Regional Trade Agreements

What are the 'drawbacks' of integration?

> Uneven distribution of benefits of integrations > Competitive 'strategic' trade policies > Adjustment costs > Economic geography > Political Factors > Inward Looking > Sovereignty

What is Gravity Modelling?

Trade flows (bilateral) between any pair of countries can be explained by: > the GDP of partner and reporting country > GDP per capita of both countries > Distance and Trade Costs > and other variables such as FTA variables also added.

In principle, what are the key gains from trade?

Trading at different relative prices to domestic relative prices = CA. Gains derive from being able to import from a relatively more efficient supplier.

What are recent RTAs?

USMCA - 2020 (US Mexico Canada) CPTPP - 2018. 11 Countries. Trans Pacific Partnership Agreement. AfCFTA - 2019. 24 Countries. African Continental FTA. <Bilateral Agreements> CETA - 2017. EU-Canada. EPA - 2018. EU and Japan.

Negative Integration vs Positive (deep) Integration

Up to common market = negative integration. Removal of Barriers. Positive Integration = coordination of instruments, institutions and policies.

Method of Baier, Yotov and Zylkin

Use gravity framework to explore not just 'average' FTA effect but a) how different agreements have different effects b) how effects may be hetereogenous within any agreement c) how effects on bilateral trade might be different for country a and b. Allow FTA effect to vary by 1) agreement 2) country in the agreement 3) country pair in the agreement

What allocative effects might we get under imperfect competition?

WITHIN INDUSTRY REALLOCATION EFFECTS. Changes in allocative efficiency can still occur if trade is driven by imperfect competition, product variety, economies of scale and where firms are hetergenous. Melitz > most countries exporting firms are larger and more productive than non-exporting firms. Changes in Trade Costs has different impacts depending on underlying levels of productivity. 1) Increased import competition means that less efficient, productive firms find it harder to respond. Their market share declines or they go out of business. 2) Increased import competition positively benefit more efficient, productive firms. They increase their market share. 3) THEREFORE - productivity in the industry will have risen due to within industry re-allocation effects.

What is Trade Facilitation?

The level of bureaucracy and paperwork that is required to export, in particular at borders.

Results of Baier, Yotov and Zylkin

1) Average FTA effect: b = 0.293. SO FTAs have partial effect. Increase trade by 34%. 2) Effects by Agreement > Positive, stat sig. partial effects for majority of agreements in the sample. (54%) >Large effects for CEE countries. > Smaller effects for Southern med countries. 3) Effects by country and direction > considerable heterogeneity. > entering the EU had bigger impact on exports from Poland to EU than vice versa. > COMPLICATED

What are the empirical techniques in assessing FTAs?

1) Econometric >Gravity modelling >synthetic control >firm level analyses 2) PE or CGE modelling 3) Macro-economic models 4) Other e.g. descriptive stats. , input output tables

How else might FTAs lead to increased productivity and technical efficiency?

1) Economies of scale, scope, or learning by doing within a firm. > Could be driven by a larger export market, or by the exit of less efficient firms. 2) Technological and Managerial spillovers between firms. 3) Growth from Investment. R&D, innovation and human capital. > FTA could be a signal of certainty. Leads to increased certainty, leading to increased investment. 4) Importing and exporting is more likely to benefit larger and more productive firms. Leading to further within industry reallocation effects. Aggregate productivity raised. (see previous cards)

Outline Ex-Ante Model.

1) Ex Ante (simulations) Before the fact/event. Estimate of what will be the impact of x on y. > Carried out on estimated econometric coefficients. > Common techniques are Partial Equilibrium and Computable General Equilibrium Models. > Aim is to predict the impact of a change in policy on the variables in the model, ceteris paribus. DON'T give predictions of what will happen, but an idea of nothing else was to change in the world, what will the effect. SImulation not prediction. Gives orders of magnitude of experiments.

What are the effects of trade liberalisation?

1) May increase aggregate economic welfare 2) Distributional Implications: FTAs lead to winners and losers.

What type of Regional Integration are there?

