Cuadernos de economía
versão On-line ISSN 0717-6821
Cuad. econ. v.40 n.121 Santiago dez. 2003
RULES OF THUMB FOR EVALUATING PREFERENTIAL TRADING
ARRANGEMENTS: EVIDENCE FROM CGE ASSESSMENTS
ARRANGEMENTS: EVIDENCE FROM CGE ASSESSMENTS
Most interesting results on the welfare effects of regional arrangements are ambiguous at a theoretical level. Many questions only have quantitative answers that are specific to the particular model and policy considered. Thus, to determine the impact of prospective regional arrangements governments often rely on a quantitative evaluation. Usually at the request of a government involved, we have implemented a number of computable general equilibrium (CGE) models to inform policy-makers.1 We summarize the main conclusions we draw from these studies, focusing on applications in the Americas.
These conclusions are drawn from a number of model variants, including: perfect and imperfect competition; comparative static, comparative steady-state and dynamic; small open economy and multi-region; and representative consumer and multi-household. Despite the fact that we have found many of these results mentioned below repeatedly in our numerical work, and frequently undertaken piecemeal and systematic sensitivity analysis to identify the source of the results, we characterize these conclusions as rules of thumb.2 We acknowledge that there are modeling variants or parameter specifications where these rules of thumb may not hold.
In Table 1 we collate some results to illustrate a number of points. These calculations are based on the 1998 tariff of Chile of 11%. With our central elasticities we estimate that excluded countries as a whole lose US$169 million per year from a Free Trade Agreement* (FTA) between Chile and MERCOSUR, but they lose US$384 per year from an agreement between Chile and NAFTA.3
Moreover, the CU may impose a diverse tariff structure on a country that has a less distortionary uniform tariff. HRT (2002) found that if Chile had accepted the invitation to join the MERCOSUR CU, its losses would have exceeded the losses we estimated from the FTA with an 11% tariff. Michalopoulos and Tarr (1997) noted that Kyrgyzstan also had a uniform 10% tariff when it was invited to participate in a CU with Russia, Kazakhstan and Belarus. But the external tariff of this CU had zero tariffs on most products produced by Kyrgyzstan and high tariffs on products produced in Russia. Thus, the Kyrgyz would have borne most of the trade diversion costs of the CU.
On the other hand, we estimated the impact of several South-South arrangements on partner countries. The results here are much more mixed. Examples of negative arrangements include Chile losing from an agreement with MERCOSUR; Kyrgyzstan losing from a customs union with Russia, Belarus and Kazahkstan; and Cameroon losing from the preferential trade aspects of its customs union arrangement in the Central African Economic and Monetary Community. Bakoup and Tarr (2000) show that the increase in the supply price due to increased trade with small partner countries is crucial to the conclusion that Cameroon will not benefit from the preferential tariff reduction.
b. Exceptions and Antidumping. On the other hand, if agriculture is excluded from a MERCOSUR-EU FTA, instead of 44% Uruguay would obtain only 1% of its GDP. In practice, regions may exclude their most highly protected sectors from regional agreements. For example, to date, the EU has provided very little preferred market access in agriculture in its network of Mediterranean agreements. This has been a great disappointment to its partner countries, especially to Morocco, which proposed this kind of arrangement with the hope of more agricultural access; and Chile and Brazil are concerned that antidumping policies may significantly limit the potential gains from a FTA of the Americas. So the large potential gains from preferred access in regional arrangements may be illusory in practice.
Rule 7: Tax Replacement Requirements Reduce the Set of Desirable Regional Arrangements.
It follows that regional arrangements that are only marginally beneficial under the assumption of lump sum distortionless tax replacement may be welfare reducing when the additional welfare cost of tax replacement is taken into consideration. In our GE framework, with a government budget constraint, the economic link between domestic tax reform and foreign trade tax reform is unavoidable.
Many analysts have found that it is factor income changes, and not expenditure patterns, that are crucial to determining the outcome on the poor from trade policy changes. Among factor income changes, the wage of unskilled labor is the most important determinant of the impact of trade policy changes on the poor. So an increase in the relative wage of unskilled labor should result in an increase in the incomes of the poorest households.
