Free Trade Agreement and Vertical Trade with a Manufacturing Base

We examine the effects of free trade agreement (FTA) on tariffs and welfare in a three‐country model with vertical trade, where an FTA is formed between a country exporting a final good whose production involves using an intermediate good, and a country exporting the intermediate good in exchange for the final good. We demonstrate that the FTA reduces its member country's external tariff, whereas it raises the non‐member country's tariff. The non‐member country unambiguously becomes better off. In contrast, the FTA may or may not make its member countries better off. This implies that the formation of an FTA may not always be Pareto‐improving.     

The Effects of Trade Liberalization in a Vertical Structure

Despite the importance of international trade on intermediate goods, the literature did not pay much attention to this aspect in determining the effects of trade liberalization in the presence of a labor union. We take up this issue here and show the effects of trade liberalization on the final goods and/or the intermediate goods, where the domestic firm pays unionized wage and imports intermediate goods. We show that trade liberalization on the intermediate goods (final goods) increases (decreases) the unionized wage, labor union's utility and domestic profit. Trade liberalization on both the final goods and intermediate goods may either increase or decrease the domestic unionized wage, labor union's utility and domestic profit depending on the input coefficients and the initial tariff levels. Our qualitative results are robust with respect to the intermediate goods market structure, the pricing strategy of the intermediate goods producers and the union's objective function.     

The role of public infrastructure and subsidies for firm location and international outsourcing

This paper presents a model in which final goods producers outsource intermediate input production. Intermediate inputs are differentiated and their production can be located at home or abroad. The model is used to examine competitive location policy in a (two-country) free trade area (FTA). It is shown that national public infrastructure investment has a positive effect on both the number of intermediate input producers and the return to the immobile factor in the home country. International outsourcing from home declines. Opposite effects are triggered in the partner country. In a welfare analysis we characterize national infrastructure policies that aim to maximize national income (net of tax costs) and compare the non-cooperative FTA-equilibrium with optimal policies from an integrated point of view. We show whether or not there is a need for policy coordination. Firm subsidies are discussed as an alternative to public infrastructure investment.     

Vertically Related Markets: Export Rivalry Between DC and LDC Firms*

We present a model of export rivalry in vertically related markets where a DC firm produces a high-quality good as well as a key input utilized by an LDC firm to produce a low-quality export good. the DC firm acts as a Stackelberg leader by setting the price of the input and the quantity of its export good. We show that the DC firm's decision on vertical supply depends on the cost, demand, and quality parameters of both producers, and that the LDC government should tax either its final good exports or its key input imports.     

FREE TRADE AREAS AND RULES OF ORIGIN: ECONOMICS AND POLITICS

Incorporating an intermediate input into a simple small-union general-equilibrium model, this paper first develops the welfare economics of preferential trading under the rules of origin (ROO) and then demonstrates that ROOs can improve the political viability of Free Trade Agreements (FTAs). Two interesting outcomes are derived. First, a welfare-reducing FTA that was rejected in the absence of ROOs can become feasible in the presence of these rules. Second, a welfare- improving FTA that was rejected in the absence of ROOs can be endorsed in their presence, but upon endorsement it can become welfare inferior relative to the status quo.     

The welfare effect of a free trade agreement in the presence of foreign direct investment and rules of origin

This paper investigates the welfare effect of forming a free trade agreement (FTA). To receive tariff‐free treatment, firms must comply with the rules of origin (ROO). Outside firms could undertake either market‐oriented or export‐platform foreign direct investments (FDIs). ROO have the following effects: (i) An infeasible FTA may become feasible by deterring outside firms' FDIs, (ii) an FDI of a less efficient firm could replace that of an efficient firm, or (iii) FDIs made before the FTA is concluded might be eliminated. These potential effects complicate the welfare effect of the FTA and could decrease the consumer surplus.     

TRADE CREATION AND DIVERSION EFFECTS OF THE U.S.-CANADIAN FREE TRADE AGREEMENT

This study empirically estimates and evaluates the economic benefits of the U.S. and Canadian Free Trade Agreement (FTA). Most past studies rely on aggregate data. The analysis here emphasizes the trade effects of removing tariff and nontariff barriers on each commodity group classified by the Standard International Trade Classification. Estimating the amount of trade expansion under FTA for both countries involves using the import demand elasticities from a dynamic demand model. Results show that U.S. imports from Canada are more sensitive to domestic, import, and world prices than are Canadian imports from the United States. U.S. imports from Canada would increase roughly £3.257 billion compared to the £2.432 billion increase for Canadian imports from the United States .     

