An empty promise: average cost savings and scale economies among Canadian and American manufacturers, 1910-1988

During the debate that led up to the implementation of a bilateral free-trade agreement between Canada and the United States on January 1, 1989, much was made of economists' claims that both nations could expect significant welfare improvements as a result of the removal of tariffs on traded goods. The welfare gains were expected to flow from average cost savings associated with the exploitation of scale economies. In this article, I show that it was overly optimistic to predict substantive, permanent average cost convergence as a result of adjustments in the scale of production among Canadian or American manufacturing firms. I conclude that the formation of reasonable expectations regarding the effects of trade-induced output adjustments should consider global- and local scale economies and should employ data that are not dominated by a single cycle of macroeconomic volatility.
I. Introduction On January 1, 1989, a bilateral trade agreement between Canada and the United States came into effect. This free-trade agreement (FTA) called for the reduction and eventual removal [...]