Could Canada’s Recent Tariff Increase be “Pro-Trade”?

Colin Simkus

Canada Tariff Increases Under Finance Minister Jim Flaherty

As Finance Minister Jim Flaherty tours Asia to promote Canada’s economic stability, questions have arisen as to some specific measures on revenue increases found in the budget that he had tabled two weeks ago. More specifically, Minister Flaherty’s budget has been labelled “anti-trade”, because it increased 1,290 tariff lines while reducing only 37 tariff lines. It means that custom officers will collect about $330 million more in revenue from – and consumers will pay hundreds of millions more for – products coming from 72 different trading partners; including China, India, Russia, Brazil, and South Korea. However, contrary to media opinion, these tariff increases are not necessarily anti-trade. They are instead a ‘pro-trade’ correction to a well-meaning, but antiquated, trade initiative that made exceptions to a cardinal rule of the General Agreement on Tariffs and Trade (GATT).

GATT: An Agreement to Reduce Tariffs

When the GATT was originally promulgated in the late 1940s, it espoused the principle of “most-favoured nation” (MFN). This principle held that, inter alia, every nation subject to the multi-lateral GATT has to treat all other participatory-nations like their ‘most-favoured’ trade partner; if Canada lowered tariffs on one nation, it would have to apply their lower tariff rate to all GATT nations. The economic logic is clear; if all the countries have an equal playing field, then the comparative advantages of each country will be properly affirmed, and that country will specialize in what it is best suited to specialize in. If, however, Canada accords country X a lower tariff rate than it does for country Y, then Canada will be artificially favouring country X’s products, even if – in a truly free-market – country Y would be the natural supplier of that product. So far so good.

However, in the 1970s, the GATT members decided to create an exception to that principle called the Generalized System of Preferences (GSP), whereby more-developed nations would lower numerous tariff lines, but only for less-developed nations. Developed-nation exporters would still pay the MFN rate. In other words, Canada would lower tariff rates to products from, say India, than it would to identical products from, say Germany. The idea was that this would help less developed countries catch up and to overcome the disadvantages of having industrialized late. Under this construct, Canada created a list of least-developed countries and began applying the General Preferential Tariff (GPT) rates to those countries, as opposed to the higher MFN rates. Immediately before last week’s budget was tabled, Canada’s list comprised 84 nations which qualified for the GPT.

The Problem with General Preferential Tariff (GPT)

Many economists believe that the GPT ended up distorting trade patterns; countries like Greece and Portugal, who were “lower upper-income” (just wealthy enough to not qualify for GSP schemes in the 1970s), suffered greatly. Meanwhile, nations like Singapore and Taiwan, who were “upper lower-income” (just low income enough to qualify for GSP schemes in the 1970s), benefited the most – much more than those truly poor countries. One of the most impacted sectors was textile manufacturing; the ‘lower upper-income’ textile sectors departed to many ‘upper lower-income’ countries, in part because of the tariff advantage. The shift was so profound that the GATT members forged the Multi-Fibre Agreement (MFA) which imposed quantitative trade restrictions (ie: quotas) on textile imports from many GSP nations. This really shows the perversity of the system; the scale of the distortion that had been created was so great that a second, partially countervailing distortion was created in order to combat it.

Apprised of this non-sense, Minister Flaherty did the right thing last week; he decided that 72 of the 84 countries on Canada’s GPT list no longer needed to be on there. They – countries like China, India, Brazil, Russia, South Korea – are now sufficiently mature, sufficiently competitive economies that no longer needed advantageous tariff rates than we offered to the moribund Greeks, Portuguese, and Cypriots. We do not need more special textile quotas; we just need to treat all textile exporters equally. Ideally, there would be no tariffs; trade in legal goods would be fulsome and unrestricted, but until such a point – if there are limits – the limits in place should be equal (and thus non-distorting).

Of course, there are bilateral trade agreements, permitted under Article XXIV of the GATT, which allow for deals that mutually lower rates below the MFN rate without triggering the MFN obligation. This could be its own article, yet it is sufficient to say that such bilateral agreements may be a necessary evil in a world where multilateral WTO / GATT agreements are stalled, but at least they provide benefits for both bilateral participants. By contrast, Canada never got any distinct benefit from India in exchange for favouring them over Portugal, by virtue of the GPT.

Time to Clean Up the Tariff Structure of Canada

We need to recognize that all GATT members, be they Laos or Luxemburg, have their own comparative advantages and deserve an equal-tariff playing field. Hopefully that playing field will one day be zero, but let’s understand that those 72 countries no longer needed that special rate. Minister Flaherty was not discriminating against those 72 countries, he was ending the discrimination against the other 75 GATT members whose MFN rights were – at least in principle – being violated.

This shines a light on the tendency of trade negotiators to create exceptions, and then exceptions to the exceptions. Let us instead use this as an opportunity to clean up our tariff structure once and for all – perhaps by eventually getting rid of them all. Either way, let’s do it equally.