Harmonizing External Quotas in an FTA: A Step Backward?

This paper explores how political–economy forces shape quantitative barriers against the rest of the world in an FTA. We show that whereas the dilution of lobbying power in an FTA typically leads to a relaxation of external quotas, this result is likely to be overturned as integration deepens. In particular, we show that cooperation among member countries on the level of their external quotas, cross–border lobbying by import–competing interests in the free–trade area, and the consolidation of national external quotas into a single one, all lead to stiffer restrictions against imports from the rest of the world. We also show that, unlike tariffs, endogenous quotas are not crucially affected by the presence of rules of origin.     

Free Trade Agreement with Endogenous Market Structure

We examine the incentives of free trade agreement (FTA) formation between two countries under endogenous market structure with leaders and followers. We demonstrate that establishing a FTA is neither an equilibrium outcome nor socially optimal when consumer demand and fixed cost are intermediate, products are close substitutes and countries are asymmetrical. This is because the FTA induces exit of followers, which makes the market less competitive and shrinks the leader’s production both in the domestic and foreign markets. We also show that large developing countries are less likely to establish a FTA than small developed countries.     

Oligopsonistic Intermediate Input and Patterns of Trade *

We examine the validities of traditional trade theorems and patterns of trade for an economy with an oligopsonistic intermediate input. Specifically, the model consists of two final goods. one intermediate good, and two primary factors. One final good and the intermediate good are produced using primary factors, capital and labor. The second final good is produced using the intermediate good and labor. All markets operate under perfect competition except the intermediate good market, which is oligopsonistic. This model reflects the real world phenomena of oligopsony power excerted by some industries (e.g., the food processing industry) in the intermediate good purchases. Our analysis shows that some of the traditional trade theorems and H.O trade pattern may be overturned if the factor intensity of the competitive sector lies between those of oligopsony and intermediate good sectors. [F12]     

The economic and trade effects of the UK–Korea free trade agreement on the United Kingdom,Korea, Japan,China, and the European Union

We explored a comparative static computable general equilibrium model with six regions and 12 sectors to estimate the impacts of the recent UK–Korea free trade agreement (FTA) along with the European Union (EU)–Korea FTA. The empirical results provide quantitative evidence of the impact on national GDP, national exports and imports by sector, and the changes in exports or imports among the United Kingdom, Korea, Japan, China, and the EU. The UK–Korea FTA, along with the EU–Korea FTA, increases GDP and welfare for the United Kingdom and Korea; moreover, there is a large increase in automobiles, transport equipment, and machinery exports between Korea and the United Kingdom. The GDP and welfare level of non-member countries such as Japan and China will slightly decline. Exports from the United Kingdom and Korea to non-member countries are also expected to decrease in most manufacturing sectors. The UK–Korea FTA will lead to increases in imports between the United Kingdom and Korea due to mutual trade creation effects and trade diversion effects. However, non-member countries such as Japan's exports are expected to experience a large decline in automobiles to the United Kingdom and in most manufacturing products to Korea due to the negative impact of the UK–Korea FTA.     

Exempted sectors in free trade agreements

Almost all participants in free trade agreements (FTAs) exclude at least a few products or sectors from complete tariff removal on the exports of their FTA partners. The positive tariffs that remain within an FTA are often the highest tariffs that the countries apply on an MFN basis. It seems plausible that such exclusions may be chosen because the domestic producers of these products are viewed as especially vulnerable to competition from imports from the partner country. In brief, they are especially “sensitive sectors.” We develop this idea theoretically and then test it empirically on data from 37 countries in 240 importer–exporter pairs within FTAs. We find support for the sensitive‐sector hypothesis only in the high‐income countries. We find that low‐income countries, in contrast, exempt sectors where bilateral tariff removal would be more likely trade‐diverting and therefore harmful. Our explanation for this, supported empirically, is not that they are following the advice of trade economists, but rather that they are avoiding loss of tariff revenue and may also perhaps be influenced by the greater bargaining power of richer and/or larger partners in their FTAs.     

ECONOMIC INTEGRATION AND RULES OF ORIGIN UNDER INTERNATIONAL OLIGOPOLY*

Free trade agreements (FTAs) have rules of origin (ROOs) to prevent tariff circumvention by firms of nonmember countries. This article points out that in imperfectly competitive markets, ROOs have another role overlooked in the existing literature. Instead of focusing on the impacts of ROOs in the intermediate‐good markets, we draw our attention to the final‐good markets to examine the effects of ROOs. We find that under some conditions, ROOs benefit both firms at the expense of consumers. Under some other conditions, ROOs benefit the firm producing outside the FTA and hurt the firm producing inside the FTA.     

