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Economic Integration and Regional Industrial Specialization Patterns: New Evidence from the Canadian-US FTA Experience

Economic Integration and Regional Industrial Specialization Patterns: New Evidence from the Canadian-US FTA Experience. Michel BEINE (Unversity of Lille, France & University of Brussels, Belgium): mbeine@ulb.ac.be Serge Coulombe (University of Ottawa, Canada): scoulomb@uottawa.ca

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Economic Integration and Regional Industrial Specialization Patterns: New Evidence from the Canadian-US FTA Experience

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  1. Economic Integration and Regional Industrial Specialization Patterns: New Evidence from the Canadian-US FTA Experience Michel BEINE (Unversity of Lille, France & University of Brussels, Belgium): mbeine@ulb.ac.be Serge Coulombe (University of Ottawa, Canada): scoulomb@uottawa.ca Workshop in International Economics, KU Leuven, October 13 2004

  2. The Issues • Impact of trade integration between Canada and the US • Impact on the regional production structures • Impact in terms of absolute specialisation • Impact in tems of relative specialisation • Impact in terms of share of intra-industry trade

  3. Why is the Canadian-US case interesting? • The FTA (1989) is one of the most spectacular integration process: trade share in GDP increased from 0.51 to 0.86 between 1990 and 2000 (Coulombe, 2003) (not a Customs Union) • This increase is not evenly spead-out across the 10 provinces (Beine & Coulombe, 2003) • The ratio international trade/interprovincial trade strongly increases for Quebec and Ontario, less for the other ones • Despite the strong effects, the FTA raised concerns • Short run costs (Job losses, Worker’s displacement) (Trefler, 2004, forthcoming AER) • Will Canada become a peripheral region of the US, specialized in primary products ?

  4. Why is the Canadian-US case interesting? • The Canadian case allows to shed some new light on the general issue of the relationship between trade integration and specialisation • Two opposite views: • Krugman, 1991: trade integration leads to specialisation • Frankel and Rose, 1998: trade integration favours diversification of production structures • This has strong implications for economic policy: increases in risk exposure (absolute specialization); future of the intra-provincial redistribution system (relative specialization) • Our paper brings 4 contributions to the empirical literature

  5. Contributions of this paper • Captures trade integration in a more precise way : use of (provincial) trade weighted tariffs between Canada and the US as a measure of trade integration rather than • Time dummies for FTA (Acharya et al.,2001); • Time (European studies : Amiti (1998, 1999 for instance) • Trade flows (endogeneity problem) • Conduct the analysis at the regional level. Important because • The Core-periphery structure • The heterogeneity of the trade integration process across provinces

  6. Contributions of this paper • Combine the pure time series information (1980-1998) with the cross-section information (10 provinces) • Panel data with more observations  more robust econometric relationships • Allows to disentangle short-run and long-run effects (Trefler, 2002) • Clear distinction between absolute and relative specialisation: • absolute specialisation important for assessing the exposure to specific economic shocks • relative specialisation important for the assessing the viability of inter-provincial redistribution schemes

  7. Theoretical background • Initial contributions from the new economic geography approach (Krugman, 1991 ; Krugman and Venables, 1995) see trade integration (decrease of transport costs) as a strong agglomerating force • Nevertheless, no clear prediction of the impact of trade integration in terms of specialisation because: • Recent contributions predict U relationship (new dispersion of activities for very low trade costs) • Specialisation and concentration are different concepts • Relocation of a given industry followed by agglomeration of other industries (backward/forward linkages)  need to disentangle short-run and long-run effects of trade integration

  8. The empirical literature • Preliminary studies of Krugman (1993) and De Grauwe and Van Haverbeke (1993) based on the comparison between countries and regions  positive link between integration and specialisation • Studies of the European integration process: mixed evidence • Increase in absolute specialisation (Amiti, 1998 & 1999) vs no trend (Sapir, 1996) • Midelfart et al. (2000) find increase in relative specialisation after 1980 while Hallet (2000) finds a steady decrease between 1980 and 1995 • Results sample-specific; level of disagregation matters !!! • Studies of the Canadian-US FTA • Sawchuk and Sydor (2001) : moderate diversification of Canadian manufacturing exports • Head and Ries (2001): stability over time of absolute specialisation

