Trade Policy and the Global Economy: The Case for Comprehensive Trade Policy Reform

Trade Policy and the Global Economy Synopsis: The Case for Comprehensive Trade Policy Reform

Trade Policy and the Global Economy Synopsis: The Case for Comprehensive Trade Policy Reform •

• • •

Comprehensive trade policy reform matters. Simultaneous and comprehensive action to cut tariffs and reduce unnecessary trade costs associated with non-tariff measures in goods and in services delivers much larger gains than the sum of the individual reforms, increasing average growth across G20 countries by 6.7%.

Gains are greater when countries work together. Reducing unnecessary trade costs on a multilateral basis, for example through international standards, generates larger benefits that are shared more widely and reduces the potential for trade diversion.

National policies also matter. Domestic policies – not trade policies - can help ensure that more people share in the gains from trade and address the needs of people that otherwise might be left behind.

Coherent trade and domestic policies, together, are key elements of the structural policy toolkit; both are necessary for making trade work for all.

In the context of fragile global growth and a challenging environment for trade, policymakers have the opportunity to boost economic performance at relatively low fiscal cost through trade reform. Recent OECD work aims to provide policy-makers with key insights into the likely outcomes from selected trade policy actions. model1,

Using the state of the art OECD METRO the possible gains and trade-offs from different trade policy choices are explored: raising tariffs; reducing tariffs; and reducing the unnecessary trade costs associated with non-tariff measures (NTMs) for goods and for services 2.

The results highlight significant costs to trade and growth from raising tariffs and significant benefits from reducing tariffs. But there are much larger payoffs from reducing costs associated with NTMs: NTMs in goods hold back trade more than tariffs, while NTMs in services hold back not just services trade, but trade in manufactured goods as well.

Indeed, the largest gains come from the economywide productivity improvements associated with addressing the costs of NTMs in services.

But even these gains are modest compared to the estimated benefits when reforms are undertaken together. Simultaneous and comprehensive action across all three policy areas – cutting tariffs and reducing unnecessary trade costs associated with NTMs in goods and in services – brings considerably larger gains than the sum of the individual reforms.

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Simultaneous reforms more than triple the gains for growth relative to individual trade policy reforms Trade policy reforms boost growth3 for all G20 economies, but different reforms bring very different payoffs (Figure 1).

When tariffs are reduced to the lowest level currently applied across the G20, growth increases, but only modestly (an average of 0.3%). This reflects earlier success – most tariffs across the G20 are already very low, thanks to successive rounds of liberalization under the World Trade Organisation (WTO) and its predecessor, the GATT. So many of the gains from cutting tariffs have already been reaped.

When countries begin to address NTMs, the gains for growth are more significant. Reducing the unnecessary costs of NTMs linked to goods boosts GDP by an average of 1.25%, while for services GDP grows by an average of 1.5%.

When countries act together to reform all three policy areas at once, average GDP growth increases by 6.7%, substantially above the sum of the individual scenarios.

Not all economies benefit to the same extent, however. A significant amount of Brazilian, Russian and South African trade, for example, is with countries outside the G20, thus they do not benefit as much from G20 liberalisation. Similarly, Mexico’s largest trading partner is the US, whose main areas of liberalisation are in products not heavily traded

with Mexico, such as cereals. That said, only the Russian Federation has gains from the combined liberalisation that are less than individual outcomes, reflecting the fact that many of its exports go to markets outside the G20.

Reforms boost trade, especially imports Liberalising tariffs and NTMs significantly increases trade. Reducing costs associated with NTMs has a larger impact than reducing tariffs, but - unlike for growth - NTMs in goods have a larger impact than NTMs in services. This is because most of the costs of NTMs in goods are borne by traders, and so reducing them directly enhances trade in goods.

Combined liberalisation again has the largest effect, and increases imports (averaging 29%) slightly more than exports (averaging 26%) for the G20 group (Figure 2). This stems from the fact that most G20 economies have significant imports from other G20 countries, while their export markets tend to be more diversified and to include more economies that, in this scenario, do not liberalize.

