Firm-level data reveal a tight relationship between trade and productivity in Canada.

Here’s an interesting figure from a new chapter in the IRPP’s trade volume:

Baldwin_Yan_blog_figures_June_1

Note: Trade share = exports + imports/GDP (current dollars); Business sector MFP (2007=100).
Source: Baldwin and Yan (IRPP, 2015, Redesigning Canadian Trade Policies for New Global Realities)

As you can see, Canada’s trade share and its business-sector productivity have tracked each other quite closely in recent decades.

In the 1990s, both grew quickly when the trade environment improved thanks to North American free trade deals and a weakening Canadian dollar.

But after 2000, both series fell as the trade environment worsened due to: the “thickening” of the Canada-US border after 9/11; an appreciating Canadian dollar related to stronger global commodity prices; and the recession of 2008/09 and weak subsequent recovery.

On its own, a correlation between two time-series doesn’t tell you much. Each has measurement issues, and we know that correlation does not equal causation.

Nonetheless, this relationship at the macro-level is consistent with the tight link predicted by trade theory– namely, that more intensive trade and trade-enhancing policies generally lead to better economic performance and productivity (see Lapham in the volume).

This new chapter by Statistics Canada researchers John Baldwin and Beiling Yan is worth a read because it goes beyond the macro story to get at the underlying micro drivers. It presents new results using Canada firm-level data and distills empirical evidence from the past decade. Here are some more noteworthy results:

Canadian exporters make an outsized contribution to economic activity
The authors find that the 35 percent of Canadian manufacturing firms that were exporters over 1974 to 2010 accounted for more than twice their share of total manufacturing employment and shipments.

Baldwin_Yan_blog_figures_June_2Labour productivity was 13 percent higher for exporters than for non-exporters on average over this period. But this average productivity premium masks stark differences across sub-periods –from the highs of the early 1990s to the recent lows in 2005-10, when Canadian exporters were actually less productive than non-exporters.

Baldwin_Yan_blog_figures_June_3The authors partly attribute the troubles in the most recent period to problems for continuing exporters who had significant excess capacity in the recession, particularly in the US market.

Exporting increases with firm size
Firm-level data reveal differences by firm size and confirm what theory predicts–that larger firms export more than smaller firms.

Baldwin_Yan_blog_figures_June_4Note: Export intensity = export share of total shipments. Small firms (10-99 employees); Medium (100-250); Large (>250).

Imports also matter for Canada’s productivity
Exports have historically received the most attention, but recent research is finding important complementarities between exporting and importing, and shows that imports are also an important source of Canada’s productivity gains. For example, between 2000 and 2007, a remarkable two-thirds of Canada’s (effective multifactor) productivity came from other countries– with half the total coming from the United States.

Firm-specific factors matter…
While there can be large productivity benefits from accessing new markets, and stronger international competition can induce domestic firms to become more efficient, such changes don’t happen automatically: firm-specific factors matter. Businesses that succeed abroad tend to be adaptable and innovative, introducing new products and processes.

Investment is a key part of the story and helps to explain why the strongest productivity gains are often found for new entrants into export markets, who typically grow faster than continuing exporters. When firms enter new markets, they often accumulate capital and invest in advanced technologies, research and development, and training. These activities develop the capacity to learn from and adopt international best practices.

In addition, larger markets– whether international or inter-provincial– can also raise productivity by allowing firms to specialize in their production, exploit economies of scale and increase their capacity use.

… but developments in the overall trading environment also impact a firm’s success.
Things that are beyond the direct control of Canadian firms also matter, such as tariffs and exchange rate movements. Of these two factors, exchange rate movements have had larger impacts on the new exporter productivity premium in Canada’s manufacturing sector– nonetheless, tariff cuts did provide a big boost to that sector’s productivity the 1990s (see below).

The reason that exchange rates seemed to matter more for new entrants was likely because Canada’s exchange rate swings have generally been larger than tariff changes.

Baldwin_Yan_blog_figures_June_5The depreciation of the dollar enhanced the superior performance of new Canadian exporters in the early 1990s. In contrast, the productivity benefits normally accompanying new exporters effectively disappeared in the period after 2000 when the Canadian dollar appreciated significantly.

Industrial restructuring promotes productivity growth
An important way that trade liberalization policies have raised productivity–perhaps the most important empirically for Canada– is by promoting industrial restructuring, which shifts production from less-productive to more-productive firms.

This ”between-firm” growth comes from reallocating production between firms– as opposed to growth that occurs within a given firm, as generally described above. The best estimates attribute over 60% of the productivity gains in Canada’s manufacturing sector after tariff cuts from the Canada-US trade deal to this between-plant effect.

Baldwin_Yan_blog_figures_June_Table_1You can read the full paper here. It does a great job of dissecting the relationship between trade and productivity and provides a rich picture of the complex dynamics of the Canadian economy and its reliance on trade.