Preliminary Analysis IDENTIFYING THE NEXT GENERATION OF CANADIAN PRIORITY MARKETS. Presented to: Foreign Affairs, Trade and Development Canada

Transcription

1 IDENTIFYING THE NEXT GENERATION OF CANADIAN PRIORITY MARKETS Preliminary Analysis Presented to: Foreign Affairs, Trade and Development Canada The Conference Board of Canada October 2012 Prepared by: Danielle Goldfarb Associate Director, The Global Commerce Centre

2 Table of Contents Contents Introduction... 3 Selecting Priority Markets... 5 Measuring Potential... 5 Inde 1: Country Growth Potential Inde... 5 Inde 2: Canadian Business Potential Inde... 6 Ecluding the Usual Suspects... 6 Our Underlying Factors Compared With Others... 7 Creating the Net Generation List... 8 Minimum Size Criteria... 8 Finding the Sweet Spot Policy and Risk Dimensions Conclusions Appendi: Additional Details on Method Inde 1: Country Growth Potential Inde Inde 2: Canadian Business Potential Inde Alternate Inde Constructions... 24

3 Introduction The global operating environment has changed. The rise of global value chains, high growth markets, digitized information, foreign direct investment, and the Canadian dollar represent some of the changes Canadian companies face. Canadian companies are adapting, many of them fundamentally shifting what they trade and with whom. In this contet, which markets are likely to represent the greatest potential for Canadian companies? Trade with the U.S. has been stagnant over the past decade, and many developed economies are growing slowly compared with rapid growth in developing economies. The obvious candidates representing the greatest business potential are the large, developing economies, mainly Brazil, China, and India. These have already been the focus of so much attention in recent years and are likely to continue to be the most important growth markets based on their economic and demographic sizes. But opportunities eist beyond these countries. Goldman Sachs (GS) and the Economist Intelligence Unit (EIU), among others, have developed lists of net countries that likely represent the most economic potential. These lists go beyond the countries that provided traditional sources of growth (such as the U.S. and U.K.), and beyond the BRIC economies of Brazil, Russia, India, and China (that Goldman Sachs highlighted a decade ago). Several of Canada s peer country governments have also developed lists of net priority countries for their global commerce efforts. Table 1 highlights and compares these lists.

4 Table 1 Identifying Promising Markets: Comparing Priority Lists Purpose of eercise is to identify markets Country (listed from highest to lowest GDP) "BRIC" (Goldman Sachs, 2003) With high GDP and growth potential "Net 11" (Goldman Sachs, 2005) With highest growth potential, beyond the BRICs "CIVETS" (Economist Intelligence Unit, 2010) With highest sustained growth potential and sizeable "L6" plus China, India (Australia)* Representing greatest Australian business growth potential, including establishing local presence High growth economies of focus (U.K.) Representing best trade and investment growth opportunities for U.K. businesses "Net Tier" (U.S.) To prioritize for U.S. eport promotion China Brazil Russia India Meico Republic of Korea Indonesia Focus on ASEAN Turkey Saudi Arabia Iran Argentina South Africa Colombia Nigeria Egypt Focus on North Africa Philippines Focus on ASEAN Pakistan Vietnam Focus on ASEAN Bangladesh Chile Peru *Australia also lists Sub-Saharan Africa as a region of focus, in addition to the L6. Sources: The Conference Board of Canada; International Monetary Fund; Goldman Sachs 2001, Building Better Global Economic BRICs; Goldman Sachs 2005, How Solid Are the BRICs?; Economist Intelligence Unit 2010, World Economy: Beyond BRICS; Austrade Corporate Plan ; Report to the President on the U.S. National Eport Initiative 2010; U.K. White Paper on Trade and Investment for Growth To our knowledge, no one has yet done such an analysis through a Canadian lens. This report commissioned by Foreign Affairs, Trade and Development Canada attempts to address this gap and to inform the Government of Canada s refreshed global commerce strategy. We create a method to identify a fresh list of net generation countries. Our method is based on available economic data that proy both Canadian business potential (two-way trade and two-way investment) and country growth potential.