The growth in imports as well as exports is important: the majority of trade, especially in G20 economies, is in intermediate goods (roughly 53% of all goods trade) and services (roughly 75% of all services trade) and these inputs affect the competitiveness of many sectors. Indeed, the number of jobs supported by trade (estimated at more than 36 million jobs in the EU alone4) is much larger when upstream and downstream industries are taken into account.

…which in turn boosts domestic production The benefits of access to cheaper inputs for most economies leads to a large increase in domestic production. The smallest gains come from tariff reductions (Figure 3), given that tariff rates are already quite low across G20 economies. Slightly larger gains in production come from reforms to NTMs for both goods and services, with the average and the relative distribution of the gains larger from addressing NTMs on services. This is because, first, on average, unnecessary costs imposed by NTMs on services are larger than those on goods. Second, reforms in services also affect manufacturing – to a greater extent than manufacturing reforms affect services – given the important role of services as an input to the manufacturing process. However, production gains from combined liberalisation across all three policy areas are, on average, more than twice the sum of the individual reforms.

Market opening across tariffs and NTMs in goods and in services also boosts the use of intermediate inputs in production (Figure 4). A combination of improved efficiency at the border which reduces the costs of NTMs on goods, coupled with lower input costs from reducing the costs of NTMs in services,

increases demand for intermediate inputs by almost 3 times as much as any single reform.

…largely driven by services opening The importance of services as an input into manufacturing drives much of the growth in production (Figure 5). Services trade liberalisation across the G20 sees barriers to entry fall and competition increase, as more innovative firms enter and less-efficient incumbents exit, driving down prices for all services. Businesses in manufacturing benefit from lower prices on services intermediates leading to an expansion in production (Figure 5).

The regional variation in reductions in services input prices depends on relative levels of liberalization, the level of services use in overall economic activity, and the extent to which the market responds to relative changes in prices. Prices for services intermediates decline the most for Korea, falling by over 10% on average across service sectors, leading to production expanding by over 12%.5 India, Canada and the EU also experience relatively larger declines in the costs of services intermediates as a result of the high services content of their economies, coupled with increased exports from improved access to other markets. By contrast, Russia has lower level of services input into its manufacturing process, and thus production output does not expand to the same extent from services liberalisation.

Services represent 18% of all inputs and 24% of intermediate inputs in manufacturing production for G20 economies (and closer to 30% globally).

On average, the value of services inputs for manufacturing production in the G20 outweighs that of either direct labor or capital inputs.

…and in turn boosting exports Better access to more efficient inputs that enables increased production across the majority of G20 economies in turn also contributes to an increase in exports (Figure 6).

Once again, the most significant gains come when policymakers coordinate efforts to streamline policies across the three areas, with average increases in production over 4% and some economies experiencing increases in domestic output of over 10%. Exports expand by almost 27% on average across the G20 economies. Individual performance depends on a country’s traditional export markets, as well as the degree to which prices change across different sectors. For example, India exports business services to most G20 economies, so they experience gains across many markets. Mexico, on the other hand, exports mainly to the United States, whose relative NTM costs are lower than other G20 economies, thus the relative price declines are smaller. Much of Russian trade is with countries outside the G20, thus market access conditions do

Trade Policy and the Global Economy - Synopsis | 2

not change for these export markets and gains for Russia are smaller than for other G20 economies.

To put the increases in domestic production in perspective: average gains across G20 economies are 4%. By comparison, the gains in US production from embodied technological change over the past 10 years are estimated at between 10 and 12%.6 However, the changes modelled in these scenarios and the ensuing gains do not depend on years of R&D or investments in innovative technology, but rather on political will.

Consumers benefit from lower prices and consumption increases The impact of comprehensive trade policy reform on consumers is also significant. The expansion in imports contributes to a large decrease in consumer prices for most G20 economies, and all see an increase in consumption (Figure 7). Import competition also helps stimulate innovation and contributes to increased production and trade across G20 members. Growth in consumer demand averages 7.8% across G20 economies, which helps to fuel overall economic growth.

