The Canadian economy is undergoing major structural shifts as a result of global economic headwinds and technological changes.

Author:Dachis, Benjamin
 
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Amid these shifts, the number of individuals employed in traditional, high-paying jobs in manufacturing has been in decline. The resources sector, which until recently had been booming, is also now in the midst of a severe employment downturn. Although these sectors remain sources of jobs that pay well above the average and likely will experience some rebound in coming years, clearly Canadians will be looking to other industries to create or sustain future growth in jobs and incomes.

In this context, we turn our attention to a large and often unheralded portion of the Canadian economy, comprised of providers of commercial services that can and do compete successfully for clients beyond Canada's borders. The importance of these services industries to Canada's economic future can hardly be overstated: together they have added hundreds of thousands of jobs over the past 15 years, jobs that on average pay more than those in manufacturing or resources (Schwanen 2014).

Furthermore, competitiveness in many of these activities--be they logistics, research and development, maintenance, engineering, architectural, software, leasing, legal, management, insurance or banking: services--is becoming critical to the goods-making sectors that rely on them. For example, the more intensive use of services by the manufacturing sector contributes to that sector's productivity and hence to its viability (USITC 2013, chap. 3). Canadians have a vital interest in ensuring that these services industries grow and compete globally including in many countries that, in the future, likely will experience faster economic growth than Canada.

Canada's financial services industry, including banking, insurance, pensions and other investments, plays a central role among those sectors, and it has been a source of strength for Canada through the economically turbulent past decade, as we detail below. In this Commentary, we review and make recommendations on how Canada could best seek, through market-opening agreements, to parlay its strengths in this sector into new international business opportunities that will not only benefit the financial services and related sectors, but also generate future income growth for Canadians.

The largest players in Canada's financial services sector have already expanded significantly overseas in recent years. International assets belonging to Canada's three largest life insurers rose by 42 percent between 2009 and 2014. Large life insurers have broadened the number of markets and business lines they participate in abroad, with 50 percent of their total assets residing in foreign jurisdictions. Similarly, international assets of large Canadian banks have grown by 43 percent since 2010. Banks, however, have been more selective in how they diversify' across jurisdictions: their US and Asian assets have increased both in absolute and in relative terms over the past five years, but their holdings in Europe and Latin America and the Caribbean have experienced a proportional decline. This more targeted geographical approach by Canadian banks is consistent with how financial institutions across the globe have reacted since the financial crisis of 2008-09. In general, financial institutions have been more selective in where they pursue foreign direct investment opportunities. (1) Although this variation in approach between banks and life insurers needs to be taken into account in any specific trade negotiations, our aim in this Commentary is to see which geographically targeted negotiations should be prioritized to leverage the strengths of the Canadian financial services ecosystem as a whole. We therefore do not spell out separate negotiating targets for different types of services, but we do make use of both banking and insurance-specific data to rank priority countries.

These country rankings are based on a set of criteria that we use to determine trade feasibility and attractiveness. This breakdown allows us to provide a detailed ordering of country priorities for Canada's trade negotiators. These countries include both those with which Canada has agreements, and those that should continue to be monitored for potential improvements to future access. The following list represents the five priorities we believe should be top of mind:

  1. Trans-Pacific Partnership (TPP) countries including both countries we have agreements with such as Mexico, the United States, and Chile, as well as countries such as Australia, Japan, Malaysia, and Vietnam with which we do not; 2. China; 3. India; 4. Other members of the Association of Southeast Asian Nations (ASEAN), such as the Philippines, Indonesia and Thailand; and 5. The Dominican Republic.

    THE IMPORTANCE OF FINANCIAL AND RELATED SERVICES TO CANADA'S ECONOMY

    Financial services--encompassing credit intermediation and related activities, (2) securities and other investments and related services, and insurance and pensions services--constitute, with transportation and communications, what have been dubbed "infrastructure services," without the efficient provision of which the rest of the economy cannot grow. Here, we review some industry characteristics that could usefully inform Canada's trade agenda.

    First on our list is the importance of financial services as an employer. The industry employs relatively more Canadians with postsecondary and postgraduate degrees than the rest of the economy, and the structure of its capital (excluding financial capital) is relatively tilted toward intellectual property and buildings. In short, financial services make intensive use of the human capital Canadians have been acquiring in earnest over the past 40 years, as well as of the space and ingenuity Canada possesses in abundance. (3) A number of other services activities tend to grow in tandem with financial services, both because they are directly complementary to them (for example, accounting or legal services) or because the financial services industry relies on them extensively as inputs (such as communications, software and other information and business services). These industries are also characterized by their relatively Greater intensive use of the more highly educated portion of the Canadian work force. Together, these industries have been leaders in the growth of relatively well-paying jobs in Canada so far this century (Table 1). A significant minority of these jobs depends on the industry's growth abroad: banks and insurance companies account for 41 percent of Canada's foreign direct investment (FDI) abroad, and arguably thousands of domestic head office jobs in the financial and related sectors exist to support these investments. (4)

    Not surprisingly, given its increasing share of employment, the financial services sector's share of gross domestic product (GDP) has also increased (Figure 1). Of itself, of course, growth in the sector's share of the economy is neither a good nor bad thins It depends on how efficiently the sector funnels funds toward activities that generate or sustain overall economic growth, and on whether the sector's growth diverts resources from other productive sectors (see Cechetti and Kharroubi 2015). The extent to which growth in the financial services industry positively contributes to growth in the rest of the economy therefore depends on the overall regulation and good governance of the financial system, the degree of competition within it and the openness of the industry to changes, including technological ones, that benefit customers.

    One important sign of whether these factors, as they play out in the financial services industry, work to the overall benefit of Canada's economy, is whether the industry can be considered competitive by international standards. Accordingly, we now turn to some markers of Canada's competitive position in financial services, which will also inform Canada's overall approach to opening markets.

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    THE INTERNATIONAL COMPETITIVENESS OF CANADA'S FINANCIAL SERVICES INDUSTRY

    The international competitive position of Canada's financial services industry cannot be represented adequately by a single metric, even abstracting from often severe data limitations. The industry is very diverse. Beyond the basic delineation between financial intermediation and insurance and pension services and other investment services, there are sharply distinct lines of specialization within these different components of financial services, and even among the types of organizations that offer these different product lines. For example, property and casualty insurance is distinct from health or life insurance, and Canada has a significant cooperative sector that offers a wide array of banking and insurance services. A single metric of competitiveness in a given market might be relevant for some firms, given their unique strengths and strategic direction, but might not be as useful to gauge others' situations.

    In addition, the competitiveness of a financial services firm in a given market often depends on access to complementary services, such as information, communications, legal or accounting services, as well as the ability to move managers and other skilled employees, data or funds across borders to exploit business opportunities and to avoid double taxation. Access to such services and mechanisms by Canadian financial services firms in a given market supports their competitive position in that market, all else being equal.

    The environment for complementary services and agreements is therefore important in evaluating the competitiveness of the industry proper, and for how Canada's trade and economic diplomacy writ large could facilitate the international growth of sectors in which Canada has an advantage, but in which its firms face policy-induced barriers. All told, this argues for a trade strategy that prioritizes target markets based on available indicators of overall competitiveness in financial services, but also on the availability or ability...

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