Trevor Tombe - Regional Integration and Aggregate Economic Volatility: A Quantitative Analysis

Regional economies within countries are integrated through trade, migration and financial flows. As a consequence, shocks to one region or sector affect many others in ways that either dampen or amplify the effect on the national economy.

Building on a large and growing literature on regional trade and migration, I quantify how such integration can affect aggregate productivity levels and volatility. To do this, I combine detailed data on internal trade, migration, and government financial flows across Canadian provinces and sectors with a rich yet tractable model of Canada’s economy.

Simulating changes in provincial and sectoral productivity to match observed volatility, I find migration flows tend to substantially amplify the national effect of local shocks. Specifically, overall volatility in Canada’s economy may be nearly 50 percent higher due to inter-provincial migration alone. Federal transfers — through budgetary revenue and expenditures that are responsive to regional economic circumstances — significantly dampen this effect by roughly one quarter. But such transfers come at the cost of lower aggregate productivity.

I find Canada’s current fiscal transfers may lower national real GDP per capita by between 0.6 and 2.1 percent. These results uncover a meaningful trade-off between aggregate economic volatility and productivity levels created by how central government finances interact with internal trade and migration.