1) Preferential Areas > Countries choose to offer each other preferences. (lower tariffs). not necessarily across all sectors in all goods. Liberalising, but not to 0 on all/most goods. Most countries not compatible with WTO rules. Possible for LDCs to do this, but not for UK and EU. 2) Free Trade Area > Abolish tariffs on intra union trade > Each country maintains control over own external tariff > Risk of trade deflection, hence ROO required. 3) Customs Union > Abolish tariffs on intra-union trade > BUT also have a common external tariff > Needs mechanism for redistribution tariff revenue. Suppose a good enters EU via Netherland, but goes to France, who gets the tariff revenue? 4) Common Market > Free movement of labour and capital: possibly services. 5) Single Market > Regulatory union. Doesn't mean all regs are the same, but many more regs are the same. Also mutual recognition of regs. 6) Monetary Union > common currency 7) Economic Union > common fiscal policy

What does the extent of 'additional gains' of value chains wrt RTAs depend upon?

1) The degree of supply chain complementarity. Therefore where increased tariffs or NTMs on intermediate goods would directly penalise production of final goods in the importing country. Making domestic goods less completive in domestic or exporter markets. SO increasing tariffs or NTMs could damage yourself.

What are rules of thumb for a 'succesful' union? (barriers)

1) The higher are the existing barriers to trade wrt to the partner country on both imports and exports, the larger the potential impact on economic activity and welfare from reducing those barriers. 2) Trade diversion is more likely the higher are the levels of domestic projection against third countries. 3) The greater is the degree of certainty with regard to future trade and investment possibilities between the partner countries the greater the possibility of gains.

What categories can the effects of Trade Liberalisation be grouped into?

1) The impact on specialisation and allocative efficiency. 2) The impact on competition, productivity and technical efficiency.

Why might size matter in an FTA?

1) The larger the partner the more likely they are to be a competitive supplier of the good. Therefore more likely to be Trade Creation. 2) Larger partner more likely to continue to import the product from the rest of the world even with an FTA. THIS maintains a higher price in the partner country, and the domestic firm therefore gains. Domestic firms' price is more likely to be higher as it is likely to be a tariff inclusive price. Domestic firm can charge a price of P(1+t). Better access to the new market, but without a large drop in price. TERMS OF TRADE GAIN. Single Product/Market Gains. 3) Large countries produce a wider range of goods, therefore more likely to be products/sectors where there may be trade creation. > more likely to be products where partner is more effective than ROW > more likely to be products where the partner country is more competitive than the domestic economy. 4) Bigger pro-competitive effects > bigger countries have more completive environments. 5) More likelihood of managerial / technical spillovers.

Brief Outline of Trade Creation and Diversion

1) Trade Creation: Welfare Increased. The decline in tariffs with partner allows for importing from a more efficient producer 2) Trade Diversion: Welfare Decreases. The decline in tariffs with partner allows the partner to undercut the more efficient (rest of the world) supplier. The importing country loses (tariff revenue) from this. Net effect of TC and TD ambigious. TD only happens when Pw<Pp.

What are rules of thumb for a 'succesful' union? (complementarity)

4) The bigger the overlap in the goods and services produced by the Home country and the Partner, the greater the possibility of welfare gains. 5) FOr those goods and services in which the partner country is competitive in world markets, the bigger the overlap between those exported by the partner and those imported by the home economy, the greater the possibilities of trade creation 6) The bigger the overlap between the goods and services imported by the partner and those exported by the home economy, the greater the possibilities of gains from increased exports. 7) For any given complementarity, the bigger the differences in competitiveness between the Home and Partner countries, the greater the likelihood of welfare gains.

What are rules of thumb for a 'succesful' union? (size)

8) The bigger the overlap in the goods and services produced by the Home country and the Partner, the greater the possibility of welfare gains. 9) For those goods and services in which the partner country is competitive in world markets, the bigger the overlap between those exported by the partner and those imported by the home economy, the greater the possibilities of trade creation. 10) The greater the degree of supply chain integration, the more likely it is that trade lib. will increase welfare. 11) The more lib there is in industries characterised by economies of scale, the more likely it is that lib will yield efficiency gains.

What are arguments against regionalism?

