Regional and Bilateral Initiatives
Canada - Korea
Preliminary Assessment of the Economic Impacts of a Canada-Korea
FTA
Table of Contents
EXECUTIVE SUMMARY
The Canada-Korea Free Trade Agreement (CKFTA) negotiations were
launched on July 15, 2005. A free trade agreement (FTA) between
Canada and Korea has the potential to enhance not only Canada’s
important bilateral economic relationship with Korea, but also to
strengthen Canada’s presence in the dynamic Northeast Asia
region. An FTA with Korea is expected to generate economic benefits
across the Canadian economy.
This document analyzes the possible economic impacts of the proposed
CKFTA. The eco-nomic impacts of tariff elimination are assessed
based on simulations using a computable general equilibrium (CGE)
model known as the Global Trade Analysis Project (GTAP) and version
6 of its database. Five alternative scenarios are simulated based
on a range of as-sumptions concerning the supply-side response of
the economy to expanded trade with Korea, including a central scenario
incorporating the assumptions best suited for Canada and Korea respectively.
The impact of non-tariff elements of a CKFTA, including impacts
on bilateral investment flows and services trade, are taken into
account only qualitatively. The main findings are as follows:
-
Assuming full elimination of tariffs for industrial and agricultural
products, Canada’s to-tal merchandise exports to Korea
in the central scenario would increase by 56%. Based on the
level of Canadian exports to Korea in 2005 of $2.8 billion1,
this would represent an export gain of about $1.6 billion.
-
Canada’s merchandise imports from Korea would increase
by 19%. Based on the 2005 figure of $5.4 billion, this would
represent an import increase of about $1 billion.
-
The value of Canada’s gross domestic product (GDP) would
increase, although the esti-mated extent varies considerably
based on alternative assumptions about the economy’s response
to expanded trade with Korea. In percentage terms, the alternative
simulations place the gain at between 0.064% and 0.268%; in
the central scenario, the gain is 0.114%. Compared to the size
of Canada’s GDP in 2005 ($1,369 billion), the corresponding
GDP gain ranges between $0.88 billion and $3.6 billion across
the five scenarios, with the cen-tral scenario estimate at $1.6
billion. The corresponding estimates for Korean GDP gains, compared
to the size of Korea’s economy in 2005, range between
$0.23 billion (0.024%) and $6.6 billion (0.691%) across the
five scenarios, with the central scenario estimate at $0.66
billion (0.07%).
-
The simulations suggest that Canadian households would derive
an economic welfare benefit, scaled to the size of Canada’s
economy in 2005, between $266 million under the most restrictive
supply-side-response assumptions and $3.5 billion under the
least restric-tive assumptions; the central scenario estimate
is $1.1 billion. The simulations suggest that Korean households
would experience a small decrease in economic welfare under
the most restrictive assumptions, but would gain benefits that
would exceed Canada’s in the least restrictive scenario.
The CGE simulations likely understate the potential economic gains
since they reflect only the impact of tariff elimination on merchandise
trade; the CKFTA negotiations, however, are ad-dressing a wide range
of issues, including trade in goods, rules of origin, customs procedures,
trade facilitation, non-tariff measures, cross-border trade in services,
financial services, tempo-rary entry, investment, government procurement,
competition, intellectual property, e-commerce, dispute settlement
and institutional provisions. In addition, Canada is pursuing en-vironmental
and labour cooperation agreements in parallel with the free trade
negotiations. At the same time, Canada’s trade gains in areas
of Korean sensitivity and Korean trade gains in areas of Canadian
sensitivity may be constrained in timing or ultimate extent by special
pro-visions that are not known prior to the conclusion of the agreement.
Provisions dealing with non-tariff measures may also affect the
estimated impacts in individ-ual sectors. Given these considerations,
together with the fact that the impacts are small rela-tive to the
size of the Canadian economy and quite sensitive to the specific
assumptions made concerning the economy’s response to increased
trade, the current simulations represent too blunt a tool to provide
reliable estimates of the sectoral impacts of the CKFTA. To assess
sectoral impacts, specific studies are required, such as the detailed
assessment of the Cana-dian automotive market commissioned by Foreign
Affairs and International Trade Canada2.
PRELIMINARY ASSESSMENT
OF THE ECONOMIC IMPACTS OF A CANADA-KOREA FTA
Introduction
This document analyses the potential economic impacts of a free
trade agreement between Canada and Korea. The analysis mainly considers
the impact of tariff elimination on merchan-dise trade. The study
briefly considers the impacts of liberalization and facilitation
of trade in services and investment, in qualitative terms. However,
for reasons discussed below, quanti-fication of these impacts was
not possible for the purposes of this preliminary report.
Analytic approach
The main tool used for the analysis is the Global Trade Analysis
Project (GTAP) computable general equilibrium (CGE) model, version
6.03. This model, which is publicly available, runs on a data set
that integrates data on bilateral trade flows, trade protection
and domestic support together with national input-output tables
that describe the sale and purchase relationships be-tween producers
and consumers within each economy. This allows the model to generate
esti-mates of the impact of trade policy changes, such as preferential
tariff elimination under free trade agreements (FTAs), on trade
flows, the level of national economic output (gross domestic product),
employment and economic welfare.
CGE simulations alone cannot, however, adequately take into account
the breadth of changes resulting from modern FTAs. For example,
negotiations between Canada and Korea are being pursued on a wide
range of issues, including trade in goods, rules of origin, customs
procedures, trade facilitation, non-tariff measures, cross-border
trade in services, financial services, tempo-rary entry, investment,
government procurement, competition, intellectual property, e commerce,
dispute settlement and institutional provisions. In addition, Canada
is pursuing environmental and labour cooperation agreements in parallel
with the free trade negotiations4.