Large increases in competitive imports (in economies such as Russia, Canada and the EU 24) drive large declines in consumer prices and increases in consumption, while the economies whose imports expand at slower rate do not benefit from the same price declines. Yet even those economies with smaller price declines (and even a small increase in the case of India) experience increases in consumption as overall economic growth and rising incomes benefit households across all economies.

The impacts of trade policy reform on jobs and incomes varies, shaped by domestic policies The effect of liberalisation on employment is complex, depending on relative cost structures among trading partners and the flexibility of labour markets. That is, domestic policies play a crucial role in how an economy adapts to changes in international trade. Context-specific factors, like the ability of workers to move across sectors and geographic regions, are crucial to understanding the impact of trade on workers’ incomes.

Combined liberalisation sees workers’ incomes, on average, increase across all G20 economies, averaging 8%. The extent to which they increase is in line with the extent to which the economy experiences an increase in production. Examining the impact on different occupations, shows that the largest increases in income for most G20 economies are in services jobs (Figure 8). This is not surprising given the key role services liberalization plays in driving the outcomes. That said, the expansion of manufacturing generates economic gains to those

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occupations in this sector as well. Thus, for most G20 economies, there are only small differences in income gains among occupations. …and overall, household incomes grow and welfare increases As noted above, trade affects wages and employment, but also the prices of consumption goods, so households are affected both as consumers and as wage earners. Bringing these changes together, we see that increases in total household income, as well as income per worker, are much larger when liberalisation occurs across all three policy areas (Figure 9). Across the G20, the higher GDP growth countries experience from trade liberalization also generates benefits at the individual level in the form of gains in household income.

Reducing NTMs in goods provides greater income gains than tariffs alone, while services liberalization adds an additional 25% to overall income gains.

However, liberalising across all three areas more than doubles household income gains, potentially significantly affecting individual worker’s lives and well-being.

What do these scenarios tell us?

These results suggest several important considerations for policymakers.

First, the results underscore the value of comprehensive trade opening – across tariffs and NTMs in both goods and services – in boosting growth and improving the welfare of households and well-being of individuals. Addressing unnecessary costs associated with NTMs across both goods and services, along with cutting tariffs, increases trade by over 20% among G20 economies, with a direct impact on the competitiveness and efficiency of every economy, raising production, GDP, incomes and well-being.

Second, the results highlight the importance of countries working together to achieve mutual gains. Reducing unnecessary trade costs on a multilateral basis, for example by agreeing and implementing international standards, generates larger benefits that are shared more widely.

International cooperation also reduces the potential for trade diversion, benefitting businesses (in terms of lower compliance costs) and governments (in terms of lower enforcement costs), as well as consumers. Coordinated policy action can also lead to improvements in domestic markets, as reducing distortions between markets can lead to fewer distortions within markets (as has been the case with Codex standards). Work coordinating regulations at the international level is also particularly useful for low and middle-income countries in the process of developing domestic regulations (OECD/FAO 2016).

Third, national policies matter. Context-specific factors heavily influence the distribution of gains, and well-designed policies, based on robust evidence, help alleviate negative outcomes on specific groups of people that otherwise might be left behind. For these adjustment policies to be effective, governments need to anticipate and prepare for the structural changes that result from liberalization.

In sum, these results aim to show governments the potential gains from undertaking comprehensive trade reforms as a key part of their structural policy toolkit, and how the benefits of those reforms are greater when countries act together, as well as to help inform the design of the package of domestic and international policies to make trade work for all.

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Endnotes 1

The OECD Trade Model (METRO), a state-of-the-art analytical tool, uses a globally integrated approach to estimate likely outcomes from illustrative policychange scenarios. METRO is not a forecasting tool and results should be seen in the context of the specified scenario and not as reflecting actual policy actions in any specific country or sector.