  9. The Data • Use of import and export data at the SIC 4 level (290 industries) between Canadian provinces and US • Covers the pre-FTA and the FTA period : 1980-1998 important because trade flows strongly increase before 1989. • Building of indexes of • absolute specialisation : Herfindahl indexes • relative specialisation : K-spec indexes • share of intra-industry trade : Grubbel and Lloyd indexes

  10. Specialisation indexes • Absolute specialisation: Herfindahl indexes: • Based on the sum of the squared of the shares over all industries • Number comprised between 1/290 between 1 • The lower, the more diversified

  11. Specialisation indexes • Relative specialisation: K-spec indexes indexes: • Captures the gap between province i and the average of the 9 other provinces • K-spec=0 if industrial structure identical from rest of Canada • K-spec=1 if industrial structure completely different from rest of Canada

  12. Trade integration • Provincial trade weighted tariffs (TWT) : • Reduction began well before the implementation of the FTA (1989)  need to consider the pre-FTA period • Striking heterogeneity of the trade integration process across provinces: see NF vs SK  need to conduct the analysis at the regional level • The FTA is a clean experiment :no strategic reduction in tariffs • Endogeneity of the TWT because possible endogeneity of the industry weights  alternative approach with constant weights:

  13. Control variables • CAD-USD Exchange rate volatility (realized volatility as suggested by Andersen et al. 2001) • CAD-USD Exchange rate misalignements :Acharya et al., 2001 argue that the increase in trade flows was mainly due to depreciation of the CAD and not to the FTA (however captured by a dummy variable) • Canadian Business Cycle (extracted from Beine and Coulombe, 2003) • US Business Cycle • Canadian Provincial Business Cycle (extracted from Beine and Coulombe, 2003)

  14. The benchmark econometric model • Dynamic Panel Data Model: • Disentangles short-run(f3) from long-run effects (- f2/ f1) • 3 different estimation methods : • Pooled Least Squares with fixed effects and White heteroskedasticity consistent standard errors • Feasible Generalized Least Squares with cross-sectional weighted regressions to account for cross-sectional heteroskedasticity • Seemingly Unrelated Regressions (to take with caution) • Extending the benchmark specification with interaction terms in order to refine the interpretation

  15. Two potential problems • Estimation bias with dynamic panel data for T small and N large (Nickell, 1981; Kiviet, 1995) • Here T=18 and N=10  if any, bias should be limited • IV generates more problems than it solves (poor efficiency) • Adjustement speed is high  if any, bias should also be limited • Ignoring parameter heterogeneity might generate substantial bias (Pesaran and Smith, 1995)  • Heterogeneous specifications and Mean group estimates • Results similar than those obtained with the benchmark specification

  16. Successive investigations • Impacts of TWT on absolute and relative diversification • Distinction between the all sectors case (290) and manufacturing sectors (213) (Trefler, 2004)  primary products are important, especially for some provinces (AB, SK, NF) • Distinction between trade with the US and with the ROW • Interaction specifications • Heterogeneous specifications • Robustness analysis : serial correlation, constant weights in TWT • Impact of TWT on ITT

  17. Results for absolute specialization • In the long run, the reduction of TWT (trade integration) induces more diversification • Very robust result to different methods, to heterogeneous specifications, estimations in logs for elasticities (this paper, short version) • Result holds for the all sector case and the manufacturing sectors • Estimates of the speed of adjustment suggests that: • Mean half life equal to about 2.3 years for all sectors • Mean half life equal to about 2 years for the manufacturing sectors • Short run effect of trade integration : more specialisation (result less significant and less robust however)

  18. Results for absolute specialization • Consistent with a story of • initial concentration in one or a few provinces of a given industry • agglomeration of different industries • The industrial production patterns are driven by the Canadian-US FTA: • no impact of index computed from exports to ROW • no long short-run and long-run impacts of TWT on specialisation indexes computed from exports to ROW • No strong effect of the share of ITT on absolute specialisation : if any, more ITT leads to more diversification

  19. Results fromheterogeneous specifications • Long-run impact is stronger for Alberta, New Founland, Quebec, Manitoba, Nova Scottia • Long run impact less obvious for Ontario • Mean Group estimates of Long-run impact (Pesaran and Smith, 1999) consistent with previous estimates • Heterogeneity also with respect to the short run effect • Mean Group estimates of short-run impact also in line with previous estimates