In addition to direct economic impacts in the areas of services
trade and bilateral investment flows, these additional features
of FTAs should have an impact on trade in goods, over and above
that resulting from tariff elimination. For example, trade facilitation
reduces non-tariff costs of market access. Similarly, given complementarities
between investment and services trade on the one hand and goods
trade on the other, measures to liberalize investment and services
trade should induce a stronger response of goods trade to an FTA
than tariff consid-erations alone would indicate. As well, FTAs
have been suggested to have galvanizing ef-fects on business behaviour;
that is, in the context of sunk costs of market entry, the political
commitment and the non-tariff facilitative aspects of an FTA can
provide extra inducement to business to commit the resources to
take advantage of the new market opportunities. On this basis, the
estimated increase in bilateral merchandise trade is likely to underestimate
the increase.
Several further cautionary notes are required concerning the interpretation
of the reported economic impacts. These are set out below.
Caveat: Interpretation of the results
The results of the simulations are best understood as estimates
of the potential economic im-pacts of a CKFTA, not as forecasts
of the actual results. This reflects the following consid-erations.
First, FTAs typically include provisions to address impacts in
sensitive sectors. Thus, with re-spect to the CKFTA, Canada’s
trade gains in areas of Korean sensitivity and Korean trade gains
in areas of Canadian sensitivity may be constrained in timing or
ultimate extent by special provi-sions that are not known prior
to the conclusion of the agreement.
Second, CGE model simulations compare the structure of a given
economy at a given point in time, as it was and as it would have
been if the simulated policy change were in place with all economic
adjustments in response to that policy change already completed.
Typically, FTA provisions are phased in to facilitate adjustment;
the adjustment path of the economy is not, however, explicitly addressed
in this study.
Third, while there is no explicit time dimension in these simulations,
the price elasticities that drive the response to tariff changes
are based on long-run changes. In other words, the as-sumed changes
would take some time to be reflected in the economy. At the same
time, the myriad developments that might influence actual outcomes
during the implementation and adjustment period cannot be taken
into account; these include importantly technological changes and
reorganization of global production patterns that alter the industrial
landscape, and trade policy changes such as preferential agreements
with third parties involving either Canada or Korea5.
Caveat: Sensitivity of the results to model specifications
and assumptions
Economic models, to be tractable, necessarily compress an enormous
amount of information on the economy into a relatively small number
of equations and estimated parameters that rep-resent the stylized
behaviour of consumers and producers. By the same token, the results
of model simulations can be heavily influenced by the model structure,
parameter estimates, the level of aggregation of the data and assumptions
made by the modeller as to how to run the simulations (most important,
as discussed below, are the assumptions concerning “closure”
of the model).
Choice of Model
The GTAP 6.0 model used for the CKFTA simulations was chosen because
it permits the greatest possible sectoral and regional disaggregations.
This level of disaggregation is impor-tant to reduce aggregation
bias in estimating trade impacts but comes at the expense of a number
of limiting features: the model is static and assumes perfect competition
as well as constant returns to scale in all sectors. The GTAP family
of models also includes a dynamic model; unfortunately this model
does not include Canada as a separate entity, and hence can-not
be used for this study. The GTAP family of models also includes
a version with imper-fect competition, which is a more appropriate
modelling framework for the non-agricultural sectors; however, this
model only permits simulations based on three sectors, agriculture,
in-dustrial goods, and services. Simulations using the static, perfectly
competitive model likely understate the gains in output and economic
welfare for a given amount of trade expansion compared to simulations
using the dynamic and/or imperfectly competitive versions, all else
being equal.
Level of Disaggregation
The simulations were conducted on a fully disaggregated sectoral
basis (57 sectors, of which 43 are merchandise). Due to computer
capacity constraints, the full level of regional disag-gregation
(92 countries and/or composite regions) could not be used. For convenience,
the simulations were conducted with the global economy disaggregated
into 15 regions:
- Canada and Korea;
- the major industrialized economies: the United States, the European
Union and Japan;
- within the Western Hemisphere: Mexico, Mercosur, the Caribbean
Community and Common Market (Caricom), and the Andean Community;
- within Asia-Pacific: China, India, Singapore and Australia;
- in Africa: the South African Customs Union (SACU); and
- the rest of the world (ROW).
Model Structure
-
The main technical features of the GTAP 6.0 model are as follows:
On the production side, the model features nested constant elasticity
of substitution (CES) production functions. Land, labour (skilled
and unskilled), and capital substi-tute for one another in a
value-added aggregate in the first nest, and composite inter-mediate
inputs substitute for value-added at the next nest. Labour and
capital are as-sumed to be fully employed, mobile across all
uses within a country and immobile in-ternationally. On the
demand side, there is a regional representative household whose
expenditure is governed by an aggregate utility function. This
aggregate utility func-tion is of a Cobb-Douglas form allocating
expenditures across private consumption, government spending,
and savings. Private household demand is represented by a Constant
Difference of Elasticities (CDE) functional form, which has
the virtue of capturing the non-homothetic nature of private
household demands (i.e., demand structure changes with increased
income, reflecting the fact that consumption of par-ticular
types of goods such as luxury goods increases more with higher
income than does consumption of other goods such as staple food
products).
-
Bilateral international trade flows are modelled based on the
Armington hypothesis that goods and services are differentiated
by region of origin and are imperfect substi-tutes. The standard
GTAP 6.0 parameter set was used; the key Armington parameters
(the elasticities of substitution between products according
to country of origin) have recently been updated based on new
econometric research. These elasticities are on average lower
than those used in some other models such as the World Bank’s
Link-age model; the estimated trade and welfare impacts reported
here are thus relatively conservative6.
