The geographic divergence of international trade and investment has become a public policy goal of many countries, including Canada. Increasingly, policy-makers are issuing concerns regarding the risks which are largely political, that arise whenever there’s too much focus on trade and investment in a small number of trading partners.

However, trade in services, may offer better opportunities for trade diversification, but facilitating trade in services needs supportive regulation and strong global cities like Toronto and London to serve as centres. In these recent years, particularly after last year’s difficult NAFTA renegotiations, Canada has indicated interest in reducing its dependence on the United States.

Canada now, reflecting that priority, has a minister of international trade diversification, Jim Carr. Canada has pursued trade agreements with more farther partners via the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union (EU) and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) with 10 other countries in the Asia-Pacific region.

The various countries that approved the CPTPP have stated one objective, the ambition to develop various and more distant trade and investment partners in the face of rise of China due to the possibility of becoming overdependent on the Chinese market.

The implied belief is that the distance is less important to trade now because technology has lowered transportation and communications costs & trade deals can now overcome the remaining costs of distance, with ease as compared to the earlier life.

Proximity versus distance

Canada and United Kingdom collaboration, comprising researchers from the London School of Economics, Western University’s Ivey Business School and Simon Fraser University’s Beedie School of Business, surveyed recent academic and practitioner data and publications on trade, which are known as foreign direct investment (FDI) flows in order to evaluate the role of distance.

To conclude, if you are trading in goods, physical distance still matters a lot. The proof also suggests that trade agreements between distant countries may not be able to overcome the costs of distance. But that’s not true for all kinds of distant trade. The findings show a very different result for trade in services. Services trade does not only include direct activities like education and tourism, professional business services, but also includes indirect services such as research and design that are submerged in final products or are traded within the companies. Over the time, indirect trade in services has increased, as global value chains have become more geographically diverged.

Global value chains allow different stages of production to be distributed around the world. One example is that the global divergence of research activities by multinational firms. A case in point: When Google creates a tech hub in Toronto, it effectively exports that knowledge to other Google centres around the world.

For the global movement, distance matters less for these services particularly when they are knowledge-intensive and digital. Therefore, it’s not surprising that evidence suggests trade in services, direct and indirect, is growing faster than trade in goods. But even though trade in services seems less affected by geographical distance, there’s evidence that other measures of distance have an impact on it.

Cultural differences are a type of distance

International business scholars have identified a series of more general distance measures, including regulatory distance and culture between the countries. These are sometimes referred to as CAGE distance, meaning cultural, administrative and economic differences between trading nations in addition to geographical distance.

Despite the vast geographic distances, commonalities in several of these areas have facilitated trade and investment flows of various types among Commonwealth countries. However, in general, these social, political and economic dimensions take on a heightened role and can inhibit trade in services, because trade in services involves the movement of people along with knowledge and capital.

Trade agreements now seek to minimize these costs by including specific clauses with respect to trade in services. For example, the CPTPP includes clauses regarding investment protection and financial services. Yet more comprehensive service sector liberalization, such as public sector procurement or recognition of certifications are difficult to negotiate as they require a higher degree of regulatory arrangement, which can be politically disputed. And the evidence suggests that the impact of distance on trade depends on the nature of what is being traded (goods or services), and how one measures distance. It turns out, most trade in services, happens between cities rather than between countries.

Cultural differences and global cities

The global cities essentially limit the impact of the earlier mentioned CAGE distance. Cities provide enlightened communication, education and transportation infrastructures, and the cosmopolitan values that attract and help retain talent. Generally, it is easier to move people and services between global centres like Toronto, London, Hong Kong and New York. The decentralized nature of global value chains, however, means that it’s not only the world’s largest cities that are global. Smaller cities can establish specific opportunities as global centres for research and design, such as Cambridge in the U.K. for biotechnology.

Global cities not only attract knowledge-intensive service firms, they have the capacity to generate the kinds of companies that will become global exporters of services. The important lesson to be drawn from cities is that they state the links between innovative activity and international integration while at the same time weaken the differences between innovation and trade policy. In other words, policies that promote innovation are not entirely separate from those that promote diversified trade. When countries help their global cities to foster knowledge-based activities, they will also promote diversified trade in services.

At the same time, cities themselves undertake trade and promotion activities that and complement those of the national government. The city-based investment and trade promotion agencies the cities have developed advanced strategies to identify and promote trade and investment opportunities, typically with other cities around the globe.

However, these activities are not always co-ordinated with national diversification strategies. Canada has created “Invest in Canada”, but its mandate is focused primarily on investment attraction. Cities have not been central to public policy discussions on trade growth and diversification, which have centred in large measure on trade agreements between countries. We suggest that while trade agreements between countries are important, the role of cities in driving trade in services should be fully explored.