In developing countries we might expect that the labor intensive sectors that are important to the poor will be disfavored by the structure of protection, so that the medium to long run effects of these trade reforms would be positive for the poorest households. In practice, there will be cases where the poor may not gain more than proportionately relative to the average for the economy. But growth from open trade regimes should be expected to lift the majority of the poor households. We emphasize, however, that at a very dis-aggregated level some poor households (like maize farmers in Mexico) could lose, especially in the short run. This emphasizes the need for effective safety net policies to be in place.5
Rutherford and Tarr (2002) show that when learning and technology effects are taken into account endogenously in a fully dynamic model with increasing returns to scale, the estimated gains from trade liberalization will be many multiples of the estimated gains from a static model. It does not follow, however, that the estimated gains from PTAs would be much larger when learning and technology transfer effects are incorporated, even if the static effects are dominated by trade diversion. In ongoing work, we find that there is a dynamic form of trade diversion in models that allow for productivity impacts and technology transfer from imports. That is, while regional preferences will encourage additional varieties and technology imports from regional partners, it will discourage additional varieties and technology imports from the rest of the world. As pointed out by Coe et al. (1997), one should question how technologically advanced and large the prospective partner really is. For prospective partners such as the European Union or NAFTA, the additional technology imports are likely to be sufficiently large to offset the losses from the rest of the world.6 In this case the dynamic model will produce gains from regional arrangements with technologically advanced partners that are several times the estimated gains from static models. On the other hand, if a PTA is made with a technologically less advanced region, the diversion of new technologies or varieties from the rest of the world could hinder productivity advances in the home country. On balance, growth and welfare may be reduced and may result in losses several multiples of the estimated static losses.
Bakoup, F. and Tarr, D. G. (2000), "The Economic Effects of Integration in the Central African Economic and Monetary Community: Some General Equilibrium Estimates for Cameroon," African Development Review, 12(2), December. [ Links ]
Coe, D. T.; Helpman, E., and Hoffmaister, A. W. (1997), "North-South R&D Spillovers," Economic Journal, 107, January, 134-149. [ Links ]
Dollar, D. and Kraay, A. (2001), "Trade. Growth and Poverty," Policy Research Working Paper 2615, The World Bank. [ Links ]
Harrison, G. W.; Rutherford, T. F. and Tarr, D. (1993), "Piecemeal Trade Reform in the Partially Liberalized Economy of Turkey," World Bank Economic Review, 7, May, 191-217. [ Links ]
Harrison, G. W.; Rutherford, T. F. and Tarr, D. G.. (1996), "Increased Competition and Completion of the Market in the European Community: Static and Steady-State Effects," Journal of Economic Integration, 11(3), September, 332-365. [ Links ]
Harrison, G. W.; Rutherford, T. F. and Tarr, D. G.. (1997 a), "Economic Implications for Turkey of a Customs Union with the European Union," European Economic Review, 41(3-5), April, 861-870. [ Links ]
Harrison, G . W.; Rutherford, T. F. and Tarr, D. G. (1997 b), "Quantifying the Uruguay Round," Economic Journal, 107(444) , September, 1405-1430. [ Links ]
Harrison, G. W.; Rutherford, T. F. and Tarr, D. G. (1997 c), "Opciones de Política Comercial para Chile: una Evaluación Cuantitativa," Cuadernos de Economía, 34, August, 101-137. [ Links ]
Harrison, G. W.; Rutherford, T. F. and Tarr, D. G. (2001), "Chile's Regional Arrangements and the Free Trade Agreement of the Americas: The Importance of Market Access," Policy Research Working Paper 2634, The World Bank. [ Links ]
Harrison, G. W.; Rutherford, T. F. and Tarr, D. G. (2002), "Trade Policy Options for Chile: The Importance of Market Access," The World Bank Economic Review, 16 (1), 49-79. [ Links ]
Harrison, G. W.; Rutherford, T. F. and Tarr, D. G. (2003), "Trade Liberalization, Poverty and Efficient Equity," Journal of Development Economics, 71, June, 97-128. [ Links ]