5 Based on this analysis, we identify preliminary net generation countries that go beyond the usual suspects. We define the usual suspects as our traditional trade and investment partners, as well as the large, developing economies of Brazil, China, and India that are already on the radar screen. Selecting Priority Markets Our selection of priority markets is based primarily on economic data, similar to the Goldman Sachs approach. A country risk analysis, for eample, is outside the scope of this analysis. We do, however, return to a few policy indicators once we have identified priority countries. Our goal is to select countries that will be important for Canada s future economic prosperity and likely represent the most Canadian business potential. We therefore use an approach that accounts for both a country s specific potential with respect to Canada and its growth potential and size. A forthcoming Conference Board Global Commerce Centre report shows that the key driver of Canada s future trade will be real GDP growth in partner countries, 1 bolstering this focus on growth potential for determining future commercial opportunities. In developing our method, we reviewed what other organizations and countries have done, and we considered alternative indees and indicators, as well as alternative weighting schemes and their pros and cons. Selecting indicators and deciding how to organize and weight them requires trade-offs. No method, including our own, is perfect, but we consider it to be a sound data-based tool to provide a preliminary analysis of net generation priority countries for Canada. We give a brief description and eplanation of our method here, and provide additional detail in Appendi A. Measuring Potential We created two indees. We call one the country growth potential inde and the other the Canadian business potential inde. Inde 1: Country Growth Potential Inde We chose indicators and summary indicators that would best capture economic potential, based on eisting evidence of what drives growth. This inde contains four equal-weighted elements for each country: 1 Beckman, Kip. Forthcoming. What Might Canada s Future Eports Look Like? The Conference Board of Canada.

6 1. Goldman Sachs Global Environment Scores 2011 Inde (to proy for future growth) 2. Past five years of real GDP growth (to proy for future growth and to balance Goldman Sachs measures, which may not capture all elements driving growth) 3. Share of global GDP (to give larger economies more weight) 4. Share of global inward and outward investment (to proy business confidence in these countries, and outward investment orientation) Inde 2: Canadian Business Potential Inde We assume that countries that already deal with Canada have higher future potential. This inde contains two equal-weighted elements for each country, on the basis that all of these elements are meaningful aspects of Canadian global commercial activity: 1. Trade equal weight to eports and imports (services are not included due to significant data limitations) 2. Investment equal weight to each of foreign direct investment in Canada and Canadian direct investment abroad There is not much commercial activity with most of the countries beyond our traditional commercial partners. But we include this element as it seems reasonable to assume that countries that have at least some activity with Canada now are more likely to represent greater future Canadian business opportunities than are countries with which there are almost no eisting Canadian relationships. Ecluding the Usual Suspects Since we have been tasked with providing a fresh, net generation list, we eclude from our indees the usual suspects. We standardize our inde values relative to the remaining countries, after we have ecluded these usual suspects. The remaining inde scores therefore represent the scores relative to the non- usual suspects. This allows us to focus on a fresh, net generation list of high growth potential economies. We define the usual suspects as the advanced economies and Brazil, India, and China. Advanced economies are also generally well known to Canadian businesses, the public, and policy-makers, Canada has strong historical ties with these economies, and Canada s government has been dealing with these countries in multiple fora for many years. More specifically, we eclude the United States, the countries of Western Europe (Austria, Belgium, Denmark, France, Finland, Germany, Greece, Iceland, Ireland, Italy, Luembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom), Japan, Australia, and New Zealand. The large, developing economies of Brazil, India, and China represent key long-term opportunities for Canada but are already on the business and policy radar screen. We therefore eclude them. We did not eclude Russia (the fourth country in the BRIC) as it is a bit different from the other BRIC economies with smaller population and GDP and

