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Canada, the United States and the World Economy

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Relations between Canada and the United States have become more strained than at any time in recent memory. There have been many earlier periods of tension, but the policy orientations of the two capitals in late 1981 appear to be far more divergent than in the past. The two governments seem to be on a collision course, in a context that political leaders cannot fully control.

Under the Reagan Administration, Washington is currently intent upon further liberalization of the economy, domestically and internationally, and upon reducing the distorting role of government intervention in key sectors. Ottawa seems to be seeking means to insulate itself, not only from the U.S. economy but from other undesirable external economic forces, while moving to enhance rather than reduce the government role in shaping the Canadian economy. As we shall see, Canada has its own varied list of complaints and grievances against the United States. But it is the list of American complaints that has now become both long and much more focused on basic policy differences.

The most contentious issues are the new Canadian National Energy Program (NEP), the expanding role of the Foreign Investment Review Agency (FIRA), the recent establishment of new official bodies to insure adequate benefits to Canadians of major energy and other natural resource projects, and various other efforts to discriminate against outsiders and favor Canadians. Some of these policies and official activities so boldly challenge U.S. government policies and private industry interests that some members of Congress and representatives of private firms have pressed for strong counteraction. The Department of Commerce has taken a broad survey of American business to identify grievances, and the U.S. Trade Representative has said that the initiation of a comprehensive investigation of Canadian policies is being considered, under a section of the law that authorizes retaliation if it is found that another government's policies unfairly affect U.S. commerce.

Beyond these bilateral concerns, the perception in Washington is that Canadian nationalism is taking forms that contravene the international trade and investment rules to which Canada has in the past committed itself. This in Washington's eyes challenges the entire international framework of cooperation and mutual restraint that has been painstakingly built since the Bretton Woods conference in 1944. At the very time when Washington is seeking further liberalization of the world economy and greater reliance on market forces in global development-in line with its drive toward freer markets at home-Canada seems to be standing in the way both ideologically and practically.

In earlier periods of strain since the end of the Second World War, mutual sensitivities and efforts to moderate policy differences sooner or later prevailed in the two capitals. Canadian leaders have often felt a political need to demonstrate Canada's autonomy and independent identity, but behind the scenes of the political drama there has usually been a pragmatic recognition in Ottawa of the realities of Canada's economic dependence on its neighbor. Attitudes of economic nationalism, a latent popular force in every country, have periodically been exploited, but they have never been allowed to be carried too far.

For their part, U.S. authorities have usually recognized the special difficulties that Canadian governments faced: not only heavy dependence on the United States, but also fundamental divisions within Canada which have stood in the way of asserting a national identity. A certain amount of Canadian economic nationalism has therefore been tolerated by U.S. officials, and even by Congress, over the years. American Presidents in any event have usually desired a friendly relationship to prevail across the border, and meetings of the President with the Prime Minister have traditionally accented the positive and glossed over specific frictions.

In sum, it was widely recognized on both sides of the border that there was a "special relationship." As recently as the congressional consideration of the Trade Act of 1979, there was sentiment in both Congress and the Executive Branch that this special relationship should be enhanced, perhaps through a continental effort to liberalize trade relations. During his presidential campaign, Ronald Reagan suggested that serious consideration be given to the possibility of a new economic accord on trade relations with America's neighbors in North America.

All of that thinking now seems to have come to an end. The special relationship no longer seems to have meaning. The rhetoric of recent policy statements by U.S. officials has openly condemned Canadian economic policies, and in reply Canadians have accused the United States of bullying Canada and of trying to prevent Canadians from asserting their independence and achieving autonomous development of their own economy. While the public exchanges between the two capitals have become more moderate in the fall of 1981, this simply reflects a sober and quiet rethinking, driven by acute frustration in Washington with Ottawa's boldness, and by irritation in Ottawa over what is perceived as America's overreaction.

A collision of interests and policies between the two nations would be dangerous to both, since the ensuing conflict would not be readily controllable. The ability of the U.S. President to manage commercial policy is limited by the independent ability of industry, labor, Congress, and even the courts to take initiatives of their own. On the other side of the border, the polls indicate that "Canadianization" policies are widely supported. Direct attacks on Canadianization efforts would only serve to entrench those policies further.

The two nations therefore confront an urgent choice among what are essentially three conceivable options. One would be inaction, leaving ongoing issues unresolved, and letting tensions rise. A second would be to treat each issue on an ad hoc basis, accepting that this runs the risk of generating a series of specific confrontations. But there is a third option-which we propose and strongly urge-namely to reconstitute and formalize the "special relationship" through establishment of two bodies, namely a bilateral commission to assess the widening array of problems and recommend interrelated answers to them, and a joint Cabinet Committee to monitor problem areas and to review the recommendations of the bilateral commission. In any event, a choice among these three options cannot long be avoided.

