THE REGIONAL IMPACT IN CANADA OF FREE TRADETHE REGIONAL IMPACT IN CANADA OF FREE TRADE* Rodrigue Tremblay Dpartement de sciences conomiques Universit de Montral c.P. 6128, Suce. ;A; MontraL Qubec H3C 37 Introduction Canada and the United States are two interdependent economies in the sense that bilateral trade flows remove demand and supply unbalances in each country and in the sense that more than 80 percent of that trade will be tariff-free after the implementation of the Tokyo Round agreements by 1987. However, there is more and more talk in Canada that the national industrial policy should move more aggressively towards free trade with the United States, either completely or along a sector-by-sector approach. If it were adopted, such a move would mark a basic departure From the original National Policy of 1879, which relied on tariff protec?tion to establish ;infant; industries in Canada by stimulating interregional trade along transport lines in an East-West manner. As a consequence, there has been a form of regional specialization in Canada: the Centre (i.e., Ontario, and to a certain extent Quebec) has developed a fairly diversified manufacturing sector, white the West and the Maritimes have seen their development more concentrated in the agricultural and resource sectors. As explained by the Eastman and Stykolt 15 hypothesis, Canadian consumers in ail regions have subsidized this development by paying higher prices for products. There are two reasons for this: first, Canadian producers have taken full advantage of the tariff ta 'Thanks are expressed ta Sylvain Gareau for technical assistance, and ta two anonymous referees. The Canadian Journal of Regional Science 1 La Revue Canadienne des Sciences Rgionales VIII, 1 (Spring/prin temps 1985), 85-99. ISSN: 0705-4580 ? Institute of Public Affairs1985 Printed in Canada 86 87 mark up prices in order to cover their higher costs of production East-West trade and more North-South trade, transport costs due to smaller scales of operation; and second, since Canada is a would be lowered, thus doubly benefitting the consumers with large country, transport costs are high and must be reflected in the removal of the tariff barrier. prices (or in taxes when these are subsidized). According to the traditional theory of international trade 211, The principal question is therefore the following: in the event therefore, the removal of the tariff would produce the traditional of North American trade liberalization, will this pattern of indus?results of lowering real wages, increasing real rents and real trial development in Canada be substantially changed (especially returns to mobile capital. In a few words, Canadians could become in favour of resource industries and to the detriment of manufac?;hewers of wood and drawers of water;. These results would turing industries) under the assumption that Canada is relatively then reflect W. A. Mackintosh's (1923) and H. A. Innis's (1930) resource-abundant and relatively less capital and technology en?;staple thesis; of Canadian export-led growth dictated by foreign dowed7 If there were a widespread interregional reorganization demand and concentrated on high natural resource content pro?of industries, this might result in structural ul1employment -the ducts. unemployment caused by changes in industrial composition. The For these traditional results to hold, however, four crucial welfare gains due to lower prices and higher efficiency couId then assumptions are required. First, factors of production must be be counteracted by economic dislocations that could make the net mobile interregionally bu t not internationally; second, firms and result uncertain. industries must operate with constant returns to scale; third, firms must be competitive; and finally, the economy must operate at full employment. Of course, capital and entrepreneurship are Free Trade and Traditional Theory very mobile in and out of Canada. Similarly, for many industries and firms in the manufacturing sectors, efficiency levels of output If we rely on simple and traditional Ricardian or Hecksher-Ohlin require large-scale production. Canadian firms are smaller than trade models, we would expect the Canadian industrial structure their American competitors, and they tend to produce a wider to be pushed towards resource industries by the establishment of range of products. Economies of scale (decreasing costs) could a North American trade zone, with a relative contraction of the therefore be reaped in many Canadian industries through speciaJ?manufacturing sector. Canada already has a comparative advan?ization and exports. Moreover, in many industries imperfect tage in resource-related products, and free trade would accentu?competition and differentiated products constitute the de facto ate this specialization. Canadian consumers would gain by such a market structure, not the competitive situation assumed b