Closure
In performing simulations, the modeller must make some choices
with regard to which vari-ables in the model are to be exogenous
(i.e., fixed at predetermined values specified by the modeller)
and which are to be endogenous (i.e., the values for which are solved
by the model). Alternative choices represent alternative “closures”
of the model. The choice of closure influ-ences the results significantly.
Under the GTAP model’s default microeconomic closure, the
factor endowments (i.e. the total supply of labour, both skilled
and unskilled, as well as of capital and land) are fixed; factor
prices (i.e. wages and return to capital and land) adjust to restore
full employment of the factors of production in the post-shock equilibrium7.
Under alternative microeconomic closures that are sometimes used,
the return to capital or to labour can be fixed and the sup-ply
of capital and/or labour then adjusts to restore equilibrium8.
Each of the above closure rules makes an extreme assumption about
the supply of labour and/or capital: it is either perfectly elastic
or perfectly inelastic. The reality is likely to be somewhere in
between.
The GTAP model can be simulated to approximate intermediate values
of the elasticity of sup-ply of capital and/or labour. The modeller’s
assumptions for these parameters, based on em-pirical evidence drawn
from outside the model, then determine how the gains from an FTA
are obtained. For example, for labour, the more inelastic is labour
supply, the greater the extent to which gains are achieved in the
form of wage increases; conversely, the more elastic is labour supply,
the greater the extent to which gains are achieved in the form of
additional jobs. Simi-larly, for the economy as a whole, the gains
reflect either improved prices or increased out-put—or some
combination of the two—depending on the assumptions about
supply-side elas-ticities established in the chosen closure. Given
the sensitivity of the results to the specific as-sumption made,
we report the results of simulations for five alternative closure
rules:
-
labour and capital supply fixed (the standard or default closure);
-
labour supply flexible, capital supply fixed;
-
labour supply fixed, capital supply flexible;
-
both labour and capital supply flexible; and
-
the central scenario, which as described immediately below
reflects judgments as to the most appropriate assumptions for
Canada and Korea respectively, coupled with the de-fault closure
for all other countries or regions:
-
With regard to the long-run supply of labour, the economic
literature supports a positive but not infinite supply elasticity--i.e.,
somewhere between the two extreme assumptions for labour
market closures. On the basis of recent empirical evidence,
we adopt a labour market closure for Canada and Korea based
on fixing the elastic-ity of labour supply at approximately
one9.
-
With regard to the long-run supply of capital, for Canada,
a small open economy that has relatively untrammelled access
to capital, the most plausible assumption for capital supply
is that it is relatively elastic; this corresponds closely
to the steady state closure rule for capital. For Korea,
which has in recent memory experienced a major international
liquidity crisis and which does not yet have the same degree
of institutional development as Canada, we expect the capital
supply schedule to be upward sloping; we arbitrarily set
the capital supply elasticity at approximately one. From
the perspective of the results, this is a conservative assumption
since the eco-nomic gains for Korea rise steeply with higher
capital supply responses10.
The second aspect of closure is macroeconomic
closure. Two approaches are available here: the standard approach
with the GTAP model, which is used in the present simulations, is
to allow the current account to adjust to the trade shock, with
passive accommodation by interna-tional investment flows. The change
in the current account implies a change in domestic in-vestment.
In the GTAP model, the change in investment is reflected in the
profile of final de-mand, which in turn affects the profile of production
and trade but does not feed through into the productive capacity
of industries/regions. The alternative macroeconomic closure is
to fix the current account, implicitly assuming no international
capital mobility; this is a much less realistic assumption for Canada
and this option is accordingly eschewed11.
Caveat: Data issues
There are several issues concerning the underlying database for
the GTAP simulations.
The base year for the GTAP 6.0 data is 2001; in other words, the
model depicts the global economy as it was in 2001, including the
size of trade flows, the level of protection and sup-port for trade
in the various economies, as well as the size and composition of
GDP and other economic variables for each country/region.
The base year for the input-output tables in the GTAP 6.0 data
base, however, varies from country to country; for Korea the reference
year is 2000 but for Canada it is 1990?in other words, the internal
linkages in the Canadian economy as mapped out in the GTAP 6.0 data
base reflect the Canadian economy’s internal linkages as of
1990, prior to its adjustment to the Canada-U.S. FTA and the NAFTA,
the Uruguay Round, China’s accession to the World Trade Organization
(WTO), and other changes in the domestic and global economic envi-ronment
since 1990.
Given the rapidity of economic change in recent years, several
steps are taken in the present analysis to make it as up-to-date
as possible:
-
The measures of trade protection in the GTAP 6.0 database
are updated to include the completion of implementation of the
Uruguay Round tariff cuts, China’s accession commitments
to the WTO and the expiry of the WTO Agreement on Textiles and
Clothing (ATC)12.
-
The model simulations are otherwise performed with the 2001
base year data in the GTAP 6.0 database (in which values are
expressed in 2001 U.S. dollar terms), we also present key data
(Canada’s imports from and exports to Korea, as well as
Cana-dian GDP and consumer welfare estimates) adjusted for scale
and composition to re-flect the Canadian economy as it was in
2005, and expressed in 2005 Canadian dol-lars. This is done
simply by applying percentage changes generated in the GTAP
model to the corresponding 2005 data. This serves to at least
partly take into account the implications of the growth of,
and structural shifts within, the economy between 2001 and 2005.
In the case of Canada’s imports from and exports to Korea,
this addi-tional step takes into account some particularly important
changes in the product composition of bilateral trade between
2001 and 2005. However, this falls short of a consistent updating
of the data to reflect the economy in 2005; the 2005-based esti-mates
are thus indicative only.
