North American Economic and Financial Integration: Volume 10

This book contains selected papers first presented by invitation at the “Canada-United States Business Conference” held at the Kelley School of Business, Indiana University, on April 11–12, 2003. The conference was co-sponsored by the Canadian Embassy of the Government of Canada and the IU Center for International Business Education and Research (IU CIBER).

Since the North American Free Trade Agreement (NAFTA) of 1994, the economic interdependence of Canada and the United States has continued to grow. With Mexico now beginning to integrate itself much more strongly with the U.S. economy, NAFTA has emerged as a strong economic block with nearly as high a degree of integration as the E.U. Furthermore, NAFTA’s economic integration is growing at a faster rate. The data to support these findings are examined in this paper.

This paper evaluates the extent and implications of Canada-U.S. economic integration in the wake of two formal trade liberalization agreements. The paper considers how quantity and price measures can be used to assess integration, then surveys the evidence on the extent of integration. Overall, we find little evidence that these trade agreements had significant incremental impacts on economic integration between Canada and the United States. We find some evidence that exchange rate variability may discourage integration. Microeconomic efficiency has not been enhanced through alignment of prices and costs and the volatility of the Canada-U.S. exchange rate may also account for this. The finding provides some tentative evidence in favor of a common currency arrangement.

Despite declining in 2001, foreign direct investment (FDI) surged during the 1990s. As a result, current levels of FDI flows are triple their 1990 levels. It is well documented in the literature that FDI occurs in large part among countries that are geographically close. It is also well established that the NAFTA had a significant impact on both U.S. FDI flows and hence FDI stocks. In addition, tax policies and tax treaties have been shown to be important drivers of U.S. FDI. The analysis presented in this chapter confirms these earlier results. We extend the analysis, however, to show that tax treaties have a significant impact on financing patterns of U.S. MNE activities abroad. Based on these results, we argue that bilateral tax treaties should be an important part of trade agreements between the United States and Latin American partners in anticipation of a Free Trade Agreement of the Americas (FTAA).

This paper examines the nature of regional trade integration between the United States and Canada by using a Similarity Index that summarizes the behavior of exports of states along the U.S./Canadian border relative to U.S. states that are not on the Canadian border. An export Similarity Index is used to show the considerable importance of industry mix relative to distance. Similarity Index changes suggest that increased export sales between the U.S. and Canada between 1996 and 2001 were not primarily driven by proximity factors that underlie a regional phenomenon. Industry factors independent of location and distance were important contributors to changes in U.S. exports to Canada. The upshot is that global, not regional, factors may underlie increasing trade between the U.S. and Canada. That is, an apparent global phenomenon may have been mistaken for a regional one.

We argue that national security is a public good and its production can be analyzed in a strategic context. We first present the context of the border between Canada and the United States. Next, we discuss the options of status quo and adoption of a common security perimeter relative to sovereignty and security. We show that efficient border policies could require cooperation among countries but motivating such collaboration may be difficult since joint border security policies may involve a prisoners’ dilemma problem. On the other hand, we show that the likelihood of joint increased security will be higher if there are country-specific benefits for a country improving security at its border. If this is the case, we demonstrate it is possible to reach optimal security using independent border policies.

This case study analyzes Wal-Mart’s market entry and expansion in the Mexican market. Today’s Wal-Mart has become the largest retailer in Mexico. The case discusses all the current issues of this debate within the perspectives of growing the international firm and other internationalization issues. The case also evaluates the global retailing industry and its changing competition. Within the current circumstances, it is expected that Wal-Mart will continue to grow in Mexico and the NAFTA region. On the other hand Wal-Mart may face heightened competition and will be challenged by Mexican and other international retailers. The significance of this work lies in its timeliness and relevance to the ongoing debate of NAFTA-related boom and internationalization in the retailing industry.

This paper investigates the role of the border in Canadian and U.S. prices, based on a sample of highly disaggregated city-level retail prices. It finds substantial short-run differences in cross-border prices. While most of these are eliminated over time, long-run differences in the cross-border prices remain. These long-run cross-border differences average just over 20%, compared to mean long-run intranational price gaps of 7–9%. Short-run price differences are eliminated at similar rates in the cross-border and intranational data. Evidence from national average prices suggests the gap between cross-border prices has not narrowed during the recent depreciation of the Canadian dollar.

This paper tests for the existence of a long-run co-movement between the three North American stock markets of Canada, Mexico, and the U.S. and examines whether or not the implementation of the North American Free Trade Agreement (NAFTA) has led to more integrated equity markets. Application of the Johansen and Juselius (1990) cointegration procedure indicates a long-term relationship. A vector error-correction (VEC) model establishes that all three markets are involved in the long-run adjustment toward equilibrium. Overall, the results suggest that the implementation of NAFTA has promoted greater economic integration between the three North American countries.

This paper attempts to evaluate whether the set of NAFTA countries (the U.S., Canada and Mexico) should adopt the same currency. The theoretical basis for the paper is the optimal currency area theory which suggests that countries or regions that experience similar business cycles can gain advantages in adopting the same currency. The statistical methodology used in the paper to evaluate whether states or provinces have similar business cycle correlations is model-based cluster analysis, a recently-developed method to group data in the applied statistics literature.

