The Canadian Agreement on Internal Trade: Developments and Prospects

Contributor Notes

Author’s E-Mail Address: mleidy@imf.org

Under a federal system of government, the division of responsibilities between the federal, provincial/state, and local levels of government may create internal barriers to trade. To deal with this problem, the federal and provincial governments in Canada established the Agreement on Internal Trade (AIT). This paper takes stock of the achievements and shortcomings of the AIT. Because the internal barriers to trade being addressed by the AIT are not unique to Canada, the agreement presents a useful model for reform that could be emulated by other countries.

Abstract

Under a federal system of government, the division of responsibilities between the federal, provincial/state, and local levels of government may create internal barriers to trade. To deal with this problem, the federal and provincial governments in Canada established the Agreement on Internal Trade (AIT). This paper takes stock of the achievements and shortcomings of the AIT. Because the internal barriers to trade being addressed by the AIT are not unique to Canada, the agreement presents a useful model for reform that could be emulated by other countries.

I. Introduction

Under a federal system of government, the division of responsibilities between the federal, provincial/state, and local levels of government may create internal barriers to the free flow of goods, services, labor, and capital, that reduce the efficiency of the economy. To deal with this problem in a systematic fashion, the federal and provincial governments in Canada established the Agreement on Internal Trade (AIT), which entered into force on July 1, 1995. Along the lines of international trade agreements, the AIT established a legal/institutional structure that is designed to diminish barriers to interprovincial trade flows. The signing of the AIT was an important step toward progressively liberalized interprovincial trade in Canada. This paper takes stock of the achievements and shortcomings of the AIT. Although no other government appears to have undertaken a comparable reform, the internal barriers to trade being addressed by the AIT are not unique to Canada. The Canadian AIT thus presents a useful model for internal trade reforms that could be emulated by other countries.

Section B presents a brief overview of the size and scope of Canadian internal trade barriers in the period leading up to the AIT. Section C reviews the essential features of the AIT. Section D updates developments since the AIT entered into force, including a review of the implementation of scheduled commitments and any developments under ongoing negotiations. Section E brings into focus the remaining obstacles to the free flow of goods, services, workers, and capital across Canadian provinces and identifies those areas where further progress is warranted.

II. Barriers to Internal Trade in Canada

In the period leading up to the AIT negotiations, the Internal Trade Secretariat identified three kinds of government practices that created barriers to internal trade: (I) discriminatory practices (e.g., preferences based on provincial residency); (ii) unharmonized practices (e.g., different product standards); and (iii) the inequitable application of administrative practices (e.g., publication of tender requests only locally). Discriminatory practices were identified in all areas except consumer protection and the operation of financial institutions, with provincial government procurement practices and discriminatory practices toward workers identified as among the most significant problem areas. Unharmonized provincial standards, business and product regulations, and licensing requirements presented difficulties in all areas except government procurement and natural resources trade. The inequitable application of administrative practices established barriers to internal trade in the areas of provincial government procurement and the sale of alcoholic beverages.

Some indication of the significance of internal barriers to trade can be inferred from recent developments in interprovincial versus international trade. After remaining relatively flat from 1984-91, the real value of Canadian international trade expanded significantly, while real interprovincial trade has remained essentially flat since 1984 (Chart 1). The increase in the former reflects the implementation of the regional trading arrangements beginning in January 1989 (Canada-U.S. Free Trade Agreement) and January 1994 (North American Free Trade Agreement). The data on interprovincial trade suggest that the restrictiveness of internal trade barriers were more or less unchanged in the decade leading up to the AIT. Most provinces have also seen a decline in the significance of interprovincial trade flows as a percent of provincial GDP; in 1996 interprovincial exports accounted for a smaller share of GDP than international exports for all but 3 of the 12 provinces and territories (Chart 2).

