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CANADA: WHY CANADA CAN'T GET MOVING AGAIN Not long ago its growth was second only to Japan's. Now businesses are fleeing to the U.S. and the economy is stuck. One reason: the rising threat of secessio
Date: 12-30-1991; Publication: Fortune; Author: Louis Kraar REPORTER ASSOCIATE Stephanie Losee

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Fortune
 
 
   THAT chill breeze you feel blasting down from the Arctic just may 
be the wheeze of Canada's ice-cold economy. Like that of the U.S., 
 it 
seemed to be easing out of recession last spring -- but since then 
has been unable to mount a robust recovery. To make matters worse, 
 
structural flaws have appeared that won't easily be cured. The 
country also faces arguably the most serious threat yet of secession 
by French separatists. 
   Canada's multiplying troubles are also bad news for Americans.  
In 
no other country does U.S. business have a bigger stake. Some $200 
billion in goods and services flow between Canada and the U.S. --  
the 
biggest trading relationship ever between any two nations. Canada 
takes 20% of American exports (almost as < much as the 12-country 
European Community) and supplies the U.S. with vital energy and 
natural resources. Many American companies, including General 
Electric and IBM, use their Canadian operations as major global 
suppliers of some of their products. 
   Americans have more invested in Canada ($68.4 billion) than in  
any 
other foreign land. A longstanding common market for autos enables 
U.S. companies to gain greater economies of scale in North America. 
And the U.S.-Canada free trade arrangement, which began phasing in 
nearly three years ago, is creating a continental market for most 
other products. 
   U.S. investors also hold much of Canada's $230 billion foreign 
debt. Canadian bonds and notes have yielded very handsome spreads 
with little apparent exchange risk. That may well change, though,  
as 
separatist sentiment grows in the province of Quebec, which has a 
quarter of Canada's 25 million people. As Lloyd C. Atkinson, 
executive vice president of the Bank of Montreal, says, ''The 
inevitable question in the mind of the foreign investor would be:  
'Do 
I really want to play in the traffic while Canadians sort out these 
matters?' '' 
   Canada's internal political turmoil could also jeopardize the 
creation of a North American free-trade area -- including Mexico - 
- 
with a population of 360 million. Such an alliance partly aims to 
deter the European Community from erecting trade barriers against 
North America. No wonder Canadian Prime Minister Brian Mulroney 
pleads with his countrymen to ''get our act together'' so that Canada 
can survive intense global competition. 
   Assuming Canada does hold together, it still faces formidable 
economic difficulties. Its gross domestic product has been on a 
roller coaster this year. In the first quarter, the economy shrank  
at 
an annual rate of 4.7%, partly because Canadian consumers were in 
shock over the new 7% national sales tax that took effect January  
1. 
Growth ballooned to a 5.7% rate in the second quarter, a cheering 
result that proved artificial because the first three months had been 
so depressed. In the third quarter, Canada expanded at just a 0.9% 
rate. The country has the lowest productivity growth (0.4% per year 
over the past decade) among major industrial nations -- and 
fast-rising labor costs. Small wonder that unemployment is 10.3%, 
compared with 6.8% in the U.S. 
   The pity is that through most of the 1980s, Canada had real growth 
second only to that of Japan. But a new study of Canada's prospects 
by Michael Porter   of the Harvard business school warns that ''the 
core of its economic prosperity is at risk.'' 
   Squeezed by high prices and taxes at home, Canadians pour across 
the border to U.S. shopping centers, spending an estimated $4.5 
billion this year. Many companies also have fled south to the U.S.  
in 
search of a more stable business environment. Those departures, plus 
the outright failure of other companies, have taken away some 300, 
000 
jobs (out of a total of 12.5 million) in the past few years. Says 
Frank Stronach, chairman of Magna International, a Toronto producer 
of auto parts: ''Less and less is made in Canada. We're eroding as  
an 
industrial nation.'' 
   ECONOMIC PRESSURES are forcing Canada to resolve 30 years of 
constitutional wrangling. Quebec plans a referendum next October on 
either accepting new federal arrangements or dropping out of Canada. 
The issue that has dominated Canadian politics for so long is simple 
enough: Quebec, originally settled by France in the 16th century, 
wants guarantees from the central government that its French language 
and distinctive laws will be protected. 
   English-speaking Canadians are weary of the tedious debate and  
of 
the often tortuous gestures to placate Quebec. Toronto, for example, 
 
has French-language television and radio stations despite its tiny 
French-speaking population. Says W. W. Stinson, chief executive of 
Canadian Pacific, the giant transportation conglomerate: ''While 
we're dealing with unity issues, the realities of becoming 
uncompetitive are pressing hard against us.'' 
   The countdown to the referendum could amount to a ticking debt 
bomb. So far, bond-rating agencies give Canada top marks for managing 
its debt. But some officials worry that even nothing more than a 
verbal civil war could turn international investors against Canadian 
bonds and securities. The $370 billion Canadian federal debt -- 
including the $230 billion of foreign debt -- represents nearly 44% 
of gross domestic product, vs. 32.9% for the U.S. If you toss in 
borrowing by Canadian provinces, the country's total government debt 
comes to over 70% of annual output -- a higher proportion than any 
major industrial country except Italy. 
   Partly because of the political squabbling, Canada has had to pay 
a premium to finance that debt. Atkinson estimates the premium to  
be 
one percentage point on long-term government bonds and two percentage 
points on short-term bonds. Meanwhile, Canada's central bank keeps 
interest rates high to dampen | inflation, attract foreign currency, 
 
