Do protectionist trade policies integrate domestic markets? Evidence from the Canada-U.S

Abstract

We consider the effects of protectionist trade policies on international and domestic market integration; using evidence from the long-standing softwood lumber trade dispute between Canada and the United States. The benefits of trade liberalization are widely acknowledged; including better home-to-foreign price transmission due to reduced tariffs and lower trade costs between countries. Yet in recent years we see efforts to protect specific domestic groups; including producers; through a revival of protectionist trade policies. Such policies could improve the home-to-home price transmission across domestic markets as consumers may seek lower-cost alternatives domestically. We investigate these ideas using a bi-variate three- regime threshold vector error-correction model (TVECM) to examine the spatial price transmission between Canadian and U.S. markets and within U.S. domestic markets. We do that by introducing a structural break at the start of an effective free trade period within our sample. The results suggest that duty-free treatment for imported Canadian softwood lumber substantially lowers the transaction costs between the two nations. Prices are more easily transmitted from the Canadian market to the U.S. at a higher speed; but the speed of price transmission in the reverse direction is not statistically significant. The U.S. domestic market experienced a higher speed of price adjustment across domestic regions prior to the free trade period; which provides evidence that protectionist policies lead to better domestic market integration.

Citation

Guo, Jinggang; Johnston, Craig M.T. 2020. Do protectionist trade policies integrate domestic markets? Evidence from the Canada-U.S. softwood lumber dispute. Staff Working Paper 2020-10. Bank of Canada. 20 pages.