Trade Creation and Trade Diversion in Deep Agreements

Trade Creation and Trade Diversion in Deep Agreements AADITYA MATTOO, ALEN MULABDIC, MICHELE RUTA Disclaimer: The views expressed in this article are those of the authors and they do not necessarily represent the views of the World Bank Group Workshop on the Economics of International Trade Agreements Villars-sur-Ollon, February 2017

Questions and motivation Since 1990 there has been a surge of preferential trade agreements (PTAs). The nature of these agreements has been changing as well, with PTAs covering measures beyond tariffs ( deep PTAs). Questions: What policy areas do deep agreements cover? What are their trade effect on members and non-members? What would be the consequences of undoing US PTAs?

Preview of main findings Content of PTAs The number of provisions has increased of a factor of 2 in the last quarter century Viner revisited Deep agreements lead to more trade creation and less trade diversion than shallow agreements Application Undoing US deep PTAs would have a large negative impact on the US and its trade partners

Literature review Content of PTAs Classification of US and EU PTAs (Horn et al. 2010) Extension to 100 PTAs (WTO, 2011) Extension to 279 PTAs (Hofmann et al. 2016) Trade Creation Dummies (e.g. Rose (2004)) Type of agreements: one-way PTAs, two-way PTAs, FTAs, customs unions, common markets and economic unions (Baier et al. (2014)) Trade Diversion Dummies (e.g. Dai et al. (2014)) Continuous variables for trade diversion (Baldwin and Jaimovich (2012); Fugazza and Nicita (2013))

The content of PTAs

Since 1990 there has been a surge of preferential trade agreements (PTAs) 35 300 30 250 25 200 20 150 15 100 10 5 50 0 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 0 Number of PTAs Cumulative

On average one country participates in fourteen agreements

The continuing proliferation of PTAs over the last 30 years involves a wide network of participants

PTAs are also becoming deeper : Coverage in terms of policy areas has widened over time 35 300 30 250 25 200 20 150 15 10 100 5 50 0 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 More than 20 Between 10 and 20 Less than 10 Not in force Cumulative 0

The Database: 279 Agreements (http://data.worldbank.org/data-catalog/deep-trade-agreements) "WTO plus" areas covered by the WTO "WTO extra" areas beyond the WTO Tariffs industrial goods Anti-corruption Financial assistance Tariffs agricultural goods Competition policy Health Customs administration Environmental laws Human Rights Export taxes IPR Illegal immigration SPS measures Investment measures Illicit drugs State trading enterprises Labour market regulation Industrial cooperation TBT measures Movement of capital Information society Countervailing measures Consumer protection Mining Anti-dumping Data protection Money laundering State aid Approximation of legislation Nuclear safety Public procurement Agriculture Political dialogue TRIMS measures Audiovisual Public administration GATS Civil protection Regional cooperation TRIPS Innovation policies Research and technology Cultural cooperation SMEs Economic policy dialogue Social Matters Education and training Statistics Energy Taxation Terrorism Visa and asylum

Coding of each provision Provision 0 Not covered 1 Covered 1 st COVERAGE 0 Imprecise or not legally enforceable language Legally enforceable language 2 nd LEGAL ENFORCEABILITY Dispute settlement not available 1 2 Dispute settlement available

Legally Enforceable Language Example of a legally enforceable provision Example of a provision that leads to conclude that an area is not legally enforceable The parties shall allow the free movement of capital... Neither party may expropriate or nationalise a covered investment... By the end of (exact date) a party shall accede to the following international conventions:... Each party shall not fail effectively to enforce labour (environmental) laws... The parties shall cooperate... Dialogue shall be established... Special attention shall be paid to... Measures necessary for development and promotion of... Parties may conclude... Source: Horn, Mavroidis and Sapir (2010)

Number of agreements WTO plus areas tend to be legally enforceable 300 250 200 150 100 50 0 Included Legally enforceable

Number of agreements so are core WTO extra areas 200 150 100 50 0 Included Legally enforceable

Viner revisited

Trade creation and trade diversion What we do Estimate the impact of Deep trade agreements on member countries non-members relative tariff preference What we find increase trade between members do not hurt trade for non-member countries mitigate the negative effect of tariff preferences

