The first Peterson Institute (for International Economics) working paper of 2007 is out, a look at the whether preferential trade arrangements (PTAs) are predominately trade creating, or trade diverting: The Trade Effects of Preferential Arrangements: New Evidence from the Australia Productivity Commission (Dean A. DeRosa, WP-07-1, January 2007).
PTAs are agreements between two or more countries to offer each other lower tariffs than they offer to non-members. Trade creation takes place when the reduction in trading costs between the participants increases the volume of trade between them. This increases the welfare of the countries that get access to lower priced goods. On the other hand, trade diversion shifts a participant's trade from low cost suppliers outside the agreement to higher cost suppliers within the agreement, reducing the importer's welfare.
So which effect dominates in PTAs? There is recent evidence that PTAs are primarily trade diverting:
This paper critically examines “new” evidence from the gravity model that indicates the majority of preferential trading arrangements (PTAs) today are predominantly trade diverting. This new evidence on trade diversion was presented in a recent Australia Productivity Commission (APC) working paper.
The Australian Productivity Commission paper is The Trade and Investment Effects of Preferential Trading Arrangements - Old and New Evidence, by Adams, Dee, Gali, and McGuire (Staff Working Paper, 2003).
However, DeRosa finds something else:
Although no major faults are found in the methodology of the APC study, the present analysis finds the opposite conclusion—that the majority of current PTAs are predominantly trade creating—when a variant of the gravity model formulated by Andrew Rose is applied to upto-date regression data using a variety of econometric methods, including the Tobit regression method employed by the APC study.
A little more detail:
Preferential trading arrangements (PTAs) are widely expected to expand trade and economic welfare in PTA partner countries. Notwithstanding the “deeper” integration elements of modern free trade agreements (FTAs)—covering for instance foreign investment rules, observance of intellectual property rights, and greater harmonization of labor and environmental practices—freer trade in merchandise and services between FTA members, leading to gains in economic welfare, remains an essential inspiration for the rapid growth in bilateral and regional FTAs today.
Since Viner’s (1950) seminal study of the customs union issue, a particular concern for economists is whether expansion of intrabloc trade under PTAs is in fact welfare enhancing for bloc member countries and the world economy. Modern economic theory and quantitative methods provide formal measures for assessing trade-related changes in economic welfare across countries. However, Viner’s original approach to judging the expected economic benefits of customs unions, free trade areas, and other PTAs involved the separate but related concepts of trade creation and trade diversion. This approach remains popular today as an initial screen for judging the economic merits of PTAs. Trade creation refers to the expansion of overall trade by a PTA country to the benefit of its economy. Trade diversion, on the other hand, refers to the expansion of trade between PTA partners that supplants erstwhile imports from non-PTA countries at a higher resource cost than would be otherwise.
Much recent evidence has suggested the trade creation impact was relatively more important:
In recent years, applied and empirical studies have widely concluded that trade creation under FTAs and other PTAs outweighs trade diversion and hence that the recent spread of FTAs generally promotes economic welfare within the trading blocs (though not necessarily in each individual member country); it remains, however, an open question whether FTAs promote economic welfare in the world economy at large, including countries outside the trading blocs.
However, a 2003 study from Australia has suggested otherwise:
Against this backdrop, a recent staff working paper published by the Australia Productivity Commission (APC) (Adams et al. 2003) reports empirical findings, based on a gravity model of world trade and aggregate trade data for the period 1970–97, that indicate that the majority of PTAs examined by the authors (circa 2000) are trade diverting on a net basis. If true, this “new” evidence would suggest that the ongoing resurgence of bilateral and regional PTAs could seriously threaten the health of the world economy.
DeRosa is going to evaluate the Australian results:
Because the empirical findings and conclusion in the APC study strongly contradict previous empirical findings and the current view of policymakers regarding the trade and welfare impacts of recent PTAs, this paper undertakes a review of the methodology and results. We offer our own empirical results using a similar but more up-to-date gravity model dataset applied over a broader spectrum of estimation periods and techniques.
...and he finds:
...no major criticisms of the APC methodology.
However, to explore the robustness of the APC study results, the present paper has undertaken an independent empirical analysis of the trade impacts of the same PTAs considered by the APC study and a substantially larger number of current PTAs identified by the WTO. Using a variant of the Rose (2004) gravity model augmented by somewhat more up-to-date data than utilized by the APC study and applying a variety of econometric techniques, inclusive of the Tobit method employed by the APC investigators, the present analysis finds that the majority of PTAs in force today are trade creating rather than trade diverting. This is true not only on an intrabloc basis but also on an overall trade basis. In sum, the present econometric results are diametrically at odds with the APC study findings but nearly squarely in line with most of the gravity model literature on PTAs.
Comments