7 more volatile growth. It is also not on the Canadian business and policy radar screen, having weak commercial linkages with Canada. To create the indees, we standardize the data in each inde component from 0 to 100. We then weight according to the descriptions above, and arrive at two inde values, one for country potential and one for Canadian business potential. Our Underlying Factors Compared With Others Other countries and organizations have developed net priority country rankings, and theirs use similar underlying factors to ours. Table 2 shows factors we included in our selection of priority markets for Canada, compared with factors that others have used. Table 2 Identifying Promising Markets: Different Approaches Factors included in assessment of priority markets "Net Gen" (this analysis) "Net 11" (Goldman Sachs, 2005) "CIVETS" (Economist Intelligence Unit, 2010) "Net Tier" (U.S.) Size Gross Domestic Product Population Growth environment and potential Past or epected GDP growth Macroeconomic stability (e.g., inflation, government deficit and eternal debt) Political conditions Macroeconomic conditions (e.g., trade openness and investment rates) Technology Human capital (e.g., education and life epectancy) Microeconomic environment (e.g., cost to start a business, urban population, patents, R&D) Market diversity Financial system soundness Foreign direct investment Economic relationship with partner country Trade Investment Country market penetration, room for epansion Purpose of eercise is to identify markets Representing high growth potential and greatest Canadian business potential, including two-way With highest trade and two-way growth investment potential (beyond the (beyond the BRICs) BRICs) With highest sustained growth potential and sizeable (beyond the BRICs) To prioritize for US eport promotion Sources: The Conference Board of Canada; Goldman Sachs 2005, How Solid Are the BRICs; Economist Intelligence Unit 2010, World Economy: Beyond BRICS; Report to the President on the U.S. National Eport Initiative 2010.

8 Creating the Net Generation List Minimum Size Criteria Our assumption is that countries need to have a minimum size to represent significant enough potential for Canada. This assumption of the importance of both GDP and population is in line with the other priority lists we reviewed. 2 So, after ecluding the usual suspects and constructing the indees, we screen the 154 countries in our sample for a minimum economic and demographic size (GDP greater than $100 billion, and population 10 million or higher). We do this even though GDP is already included in our country growth potential inde, since in that inde it is only given partial (one-quarter) weight, and since we feel a minimum GDP is a key criterion on which to determine priorities. Countries that did not meet our minimum criteria included the Caribbean countries, Singapore and Hong Kong, some Eastern European countries (such as the Slovak Republic, Croatia, Bulgaria, and the Baltic countries), the Gulf states, many of the former Soviet republics, many African countries, smaller Latin American countries (such as Panama and Uruguay), and many island countries. Table 3A shows those 31 countries that meet this minimum set of criteria, listed in order of country growth potential. Table 3B shows the same countries, listed in order of Canadian business potential. 2 For eample, Goldman Sachs (2005, How Solid Are the BRICs?) notes that Without a substantial population, even a successful growth story is unlikely to have a global impact. Hong Kong will never be a global power nor Luembourg, despite the very high levels of income and living standards that they have achieved.

9 Table 3A Countries Meeting Minimum Criteria, in Order of Country Potential Rank (country growth potential) Country GDP (2011, US$billions) Sources: The Conference Board of Canada; World Bank. Population (2011, millions) Country growth potential inde (0-100, higher is better) Canadian business potential inde (0-100, higher is better) 1 Russia Republic of Korea Meico Indonesia Saudi Arabia Argentina Poland Iran Malaysia Turkey Thailand Chile Colombia Vietnam Czech Republic South Africa Egypt Kazakhstan Taiwan Peru Hungary Romania Algeria Iraq Venezuela Philippines Ukraine Angola Pakistan Bangladesh Nigeria

10 Table 3B Countries Meeting Minimum Criteria, in Order of Canadian Business Potential Rank (Canadian business potential) Country GDP (2011, US $billions) Sources: The Conference Board of Canada; World Bank. Population (2011, millions) Country growth potential inde (0-100, higher is better) Canadian business potential inde (0-100, higher is better) 1 Meico Republic of Korea Chile Hungary Peru Indonesia South Africa Kazakhstan Taiwan Argentina Turkey Russia Thailand Colombia Saudi Arabia Malaysia Algeria Venezuela Egypt Bangladesh Philippines Poland Iraq Nigeria Pakistan Angola Vietnam Czech Republic Romania Iran Ukraine

