The Simple Analytics of Trade Creation and Diversionalandear/presentations/Kohler... · 2019-05-29 · trade diversion Gain from trade creation-'-' 2"= 2% •Loss is an area, product

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The Simple Analytics of Trade Creation and Diversion

Alan V. DeardorffUniversity of Michigan

Rishi R. SharmaColgate University

For presentation at

Conference on International Economic Integration: Firms, Workers, and Policies

Universität Tübingen May 22-23, 2019


To Willi

• Known since his year at Michigan in the 1980s

• Visited him and Gabi in Essen, Linz, and Tübingen

• Have admired his work throughout• Delighted to be here to honor him

2


My Topic

• FTAs• Willi has touched on these throughout his

career, as have most of us in the trade field

3


Outline

• Background• 3-country case, in graphs• Somewhat more general case, in equations• 4-country case, in graphs

4


Background

• Viner’s (1950) trade creation and trade

diversion are usually illustrated with

– Constant costs

– 2-country FTA or CU plus rest of world

• We’ll look here at cases with

– Upward sloping supplies

– And in the last case, an FTA with pre-existing

other FTA

5


3-country case*

6

• Three countries, importer A, and exporters B, and C

• Export supply and import demands are linear• Countries B and C are identical• Two equilibria

– 0: MFN specific tariff t on exports of both B and C– 1: FTA of A and B:

• tariff t on exports of C; • zero tariff on exports of B

For

simplicity

*Much of this is an elaboration of material in World Trade Organization,

"Causes and Effects of PTAs: Is it all about preferences?", Ch. C: World Trade Report 2011, pp. 92-121.


7

P

!" = !$

Q

Export Supplies of B and C

Q

Exports to Country A

%"&, %$& P %"& + %$&

%") + %$&

*

Export Supplies

%"), %$)


8

P

!"#, !%#

Q Q

Import Market

!"&, !%& P

'(

!)" = !)% ')( = !)" +!)%

MFN Equilibrium

," = ,%-

!"& + !%&

!"# + !%&.)(

Export Supplies


9

P

Q Q

!"#, !%# P

&'

!("= !(%

!*%

FTA Equilibrium

!*" &(' &*'

+" = +%,

!"# + !%#

!". + !%#/('/*'

!"., !%.

Export Supplies Import Market


10

Trade Creation and Diversion

P

Q Q

!"#, !%# P

&'

!(" &)' &('

*" =*%

,

!"# + !%#

!". + !%#!"., !%.

/)'/('

TD TC


!)"= !)%

!(%


11

TC & TD, another View

!"

Q Q

#$%, #'%

("

#)$ (*" ()"

+

#$% + #'%

#$- + #'%#$-, #'-

!*"!)"

TD TCTDTC


#*$= #*'

#)'2$ =2'

!"


12

Welfare Effects on Country A

Q

Export Supplies

Q

!"#, !%#

&'

!(" &)' &('

Tariff revenue lost fromB C

Net gain of A’s private sector

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC

Import Market

!)"= !)%

!(%

-' -'

2"= 2%

See immediately that country A• Gains from trade creation• Loses from trade diversion• As well as from lost revenue from country B


13

Welfare Effects on Countries B and C

Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

Gain by partner country B

Loss by outside country C

-' -'

2"= 2%


14

Welfare Effects on the World

These add up, with much cancellation to yield the following:

Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

-' -'

2"= 2%


15



Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

-' -'

2"= 2%


16



Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

-' -'

2"= 2%


17



Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

-' -'

2"= 2%


18



Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

-' -'

2"= 2%

=


19



Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

-' -'

2"= 2%


20



Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

-' -'

2"= 2%


21


Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

Loss from trade diversion

Gain from trade creation

-' -'

2" =2%


22

Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

Why the Loss from Trade Diversion

C’s fall in cost

B’s rise in cost

-' -'

2" =2%


23


Q Q

!"#, !%#

&'

!(" &)' &('

*

!"# + !%#

!", + !%#!",, !%,

-)'-('

TD TCTDTC


!)"= !)%

!(%

Loss from trade diversion

Gain from trade creation

-' -'

2" =2%

• Loss is an area, product of the price change and the quantity of trade diversion, with the latter depending on the former.

