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The trade and welfare benefits of deep trade agreements

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The trade and welfare benefits of deep trade agreements

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Trade agreements are one of the most widely used policy tools for economic integration. Over the past decades, they have evolved both in volume and in scope. Whereas the predominant focus of early trade agreements was lowering tariffs, modern trade agreements contain a range of deeper provisions which go beyond the narrow remit of traditional trade policy instruments.  

Such provisions apply to trade in services as well as trade in goods, and are widespread across agreements. They encompass measures ranging from recognition of professional qualifications for service providers, investment liberalisation, and intellectual property protection commitments, to policy areas such as anti-corruption, visa, and asylum. Trade agreements which include these provision types are referred to as deep trade agreements (DTAs).

In recent years, enormous progress has been made to classify the text of trade agreements into key policy areas (Hoffman et al. 2017, Mattoo et al. 2020). Such advancements have led to a richer understanding of the effects of DTAs on trade, from various angles: trade creation and trade diversion (Mattoo et al. 2017); the impact of EU membership (Mulabdic et al. 2017); global value chains (Laget et al. 2018; Orefice and Rocha 2014); among others. Yet studies examining how deep trade provisions contribute to trade in goods and services, and to welfare are rare. 

In recent work (Dhingra et al. 2021), we estimate the impact of DTAs on trade in goods and services, and use a quantitative general equilibrium model to unpack their welfare effects. We uncover the main sources of countries’ welfare gains by  decomposing overall welfare effects into those from non-tariff versus tariff measures, and those from goods versus services sectors. Building on recent advances in codifying deep trade provisions, one key finding is that DTAs boosted trade in services and were an important contributor to the welfare gains from trade policy since the conclusion of the Uruguay Round in 1994. Looking forward, we examine the future of trends towards deglobalisation, as embodied in the UK’s departure from the EU, which is the deepest trade agreement in the world.   

Deep trade agreements play an instrumental role in boosting services exports

DTAs have increasingly incorporated non-tariff commitments which target goods and services alike. We examine the impact of DTAs on goods versus services trade over the period 1995-2011. Despite services being the most important sector in the majority of developed economies, the paucity of data on cross-border services flows has limited research in this area. Disaggregating gross trade data from the World Input-Output Database (WIOD) into goods versus services flows and matching it to the universe of DTAs from the World Bank Content of Deep Trade Agreement Database enables an analysis of their trade and welfare impacts. 

We use three different measures to capture trade agreements, each of which reflects varying levels of trade agreement depth. The shallowest representation is a simple trade agreement dummy, which represents whether a given country-pair has an agreement in place. Second, we compute an index based on the count of legally enforceable core provisions in an agreement. These core provisions cover policy areas that fall under the main WTO remit as well as a few areas in which it has limited reach, including investments, intellectual property rights, and competition policy. Finally, we compute an index based on the count of all legally enforceable provisions, expanding the scope to areas like visa and asylum, financial assistance, political dialogue, etc.

Reduced form estimates show that DTAs, which include a wide range of non-tariff provisions, have a stronger effect on exports than shallower agreements, given their ability to address behind-the-border trade barriers in addition to the reduction of tariffs. Further, in the 16 years following the Uruguay Round, the effect of DTAs on bilateral exports was relatively larger for trade in services (30%) than for trade in goods (25%), as shown in Figure 1. These effects hold up while controlling for bilateral applied tariffs on goods exports and under a range of robustness checks.

Figure 1 DTAs have a relatively larger impact on trade in services than goods

The trade and welfare benefits of deep trade agreements 1

Source: Dhingra et al. (2021) 
Notes: This figure shows the results of the reduced form results from our baseline regression of DTA variables on total, goods, and services exports. 

The welfare effects of deep trade agreements: Integration versus deglobalisation

We map our reduced-form estimates to a quantitative trade model à la Costinot and Rodriguez-Clare (2014) and calculate welfare changes in response to post-Uruguay Round trade liberalisations.  Tariff reductions and deepening of trade policy commitments increased welfare by over 2% on average, with China, India, and the Eastern European block benefitting in particular. These countries undertook the greatest liberalisations in our sample: China and India significantly cut their tariffs over the period, and Eastern European countries acceded to the EU in 2004.