11 (If we were to halve the minimum population and GDP required for a minimum GDP of $50 billion and population five million and above additional countries that would make the cut-off are: Azerbaijan, Belarus, Bulgaria, Hong Kong, Israel, Singapore, Slovak Republic, and the United Arab Emirates.) Finding the Sweet Spot We plot the short list that made our minimum size cut-off of $100 billion in GDP and 10 million or greater in population on Chart 1. We plot country growth potential on the vertical ais and Canadian business potential on the horizontal ais. To identify priorities among the non-usual suspects, we focus on which part of the scatterplot these countries fall into, rather than their inde values. The top right section represents countries with both high country potential and high Canadian potential. This is the sweet spot of countries that have the potential to become more important for Canada over the medium to longer term. What is immediately obvious is that South Korea (the Republic of Korea) and Meico are clearly in the sweet spot, ranking high on both Canadian business potential and country growth potential. South Korea has a large economy, a strong growth environment, and Canada eports and receives a large amount of investment from Korea, relative to the non-usual suspects. Similarly, Canada s trade links with its NAFTA partner Meico are relatively large when not compared with the U.S., and Meico s economy is a relatively large economy (though has relatively low recent growth and only a modest growth environment score ).

12 Chart 1 Countries Meeting Size Criteria Source: The Conference Board of Canada. The top left corner is also interesting. Russia is clearly an outlier here, with high growth potential due to its large economy and relatively rapid growth (though low growth environment score, and as we ll see later, a poor rating on the World Bank s ease of doing business measure). Russia has a very limited commercial relationship with Canada, and thus places very low on the Canadian business potential inde. Beyond Meico, South Korea, and Russia, there are a number of candidates that appear clustered together. To better be able to determine priorities amongst these remaining countries, Chart 2 ecludes these top three countries. We are then able to zero in on the remaining countries that have met our minimum size criteria. In order to determine priorities, we use a thick black line to define four sections. The bottom left section shows countries with low potential on both indees. Countries in this section include Algeria, Angola, Bangladesh, Iraq, Nigeria, Pakistan, the Philippines, Romania, Ukraine, and Venezuela. We drop these countries from consideration. (Note that many of the countries that would place in this section have already been eliminated due to our minimum size criteria cut-offs.)

13 Chart 2 Countries Meeting Size Criteria Ecluding Meico, South Korea, and Russia Source: The Conference Board of Canada. The top right section in Chart 2, by contrast, represents countries with both high country potential and high Canadian potential. In addition to Meico and South Korea, we consider this the sweet spot of countries that have the potential to become more important for Canada over the medium to longer term. Note that Indonesia ranks so highly because of its recent rapid growth and large size, rather than its more modest Goldman Sachs growth environment rank. The top left section which is where Russia placed in Chart 1 may also be promising. If a country has high growth potential but little Canadian involvement, it may still be worthwhile to consider this group. Canadian businesses may not have eplored the full potential of rapidly growing countries like Colombia and Vietnam, for eample. Governments may decide to prioritize a country that has huge growth potential but of which Canadian companies have not fully taken advantage. As Chart 2 shows, no countries place in the bottom right section of high Canadian engagement but low growth potential.

14 Chart 3 zeroes in on the countries in the sweet spot, with bubble size representing the size of their economy. It shows that Indonesia stands out in terms of its growth potential due to its large economy and rapid recent growth (though this is tempered by its low growth environment scores). Chile, Peru, and Hungary stand out in terms of Canadian involvement, but have smaller economies (Hungary s GDP just barely placed it above our minimum size criteria). South Africa and Taiwan have relatively large economies. Taiwan also has a strong growth environment score though modest recent growth compared with rapidly growing Kazakhstan. Chart 3 Sweet Spot Ecluding Meico and South Korea (bubble size represents GDP) Source: The Conference Board of Canada. Chart 4 zooms in on the countries in the top left hand corner of Chart 2 that have at least a value of 3 on the Canadian business potential inde (this ecludes the Czech Republic and Iran, which have values lower than 3). These countries have relatively high growth potential. But they have little Canadian involvement, and possibly represent uneplored

