See https://www.stuff.co.nz/opinion/129164371/beware-of-fishhooks-in-free-trade-deals
Beware of fish-hooks in free trade deals
05 Jul 2022 Leave a comment
in applied price theory, applied welfare economics, comparative institutional analysis, economics of regulation, income redistribution, international economics, politics - New Zealand, Public Choice, rentseeking Tags: customs unions, tariffs, trade diversion, trade negotiations
Trade creation and trade diversion for NZ lamb imports into the UK
14 Mar 2022 Leave a comment
in applied price theory, applied welfare economics, income redistribution, industrial organisation, international economic law, international economics, International law, Public Choice, rentseeking Tags: free trade agreements, preferential trade agreements, trade creation, trade diversion
@paulkrugman at his best on #TPPANoWay
31 Jul 2019 Leave a comment
in international economics, politics - USA, Public Choice, rentseeking Tags: preferential trade agreements, trade creation, trade diversion
@toddmcclaymp #MFAT hasn’t heard of trade diversion? @DavidShearerMP #TPPANoWay @KennedyGraham
15 Mar 2016 Leave a comment
in economics of bureaucracy, international economics, politics - New Zealand, Public Choice, rentseeking Tags: customs unions, free trade agreements, preferential trading agreements, TPPA, trade creation, trade diversion
Trade diversion occurs when preferential trading agreements cause imports to shift from low cost countries to higher cost countries. Rather than gaining tariff revenue from inexpensive imports from world markets, a country may import expensive products from member countries but not gain any tariff revenue. An example of trade diversion is when Britain closed its doors to New Zealand agricultural exports after joining the common market.
Preferential trading agreements are trade agreements between countries in which they lower tariffs for each other but not for the rest of the world. The mass media mislabel them free trade agreements.
Under trade diversion, the partner country benefits from this change as an exporter, but the importing country loses due to this higher cost, as does the third country whose exports fall.
The loss to the importing country is not visible to consumers, who find the higher-cost product cheaper due to the absence of tariff. The country as a whole loses, with that loss being lost tariff revenue – lost to cover the cost of the higher cost imports from a member of the new preferential trading agreement.
It does not take much trade diversion to make a preferential trading agreement welfare reducing because of this switch to high cost producers.
The New Zealand Minister of Trade and the Ministry of Foreign Affairs and Trade did not discuss this major risk even from the simplest preferential trading agreement in recent policy analysis of the TPPA as my Official Information Act request has revealed. The term trade version does not appear in any of their analysis.
Adherents of the natural trading partner hypothesis argue that preferential trade agreements are more likely to improve welfare if participating countries already trade disproportionately with each other. Opponents of the hypothesis claim that the opposite is true: welfare gains are likely to be greater if participating countries trade less with each other. The powerful critique by Bhagwati and Panagariya (1996) is now widely accepted and one hears little justification of on preferential trading agreements on the grounds of the natural trading partners hypothesis
My submission to Parliamentary committee on TPPA treaty examination
15 Feb 2016 2 Comments
in applied welfare economics, international economic law, international economics, politics - New Zealand Tags: customs unions, intellectual property, preferential trading agreements, TPPA, trade creation, trade diversion
Despite all the passions about the TPPA, the correct starting post for an economist on regional trade agreements is lukewarm opposition. That is the position of Paul Krugman. Paul Krugman summarised the TPPA well recently from a standpoint of a professional economist:
I’ve described myself as a lukewarm opponent of the Trans-Pacific Partnership; although I don’t share the intense dislike of many progressives, I’ve seen it as an agreement not really so much about trade as about strengthening intellectual property monopolies and corporate clout in dispute settlement — both arguably bad things, not good, even from an efficiency standpoint….
What I know so far: pharma is mad because the extension of property rights in biologics is much shorter than it wanted, tobacco is mad because it has been carved out of the dispute settlement deal, and Republicans in general are mad because the labour protection stuff is stronger than expected. All of these are good things from my point of view. I’ll need to do much more homework once the details are clearer.
Krugman then reminded that a trade agreement is most politically viable when it is most socially harmful. This is the point that the opponents of the TPPA miss. They will not want to discuss how some trade agreements are good deals but others are bad. That would admit that trade agreements can be welfare enhancing, and sometimes they are but sometimes not.
The correct economic name for free trade agreements is preferential trading agreements. These agreements give tariff and other preferences to some countries over others.
Tariffs are lower for the members of the agreement, creating more trade, but there is also trade division.