-
Foreign Affairs and International Trade Canada (DFAIT) is arranging
for the updating of the Canadian input-output data in the GTAP
database. The present preliminary analysis is, however, based
on the 1990 input-output structure; an update to this report
will reflect more up-to-date input-output data, when those become
available. The out-dated input-output data reduce the level
of confidence in the estimated sectoral output changes in the
present simulations, since these changes combine the direct
impact on sectors of own-tariff changes (e.g., the impact on
the steel sector of changes in the tariff on steel) with the
indirect impact of changes in production in other sectors induced
by the FTA (e.g. steel sector output changes in response to
a change in auto production in-duced by tariff changes on autos),
based on the input-output structure as represented in the model.
Moreover, the sectoral output numbers reflect the structure
of trade in 2001. For these reasons, we do not report detailed
sectoral output results since these could be quite misleading,
given the significant changes in Canada’s economic structure
since 1990 and trade since 2001.
BACKGROUND ON THE CANADIAN
AND KOREAN ECONOMIES
Table 1 sets out summary information on the Canadian and Korean
economies.
Table 1: Canada and Korea: Summary Statistics, 2005
|
Korea |
Canada |
Income
|
|
|
GDP at market prices (C$ billions) |
$955 |
$1,369 |
Gross National Income at purchasing power parity
(US$ billions) |
$1,055 |
$1,040 |
Population (2005, millions) |
47.82 |
32.27 |
Per-capita GDP at market prices (C$) |
$19,972 |
$42,423 |
Per-capita GNI at purchasing power parity (US$41,950)
|
$21,850 |
$32,220 |
Trade
and Investment |
|
|
Exports of goods and services as share of GDP
|
42.5% |
37.8% |
Imports of goods and services as share of GDP
|
40.0% |
34.1% |
Two-way trade in goods and services as share
of GDP |
82.5% |
71.9% |
Outward direct investment as share of GDP (2004)
|
4.7% |
35.0% |
Inward direct investment as share of GDP (2004)
|
12.9% |
29.5% |
Economic
Structure: shares of total output* |
|
|
Primary (agriculture, forestry, fishery &
mining) |
3.7% |
7.2% |
Secondary (manufacturing, construction &
utilities) |
40.0% |
25.1% |
Tertiary (services) |
56.3% |
67.7% |
Source: GDP and population figures are from the International
Monetary Fund (IMF), International Financial Statis-tics; purchasing
power parity data are from the World Bank, World Development Report
2007, Table 1; the Canada-Korea exchange rate used to convert Korean
won data into Canadian dollars is from the Bank of Canada website;
trade and industrial structure data and inward and outward investment
are from Korea National Statistical Office and Statistics Canada
respectively.
*Shares of GDP at factor cost. For Korea, industrial structure is
as of 2005; for Canada as of 2002 based on current dollar GDP shares.
Korea ranked 11th globally in terms of gross domestic product (GDP)
in 2005 with an econ-omy measured at market exchange rates about
70% the size of 9th-ranked Canada’s. Meas-ured in terms of
gross national income (GNI) at purchasing power parity exchange
rates, Ko-rea’s economy was slightly larger than Canada’s
in 2005. Korea’s population in 2005 was almost 50% larger
than Canada’s, resulting in substantially lower levels of
per-capita income when compared at purchasing power parity exchange
rates, and even more so when com-pared at market exchange rates.
Like Canada, Korea is a highly open economy, with two-way trade
in goods and services equivalent to 82.5% of GDP in 2005 (versus
71.9% for Canada). In 2005, Korea ranked 12th in the world in two-way
merchandise trade of $660.3 billion. However, Korea is much less
open in terms of two-way investment than it is in trade: the stock
of inward foreign direct investment (FDI) in Korea in 2004 amounted
to $114 billion or 12.9% of Korea’s GDP; the stock of outward
investment totalled only $42 billion or 4.7% of Korea’s GDP.
Over time, Korea’s industrial structure has come to increasingly
resemble the structure of the advanced economies. Compared to Canada,
Korea’s primary and services sector are smaller, while manufacturing
and other industry accounts for a greater share of output than in
Canada.
Korea’s macroeconomic performance and prospects
Korea’s economic growth has slowed from the torrid pace of
8.3% maintained from 1963 through 1996, which served to elevate
Korea from an impoverished agrarian economy to OECD membership status
in 1996. Since then, a period that includes the steep recession
at the time of the Asian Economic and Financial Crisis, Korea has
averaged 4.2% real growth; however, in the context of the global
upswing from the global recession of 2001, Korea has maintained
an average growth rate of 4.7%. Current IMF projections suggest
that Korea will maintain a 4.7% pace in 2006-2007 on average13.
Source: Historical data from the IMF, International Financial
Statistics; 2006-2007 projections from the IMF, World Economic Outlook,
September 2006. Trend line is a polynomial trend fitted with Excel.
The short- and medium-term prospects for the Korean economy are
broadly positive. Infla-tion has been moderate (3.3% average CPI
growth over 2001-2005 with “core inflation” at 2.2%
in mid-2006) and unemployment has been low (average of 3.7% over
2001-2005 and 3.5% in mid-2006). The external accounts have been
in steady surplus since the Asian crisis (including a trade surplus
equivalent to 2.5% of GDP in 2005). External debt is moderate (about
25% of GDP in 2005) and fully covered by foreign exchange reserves,
which reached US$228.2 billion in September 2006.
Korea’s economic policy posture is essentially neutral. Korea
was expected to achieve a modest budget surplus of about 1% of GDP
in 200614. Korean short-term interest rates rose to the 4% to 5% range
in 2006, reflecting some tightening of policy since 2005; however,
the yield curve has remained moderately upward sloping.