II

The present direction of Canadian policies is not new. Its roots lie deep in Canada's history and its long search for a national identity. The effort to shield Canada while it developed in its own way began with the origins of the nation itself.

Canadians are repeatedly reminded, from their school days onward, that Canada's very existence rests in large part on the desire not to be American. Repugned by the 13 colonies to the south which had violently broken with the British Crown, more than a century ago Canada set out to protect itself from the political and economic influence of its southern neighbor. Numerous efforts were made from the very beginning to define and develop an independent economy. The construction of a coast-to-coast railway was presented as the "national dream" of a unifying link between East and West, as well as a counterweight to the more natural North-South trade and immigration links. The National Policy established by Canada's first Prime Minister, Sir John A. Macdonald, set the tone for a highly protectionist tariff structure, which endured well into this century. Even after trade became freer, there persisted a major strand in Canadian thinking that industrial development should be at least partially insulated from external pressures.

In 1867, the drafting of the Canadian constitution, with its emphasis on "peace, order, good government," created a framework whereby government intervention and collective action were not only tolerated but anticipated and accepted. The drafters intended a clear contrast with the American emphasis on "life, liberty, and the pursuit of happiness," which was often said to reflect a "maniacally individualistic" United States. Throughout Canada's history, government and Crown corporations have proliferated. When the Conservatives proposed in 1979-80 that Petro-Canada, the national oil company, be broken up and privatized, the subsequent public controversy became one of the election issues which contributed to the defeat of Prime Minister Joe Clark's Progressive Conservative government. In contrast, the current Prime Minister, Pierre Elliott Trudeau, has drawn broad support in selecting policies which expand the role of governmental chosen instruments (e.g., Petro-Canada in the energy sector; the Canada Development Corporation in industry; Telesat in satellites; Canadair, DeHavilland and Spar Aerospace in aeronautics).

The broad public support for collective action gave birth in the 1950s to policies that gave greater priority to income redistribution and egalitarianism than to economic growth and productivity. Since then, Canada has been developing a complex system of intergovernmental transfers designed to equalize revenues among the provinces, and set average standards of services nationally. Concurrently, the network of social, health and unemployment benefits was expanded well beyond that of the United States. Pursuit of the "just society" became the central thrust of public policy. Political rhetoric distinguished Canada's goals and policies from those of growth-oriented, materialistic Americans. Despite similar life-styles and values, Canadians are often encouraged by their political leaders to feel that they hold higher values than the United States and its people-more tolerance, more concern with social justice and equity, less crime and violence.

This differentiation of Canadian values has been part of the continuing effort to develop an independent national identity, in the face of the pervasive influence of the United States. Prime Minister Trudeau once put the problem bluntly to President Nixon: "Living next to you is like sleeping with an elephant. No matter how friendly the beast, if one can call it that, one is affected by every twist and grunt." Canadian law and policy are often developed in an atmosphere of frustration. The United States dominates the economy of the non-communist world, and Canada has always felt itself by comparison to be weak and with little influence. At the same time, Canada does two-thirds of its trade with the United States. Canadians have been unwilling to cut themselves off from the most important market in the world for capital and technology, and the management styles and objectives in the two countries are very similar. There is a U.S. influence on every aspect of Canadian culture. Travel between the two countries, especially Canadian travel toward the United States, has meshed the two countries together in a way which is unique.

As Canada gradually unravelled its ties with the British Crown in the postwar years, efforts were intensified to avoid having a greater American presence replace the British influence. Except in Quebec, where linguistic differences provide a partial barrier vis-à-vis the United States, Canada from the late 1950s onward has been increasingly sensitive, almost to the point of paranoia, over U.S. influence. Economic nationalism in Canada has always come in waves, and the wave that began at that time reflected this underlying sentiment.

Thus, U.S.-Canadian negotiations in the early 1960s on the structure and treatment of the border-straddling automotive industry were an effort not so much to solidify friendship as to mitigate the virulence of economic nationalism in Canada. Continued complaints on the part of businessmen as well as government spokesmen about the "branch plant" and "miniature replica" effects of U.S. investment in Canada finally led to the Watkins and Gray reports on foreign investment and these in turn to the creation of FIRA (the Foreign Investment Review Agency). This body not only screens the merits of foreign investments and foreign takeovers of Canadian assets, but guides the nature and scope of such investments, by negotiating the specific conditions under which a foreign firm might be allowed to invest. When it was conceived, FIRA was intended to become Canada's most important tool to limit access to its markets and to guide Canadian industrial policy. At first its influence on foreign businesses was weak, but in recent years it has become more aggressive and effective.

During the 1960s and 1970s, a substantial amount of Canadianization did take place in the field of investment. The Chairman of the Royal Bank of Canada, Mr. Rowland Frazee, recently observed that the share of foreign ownership of Canadian assets has been falling significantly.1 In 1961, total foreign investment was one-third of the net Canadian capital stock (a measurement of the book value of all investment in Canada, public and private). By 1971, it had declined to 27 percent. By 1977, the last year for which figures are available, it was down to 23 percent.