15 Canadian potential. (Note that charts 3 and 4 are on different scales and are therefore not directly comparable.) Chart 4 High Growth Potential Ecluding Russia (bubble size represents GDP) Source: The Conference Board of Canada. Many of these countries are clustered together, with various trade-offs between country potential, Canadian potential, and GDP. Colombia, Egypt, and Vietnam have all had over 20 per cent annual average growth over the past five years and so rank relatively high on growth potential, despite their modest economic sizes. Argentina has had similarly rapid growth, but also has a much larger GDP, placing it relatively higher in terms of growth potential (though it ranks as a very difficult place to do business by the World Bank s ease of doing business measure, as Table 5 will show below).

16 To summarize, Table 4 lists those countries that either hit the sweet spot or are above the cut-off line for high growth potential and have at least a value of 3 on the Canadian business potential inde. Countries are listed in alphabetical order, and we show their economic and demographic size, as well as their inde scores. Table 4 Countries in the Sweet Spot or With Growth Potential Country GDP (2011, US$billions) Sources: The Conference Board of Canada, World Bank. Of note in this list are the large economies of Korea and Russia, the Latin American countries of Meico, Chile, Peru, Argentina, and Colombia, the Southeast Asian countries of Indonesia, Malaysia, Thailand, and Vietnam, the Eastern European countries of Turkey, Hungary, and Poland. Others include Saudi Arabia, South Africa, Kazakhstan, Taiwan, and Egypt. As will be discussed in the net section, each country has its pros and cons, and needs to be considered in a broader contet to determine if it should truly be a Canadian priority country. This country list is not out of line with the findings from other organizations (as Table 1 showed, and as Table 5 will show below). The countries in the overall list are also largely consistent with variations of our own method. Population (2011, millions) Canadian Country growth business potential inde (0- potential inde 100, higher is (0-100, higher better) is better) Sweet spot Chile Hungary Indonesia Kazakhstan Meico Peru Republic of Korea South Africa Taiwan Growth potential Argentina Colombia Egypt Malaysia Poland Russia Saudi Arabia Thailand Turkey

17 Some may wonder which countries might have made the list if we had lower size requirements. If we cut our minimum GDP and population sizes in half (to $50 billion and five million respectively), the sweet spot would additionally include Hong Kong and Singapore. And the growth potential section of the table would additionally include Israel and the United Arab Emirates. This list necessarily ecludes many countries with potential for Canada, simply because they could not all be priorities. We had to include those that indicated the most potential according to our indees, which are based on economic data. This does not mean ecluded countries do not represent future potential for Canada. Policy and Risk Dimensions This list should be viewed as a preliminary one, based on readily available economic indicators. Each of the countries in the list needs to be eplored further. In particular, to determine Canadian priority countries, candidate countries should be put through other filters and other factors should be considered. Such factors include the compatibility of Canada s and the country s industrial structure, political and other risks, 3 human rights records and policies, and whether a country is like-minded with Canada regarding trade and investment policies. It may also be important to consider how policy accessible a particular country is i.e., to what degree Canada s government can have a meaningful impact on changing another country s policy affecting Canadian businesses, or to what degree Canadian trade commissioners on the ground can help Canadian businesses access markets. Policy accessibility is less straightforward to assess than economic potential. Also, it may be important to consider any dramatic policy changes that are not reflected in eisting economic data. For eample, Burma s government has made major political and economic reforms in , and Canada has adjusted its policy towards the country in response. Any resulting greater commercial potential with that country would not yet be reflected in economic data. It may also be important to consider whether to approach or address countries with a regional approach. For eample, Malaysia, Thailand, Indonesia, and Vietnam are part of ASEAN a regional trading bloc and so may be better addressed via a regional approach. A full eploration of these factors is outside the scope of this study. But to get a brief sense of the range of policy and risk filters that may also need to be considered, we add 3 Political stability is included in one component of the Goldman Sachs inde that forms part of one of our indees, but it is a very small component of the overall inde.

