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Canada’s Problem: Domestic Trade Barriers

Tuesday, May 22, 2007

Free trade among the fifty states may account for much of the U.S. productivity advantage over Canada.

Canada is a fascinating country to study. Its similarity to the United States in geography, British colonial heritage, and economic structure all make Canada a kind of “control subject” for studies of the United States—like the lab rat that goes untreated, Canada can provide us with a sense of what might have happened in the United States barring certain accidents of history and deliberate policies adopted in our past.

One of the most intriguing questions about Canada and the United States today is why, despite broad similarities, Canada lags the United States in productivity.

According to the latest data from the Organization for Economic Cooperation and Development (OECD) Canada’s GDP per hour worked in 2005 was just 80 percent that of the United States. To be fair, that placed Canada well above the average for OECD countries, which is 75 percent of U.S. productivity levels, but given that many of the companies employing Canadians and Americans are the same, what accounts for the gap?

There are nearly as many explanations out there as there are Canadian economists. One that might surprise Canada’s American neighbors is the lack of free trade within Canada itself.

Canada’s ten provinces and three territories maintain an extensive array of trade barriers against each other. Even after being confederated into a single Dominion of the British Empire in 1867, the formerly separate colonies of British North America retained an export orientation to global markets with only secondary interest in inter-Canadian trade. The British Empire’s mercantilist trade policies left their mark on the mindset of the provincial legislators of the Dominion of Canada, who erected protectionist barriers to the free movement of goods and labor from one province to another.

Even after being confederated into a single Dominion of the British Empire in 1867, the formerly separate colonies of British North America retained an export orientation to global markets with only secondary interest in inter-Canadian trade.

The 1988 Canada-U.S. Free Trade Agreement, supplemented by the North American Free Trade Agreement (NAFTA) in 1994, gave companies and workers in the Canadian provinces greater access to the U.S. and Mexican markets than they had in other Canadian markets. The economies of scale that came from access to more than 400 million consumers to the south helped to dramatically boost Canada’s productivity and annually increase Canadian GDP—but the United States has improved in both categories as well, and Canada has yet to close the gap.

Shortly after implementing NAFTA, Canada’s federal government and the governments of the provinces and territories negotiated an Agreement on Internal Trade (AIT) that was designed to reduce interprovincial trade barriers. The AIT took effect in 1995, but because it requires separate legislative and administrative actions by each of the provincial governments to take effect, implementation started slow, and petered out before much progress had been made.

But wait a minute—Ottawa convened the provinces to discuss internal barriers? Why didn’t Ottawa just eliminate the barriers?

In the United States, the Constitution’s interstate commerce clause (Article I, Section 8, Clause 3) gives the federal government the powerand even the responsibilityto strike down any barriers to the free movement of goods and people across state borders.

The British North America Act of 1867 gave Ottawa the same power; in fact, it gave the Canadian federal government exclusive legislative authority over the regulation of trade and commerce (Section 91). In addition, it gave the federal Parliament the additional power of disallowance—permitting Ottawa to strike down provincial legislation by a simple vote, which if exercised in the interest of eliminating provincial protectionism could have created an internal free market in one stroke.

Ottawa could have done so, but didn’t. The reason, then as now, was politics. Provincial protectionism had organized support from protected segments of the economy. The most the federal government would risk was to convene negotiations among the provinces—negotiations that ultimately failed to achieve much. In a 2006 hearing, the chairman of the Canadian Senate’s Standing Committee on Banking, Trade and Commerce estimated the cost of current interprovincial trade barriers at between $10 and $25 billion annually—about half the value of the gap in productivity between Canada and the United States.

In 2006 there was a promising sign of change. The governments of British Columbia and Alberta signed a Trade, Investment, and Labor Mobility Agreement, giving it the euphonious acronym TILMA. With some exceptions, the TILMA phases out existing barriers and buy-local preferences for public procurement and provides a mechanism for dispute settlement that is accessible by businesses, NGOs, and individuals. The BC-Alberta TILMA took effect last month and has so far met with no major political backlash. Politicians in Ontario and Quebec are said to be considering talks on a TILMA of their own.

Praiseworthy as the TILMA is, the lesson from American history is that the responsibility for creating and preserving an internal free market belongs at the national level, where politicians must act in the interest of the whole citizenry and not just sectional interests. To be sure, American history is also full of protectionist legislation. But imagine the problems we would have had if each state could protect itself from imports. The southern states might not have had to secede from the Union—they could have simply seceded from the U.S. economy by erecting barriers to low-cost goods produced by machine that undercut the economics of slavery!

Canadian Prime Minister Stephen Harper holds a degree in economics, and is a student of Canadian history. If his Conservative Party is elected to a majority government in the next federal election—they are in a minority position now—he might enrich Canada and help eliminate the 20 percent productivity gap with the U.S. economy by leading the federal government to use its constitutional authority to dismantle internal trade barriers.

Meanwhile, Americans can look north for a lesson in what might have been.

Christopher Sands is a senior fellow at the Hudson Institute.  

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