In parallel with this drive at home, the Trudeau government at the start of the 1970s considered three options for its foreign policy, and especially for its policy toward the United States. The first option was to maintain the existing U.S. relationship, with a minimum of policy adjustments. The second was closer integration with the United States. The third option was, in the words of Mitchell Sharp (then Secretary of State for External Affairs), "a comprehensive, long-term strategy to develop and strengthen the Canadian economy and other aspects of our national life and in the process to reduce the present Canadian vulnerability." As a result of its comprehensive review, the Canadian government decided to pursue vigorously the so-called Third Option. A central aim of this foreign policy was to diversify trade away from the United States and toward the European Community and Japan. By the end of the decade this effort to alter the pattern of economic ties had clearly failed. Canada's reliance on the U.S. market for sales of its exports actually grew, to the extent that roughly 70 percent of Canada's exports now flow south across the border.

Nonetheless, slowly but surely, Canada has been moving to set itself apart from the United States. Canadian political leaders have not only encouraged this divergence, but developed numerous policies and institutions aimed at sharpening the differences while shielding Canada from unwanted influences and manipulation. That these actions were not confined solely to the economic field simply reflects the depth of feeling-for example, one of the most conspicuous was the Canadian legislation in 1976 to constrain advertisement by Canadians in U.S. publications and TV broadcasts available in Canada, unless the Canadian content was significantly increased.

And in the late 1970s there has been a growing link between rhetoric and proposals concerning U.S. influence, and the internal political struggle within Canada. As Quebec expressed its separatist views more clearly and the other provinces sharpened their differences over the economic and political dimensions of provincial relations, the federal government saw that the weak sense of Canadian identity provided an opportunity to exploit anti-Americanism. This provided a counterweight to the separatist drive of Quebec, and to the pressure to yield more economic and political power to the other provinces.

But these political controversies are themselves reflections of the underlying problem of identity. Essentially, Canada's effort to shield itself from external influence and manipulation remains part of a historical search for that identity. It is not new, and it will likely continue. Attempts to deal with it as if it were novel or a passing outburst-the tendency in Washington today-only aggravate the tensions, making many Canadians feel that U.S. leaders simply do not understand how deep the differences run.

III

The return of Pierre Elliott Trudeau to power in early 1980-after a year of Progressive Conservative government had interrupted his tenure dating from 1968-led directly to the constitutional crisis of 1980-81, which has further strengthened the historical forces behind economic nationalism and anti-Americanism. In fact, just as the present Canadian federal government is determined to cut "colonial" political ties with Britain through patriation and amendment of the constitution, it appears as determined to reduce "colonial" economic ties with the United States. All the issues that had arisen in the 1960s and 1970s, including friction over energy policy and concern about American dominance of the oil industry, have reached a new pitch, with the current federal government encouraging the fear of external influence.

The deep divisions within Canada, as between the western, central, and eastern provinces, reflected differences among the political parties as well as on the philosophy of the appropriate federal-provincial relationship. Many groups were brought into battle, not only among themselves but against outside forces that help divide the nation. Concern with independence and sovereignty vis-à-vis the United States is currently reinforcing a number of ideological positions which, in essence, are anti-American. The growing environmental movement in Canada is continually attacking U.S. polluters, particularly blaming them for the acid rain which is falling on Canadian lakes and forests. Both the socialist groups and the wider public that supports a strong government role in shaping the economy are upset by Reaganomics. The pacifists are dismayed by the neutron bomb and the confrontational posture of the United States toward the Soviets. The supporters of the anti-growth school are distressed by the U.S. push toward revitalization and renewed high growth. A general distrust of multinational enterprises, a preoccupation that profits are being repatriated to the United States rather than invested in Canada, a perception that U.S. corporations concentrate their research and development efforts at headquarters rather than dispersing their research expenditures in Canadian affiliates-all of these feelings have created a fertile environment for an even more assertive, nationalistic array of Canadian policies.

When he returned to office in March 1980, Mr. Trudeau had not campaigned on major issues and therefore had a free hand. He considered his mandate to be defined by the public rejection of the Conservatives and their policies. His political agenda was clear: contain the Quebec separatists, constrain the efforts of the other provinces to pull away from federal leadership, and establish a new constitution. The historical importance of keeping Canada together, and drawing up a new constitutional foundation which gave the nation true independence, dwarfed all other considerations. But the politics were awkward. The government's majority was centered almost entirely in Ontario and Quebec. While Ontario once held all the economic cards, the international oil shocks of the 1970s brought about a major shift in capital resources to the oil-rich and gas-rich West.