18 a few indicators to the country list in Table 4. Table 5 shows these countries on a few policy measures, as well as compared to priority country lists by other organizations and other countries. Table 5 Countries in the Sweet Spot or With Growth Potential: Policy Measures and Comparators Country "Policy" measures Ease of doing business (rank out of 183 countries) Simple average applied MFN tariff (%) FTA or FIPA with Canada (Ongoing negotiations in brackets, eploratory discussions in double brackets) Comparators BRIC/Net-11 (Goldman Sachs) or CIVETS (EIU) Priority country for U.S., U.K., Australia Sweet spot Chile 39 6 FTA Aus Hungary 51 5 FIPA, (FTA with EU) Indonesia (FIPA) N-11, CIVETS U.S., U.K. (ASEAN focus) Kazakhstan 47 9 (FIPA) Meico 53 9 FTA N-11 Aus, U.K. Peru 41 5 FTA, FIPA Aus Republic of Korea 8 12 (FTA) N-11 U.K. South Africa 35 8 CIVETS U.S., U.K. Taiwan 25 6 Growth potential Argentina FIPA, ((FTA with MERCOSUR)) Aus Colombia FTA CIVETS Aus, U.S. Egypt FIPA N-11, CIVETS U.K. (North Africa focus) Malaysia 18 8 U.K. (ASEAN focus) Poland 62 5 FIPA, (FTA with EU) Russia FIPA BRIC Saudi Arabia 12 5 U.S. Thailand FIPA, ((FTA)) U.K. (ASEAN focus) Turkey ((FTA)) N-11, CIVETS U.S. Vietnam (FIPA) N-11, CIVETS U.S., U.K. (ASEAN focus) Sources: The Conference Board of Canada; World Trade Organization; World Bank; Department of Foreign Affairs and International Trade; Goldman Sachs; Economist Intelligence Unit; country trade policy plans. For eample, Indonesia is in the sweet spot but, as Table 5 shows, it ranks 129/183 on the World Bank s ease of doing business measure (the higher the number, the harder it is to do business). Similarly, Argentina also ranks as a difficult place to do business. Egypt has high growth potential and is ranked as a Net-11 country by Goldman Sachs but also ranks poorly on ease of doing business, has a very high average tariff rate, and is considered a failed state (ranked number 31 of 177 on the Foreign Policy Failed States Inde, where higher rank is worse note that this inde is not shown above). In short, each potential net generation market has different non-economic circumstances. Because this is only a preliminary analysis we do not do a complete assessment of the policy and risk dimensions. What we do provide is a starting point for policy-makers to consider possible priority economic potential markets, which they can then put through relevant political and other filters.

19 Conclusions To be sure, Canada s traditional trade partners including the U.S., much of Western Europe, and other advanced economies plus Brazil, India, and China will continue to represent the most significant long-term potential for Canadian businesses. Canada s refreshed global commerce strategy should necessarily focus on these usual suspects, but also consider the net generation of countries that could represent potential for Canadian businesses. This preliminary analysis finds a fresh list of additional, net generation economies that might represent economic potential for Canada going forward, despite being relatively modestly engaged with Canada at present. We define potential in the broad sense of all types of commercial opportunities, including eports and imports of both goods and services, and two-way investments, as well as a country s growth potential. Canada s government should eamine each potential market relative to country risk, complementary industrial structures, and policy accessibility, as well as other filters. Moreover, economic and political circumstances change, and a net generation list should evolve over time in response to changed circumstances and new information. This report was produced by The Conference Board of Canada s Global Commerce Centre. The Conference Board of Canada is the foremost independent, not-for-profit applied research organization in Canada. The Board has a long history of developing data-based methods for establishing rankings and priorities. The Global Commerce Centre has an active research program on trade, investment, and trade policies. The Centre has produced over 50 evidencebased reports. This report was written by Danielle Goldfarb, with input, underlying data analysis, and guidance from Doris Chu, Brenda Lafleur, Paul Darby, and Glen Hodgson.

