their products with a profit margin artificially subsidized by a made-in-Canada price for energy from oil. However, as Canadian manufacturers failed to make capital equipment, manufacturing processes, and marketing investments, they realized lower productivity, lower demand, and lower prices for Canadian-manufactured products. The reluctance of Canadian manufacturers to make these investments has seemingly been institutionalized as the Canadian way, some twenty-five years after the reversal of the NEP as Canada returned to the world price for domestically produced oil.⁵

The U.S. switch from leaded to unleaded gasoline in the 1970s is a relatively early example of engaging environmentalist regulations as a form of trade protectionism—"environmental protectionism." By signing on to the U.S. leaded-to-unleaded gasoline conversion in the 1970s, the Government of Canada effectively barred the export of Canadian-refined, fuel-tank-ready, "finished" gasoline to the U.S. from its implementation right up through the present. Further, Canadian purchases of U.S. leaded gasoline allowances under the leaded gasoline cap-and-trade scheme meant that Canadian producers largely financed U.S. refiners' costs on refinery plant modifications, and less than 30 per cent of the cost of U.S. allowances was passed on to U.S. retail customers. Now, only "partially refined" fuel is exported to the U.S. where the refining is completed, and finished gasoline is produced. As a result, Canada's overall gasoline refining capacity continues to shrink.

Even when the U.S. Government has tightened environmental standards for domestic supply, it leaves exports unaffected. At least two diesel refineries in the Deep South are taking delivery of, and running at full capacity on, synthetic crude from the Alberta oilsands. Oilsands synthetic crude (upgraded bitumen) is a near-perfect feedstock for refineries producing ultra-low sulfur diesel. U.S. refineries in the Deep South are running at full capacity to refine oilsands synthetic crude into ultra-low sulfur diesel for sale and export to the European Union market. Meanwhile, other U.S. plants refine domestically produced light crude to produce conventional, high-sulfur diesel for export and sale to Asian markets.

That is, when U.S. environmental regulations target products sold in the U.S. domestic market they generally don't tie the hands of U.S. producers selling to foreign markets products that are not permitted for sale domestically. Canadian environmental regulations, however, tend to limit both what may be produced and sold in Canada.

The U.S. has also done this with CFCs and SO2 regulations. Ironically, while Brian Mulroney was seen as something of a thorn in Ronald Reagan's side on SO2 emissions and "acid rain," the policy adopted in both countries meant that Canadian suppliers to the U.S. market effectively helped cover the cost of the SO2 cap-and-trade policy to U.S. industry in a way similar to the leaded gasoline standards.

That brings us to the "back-burnered" Waxman-Markey cap-and-trade policy, or anything like it. Taking a cue from Waxman-Markey and given the right political environment, the U.S. Congress might well enact GHG cap-and-trade legislation and regulations. Any GHG cap-and-trade legislation would almost certainly be designed to preserve privileged, domestic access to the U.S. domestic market while setting a higher bar for foreign suppliers. Foreign suppliers would effectively be required to pay or defray the costs to U.S. industry on compliance by renting (but not purchasing outright) U.S. quota, or transferring Canadian quota outright, for the privilege of supplying GHG-producing products—namely, imports of Canadian oil—to the U.S. market.

With the full cooperation of U.S. industry, the U.S. Government might well pursue a policy of trade protectionism passed off as an environmentally enlightened and responsible GHG policy while engaging in a free trade rhetorical flourish.

Finally, some analysis of the potential consequences of a policy against exports of "raw bitumen." First, some top-level explanation on bitumen extraction and refining. "Bitumen oil" is extracted in two ways. Bitumen was first extracted by way of open pit mining with mammoth shovels and trucks that take the bitumen sand from the pit to plants that separate the bitumen from the sand and upgrade it into synthetic oil, also known as "synbit." The second method of extraction is in situ: pumping natural gas-generated steam underground into the bitumen to separate the bitumen from the sand and, in turn, pumping the liquefied bitumen oil to the surface where, in its turn, it is pumped to upgraders for further "upgrading" or refining. The in situ process itself partially upgrades or refines the bitumen even before it goes to an upgrader plant to be refined into synthetic oil or, again, "synbit."

Canada's bitumen is exported in two forms: either as synbit, or as "dilbit." Typically, dilbit is the partially upgraded, in situ product that is combined either with synbit or with "diluents" which allow the partially upgraded product to flow freely through the pipelines for domestic transport to Canadian refineries or for export. Canadian producers do not export raw bitumen.