The National Energy Program was devised to correct the shifting balance of power. A massive restructuring of the industry is sought by altering the price structure, taxes and incentives for development on provincial lands, so as to favor the creation of a new industry on federal lands, outside the reach of the provincial governments. The new industry would be supported with revenues siphoned off from the producer provinces and the old industry located on provincial lands. Furthermore, it is intended that the national oil company, Petro-Canada, be strengthened, both by offering it more liberal incentives and by making its acquisition of assets of private companies easier. Thus the NEP establishes a discriminatory framework of aid, in which Petrocan will get most, and foreign subsidiaries will be the most disadvantaged. A range of intermediate private firms will exist on the spectrum between, with differential benefits according to the degree of their Canadian ownership and their conformity with NEP objectives. The overt discrimination against foreign firms is intended to reduce drastically the degree of foreign control and influence in the energy sector, which had been over 70 percent according to federal spokesmen.

A further element of this policy is a separate bill, now before Parliament and apparently certain to be enacted, which authorizes federal acquisition of a 25 percent share of existing leases, on the basis that only a fraction of the exploration and drilling costs of proven productive wells will be compensated. The expenditures made for dry holes, normally considered to be a part of development costs, will be ignored. This so-called "back-in" provision for acquisition of privately held leases has particularly incensed American firms; from the standpoint of principle and example it also worries U.S. officials. American firms that entered Canada and followed its rules, and then spent substantial sums developing new oil and gas fields, now find that they not only will experience discrimination but that some of their assets will be expropriated well below market value and far below the level of expenditures they have already made.

The U.S. government fears that the gross unfairness of all these measures teaches a very bad lesson to developing nations-at a time when President Reagan has urged greater reliance on private investment in global development, and when the United States itself is embarked on a new international effort to negotiate improvements in the treatment of foreign direct investment. U.S. officials have already warned publicly that the Canadian back-in proposal does not constitute "prompt, adequate, and reasonable compensation." This is something the United States said to developing countries in the past, especially in the 1960s; it has rarely been addressed to an industrialized country.

To complicate matters further, there is a feeling among some members of the present Ottawa government, as well as among officials, that this kind of draconian Canadianization and federalization should not stop with energy, but should be extended to other natural resources, and perhaps even to the high technology sectors in which Canada's future lies. The Science Council of Canada has long advocated stronger policies of Canadianization and discrimination against outsiders, and agreement with this general line of thinking was expressed publicly on many occasions by the current Minister of Industry and Trade, Mr. Herb Gray. Prime Minister Trudeau himself has expressed over the years a strong interest in bringing about greater federal control of private enterprise operating in such key sectors. While there have been recent statements by Canadian Cabinet members that it has been decided not to extend the NEP approach to other sectors, Washington cannot safely assume that this expression of intent will hold in the future, given the mind-set of the present Canadian government.

Additional actions taken during 1981 to strengthen the underpinnings of the NEP and other Canadianization policies have included establishment of an Industrial Renewal Board and a Committee on Industrial and Regional Benefits. Their assignment is to assure that Canadian firms benefit from projects generated by the NEP and comparable policies. The implicit intention seems to be to deny equal opportunity to foreign firms and subsidiaries of foreign firms.

The activities of FIRA have also been intensified under the returned Trudeau government. The deliberations of this agency are not made public, and foreign firms that negotiate with it seem fearful of explaining the commitments they felt compelled to make in attaining approval for direct investment in Canada. FIRA now does not simply review applications in terms of their likely benefits to Canada. It will insist on commitments regarding Canadian job content, the level of purchases from Canadian suppliers, the use of Canadian banks, the share of production which is to be exported, etc. If a firm is willing to meet these "performance requirements," it will not only be approved for investment but will probably receive local tax incentives for establishment of new production facilities in Canada. This carrot and stick relationship is highly questionable under Canada's international commitments, especially to the longstanding and basic General Agreement on Tariffs and Trade (GATT).

Minister Herb Gray had argued in public for an expansion of FIRA's activities to cover ongoing operations of subsidiaries of foreign firms, and at one point expressed an intention to introduce new legislation in October of this year. The intent was clearly to force further Canadianization on the part of those enterprises already in Canada. This set off even more alarms in Washington, and the Canadian Cabinet decided not to put this proposal to Parliament. Whether the idea will be revived at a later date remains an open question.

Other discriminatory Canadian policies have also been used to strengthen Canadian enterprises relative to their foreign competitors. Recent U.S. Administration statements have cited Canada's often-used "duty remission schemes," which are aimed at export promotion (e.g., of automotive parts) and import substitution (e.g., of TVs, power boats and construction equipment). While such trade policy measures are not new, the cumulation of discriminatory policies seems to have brought about an order of magnitude change in the intensity of Canadianization.

In essence, the present government in Ottawa, from its essentially social democratic perspective, has chosen a path of intensified Canadianization and federalization, with substantially increased government intervention in the marketplace. Canadian anxieties have been channeled into support of policies which directly challenge the United States, and which run counter to many of the rights and obligations laid out in the GATT and other international agreements.