• So the loss rises with the square of trade diversion.


The Model

24

• Four countries:

– Importer A

– Exporters B, C, and D

• Export supply and import demands are linear

• Three equilibria

– 0: MFN tariff t on exports of B, C, and D

– 1: FTA of A and D:

• Tariff t on exports of B and C;

• Zero tariff on exports of D

– 2: FTA of A with B, keeping FTA with D

• Tariff t on exports of C only

• Zero tariff on exports of B and D

• Consider only cases with !" > 0, & = (, ), *


The Model

25

Exports:

Imports:

Equilibrium:

!" = $" %" − '" , ) = *, +, ,, %" ≥ '"

./ = $/ '/ − %/ , %/ ≤ '/

./ = !1 + !3 + !4


The Model

26

Let:

Then solution is:!" = $ + &'(' + &)() + &*(*

+ = ," + ,' + ,) + ,*

$ = &"-" + &'-' + &)-) + &*-*&. = ⁄,. +


The Model

27

• With more assumptions, !" are proportional to country size– (See paper)

• Therefore #" is country i’s share of world economy– (This is not really right, as it assumes both

demanders and suppliers in proportion to population. Exporters will in fact have more firms, and thus greater weight, than importers.)


The Model

28

Effect of new FTA between A and B (in presence of A’s FTA with D)

Let ∆ be change from equilibrium 1 to equilibrium 2

Thus price in A falls by a fraction of the tariff, in proportion to size of new partner compared to world.

Country B’s price rises by the rest of the tariff

Because A’s tariff on C and D does not change

∆"# = −&'(

∆"' = (1 − &')(

∆", = ∆"- = ∆"# = −&'(


The Model

29

From the price changes, one derives the following changes in quantities of trade:

∆"#= %&'#( > 0∆+&= %& '# + '- + ./ ( > 0

∆+-= −%&'1( < 0

∆+/= −%&'3( < 0


The Model

30

As must be from market equilibrium

Thus the added exports of the partner country include the new imports of country A plus the reduced exports of countries C and D. The latter trade may be said to be “diverted,” but we label

and

because it is reversal of trade diversion from the prior FTA.

∆"#= ∆%& − ∆"( −∆")

−∆"( as “trade diversion”

−∆") as “trade reversion”


The Model

31

Thus

!"#$% &"%#'()* = !& = ,-./' > 0

!"#$% 2%3%"4()* = !2 = ,-.5' > 0

!"#$% 6(3%"4()* = !6 = ,-.7' > 0


The Model

32

Welfare effects of new FTA

Country A (home):

Country B (new partner):

Country C (outside world):

Country D (old partner):

∆"#= ⁄&'# (# + *+ ⁄, 2 ./ − ,.1 − ,2'+

∆"+= ∆34+= 2'+ +12 ./ + .1 + .6 1 − *+ ,

∆"7= −2'7 +.12 *+,

∆"8= −2'8 +.62 *+,

Lost tariff revenue


The Model

33

Welfare effects of new FTA on the World

World (A+B+C+D):

∆"#= 12'() +

12 '+ − '- )


4-country case

34

• Three countries, importer A, and exporters B, C, and D

• Export supply and import demands are linear

• Countries B, C, and D are identical

• Two equilibria

– 1: MFN tariff t on exports of both B and C• Zero tariff on exports of old FTA partner D

– 2: New FTA of A and B:

• tariff t on exports of C only;

• zero tariff on exports of two FTA partners B and D

For simplicity


35

P

!" =!$ =!% Q

Export Supplies of B, C, and D

Q

Export Supplies to Country B

&"', &$', &%' P

∑&* = &"* + &$* +&%*,

Export Supplies

∑&- = &"* + &$' +&%*

∑&. = &"' + &$' +&%*

/" = /$ = /%

∑&0 = &"' + &$' +&%'&"*, &$*, &%*


36

P

Q


Q

!"#, !%#, !&# P

Equilibrium 1: A has FTA with 1 country, D

∑!(

∑!)*+

!("= !(%

!(& *(+

= !(" +!(% + !(&

!"., !%., !&.

