The Canada U.S.

Free Trade Agreement:

Competitive Tradeoffs Between
Foreign Direct Investment and Trade
RAVICHANDRAN MUNIRATHINAM, MARY A. MARCHANT,
AND MICHAEL R. REED*

This paper assesses the impact of the Canada U.S. Free Trade Agreement on exports and
foreign direct investment of processed foods. Results indicate that U.S. exports to Canada more
than doubled, while Canadian exports to the U.S. nearly doubled after the implementation of
the Canada U.S. Free Trade Agreement in 1989. Regression results of the covariance model
on paneI data show that U.S. and Canadian food processing firms appear to use both exports
and foreign direct investments as complementary market access strategies. (JEL QIO)

Introduction

The Canada U.S. Free Trade Agreement (CUSTA) was implemented on January 1,
1989, creating the world's largest free trading bloc between the world's largest trading
partners [Dixit and Roningen, 1989, pp. 1023-33]. This trade agreement also helped in
formulating the North American Free Trade Agreement, which went into effect on
January 1, 1994. According to CUSTA, all agricultural tariffs between the U.S. and
Canada would be phased out over a 10-year period and there would be improved market
access for products from both countries and limited use of subsidies.
Since its enactment, CUSTA impacted U.S. and Canadian agriculture in different
ways. For example, even though total agricultural exports increased dramatically in both
countries, their export market share changed. Agricultural exporters in the U.S. increased
their export share of consumer-oriented processed food products to Canada, while
Canadian exporters shifted their exports to the U.S. toward bulk and intermediate
products. Additionally, U.S. direct foreign investment in Canadian food processing
industries increased from $2.0 billion to $3.6 billion between 1989 and 1995. During this
same period, Canadian investment in U.S. food processing industries increased from $894
million to $5.4 billion in 1994. (All values in this paper are reported in current U.S.
dollars.)
The primary objective of this research is to analyze the impact of CUSTA on U.S. and
Canadian trade and foreign investment in the food processing industry. The attention will
be focused upon activities of U.S. multinationals in Canada and Canadian multinationals

*Universityof Kentucky--U.S.A.This researchwas supportedby a grant from the CanadianEmbassy. In

addition, the authors thank CarolynDimitriof the Universityof Marylandfor helpfulcomments.
312

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MUNIRATHINAM ET AL.: CUSTA: INVESTMENT AND TRADE

in the U.S. This paper first provides an overview of the effects of CUSTA. Second, we
empirically analyze specific effects of CUSTA on U.S. exports as well as sales of U.S.
food processing affiliates operating in Canada. Third, we conduct a similar analysis for
Canadian exports. Analyses of other relationships are in progress--specifically exports
of other types of agricultural products (bulk and intermediate) and the behavior of
Canadian food processing affiliates operating in the U.S.
U.S. Exports and Investments in Canada
Following the enactment of CUSTA, two-way trade between the U.S. and Canada
increased substantially. Total agricultural exports from the U.S. to Canada increased from
$2.2 billion in 1989 to $5.7 billion in 1995, which is an increase of 159 percent (Table
1). Examination of trade composition shows that exports of bulk, intermediate, and
consumer-oriented processed food products from the U.S. to Canada increased by 54
percent, 80 percent, and 215 percent, respectively, between 1989 and 1995.
TABLE 1

U.S. Agricultural Exports to Canada by Food Processing Categories

(millions U.S. dollars)

Products

1989

1990

1991

1992

1993

1994

1995

1989-95
% change

Bulk

280

347

286

325

371

328

430

54

Intermediate

593

836

871

896

989

1057

1067

80

Consumer

1343

3005

3382

3671

3891

4104

4232

215

Total

$2217 $4189 $4539 $4893 $5252 $5490 $5731

159%

Source: Tradeand EconomicAnalysisDivision,ForeignAgriculturalService[U.S. Departmentof Agriculture,

annual reports].