The agenda of issues between the two countries is by no means limited to these general Canadianization policies. As is to be expected in the normal interaction of two nations linked by a common border, there are many other pending issues-which we shall for convenience label "secondary," recognizing that their individual and cumulative impact is strong especially in Canada. The bilateral tax treaty is being revised. The Alaska Highway Pipeline is being reviewed by Congress, at the request of the Canadian government, to determine whether changes in the pricing formula should be made which would improve the ability to finance construction of further sections-as matters stand the completion of the American end of the pipeline is doubtful, so that it could be left dangling in Canada.

We have already noted that environmentalists in Canada have complained bitterly over the threat to Canada's lakes and forests of emissions from U.S. industrial plants. Some members of the U.S. Congress have replied that the noxious emissions emanate from both sides of the border, and that Canada should consider what action it plans to take before berating the United States. The environmentalists and others are also very worried that the potential trajectory of tankers moving oil from Alaska will bring them through the Arctic Islands and then along the coast of British Columbia, generating a serious danger of oil spills in that region. Another worry is an increasing perception in Canada that the United States will have a shortage of water in coming decades, and will then demand supplies from water-rich Canada.

Serious disputes on fisheries continue unabated, even though the two governments thought they had resolved some of the issues with negotiation of an elaborate package of a fisheries treaty and boundary agreements concerning the Gulf of Maine. The U.S. Senate did not like the fisheries treaty, and President Reagan withdrew it from the Senate agenda. The boundary agreement was ratified, but the splitting of the package greatly irritated Ottawa. The fisheries issues therefore remain open.

The 1976 Canadian legislation restricting Canadian advertisement in the American border media brought about in the Carter Administration a proposal to enact reciprocal conditions in U.S. law, but this proposal languished and was allowed to lapse. Now, the Reagan Administration intends to pursue reciprocal U.S. legislation, to create a counterthrust to what is considered to be an unfair Canadian policy.

Such "secondary" issues are the stuff of normal relations. They should be manageable and resolvable. However, the present climate of opinion in Washington does not make this easy. There are few officials ready to do any favors for Canada, or who feel able to persuade others to do so. The residual pool of good will between the two nations seems to have run dry.

IV

Almost certainly any American Administration would have objected to the major Canadianization measures recently taken by the Trudeau government. But it is worth taking a longer look at the reasons that have made these measures particularly objectionable to the present Reagan Administration. At the moment when the tide for further Canadianization efforts is running high, that Administration is embarked on a new mission to strengthen the world economic order through a worldwide fight against economic nationalism and a greater reliance on free-market forces. The new themes of Reaganomics pushed outward into the global marketplace run in a direction 180 degrees opposite from that of Ottawa's policies.

The widening disagreements between the two nations are not simply a consequence of ideological differences, however. There are a number of practical aspects which give momentum to Washington's new international economic policy thrust, and which also generate special frictions with Canada.

First is the fact that international investment has grown to a scale that is publicly perceived as having a direct effect on the U.S. economy-not only on the U.S. balance of payments but also on the pattern of imports and exports, on the location at home or abroad of new production facilities, and on jobs. (U.S. direct investment abroad reached a value of $213 billion by 1980, and foreign direct investment in the United States reached $65 billion in the same year.) Washington believes that U.S. trade is now closely associated with the pattern of U.S. investments abroad.

The Reagan Administration also has concluded that a fundamental change occurred in the mid-1970s in the nature, direction and growth of international investment flows. Since the mid-1970s, the rate of growth of international direct investment has shown a sharp deceleration in real terms (adjusted for inflation). On the other hand, many governments around the world, and even a number of U.S. states, have looked to foreign investment as an instrument to create new jobs, support existing ones, expand exports and foreign exchange earnings, acquire improved technologies, and otherwise enhance competitiveness-at a time when the governments themselves were faced with fiscal austerity and unable to provide incentives and subsidies to industries. The global competition for foreign investment funds has stepped up, and various incentives are being offered to entice investors.

At the same time, to maximize the effectiveness of foreign investment funds and channel their direction, many governments have lately intensified their use of regulations and restrictions to force foreign enterprises to meet certain objectives. As a condition of entry, establishment and continuing operational freedom, foreign enterprises are often required to commit themselves to specified levels of local value-added and job content, to purchases of supplies from domestic firms, to use of domestic banks, to export sales at some targeted share of total production, to provision of technology and know-how to the local enterprise and its suppliers, and so on.

As Washington sees it, such performance requirements are proliferating around the world. Often, if a foreign company accepts the conditions, it also becomes eligible for a variety of investment incentives. The requirements, as well as their frequent link to various aids, are perceived by the U.S. government as violations of various articles of the General Agreement on Tariffs and Trade. This in turn is seen as undermining the elaborate system of rights and obligations of the GATT, which constitute the basic rules of behavior among the major trading nations, and in effect as an effort to reverse the substantial liberalization which has taken place in the world economy since 1947, through new types of restrictive and trade-distorting measures.