Prima facie evidence: Trade Creation Distribution of imports over levels of depth

Empirics: Trade Creation X ij,t = exp β 1 Depth ij,t + β 2 ln 1 + TTRI ij,t + θ ij + θ j,t + Ω i,t + ξ ij,t where Depth ij,t = σ l ALL(LE,SLE,CORE) Prov l ij,t max TotalDepth TTRI ij,t = σ hs X ij,95 97 hs ε j,hs T ij,t hs σ hs X ij,95 97 hs ε j,hs X indicates exports from country i to country j (95 countries) in year t (2002-2014) Bilateral Trade Costs Depth TTRI, the Tariff Trade Restrictiveness Index (Kee et al. (2009)) Bilateral fixed effects

Results: Trade Creation Table 1. PPML Regression: Trade Creation Depth (1) (2) (3) (4) (5) (6) (7) (8) VARIABLES Trade Trade Trade Trade Trade Trade Trade Trade Depth All 0.099** 0.267*** 0.259*** (0.042) (0.099) (0.098) Depth LE 0.115** 0.245*** 0.236*** (0.047) (0.090) (0.088) Depth SLE 0.118** (0.053) Depth Core 0.053* (0.030) PTA -0.098-0.072-0.102* -0.076 (0.062) (0.051) (0.061) (0.050) ln(1+ttri) -0.208-0.205 (0.562) (0.562) Observations 110,739 110,739 110,739 110,739 110,739 110,739 94,057 94,057 Exp.-Year yes yes yes yes yes yes yes yes Imp.-Year yes yes yes yes yes yes yes yes Exp.-Imp. yes yes yes yes yes yes yes yes Period 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 Note: Robust standard errors, clustered at the country-pair level, are in parentheses. *** p<0.01, ** p<0.05, * p<0.1 Extra: log of depth 3 year intervals internal flows

Dynamic effects of Deep PTAs (95% C.I.) 23

Empirics: Trade Diversion and Depth X ij,t = exp β 1Depth ij,t + β 2 Others Depth ij,t + β 3 RPM ij,t +β 4 ln(1 + TTRI ij,t ) + θ ij + θ j,t + Ω i,t + ξ ij,t Others Depth ijt = σ v X vj 95 97 Depth vj, v i σ v X vj 95 97 RPM ij,t = σ hs X ij,95 97 hs ε j,hs (T ij,t hs T wj,t hs ) σ hs x ij,95 97 hs ε j,hs with T wj,t hs = σ v x vj,95 97 hs T vj,95 97 hs σ v x vj,95 97 hs, v i

Results: Trade Diversion and Depth Table 2. PPML Regression: Trade Diversion Depth (1) (2) (3) (4) (5) (6) VARIABLES Trade Trade Trade Trade Trade Trade Depth 0.165*** 0.147*** 0.101** 0.161*** 0.140** (0.061) (0.056) (0.047) (0.062) (0.057) Others Depth 0.854 0.853 (0.545) (0.550) Others MFN 1.814* 1.845** (0.951) (0.941) Others PREF -1.335-1.353 (0.967) (0.963) ln(1+ttri) -0.234-0.236-0.126-0.083 (0.696) (0.695) (0.694) (0.674) RPM 0.042 0.097-0.163-0.414 (0.891) (0.894) (0.904) (0.852) N 100,157 100,157 94,057 94,057 94,057 94,057 Exp.-Year FE yes yes yes yes yes yes Imp.-Year FE yes yes yes yes yes yes Exp.-Imp. FE yes yes yes yes yes yes Period 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 Note: Robust standard errors, clustered at the country-pair level, are in parentheses. *** p<0.01, ** p<0.05, * p<0.1

Empirics: Trade Diversion Revisited X ij,t = exp β 1Depth ij,t + β 2 RPM ij,t + β 3 RPM ij,t MaxDepth jt +β 4 ln(1 + TTRI ij,t ) + θ ij + θ j,t + Ω i,t + ξ ij,t We interact the RPM with two measures of depth of trade partners agreements: Others Depth_ij,t MaxDepth_jt