Bilateral Canada-Korea Economic Relations
In 2005, Korea was Canada’s seventh-largest merchandise trading
partner. From Korea’s perspective, Canada was its 21st-largest
trading partner. Two-way merchandise trade is sub-stantial, with
Korea in the surplus position by about $2.2 billion, going by import
statistics to measure the bilateral flows15.
Table 2: Canada-Korea Merchandise Trade, 2005, C$ Millions
Korean
Statistics |
Exports to Canada |
4,171 |
Imports from Canada |
3,147 |
Two-way trade |
7,318 |
Balance (Korean perspective) |
1,024 |
Canadian Statistics |
Exports to Korea |
2,806 |
Imports from Korea |
5,374 |
Two-way trade |
8,181 |
Balance (Canadian perspective) |
-2,568 |
Import-Import Comparison |
Korean Imports from Canada |
3,147 |
Canadian Imports from Korea |
5,374 |
Two-way trade |
8,522 |
Balance (Canadian perspective) |
-2,227 |
Source: World Trade Atlas
Following the Asian Economic and Financial Crisis, which resulted
in a steep depreciation of the won against the Canadian dollar,
Canada’s merchandise exports to Korea fell off sharply and
remained low for several years. Since 2003, however, they have rebounded
strongly. In 2005, Canadian exports were 54% higher than the low
point in 1998, although they still have to regain the peak of 1997
(Figure 2).
Source: Statistics Canada
In terms of market share, Canada has witnessed a decline in its
share of Korean imports from the 2% range in the mid-1990s to the
1% range (Figure 3).
Canada-Korea cross-border services trade has grown in recent years
but remains small and flows have been rather volatile from year
to year (see Table 3). Of particular note, it is diffi-cult to discern
a sustained dynamic expansion in the area of commercial services,
the main area for potential gain from a services component in the
CKFTA and an area in which trade has been growing very rapidly worldwide
in the age of outsourcing, notwithstanding the lack of progress
in the multilateral negotiations on trade in services.
Table 3. Canada-Korea Cross-border Trade in Services, 1996-2004,
C$ millions
|
1996 |
1997 |
1998 |
1999 |
2000 |
2001 |
2002 |
2003 |
2004 |
Total Services Receipts (Canadian
exports) |
479 |
506 |
400 |
456 |
568 |
681 |
643 |
607 |
706 |
Travel |
195 |
204 |
109 |
146 |
238 |
284 |
269 |
251 |
273 |
Commercial services |
180 |
190 |
190 |
182 |
149 |
198 |
192 |
183 |
171 |
Transportation (incl. gov’t services) |
105 |
113 |
100 |
127 |
181 |
199 |
182 |
173 |
262 |
Total Services Payments (Canadian
imports) |
257 |
249 |
166 |
176 |
303 |
229 |
216 |
296 |
350 |
Travel |
60 |
60 |
15 |
27 |
28 |
27 |
31 |
66 |
60 |
Commercial services |
71 |
74 |
66 |
47 |
140 |
77 |
60 |
125 |
106 |
Transportation (incl. gov’t services) |
126 |
115 |
85 |
101 |
135 |
125 |
125 |
105 |
184 |
Source: Statistics Canada
Overall, Canada has thus experienced an erosion of its share of
the Korean market since the mid-1990s Given Korea’s program
of free trade negotiations (see footnote 3), Canada’s pres-ence
in this dynamic East Asian economy is at risk of further marginalization.
While the bilateral investment relationship has been expanding,
it remains modest. The stock of Canadian direct investment in Korea
was $779 million in 2005, while the stock of Korean direct investment
in Canada was $364 million.
SIMULATION RESULTS: IMPACT
OF CANADA-KOREA MERCHANDISE TRADE LIBERALIZATION
This section describes the impact of tariff elimination on Canada-Korea
bilateral merchan-dise trade and the implications for GDP and economic
welfare. The simulation involves full elimination of trade protection
as captured in the GTAP database, updated as described above, for
all industrial and agricultural sectors. Two interventions are made
to take account of developments affecting the auto and dairy sectors:
-
Explicit account is taken of the impact on automotive shipments
from Korea to Can-ada of the establishment of Korean brand auto
production in the United States. These “transplants”
are assumed to reduce automotive shipments from Korea to Canada
by 57.2% compared to the level that otherwise would have been
the case.
-
The dairy sector impacts are constrained to nil to reflect
a WTO dispute settlement ruling that constrains Canadian exports
of dairy products and the lack of Korean ex-port capacity.
A detailed discussion of the rationales and methods for these interventions,
with supporting evidence, is provided in Appendix
1.
Sectoral Aggregation, Armington Elasticities and Protection
Levels
The simulations were run with a full sectoral disaggregation. The
definitions of the GTAP merchandise trade sectors are given in Table
4a below, along with the values of the corre-sponding Armington
elasticities of substitution.