The objective of this paper is two-fold. First, through the use of two indices that correct for the bias introduced by the relative size of the U.S. economy, it describes the degree of regional dependence reached in the NAFTA area as compared to Europe. Second, it asks whether the stage is set for the successful adoption of a single currency, namely the dollar, within the area. In an attempt to answer this question, the paper identifies the one critical asymmetry that should be addressed before considering the complete monetary integration of the area.

It is widely accepted that international trade and investment are complementary to each other at the macro level. Investment flows to areas where the market opportunities are the greatest, resulting in greater integration of the markets. However, once the decision to invest abroad is made by companies, where they locate, (i.e. which states/regions in the host country the company will choose to locate) is not very well appreciated. In order to gain greater understanding of the factors affecting such decisions, this study seeks to identify the factors that are important to Canadian companies for investing in the United States, given their choice of locations in the U.S. The managers’ views of further U.S.-Canadian economic integration are also investigated and verified.

The U.S. 2002 Farm Bill provides sizeable direct and indirect subsidies to U.S. farmers, which has created increased competition in markets where the United States and Canada compete. Target prices were reintroduced and the overall level of U.S. Government support was increased. Canadian farmers will find it more difficult to compete in grains, oilseeds, and pulses. Government support in Canada for these crops is significantly below U.S. support. Canada and the United States have a significant two-way trade in agricultural products, including beef and pork. The outbreak of Mad Cow Disease in Canada in 2003 clearly illustrates the need for cooperation between the two countries.

Disputes about Canadian exports of softwood lumber to the U.S. have persisted for more than a century. In this paper the roots of the disputes and the prospects for their resolution are examined. The focus is on the following key factors: (1) the nature of supply and demand; (2) the normative differences underlying the systems of timber management in the two countries and differences about what constitutes a “level playing field”; (3) rent seeking by stakeholders; and (4) weakness in bilateral and multilateral trade dispute resolution institutions. The paper concludes that there are good reasons to expect short term solution to the current dispute but persistence of the disputes in the long run.

NAFTA established guidelines for creating a seamless trilateral trucking market that has proven problematic to implement. Costs of border delays, traffic congestion, added pollution, and documentation requirements stymie North American policy makers. Use of just-in-time supply chain techniques by shippers exacerbates the inability of border infrastructure to meet time-sensitive traffic demands. This paper reviews NAFTA’s transport provisions and explores Mexican, U.S., and Canadian disputes in the context of continental integration. Progress toward harmonizing labor and equipment standards in the course of instituting NAFTA is investigated. Policies for additional border facilities investments and streamlining procedures are compared to heightened national security concerns.

This paper reports on the results of a research project aimed at estimating the costs of border crossing transit time and uncertainty for the U.S. and Canadian economies. The cost estimates are based on a review of prior reports, some 20 site visits to seven key crossings, and 173 interviews of knowledgeable organizations/persons. The key finding is that border transit time and uncertainty are costing some U.S.$4.01 billion, or 1.05% of total 2001 merchandise trade, and 1.58% of truck-based trade levels. The primary implication of the research is that it provides a baseline estimate of costs that can be used in cost-benefit analysis of alternative border management strategies.

Creating a continental energy market, including an interconnected electricity industry, was a central motivation for the U.S. government in the negotiation of the CUSFTA and NAFTA. Free trade agreements and regulatory changes in North America have fundamentally altered the characteristics of the electricity industry and the strategies of its constituent firms over the past decade. Markets are replacing extensive regulation in many states, many new firms have entered the industry, long term stability and predictability of returns to firms and of electricity prices have been replaced with the uncertainties of competition, and blackouts in California have become global headline news. In this period of rapid transition in the electricity industry, firms, states and consumers confront both new opportunities and new problems that were unimaginable a decade ago. The essential role of electricity in all economic activity makes this industry a critical component of the North American economy, but the future of the industry is far from clear.

This paper discusses the material characteristics of the electricity industry and outlines the provisions of the CUSFTA and NAFTA and regulatory changes that affected the electricity industry over the past decade. The paper then examines the evolution of the continental electricity industry, with particular emphasis on the efforts to create competitive markets. The paper then analyzes the strategies of particular firms to respond to and take advantage of these processes. The conclusion analyzes the policy implications of these processes and firm strategies.

Civil society, as represented by non-governmental organizations (NGOs), is exerting increasing pressure on national governments, multinational corporations, and international institutions. In this chapter we document the evolution of participation by civil society and NGOs in Western Hemisphere economic integration, focusing particularly on the NGO role in three important trade and investment agreements: the U.S.-Canada Free Trade Agreement, the North American Free Trade Agreement, and the Free Trade Area of the Americas process. We find that NGOs are having increasing influence on the trade and investment agreements in the Hemisphere, and are poised to take on a major role in multilateral negotiations and agreements.

Effective in 1994, the North American Free Trade Agreement (NAFTA) has substantially lowered tariffs and other trade and investment restrictions. Consequently, three-way trade expanded exponentially as did inward and outward investment in Mexico, Canada, and the United States through 2000. However, both trade and investment decreased in 2001 and 2002 because of a global recession. Critics of NAFTA argue that jobs have been destroyed and wages suppressed in both Mexico and the U.S. But these claims do not hold up to careful scrutiny. Though many points of friction remain among the three NAFTA partners, the agreement must be considered a qualified success.