The U.S., which exports primarily bulk commodities with low value added, has fallen
behind the rest of the world in exporting (consumer-oriented) processed food products
with high value added. In this sector, growth in world trade greatly exceeds growth of
U.S. exports. This decline in U.S. market share is partially explained by the tendency of
large U.S. firms to invest in foreign countries rather than export [Bredhal et al., 1995].
In contrast, U.S. exports of processed foods to Canada present a different picture,
where the U.S. export share for consumer-oriented commodities to Canada increased
from 61 percent in 1989 to 74 percent in 1995. During the Same period, the export share
for bulk commodities to Canada declined from 12 percent to 7 percent. Similarly, the
share for intermediate products declined from 27 percent to 19 percent.

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Looking at investment, the stock of the U.S. investment in Canadian food industries
increased from $2.02 billion in 1989 to $3.6 billion in 1995, which is an increase of 78
percent. Figure 1 compares U.S. investment in Canada, sales of Canadian affiliates of
U.S. food processing firms, and U.S. exports of consumer-oriented processed food
products between 1982 and 1993. All categories increased, with the greatest changes
occurring in the export and affiliate sales categories. For example, U.S. exports of
consumer-oriented products increased from $1.1 billion to $3.9 billion--a 256 percent
increase--during this time period, while sales of Canadian affiliates of U.S. firms
increased from $5.2 billion in 1982 to $8.5 billion in 1993, which is an increase of 64
percent. Trade theory suggests that with market liberalization and free trade agreements,
multinational firms may choose to export to foreign countries--in this case
Canada--rather than invest in processing facilities. Our empirical analysis will examine
whether these strategies compete or complement each other.
FIGURE 1
Performance

o f U . S . F o o d C o r p o r a t i o n s in C a n a d a

Billion Dollars
10
-*-DFI

--1-- Sales

--~-- Exports

8 ...........................

[
I. . . . . . . . . . . . . . . . . . . . . . . . . . . .

~.......

1982
1985
1988
1991
1993
Notes: DFI = U.S. Investmentin Canada; Sales = Salesof CanadianAffiliates;Exports = U.S. Exports of
Process Foods.

Canadian Exports and Investment in the U.S.

Canadian agricultural exports to the U.S. increased from $2.9 billion in 1989 to $5.5
billion in 1995, which is an increase of 91 percent (Table 2). Examination of trade
composition shows that Canadian exports of bulk, intermediate, and consumer-oriented
products to the U.S. increased by 110 percent, 103 percent, and 77 percent, respectively.
The Canadian export share of consumer-oriented processed foods imported by the U.S.
declined from 52 percent in 1989 to 48 percent in 1995. Concurrently, Canadian exports
of bulk and intermediate products to the U.S. increased marginally.

MUNIRATHINAM ET AL.: CUSTA: INVESTMENT AND TRADE

315

TABLE 2

Canadian Agricultural Exports to the U.S. by Food Processing Categories

(millions U.S. dollars)

Products

1989

1990

1991

1992

1993

1994

1995

1989-95
%change

Bulk

$355

$310

$279

$453

$570

$848

$744

110%

Intermediate

1050

1196

1321

1744

1824

1932

2131

103

Consumer

1507

1646

1685

1855

2195

2439

2672

77

Total

2913

3150

3286

4053

4590

5220

5548

91

Source: Trade and Economic Analysis Division, Foreign Agricultural Service [U.S. Department of Agriculture,
annual reports].

Canadian investment in U.S. food industries increased from $894 million in 1989 to
$5.4 billion in 1994. The sales of Canadian food processing affiliates operating in the
U.S. grew steadily throughout the 1980s and were particularly strong from 1988 to 1990,
peaking at over $6 billion in 1990 (Figure 2). However, these sales fell to $5.21 billion
in 1993 (data were not available for 1991-93 due to disclosure problems). It is during this
later period that Canadian exports of bulk, intermediate, and consumer-oriented products
increased.
FIGURE 2

Performance of Canadian Food Corporations in the U.S.

Billion Dollars
7

4+
.-~ FDI ._-t-..

2
1 7- . . . . N - - 7 ~ - - - - N

0"
1982

--

~-'---~ "
1985

/"

I
1988

~
1991

,
1993

Notes: FDI = Canadian Investment in the U.S.; Sales = Sales of U.S. Affiliates; Exports = Canadian Exports.

