The impact of trade liberalization and the fiscal equalization transfer policy on provincial income disparities in Canada: an application of GMM estimation

Abstract

This article uses the Solow growth model and the panel data method to examine the effect of trade liberalization and the federal equalization transfers on income convergence among Canadian provinces between 1981 and 2006. Estimation problems of weak instruments and endogenous regressors are addressed by the use of a system Generalized Method of Moment (GMM) estimator. The results from the empirical analysis indicate that the current rate of convergence of Personal Income (PI) in Canada is 4.41% per year. This rate is considerably higher than the range of 1.80 and 2.41% per year that previous studies using least-square estimators have reported. The findings from the policy analysis show that the launching and expansion of the North America regional integration have de-accelerated the convergence speed for Canadian provinces by 3.99 and 3.15% per year, respectively. However, consistent with the results from previous studies, the fiscal transfers, which are part of the federal equalization programme, have accelerated the convergence speed for Canadian provinces.