Harrison, G. W.; Rutherford, T. F., Tarr, D. G. and A. Gurgel (2003), "Regional, Multilateral and Unilateral Trade Policies of MERCOSUR for Growth and Poverty Reduction in Brazil," Policy Research Working Paper 3051, The World Bank, May 2003. Portuguese version forthcoming as "Politicas comerciais regionais, multilaterais e unilaterais do MERCOSUL para o crescimento economico e reduçao da pobreza no Brasil," Pesquisa e Planejamento Econômico. [ Links ]
Jensen, J. and Tarr, D., "Trade, Exchange Rate and Energy Pricing Reform in Iran: Potentially Large Efficiency Effects and Gains to the Poor," Review of Development Economics, forthcoming. [ Links ]
Michalopoulos, C. and Tarr, D. G. (1997), "Customs Unions in the Commonwealth of Independent States," Post-Soviet Geography and Economics, 38(3), March, 125-143. [ Links ]
Reidel, J. (1988), "The Demand for LDC Exports of Manufactures: Estimates from Hong Kong," Economic Journal, 98, March, 138-148. [ Links ]
Rutherford, T. F.; Rutström, E. E. and Tarr, D. G. (1994), "L'Accord de Libre-Échange entre le Moroc et la CE: Une Evaluation Quantitative," Revue d'Economie du Developpement, 97-133. [ Links ]
Rutherford, T. F.; Rutström, E. E. and Tarr, D. G. (1997), "Morocco's Free Trade Agreement with the EU: A Quantitative Assessment," Economic Modelling, 14(9), April, 237-269. [ Links ]
Rutherford, T.; Rutström, E. E. and Tarr, D. G.(2000), "A Free Trade Agreement Between the EU and a Representative Arab Mediterranean Country," in B. Hoekman and J. Zarrouk (eds.), Catching Up with the Competition: Trade Policy Challenges and Options for the Middle East and North Africa (Ann Arbor, MI: University of Michigan Press). [ Links ]
Rutherford, T. F. and Tarr, D. G. (2002), "Trade Liberalization, Product Variety and Growth in a Small Open Economy: A Quantitative Assessment," Journal of International Economics, 56(2), March, 247-272. [ Links ]
Rutherford, T. F., and Tarr, D. G., "Chile's Regional Arrangements - Do the Results Differ with a Dynamic Model?" Integration and Trade, forthcoming; available at http://www.iadb.org/intal/ingles/idefault.htm. [ Links ]
Schiff, M. and Wang, Y., "NAFTA, Technology Diffusion and Productivity in Mexico," Cuadernos de Economía, this issue. [ Links ]
Schiff, M. and Winters, L. A. (2003), Regional Integration and Development (Washington D.C.: Oxford University Press and the World Bank). [ Links ]
* University of Central Florida, Email: Glenn.Harrison@bus.ucf.edu; University of Colorado, Email: firstname.lastname@example.org; and the World Bank, Email: email@example.com, respectively. The views expressed are those of the authors and do not necessarily represent those of the World Bank or its Executive Directors.
2 These are rules of thumb for welfare evaluation of these agreements, and thus are different from the rules of thumb suggested by Schiff and Winters [2003, ch. 9]. The latter are designed to maximize the benefits or minimize the costs of the agreements.
3 Column 4 for Japan is an interesting exception. In this case, Chile adds an FTA with the EU to its network of FTAs with MERCOSUR and NAFTA. This illustrates that it is possible that an excluded country (here, Japan) can gain from a PTA from which it is excluded if one or more of the partner countries (here, the EU) is a significant competitor with the excluded country in third country markets (here, the Rest of the World). Since the EU diverts sales from third country markets to Chile, the excluded country (Japan) would experience a terms of trade gain in the third country markets that could more than compensate for the terms of trade loss in the partner countries.
4 Based on the estimates of Reidel (1988), in our multi-region trade models we use elasticities of substitution in import demand several times those employed in most CGE models. As a consequence our models are not dominated by high terms of trade effects (so countries will be expected to gain from unilateral trade liberalization except for very low tariff levels), and trade diversion effects are larger. This significantly contributes to our results for multilateral trade liberalization and for regional arrangements. We argued in HRT (1997b) that the choice of elasticities is crucial to explaining different results across competing models of the impact of the Uruguay Round.
5 Jensen and Tarr (forthcoming) have shown that incomes of the poor in Iran would double or triple if commodity subsidies were converted to non-targeted direct income support. Of course, targeted income support for the poor would be even more beneficial for them.