20 Appendi: Additional Details on Method We created two indees. One we call the country growth potential inde and the other the Canadian business potential inde. We bucket indicators in these two separate indees, 4 rather than add them together. We do this so the trade-offs between the indees will be transparent, and also so as to not over- or under-weight either factor. In other words, a country should, in theory, have both growth potential and Canadian business potential in order to be considered for our priority list. We show results on an XY scatterplot, with each inde on an ais, thus effectively giving each equal visual weight. Within each inde, we selected indicators that are readily available, available for a large number of countries, and available for the most current time periods. We dropped those countries from the analysis for which no data were available for three or four of our chosen indicators. We also eclude Barbados from the analysis as $53 billion of Canada s direct investment abroad in 2011 is recorded as going to Barbados. Barbados is a low ta conduit for this investment rather than its final destination. Leaving Barbados in would result in Canadian direct investment values being standardized relative to this highly misleading Barbados investment value (since the value of $53 billion is the highest in our non-usual suspects sample). Barbados will later be ecluded from the analysis in any case, based on not meeting our minimum size criteria. Once we drop advanced economies, Brazil, India, and China, countries without sufficient data, and Barbados, we are left with 153 countries in our sample from which to draw our net generation list. In constructing the indees, we tried to include enough indicators or summary indicators to a) capture the most significant aspects of economic potential and b) ensure that any one underlying indicator would not overpower the results, particularly in the event that the data represented a short-term blip rather than a long-term trend. Where we felt it was necessary, we added more indicators to make our results more robust. We tried various weightings, as well as adding and deleting additional indicators to see whether they would affect the results. Inde 1: Country Growth Potential Inde We chose indicators and summary indicators that would best capture economic potential, based on eisting evidence of what drives growth. This inde contains four equal-weighted elements for each country: Goldman Sachs Global Environment Scores (GES) 2011 Inde 5 4 This bucket approach is used frequently in constructing indees. See, for eample, Goldman Sachs, Our 2011 GES, and The Conference Board of Canada, How Canada Performs Source: Goldman Sachs Our 2011 GES: A Sharper Signal for Growth..

21 Past five years of GDP growth Share of global GDP Share of global inward and outward foreign direct investment We chose to include the Goldman Sachs GES measure as it is a broad-based, databased measure that tries to capture the conditions for growth in any country. This inde includes a range of economic, political, and social variables that have been strongly and robustly related to subsequent GDP growth outcomes across both countries and time. Specifically, the inde includes 18 indicators grouped into si broad categories: Macroeconomic stability o Inflation (percentage change in rate) high inflation can increase uncertainty o Government deficit (percentage of GDP) high deficits can hurt economic stability o Eternal debt (percentage of GDP) large foreign borrowing raises the risk of eternal crises and tends to push up real interest rates Macroeconomic conditions o Investment rate (gross fied capital formation, as a percentage of GDP) higher investment in productive activities and resources encourages capital accumulation and future productivity growth o Openness (trade balance as a percentage of GDP, adjusted for population and surface area) more open economies may grow faster for several reasons, including technology and knowledge diffusion, eploitation of comparative advantage, eposure to competition, and increasing economies of scale Technology o Mobile cellular subscriptions (per 100 people) mobile phone penetration is a proy for information and communication technology (ICT) adoption, which encourages productivity growth o Personal computers (per 100 people) personal computer penetration is another dimension of ICT diffusion o Internet users (per 100 people) Internet penetration is another dimension of ICT diffusion o Secure Internet servers (per 1 million people) the number of secure Internet servers is another dimension of ICT diffusion Human capital o Life epectancy (number of years) poor health conditions, as proied by low life epectancy, can hinder productivity and educational attainment, thereby depressing growth rates as well o Schooling (net secondary school enrolment) higher levels of educational attainment encourage productivity growth and technological adoption