> Trade Diversion > WTO does not provide adequate discipline over RTAs, which can undermine the multilateral trading system. > World with increasing fragmentation... multiple overlapping FTAs with restrictive ROOS may be highly distortionary and protectionist. > cost to DCs from moving away from non-reciprocal preferences to symmetric regional prefs. > May promote wasteful competition for FDI > Too easy to protect sensitive sectors > Impact on excluded countries.

What does adding domestic supply show?

Adding domestic supply demonstrates SUPPLY SIDE TRADE CREATION Without domestic supply showed that trade was created in demand side due to lower prices. Can now show the increase in imports because the partner can supply the good more efficient than the domestic economy.

Outline Ex-Post Models.

After the fact/event. TO understand casual rships. e.g. do increased exports lead to higher firm level productivity. BUT Correlation =/= causation. Econometrics is to identify causal rships. TO understand the relative orders of magnitude of causual rship between variables. TO understand whether the identified rship are different across different categories. > does impact differ across sectors. TO understand how variables might interact with each other. TO estimate key co-efficient

What is Article XXIV?

Allows for the formation of Customs Union and FTAs. PROVIDING: that the duties with the outside parties shall not on the whole be higher to other countries. UK EU could not sign a FTA and then increase tariffs for everyone else. Must cover substantially all trade.

What are regulations?

Are laws which may or may not make it obligatory to follow certain standards. In doing this they can create a trade barrier if it makes it more difficult to access a given market. May be good reasons (H&S) for regulations. >Tastes, tolerance of risk, labelling requirements. Regulations can enforce types of standards.

Which parts of the GATT/WTO affect FTAs?

Article 24 (XXIV). Enabling Clause (1979)

How can this analysis be extended to NTMs?

Barriers may be quotas, regulations etc. Think of these as Ad Valorem Equivalents (AVEs) > what tariff would restrict by the same amount? Instead of tariffs reduced, the FTA could reduce a NTMs. BUT you no longer have the tariff revenue, and need to adjust the welfare gains to factor this in.

What are the effects of FTAs with respect to Pro-Competitive Markets?

Competitive markets have market power. Set price > MC. Trade liberalisation - can generate welfare gains for consumers as increased competition from imports lower price-cost markups, reducing prices. Those price reduction will be greater in that it makes it harder for firms to price discrim across markets. Anything that facilitates price discrim for firms, to segment markets, gives them market power. If it is harder for firms to price discrim, more integrated market, the great pro-competitive gains. Reduce price discrimination, firms need to increase competitiveness. Which may have positive impacts on productivity and technical efficiency.

Possible Explanation for Baier's results

Conditioning for size, FTA effects tend to be bigger for larger countries and richer countries. Both import and export side. Countries which trade a wider range of products with one another, ex ante, experience stronger trade creation effects FTAs ex post. Countries that are further away tend to have weaker impact of FTAs Countries that already had a FTA experience less trade creation Contiguous countries see larger results Conditional on a given level of trade friction: those countries with common legal systems see larger results.

How can FTAs lower conformity and regulatory barriers?

Conformity Assesments = Potentialy sig. barriers to trade. 1) National Treatment: Article III GATT (1947). Requires countries to treat foreign made products the same as domestic. EU cannot demand that UK producers produce to a different standard to the EU. Rules must be applied in non-discrim way. 2) Harmonisation >Agree to have same standards, rules, procedures. >Very difficult. 3) Mutual Recognition > In EU, goods made to the rules prevailing in one country are deemed acceptable in the partner country. > EU wide system of accreditation to ensure member states mutually recognised each other's testing and certification systems.

How might value chains impact the effect of RTAs?

Context of TC and TD: supply chain fragmentation leads to the exploitation of CA at a finer level of specialisation. Consequences: 1) Enhances the number of products from which there may be gains from specialisation arising from lower trade barriers. QUANTITY. 2) Additional gains, such as the availability of cheaper, higher quality, imported inputs as a result of trade lib. This may increase the competitiveness of final goods in a countries other products /sectors, in domestic or exporter markets.

Does partner size matter in RTAs?

Countries tend to focus on their biggest partners. Gravity Modelling: One regressor is the size of the country (importing and exporting countries). We trade more with bigger countries, and countries with bigger populations. Show that country size really do matter as a determinant of bilateral trade flows. BUT does not mean if we sign an FTA benefits will be higher,

What are Cumulation Provisions?