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Notice that the time-related effects of CUSTA appear to differ between the U.S. and
Canada. There was an immediate dramatic increase in U.S. agricultural exports to Canada
in 1989 (the first year of the CUSTA), especially for intermediate and consumer-oriented
products (Figure 1). Yet, for Canada, there appears to be a two-year lag before exports
were positively affected. Canadian exports to the U.S. did not increase appreciably until
1991 and the increase was more gradual (Figure 2). Additionally, when comparing
Figures 1 and 2, notice that sales by foreign affiliates is the largest component for both
the U.S. and Canada, especially relative to exports. Thus, firms appear to be using both
trade and foreign investment strategies to develop foreign markets.
Literature Review

According to Malanoski [1994, pp. 13-7], international trade agreements such as the
General Agreement on Tariffs and Trade and the North American Free Trade Agreement,
which lower tariffs and other trade barriers, will have a limited influence on U.S. food
manufacturers' decision to locate production facilities abroad. Malanoski states that the
major factors which motivate corporations to move production facilities abroad are
delivery costs, availability of raw ingredients, and tailoring products to foreign needs.
Tariffs and labor costs are not usually important factors. Labor cost results are
corroborated empirically by Reed and Ning [1996].
Ruppel and Harris [1993, pp. 43-7] found that U.S. firms are directly investing in
overseas processed food plants. However, leading U.S. multinational food processors are
clearly expanding U.S. exports, even as they increase their investment in foreign food
processing facilities. The authors reported that sales from foreign affiliates rose 56
percent between 1988 and 1993, while exports from their U.S. plants grew even faster
to a value of 143 percent.
According to Handy and Henderson [1994, pp. 203-30], most large food manufacturers
rely more heavily on foreign investment than on exports as their major strategy to access
foreign markets. Sales from U.S. foreign affiliates are nine to 10 times larger than are
exports from their U.S. parent firms. This highlights the importance of using both trade
and foreign affiliate sales data in assessing the international competitiveness of food
manufacturing firms.
Finally, the determinants of direct foreign investment are classified into demand-side
and supply-side factors. Demand-side (pull) factors include political stability, cultural
similarity, host market size, growth rate, wage rate, investment incentives, and tariff
levels. Supply-side (push) factors are more firm-specific, such as economies of scale,
market power, product life cycle, intangible assets, and internalization [Ning and Reed,
1995, pp. 77-85].
Empirical Model

In a liberalized trade environment, producers use both exports and foreign direct
investment strategies to operate in the international market. The equilibrium level of
exports and foreign direct investment can be estimated by using a system of simultaneous

MUNIRATHINAM ET AL.: CUSTA: INVESTMENT AND TRADE

317

equations. However, this approach is not possible in this study because of severe data
limitations. For example, the data on U.S. investment in Canada and Canadian investment
in the U.S. are not available prior to 1983. Due to these data limitations, investments and
exports are estimated individually using two separate models as described below.
Trade Model

There are many factors which determine the demand for U.S. exports to Canada and
Canadian exports to the U.S. Equation (1) specifies our empirical model, where the
dependent variable is U.S. exports of consumer-oriented processed products to Canada
(EXPORTS), comprised of 16 agricultural industries. This variable (originally expressed
in U.S. dollar terms) was deflated by a U.S. export price index so that it would be
denominated in quantity units rather than in dollars.
The independent variables include real gross domestic product ( G D P ) of Canada as
a measure of national income, which should have a positive coefficient; the deflated
export price of U.S. exports (converted into Canadian dollars) as a price variable
(XPRICE), which should have a negative coefficient; and foreign direct investment sales
( S A L E S ) by Canadian affiliates of U.S. food processing corporations to capture
synergistic effects between trade and foreign direct investment. A positive coefficient on
SALES indicates trade and foreign direct investment are synergistic marketing strategies,
while a negative coefficient indicates that they are competing strategies. Additionally, a
dummy policy variable ( D U M M Y ) was used to capture the impact of CUSTA, zero
before 1989 and one after 1989.
E X P O R T S i = ct o + ctiGDP ~ + tx2 XPRICE, + tx 3 D U M M Y i + t~4 SALES~ + 6 i .

