Regional Trade Arrangements Trade Creation and Trade Diversion

Regional Trade Arrangements Trade Creation and Trade Diversion

Types of preferential trade agreements 2

Economic Effects v Trade Creation and Trade Diversion v Terms of trade v Increasing returns and increased competition v Investment 3

Trade Creation v Efficient production of B replaces inefficient domestic production. 4

Trade Diversion v Inefficient production of B replaces efficient production of C. 5

Trade Creation Price S’ D V 1 T B N 1 N 2 V 2 N 3 T’ N 4 D’ S O B’ Q 1 Q 2 Q 3 6 Q 4 Quantity

Trade Diversion Price S’ D T B C V 1 N 1 Z 5 Z 1 V 2 N 3 Z 2 Z 3 N 4 Z 4 D’ S O Z 6 T’ B’ C’ Q 1 Q 2 Q 3 Q 4 7 Quantity

IR(intra-regional exports/total exports) and Share of RI scheme in total world exports 8

Mercosur: a Trade Diversion Case?

Background v One concern raised in the discussion over RTAs is whether the discriminatory trade barriers applied in these arrangements encourage high cost imports from member countries at the expense of lower cost goods from non-members. 10

Objective v It examines changes in the regional "orientation" of exports, and shows how this information can be employed in connection with the RCA index to identify apparent "inefficiencies” in trade patterns. v The approach is applied to Mercosur countries' exports to determine if recent trade is evolving along lines compatible with these countries' comparative advantage. 11

Results v The results show the most dynamic (fast growing) products in Mercosur's intratrade generally are capital intensive goods in which members have not displayed a strong export performance in outside markets. v Neither the RCA indices, nor statistics relating to factor proportions, indicate that Mercosur has a comparative advantage in these products. 12

History v Member states: Argentina, Brazil, Paraguay and Uruguay. Chile and Bolivia became an associate member of MERCOSUR in October and December 1996, respectively. v Date founded: March 1991 v The biggest regional group in LAC with a total population of more than 200 million and a combined GDP of over $1000 billion. 13

v MERCOSUR is a customs union between the four founding members where internal trade is largely free of any duties and the external protection averages about 13 percent. v The agreement with Chile and Bolivia allows the two countries to retain their own external protection level and structure, which are generally more liberal than MERCOSUR’s (a uniform 11 percent versus an average of 13 percent in the latter). 14

v A surge in the share of their internal trade § Intra-MERCOSUR export trade doubled during 1990 -95 compared to the previous 5 -year period. § Between 1990 and 1995, Argentina and Brazil doubled and tripled, respectively, their share of exports to the MERCOSUR market. § Even in the case of Paraguay and Uruguay, there is a considerable increase in the share of their exports destined to partners markets over the same period of time. 15

Mercosur: Recent Trade Trends (Table 1) v (i) a greatly increased relative importance in intra-trade; v (ii) a stable, or slight decline, in the relative importance of countries that formed NAFTA and v (iii) a reduction in the relative importance of Europe. 16

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What products are most important in this exchange and how has the composition of exports changed? (Table 2) v On average, about 63 percent of Mercosur's intra-trade now consists of manufactures. § This is about 15 percentage points higher than their share in the region's global exports. v Over 81 percent of Brazil's exports to Mercosur now consist of manufactured goods. 18

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Trade Intensity Index v Iij is defined for country i's exports to country j as the share of i's exports going to j (Xij/Xi) relative to the share of j's imports (Mj) in world imports (Mw). v If the trade intensity index takes a value above (below) unity the countries have greater (smaller) bilateral trade than would be expected based on the partner's share in world trade. (However, our interest is time series) 20

Trade Intensity Index Iab =(200/500)/(400/40, 000) = 40 World Trade(Imports) = 40, 000 400 B 200 500 A 21

Table 3 v ”Intensity" of trade between Mercosur members increased. § Argentina's intensity index for trade with Brazil took a value of 39 in 1994 which was more than five times its corresponding level in 1979 -81. § Brazil's index for trade with Argentina more than doubles over the same period. § A major re-orientation of exports toward regional markets has occurred. 22

