Increasing Need for FTA Effect Analysis
Faculty Fellow, RIETI
Rapid proliferation of FTAs in Asia and Worldwide
Free trade agreements (FTAs), an arrangement under which two or more countries eliminate trade barriers between themselves have been rapidly proliferating in recent years. As of September 15, 2006, the number of FTAs (FTAs and customs unions, to be precise), reported to the General Agreement on Tariffs and Trade (GATT) and the World Trade Organization stood at 211. Among the WTO members, Mongolia is said to be the only country not covered by any FTA, while intra-FTA trade has come to constitute more than 40% of world trade today. East Asia, compared to other regions, was relatively slow to take interest in FTAs. The Association of Southeast Asian Nations (ASEAN)-formed ASEAN Free Trade Area (AFTA) is the only major FTA that existed in East Asia before the turn of the century. In the 21st century, however, East Asian countries have begun to aggressively promote FTAs.
Japan's first FTA, the Japan-Singapore Economic Partnership Agreement (EPA) was put into force November 2002, followed by FTAs with Mexico and Malaysia in April 2005 and July 2006 respectively. Japan is currently negotiating similar arrangements primarily with East Asian countries including Indonesia. As characterized by Japan's FTAs (officially referred to as EPAs), FTAs concluded and/or negotiated by countries in recent years are not simply about trade liberalization. Rather, they are meant to be comprehensive arrangements calling for the liberalization and facilitation of trade and investment as well as for the enhancement of economic cooperation among member countries.
With trade liberalization under the WTO remaining bogged down, it is expected that FTAs will in the coming years continue to proliferate. Japan, for its part, has shown a great deal of enthusiasm for signing more FTAs. In order to develop a desirable FTA strategy conducive to the economic growth of Japan and other countries, analysis of the economic effects of FTAs is crucial. Basically, there are two types of analysis: ex ante analysis, conducted prior to the formation of an FTA, and ex post analysis, conducted after the formation of an FTA. In an ex ante analysis, an FTA's effects are examined through simulations using economic models, whereas an ex post analysis measures the effects of an FTA using actually observed numerical values.
CGE simulation analysis
Simulation analysis using a computable general equilibrium (CGE) model is the most frequently used method of ex ante analysis. A CGE model for this purpose assumes the world economy consists of all countries and that individual consumers and producers in each country act to maximize their respective satisfaction and profits within given budget constraints. And it is structured in such a way that demand and supply for each good or service is equalized through a price mechanism. As such, CGE models are meant to be an analytical tool that explicitly represents a greatly simplified description of actual economic activities. The effects of an FTA, in a simulation using a CGE model, are estimated by eliminating import tariffs on goods from FTA partners.
From FTA simulation results obtained so far, several general tendencies can be seen. First, while an FTA benefits its members in terms of economic growth and increased economic welfare, there is a high possibility that the arrangement can adversely affect non-member countries by way of a slowdown in economic growth and decreased economic welfare. Second, the greater the number of countries party to an FTA, the greater the benefits they receive from it. Judging from these two tendencies, the most desirable form of FTA for all countries is a worldwide FTA, i.e. liberalization under the WTO.
CGE models have been a fairly effective tool for simulation analysis. However, as international economic activities become increasingly complex and FTAs become more comprehensive in substance, these models are now in need of certain enhancements. Specifically, new factors such as investment liberalization, trade and investment facilitation, and economic cooperation need to be incorporated into a model.
Gravity model analysis of trade impact
As to ex post analysis of an FTA's effects, many studies attempt to analyze how the formation of an FTA affects trade. An FTA has two types of effect on trade: "trade creation" effects that expand trade flows among FTA members and "trade diversion" effects that reduce trade flows between FTA members and non-members. The mainstream method of analyzing these effects is a gravity model approach using cross-country data. In this approach, bilateral trade volume is explained by the distance between two specific countries and the size of their respective economies. It is presumed that trade volume between two countries is in direct proportion to their economic size, while inversely proportional to their physical distance from one another. Such direct and inverse relationships can be recognized in estimations based on actual figures. In analyzing the ex post impact of an FTA, an FTA dummy variable is introduced to represent the changes in intra-FTA trade and a non-FTA dummy variable to represent the changes in extra-FTA trade, whereby the signs of these variables would be examined. No uniform pattern of trade creation or diversion effects has been recognized in studies undertaken so far. Results differ among different FTAs and often even results for the same FTA differ depending on the time period covered.
Studies on the impact of FTAs on trade are mostly based on cross-country analysis using a gravity model and covering all trade. However, it is also necessary to perform more detailed analysis, for instance focusing on specific trade items of FTA members. It is also crucially important to analyze the impact of FTAs on other aspects of economic activities such as production, employment, investment, and productivity in developing an FTA strategy. Any ex post analysis must wait a certain length of time after the formation of an FTA until statistical data become accessible. As far as Japan's FTAs are concerned, statistical data necessary for analysis are now beginning to become available and it is hoped that ex post analysis of these FTAs will take place.
November 14, 2006
Article(s) by this author
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