Assessing the gains from removing interprovincial barriers

Introduction: Welcome to Eyes on the Economy by CIBC Capital Markets, a podcast series dedicated to addressing current issues in a concise format, helping to make sense of the evolving economic complexities, so that you can take action.

Ali Jaffery: Welcome to another episode of Eyes on the Economy. I’m your host, Ali Jaffrey, and I’m joined by our chief economist, Avery Shenfeld. Today we’re going to talk about a note Avery and I put out this week on inter-provincial trade barriers. This is, of course, a subject that’s getting a lot of attention right now in Canada with both the federal and provincial governments putting in work to support internal trade, given the trade tensions we face with the United States. We definitely applaud those efforts, but Avery, why don’t you tell our listeners why we’re skeptical about the size of the benefits to the economy from scrapping these internal trade barriers.

Avery Shenfeld: Well, we looked at some studies that are out there that are cited around and that talk about anywhere from the equivalent of a 7 % to 20 % tariff across provincial boundaries and a potential boost to GDP of something on the order of 4 to 7%. And that’s actually larger in some sense than the hit we might be facing from a trade war on all our trade war with the US. And we started off a bit skeptical of those studies because when we thought about the Canadian economy, for one, there were many segments of the economy that didn’t seem to be affected at all. They’re either very local services like rental housing or live entertainment or haircuts, or they’re in the good sector in national brands, whether that’s frozen French fries or automotive or defense equipment or toilet paper. These all sell nationally without any obvious barriers. And so, yes, there are some service sectors where perhaps there’s some barriers associated with licensing and so on. And there may be some barriers to good sectors like wine, for example. But it seemed like a large part of the economy wouldn’t be affected or already had very localized markets that were unlikely to change. When we dug into the studies then, we did find further reasons to be skeptical of those very large benefits. Remember that economists don’t really have the ability to measure each of these barriers and do a study of them one at a time. So they naturally look for some roundabout methods to estimating the barriers. And essentially these revolve around trying to explain trade flows, looking at the size of the markets and their distances, and then looking at what isn’t explained and essentially assigning that to a trade barrier. So if there isn’t as many lobsters going from Nova Scotia to Saskatchewan as the model says there should be, then the models basically assume that those are trade barriers. We found some of the results, though, not very intuitive. Some of the largest barriers seem to be in things like services, like hotel services, for example, where it’s pretty easy to book a room online or over the phone. It’s hard to see what those barriers might, in fact be. And then we also recognize that there may be some things that the models can’t capture. For example, in some of the models, equipment is equipment. And that may well be the reason why, for example, a company in PEI making fishing equipment doesn’t find a market in landlocked Saskatchewan rather than the distance or some obvious trade barrier. And finally, these models try to measure population weighted distances to measure basically the geographic barriers, those not assigned to trade barriers. But in one of the studies that added in international trade opportunities, the US was basically located as if it was a single dot in the map in the center of its population, which happens to be in Missouri. That makes it a long way from BC, despite the fact that, of course, an exporter in BC is very close to California’s very large population. much closer than it is to Ontario. And Ontario companies don’t have to ship their goods to Missouri. They may be shipping to Michigan just across the river in Detroit. And as a result, we may be simply mismeasuring the geographic barriers and over assigning the lack of trade across provinces to some trade barrier that we’re not really identifying. And lastly, The models also have to then take this tariff equivalent barrier and translate it into a gain in GDP. And we don’t really have a data-based measure for how much a given percentage move in some trade barrier would generate additional trade. And the result is the authors have had to take estimated elasticities that aren’t really that closely related. They relate to economic shifts as a result of price changes among NAFTA countries rather than anything domestically in Canada. And for services, it seems that they just picked a number out of the air, which actually looks quite high in terms of the estimated sensitivity. And we just, on our own, looked at an alternative sensitivity, changing one of the parameters in the model that essentially is either guessed or comes from unrelated studies, reduce the benefits in GDP terms from almost 5 % to something closer to 1%. And so the bottom line here is that the studies really lack the detail necessary to assign trade flow distortions to particular barriers as opposed to geography or market size, and maybe overstating even with those barriers how much GDP we could gain. And so with that, we decided to explore on our own some of the underlying measures here and to see whether we could come up with our own view on how big these barriers are. I’ll turn it back to you, Ali, to talk about what we found when we looked at what the real barriers to trade really are across provinces.