Table 4a: GTAP sectors and Armington elasticities of substitution
|
|
Armington Elasticities |
|
Full GTAP description |
Domestic vs. Imports |
Between alternative sources of imports
|
Rice |
Paddy rice |
5.1 |
10.1 |
Wheat |
Wheat |
4.4 |
8.9 |
Cereal grains |
Cereal grains |
1.3 |
2.6 |
Vegetables & fruit |
Vegetables, fruit, nuts |
1.9 |
3.7 |
Oil seeds |
Oil seeds |
2.5 |
4.9 |
Sugar |
Sugar cane & sugar beet |
2.7 |
5.4 |
Plant-based fibres |
Plant-based fibres |
2.5 |
5.0 |
Crops |
Crops |
3.3 |
6.5 |
Live animals |
Cattle, sheep, goats, horses |
2.0 |
4.0 |
Animal products |
Animal products |
1.3 |
2.6 |
Wool |
Wool, silk-worm cocoons |
6.4 |
12.9 |
Forestry |
Forestry |
2.5 |
5.0 |
Fishing |
Fishing |
1.3 |
2.5 |
Coal |
Coal |
3.0 |
6.1 |
Oil |
Oil |
5.2 |
10.4 |
Gas |
Gas |
17.2 |
34.4 |
Minerals |
Minerals |
0.9 |
1.8 |
Bovine meat |
Meat: cattle, sheep, goats, horses |
3.8 |
7.7 |
Meat products |
Meat products |
4.4 |
8.8 |
Vegetable oils |
Vegetable oils & fats |
3.3 |
6.6 |
Dairy products |
Dairy products |
3.7 |
7.3 |
Processed rice |
Processed rice |
2.6 |
5.2 |
Processed sugar |
Sugar |
2.7 |
5.4 |
Food products |
Food products |
2.0 |
4.0 |
Beverages & tobacco |
Beverages & tobacco products |
1.1 |
2.3 |
Textiles |
Textiles |
3.8 |
7.5 |
Apparel |
Wearing apparel |
3.7 |
7.4 |
Leather products |
Leather products |
4.1 |
8.1 |
Wood products |
Wood products |
3.4 |
6.8 |
Paper & publishing |
Paper products & publishing |
3.0 |
5.9 |
Petroleum & coal |
Petroleum & coal products |
2.1 |
4.2 |
Chemical products |
Chemical, rubber, plastic products |
3.3 |
6.6 |
Mineral products |
Mineral products |
2.9 |
5.8 |
Ferrous metals |
Ferrous metals |
3.0 |
5.9 |
Metals |
Metals |
4.2 |
8.4 |
Metal products |
Metal products |
3.8 |
7.5 |
Motor vehicles & parts |
Motor vehicles & parts |
2.8 |
5.6 |
Transport equipment |
Transport equipment |
4.3 |
8.6 |
Electronic equipment |
Electronic equipment |
4.4 |
8.8 |
Machinery & equipment |
Machinery & equipment |
4.1 |
8.1 |
Other mfg products |
Other manufacturing products |
3.8 |
7.5 |
The protection data in the GTAP 6.0 database are obtained from Market
Access Map (MAcMap), which was produced and is maintained collaboratively
by the Paris-based Centre d’Etudes Prospectives et d’Informations
Internationales (CEPII) and the International Trade Centre (ITC) in
Geneva. The tariff data are compiled at the Harmonized Tariff System
6-digit level and include the ad valorem equivalent of specific tariffs
and the tariff equivalent of tariff rate quotas (TRQs). The GTAP 6.0
protection data are, however, current only as of 2001; accordingly,
as previously noted, these data were updated to take into account
the full implementation of the Uruguay Round tariff cuts, China’s
accession commitments to the WTO, and the expiry of the WTO Agreement
on Textiles and Clothing (ATC).
Table 4b presents the updated Canadian and Korean bilateral protection
data for the GTAP merchandise trade classification16, along with the
2001 trade levels in the GTAP database on the basis of which the
simulations were run. Generally speaking, the size of the trade
impact is determined largely by the size of the elasticities and
the size of the “wedge” between do-mestic prices and
imports created by protection. As can be seen, Canada has high tariffs
(9.9-113.9%) in few product categories, namely dairy, transport
equipment, vegetable oils, and textiles and apparel. These products
accounted for 13.3% of total Canadian imports from Ko-rea, with
textile products accounting for more than half of this total (7.2%).
The bulk of Ca-nadian imports from Korea faced duty rates that ranged
between 0.1% and 8.6%. Electronic equipment was clearly the most
significant sector in this group, representing 28.9% of total Canadian
imports, followed by motor vehicles and parts with a trade-weighted
tariff rate of 5.9%. Other major Canadian imports from Korea were
machinery and equipment as well as chemical products. The duty rates
for these products were low.
Korea has much higher levels of protection than Canada. About 0.3%
of Canadian exports to Korea faced tariffs ranging between 206.8%
and 1,000%. The main Canadian exports in this category were cereal
grains (tariff rate of 321.7%) and beverages and tobacco (206.8%).
About 7.8% of Canadian exports to Korea faced tariffs of 10.4% to
47.4%. Most products in this category were agricultural and food
products, in which Canada has a clear comparative advantage. The
majority (71.6%) of total Canadian exports to Korea faced duty rates
of 0.1% to 8.1%. Sectors in this category included coal, chemical
products, metals, electronic equip-ment, machinery and equipment,
and mineral products. About 20.3% of Canadian exports (pulp and
paper products) to Korea were duty-free.
Given the generally higher tariffs faced by Canadian exporters
to Korea than Korean export-ers to Canada, the CKFTA would be expected
to result in a larger percentage increase in Ca-nadian exports than
in Canadian imports. Given Korea’s high levels of protection,
particu-larly in the agricultural sector, Canadian exports to Korea
would also be expected to be boosted by market share captured from
third-country exporters. Such a trade diversion would reduce Korea’s
economic welfare gains derived from expanded trade with Canada.