CER offers a neat example of trade diversion. Instead of buying cars from the cheapest source and collecting tariff revenue, the hopelessly inefficient Australian car industry did not have to pay tariffs so it made New Zealand into a major export market until tariffs were abolished in 1998.
Less tariff revenue because of CER but we still paid way over the odds for Australian instead of Japanese cars. We were worse off. Less tariff revenue but car prices pretty much as high as before.
New Zealand tariffs are minimal these days. The TPPA reduces the key tariffs on our exports at an excruciatingly slow pace.
There is no discussion of trade diversion in the National Interest Analysis before this committee. For that reason alone, the National Interests Analysis is inadequate and should be returned to the Ministry for further work. Right now, it would not pass a first semester test in a basic international economics course because that most basic risk from trade agreements is not discussed.
Most of the TPPA is not about tariffs. Many of these other chapters are suspicious add-ons to trade talks.
Developing countries rightly regard trade and environment clauses in any trade agreement as a new form of colonialism.
Unions, the Labour Party and Greens happily demand these intrusions into the regulatory sovereignty of developing countries to protect special interests against import competition.
The sovereignty objections to trade agreements are no different to those that can be made to climate change treaties and International Labour Organisation conventions. It is all in the details – what do we get in return?
Consistency would help too. Trade agreements should not include labour or environmental standards as they, for example, limit our right to deregulate our labour market. Be careful for what you wish for when you oppose international agreements on sovereignty grounds.
The intellectual property chapters of the TPPA are truly suspicious. With each new day, the case for patents and copyrights is weakening in the economic literature. Some have made powerful arguments to abolish patents and copyrights altogether.
There are modest extensions of the term limits of drug patents and much more mischief on copyright terms. These should be watched carefully in future trade talks and one day will be a deal breaker.
Good arguments can be made against investor state dispute settlement provisions even after the carve-outs. These provisions have no place in trade agreements between democracies.
Foreigners can take their chances in democratic politics like the rest of us. They might occasionally get a short deal because of left-wing or right-wing populism but these gusts of xenophobia are mostly an occasional irritant in the rich fabric of Western democracies.
Developing countries sign-up to investor state dispute settlement to signal they are open for business. Foreign investors do not have to put up with their corrupt courts and bureaucracies and hopelessly venial politicians.
The logic of regional trade negotiations is we cut tariffs we should have cut long ago in return for others cutting their tariffs which they too should have cut long ago.
Much is made of the cost-benefit analysis of the TPPA. All the critics are really saying is cost benefit analysis is really hard and often imprecise.
If the econometric estimates were not in doubt in this or any other public policy field, the academics are simply not trying hard enough to win tenure and promotion. Academics make their careers by being contrarian.
For this lukewarm opponent of regional trade agreements, the TPPA is a so-so deal with small net gains. There is no harm in signing it.
The Evolution of Trade Agreements — Information is Beautiful Awards
09 Feb 2015 Leave a comment
in economic history, international economics Tags: free trade agreements, preferential trading agreements, regional trade agreements, trade creation, trade diversion
Jacob Viner and the ambiguous welfare effects of preferential trade agreements
17 Jun 2014 1 Comment
in applied price theory, applied welfare economics, international economic law, international economics Tags: Jacob Viner, Paul Krugman, preferential trade agreements, trade creation, trade diversion
The world trade system is a growing assortment of discriminatory trade agreements known as the ‘spaghetti bowl’ for reasons that the diagram of regional trade agreements (RTAs) in the Western Hemisphere makes clear.
Preferential trade agreements are the correct name for the political spin masters call free trade agreements or regional trade agreements.
- A preferential trade agreement is a trading bloc that gives preferential access to certain products from the participating countries. This is done by reducing or abolishing tariffs and other trade restrictions for the members of the trade bloc.
- A customs union is a type of trade bloc which is composed of a free trade area with a common external tariff.
Everything you need to know about trade blocs, preferential trading agreements, and customs union is in a book written by Jacob Viner in 1951. His book The Customs Union Issue introduced the distinction between the trade-creating and the trade-diverting effects of customs unions:
Trade diversion occurs if the common tariff around a customs union and the absence of tariffs within the union lead one of the members to purchase products from another member rather than from a “cheaper” producer in the outside world.
The classic example of this is the entry of Britain into the European Common market in 1973. It started sourcing dairy and wool imports from within the common market rather than from New Zealand as was the case for the past hundred years.