Vertically related markets, tariffs, and technology adoption

This study considers the effect of trade policy on the time of technology adoption. Home firm is dependent on a foreign vertically integrate firm for supplies of a key input before the technology adoption and can produce the intermediate input after the technology adoption. Both firms compete by Cournot in the home final product market. I show that the decrease in the tariff on final product imports and the increase in the tariff on input imports create incentives for earlier technology adoption by home firm. While maximizing the discounted sum of welfare, the domestic government should protect home firm initially. Further, provided the cost of technology adoption declined sufficiently over time, the domestic government should stimulate the earlier technology adoption by decreasing the tariff on final product imports and increasing the tariff on intermediate product imports.     

Preferential Trade Liberalization Under Cournot Competition

Suppose a country imports a homogeneous good from n foreign countries/producers and wants to eliminate tariffs on imports from m < n of them. If foreign producers differ in their marginal costs, which ones will be among the m that are granted free trade? This paper shows, among other things, that under constant marginal cost and fairly general assumptions about demand it will be the least efficient producers.     

Intraindustry trade in intermediate goods

Since intermediate goods play such a vital role in foreign trade, this paper develops a model that explains the benefits from intraindustry trade in differentiated intermediate goods. In comparison with a situation of autarchy, this type of trade causes an increase in the number of intermediate good varieties. In this way, the producers of final goods will benefit from intermediate good varieties, which are closer to the ideal for a specific production process. At the same time, the producers of intermediate goods will, under conditions of international division of labor, benefit from economies of scale.     

FIRM HETEROGENEITY,RULES OF ORIGIN,AND RULES OF CUMULATION*

This article sheds light on the restrictive nature of rules of origin (ROO) and on the role of diagonal cumulation in mitigating the protectionist content of ROO. Empirical evidence suggests that diagonal cumulation has beneficial effects on trade—particularly among spoke countries. We show that these patterns can be reconciled with a theoretical setting where heterogeneous firms buy intermediate inputs from domestic and foreign sources. The model finds that switching from bilateral to diagonal cumulation relaxes the restrictiveness of the ROO and leads the least productive exporters to stop exporting.     

Input-output anatomy of import elasticities

The elasticity of imports with respect to final demand, calculated from the 1964 and 1970 input-output tables for Austria, is equal to 1.35. Input-output analysis makes it possible to show how the value of the import elasticity is related to following structural changes: i) Changes in the shares of final demand components (i.e. of consumption, capital formation and exports) on total final demand; ii) changes in the pattern of final demand components; iii) changes in the technology matrix; iv) substitution of domestic output by imports in the final demand; and v) substitution of the domestic output by imports in the intermediate demand.     

Trade Liberalization,Skill‐linked Intermediate Production and the Two‐sided Wage Gap

Abstract

A rising wage‐gap, almost universally, in the last two decades has contradicted the age‐old conventional wisdom of asymmetric wage movements across nations when trade is liberalized. We offer an explanation that fits well with the emerging trade pattern between the developed and more advanced developing countries like India and Mexico. We argue that a tariff reduction in the South on imports of an intermediate good from the North may raise the wage‐gap in both the North and the South. The price of the intermediate good moving in different directions and different factor‐intensity‐ranking of this good relative to the two different final goods produced in the two countries underlie this result. Rising wage inequality may specially affect the South because educational expenses and infrastructure do not allow ready transformation of the vast masses of unskilled workers into skilled workers. Hence, the policy lesson of the paper seems to be more public effort in arranging for smoother acquisition of human capital by the unskilled.     

The Exchange Rate and Inflation in the UK

The United Kingdom is a highly open economy, and has a monetary policy strategy of targeting inflation in consumer prices. In this paper, we look at the evidence from the UK on inflation behaviour, and examine the propositions from several theoretical models about inflation dynamics in an open economy, focusing in particular on the hypothesized connections between the exchange rate and consumer price inflation. Theoretical open‐economy macroeconomic models ‘cover the waterfront’ on this issue, ranging from ‘exchange rate disconnect’ to a rigid link between nominal exchange rate changes and inflation. We estimate on UK data the open‐economy Phillips curves implied by the alternative explanations. We argue that, of the alternatives considered, only a model where imports are modelled as an intermediate good, as in McCallum and Nelson (1999) , provides a reasonable match with the data. Unlike the standard model, in which imports are treated as a final consumer good, the intermediate‐goods specification provides support for a policy of CPI inflation targeting.