(1)

Ordinary least squares regression analysis using a covariance model on panel data was
conducted with SAS software [Kmenta, 1986, pp. 630-35; SAS Institute Inc., 1988]. The
16 industries were treated as separate observations and dummy variables were included
so a covariance analysis could be performed. (The model pooled time series and crosssectional data by food industry but allowed different coefficients for all independent
variables by industry.)
Similar analyses were conducted on Canadian exports of consumer-oriented processed
food products to the U.S. The dependent variable was Canadian exports to the U.S.,
deflated by a Canadian export price index. The independent variables included the U.S.
real gross domestic product, the Canadian export price index, a dummy variable to
capture the impact of CUSTA, and sales of U.S. affiliates of Canadian corporations.
U.S. Direct Foreign Investment in the Canadian Food Sector

Using the Ning and Reed classification of the determinants of direct foreign investment
described in the literature review [1995, pp. 77-85], this study focuses on demand-side
factors. The dependent variable is U.S. direct foreign investment (DFI) in Canadian food
industries. The independent variables include income generated from Canadian operations
( I N C ) , the real effective exchange rate between Canada and the U . S . ( E X C H ) , and a
dummy variable to capture CUSTA's influence ( D U M M Y ) .

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A parallel study could not be conducted for Canadian investment in the U.S. due to
lack of data stemming from disclosure problems in Canadian business transactions.
Again, ordinary least squares estimation using SAS software was used to obtain the
coefficient estimates. Both income and the dummy variable are expected to have positive
coefficients, while the exchange rate (Canadian $/U.S. $) is expected to have a negative
coefficient. For example, as the U.S. dollar strengthens relative to the Canadian dollar,
U.S. exports should contract since Canadians can now buy relatively fewer U.S. goods.
However, U.S. investment in Canada should expand since U.S. investors can buy
relatively more Canadian assets for their investments. The functional form of this
investment model is presented below:
DFIj : a o + a l l N C t + a 2EXCHj + a 3DUMMYj + c i .

(2)

Empirical Analyses
Data Sources
The data were collected for the period 1976-94. Data on U.S. agricultural exports to
Canada were collected from the Trade and Marketing Analysis Branch of the Foreign
Agricultural Service, U.S. Department of Agriculture. Gross domestic product, export
and import price indices, and the real effective exchange rate data were collected from
International Financial Statistics, published by the International Monetary Fund [annual
reports]. Foreign direct investment, income from operations in Canada, and direct
investment data were collected from the Survey of Current Business, published by the
Bureau of Economic Analysis [U.S. Department of Commerce, annual reports]. Data on
sales of processed foods by foreign affiliates of their U.S. parent companies in addition
to data on sales of processed foods by the U.S. affiliates of Canadian companies were
collected from the following BEA publications: U.S. Direct Investment Abroad:
Operations of U.S. Parent Companies and Their Foreign Affiliates and Foreign Direct
Investment in the U.S.: Operations of U.S. Affiliates of Foreign Companies [U.S.
Department of Commerce, annual reports].
U.S. Exports of Consumer-Oriented Products to Canada
Two sets of regression analyses were performed on (1) using a covariance model on
panel data to determine the behavior of U.S. agricultural exports to Canada [Kmenta,
1986, pp. 630-5]. One analysis (model I) used all data available (1976-95) but excluded
the U.S. affiliate sales in Canada (which were only available for a limited number of
years). The other analysis (model 2) used the fully specified model but with fewer
observations (1982-93) due to data limitations. Both regressions pooled observations from
the 16 agricultural industries within the consumer-oriented processed food category.
These 16 industries of processed foods include snack foods, breakfast cereals, red
meats--fresh and prepared, poultry, processed dairy products, eggs and egg products,
fresh fruits, fresh vegetables, processed fruits and vegetables, fruit and vegetable juices,
tree nuts, wine and beer, nursery products and cut flowers, pet foods, and other
processed foods, which is used as a base industry for our covariance model using the
above-pooled cross-section and time-series observations [Kmenta, 1986, pp. 630-5].