Results: Trade Diversion Revisited Table 3. PPML Regression: Trade Diversion Revisited Depth (1) (2) (3) (4) (5) (6) VARIABLES Trade Trade Trade Trade Trade Trade Depth 0.114** 0.114** 0.113** 0.174*** 0.172*** 0.170*** (0.047) (0.046) (0.046) (0.061) (0.061) (0.061) ln(1+ttri) -0.196-0.188-0.174-0.084-0.080-0.066 (0.697) (0.693) (0.689) (0.696) (0.692) (0.689) RPM -1.334-3.330* -2.992* -1.632-3.493* -3.156* (1.475) (1.934) (1.766) (1.487) (1.962) (1.793) (RPM * Max Depth Imp.) 2.680* 2.737* (1.599) (1.598) (RPM * Max Depth Core Imp.) 4.095*** 3.975** (1.590) (1.609) (RPM * Max PREF Imp.) -0.444-0.483 (2.045) (2.074) (RPM * Max MFN Imp.) 4.235* 4.158* (2.485) (2.505) Others Depth 0.855 0.832 0.833 (0.550) (0.549) (0.549) N 94,057 94,057 94,057 94,057 94,057 94,057 Exp.-Year FE yes yes yes yes yes yes Imp.-Year FE yes yes yes yes yes yes Exp.-Imp. FE yes yes yes yes yes yes Period 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 Note: Robust standard errors, clustered at the country-pair level, are in parentheses. *** p<0.01, ** p<0.05, * p<0.1 Figure c2 & c3

Application: Undoing US PTAs

Depth of US trade agreements

Counterfactual Partial Equilibrium Analysis Steps 1. Estimates the impact of depth on trade flows 2. Predict bilateral trade flows for different scenarios a) No NAFTA b) No TPP c) TPP without the US d) No agreement 3. Calculate the change in total exports 4. Use elasticity of income to trade estimates from the literature to calculate the welfare impact

Undoing US Trade Agreements Impact on U.S. trade and welfare Total Trade Change (% Change) Welfare (% Change) (1) (2) (1) (2) No Agreements -4.31-10.76-2.16-5.38 No NAFTA -3.16-7.87-1.58-3.93 No TPP -2.32-5.90-1.16-2.95 Note: (1) Beta =.19, gravity w/out internal flows; (2) Beta =.52 w/ internal flows. Trade and welfare change (U.S. trade partners) Scenario Country Total Trade Change (% Change) Welfare (% Change) (1) (2) (1) (2) No NAFTA Canada -7.19-17.93-3.60-8.96 Mexico -7.44-18.55-3.72-9.27 No US in TPP Australia -0.21-0.54-0.10-0.27 Canada -2.89-7.55-1.45-3.77 Chile -0.53-1.37-0.26-0.68 Japan -2.56-6.20-1.28-3.10 Malaysia -1.11-2.69-0.55-1.34 Mexico -2.94-7.66-1.47-3.83 New Zealand -1.29-3.11-0.64-1.56 Peru -0.64-1.67-0.32-0.84 Singapore -0.36-0.91-0.18-0.46 Vietnam -2.58-6.24-1.29-3.12 No TPP Australia -2.77-6.81-1.38-3.40 Canada -3.32-8.60-1.66-4.30 Chile -1.58-4.07-0.79-2.03 Japan -3.32-8.09-1.66-4.05 Malaysia -3.83-9.40-1.92-4.70 Mexico -3.17-8.26-1.59-4.13 New Zealand -4.27-10.47-2.13-5.23 Peru -1.63-4.19-0.82-2.09 Singapore -2.71-6.70-1.36-3.35 Vietnam -3.89-9.51-1.95-4.75 Note: (1) Beta =.19, gravity w/out internal flows; (2) Beta =.52 w/ internal flows.

