Executive summary

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Over the past three decades, the Canadian economy has become increasingly integrated into world markets through trade. This growing integration raises questions regarding how trade has affected the Canadian economy. While many analyses to date have focused on the impacts of trade at the national scale, relatively few have analyzed the effects of trade at the regional scale. The purpose of this study is to help fill this gap in our knowledge.

This study focuses on how trade has influenced the level and change in industrial specialization experienced by regional manufacturing economies over a 25-year period (1974 to 1999). Theoretically, trade liberalization should increase the size of those industries that have a comparative advantage in world markets and decrease the size of those that have a comparative disadvantage. In short, increased trade should lead to greater industrial specialization.

Increased industrial specialization creates both benefits and risks. On the one hand, trade driven by comparative advantage should result in a more efficient allocation of resources across industries, increasing productivity. On the other hand, greater specialization increases the risk arising from a significant downturn in the local economy with the loss of one or two key industries.

There are several questions that this paper seeks to answer regarding the link between trade and industrial specialization.

Is there a positive association between the level of trade and the level of industrial specialization of regional economies?

• Across regions, higher levels of export intensity (exports as a proportion of total manufacturing output) are positively associated with higher levels of industrial specialization, after controlling for a series of other factors that influence specialization.

In which regions is the effect of higher levels of trade on specialization strongest?

• The positive association between export intensity and specialization was strongest in the Western and Atlantic provinces, while it was weaker in Ontario and Quebec. Higher levels of export intensity are also more strongly associated with specialization in rural areas than in urban areas.

• The weaker association between trade and specialization in Ontario and Quebec may stem from the fact that a higher proportion of their trade is driven by specialization in particular types of products, rather than specialization across industries.

• The association between export intensity and specialization was stronger in the pre-free trade era (1974 to 1984) than in the post-free trade era (1990 to 1999).

What is the association between growing trade and industrial specialization?

• Canada's manufacturing sector more than doubled its level of export intensity between 1974 and 1999, from 18% to 43%. But this growing integration through trade has not been accompanied by an increase in regional levels of industrial specialization.

• Utilizing a multivariate statistical model to explore further the relationship between changes in export intensity and specialization, the analysis indicates that there is only a weakly positive association between the two variables, holding all other factors constant. This is particularly true of the post-1990 free trade era.

What underlies the weak association between growing trade and industrial specialization?

• Underlying this weak association is the tendency for comparative advantage to ebb in sectors that are relatively important (those with relatively large employment shares) and flow to sectors that are relatively unimportant (those with relatively small employment shares) to regional economies. In short, there is a tendency for export intensity to grow fastest in sectors that are, at least initially, relatively small.

Overall, this study finds a strong and positive association between trade and specialization, particularly outside of Central Canada and urban areas. But it also finds that increased trade does not appear to have resulted in greater specialization, largely because comparative advantage tends to ebb in sectors that were once important to a regional economy and flow to sectors that are only emerging as important sectors. Trade may unleash forces that push regional economies towards greater specialization, but these same forces are undermined by the tendency for comparative advantage to switch from sector to sector.

View the publication The Ebb and Flow of Comparative Advantage: Trade and the Industrial Specialization of Canadian Manufacturing Regions, 1974 to 1999 in PDF format.