The degree of flexibility countries have in counting imports from third countries which they both have FTAs as 'local' for the purposes of establishing origin.

How do the sizes of barriers affect FTAs?

Economic effects depend on the extent to which barriers are reduced, and depends on their current level! UK MFN tariff roughly 2.4%. Relatively low. Not much scope for movement. Mostly depends on NTMs. Differences in regulations and admin barriers. Important in services, but not only. Vertical Fragmentation of Supply Chains: goods cross borders several times. Likely that reduced NTMs have aided vertical specialisation/fragmentation. Uncertainty and Certainty matters. Investment crucial to economic - more likely to invest in certainty and clear mechanism for dispute resolution. FTAs provide more certainty.

What is conformity assessment?

Even if two countries have the same standards and regulations, they may have different inspection regimes and enforcement mechanisms. Even domestic firms must demonstrate that they comply with the regulations in their country. If goods are exported they too must prove that they conform to the standards of the importing country, and hence may be tested where they are imported, or have documentary proof of compliance. REQUIRES: agreements between countries to recognise each others testing and certification procedures. Increasingly important elements in FTAs but in practice are hard to achieve.

What is Residual Imputation?

Ex Post Methodology. Relies on comparing observed patterns of trade with a counterfactual on the pattern of trade in the absence of integration. Assumes the trade flows continue along same trajectory prior to FTA. So construct hypothetical counterfactual to asses what the impact of integration would have been. (difference between actual and hypothetical) Reliability of estimate depends on how good the counterfactual is.

How do FTAs liberalise services?

Focus is on lifting Regulatory Barriers.

What results do we typically find for gravity models?

GDP is a key driver of trade. Big and sig coefficients. Distance matters. Countries that are further away trade less with each other. Contiguity (sharing a border) matters. Trade is higher. Average impact of FTA is 0.47. Structural (better) gravity models are smaller for FTAs and EUs. Average RTA effect for RTA = 0.36.

What did Viner show? (1950)

General view prior was that all liberalisation was good, whether prefernetial, uni,multilateral. BUT it's actually complicated. Whether or not an FTA is welfare increasing depends on whether trade is being diverted or created. (so what is the effect of increased imports on the country?) a) Trade Diversion > importing country switches its supply of imports away from a more efficient country towards a less efficient FTA partner country, as a result of being granted preferential access. b) Trade Creation > As a result of lowering tariffs, more trade takes places because > lower prices increase domestic demand > lower prices reduces less efficient domestic supply which is replaced by imports

What are the additional gains from trade from exporting?

If firms have some market power abroad, and sell at price greater than marginal cost. p > mc. THEN expanding those sales increases the profits the firm makes. WELFARE GAINS. If an FTA signed with a country with high levels of tariffs or NTMs against third countries in products which the domestic economic has a CA. Makes it easier to expand those sales and increase those profits. These high tariffs/NTMs means that higher prices are maintained. Domestic exporters charge high prices when selling to that partner country. Higher prices = higher profits for domestic exporters. Partner country may experience trade diversion but home country gains.

Issues of ROO and Trade Faciliation

Issue of Rules of Origin. In order for UK to export tariff free to Japan, UK has to prove that the good it is sending is genuinely a UK good. SO firms can only take advantage of tariff preferences if they can prove the good that they are exporting was sufficiently produced in the FTA region. Only then can a firm take advantage of tariff preferences. Different ROO applied to different goods. Vary from one FTA to another too. In assesing potential welfare consequences of FTA, degree of strictness of ROO and the procedures for proving where origin should be assessed.

What is a Synthetic Control Method?

It uses a weighted combination of potential control units to act as a counterfactual. Method of identifying a suitable benchmark in a more sophisticated way, against which to compare the actual outcomes. Typically a weighted average of a suitable group of comparative units of data

What are the impacts of deep arrangements?

