This QED Spotlight article by Brock Mutic (JDI Research Associate) presents research by QED Professor Beverly Lapham and PhD Candidate Daniel Teeter.

It is widely agreed upon by economists that intra-national trade frictions—barriers to seamless trade between regions within a country—can impact a country’s economic performance. In the Canadian context, as each province and territory has its own regulatory environment and particular trade rules, provincial borders—in addition to being geographic—are also frictional and affect the flow of goods and services within the country. Understanding the size of inter-provincial trade frictions in reality, and their effect on the flow of trade in Canada, is an important question for understanding their costs to the Canadian economy. Queen’s Economics Department Professor Beverly Lapham recently teamed up with QED Ph.D. candidate Daniel Teeter to study this important issue in a recent QED Working Paper, where the team used a state-of-the-art gravity analysis to examine the size and importance of inter-provincial trade frictions in Canada between 1997 and 2019. Their research ultimately produced insightful and policy-relevant results. 

Professor Lapham’s and Mr. Teeter’s research begins by analyzing the inter-provincial trade between all 10 Canadian provinces, as well as between each province and the rest of the world, in the agricultural, services, mining, and manufacturing sectors, in their time period of interest. Although they found that trade was dominated in all provinces by manufacturing and services, they also found that the share of manufacturing trade generally declined while the share of trade in services increased. Across provinces, they also found evidence that there was considerable variation in the relative importance of inter-provincial trade compared with international trade. 

Turning to examine the size and importance of frictions to inter-provincial trade, the co-authors utilized a framework of ‘structural gravity equations’. Originally inspired by Newton’s Law of Gravitation, such equations make the basic assumption that two regions have a stronger connection—or a stronger ‘gravitational’ pull—on each other, and consequently a higher degree of mutual trade, the bigger they are, and the closer they are together. The workhorses of empirical trade economics, gravity equations are useful for estimating the relative importance of various determinants which affect the flows of trade between two regions using a variety of statistical methods while controlling for possible confounding variables. Using a set of carefully constructed gravity equations specified for the Canadian context, and building on techniques developed in previous literature, Professor Lapham and Mr. Teeter estimated the relative frictions associated with shipping goods and services from each province to every other province, as well as the rest of the world, and vice versa, in their time period of interest. By quantifying the resistance provinces faced to such trade when they bought and sold goods (denoted ‘inward’ and ‘outward’ resistances, respectively), they estimated the size and relevance of the frictions to this trade for various sectors and manufacturing sub-industries. 

Overall, Professor Lapham and Mr. Teeter found that different provinces faced varying inter-provincial trading frictions across sectors. The widest dispersion of inter-provincial trading frictions across Canadian provinces was found to have occurred in the service sector. In Alberta, Ontario, and BC, inter-provincial trade frictions were relatively lower in the manufacturing and services sectors than they were in the maritime provinces; however, this pattern did not hold for agriculture or mining. For example, Newfoundland and Labrador faced relatively lower frictions in those sectors compared with the economically larger provinces. Additionally, as the large provinces did not exhibit smaller frictions from importing goods from other provinces, the research found that the relative severity of trade frictions across provinces also varied by the direction of trade. Over the period studied, the research also discovered evidence of changes in inter-provincial trading frictions, particularly in sub-industries of the manufacturing sector. For example, both buying and selling frictions faced by provinces domestically decreased, compared to those faced internationally, in the textiles, wood, minerals, machinery, and equipment industries and increased only in the petroleum industry. 

Given their research found evidence that inter-provincial trade frictions were both geographically and industrially dispersed in the time period they studied, Professor Lapham and Mr. Teeter speculated that regional inter-provincial trade agreements may have affected trade in different sectors differently. As such, they then turned to analyze the effects of two inter-provincial trade agreements on trade frictions: the combined Trade, Investment and Labour Mobility Agreement and the New West Partnership Trade Agreement (TILMA/NWPTA), which began in 2007 between Alberta and British Columbia, and later expanded to include Saskatchewan in 2010 and Manitoba in 2017; and the Trade and Cooperation Agreement (TCA), which was signed by Ontario and Quebec in 2009. Namely, they analyzed the respective effects of each trade-liberalization agreement on trade flows by using consecutive-year data to estimate structural gravity systems that incorporated real-world dynamics, such as the phasing-in of agreements, non-linear effects, and the possibility of changing effects over time. 

As they hypothesized, such analyses revealed that both agreements induced differing effects on trade flows across sectors—after going through adjustment periods of initially negative growth before coming into maturity roughly eight years after their respective implementations. The TILMA/NWPTA, on the one hand, may have increased inter-provincial trade flows in mining, textiles, petroleum, and transportation and decreased trade in agriculture, forestry & fishing, and in food manufacturing. On the other hand, while the TCA likely only increased trade in the mining sector, it may have decreased trade in many sectors, including services, food manufacturing, petroleum, and chemicals, indicating it was relatively less effective at reducing frictions to trade between provinces. The researchers suggest the greater effectiveness of the TILMA/NWPTA may be a product of its differing design compared with the TCA: while the former applies to essentially every industry unless otherwise specified, the latter only applies to a relatively limited list of specific sectors and industries. Overall, neither agreement affected the manufacturing sector as a whole, likely because both agreements contained specific provisions aimed at meeting specific provincial policy goals. An example of this would be policies that bolster important provincial industries, such as dairy in Ontario, which may have caused them to impact different manufacturing sub-industries differently, and to generate ambiguous manufacturing sector-wide results.  

Overall, in addition to providing interesting insights into the historical trading dynamics among Canadian provinces between 1997 and 2019, Professor Lapham’s and Mr. Teeter’s research has relevance for policy. The researcher’s estimates of both the outward and inward trade resistances faced by Canadian provinces generated by its state-of-the-art gravity analysis provide a novel measure of the provinces’ relative inter-provincial trade frictions and can be used by policymakers going forward. Specifically, policymakers seeking to lower inter-provincial trade barriers can use the QED economists’ highly-detailed reports of trade frictions—which are given for any province, whether they are exporting or importing, in any year or industry, and for any combination of trading partner provinces—to compare and contrast the effectiveness of previous inter-provincial agreements. This approach has the ability to inform the best practices for the structural design of future agreements aimed at reducing internal trade barriers in Canada. In this way, the research undertaken by the QED team has the potential to help make the Canadian economy ‘more strong’, and ‘more free’.