Assume the most efficient producer of lamb in the world is New Zealand. Before joining a customs union the UK will place an identical tariff on lamb imported from any country, this is shown on the diagram below. Before the customs union, French lamb is more expensive than New Zealand lamb once the tariff was paid. There are no imports from France. After joining the EU the tariff on French lamb will be removed.
The formation of the customs union between Britain and France reduces the price of lamb imports from PNZ+t to PFrance. Trade diversion now takes place as consumption switches from the low cost New Zealand farmers to the higher cost French lamb. Lower cost imports from outside the customs union have been replaced by high cost imports from within the customs union.
The welfare analysis analysis is tricky because consumer prices fall, but some of the tariff revenue is now converted into higher import prices because the lamb is sourced with the inefficient French farmers. This is shown in the multiple graphs below where some government tariff revenue is lost and is instead converted into payments to the higher-cost French farmers.
On the diagram below it is possible to highlight the gains and losses in welfare:
- There has been an increase in consumer surplus of areas 1 + 2 + 3 + 4.
- There has been a reduction in the producer surplus of UK lamb producers of area 1.
- There will be a loss of government tariff revenue of 3 + 5.
The will be a net loss in UK welfare if 2 + 4 < 5. It is possible that trade diversion will lead to an increase in UK welfare if 2 + 4 > 5. All in all this situation is full of ambiguity rather than the glories of straight out free trade were a country simply abolish the tariffs and buy from the cheapest supplier. As Paul Krugman explains:
If economists ruled the world, there would be no need for a World Trade Organization. The economist’s case for free trade is essentially a unilateral case – that is, it says that a country serves its own interests by pursuing free trade regardless of what other countries may do.
Or as Frederic Bastiat put it, it makes no more sense to be protectionist because other countries have tariffs than it would to block up our harbours because other countries have rocky coasts. So if our theories really held sway, there would be no need for trade treaties: global free trade would emerge spontaneously from the unrestricted pursuit of national interest.
Trade creation occurs if the abolition of tariffs between members of the customs union leads a member country to purchase products from another member country rather than producing it at higher cost itself.
Whether the trade creation of seats that trade to version requires very careful calculations such as those above . Whether there is a net loss or net gain will depend upon how the elasticity of domestic demand and the size of the initial tariff.
It doesn’t take much trade diversion to offset any trade creation. The trade diversion must be to a supplier within the trade bloc that is not much more expensive than the global cheapest price.
Source: http://www.mhhe.com/economics/pugel12e/keygraph/graphkey10h.html
Viner noted that the greater the similarity of the production mixes of the member countries, the greater the scope for trade creation relative to trade diversion; the more different the production mixes, the greater the scope for trade diversion!
Viner recognized that countries forming a customs union would in fact not be likely to permit the extensive relocation and reorganization of industry required to realize the potential benefits from the finer division of labour. This led him to regard customs unions as:
“unlikely to prove a practicable and suitable remedy for today’s economic ills” but rather “a psychological barrier to the realization of the more desirable but less desired objectives of … the balanced multilateral reduction of trade barriers on a non-discriminatory basis”
The expansion of trade after the signing of preferential trading agreements such as the common market and the many that followed including those signed by New Zealand, Australia and NAFTA are consistent with both trade creation and trade diversion.
The quality of arguments mounted against preferential trade agreements are surprisingly poor.There are good economic arguments against them based on the trade diversion cancelling out the trade creation.
By introducing discriminatory treatment into the trading system, the proliferation of preferential trade agreements promote costly trade diversion, interfere with the efficient operation of global business and allow great powers to extract unjustified concessions from weaker countries. These concessions can be in areas such as intellectual property rights, the purchasing pharmaceuticals by government agencies and social clauses on issues such as environmental and labour standards. Krugman again:
Fortunately or unfortunately, however, the world is not ruled by economists. The compelling economic case for unilateral free trade carries hardly any weight among people who really matter.
If we nonetheless have a fairly liberal world trading system, it is only because countries have been persuaded to open their markets in return for comparable market-opening on the part of their trading partners.
Never mind that the “concessions” trade negotiators are so proud of wresting from other nations are almost always actions these nations should have taken in their own interest anyway; in practice countries seem willing to do themselves good only if others promise to do the same.
The last time a world trade agreement was negotiated Clinton was President, cell phones were as heavy as a brick and no one had heard of email.
Utopia, you are standing in it! 
Recent Comments