Table 4b: Canadian and Korean bilateral tariffs &
trade weights, GTAP classification
|
Trade-weighted Canadian tariffs, updated
(%) |
Canadian imports from Korea
in 2001 (US$ millions) |
% of Canadian imports |
Trade-weighted Korean tariffs, updated (%)
|
Korean imports in 2001 (US$ millions)
|
% of Korea imports |
Rice |
0.0 |
0.0 |
0.0 |
1,000.0 |
0 |
0.0 |
Wheat |
2.1 |
0.0 |
0.0 |
2.2 |
49.5 |
3.2 |
Cereal grains |
0.0 |
0.0 |
0.0 |
321.7 |
2.6 |
0.2 |
Vegetables & fruit |
1.1 |
5.8 |
0.2 |
31.4 |
1.6 |
0.1 |
Oil seeds |
0.0 |
0.1 |
0.0 |
33.7 |
0.8 |
0.1 |
Sugar |
0.0 |
0.0 |
0.0 |
2.9 |
0 |
0.0 |
Plant-based fibres |
0.0 |
0.0 |
0.0 |
1.8 |
0 |
0.0 |
Crops |
0.5 |
2.1 |
0.1 |
47.7 |
20.9 |
1.3 |
Live animals |
0.0 |
0.0 |
0.0 |
0.1 |
0.2 |
0.0 |
Animal products |
0.0 |
0.7 |
0.0 |
3.3 |
38.4 |
2.4 |
Wool |
0.0 |
0.0 |
0.0 |
3.0 |
0 |
0.0 |
Forestry |
0.0 |
0.1 |
0.0 |
2.0 |
3.8 |
0.2 |
Fishing |
0.0 |
0.5 |
0.0 |
19.7 |
0.1 |
0.0 |
Coal |
0.0 |
0.0 |
0.0 |
1.0 |
225.5 |
14.4 |
Oil |
0.0 |
0.0 |
0.0 |
5.0 |
16.4 |
1.0 |
Gas |
0.0 |
0.0 |
0.0 |
1.0 |
16.1 |
1.0 |
Minerals |
0.0 |
0.2 |
0.0 |
1.4 |
104.5 |
6.7 |
Bovine meat |
6.5 |
0.1 |
0.0 |
32.9 |
20.9 |
1.3 |
Meat products |
9.9 |
0.4 |
0.0 |
24.5 |
29.6 |
1.9 |
Vegetable oils |
17.5 |
0.1 |
0.0 |
14.4 |
6.1 |
0.4 |
Dairy products |
113.9 |
0.5 |
0.0 |
47.7 |
7.2 |
0.5 |
Processed rice |
0.0 |
0.7 |
0.0 |
1,000.0 |
0 |
0.0 |
Processed sugar |
6.0 |
0.0 |
0.0 |
11.9 |
0.4 |
0.0 |
Food products |
4.3 |
26.0 |
0.9 |
15.1 |
31.9 |
2.0 |
Beverages & tobacco |
8.6 |
6.8 |
0.2 |
206.8 |
2.6 |
0.2 |
Textiles |
9.9 |
214.5 |
7.2 |
8.1 |
17.9 |
1.1 |
Apparel |
16.8 |
161.5 |
5.4 |
10.4 |
2.4 |
0.2 |
Leather products |
6.1 |
28.7 |
1.0 |
5.1 |
3 |
0.2 |
Wood products |
3.6 |
4.8 |
0.2 |
5.7 |
19.3 |
1.2 |
Paper & publishing |
0.0 |
15.1 |
0.5 |
0.0 |
318.2 |
20.3 |
Petroleum & coal |
0.0 |
34.0 |
1.1 |
6.0 |
4.8 |
0.3 |
Chemical products |
3.0 |
187.9 |
6.3 |
3.3 |
182.2 |
11.6 |
Mineral products |
0.9 |
16.9 |
0.6 |
7.9 |
6.4 |
0.4 |
Ferrous metals |
0.2 |
113.6 |
3.8 |
3.0 |
1.2 |
0.1 |
Metals |
0.1 |
14.6 |
0.5 |
3.0 |
128.3 |
8.2 |
Metal products |
2.7 |
85.2 |
2.9 |
7.2 |
6.8 |
0.4 |
Motor vehicles & parts |
5.8 |
730.8 |
24.6 |
8.0 |
43.9 |
2.8 |
Transport equipment |
21.0 |
17.5 |
0.6 |
2.4 |
49.7 |
3.2 |
Electronic equipment |
0.1 |
859.4 |
28.9 |
0.6 |
91.8 |
5.8 |
Machinery & equipment |
0.9 |
400.2 |
13.5 |
5.6 |
109.2 |
7.0 |
Other mfg products |
2.3 |
41.5 |
1.4 |
7.2 |
6.4 |
0.4 |
Total |
|
2970.3 |
100.0 |
|
1570.6 |
100 |
Source: Authors’ calculation based on the GTAP data.
Merchandise Trade Impacts
Table 5 sets out the changes in Canada’s exports to Korea
as a result of tariff elimination on bilateral trade in industrial
and agricultural products based on the central scenario for closure.
Table 5: Changes in Canada’s merchandise exports
(f.o.b) to Korea under a CKFTA
|
Pre-FTA 2001 US$ millions (1) |
Change in 2001 US$ millions (2) |
% of Change (3) |
2005 Base in C$ millions (4) |
Change in C$ millions (5) |
% Change (6) |
Primary sectors & food products (GTAP 1-25) |
516 |
606 |
117 |
1,296 |
1,177 |
91 |
Other manufactured products (GTAP
26-41) |
939 |
211 |
22 |
1,386 |
333 |
24 |
Total merchandise exports |
1,456 |
817 |
56 |
2,806 |
1,581 |
56 |
Source: Authors’ calculations based on GTAP simulations;
central scenario closure. Note: differences in the percentages in
column (3) vs. (6) reflect differences in weights and a minor difference
in the definition of total merchandise trade in the GTAP database
and the total as given by Statistics Canada based on the harmonized
system (HS) classification of merchandise trade.