In addition to their incompatibility with GATT rules concerning investment, Canadian policies are felt to contravene basic elements of GATT relating to trade, including the new codes just negotiated in 1979 under the so-called Tokyo Round, within the GATT framework. Perhaps the most vital, and simple, of these is the fundamental GATT requirement of "national treatment"-the same treatment of foreign and domestic goods.

Since world trade has grown faster than the GNP of most nations for the last couple of decades, the share of trade in GNP has grown, and trade has become a far more vital part of national economic performance than it was ten or 20 years ago. The importance attached by Washington to international rights and obligations of the GATT and other agreements, and to the mutual restraint generated by these rules, is far greater now than it was just a decade ago. This framework is seen as particularly vital in the present global environment of slow growth, slow capital formation, budget austerity, and relatively high unemployment. It is in such an environment that national governments are most tempted to exercise beggar-thy-neighbor policies and appeal to the popular forces of economic nationalism, which are latent in every country.

Some of the instruments of Canadian national policy toward foreign investment are also seen by Washington as contravening undertakings made by the industralized countries, including Canada in the OECD (the Organization for Economic Cooperation and Development), particularly regarding national treatment of foreign-owned enterprises.2

The U.S. official perception of the global economic challenges posed in the 1980s, and their gravity, was summed up in a recent statement before Congress by Assistant Secretary of State Robert Hormats.3 He cited two major investment-related challenges. The first is a "need to establish new international understandings to avoid short-term nationalistic approaches to investment. We risk today in the international investment arena a serious deterioration in the climate similar to that experienced in the world trading arena in the 1930's." The goal must therefore be to "reverse the trend toward government induced distortions in the investment process" and create "a more open and less interventionist climate."

The second challenge is "to create, through cooperation among developed and developing nations, an international environment in which investment can make a greater contribution to the development process." This latter consideration is based not only on ideological preference but also on the pragmatic view that development assistance, both multilateral and bilateral, cannot and should not be greatly expanded. In a time of official budget austerity, and congressional reluctance to do more for developing nations while cutting back on social programs at home, it is natural that private investment should be encouraged to meet the growing needs of the Third World. This theme was central to President Reagan's remarks to the annual meeting of the International Monetary Fund and World Bank, as well as to the summit meeting at Cancún in late October.

But expanding the role of private investment requires a significant improvement in the treatment of such investment in recipient countries. Toward this end, the Administration hopes to move on several fronts to develop an international system of rights and obligations governing treatment of foreign investment, partly based on strengthening of existing multilateral institutions and partly based on new or modernized Bilateral Investment Treaties (BITS). Vital issues would be confronted and regularized, such as "national treatment," and "prompt, adequate, and reasonable compensation" for assets acquired by governments from foreign-owned enterprises.

Another and more pragmatic consideration is a growing pressure on the U.S. Administration from organized labor and a number of businesses to correct unfair trade and investment conditions. In this connection, the Administration is currently groping for an international "Agenda for the 1980s." In the 1960s, the pressing international commercial problem was seen to be the emergence of the European Common Market, and the urgent need to reduce tariffs so as to offset the potential discriminatory effects of this new, gigantic customs union in Europe, and its special trade arrangements with other European nations, as well as with former European colonies.

The Kennedy Round trade negotiations which ended in 1967 did bring about major worldwide tariff reductions. However, almost immediately there were complaints in the United States about the growing role of non-tariff barriers and subsidies in the shaping of world trade access and competitiveness. Consequently, in the 1970s the international agenda covered these non-tariff measures, as well as the remaining tariffs, and a series of codes of conduct were negotiated as a supplement to the GATT.

Now, in the 1980s, there are new domestic complaints of unfairness in global competition. These complaints are focused on internal intervention measures, such as aids to troubled industries and regions, discriminatory treatment as between foreign-owned and domestic enterprises, performance requirements, and other such industrial or sectoral policies. Thus, as successive layers of protection and discrimination have been peeled back internationally, each succeeding layer has proven not only more complex, but more directly interrelated with domestic industrial (and agricultural) development policies.

In one sense, this U.S. domestic thrust for action against the remaining elements of "unfairness" represents a further move toward really free, nondiscriminatory markets. It fits the Reaganomics of reliance on broad macroeconomic policies and avoidance of special intervention measures in aid of particular sectors. But it also constitutes a fundamental attack on the differences among nations about their internal policies, and even on the freedom of action of governments to shape the national economy and alter its direction of growth and its structure. Profound issues of sovereignty will be raised if the American agenda for the 1980s develops on its present course.

It is in this context that Canada's recent discriminatory economic initiatives, and the apparent political support for their application to an ever-widening part of the Canadian economy, are perceived as a fundamental challenge.