/

Import Market


37

P

Q


Q

!"#, !%#, !&# P ∑!(

∑!)*+

!("= !(%

!(& *(+

Equilibrium 2: A has FTA with 2 countries, B & D

!)% !)"= !)&

*)+

!"-, !%-, !&-

.

Import Market


38

P

Q


Q

!"#, !%#, !&# P ∑!(

∑!)*+

!("= !(%

!(& *(+

Changes in Trade from expanding FTA to Country B

!)% !)"= !)&

∆*+∆!% ∆!&

*)+

!"., !%., !&.

/

Import Market

∆!"


Trade Creation

39

P

Q


Q

!"#, !%#, !&# P ∑!(

∑!)*+

∆!" ∆*+∆!% ∆!&TD TR TC

Trade Creation (TC), Diversion (TD), and Reversion (TR)

!"1, !%1, !&1

2

Import Market

Trade CreationTrade Diversion Trade Reversion


40

P

Q


Q

!"#, !%#, !&# P ∑!(

∑!)*+

Trade Creation (TC), Diversion (TD), and Reversion (TR)

∆!" ∆*+∆!% ∆!&

TRTDTCNote that ∆!", while a gain to Country B, is the sum of TC, TD, & TR, since ∆!"= ∆*+ − ∆!% − ∆!&

!"2, !%2, !&2

3

Import Market

TD TR TC


41

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+

Welfare Effects on Country ATariff

revenue lost from

B CNet gain of A’s private sector

Note that trade reversion does not appear to affect A’s welfare. I suspect this is an artifact of making export supplies from B and D the same.

!",, !%,, !&,

-

Import Market

Q

∆!" ∆*+∆!% ∆!&

∆!&TR

∆!%TD∆*+

TC

TR TCTD


42

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+

Welfare Effect on Country B

!",, !%,, !&,Net gain of B’s private sector

-

Import Market

QTRTDTC

TR TCTD


43

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+

Welfare Effect on Country C

Net loss of C’s private sector

!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


44

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+

Welfare Effect on Country D

!",, !%,, !&,Net loss of D’s private sector

-

Import Market

QTRTDTC

TR TCTD


45

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+

Welfare Effects on World

!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD

I claim that these gains and losses mostly cancel out to reduce to the following:


46

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+

Welfare Effect on World

!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


47

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


48

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


49

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


50

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


51

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


52

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


53

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


54

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!(" !(% !(&!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD

!("= !(%

!(&


55

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!(" !(% !(&!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD

!("= !(%

!(&


56

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD

!("= !(%

!(&!(" !(% !(&


57

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


58

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


59

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


60

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


61

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


62

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


63

P


Q

!"#, !%#, !&# P ∑!(

∑!)*+


!",, !%,, !&,

-

Import Market

QTRTDTC

TR TCTD


4-country case

64

• Result:– World welfare rises with second FTA, by amount

depending on trade creation and the tariff• Recall from model:

• Here, because we’ve assumed countries B and D are the same, TR=TD

∆"#= 12'() +

12 '+ − '- )

∆"#= 12'()


4-country case

65

• In general, !" ≠ !$• Which is larger depends just on country size, size

both face the same price change.

• If the new partner is smaller than the old, !" > !$ , and world gain will be larger

• If new partner is bigger than old, then !" < !$and world gain will be smaller and perhaps a loss.

∆45= 12!9: +

12 !" − !$ :


Conclusion

• Analysis of FTAs shouldn’t treat each independently of FTAs that already exist

• Sequencing of FTAs can matter.

66

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The Simple Analytics of Trade Creation and Diversionalandear/presentations/Kohler... · 2019-05-29 · trade diversion Gain from trade creation-'-' 2"= 2% •Loss is an area, product