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Assessing to Effects of RTAs v Were the trade changes consistent with member countries' current comparative advantage? v Was the increased intra-Mercosur trade in sectors where Mercosur countries had evidenced an ability to compete in markets where they were not shielded by preferential trade arrangements? 24

“Regional Orientation” Index v ROj for Mercosur exports of product j v Xrj and Xoj represent the value of exports of j in Mercosur's intra-trade and to third countries respectively. v Xtr and Xto reflect the total value of member countries' exports within and outside the arrangement. 25

“Regional Orientation” Index ROj=(80/500)/(40/2000)=8 World 2000 40 RTA 500 B 80 26 A

Revealed comparative advantage v Xwj and Xw represent world exports of product j and total world exports of the RTA member countries. § Regional trade was excluded in order to more accurately reflect the capacity of Mercosur members to compete evenly in markets without distortions. 27

Revealed comparative advantage RCAj=(5/500)/(200/40000)=2 World 5 Exports 40, 000 200 500 B 28

Factor Intensity v The factor intensity for industry j (Lj) v Vj and Vt represent value added in industry j and all US manufacturing respectively, while Nj and Nt represent the number of workers in the industry and all manufacturing activity. 29

Table 4 v 30 three-digit SITC processed products that met two separate criteria: § (i) they recorded at least one-quarter of a million dollars in intra-trade in 1988; § (ii) that registered the highest 1988 -94 compound annual growth rates in trade among Mercosur members. 30

v Much of the dynamism in the intra-trade is associated with a shift in the regional orientation of exports toward Mercosur. v The dynamic products generally consist of goods that are relatively capital intensive in fabrication. 31

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Table 5 v Have Mercosur countries shown any evidence of export strength in these goods in "independent" markets where they are not protected by discriminatory trade arrangements? § No. For the 30 groups with the largest regional shift only two have RCA indices slightly above unity, while the index averages only 0. 27 for the other items. 33

v Mercosur members experience a strong comparative disadvantage for these goods in markets that do not incorporate discriminatory trade measures against outsiders. v Mercosur is becoming less internationally competitive in products where trade is most rapidly re-orienting toward the region. 34

v What factors are responsible for this surprising reorientation of trade? v Mercosur's own trade barriers are the cause. Table 7 shows that goods, such as those listed in Table 5, generally are protected by higher than average discriminatory trade measures. 35

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Figure 1 v Figure 1 provides little evidence that Mercosur's intra-trade is evolving along lines consistent with current comparative advantage. v Rather the products recording the largest shift toward the region are those for which Mercosur has not demonstrated an ability to export competitively elsewhere. 37

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Table 6 v A composite view of the complete profile of intra-trade changes within Mercosur. § 1988 and 1994 regional orientation indices for each individual product was computed and ranked in descending order based on changes in this index. § Next, this ranked distribution was divided into deciles and 1988 and 1994 average RCA and RO indices were computed for each group. 39

v For the first decile products, the average 1994 Mercosur RCA index was only 0. 24. v Average RCA index declines occur for the top three decile product groups which indicates Mercosur was becoming less, not more, internationally competitive for goods experiencing the greatest shift toward intratrade. 40

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Table 7 v Table 7 summarizes statistics relating to these barriers. 42

Frequency Index v The frequency index for a country j shows the percentage of tariff lines covered by some nontariff measures where Ni is tariff line item i, Di is a dummy variable that takes a value of unity if one or more NTBs is applied to the item or zero otherwise, and Nt is the total number of lines in the product group. 43

Trade Coverage v Trade coverage index (Cj) Index Vi, t-n is the value of imports in tariff line item i in year (t-n) and Di, t is a dummy that takes a value of unity if an NTB is applied to the item and zero otherwise. If n and m are zero the index is based on current trade values, otherwise base year weights are used. 44

Table 7 v The data strongly suggest that tariff preferences, and the protection they provide for intra-trade, have been a major factor behind the recent pattern of trade changes. v Mercosur tariffs on the most dynamic products about 7 percentage points higher than the average duty on all goods in the ten decile groups. 45

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