Canada Free Trade Agreement

Summary of working paper 8293
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The tariff cuts boosted labor productivity (how much output is produced per hour of work) by a compounded annual rate of 2.1 percent for the most affected industries and by 0.6 percent for manufacturing as a whole.

There is good news and bad news in regard to the Canada/U.S. Free Trade Agreement (FTA). The good news is that the deal, especially controversial in Canada, has raised productivity in Canadian industry since it was implemented on January 1, 1989, benefiting both consumers and stakeholders in efficient plants. The bad news is that there were also substantial short-run adjustment costs for workers who lost their jobs and for stakeholders in plants that were closed because of new import competition or the opportunity to produce more cheaply in the south.

"One cannot understand current debates about freer trade without understanding this conflict" between the costs and gains that flow from trade liberalization, notes Daniel Trefler in The Long and Short of the Canada-US Free Trade Agreement (NBER Working Paper No. 8293). "This paper," he writes, "does not provide the silver bullet that makes the case either for or against free trade." The central tenet of international economics is that free trade improves economic welfare. "Yet the fact of the matter is that we have one heck of time communicating this to the larger public, a public gripped by Free Trade Fatigue." The FTA, he writes, provides a unique window on the effects of trade liberalization because it was an unusually clean trade policy exercise, not bundled into a larger package of national economic measures or market reforms.

His paper looks at the impact of the FTA on a large number of performance indicators in the Canadian manufacturing sector from 1989 to 1996. In the one-third of industries that experienced the largest tariff cuts in that period, ranging between 5 and 33 percent and averaging 10 percent, employment shrunk by 15 percent, output fell 11 percent, and the number of plants declined 8 percent. These industries include the makers of garments, footwear, upholstered furniture, coffins and caskets, fur goods, and adhesives. For manufacturing as a whole, the comparable numbers are 5, 3, and 4 percent, respectively, Trefler finds. "These numbers capture the large adjustment costs associated with reallocating resources out of protected, inefficient, low-end manufacturing," he notes.

Since 1996, manufacturing employment and output have largely rebounded in Canada. This suggests that some of the lost jobs and output were reallocated to high-end manufacturing. On the positive side, the tariff cuts boosted labor productivity (how much output is produced per hour of work) by a compounded annual rate of 2.1 percent for the most affected industries and by 0.6 percent for manufacturing as a whole, Trefler calculates. The tariff cuts raised "total factor productivity," a measure that takes account of capital input as well as labor input, by a compounded annual rate of 1 percent for the most affected industries and by 0.2 percent for manufacturing as a whole. Trefler figures this is attributable to a mix of plant turnover (closings, openings, takeovers) and rising technical efficiency within plants. It is not because of plants being bigger, or a shift in market share toward firms with already high productivity. In low-end manufactures, productivity rose sharply.

Surprisingly, Trefler writes, the tariff cuts raised annual earnings slightly. Production workers' wages rose by 0.8 percent per year in the most affected industries and by 0.3 percent per year for manufacturing as a whole. The tariff cuts did not effect earnings of higher-paid non-production workers or weekly hours of production workers. Thus, the FTA reduced inequality in incomes, albeit minimally.

Between 1989 and 1996, U.S. exports to Canada of products of the most affected industries increased 70 percent. The tariff cuts, reducing the barriers to goods from the United States, account for three quarters of that increase. Also, the tariff cuts explain about a third of the increased share of imports from the United States in total Canadian imports from all countries, from 85 percent to 90 percent. Trefler concludes, "Most of the effects of the FTA tariff cuts are smaller than one would imagine given the heat generated by the debate."

-- David R. Francis