Internal trade barriers are as stifling as tariffs

Welcome back. It’s a busy time for trade negotiators. Nations are trying to bargain with the White House to convince US President Donald Trump to dilute his plans for “reciprocal” tariffs. They are also hashing out deals with third countries, to soften any blow from American duties.

This week, however, I argue that for all the focus on international trade barriers, internal ones shouldn’t be overlooked.

In many large countries and trading blocs, impediments to the flow of goods, services, people and capital between provinces and member states are as much a brake on economic growth as external import duties.

“Tariff walls are visible and grab headlines. But since most economic activity is internal, barriers at home likely matter more,” said Simon Evenett, professor at the IMD Business School. “Domestic regulations quietly strangle commerce.”

Internal restrictions range from a patchwork of parochial taxes, regulations and licence requirements, to poor regional connectivity via physical and digital infrastructure. And just like tariff barriers with other countries, they inhibit productivity and competitiveness.

Canada, the world’s second-largest country by land mass, is a prime example. Its decentralised federal system gives its provinces significant autonomy to regulate and oversee trade within its borders. However, over the years, bureaucratic hurdles have accumulated, limiting the flow of goods across the country.

“Many trade barriers are imposed to protect local industries, uphold regulatory standards, generate revenue and preserve jurisdictional autonomy,” writes Salim Zanzana, an economist at RBC Economics.

For instance, a recent report from the Macdonald-Laurier Institute estimated that differences in trucking regulations — including variations in qualification requirements and trailer registration validity periods — add 8.3 per cent to freight rates.

Overall the IMF has estimated that Canada’s non-geographic interprovincial trade barriers could be equivalent to an average tariff of 21 per cent on goods and services.

As for the US, though Trump is fixated on deficits with foreign trade partners, it also has significant interior obstacles to cross-state business.

“We often think of the United States as a single, unified market, but that’s not really true,” said Scott Lincicome, a vice-president at the Cato Institute. He cites occupational licensing, tax disparities and zoning laws, alongside other state specific rules, as obstructing the flow of goods, services and people across state lines. “Workers can’t get to where they’re most needed and businesses face frictions to expanding, especially into other states.”

Federal regulations scraped by QuantGov show extreme differences in red tape volumes between even neighbouring US states. Lincicome estimates that state-level frictions could be costing the US “billions, if not trillions” of dollars per year, given the level of domestic freight flows, which are currently around $20tn annually.

Internal trade barriers are a problem in developing nations too.

In China, examples of local protectionism include giving preferential treatment to provincial champions through procurement, permits and lighter fees. And, despite the nation’s large labour force, workers lack full mobility. Welfare entitlements, tied to one’s household registration under the country’s “Hukou” system, make it harder for rural migrants to access public services in urban areas. (Studies show that migrant workers make greater precautionary savings as a result.)

Camille Boullenois, an associate director at Rhodium Group, says that intense provincial and sub-provincial competition to attract business and investment with inducements can boost private sector activity. “But it often leads to a fiscal race to the bottom, and ultimately to overcapacity”.

India’s multilingual union of states also brings numerous bureaucratic hurdles. A plethora of local taxes, licences and restrictions on the distribution of agricultural goods and energy for example slows business activity.

Its logistics costs are estimated to be around 14 per cent of its GDP. That number is closer to 10 per cent in advanced economies. Research suggests one-third of India’s logistics spending emanates from inefficiencies in infrastructure.

Hurdles to internal trade in any country can also exacerbate income disparities, by entrenching geographic disadvantages. States in India have experienced a particularly stark divergence in economic fortunes. Regional business frictions are one factor.

Of course, barriers within trading blocs are significant too. For measure, the IMF estimates that intra-EU trade barriers — including differences in banking and capital market regulations — could be equivalent to a tariff of 44 per cent on goods and 110 per cent on services on average.

The ASEAN trade area might be less reliant on external trade partners if its internal regulatory barriers, including customs surcharges and technical standards, weren’t so burdensome. Only around one-fifth of the bloc’s exports go to internal markets.

Removing internal barriers lowers costs and enables producers, service providers, workers and investors to access a wider domestic market. This promotes economies of scale and allows people to move to where suitable jobs are. Overall, it can boost productivity and export competitiveness.

For measure, a 2016 study by Eva Van Leemput, an economist at the Federal Reserve Board, estimated that India’s internal trade barriers comprised around 40 per cent of its total trade cost on average. It is likely to have fallen since because of reforms. Still, it highlights how tariffs are just one part of the total cost of trading.

A BDO Canada survey finds close to 60 per cent of Canadian businesses engaged in cross-province trade had been prevented from expanding into additional provinces due to barriers. The estimated average annual cost of interprovincial compliance per business was C$274,000.

Global tariff wars are also raising concerns about foreign direct investment. While trade openness is a key factor in determining where businesses set up, a systematic review of studies on FDI suggests market size is the number one driver.

Indeed, large, integrated internal economies offer a broader consumer base and higher potential for sales, profits and liquidity.

The IMF estimates that removing Canada’s interprovincial trade barriers in goods alone could raise its GDP per capita by about 4 per cent. In the EU, it reckons regulatory harmonisation could halve the productivity gap between advanced European economies and the US.

Where reforms have taken place, the economic gains are evident. Australia’s Mutual Recognition Act in 1992 enabled goods sold in one state or territory to be sold in another without needing to meet further requirements. (It also established equivalence in occupations.) This contributed to increased domestic freight movement and productivity growth.

India has also made progress on easing red tape. In 2017, it introduced a goods and services tax that unified regions’ value-added taxes. A recent analysis of satellite data and trucking logs found the reform helped to slash average state border crossing times by more than one-third.

Balancing regional autonomy with national economic unity is not easy. Devolution allows policy to be set according to local economic needs, rather than one-size-fits-all decisions from the centre. This can support growth.

But over time, excessive internal bureaucratic hurdles limit competition, undermine the ability of businesses to scale and make it harder to match suitable workers to jobs. This is in neither regional nor national interests.

The current risk of higher external trade barriers makes removing internal ones even more important. In Canada, there is now near unanimous support to remove interprovincial barriers. EU policymakers are more vocal about pushing for a stronger capital union. And in China, the need to boost jobs and consumption also raises the significance of removing internal hurdles.

Policymakers should capitalise on this moment, and ensure the focus on tariff wars does not sap the political bandwidth and resources needed to streamline internal regulations and push for mutual recognition agreements across their regions.

As protectionism rises outside, domestic supply chains can at least recoup some of their competitiveness in global markets through reductions in inefficiencies at home. If tariffs do come down in the future, they will then be at an even greater advantage.

Food for thought

There are some tasks that will always be better left to humans. This study finds that artificial intelligence-based tools do not make particularly good debt collectors.