Uploaded byRohit Patidar
Trade Creation & Diversion
This document analyzes the trade creation and diversion effects of free trade agreements using the North American Free Trade Agreement (NAFTA) as a case study. It finds that tariff reductions resulting from NAFTA led to a significant increase in US agricultural imports from Mexico, demonstrating trade creation. There was no evidence of significant trade diversion away from other trade partners to Mexico. The increases in imports from Mexico were greater in the early years of NAFTA's implementation between 1994 and 1999.
In this document
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Introduction to FTAs, discrimination issues, trade creation, and diversion effects on GDP.
General model for US-Mexico imports assessing factors like tariffs, exchange rates, and economic metrics.
Negative coefficient for tariffs reveals significant import increases from Mexico due to tariff reductions.
Investigation of potential trade diversion due to NAFTA effects on import demand from Mexico vs. ROW.
Trade dynamics show no significant diversion; NAFTA positively influenced imports mainly in early years.
Periodic evaluation of FTAs recommended, focusing on trade creation vs. diversion, using predictive models.
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Trade Creation & Diversion
- 1. Trade Creation and Diversion-Free Trade Agreements Brought to you by: 1. Rohit Patidar-31 2. Siddharth Dixit-56 3. Sudipto Das-63 4. Tarun Acharya-68 5. Varun Sharma-75 6. Vasudev Kaushik-76
- 2. Trade Creation andDiversion- Introduction Important in the context of FTA FTA- considered discriminatory May lead to trade diversion- loss for importing country Trade creation- Main objective when implementing FTA Trade diversion- significant effect on GDP of a country, consequently on other parameters as well.
- 3. Analysis of theModel General model for US imports from Mexico: Q= f(Border Price, exhange rate, NAFTA, Tariff, time period of NAFTA implementation) Above model can be represented as follows: Q α TrMEX α1xDNAFTAt α2xTRDN1t α3xTRDN2t α4xDT1t α5xDT2t α6xYt α7...... The log linear form is used for regression and econometric analysis.
- 4. • Canadian EconomistJacob Viner proposed trade creating and trade diverting effect of FTA. • Trade Creation: When imported goods from another FTA member replace high cost domestic goods. • Trade Diversion: When trade is diverted from an efficient exporter towards a less efficient one by the formation of FTA or customs union.
- 5. Constraints and Assumptions 12 years (1994 to 2005) considered for analysis. Commodities with HSN/HTS codes classification as agricultural products considered Tariff- available only for items traded For other items- average tariff of surrounding items taken Cap of 10% taken for pre-NAFTA tariff rates for Mexico Tariff rate= Calculated Duty/Customs value GDP adjusted for CPI inflation considered NAFTA tariff- adjusted gradually over a period of time Items with zero tariff pre-NAFTA- excluded from analysis
- 6. Results- Imports fromMexico Coefficient for tariff on import from Mexico-Negative and Significant, 1% reduction in tariffs against Mexico would increase imports of agricultural products by 2.4%. Quantity imported rises significantly with decrease in tariff rates ( 1% reduction- 5.3% increase in import) in the first six years. Agricultural products- Income elastic, price inelastic
- 7. Effect of tariffreduction in 1994-1999- Greater increase in starting years of NAFTA (Coefficients for 1994-1999 relatively higher than for 2000 to 2005) 26% increase seen in items with pre-NAFTA tariff up to 10% 37% increase seen in items with pre-NAFTA tariff 15% and above.
- 8. Import Demand fromRest of the World(ROW) To measure the diversion that might occur, due to the implementation of NAFTA
- 9. U.S. import demandfrom Row Tariff rates against ROW Tariff rates against Mexico Import prices from ROW Trade weighted exchange index Quarterly dummy Variables (where i = 1 , 2 , 3) GDP of USA DNAFTA is a dummy variable for NAFTA, which takes the value of 1 during the NAFTA period and 0 otherwise.
- 10. Expectations Increasein TR(ROW) would negatively affect the US imports from ROW Increase in TR(Mex) would positively affect the US imports from Mexico DNAFTA expected to have positive effect Central issue If trade diversification actually occurs then TR(Mex) must have a positive sign Meaning a decrease in tariff rates against Mexico, thus decrease US imports from ROW
- 11. Results- Import fromRest of the World Coefficient for tariff on import from ROW-Negative and Significant Quantity imported rises significantly with decrease in tariff rates ( 1% reduction- 1.5% increase in import) Shows preference for Mexican goods, geographic proximity factors Coefficient of NAFTA with Mexico- Not significant
- 12. Observations No significant tradediversion due to positive, insignificant value of NAFTA dummy variable in ROW analysis Exact extent of effect of NAFTA-not ascertainable due to variability in other factors (economic growth, geographic proximity etc.) Trade increase due to NAFTA- higher during first 6 years of implementation
- 13. Recommendations Evaluation of FTAto be done periodically Evaluate trade creation vs. trade diversion trade off Models for predicting trade based on past data for FTAs Can be used for predicting future viability/need for FTA with a particular country
- 14.