Tracking welfare gains over time and separating welfare effects into gains from tariff versus DTA liberalisation shows that China and India experienced welfare gains predominantly through the channel of tariff liberalisation. On the other hand, welfare gains in Eastern European countries were predominantly driven by tariff reductions prior to EU accession. After accession in 2004, there is a notable rise in welfare gains stemming from DTAs. All other regions in our sample experienced relatively modest gains of roughly 1% (Figure 2).

Figure 2 Evolution of overall welfare gains from trade liberalisation, 1996-2011

The trade and welfare benefits of deep trade agreements 2

Source: Dhingra et al. (2021) 
Notes: This figure shows the estimated changes in real consumption for each country and each year by feeding the observed changes in tariffs and estimated non-tariff barriers as compared to the year 1995 into the quantitative model. 

Further, separating welfare effects into gains from goods versus services sectors shows that the split is roughly even for industrialised countries. Gains from goods liberalisation dominates for developing and emerging markets, which undertook tariff reform and joined DTAs simultaneously.

Having modelled gains from trade with post-Uruguay Round data, we run a counterfactual exercise to simulate the welfare impacts of Brexit. The UK’s decision to withdraw from the the EU is an unprecedented instance of trade de-integration: it is the first time in modern history that a country has sought to leave such an integrated trading bloc (Dhingra et al. 2017). 

We use the information on trade agreement depth and tariffs to explore the welfare impacts of a UK-EU ‘Soft Brexit’ deal with equivalent depth as NAFTA and NAFTA tariff-rates. Further, we layer additional NAFTA-depth DTAs between the UK and the US, as well as the UK and Canada and Australia (both Commonwealth countries). 

The bottom line is that even under the most comprehensive scenario whereby the UK concludes NAFTA-like deals with the EU, US, Canada, and Australia, Brexit losses are 0.7%. While this number might seem small, such welfare losses are significant: the UK’s welfare gains from deep trade liberalisation accumulated during nearly two decades were roughly 1.2%. 

Summing up

Emprirical and theory-based research has consistently highlighted the benefits of tariff reductions, both in terms of boosting goods exports and increasing welfare. However, in light of deepening trade policy since the Uruguay Round, focusing on tariffs and trade in goods misses a considerable part of the story. We show that non-tariff provisions embodied in deep trade agreements have a relatively larger impact on trade in services than trade in goods. We also show that tariff and non-tariff liberalisations have similar average welfare benefits: tariffs increased welfare by 1.8% on average, compared to 1.4% for non-tariff measures. Accordingly, the highest welfare gains accrued to countries that undertook the deepest liberalisations in non-tariff as well as tariff barriers. This suggests that developing nations which have yet to sign comprehensive deep trade agreements could still have much to gain through pursuing agreements which remove non-tariff barriers. For developed countries, as posited by Baldwin et al. (2017), trends of de-globalisation suggest a tradeoff between the trade-enhancing impacts of deep trade agreement commitments and other policy commitments.

References

Baldwin, R, P Collier and A Venables (2017), “Post-Brexit trade and development policy”, VoxEU.org, 29 March. 

Costinot, A and A Rodríguez-Clare (2014), “Trade theory with numbers: Quantifying the consequences of globalization”, Handbook of international economics, Vol. 4, pp. 197-261.

Dhingra, S, H Huang, G Ottaviano, J Paulo Pessoa, T Sampson and J Van Reenen (2017), “The costs and benefits of leaving the EU: trade effects”, Economic Policy 32(92): 651-705.

Dhingra, S, R Freeman and H Huang (2021), “The impact of deep trade agreements on trade and welfare“, LSE Centre for Economics Discussion Paper 1742. 

Hofmann, C, A Osnago and M Ruta (2017), “Horizontal depth: A new database on the content of preferential trade agreements”, World Bank Working Paper 7981.

Laget, E., A. Osnago, N. Rocha, and M. Ruta (2018). Deep agreements and global value chains. World Bank Working Paper 8491.

Mattoo, A, N Rocha and M Ruta (2020), “The Evolution of Deep Trade Agreements”, Handbook of Deep Trade Agreements, World Bank. 

Mattoo, A, A Mulabdic and M Ruta (2017), “Deep trade agreements as public goods”, VoxEU.org, 12 October.

Mulabdic, A, A Osnago and M Ruta (2017), “Deep integration and UK-EU trade relations”, World Bank working paper 7947 

Orefice, G and N Rocha (2014), “Deep integration and production networks: An empirical analysis”, The World Economy 37 (1): 106-136.

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