Canada and the U.S. are reconnecting

A large portion of global cross-border trade is trade conducted between multi-national corporations and their affiliates, often referred to as “related-party” or “intra-firm” trade.

Canada-U.S. Intra-Firm Goods Trade

Growth in Canada-U.S. intra-firm trade has dropped from 42% in 1991 to 33% in 2011.

Data: U.S. Department of Commerce, Bureau of Economic Analysis

This is also the case for Canada-U.S. trade. In 20111 , one-third (33% or $196.8 billion U.S. dollars) of Canada-U.S. goods trade was of the intra-firm variety. However, growth in Canada-U.S. intra-firm trade has not kept pace with total Canada-U.S. trade, and the share of Canada-U.S. trade conducted within the firm has dropped from 42% in 1991 to 33% in 2011.

Even more surprisingly, while the Canada-U.S. trade relationship is one of the largest in the world, the share of intra-firm trade relative to total trade remains lower between the two neighbours than between the U.S. and its other trading partners in the G7.

There are both structural and institutional reasons behind the relatively smaller amount of Canada-U.S. intra-firm trade, and its decline. A major structural factor limiting the share of intra-industry trade between Canada and the U.S. has been falling foreign direct investment (FDI) in manufacturing. Because intra-firm trade occurs between a parent and its affiliate in another country, the parent must first invest in that country before any intra-firm trade may occur. If, for example, FDI is mostly outside of sectors that require extensive exchange of goods, intra-firm trade levels would stay at low levels. In the case of Canada, manufacturing industries — which make use of a greater number of intermediate inputs — have seen their share of total inward FDI stock decline from 43.5% in 2000 to 30.5% in 2013.

Another reason for the lower share of Canada-U.S. intra-industry trade may stem from highly-developed and well-governed institutions in both countries, which lessen the need for intermediaries. Developed theoretically, it has been shown that good governance invites greater intra-firm trade between nations. However, once intra-firm trade is established, as governance improves, a negative relationship between better governance and intra-firm trade develops. This is because although good governance is a requirement for the enforcement of contracts, past a certain threshold, there is less of a need for an intermediary as contracts may be established directly in the foreign country.

Institutional quality is of great importance because the contract between a final goods producer and the supplier of the intermediate good must be enforceable. In a country with weak institutions, it may be too risky for an enterprise to outsource or contract out to another firm within that country without the proper mechanisms to ensure recourse if their contract is not met. This, in turn, often motivates offshoring (within firm) and intra-firm trade to occur instead of outsourcing (contracting out).

Nonetheless, after falling to $146 billion in 2009, Canada-U.S. intra-firm trade does appear to be reinvigorating somewhat, and at US$ 96.8 billion in 2011, was already above its pre-recession levels. In comparison, total Canada-U.S trade did not fully recover to its pre-recession level until 2013, two full years later. Likewise, at 33%, the intra-firm share of Canada-U.S. trade, although down from 34% in 2009, is above the 31% share seen between 2005 and 2008.

The Upshot

Accounting for a third of Canada-U.S. trade, intra-firm trade is an important part of the Canada-U.S. trade relationship. Although industrial structure and strong institutions may explain part of the declining importance of intra-firm trade over the last two decades, more recently intra-firm trade has shown a strong recovery in the wake of the global financial crisis.

For more information, visit Foreign Affairs, Trade and Development Canada’s Office of the Chief Economist.


Footnotes

1 Related party trade data is released at a lag of two years, and 2011 is the most recent data available.

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