22 Political conditions o Political stability (inde score from the World Bank s Worldwide Governance Indicators) unstable political regimes result in higher uncertainty, which tends to deter investment and hinder growth o Corruption (inde score from the World Bank s Worldwide Governance Indicators) greater corruption tends to distort incentives and divert human and physical resources from their most productive uses o Rule of law (inde score from the World Bank s Worldwide Governance Indicators) well-defined property rights and well-functioning institutions are prerequisites for sustained, productive investment and growth Microeconomic environment: o Cost to start a business (percentage of income per capita) ecessive business-entry regulations can hinder competition, strangle entrepreneurship, encourage rent-seeking, and promote informality, all of which delay the entry and growth of firms o Urban population (percentage of total population) a higher share of people living in cities reflects a rebalancing from agriculture towards more productive service and manufacturing industries; also, the concentration of people can boost productivity via economies of scale and network eternalities o Patent applications (per 1 million people) a higher number of patent applications is indicative of incentives for innovation, along with the institutional capacity to provide protection for new ideas o Ependitures on research and development (percentage of GDP) R&D activity enables technological progress and, thus, productivity growth Each component is standardized from 0 to 10, and then aggregated into category scores. Goldman Sachs assigns equal weight to each category to arrive at a growth environment score for each country. While the GES inde may capture many of the factors underlying an economy s ability to grow, it might miss some important countries (China, for eample, ranks 65th in the 2011 ranking). So we think it meaningful to add a measure of epected growth. Rather than relying too heavily on one forecaster s opinion, we chose to use past GDP growth rates as a proy for future growth. We also tried including growth in population and per capita GDP but found this led to less meaningful results. Our third element in this inde was the economy s size as a share of the world. This was intended to rank larger economies higher in terms of their potential. To add further information to the inde, we added in a final element of investment as a vote of confidence by other countries, and as a way of proying a country s global competitiveness and outward orientation. Our measure was composed of half-weight world outward foreign direct investment stock as a share of the world, and half-weight inward foreign direct investment stock as a share of the world. We found that adding this

23 investment element had the effect of lowering the ranking of countries like Argentina, Iran, Iraq, Nigeria, and Venezuela. We considered alternative weightings within this inde, but decided on an equal weight scheme for simplicity s sake and in order to not arbitrarily under- or over-weight any particular element. Inde 2: Canadian Business Potential Inde We chose those indicators that seem likely to best capture future business potential based on eisting evidence of what drives trade and investment. We define business potential broadly, in the sense of both eports and imports, ideally of both goods and services, and two-way investment. We assume that countries that already deal with Canada have higher future potential. This inde contains two equal-weighted elements for each country: 1. Trade equal weight to eports and imports 2. Investment equal weight to each of inward FDI and Canadian direct investment abroad Our method gives equal weight within the Canadian business potential inde to each of the trade and investment sub-indees. This implicitly assumes that recent trade and investment activities are equally important metrics of future Canadian trade and investment potential, which may or may not be true. But it seems a reasonable assumption if we are trying to evaluate country potential with respect to a wide array of commercial activities. Within each of trade and investment, we also give each sub-component equal weight. In effect, we use a global value chain approach that considers both eports and imports and both inward and outward foreign direct investment valuable aspects of Canadian commercial activity. Within the trade component, we use a three-year average to smooth out the impact of annual swings in Canadian trade performance. We tried to include services data, but there were simply so little services data available for the majority of the countries in the sample (only available for 30 of 180 countries) that we ecluded them. Goods trade data should at least be a partial proy for where services trade may go, so these could partially cover such a gap. We note that the trade and investment data are imperfect. For a fuller discussion of the gaps in such data, see the Conference Board s Global Commerce Centre series on Missing Trade and Value-added Trade. (It might be useful to include in such an inde an element that captures Canada s industrial structure and areas of comparative advantage relative to the target country, but this is outside the scope of this preliminary analysis.)

24 Alternate Inde Constructions To ensure that our final method would be meaningful, we considered alternate constructions for our inde. When our method produced an unusual set of countries and rankings, or was wildly out of line with peer results, we reviewed the method and dropped or added indicators. Our final method is one in which slight variations in method yielded a similar list of countries. Variations in method did result in countries moving between the sweet spot and the high growth potential sections of the list. We found that our resulting list is not out of line with those chosen by other countries and organizations, with a few differences that might be epected due to different geographies, and political and other priorities. That said, this is one method of evaluating potential, and alternative methods could yield different results.

25