V

Current Canadian policies pose painful dilemmas for the U.S. government. It is evident that harsh rhetoric from the U.S. side simply fans the flames of Canadian nationalism, and is deeply resented by the Canadian public. On the other hand, cooling the rhetoric risks sending the signal that all is well, when it is not.

The Administration cannot easily soften its efforts to persuade Canada to choose more acceptable instruments of policy that do not so dramatically undermine international rules and principles of fair treatment. If the United States turns its cheek, the impression is left that "anything goes," and other nations are watching. It is often said by high officials in Ottawa that "the U.S. always backs off after making politically appropriate noises." Officials of the new Administration fear that this impression will not only mislead the Canadian Parliament, but also encourage other nations to break the rules. There is also a worry that the Reagan Administration will be accused of being soft on foreigners that treat Americans unfairly.

U.S. threats of retaliation would only entrench nationalist sentiment in Canada. A confrontation with the United States, even if it were economically costly, might be welcomed by the present Canadian leadership, especially during the domestic federal-provincial deliberations over the future character of Canada. Recent Canadianization policies are already having a negative economic impact north of the border, especially in energy. But this is recognized in Ottawa, and the short-term costs are viewed as necessary elements in the laying of a new foundation for the long-term achievement of Canada's aspirations.

At home, the Administration faces an even more dangerous problem. The U.S. Constitution vests in Congress the regulation of foreign commerce, and the laws Congress has written delegate substantial powers and rights of initiative to private businesses and workers, and substantial power to the courts to override the President. Moreover, the Congress reserves to itself a number of veto rights on administrative action, as well as retaining the power to rewrite the laws regulating foreign commerce as and when it feels this is desirable. If the U.S. government fails to take counter-actions, or fails to negotiate accommodations on the part of Canada, will the direction of policy be taken over by initiatives on the part of private businesses and labor, and by Congress and the courts? If so, will this not generate nationalistic and protectionist sentiment in the United States against Canada, and perhaps even against other nations?

The Reagan Administration thus has to deal with exquisitely painful alternatives. There are no simple solutions.

And behind these painful choices, to repeat, lie very deep divisions in thinking. One capital favors wider reliance on free-market forces, and on international rules of the road that constrain the freedom of action of national governments in favoring certain sectors, or in discriminating against foreigners. The other capital believes that government must accept greater responsibility to direct and shape the national destiny, and that foreign influences must be substantially diminished, or at least tightly controlled. Washington leaders believe that discrimination is illegal, unethical and disruptive of international political and economic order. Ottawa's leadership believes that discrimination is essential to prevent Canada from evolving solely as a branch plant economy to support American business, and to ensure social and economic equity for all Canadians. The Americans feel that Canada's policies undermine the validity of the entire international economic order. The Canadians feel their actions are no threat to legitimate interests of other nations, because Canada has so little economic power, and its circumstances are unique.

VI

Since a complete reversal on either side of the border is unlikely in the near future, are there any ways in which the emerging confrontation can be deflected? Can further entrenchment of positions be avoided? Is there some means to facilitate conflict management, even if conflict resolution is not possible? Can the likely damage from conflicting policies be constrained or diminished?

President Reagan and Prime Minister Trudeau have discussed some of the differences, and have decided that their approaches to national and international order are fundamentally different. They have agreed to disagree. But that is not sufficient to control dissatisfied interest groups on both sides of the border, nor to control the reactions of other nations to the way in which the two countries deal with their differences.

Let us start by ruling out once more any theoretical possibility of the United States simply confronting Canada's policies all at once, through some dramatic action such as invoking the unfair trade provisions of U.S. law and proceeding to threaten, or actually take, specific retaliatory action. Such a frontal attack-which happily seems to have few serious backers either in official or private circles-would surely only stiffen Canadian resolve, as well as raise the political temperature on both sides to a sharp boil. A U.S. threat along these lines would be a bluff soon called, forcing the United States either to back down or carry it out on a broad basis. Either way, general confrontation is simply not a realistic option.

At the opposite extreme, one apparently workable option would be, essentially, inaction. The two governments simply agree to keep the rhetoric under reasonable control, recognizing that the political attitudes on both sides of the border regarding solution of mutual problems may become more negative. Ongoing issues are left unresolved, or no further action is taken: acid rain, fishing rights, the Alaska Highway pipeline, the bilateral tax treaty, etc.

This kind of approach is viable, but it will heighten mutual tensions over time. The cumulation of unresolved problems will eventually force action. If the U.S. government did not move, private petitions for action and congressional initiatives would tend to take over and guide the relationship. The best that can be said for inaction is that it buys time.

A second option would be to deal with each issue on an ad hoc basis, avoiding any linkage to other issues. Decisions might be delegated to lower levels of government, and issues might be presented in their most technical aspects, in an effort to depoliticize them. Certain of the Canadian policies could be raised in the GATT, with the intention of seeking an international determination that some of Canada's measures are inconsistent with GATT rules. The OECD could also be asked to review Canada's investment policies and to exert moral pressure on Ottawa.

