The Effect of Trade Liberalization on Capital Markets- Case of Canada and U.S FTA, Sector Level Study.

Abstract: Transitional economies tend to see trade liberalization and capital reforms hand in hand. The main goal or aim for lawmakers is to maximize welfare effects when bringing trade and capital reforms within an economy. A nation gets greater access to international financial markets, which in turn attracts inflow of investments within economy. This newfound inflow of investments can also be attributed as a major contributor to a nations growth, leading to an upward push in the capital markets. The presented empirical study investigates if there exists a relationship in between Trade Liberalization and Capital Markets, at sector level over a period of ten years (1989- 1999). This paper investigates this relationship by using the case of Canada- USA free trade agreement (1988) and Toronto Stock Exchange Index (S&P/TSX). This being a relatively new topic in the field of research, only few past studies have been conducted. And they mostly rely on ‘Event Study’ methodology for their analysis. This empirical paper applies a different approach (i.e. Fixed Effects and Random Trend Model.) in analyzing the relationship between trade liberalization and capital markets. In this empirical study, we find in the case of Canada-USA FTA, TSX on average saw a fall of 0.22 percent, when tariffs rose by one percent. Enough the effect is negligible, but it is statistically significant as well. Though the model is not capable of explaining in the detail the cause of this effect, I believe in future study employment and firm size should also be included in the modeling.