Ali Jaffery: The bottom line is we think inter-provincial trade is fairly healthy and a lot of it is explained by market size and distance, of the classic economic ingredients that drive trade in that gravity model framework. Inter-provincial trade as a share of GDP has been roughly stable over the past three decades, around 20 % of GDP, whereas trade in international trade has risen and fallen with you know, with NAFTA and different international shocks. And so we looked at those ingredients in more detail, market size and distance, and try to measure them more carefully than in the studies. And what we find is when you look at existing trade-weighted GDP of inter-provincial versus in US state trade partners, that provinces have access to much larger markets in the US, on average two and a half times. the size of the inter-branchal market that they face within Canada. And for Ontario, given its trades with fairly large US states, the market size difference is massive, around four times the size of what it has access to within Canada. So that’s a big part of the story, of course. But distance is critical as well. And when you try to properly measure that, instead of looking at just Missouri on the map, we looked at the distance from every provincial capital to its inter-provincial trade partner capital and US state capital, weighting that by exports. So a trade weighted distance measure from city to city. We find that 70 % of Canada’s GDP, Ontario, BC and Quebec, they’re as close or closer to the United States than they are to their inter-provincial partners. And when you take all that together and plug it into kind of a gravity equation that looks at exports as a share of market size relative to distance, then actually our interventional goods trade is looking as healthy or healthier across most provinces. The only exception are the commodity provinces, which obviously are a special case and have strong relationships within the United States, either through pipelines or other means. So we don’t think that there’s a huge amount of ground to be made up on removing inter-venture trade verse. Of course, it’s unambiguously a good thing for the Canadian economy, but it’s not obviously going to provide a massive boost to our economy anytime soon. And also the survey evidence that we consulted lines up with that. Statistics Canada asked businesses in 2023, what are the reasons why they don’t engage in trade with other provinces? And about 40 % of the responses were related to the difficulties of transport costs or distance. And about 20 % due to demand related issues, which kind of lines up with our analysis. And the reasons related to trade barriers were only about 10%. Trade barriers certainly are a challenge, but not anywhere near the magnitude of distance and demand. So Avery, why don’t you tell our listeners, what’s the broader message here for Canadian businesses?

Avery Shenfeld: So make no mistake, we would certainly applaud the efforts that are now underway to remove the barriers because at a time when we’re challenged on international trade, we want to make sure we’re doing our utmost to make sure that Canadian goods have access to their own market. But at the same time, we want to be clear-eyed that the benefits that we could get from that are unlikely to make up for losses from a protracted trade conflict with the U.S. We’re probably likely to see more of a benefit in international an inter-provincial trade rather, not from removing barriers, but actually just from Canadian businesses who are worried about the U.S. market doing more to try to market their products across the country, and also from Canadian consumers and businesses out of patriotic reasons or desire to avoid U.S. tariffs trying to find suppliers in their home country. So that has nothing to do with moving legal barriers. It has to do with efforts on buyers and sellers to line themselves up within Canada. But overall, that should have some benefit, but we want to underscore that we shouldn’t be lulled into thinking that we can sort of absorb a huge trade war with the U.S. without much damage to the Canadian economy because of these interprovincial opportunities. We also want to reiterate the importance then of the diplomatic effort that we hope will be underway in order to negotiate an end to this trade war as soon as possible. And with that, I’ll turn it back to you, Ali, to wrap up.

Ali Jaffery: Yeah, so I think that’s a great place to stop and I encourage our listeners to check out our note on our CIBC economics website and we thank them for joining us on today’s podcast. Until next time, we’ll have our eyes on the economy and we’ll be calling it as we see it.

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