This approach would in a sense represent an effort to go back to the old modus vivendi. It would fit President Reagan's style, which is to delegate responsibilities and narrow the scope of decisions that have to be made at the top. It would bureaucratize the relationship, putting issues back into the hands of specialists and technical experts.

One problem with this is that there are hardly any "Canada experts" left in Washington who have had long experience with the politics and economic preoccupations north of the border. In Ottawa, the post-World War II civil service mandarins, who were experts on the United States and its complex constitutional division of powers, have all retired, and the new senior officials have much more limited relationships and experience with Washington. The new technocrats on both sides of the border may be able to contain the conflict on a nonpolitical level; but they may also spark a series of conflicts.

Finally, the GATT and OECD memberships include other nations which have policies similar to one or another aspect of Canada's policies. It might be difficult to achieve a clear consensus that Canada was in the wrong, and if consensus proved to be unattainable the credibility of the present international rules would be further undermined.

In short, the ad hoc approach-picking at the fringes of the basic issues and leaving the secondary issues largely to the bureaucrats on both sides-has its own risks. But above all it fails to get at the heart of the problems. Sooner or later it is bound, like the inaction option, to generate a cumulation of present and additional conflicts and frustrations. Again like the inaction option, it may on the face of things buy time, but time for what? To postpone the basic issues or nibble at them makes sense only if one believes that the situation of high tension is temporary and that the general thrust of policy in Canada will change. Both history and a realistic reading of the current mood in Canada suggest the exact contrary-while on the U.S. side delay carries the grave risk of the Administration losing political control and yielding the initiative to private groups appealing to a Congress already well armed with legal weapons for action.

Is there, then, a third realistic option? We believe there is, and that it would be to formalize the process of dealing with bilateral economic problems. Specifically, we urge the creation of a joint Canada-U.S. economic commission, composed of respected political and public figures, businessmen, labor leaders and economists, adequately staffed, and charged with sorting out the whole range of problems, assessing them and coming up with recommendations for interrelated actions by both countries. A joint Cabinet Committee should also be formally designated- on the one hand to manage the day-to-day conflicts and prevent their untimely eruption into crises, and on the other hand to advise and assist the leaders of the two countries in implementing recommendations of the joint economic commission.

There is already a partial precedent for such action. Early in 1981 the U.S. government established a Joint Trade Commission with its other great neighbor in North America, Mexico, and this effort has already had some modest success. (The Commission is composed solely of government officials.) In that case there were special legal reasons for such a formal bilateral framework: Mexico does not adhere to GATT and has no bilateral trade treaty with the United States, and U.S. trade laws are harsh on countries with which there is no juridical framework.

Apart from differences of scope and composition, the reasons for establishing a formal process of reconciliation between Canada and the United States would not be technical or legal, but political. A strong case can be made for restoration and reinvigoration of the political idea of a "special relationship." But this would only be sustainable if the two governments acknowledge that their differences have to be managed. Formal creation of a bilateral commission would constitute such an acknowledgement.

Such a framework would force issues to be seen in a broader perspective, and give the leaders of the two nations a device for demonstrating partnership rather than confrontation. It would indeed give the two parties an equal partner status, which in itself would improve Canadian attitudes toward Washington's demands and reduce fears of its global power.

A commission with a regular meeting schedule could have both a visible and an invisible agenda. It could allow the two sides a substantial amount of time to deal with coming conflicts, by providing an early warning system, one that need not be made public. Each of its recommendations would set a precedent, and each precedent would help to shape a system of mutual forbearance and restraint.

A formal framework would force a degree of specialization in the two capitals. It would help educate a new generation of political and economic experts, to replace the old hands who managed the relationship successfully from the 1940s to the 1960s. It would provide a quiet place in which differences of view and of policy could be smoothed out, or sufficiently reconciled to prevent public confrontation. This would reduce the political pressures on both governments. It would place a screen between the private fights of the two close parties and the watchful eyes of the rest of the world. It could therefore reduce the danger of undermining other U.S. efforts to strengthen the world economic order.

It should now be evident that the future relationship cannot be the same as the past. There must either be conflict, or a process of reconciliation, taking into account the deep differences in thinking. A reconciliation through creation of a formal bond of partnership to manage the relationship offers the greatest chance of success, both politically and economically.

1 "Foreign Ownership in Canada: The Need for a Balanced View," remarks prepared for delivery to the Canadian Club of Winnipeg, October 19, 1981.

2 The OECD nations adopted in 1976 a consensus Declaration and Related Decision on National Treatment. This was reviewed and reaffirmed in 1979.

3 Statement before the Subcommittee on International Economic Policy, Senate Committee on Foreign Relations, October 28, 1981.

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