  20. Results for relative specialization • TWT do not exert any direct significant impact  trade integration does not lead to more different provinces • On the contrary, indirect effect of trade integration: trade integration increase absolute diversification which in turn is found to make provinces more similar • No interaction from relative to absolute diversification

  21. Results for intra industry trade (IIT) • Mixed evidence on the impact of trade integration • In general, negative impact : trade integration raises the share of IIT: consistent with previous findings (Torstensson , 1996 ) for Sweden • no significant impact for the all sectors case • significant impact for manufacturing sectors • Impact of misalignment of CAD on the share of IIT • Deviations from equilibium exchange rate lead to more IIT • Effect observed for the all sectors case but not for manufacturing  effect goes through primary products • Indeed, heterogeneous specification wrt misalignment show that the impact is driven mainly by the western provinces : AB, BC, SK

  22. Accounting for non stationarity • Important issues: presence of stochastic trends in TWT and Herfindahl indexes • The presence of unit roots in these variables call for specific econometric procedures because: • Inference problems in homogeneous panels (Pedroni, 2003) • Spurious regressions in heterogeneous panels • Long run relationships have to be tested by cointegration tests • The statistical procedures have to integrate the panel dimension: • Panel unit root tests (Levin and Lin, 1993; Pedroni, 2003) • Panel Cointegration tests (pedroni, 1999)

  23. Accounting for non stationarity • Procedures involving • the raw data • the logistic transformation (the interest variables are bounded) • Two different cases: • homogeneous case: the autogressive dynamics is the same in the URT and the cointegration relationship is the same • heterogeneous case: specific autoregressive part and different long-run relationships • Three lag structures in URT : 0 , 1 and 2

  24. Statistical procedures • For unit root tests: • 3 different test statistics • Strong evidence of unit roots for TWT • Mixed evidence of unit roots for Herfindahl (especially in homogeneous case) • Cointegration Tests: • 7 different test statistics • In general, evidence in favour of a long-run relationship • More evidence in the homogeneous case • Lead to the estimate of a an Error correction specification:

  25. Results • The presence of a long-run relationship confirmed: • Positive cointegrating relationship confirmed • Values of the long-run relationship very similar : 2.66 vs [1.15; 3.85] for the all sectors case and 2.80 vs [1.49; 4,14] • In general, heterogeneous specification fully confirmed • Estimates of the adjustement speed in the ECM consistent with previous findings: • Adjustment to equilibrium takes about 4 years for the all sectors case and 3 years for manufacturing sectors (homogeneous case) • Adjustment speed slightly higher for heterogeneous specification • To sum-up: main results robust to the issue of non stationarity

  26. Further robustness analysis • Robustness analysis on the effects of TWT on absolute diversification in different directions • Estimations in logs to obtain short-run and long run elasticities: short run effects not so robust ; long run elasticities very robust (about 20) • Influence of the core-periphery structure captured by the ratio of the primary to manufacturing products : • Results wrt to TWT fully robust • Caution because of endogeneity of the ratio • Issue of the endogeneity of the weights in the TWT: • Tackled with a measure of TWT fixing the weights to the time average over the 1980-2001 period • Results similar wrt long-run effects and adjsument speed, less wrt to short-run effects

  27. Further robustness analysis (continued) • Recursive regressions, dropping one province at a time: • Long-run stimates very stable • Results are not driven by a particular provincial dynamics • Wiping out potential time trends : time dummies to capture general decrease of the tariffs  results robust : the cross-sectional variance matters !!!! • Serial correlation (Dan Trefler ’s comment) : important in dynamic models : no evidence of serial correlation  results robust

  28. Conclusion and extensions • Main result : Canadian-US trade integration has led to : • long-run diversification of Canadian provincial production structures • short-run specialisation (less robust) • Trade integration does not make Canadian provinces more different from each others • Economic implications: • No increased exposure to specific shocks • No strenghtening of the core-periphery structure • No additional pressure on the inter-provincial redistribution schemes or on market adjustement mechanisms (migration, …)

  29. Conclusion and extensions • Other economic implications: provinces are not equally affected by exchange rate developments: sensitivity to misalignement is very different across the Canadian provinces  consistent with the main conclusion of Beine and Coulombe (2003) • Application to EU enlargement : choice of the integration measure ? • Role of the disaggregation level : is diversification a vertical or an horizontal phenomenon ? (on going) • Comments welcome - thanks

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