However, some critics of the oilsands describe the partially upgraded, in situ product—"dilbit"—as "raw bitumen." If Canadian policymakers were to define dilbit as raw bitumen, and to formalize and to implement an embargo on exports of dilbit, what might be some of the consequences? The intended consequences of this mercantilist policy would be to generate greater domestic, "valued added" economic activity and job creation from requiring all bitumen extracted to be fully upgraded into synbit on Canadian soil prior to export. However, we can identify some potential, unintended consequences:

1. Canadian capacity to upgrade bitumen partially upgraded in the in situ process could not expand immediately in order to fully upgrade existing bitumen extracted in situ into synbit. This could effectively create a bottleneck between production and export which would likely see a scaling back of in situ bitumen extraction to line up with available upgrader capacity.
2. Production expansion could, therefore, shift from in situ extraction—with a small footprint—to a renewed emphasis on open pit mining extraction with a much larger footprint on the landscape.
3. At least in the short to medium-term, Canada's oil production and industry would shrink with significant consequences for other Canadian sectors that produce steel and other goods for the industry. This would result in unemployment in industrial construction as well as oil extraction, and the attendant reduction in tax revenues for the Alberta and Canadian federal treasuries.
4. As Canadian exports slowed in line with reduced upgrader capacity, there would be less availability of Canadian bitumen oil to the U.S. market which, in turn, might well increase imports of—and reliance on—Venezuela heavy oil and Saudi Arabia heavy oil to U.S. refineries. When oilsands bitumen is refined into gasoline, its lifecycle GHGs are comparable to the lifecycle GHGs from the refining of California, Venezuela, and Saudi Arabia heavy oil.⁶ But when oilsands bitumen is used optimally—as a feedstock to be refined into ultra-low-sulfur diesel, its lifecycle GHGs are considerably lower than California, Venezuela, and Saudi Arabia heavy oil. So GHG emissions might very well rise if Canada implemented such an embargo.

Would Canadians embrace an embargo on "raw bitumen" (that is, "dilbit") exports with these unintended consequences?

Some lessons:

1. Governments' rhetorical flourish on free trade is frequently inconsistent with their protectionist practices.
2. Certain protectionist practices can be justified under the aegis of national security.
3. Special concessions designed to protect certain economic sectors—mercantilism—have unintended consequences that can undercut the intended consequences of the concessions, and may do more harm than good even to the sector they set out to protect.
4. High-toned environmental standards can be—and frequently are—used to simultaneously engage in trade protectionism and to require foreign suppliers to pay for the implementation of domestic, environmental policy—environmental mercantilism.
5. Environmental mercantilism, too, can have unintended and harmful effects for the regulated sector and for the environment the regulations are intended to protect.
6. Insisting on "value added" economic activity is, too, a form of mercantilism with, again, unintended and harmful effects for the regulated sector and for the environment from which the product is extracted, as with bitumen crude oil.

To summarize, a principled approach would have the free movement of people and goods grounded in the law of peoples and the treatment of the stranger, structured by treaties between political jurisdictions. Further, as Smith's arguments suggest, principled freedom of movement of people and goods is embedded in the structure of reality as we know it, with all-too-real consequences for economies overseen by governments that attempt to overturn or subvert that structure with mercantilist trade policy of any kind.

Notes:

1 See "Free Trade @ 20," Policy Options (October 2007) .

2 "Francisco de Vitoria." In Oliver and Joan Lockwood O'Donovan, From Irenaeus to Grotius: A Sourcebook of Christian Political Thought, A.D. 100 to A.D. 1650. Grand Rapids, Mich.: Eerdmans, 1999, pp. 626ff.

3 Proposition XIII, "The General Rights of Things." In The Rights of War and Peace, Chapter II.

4 "Conclusion of the Mercantile System," Wealth of Nations, Book IV, Chapter VIII.

5 An undervalued Canadian dollar through the 1990s meant that Canadian manufacturers could persist in lower productivity, without making capital equipment and marketing investments, since the low Canadian dollar meant their products undercut the world price.

6 Tiffany Groode, Rob Barnett, and Samantha Gross, From Well to Wheels: Life-Cycle Greenhouse Gas Emissions of Various Sources of Crude Oil. A Cambridge Energy Research Associates (CERA), October 2nd 2009. Found at: https://client.cera.com/aspx/cda/client/report/report.aspx?KID=11&CID=1064, January, 2010. The CERA study claimed GHG emissions from Alberta oil sands bitumen oil is about 10 per cent higher than the average of well-to-wheels, GHG emissions from all heavy oil produced globally. On average, GHG emissions from oil production are 20 per cent of the total. For oilsands heavy crude, the production GHG emissions are about 25 per cent of the life-cycle total.