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Forecasting California-Canada relations

Daniel J. Smith and Patrick James

Smith_Steve_Rhodes_flickr_small

Photo: Steve Rhodes on Flickr
Jerry Brown and Barbara Boxer at Oakland rally, November 2010.

The United States and Canada are both striving to recover from the global recession, but Canadians have been more successful in resuscitating their economy. In the U.S., the state of California especially is beset by burgeoning political and economic problems. While California has only made piecemeal economic progress in the last two years, extreme partisan politics and interest-group influences have produced persistent gridlock in the legislature, notably on the issue of deficit management. These continuing political struggles could undermine efforts toward full recovery. Failure to stabilize the state’s economy would impact California-Canada relations in the short- to medium-term. The outcome of the California Nov. 2 gubernatorial election will certainly shape the economic opportunities and constraints of firms and industries, and could affect trade and investment patterns with Canada. 

The state finally enacted a budget on Oct. 8, 2010. With the new administration in place, the priority for Californian politics will continue to be initiating economic growth. During the gubernatorial race, the approaches of candidates Jerry Brown and Meg Whitman, though divergent, both provided prospects for sustained economic relations between Canadian and Californian firms. Despite political and economic struggles in California, and the expansionary and fiscal restraint of most businesses in the state, trade and investment with Canada in 2011 and beyond should not be considered entirely uncertain. 

Canada is the second-largest export market of California. Since 2006, the country has annually imported between 11 and 12 per cent of California’s goods. Approximately 25 per cent of all the state’s exports to Canada are computers and electronic products; agricultural goods account for more than 20 per cent; and transportation products comprise 15 per cent of total exports. These primary exports to Canada can be expected to remain a pillar for the future. California, likewise, is the fourth largest market for Canadian firms in the U.S. Another primary Canadian import is alternative energy. California obtains nearly one-quarter of its natural gas and one-third of its hydropower from its northern neighbour country.

But trading in goods is not the panacea for California’s economic situation. Despite its reputation as a leading centre for technology (e.g. biotechnology and medical instruments, computers, digital media, nanotechnology and advanced materials, telecommunications), California has experienced “a reversal of fortune” in recent years through capital flight. Between 2002 and 2006, Canadian investment in Silicon Valley totalled US$230 million, while capital flowing in the opposite direction reached US$760 million. However, this U.S. investment in growing technology sectors in Canada could lead to new firm integration or international collaborations between the two economies —as happened with MarketLink for instance. 

The gubernatorial race allows us to point to some opportunities and impediments particular firms and industries could encounter under the new economic policies of the incoming administration. Republican candidate Meg Whitman centred her economic strategy primarily on eliminating costs for the private sector, thereby providing businesses with the fiscal capacity to expand. This emphasis on reducing costs for businesses —in start-up, factory and capital gains taxes— would create the incentives needed to generate larger Canadian investment in California’s industries. The shortcomings of this policy, however, rest in the uncertainty of real expansion and growth, and in its short-term viability.

The strategy of Democratic candidate Jerry Brown is founded on developing new industries, particularly in renewable energy. Funding the development of the alternative energy sectors could provide new channels for California-Canada exchange in energy, as well as for Canadian firms to establish collaborative ventures or acquire clean technology; yet it may also create a California that is more energy independent. The downside of this strategy for the state’s economy lies in the lack of short-term gains for Californians as it may not provide the same potential for growth in labour as Whitman’s vision promises.

California’s economic policy will continue to target the high unemployment rate, which is currently standing at approximately 12 per cent. Solutions emanating from Sacramento will give primacy to job creation rather than production efficiency; improving the state’s industries will be central to this objective. Nonetheless, continued economic relations with Canada are essential to job growth, as trade alone supported the employment of more than 832,000 Californians in 2007. Both Brown’s and Whitman’s strategies present opportunities for firms and industries to expand. For those businesses not benefiting from the state’s new economic policy, Canada offers ample prospects for growth.

Another source of potential change in California-Canada ties, including in energy, could emerge from ballot initiatives. Proposition 23, in particular, would adversely affect the goal of job creation embedded in California’s alternative energy initiatives. But this is a moot point. While Proposition 23, akin to the policies supporting renewable energy development (e.g. AB 32), is also asserted as being essential to reversing the state’s unemployment rate, the net effect of the energy industry on job growth is uncertain as it is mostly a capital-intensive one. This issue reflects the ability of direct democracy to counter attempts at economic reform, which contributes to California’s political dysfunction. 

Economic relations between Canada and California could benefit from the former’s optimal business environment. The country’s sound fiscal management, ironically, is grounded in policies of the 1990s similar to the current profligate spending in the U.S. These Canadian policies now attract inward investment. According to the Economist Intelligence Unit, the country is rated as the number one location to conduct business over the next five years among G7 members. Particularly propitious to foreign firms are the low transaction costs. The country’s incentives include a falling federal corporate tax rate, which by 2012 will be less than half of the U.S. rate, and the lowest payroll taxes among G7 countries. This is in stark contrast with California, where high taxes pull the state to the bottom of the ranking of favourable tax climates in the U.S. In sum, Canada’s healthy business environment is an advantageous alternative, or potentially a first-best option, for expansionary Californian firms looking to escape the state’s higher transaction costs. 

In the near term, economic relations between California and Canada will remain inherently tied to the state’s political developments. Despite lower levels of economic exchange due to the global recession, trade and investment between the two economies can be expected to stay as robust as it has been over the last decade. Nevertheless, the gubernatorial election and ballot initiatives such as Proposition 23 present some firms and industries from both economies with opportunities, while others will need to be more innovative to overcome the constraints of California’s economic environment. 

Patrick James is a Professor of International Relations and the Director of the Center for International Studies at the University of Southern California. Daniel J. Smith is a Master of Public Diplomacy candidate at the University of Southern California. He can be contacted at danieljs@usc.edu.


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