and bolster the Canadian dollar. The results are punishing for 
business. 
   For all its pride, an independent Quebec would be hard pressed  
to 
service its own loans, let alone its share of Canada's national debt. 
The province has borrowed just over $15 billion in foreign currencies 
and pays even higher interest than does the federal government. Says 
Robert Blohm, an American investment banker in Montreal who helps 
bring Japanese capital to Canada: ''Quebec cannot do what it wants 
unless the international financial community provides support.'' 
Quebec politicians blithely talk about seceding while maintaining 
monetary links with the rest of Canada. Warns Prime Minister 
Mulroney: ''Separation means separation. Period.'' 
   Mulroney hopes to hold his country together by focusing on 
economic challenges. At the same time, he wants to increase the free 
flow of goods and services within Canada. For example, provinces 
often impede the sale of beer that is not brewed locally. As a 
result, the country has 67 breweries, far more than required for an 
efficient industry. Because electric and telephone utilities in 
various provinces give preference to local suppliers, there are 31 
wire and cable plants. Such practices, designed to create jobs, cost 
the economy an estimated $5.3 billion a year, just under 1% of the 
GDP. 
   Despite Mulroney's efforts, the notion that government can spend 
an economy to prosperity is clearly growing in Canada. In little more 
than a year, three provinces -- Ontario, British Columbia, and 
Saskatchewan, which together have more than half the population -- 
 
have elected moderately socialist governments. Ontario already is 
planning to help bail out de Havilland, a commuter aircraft 
manufacturer that has been losing money over the past five years. 
Boeing, which bought the company in 1986, has been unable to turn  
it 
around and now wants to sell. Never mind that de Havilland earlier 
limped along under state ownership for more than a decade. The swing 
to the left is reflected in the approval ratings -- 12%, the lowest 
ever -- of Mulroney's conservative government, which came to power  
in 
1984. 
   Canada's smokestack industries are just beginning to cope with  
the 
restructuring that U.S. companies have been going through for as much 
as a decade. While American manufacturers closed obsolete facilities 
and modernized others, Canada coasted on cheap currency. Says 
Frederick Telmer, CEO of Stelco, Canada's second-largest integrated 
steel producer: ''We were   competitive without having to change,  
and 
now we have to face reality.'' 
   THAT REALITY is grim: The Canadian dollar has appreciated over  
25% 
in the past five years, mainly because the Bank of Canada's strong 
monetary policy has kept inflation down. In the same period, Canadian 
unit labor costs rose more than 46% (in U.S. dollar terms), vs. a 
decline of 0.3% in American manufacturing. 
   After a 100-day strike last year, Stelco found that many of its 
customers had folded or moved to the U.S. To survive, the company 
raised more than $220 million by floating new stock and is 
restructuring operations to raise productivity. Says Telmer: 
''Adversity tends to focus the mind on the need to accept change.' 
' 
New labor contracts peg compensation partly to the performance of  
the 
plant in which an employee works. Stelco has also teamed with 
Mitsubishi to make zinc-coated steel for Japanese auto plants in 
North America. 
   Michael Porter's $1 million study, underwritten by the government 
and by Canada's equivalent of the Business Roundtable, warned that 
Canada is ''in many respects ill equipped to respond to a rapidly 
changing competitive environment.'' Exports represent over 25% of 
Canada's GDP, more than those of any major industrial country except 
Germany. Mostly Canada exports relatively unprocessed natural 
resources, which are vulnerable to low-cost Latin American rivals. 
Canada has seriously shortchanged investment in research, worker 
training, and new machinery. As Porter put it to the Canadians, '' 
You 
need a new mode of competing.'' 
   A few smart Canadian companies that have long followed Porter's 
prescription are thriving in global markets. Inco (with $3.1 billion 
in sales last year) supplies one-third of the world's nickel. By 
investing heavily over the past decade in new mining techniques -- 
 $1 
billion in the past two years alone -- Inco has cut its Canadian work 
force in half, to some 9,500. At one experimental operation, miners 
operate giant hauling vehicles a mile below ground from a control 
center on the surface. Says Inco Chief Executive Donald Phillips: 
''We cannot control prices, but we can control costs.'' Labor 
contracts peg pay partly to the price of nickel and the cost of 
living. And the company adds significant value to ores by producing 
nickel alloys, turbine blades, and mining equipment largely for 
foreign customers. 
   Another promising Canadian company, SHL Systemhouse, sells 
computer services to such American clients as Motorola, the 
California Department of Motor  Vehicles, and Los Angeles 
International Airport. On the strength of its work with the Canadian 
post office, Systemhouse has been awarded a $270 million contract  
to 
build a system to track U.S. Express Mail at 16,000 locations. An  
800 
phone number will allow customers to check the delivery time of any 
item. 
   CAE, a world leader in flight simulation and training devices, 
spends 16% of its nearly $1 billion annual sales on research and 
development. Says President David Race: ''We've succeeded by finding 
niches.'' Several years ago CAE abandoned a successful foray into 
auto parts to focus on what it does best. To win U.S. government 
contracts, it acquired Link, the American pioneer of ground-based 
pilot-training devices, from Singer. Digesting Link has been 
troublesome, but the company now provides training devices for U.S. 
manned spaceflights. During the war with Iraq, American pilots 
rehearsed for precision bombing missions on CAE simulators using 
satellite photos taken just hours before. 
   Clearly, many Canadians can compete. As Race puts it, ''It's 
almost a cultural problem. We have traded on our resources for so 
long, and now we've got to get down to work.'' So do Canadian 
government leaders. The last thing the U.S. needs is the creation  
of 
one or more new (and insolvent) nations on its border. 
 
 

Louis Kraar REPORTER ASSOCIATE Stephanie Losee, CANADA: WHY CANADA CAN'T GET MOVING AGAIN Not long ago its growth was second only to Japan's. Now businesses are fleeing to the U.S. and the economy is stuck. One reason: the rising threat of secessio. , Fortune, 12-30-1991, pp 122.

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