M U N I R A T H I N A M E T AL.: CUSTA: I N V E S T M E N T AND T R A D E

319

E m p i r i c a l results r e p o r t e d in T a b l e s 3 and 4 are for the b a s e industry in the c o v a r i a n c e

analysis, which was the other processed foods category described above. T h e full results
for the r e m a i n i n g 15 industries are available f r o m the authors t h o u g h they are briefly
discussed below.

TABLE 3
Regression Results to Explain U.S. Exports to Canada
Model 1: U.S. Exports, Excluding Canadian Affiliate Sales (1976-95)

Variables

Estimate

Intercept

-2620.61

1104.64

-2.372

0.0184

GDP

5.24

1.31

3.979

0.0001

XPRICE

5.41

2.84

1.902

0.0582

2277.68

184.07

12.374

0.0001

D UMMY

S.E.

t-ratio

prob >

It I

Notes: Adjusted R 2 = 0.96, DW = 1.783, Degrees of Freedom = 256, DL = 1.643, and D u = 1.704 at the
1 percent level, where the variables and abbreviations are defined as: GDP = Real Gross Domestic Product of
Canada; XPRICE = U.S. Export Price; DUMMY = 0 before 1989, 1 after 1989; S.E. = Standard Error; DW
= Durbin-Watson test statistic; DL = Durbin-Watson Lower Limit at the 1 percent significance level; and Du
= Durbin-Watson Upper Limit at 1 percent significance level.

TABLE 4
Regression Results to Explain U.S. Exports to Canada
Model 2: U.S. Exports, Including Canadian Affiliate Sales (1982-93)

Variables

Estimate

S.E.

Intercept

6356.68

1119.01

5.681

0.0001

-8.95

1.87

-4.774

0.0001

XPRICE

-26.68

4.73

-5.637

0.0001

DUMMY

551.07

294.85

1.869

0.0642

0.71

0.15

4.669

0.0001

GDP

SALES

t-ratio

prob >

[t I

Notes: Adjusted R 2 = 0.98, DW = 1.754, Degrees of Freedom = 112, DL = 1.584, and D v = 1.665 at the
1 percent level, where previous definitions hold and SALES = Sales of Canadian affiliates of U.S. corporations.

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Empirical results for model 1 (the regression without affiliate sales--Table 3) indicate
that the CUSTA policy coefficient (DUMMY) had the correct sign and significantly
differed from zero at the 1 percent level, indicating that CUSTA did, in fact, have an
impact on U.S. exports to Canada. The coefficient indicates that CUSTA alone increased
U.S. exports of other processed foods by $2.3 billion per year. The coefficients on the
CUSTA dummy variables for the other 15 industries were mostly negative (11 of 15) but
all were smaller in absolute value than the coefficient for our base industry (Table 3).
Thus, the net effect for this covariance analysis indicates that the CUSTA effect was
positive for each food industry. The Durbin-Watson statistic indicated that no serial
correlation was present at the 1 percent level of significance. Additionally, no
multicollinearity was detected since all variance inflation factors were less than 10
[Gujarati, 1995, pp. 300-2; Kennedy, 1992, pp. 183-7].
Additionally, the Canadian income coefficient (GDP) had the correct sign and was
significantly different from zero at the 1 percent level in our base industry. Income
coefficients for the remaining 15 processed foods industries were generally negative and
significantly different from zero (indicating that the income effect for those other
industries was less than for the other processed foods base category). The size of the
coefficients for many of these 15 industries was such that the combined effect would be
very close to zero, indicating that income effects were minimal for many industries.
The export price coefficient was positive, which was not expected, but not significantly
different from zero at the 5 percent level for our base industry. Export price coefficients
for the other 15 industries were negative though only three were significantly different
from zero. Thus, it does not appear that the export price has much impact on U.S.
exports to Canada.
Next, we examine the empirical results for model 2, which included the full model
specification (with the U.S. affiliate sales variable) but with fewer observations. Looking
first at our other processed foods base industry (Table 4), empirical results indicate that
affiliate sales (SALES) were, in fact, positively related to exports and the coefficient was
significantly different from zero at the 1 percent level, indicating that U.S. exports and
U.S. direct foreign investment in Canada are synergistic market strategies rather than
competing strategies.
In this model, the coefficients for the export price and the CUSTA dummy variables
had the correct signs and were significant at the 1 percent and 10 percent levels,
respectively. The results indicate that CUSTA increased U.S. exports of other processed
foods by $551 million per year, which is a much smaller amount than in model 1.
Further, the income coefficient turned negative and significantly different from zero. As
with model 1, the Durbin-Watson statistic indicated that no serial correlation was present
at the 1 percent level of significance. Additionally, no multicollinearity was detected.
Turning to empirical results for the remaining 15 agricultural industries, income
coefficients for all of the other 15 processed food industries were positive (with one
exception) and most coefficients were similar in absolute value to the other processed
foods result as reported above. This means that for most food industries the income effect
was close to zero. All of the export price coefficients for the other 15 processed food

