A Simple Method to Quantify the Ex-Ante Effects of “Deep” Trade Liberalization and “Hard” Trade Protection

Mario Larch,Shawn W Tan,Yoto V Yotov

doi:10.1596/1813-9450-9791

Abstract

We propose a simple and flexible econometric approach to quantify ex-ante the “deep” impact of trade liberalization and the “hard” effects of protection with the empirical structural gravity model. Specifically, we argue that the difference between the estimates of border indicator variables for {affected and non-affected countries} can be used as a comprehensive measure of the change in bilateral trade costs in response to a hypothetical policy change. To demonstrate the effectiveness of our methods, we focus on the integration between the countries from the Central European Free Trade Agreement (CEFTA) and the European Union (EU); an important policy application that has not been studied before due to lack of data. We overcome this challenge by utilizing a new dataset on trade and production that covers all EU countries and all CEFTA members (except for Kosovo). The partial equilibrium estimates that we obtain confirm the validity of our methods, while the corresponding general equilibrium effects point to significant and heterogeneous potential gains for the CEFTA countries from joining the EU. The proposed methods can also be extended to ex-post analysis and are readily applicable to other applications, e.g. “hard” Brexit.

Highlights

Quantifying the ex-ante effects of trade liberalization, e.g., the impact of free trade agreements (FTAs) and the expansion of the European Union (EU), or trade protection, e.g., Brexit or the break up of the free trade agreement between Estonia and Ukraine due to Estonia’s accession to the EU, are important but difficult tasks
Without any exception, the additional barriers to trade between Central European Free Trade Agreement (CEFTA) and EU are larger as compared to the barriers to trade within the EU in each of the four main sectors in our sample, including Agriculture, Mining, Manufacturing and Services
Subsection 4.1 offers an analysis of our partial equilibrium estimates, while Subsection 4.2 describes the results from our general equilibrium analysis

Summary

Introduction

Quantifying the ex-ante effects of trade liberalization, e.g., the impact of free trade agreements (FTAs) and the expansion of the European Union (EU), or trade protection, e.g., Brexit or the break up of the free trade agreement between Estonia and Ukraine due to Estonia’s accession to the EU, are important but difficult tasks. Most important for our purposes, we capitalize (i) on the fact that the border variable is exogenous by construction and (ii) that it captures the impact of all possible observable and unobservable factors that impact bilateral trade in addition to the standard covariates that we already control for in order to allow for possible differential border effects within the EU vs border effects on trade between EU and CEFTA. The estimate on BRDR_EU _CEF T Aij,t would capture the impact of borders on trade between the CEFTA members and the EU Taking into account these modeling choices, our main estimating equation becomes: Xij,t = exp[η1DISTij + η2CN T Gij + η3LAN Gij + η4CLN Yij + η6F T Aij,t + η7BRDRij,t] ×. Given the methodological purpose of our paper we abstract from such refinements in our estimating specification and we focus on two variables only, which are sufficient to prove the validity of our methods

Background and Relevance

Data: Description and Sources

On the Uneven Impact of EU and CEFTA Borders

Gravity Estimates DIST CNTG LANG BRDR FTA BRDR_EU_CEFTA BRDR_EU

On the GE Effects of CEFTA-EU Harmonization

Conclusion

A Robustness Checks and Additional Results

B Theoretical Framework for Counterfactual Analysis