Mattoo, Mulabdix and Ruta. Number of Legally enforceable provisions in Preferential TAs notified and in force. Mid 1990s onwards, trade agreements increasingly incorporated other elements. e.g. NTMs. Deep agreements have a bigger impact on trade flows. > country pairs that sign deep agreement, trade increases by at least 44%. > Controlling for tariffs and whether a country is in a preferential trade agreement (PTA) deep provision induce more trade creation than shallow PTAs. Future levels of PTA depth are statistically uncorrelated with current levels of trade flows > i.e. depth of agreements is not determined by the closeness of current trade relations. Deep integration measures take time to have an effect > average of 2 years. Trade creation from deep PTAs does not seem to be associated with trade diversion. This is because deep integration reduces trade costs more generally, and not just bilaterally (not just partner countries)

What are the observed effects of RTAs?

Mean = 0.36. Therefore corrsesponds to trade being 43% higher. Other studies: average coefficient of 0.59. So trade = 80% higher. South-South RTAs. Substantial Trade Creation from CARICOM, SADC etc Baeir: if both countries are in EU trade increases by about 62%

Effects of FTAs via different GATS service modes.

Mode 1: Service consumed in importing country. Producing more, possibly increasing employment and FTA gains from increased profitability from sales abroad. Mode 2: Buyer/consumption travels. Mode 3: Service suppliers establish abroad. > Outward FDI uses some domestics factors of production. (capital, HQ services, knowledge etc). However, Employment effects given mostly to the host economy. > The profit/rents: depend on monopoly power in the host country and ability to charge markup. Depends on the competitivity of the host market. > If the host market remains protected to non-FTA suppliers (high STRI) preferntial market access may afford higher rent extraction. Mode 4: Temporary Movement of Natural People. > Can get rents from these. > Most likely to be in higher skilled services, with higher mark-ups. > Mode 4 typically highly protected and so less likely there is competitive pressure from third countries in FTA partner market. (higher rents) Mode 5: Services embodies in exports of goods. > Higher share of services embodied the more services lib. may increase the competitiveness of manufacturing. > The greater the positive impact of lib on trade in goods, the greater the induced impact on services.

Difficulties in Measuring Impacts

Models traditionally generated very small aggregate welfare numbers. CGE model typically finds very small gains from FTAs. e.g. 1% gain of GDP. Aggregate numbers may hide detailed sectoral or product level impacts. Gains from integration mostly focus on a small subset of issues. Depend much on underlying assumptions. Larger numbers generated when imperfect competition is allowed for.

Why are RTAs important for global markets?

Most countries have at least one RTA. Most members of more than 1. EU has about 40-44 FTAs with over 70 countries. Big surge in RTA since early 1990s. Almost all RTA are FTAs. Only about 10% are customs unions.

Issues with empirical work on FTAs?

Mostly focuses on aggregate gains and losses. BUT changes in trade policy have important distributional implications as well.

What are the effects of FTA on services trade?

Much of the gains are analogous from gains from goods trade: > Gains from specialisation > Benefits from efficiency enhancing effect of cheaper services as inputs into production > Profit and gain rents from exporting services. Gains from inward FDI from jobs. Increase capital stock in the country which increases labour productivity and tech transfer. Barriers = regulatory. Lift these > In consumer services leads to gains in consumer surplus from lower barriers.

What is the Enabling Clause?

Partial RTAs. Allows developed countries to grant one-way partial tariff preferences to developing countries. E.g. GSP. Two or more developing countries allowed to grant two-way partial trade preferences (e.g. ASEAN) (bilateral partial trade prefs) Counters MFN principle, but allowed because its developing countries.

What is the effect of FTA if the Partner Country is more efficient than the Rest of the World? (no domestic supply)

Pp < Pw. If there is no domestic supply: start at Pp(1+t) with a tariff being levied. Prior to the FTA: >Price = Pp(1+t) >Imports = D1 After the FTA: >Price = Pp < Pp(1+t). Decrease. >Imports = increased from D1 to D2. >Consumer Surplus Increases >Tariff Revenue decreases. >Welfare increases. [a] TRADE HAS BEEN CREATED. Driven by lower prices and increased demand.

What is the effect of FTA if the Partner Country is more efficient than the Rest of the World? (with domestic supply)

Pp < Pw. Start at Pp(1+t) with a tariff being levied. Prior to FTA >Price = Pp(1+t) >Imports = S1-D1 Up to S1 supplied domestically, S1 to D1 imported. After FTA >Price = Pp<Pp(1+t). Decrease >Imports = increased S2 to D2. >Consumer Surplus increases >Producer Surplus decreases >Tariff Revenue decreases. >Unambigious welfare gain. [a+b} TRADE HAS BEEN CREATED. Driven by lower prices increasing demand. Less efficient domestic suppliers supply less and more efficient foreign suppliers supply more. Both supply and demand side trade creation. Adding domestic supply demonstrates supply side trade creation.