Concluding Remarks We document the deepening of PTAs New database covering 279 PTAs signed by 189 countries (all PTAs notified to the WTO and in force in 2015) We revisit the question of trade creation / diversion for deep PTAs Deep agreements have been successful in boosting trade between members While we find evidence of tariff diversion, there is no evidence that deep PTAs lead to trade diversion: The inclusion of deep MFN provisions increases trade with non-members and reduces the negative impact of relative tariff preferences Finally, we study the impact of undoing US PTAs Undoing NAFTA will have the largest impact on US trade Canada, Mexico and other Central American countries most affected by the undoing of US PTAs Malaysia and Vietnam lose the most by a TPP failure Next steps: Data capture horizontal depth, future work and data needed to assess the impact of vertical depth (i.e. depth of commitments in each policy area)

Extra slides

ln(1+depth) Table 1b. PPML Regression: Trade Creation ln(1+depth) (1) (2) (3) (4) (5) (6) (7) (8) VARIABLES Trade Trade Trade Trade Trade Trade Depth All 0.123** 0.408*** 0.394*** (0.056) (0.155) (0.152) Depth 0.140** 0.357** 0.341** (0.062) (0.141) (0.137) Depth SLE 0.144** (0.070) Depth Core 0.071* (0.043) PTA -0.127* -0.091-0.129* -0.093 (0.072) (0.060) (0.071) (0.058) ln(1+ttri) -0.207-0.205 (0.562) (0.562) N 110,739 110,739 110,739 110,739 110,739 110,739 94,057 94,057 Exp.-Year FE yes yes yes yes yes yes yes yes Imp.-Year FE yes yes yes yes yes yes yes yes Exp.-Imp. FE yes yes yes yes yes yes yes yes Period 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 Note: Robust standard errors, clustered at the country-pair level, are in parentheses. *** p<0.01, ** p<0.05, * p<0.1 back

3 Year Intervals (Trefler, 2004; Cheng and Wall, 2005) Table 1c. PPML Regression: Trade Creation data every 3 years Depth (1) (2) (3) (4) (5) (6) (7) (8) VARIABLES Trade Trade Trade Trade Trade Trade Trade Trade Depth All 0.098** 0.293** 0.289** (0.050) (0.136) (0.132) Depth 0.114** 0.268** 0.264** (0.053) (0.120) (0.115) Depth SLE 0.117* (0.060) Depth Core 0.058 (0.037) PTA -0.116-0.087-0.125-0.096 (0.090) (0.075) (0.086) (0.071) ln(1+ttri) -0.286-0.284 (0.609) (0.609) N 110,739 110,739 110,739 110,739 110,739 110,739 94,057 94,057 Exp.-Year FE yes yes yes yes yes yes yes yes Imp.-Year FE yes yes yes yes yes yes yes yes Exp.-Imp. FE yes yes yes yes yes yes yes yes Period 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 3yrs 3yrs 3yrs 3yrs Note: Robust standard errors, clustered at the country-pair level, are in parentheses. *** p<0.01, ** p<0.05, * p<0.1 3yrs 2002-2014 3yrs 2002-2014 3yrs 2002-2014 3yrs back

Internal Flows Table 1d. PPML Regression: Trade Creation Internal Flows Depth (1) (2) (3) (4) (5) (6) (7) (8) VARIABLES Trade Trade Trade Trade Trade Trade Trade Trade Depth All 0.722*** 0.811*** 0.850*** (0.041) (0.127) (0.124) Depth 0.763*** 0.689*** 0.715*** (0.043) (0.102) (0.100) Depth SLE 0.849*** (0.045) Depth Core 0.492*** (0.033) PTA -0.059 0.049-0.127-0.009 (0.079) (0.060) (0.078) (0.059) ln(1+ttri) -2.139*** -2.127*** (0.552) (0.552) N 116,134 116,134 116,134 116,134 116,134 116,134 97,825 97,825 Exp.-Year FE yes yes yes yes yes yes yes yes Imp.-Year FE yes yes yes yes yes yes yes yes Exp.-Imp. FE yes yes yes yes yes yes yes yes Period 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 2002-2014 Note: Robust standard errors, clustered at the country-pair level, are in parentheses. *** p<0.01, ** p<0.05, * p<0.1 back

-6-4 -2-6 -4-2 0 2 4 0 2 4 Trade Diversion Revisited Marginal Effect of Tariff Preferences (90% C.I.) 0.2.4.6.8 1 Depth Core 0.2.4.6.8 1 MFN (with Pref=mean) back