MUNIRATHINAM

Err AL.: CUSTA: INVESTMENT

321

AND TRADE

industries were also positive but all were smaller in absolute value than the export price
coefficient for the other processed foods base category.
The coefficients on the CUSTA dummy variables for the other 15 industries were split
between positive and negative values, with only three positive coefficients significantly
different from zero. The conclusion here is that the $551 million effect reported each year
for our base industry is indicative for most food industries. Twelve of the 15 coefficients
for DFI sales in Canada were negative and significantly different from zero, yet only one
negative coefficient was larger in absolute value than the coefficient for the other
processed food base category. These results lend mild evidence in support of the idea that
DFI and trade are complementary and no support to the idea that DFI and trade are
substitutes.
U.S. Direct Foreign Investment in Canadian Food Industries
Empirical results for the DFI model specified in (2) are shown in Table 5. This model
explains aggregate U.S. direct investment in Canadian food industries. The ordinary least
squares regression results indicated that all coefficients had correct signs and all were
significantly different from zero at the 5 percent level with the coefficients on income
from existing operations and the CUSTA dummy significant at the 1 percent level.
Results indicate that CUSTA seems to have stimulated American investment in Canada
by $1.06 billion per year. Further, a one dollar increase in U.S. affiliate income in
Canada stimulates a $3.30 increase in investment. The model was tested for serial
correlation and multicollinearity and none was detected.

TABLE 5
Regression Results to Explain U.S. Direct Foreign Investment Behavior
Variables

Estimate

S.E.

Intercept

4066.69

1199.69

3.390

0.0040

3.30

1.09

3.028

0.0085

1066.55

220.53

4.836

0.0002

-33.98

14.51

-2.341

0.0335

INC
DUMMY
EXCH

t-ratio

prob > It ]

Notes: Adjusted R 2 = 0.68, DW = 1.722, Degrees of Freedom = 14, DL = 0.708, and D v = 1.422 at the 1
percent level, where the variables are defined as: INC = Income generated from U.S. operations in Canada;
DUMMY = 0 before 1989, and 1 after 1989; and EXCH = Effective exchange rate between the U.S. and
Canada (Canadian $ / U . S . $).

Canadian Exports of Consumer-Oriented Products to the U.S.

In addition to the above U.S. trade model assessing the impact of CUSTA on U.S.
exports to Canada, a parallel analysis was conducted for Canada. Regression analyses

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based on the specification of (1) used ordinary least squares to explain the behavior of
Canadian exports of consumer-oriented processed food products to the U.S. Canadian
exports of consumer-oriented products to the U.S. was the dependent variable while
independent variables included the real gross domestic product for the U.S., the deflated
export price of Canadian products, a dummy variable to capture the effect of CUSTA,
and sales of U.S. affiliates of Canadian firms. As with the above U.S. trade model, data
limitations resulted in two sets of regression analyses. One analysis (model 1) used all
data available (1976-95) but excluded the Canadian affiliate sales in the U.S, The other
analysis (model 2) used the fully specified model but with fewer observations (1982-93)
due to data limitations. The results are reported in Tables 6 and 7 with the other
processed food category again serving as the base industry.

TABLE 6
Regression Results to Explain Canadian Exports to U.S.
Model 1: Canadian Exports, Excluding U.S. Affiliate Sales (1976-95)

Variables

Intercept
GDP
XPRICE
DUMMY

Estimate

-106093.0

S.E.