CHART 1

CANADA

CANADIAN INTERNATIONAL AND INTERPROVINICIAL TRADE

(In millions of 1986 dollars)

F1
Source: Statistics Canada.
CHART 2

CANADA

INTERNATIONAL AND WIERPROVINICIAL TRADE, 1984 and 1996

(In percent of provinicial GDP)

F2
Sources: Statistics Canada.

Despite qualitative evidence that barriers to interprovincial trade have been significant,2 the restrictiveness of these barriers do not appear to have been as large as international barriers to trade, particularly those that existed between Canada and the United States prior to implementation of the regional trading agreements.3 McCallum (1995), using a gravity-type model of trade,4 compared interprovincial trade flows within Canada to trade flows between Canada and the United States using 1988 data.5 The data suggest that, other things equal, trade between two Canadian provinces is more than 20 times larger than trade between a province and a U.S. state.6 Engel and Rogers (1996) investigate departures from the law of one price within Canada and between Canada and the United States. Using disaggregated price data from nine Canadian cities in six Canadian provinces and from 14 U.S. cities, they compared the variation in relative prices of the same goods across cities, controlling for differences in geographical distance.7 Engel and Rogers found, however, that crossing the border was comparable to adding about 75,000 miles of distance.8

III. Elements of the AIT

The AIT eliminates some existing barriers and impedes the introduction of new barriers. It does this through a number of general rules governing trade-related provincial policies, and through a set of specific sectoral provisions that address some of the direct and indirect barriers to internal trade. The Agreement also establishes a framework for settling internal trade disputes.

Under the AIT, the parties to the agreement are guided by six general rules. A nondiscrimination provision requires that Parties accord equal treatment to all Canadian persons, goods, services, and investments regardless of their provincial origin.9 A right of entry and exit prohibits measures (adopted or maintained) that restrict the movement of persons, goods, services, or investments across provincial boundaries. Parties must ensure that measures (adopted or maintained) create no obstacles to internal trade. It is recognized that provincial governments in pursuing important nontrade objectives may cause some deviation from the above rules, but in pursuit of such legitimate objectives governments must ensure that policies have a minimal adverse impact on interprovincial trade.10 Different standards and regulatory practices across provinces must be reconciled through harmonization, mutual recognition,11 and other means, in order to underpin the freer movement of goods, services, labor, and investment. Parties must also ensure a high level of transparency respecting all matters covered by the AIT. These general rules apply only to matters covered in the specific-provisions sections of the agreement and these specific provisions often explicitly qualify, or exclude, the applicability of these general rules.12 Moreover, the AIT specifically indicates that in cases of inconsistency between the highly liberal general rules and the specific sectoral provisions, the specific rules are to prevail.

Eleven sectoral chapters govern the reduction of internal trade barriers in such areas as government procurement, labor mobility, and agriculture. While these specific rules institute important steps toward freer internal trade, significant exceptions remain. Major exceptions to the liberalizing elements of the agreement include: an exclusion for financial institutions or services;13 an exclusion for energy products and related services until a specific agreement could be reached;14 exceptions for measures that are part of a “general framework” of regional economic development; exceptions for a number of services and the exclusion of certain government agencies from the obligations on government procurement; a blanket exemption for measures adopted or maintained with respect to culture or cultural industries; and the potentially far-reaching “legitimate objectives” exceptions described in footnote 11. Moreover, numerous areas in which agreement could not be reached, or which required further clarification of obligations, were left for future implementation or further negotiations; these are detailed in Appendix 1 and summarized in the next section. Each sectoral chapter is discussed briefly in Appendix 2 with a view to laying bare important liberalizing features and identifying areas of retrenchment and/or delay.