2

The scenarios are: (i) Tariffs in G20 countries are increased in sectors that historically have been targeted during trade disputes; (ii) tariffs in G20 countries are reduced to the lowest level among them; (iii) estimated costs of NTMs on goods trade between G20 economies are reduced to their lowest level among them; and (iv) the estimated costs of NTMs on services trade among G20 economies are reduced to the average level among economies in the European Economic Area (EEA, considered to be best practice). The details of these individual scenarios can be found at http://www.oecd.org/ trade/topics/metro-trade-model.

3 Measured by increases in Gross Domestic Product (GDP).

4

Representing a 65% increase since 2000. See https://ec.europa.eu/jrc/en/news/new-study-tradesupports-over-36-million-jobs-across-eu.

5

Much of this decline can be attributed to services reforms that have already been implemented as part of FTAs. 6 https://www.ecb.europa.eu/pub/pdf/scpwps/

ecbwp158.pdf?615e8f2c92db7cb856cc31eee5c7007c.

Figure 1. Simultaneous reforms more than triple the gains for growth Changes in Real GDP Tariffs

NTMs Goods

NTMs Services

Combined Liberalisation

16 14 12

Percent

10 8 6 4 2 0 -2

Note: Argentina was not included in the services simulation due to a lack of data. Some of the gains shown for Korea have already been realized as Korea has begun implementing tariff reduction in the context of recent FTAs.

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Figure 2. Combined reforms significantly increase trade flows beyond individual reforms

Note: Figures represent that G20 high, low and average.

Figure 3. Access to cheaper inputs leads to a large increase in domestic production

Note: Figures represent that G20 high, low and average

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Figure 4. Lower input costs across goods and services almost triple demand for intermediates

Note: Figures represent that G20 high, low and average.

Figure 5. Lower services input costs drive increased production of both goods and services

Services impact on production

14

KOR

12

% change in production

TUR 10

8

CAN AUSNZL

6

JPN

IDN

ARG

CHN

4

IND GBR DEU

EU24

FRAUSA

BRA

-12

-10

-8

RUS

-6

% change in services input prices

Note: Services NTMs were not reduced for Argentina due to a lack of data.

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-4

ITA ZAF MEX

-2

2

0

-2

0

Figure 6. Combined liberalisation boosts exports for all G20 economies Changes to production and exports from combined liberalisation Change in Domestic Production (Right Axis)

Change in Total Exports

60%

14%

12% 50% 10% 40% 8%

30%

6%

4% 20% 2% 10% 0%

0%

-2%

Note: Services NTMs were not reduced for Argentina due to a lack of data.

Figure 7. Reforms benefit consumers across all G20 economies Changes to Household Consumption from Combined Liberalisation 0.4

0.2

India

Decline in Consumer Prices (%)

Argentina 0

0

2

4

6 8 China United States Japan Mexico South Africa

10

Indonesia

12

14

16

18

20

Turkey

Brazil

-0.2

Australia and New Zealand -0.4

-0.6

-0.8

-1

Italy

France

EU (24)

Korea United Kingdom Germany Canada

Russia

Change in Private Consumption(%)

Note: Services NTMs were not reduced for Argentina due to a lack of data.

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Figure 8. Incomes for Service jobs increase, but so does low-skilled or agricultural workers Change in incomes by occupation groupings Technical and other professionals

Office workers

Service and shop assistants

Office managers and professionals

Agricultural and low skilled workers

Average

20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

Note: Services NTMs were not reduced for Argentina due to a lack of data.

Figure 9. Combined liberalisation more than doubles household income gains, significantly affecting individual worker’s wellbeing Changes in household welfare Average Gains in Household Income

Average Gains in Income per Worker (right axis)

60,000

1,200

50,000

1,000

40,000

800

30,000

600

20,000

400

10,000

200

0

Tariffs

NTMs Goods

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NTMs Serices

Combined Liberalisation

0

This work is published under the responsibility of the Secretary-General of the OECD. The opinions expressed and the arguments employed herein do not necessarily reflect the official views of OECD countries.

The publication of this work has been authorised by Ken Ash, Director of the Trade and Agriculture Directorate. Any comments should be sent to tad.contact@oecd.org.

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