33700.2

t-ratio

prob > ]t[

-3.148

0.0018

36.76

14.15

2.598

0.0099

496.86

1045,34

0.475

0.6350

8.952

0.0001

165064.0

18438.2

Notes: AdjustedR 2 = 0.97, DW = 1.816, Degrees of Freedom = 256, DL = 1.643, and D v = 1.704 at the
1 percent level, where the variables and abbreviationsare defined as: GDP --- Real Gross Domestic Product of
the U.S.; XPRICE = Canadian Export Price; and DUMMY = 0 before 1989, 1 after 1989.

Results for model 1 (without affiliate sales) indicate that G D P and the C U S T A
coefficient ( D U M M Y ) had the correct sign and significantly differed from zero at the 1
percent level. The export price coefficient was positive, which was not expected, but not
significant. These results reinforce the influence of CUSTA on Canadian exports to the
U.S. The income and CUSTA coefficients were significant for all the 16 processed food
industries included in this study. The Durbin-Watson statistic indicated that there was
serial correlation in the original estimated model, which was corrected using the CochranOrcutt transformation [Kmenta, 1986, pp. 298-334], with final results reported in Table
6.
Results for model 2 (including affiliate sales) indicate that the G D P and C U S T A
coefficients had correct signs and were also significantly different from zero at the 1
Percent level (Table 7). Additionally, the CUSTA coefficient was positive and significant
for 11 of 16 industries, indicating that the free trade agreement influenced exports of

MUNIRATHINAM ET AL.: CUSTA: INVESTMENT AND TRADE

323

processed foods from Canada to the U.S. The coefficient for foreign direct investment
sales (SALES) for Canadian affiliates operating in the U.S. was negatively related to
exports and the coefficient was significant at the 1 percent level for the base industry.
However, sales were positive for nine of 16 industries and, thus, indicate that exports and
investment are complements for these industries. No serial correlation or multicollinearity
was detected in this model.
TABLE 7
Regression Results to Explain Canadian Exports to U.S.
Model 2: Canadian Exports, Including U.S. Affiliate Sales (1982-93)

Variables

Intercept
GDP
XPRICE
DUMMY
SALES

Estimate

-279356.0

S.E.

45817.9

t-ratio

prob > It[

-6.097

0.0001

318.11

97.20

3.273

0.0014

-9506.59

4127.50

-2.303

0.0231

6.410

0.0001

-3.762

0.0003

134293.0
-72.09

20950.9
19.16

Notes: Adjusted R z = 0.98, DW = 1.7866, Degrees of F r e e d o m - 112, D L = 1.584, and D U = 1.665 at the
1 percent level, where previous definitions hold and SALES = Sales of U.S. affiliates of Canadian corporations.

Summary and Conclusions

This research contributes to the knowledge base on the impacts of the Canada U.S.
Free Trade Agreement, which was enacted in 1989. Analysis of the data indicated a
definite change in trade patterns for both the U.S. and Canada after the implementation
of CUSTA. Total agricultural exports dramatically increased for each country--U.S.
exports to Canada more than doubled (2-1/2 times), while Canadian exports to the U.S.
nearly doubled between I989 and 1995. The rate of these effects varied by country in
which U.S. industries adjusted immediately to the benefits of trade liberalization while
Canadian industries took two years before witnessing a dramatic increase in export
volume. Additionally, although total exports increased for each country, the product mix
of exports changed. For the U.S., the export share of consumer-oriented (processed food)
products to Canada increased significantly--from 61 percent in 1989 to 74 percent in
1995--corresponding to a decline in the export share for both bulk and intermediate
products. Canada's export share for processed foods declined slightly from 52 percent to
48 percent as its export share for both bulk and intermediate products slightly increased.
Econometric analysis indicates that CUSTA did, in fact, impact U.S. exports to Canada
and investment in Canada for processed foods. Additionally, results indicate the

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synergistic effects of export and direct foreign investment strategies used by food
processing firms in both the U.S. and Canada. Further research will determine how
CUSTA has impacted exports of bulk and intermediate products for both the U.S. and
Canada.

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