Liberalizing Internal Trade Through Mutual Recognition: A Legal and Economic Analysis

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By Ryan Manucha and Trevor Tombe
September 20, 2022

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Summary

In Canada, provincial and territorial governments have constitutional powers that give them considerable jurisdiction over the standards, rules, regulations and certifications that govern goods and services. These regulatory differences can and do affect interprovincial trade by making it difficult to move goods, services, labor and capital across borders. These barriers can make it more expensive for consumers in one region to purchase goods and services produced in another, and therefore increase costs and reduce Canada’s overall productivity.

This paper examines possible approaches to mitigating these trade frictions and recommends serious consideration of “mutual recognition”, a framework in which an item of trade that meets the regulatory requirements of a provincial or territorial government is deemed to automatically meet the requirements of ‘another. Simply put, mutual recognition requires a host province to accept the standards set by the province from which the good or service originates. Therefore, mutual recognition can ease the compliance burden on suppliers of goods and services and eliminate duplicate testing, making it a powerful tool to eliminate policy-relevant interprovincial trade costs.

The economic implications of internal trade costs in Canada are significant. Currently, the volume of cross-border provincial and territorial trade is equivalent to nearly 18% of Canada’s GDP. And in some regions, such as the Prairie provinces, the Atlantic provinces or the three territories, internal trade represents an even larger proportion of GDP. At the same time, trade costs are relatively high, averaging between 8 and 22% (depending on the method of calculation) when all goods and services are included. Clearly, these costs can significantly affect the overall productivity and standard of living of Canadians.

Of all approaches to internal trade liberalization, mutual recognition can go the furthest in reducing policy-relevant trade barriers. In its extreme form, mutual recognition would allow any good, service or professional title to be automatically considered compliant in one province if it is already compliant in another. In this situation, there would be no differences in rules or regulations, and therefore no inter-provincial costs other than time, fuel, etc.

Measuring internal trade costs in Canada is challenging because the barriers are generally not explicit fees imposed on cross-border transactions. Rather, they represent the costs of compliance with rules, regulations, standards and certifications that vary from province to province. This paper uses two methods to estimate the magnitude of these unobservable trade costs: an inferential approach that derives a cost estimate from the observed pattern of trade based on the Head-Ries index of trade costs, and a the Canadian economy which incorporates the latest available date (from 2018) to estimate the economic effects of internal trade costs.

Beyond estimating the magnitude of trade cost reductions that mutual recognition could achieve, this paper also estimates the potential economic gains that could result. We find that Canada’s economy could grow by 4.4-7.9% over the long term – a significant gain of $110-200 billion per year, or the equivalent of $2,900-5,100 per capita – if internal trade barriers are eliminated through mutual recognition policies. .

The potential economic benefits to Canada of adopting mutual recognition policies are significant, but there are important trade-offs to consider. Trade liberalization requires that resources, production and employment move between sectors and even between regions. Sectors within a province that may not survive competition from lower-cost imports may contract, while sectors experiencing increased export volumes may expand. The same is true in all regions. Workers from one location may move to another in response to changes in wages and prices.

Our model suggests that between 1.3 and 1.7% of the Canadian labor force would migrate from one province to another in response to the elimination of internal trade costs. In the long term, these changes improve productivity for the economy as a whole, but are not without short-term cost for the individuals concerned. Such moves can be particularly costly if retraining is necessary. These adjustment costs are not taken into account in our estimates of the economic effect of trade liberalization but are nevertheless essential for policymakers to take into account.

With such great potential for further internal trade liberalization within Canada and the economic and productivity benefits that can result, these challenges may not be insurmountable. Pursuing mutual recognition policies in specific areas, such as trucking regulation, food safety, or financial services, may be appropriate. Whatever the best way forward, government interest in improving economic growth and liberalizing trade may be higher today than at any point in recent memory. And mutual recognition should be an important part of the political conversation.

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