IV. Developments Since Entry Into Force

With the exception of a number of important time-specific obligations contained in the AIT, indications are that the terms of the Agreement are being met. Of the 20 complaints lodged since the agreement entered into force, 17 of which involved alleged barriers to labor mobility, investment flows, or government procurement contracts, at least 8 were dropped before a ruling was reached and none has resulted in a finding of a prohibited practice.15

There have, however, been a number of significant delays in meeting the AIT’s time-based commitments. Perhaps the most significant of these has been the inability to conclude an agreement on the energy sector, which was to have been concluded by July 1, 1995. Negotiations have produced a draft agreement, and a final agreement is expected to be finalized by July 1998. The commitment to extend the obligations of the Agreement in the area of government procurement to the so-called MASH sectors16 also was delayed beyond the scheduled completion date of June 30, 1996. Since mid-1997, there has been a good deal of progress in the MASH extension talks, and it is likely that an agreement will be reached. However, British Columbia has been resisting an extension to the MASH sector. To get around this problem, because the AIT requires a consensus among all parties on new commitments, the other provinces and territories are reportedly considering an agreement to accept new commitments on MASH sector procurement outside of the AIT.

In the area of labor mobility, a number of time-based commitments were specified with open-ended completion dates, and progress in these areas generally has been slow. The obligation to complete a work plan for the implementation of the agreement on labor mobility was completed, but the commitment to implement, within a “reasonable period of time,” the agreement on the recognition of occupational qualifications and reconciliation of occupational standards remains incomplete. Most of the time-based commitments in the sensitive areas of agriculture and food goods remain under discussion. In the area of trade in alcoholic beverages, a number of reviews on the implementation of the Agreement and mandated negotiations for further liberalization were delayed from July 1, 1996 to March 31,1997 before the reviews were completed. In the event, no changes in existing discriminatory practices resulted from these reviews. Negotiations to reach agreement on special provisions required to extend coverage of the transportation chapter to regional, local, district, or other forms of municipal government were not completed, and Ministers now recommend dropping this obligation. Efforts to reconcile (“by harmonization, mutual recognition, or other means”) regulatory and standards-related measures affecting trade in transportation services are nearing completion.

V. Scope for Further Progress

Improving the record of compliance with agreed timetables for the implementation of existing obligations may require some strengthening of the AIT’s institutional arrangements; for example, steps could be taken to increase transparency and thus heighten all Parties’ interest in abiding by agreed timetables. There are also a number of open-ended commitments (particularly in the chapter on labor mobility) that could be set on a firm timetable. Beyond such steps, however, the AIT, as virtually all trade agreements, contains significant holes (exclusions and exemptions from the obligations of the Agreement) and loopholes (conditions under which exceptions to obligations arise), some of which could be narrowed over time.17 In formulating an agenda for further progress, priorities should be set for gradually narrowing those holes and loopholes that are not necessary to accommodate important noneconomic objectives.

Exclusions for energy products and related services, financial institutions and services, and measures adopted or maintained with respect to culture or cultural industries are the most prominent sectoral holes in the AIT; the former two would appear to address no clearly defined noneconomic objective. The deadline for achieving agreement on the energy sector was missed, but negotiations have produced a draft agreement and a July 1998 completion date is envisaged. On the other hand, no timetable was established for integrating the financial sector or cultural industries into the Agreement.18

The general exception for “legitimate objectives” is a loophole with potentially far-reaching effects. Whether this escape clause will be applied sparingly or not remains unclear. However, the prospect that this provision could cast a wide net generates uncertainty, and efforts to narrow its potential reach could help solidify the liberalizing goals of the Agreement. This might be done, for example, by creating a short positive list of examples for each of the general areas of “legitimate objectives” that would apply; applications of the “legitimate objectives” escape clause in specific cases outside the list could then require a high burden of proof before being judged acceptable. Moreover, all of the various exceptions in the Agreement should be assessed according to whether they address specific legitimate noneconomic objectives. For those exceptions that do address a legitimate noneconomic objective, it would be desirable to determine whether nonconforming measures taken or maintained under these rules are serving the objective without creating undue barriers to trade.19 For those exceptions that serve no clear noneconomic objective, it would be desirable to launch further negotiations to narrow or eliminate them.