Border Policies, Exchange Rates, and Canadian Retailers

By Beverly Lapham, Queen’s University

The nominal exchange rate between Canada and the U.S. fluctuates considerably over time. These fluctuations affect Canadian retailers in at least two ways. Firstly, exchange rate movements affect retail price differences between the two countries (see [3]). In response to these price differences, consumers travel across the U.S.-Canada border to purchase goods in the country with lower prices. This is illustrated in the figure below which shows that nominal exchange rates are correlated with cross-border travel by Canadians. Hence, through travel responses, Canadian dollar appreciations tend to decrease demand, revenue, and profits for Canadian retailers. Secondly, because Canadian retailers often use imported inputs, movements in exchange rates may cause fluctuations in retailers’ costs. Thus, Canadian dollar appreciations tend to decrease costs and increase profits of Canadian retailers. My research with co-authors estimates the effect of exchange rate fluctuations on heterogeneous Canadian retailers’ revenues and profits and examines the impact of changes in border policies on those relationships.[1][2]

FigTOTTRAV-CD-NER
Nominal Exchange Rates and Canadian Travellers

In [2], we analyze a model with:

  1. Heterogeneous retailers who set prices, and
  2. Heterogeneous households who have imperfect information on prices, and who are able to travel across national borders for purchases.

In the model, retailers and households face nominal exchange rate shocks and optimally change prices and travel decisions, respectively, in response to those shocks. We use data for Canada from 1986 to 2007 on household cross-border trips and individual retailers’ revenues along with regional, industry, and national data to estimate our model. We then use simulations of the estimated model to quantify the impact of observed exchange rate movements on cross-border travel by Canadian residents and on small Canadian retailers’ revenues and profits. We note that Canadian households may also be able to cross-border shop by ordering foreign goods online and this may affect Canadian retailers. However, for the earlier years in our study, 1986-1995, online shopping was negligible and although it has grown since 1995, in the last full year in our sample internet shopping accounted for less than 3% of all retail sales in Canada. 

We use this model to estimate the impact on small Canadian retailers of policies which increased border security and border wait-times after September 2001 and of policies instituted in June 2012 which increased duty-free limits on goods that Canadian travellers are permitted to bring back into Canada. Our estimates indicate that due to the nearly 16% appreciation of the Canadian dollar from 1987 to 1991, a typical small Canadian retailer located close to the border experienced a loss of revenue of 6.5% and a profit loss of 3.5%. That same retailer enjoyed an 11% increase in revenue and a 4% increase in profits due to the 26% depreciation from 1991 to 2001. Distance from the border insulates retailers to some degree from the impact of exchange rate movements: the analogous impact of the early appreciation for a retailer located 100 kilometres from the border was a fall in revenue of 1.4% and a rise in profits of 1.6% from 1987 to 1991. Retailers operating in industries that sell goods that are particularly subject to cross-border shopping such as clothing retailers and gasoline stations experienced an even larger impact on their revenues.

Our estimates indicate that changes in border policies which made crossing the border substantially more difficult after 2001 significantly protected Canadian retailers’ revenues from the negative impact of the nearly 47% appreciation of the Canadian dollar from 2002 to 2007. In particular, counterfactual simulations of our estimated model indicate that this large appreciation would have decreased the revenues of a typical small Canadian retailer located near the border by 23.2% had border policies not changed. This stands in stark contrast to our estimate of the actual effect of the appreciation of only a 0.09% decrease in revenues.

In June 2012, policy changes raised the value of goods that Canadians are allowed to bring back to Canada duty-free. The most important changes were that the allowance increased from $50 to $200 for trips between 24-48 hours and increased from $400 to $800 for trips between 48 hours and 7 days. This policy shift increased both the number of Canadian cross-border travelers and the amount that they purchased in the U.S., resulting in a negative impact on Canadian retailers’ revenues. In particular, our estimates indicate that had that policy change not occurred, average firm revenue for a small retailer located near the border would have been 1.6% higher while it would have been 0.8% higher for a firm located 100 kilometers from the border. For small retailers operating in industries with traditionally low margins, these are significant effects.

This research and the analysis in [4] indicates that exchange rate movements and border policies have different effects on Canadian communities depending on community characteristics such as distance from the border, income, and shopping opportunities in nearby U.S. communities. Furthermore, border policies have heterogeneous effects on retailers according to their location, the types of goods they sell, their use of imported inputs, and other features. Given current trends towards “thickening” of borders, it is important to understand the differential impacts of these policies across heterogeneous households, firms, industries, and regions

References

[1] Baggs, J., Beaulieu, E., Fung, L., and Lapham, B. (2016) “Exchange Rate Movements and Firm Dynamics in Canadian Retail Industries,” Review of International Economics 24, 635-66.

[2] Baggs, J., Fung, L., and Lapham, B. (2018) “Exchange Rates, Cross-Border Travel, and Retailers: Theory and Empirics,” Journal of International Economics 115, 59-79.

[3] Burstein, A. and Gopinath, G. (2014) “International Prices and Exchange Rates,” in Gopinath, G., Helpman, E. and Rogoff, K. (Eds.), Handbook of International Economics, Vol. 4, Elsevier, Amsterdam, 391-451.

[4] Chandra, A., Head, K., and M. Tappata (2014) “The Economics of Cross-Border Travel,” The Review of Economics and Statistics 96(4), 648-61.