Make no mistake, lowering the barriers to trade between the Canadian and American borders could bring huge economic gains for Canada. As it stands, trade between Canada and the U.S. is far below its potential level. Although NAFTA eliminated a huge swath of tariffs and duties, other barriers to trade remain. The border between Canada and the U.S. creates both real and invisible barriers to trade, such as different technical standards, security, and administrative costs. Hopefully, the details of today’s Canada-U.S. border deal will show that Canada and the U.S. are serious about reducing non-tariff trade barriers, while co-ordinating national security.
In the past, many economists have estimated the border effect by using the gravity model of trade. The gravity model is very basic, but quite useful. Essentially, the trade (imports + exports) between two countries or states should be proportional to the size of their economies and inversely proportional their distance apart, assuming no other barriers to trade. For example, in a 1995 paper, John McCallum looked at Ontario- British Columbia trade and Ontario-California trade. The gravity model predicts that the total trade between Ontario and California should be roughly 10 times as large as trade between Ontario and British Columbia. The difference in distance between Ontario and California and Ontario and B.C. is negligible, but the Californian economy is roughly 10 times the size of the B.C. economy.
What McCallum found was that trade between Canadian provinces and American states was far, far below potential. In 1988 (pre-NAFTA), trade was three times larger between Ontario and B.C. than between Ontario and California. Thus, trade between Ontario and California was an incredible 96 per cent smaller than if the U.S. and Canadian economis were fully integrated. NAFTA greatly reduced barriers to trade. Based on Industry Canada and B.C. government interprovincial trade data, in 1999, trade between Ontario and California was actually 40 percent larger than between Ontario to B.C. (see the chart below), a huge improvement. However, this is still magnitudes lower than potential. Despite NAFTA, non-tariff barriers such as different regulatory regimes, border security, and administrative costs have continued to stifle trade.
Worse yet, the gains made by NAFTA were eroded through the 2000s. Although, tariff trade barriers continued to fall between Canada and the U.S., 9/11 resulted in more non-tariff barriers. National security barriers to trade increased substantially – examinations at border crossings nearly doubled and passport requirements for Canadians became more strict. By 2007, trade between Ontario and B.C. was back above Ontario and California.
Not all non-tariff barriers to trade can be eliminated, but there is obviously a lot of room for improvement. Today’s border deal is expected to reduce some of these non-tariff barriers to trade by streamlining security and information sharing, and overtime it will reduce regulatory barriers to trade. Hopefully, the deal goes far enough in reducing the invisible barriers to trade between the U.S. and Canada.