What is the effect of FTA if the Partner Country is LESS efficient than the Rest of the World? (no domestic supply)

Pp > Pw Prior to FTA > Price = Pw(1+t) > Imports = D1 After FTA > Prince = Pp > Imports = increased from D1 to D2 > Consumer Surplus > Tariff Revenue Decrease > Welfare effect is ambiguous. Depends if consumer surplus ? tariff rev decrease. Trade has been CREATED. Lower prices = increased demand. BUT Trade has also been DIVERTED. Away from more efficient supplier (w) to partner (p)

What is the effect of FTA if the Partner Country is LESS efficient than the Rest of the World? (domestic supply)

Pp > Pw Prior to FTA > Price = Pw(1+t) > Imports = S1 - D1 After FTA > Prince = Pp > Imports Increased: S2 - D2 > Consumer Surplus Increases >Producer Surplus Decreases >Tariff Revenue Decreases >Welfare effect is ambiguous. Trade has been CREATED by lower prices. Trade has been DIVERTED, as the decline in tariffs w/ partner allows partner to undercut the more efficient supplier.

Potential Effects of Higher Supply Chain Fragmentation?

Preceeding effects could be magnified in industries with higher degree of supply chain fragmentation. WHY? 1) Impact of changes in trade costs can be magnified with complex supply chains. Therefore, as trade is liberalised, this may create greater competitive pressure on firms. 2) There may be increased managerial and technological spillovers from closer interactions between upstream and downstream firms. Close SC rships, may gain more than from an arms length rship.

Why is there a growth in RTAs?

Range of issues difficult to negotiate in the multilateral system, so need to go down regional route. Hard to agree by consensus in WTO. New regionalism typically involves 'deeper' integration. (more than tariffs, other issues). Countries are more prepared to grant and agree these regionally. Prepared to grant greater market access to selected partners, not everyone in the WTO. May be useful to try and lock in commitment to liberalisation. In order to attract FDI. Give countries greater negotiation power. As a stepping stone to further multilateralism > Baldwin's Domino Theory. Political reasons: promote better international relations with neighbours.

What is Domestic Market Expansion Effect?

Reducing domestic firm costs through reducing the costs of imported intermediates is likely to increase the competitiveness of the firm in the domestic market (relative to imports). SO domestic markets may expand! Therefore the effect is not just abroad.

What is the Effective Rate of Protection?

Relationship between the tariff on your final good and the tariff on the intermediate good.

What factors impact the influence of an FTA?

Size of the barriers. GATT/WTO Rules.

What are Standards?

Standards define particular product characteristic or processes that may be used. Primarily intended to facilitate commerce by ensuring that the buyer knows exactly what they are getting even if they never see the supplier. Three Types: 1) Performance standards require certain characteristics for the product. 2) Materials. Types of materials of the way it was constructer 3) Production Processes. Require a certain process to be conformed to to comply with the standard.

What are the effects of Rules of Origin on Value Chains?

Stricter rules of origin could induce additional trade diversion. Because .... it is harder it is to use intermediates from another country.

What do the welfare effects of NTMs depend on?

Whether the NTM barrier simply introduced a price wedge between the foreign and domestic market. Who gains from that wedge Whether there are resource costs associated with NTM. The difference between the price of which the good can be supplied (Pp) and the price at which it is sold (Pp(1+AVE) gives quoat rents. Quota rents can go to: >Domestic Importer >Foreign Supplier >Domestic govts if quotas are sold Do not know a priori the effects.

What are Multiple Border Crossings?

With closely integrated supply chains, intermediates may cross borders multiple time. A decrease / increase in trade costs between countries is likely to have a magnified impact on trade and output if goods cross borders multiple times.

Actions of Trump on TAs.

Withdrew US from CPTPP. Renegotiated the NAFTA. BUT enthusiastic for a deal with the UK.