In mid-March 2013, Prime Minister Shinzo Abe announced his decision to participate in the Trans-Pacific Partnership (TPP) negotiations, and the situation is developing rapidly. While the TPP is a regional trade agreement (RTA, See "Keywords"), it goes beyond the trade liberalization of goods and services of a free trade agreement (FTA) and is a "high-level" agreement that seeks common rules including one on the protection of intellectual properties, which is also referred to as an economic partnership agreement (EPA). Why are RTAs, such as the TPP, drastically increasing throughout the world? Will they serve Japan's national interest as well as the interest of the world? I will discuss this issue based on economic studies introduced in recent years.
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Concurrently with the TPP, Japan, China, and Korea held their first negotiations for an FTA at the end of March 2013. By the end of this summer, Japan and Australia are expected to agree on and conclude their own EPA negotiations. Six countries—Japan, China, Korea, India, Australia, and New Zealand—and the Association of Southeast Asian Nations (ASEAN) countries began negotiations on a Regional Comprehensive Economic Partnership that will integrate their five FTAs. Such movements are expanding on a global basis. (See Figure)
On the other hand, multinational trade negotiations through the World Trade Organization (WTO) are not making progress. Andrew Rose, a professor at the University of California, Berkeley, in his 2004 paper reported his empirical finding that participation in the WTO and its predecessor, the General Agreement on Tariffs and Trade (GATT), had not necessarily contributed to the promotion of trade. Michael Tomz, a professor at Stanford University, et al. reexamined Rose's research, and indicated that the effects of the GATT/WTO were limited, if any. Such limitation might be preventing progress of negotiations throughout the organization.
On the contrary, regional economic integrations are rapidly advancing. Richard Baldwin, a professor at the Graduate Institute of International and Development Studies in Geneva, Switzerland, in his 1993 paper demonstrated a "domino effect" structure in which many countries enter into RTAs successively. These phenomena might be promoting the liberalization of multilateral trade.
In fact, Scott Baier, an associate professor at Clemson University, et al. found the "trade creation effect" of bilateral trade between parties to FTAs had increased by two fold in a decade. How, then, is this domino effect generated? In relation to the economic effect of RTAs, "trade creation" and "trade diversion" effects have long been discussed. (See "Keywords")
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If a country lags behind in participation in a RTA, it loses exporting partners and suffers losses. Therefore, it would try to participate in a RTA to avoid falling behind the trend. There have been many studies conducted on such aspect in recent years including political-economic analyses using the game theory and empirical studies using subtle data analyses based on the theory of corporate behavior.
Gene Grossman, a professor at Princeton University, and Elhanan Helpman, a professor at Harvard University, demonstrated in their 1994 paper a structure in which multiple industry groups conduct lobbying activities with political donations, thereby affecting the government's trade policies. Their research indicated the following theoretical conclusion, which was similar to the conclusion of Baldwin's paper above.
When a RTA is formed, the export market for non-participating countries excluded from the agreement shrinks. The exporting industries of the non-participating countries then urge, with political contributions, their respective governments to participate in the RTA, and the governments respond to such request. Such process occurs successively with the domino effect.
To examine this "domino effect theory," Baldwin et al., in their 2012 paper, conducted a detailed analysis on trade data of over 100 countries between 1977 and 2005. Its result was consistent with the theory—FTAs are formed one after another out of the fear of the trade diversion effect. It is noteworthy that their research clearly demonstrated that domestic political motivation affected actual trade policies.
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International trade has drastically expanded after the Second World War because of the benefits it provides. Daniel Bernhofen, a professor at the University of Nottingham, and John Brown, a professor at Clark University, in their 2005 paper compared the situation of Japan at the end of the Edo Period with that in the early Meiji Period when the country drastically opened up its economy. It concluded that the opening of Japan increased the country's gross domestic product (GDP) per capita by approximately 8% to 9%. Does trade still provide similar benefits today?
Daniel Trefler, a professor at the University of Toronto, in his 2004 paper examined the effects of the U.S.-Canada FTA that came into effect in 1989. His analysis indicated that, although the employment rate in Canada's manufacturing industry decreased by 5% on a short-term basis, average labor productivity improved by approximately 6%, demonstrating the possibility of FTAs benefitting the country's economy in total. Such effect resulted from the fact that companies with low productivity were driven out of the market and that the share of those with high productivity increased.
Marc Melitz, a professor at Harvard University, in his 2003 paper theoretically demonstrated a mechanism that the liberalization of trade improves the productivity of the entire economy through the selection of companies. His "Melitz Model" has triggered various studies.
For example, Alla Lileeva, an assistant professor at York University, et al. reported in their 2010 paper that the productivity of Canada's exporting companies improved as a consequence of the U.S-Canada FTA which lowered tariffs against the United States. Kensuke Teshima, an assistant professor at Instituto Tecnológico Autónomo de México (ITAM), demonstrated in his 2010 paper that the North American Free Trade Agreement (NAFTA) and Mexico's trade agreement with the European Union (EU) not only promoted the selection of companies but also stimulated companies' research and development investment and encouraged competition. Albert Park, a professor at the Hong Kong University of Science and Technology, in his 2010 paper demonstrated the "learning effect through exports" based on data on China around the time of Asian currency crisis—that exports improve productivity.
Many studies on Japan have been conducted at RIETI and other institutions. Ryuhei Wakasugi, a professor emeritus at Kyoto University, and Yasuyuki Todo, a professor at the University of Tokyo, in their 2011 article demonstrated that the labor productivity of companies that started exporting was some 30% higher in four years than companies that did not. Fukunari Kimura, a professor at Keio University, and Kozo Kiyota, an associate professor at Yokohama National University, in their 2006 paper confirmed a similar effect with a certain reservation.
Since Fumio Hayashi, a professor at Hitotsubashi University, and Edward Prescott, a professor at Arizona State University, published their paper in 2002, it has become a well-established fact that the decrease in the productivity of Japan's economy has caused the downturn of the country's economy as a whole. If this perception is valid, participating in the TPP, which will be the "third opening of the country" following the end of the Edo Period and the Second World War, might become a foundation for future economic growth through the selection of companies and the improvement of productivity.
Will the expansion of RTAs serve the development of the world's free trade or cause its stumbling? Paul Krugman, a professor at Princeton University, demonstrated in his 1991 paper a theoretical possibility that, if the world is divided into the three blocs of North America, Europe, and Asia, each country's welfare will be minimized. The TPP, a gigantic RTA including Asia and the United States, also has the potential to solve such an important problem. Japan is requested to exert leadership to benefit the whole world instead of being constrained by its national interest in its narrow sense.
* Translated by RIETI.
Keywords
- [Regional trade arrangements (RTA)]
RTAs are trade agreements specific to certain regions that liberalize trade by eliminating tariffs between two countries or among a limited number of countries etc. FTAs to seek the liberalization of intra-regional trade of goods and services are leading RTAs. The WTO, which is based on the "most favored nation treatment" of impartiality toward all member countries, allows for RTAs as an exception with some conditions. - [Trade creation and trade diversion effects]
The "trade creation effect" refers to the condition in which participation in RTAs creates trade between member countries by eliminating tariffs between them which remove the distortion of trade. On the other hand, the "trade diversion effect" refers to the condition in which the execution of RTAs diverts the imports from non-member countries producing goods productively to the imports from member countries with lower productivity.
April 18, 2013 Nihon Keizai Shimbun