Description Provisions 1/3 FTA Industrial Tariff liberalization on industrial goods; elimination of non-tariff measures FTA Agriculture Tariff liberalization on agriculture goods; elimination of non-tariff measures Customs Provision of information; publication on the Internet of new laws and regulations; training Export Taxes Elimination of export taxes Affirmation of rights and obligations under the WTO Agreement on SPS; harmonization SPS of SPS measures Affirmation of rights and obligations under WTO Agreement on TBT; provision of TBT information; harmonization of regulations; mutual recognition agreements Establishment or maintenance of an independent competition authority; nondiscrimination regarding production and marketing condition; provision of STE information; affirmation of Art XVII GATT provision Retention of Antidumping rights and obligations under the WTO Agreement (Art. VI AD GATT). Retention of Countervailing measures rights and obligations under the WTO Agreement CVM (Art VI GATT) Assessment of anticompetitive behaviour; annual reporting on the value and distribution State Aid of state aid given; provision of information Progressive liberalisation; national treatment and/or non-discrimination principle; publication of laws and regulations on the Internet; specification of public procurement Public Procurement regime TRIMs Provisions concerning requirements for local content and export performance of FDI GATS Liberalisation of trade in services Harmonisation of standards; enforcement; national treatment, most-favoured nation TRIPs treatment

Description Provisions 2/3 Anti-Corruption Regulations concerning criminal offence measures in matters affecting international trade and investment Maintenance of measures to proscribe anticompetitive business conduct; harmonisation of competition laws; establishment Competition Policy or maintenance of an independent competition authority Development of environmental standards; enforcement of national environmental laws; establishment of sanctions for Environmental Laws violation of environmental laws; pubblications of laws and regulation IPR Accession to international treaties not referenced in the TRIPs Agreement Information exchange; Development of legal frameworks; Harmonisation and simplification of procedures; National Investment treatment; establishment of mechanism for the settlement of disputes Regulation of the national labour market; affirmation of International Labour Organization (ILO) commitments; Labour Market Regulation enforcement Movement of Capital Liberalisation of capital movement; prohibition of new restrictions Consumer Protection Harmonisation of consumer protection laws; exchange of information and experts; training Exchange of information and experts; joint Data Protection projects Agriculture Technical assistance to conduct modernisation projects; exchange of information Approximation of Legislation Application of EC legislation in national legislation Promotion of the industry; encouragement of Audio Visual co-production Civil Protection Implementation of harmonised rules Innovation Policies Participation in framework programmes; promotion of technology transfers Promotion of joint initiatives and local Cultural Cooperation culture Economic Policy Dialogue Exchange of ideas and opinions; joint studies Measures to improve the general level of Education and Training education Exchange of information; technology Energy transfer; joint studies Financial Deep Assistance trade agreements Set of rules guiding the granting and administration of financial assistance

Description Provisions 3/3 Health Monitoring of diseases; development of health information systems; exchange of information Human Rights Respect for human rights Illegal Immigration Conclusion of re-admission agreements; prevention and control of illegal immigration Treatment and rehabilitation of drug addicts; joint projects on prevention of consumption; reduction of Illicit Drugs drug supply; information exchange Industrial Cooperation Assistance in conducting modernisation projects; facilitation and access to credit to finance Information Society Exchange of information; dissemination of new technologies; training Mining Exchange of information and experience; development of joint initiatives Money Laundering Harmonisation of standards; technical and administrative assistance Nuclear Safety Development of laws and regulations; supervision of the transportation of radioactive materials Convergence of the parties positions Political Dialogue on international issues Public Administration Technical assistance; exchange of information; joint projects; Training Regional Cooperation Promotion of regional cooperation; technical assistance programmes Research and Technology Joint research projects; exchange of researchers; development of public-private partnership Technical assistance; facilitation of SME the access to finance Social Matters Coordination of social security systems; non-discrimination regarding working conditions Statistics Harmonisation and/or development of statistical methods; training Assistance in conducting fiscal Taxation system reforms Terrorism Exchange of information and experience; joint research and studies Exchange of information; drafting Visa and Asylum legislation; training