Based on the 2001 level and sectoral composition of Canada’s
merchandise exports to Korea, the CKFTA induces an increase of 56%
(these results are reported in columns 1 through 3). Applying the
percentage changes by GTAP sector to the 2005 level and sectoral
trade com-position (set out in columns 4 through 6) shows the implications
for these results of the changes in Canada-Korea trade levels and
composition between 2001, the base year for the GTAP model, and
the most recent year for which we have complete sectoral merchandise
trade data. Overall, the increase in Canadian exports is at the
same at 56%. Based on the 2005 data, the value of Canadian exports
to Korea would increase by $1,581 million17.
The major export gains are in the primary and processed food sectors,
areas where Canada has been making inroads into the Korean market
in recent years. Exports of other manufac-tured goods are boosted
to a lesser degree, although the gains are still substantial.
Table 6 sets out the changes in Canada’s imports from Korea
as a result of tariff elimination on bilateral trade in industrial
and agricultural products. Based on the 2001 level and sectoral
composition of Canada’s merchandise imports from Korea, the
simulation results indicate a 29% increase. Based on the 2005 level
and sectoral composition, the increase is smaller at 19%; this largely
reflects the steep decline in Korean exports of textiles and clothing
since 2001. This difference demonstrates the potential sensitivity
of the results to the initial conditions reflected in the model
database; by the same token, it shows the importance of taking into
account significant structural changes that have occurred in the
post-base-year period, such as in this case, the major reorganization
of global trade in textiles and clothing due to China’s emergence
and the expiry of the WTO’s Agreement on Textiles and Clothing,
which resulted in the dismantling of the quota-based system of trade
in this sector. Based on the 2005 data, the value of Canadian imports
from Korea would increase by $1,006 million.
Table 6: Changes in Canada’s imports (c.i.f) from
Korea as a result of a CKFTA
|
Pre-FTA 2001 US$ millions (1) |
Change in 2001 US$ millions (2) |
% of Change (3) |
2005 Base in C$ millions (4) |
Change in C$ millions (5) |
% Change (6) |
Primary sectors & food products (GTAP 1-25) |
44 |
8 |
18 |
46 |
8 |
17 |
Other manufactured products (GTAP
26-41) |
2,926 |
848 |
29 |
4,891 |
916 |
19 |
Total merchandise exports |
2,970 |
856 |
29 |
5,374 |
1,006 |
19 |
In contrast to Canada’s export gains, which are concentrated
in the primary and food prod-ucts sectors, Canada’s import
increases are primarily in the other manufactured goods sectors.
Trade Creation and Trade Diversion
The relative sizes of the trade creation/diversion effects of a
CKFTA in respect of imports and exports are shown in Tables 7 and
8 below. All data in these tables are on the original GTAP 6.0 basis,
based on 2001 trade levels and expressed in 2001 U.S. dollars.
Preferential access to a market created by a free trade agreement
can lead to both trade creation and trade diversion. A concrete
example serves to illustrate these effects. Consider, for example,
the substantial increase in Canadian exports to Korea of primary
and food products predicted by the model (as shown in Table 5).
One such food product is boneless beef, which currently faces a
40% tariff in the Korean market. With the model’s assumption
of price-sensitive consumer preferences, the elimination of this
tariff on Canadian boneless beef imports would necessarily expand
demand in Korea for beef, as lower-priced imports from Canada lead
to a decline in boneless beef prices in Korea. However, much of
the increase in Canadian exports would not reflect the expansion
of final demand, but rather the capture of additional market share
in Korea. In part, this additional market share would be captured
from higher-priced domestic Korean producers; this is trade creation,
which drives efficiency-enhancing structural adjustment in the Canadian
and Korean economies. However, in part, the additional market share
would be captured from third-party suppliers of beef (e.g. Australia),
which would still face the 40% tariff. So while Korean imports of
beef from Canada would increase, imports of beef from third parties
would fall; this is trade diversion. As discussed below, whereas
trade created by the CKFTA leverages economic welfare gains, diverted
trade partly offsets these gains.
As can be seen in Table 7, the choice of closure impacts significantly
on the extent of trade diversion in import markets. The extent of
trade diversion is greatest under the most restrictive closure,
in which both capital and labour supply are fixed and the gains
from trade in the factor markets take the form of increases in wages
and returns to capital. The amount of trade diversion is least in
the closure scenario, in which both labour and capital supply are
fully flexible and gains from trade in factor markets are reflected
in increases in jobs and capital. The expanded economic activity
due to the increased supply of labour and capital generates additional
demand for imports from all parties, offsetting the diversion effect
of the CKFTA with the third parties. In the case of Korea, the demand
for imports—when both supplies of labour and capital are allowed
to change—more than offsets the trade diversion effect, resulting
in a net increase in imports from third parties.
Table 7: CKFTA Impact on Source of Canadian and Korean
Merchandise Imports Under Alternative Closures, in 2001 US$ millions
|
Labour & capital
fixed (i) |
Labour flexible,
capital fixed (ii) |
Labour fixed,
capital flexible (iii) |
Labour &
capital flexible (iv) |
Central Scenario
(v) |
Change in Canadian imports |
Korea |
852 |
858 |
859 |
891 |
856 |
ROW |
-538 |
-455 |
-510 |
-161 |
-433 |
Total |
315 |
403 |
349 |
730 |
423 |
Change in Korean imports |
|
Canada |
884 |
887 |
887 |
907 |
887 |
ROW |
-442 |
-284 |
-321 |
445 |
-384 |
Total |
442 |
604 |
566 |
1,352 |
502 |
Table 8 below provides a similar comparison of the trade creation
and trade diversion effects on the export side.
Table 8: CKFTA Impact on Destination of Canadian and Korean
Merchandise Exports Under Alternative Closures, in 2001 US$ millions
|
Labour & capital fixed
(i) |
Labour flexible, capital fixed
(ii) |
Labour fixed, capital flexible
(iii) |
Labour & capital flexible (iv)
|
Central Scenario
(v) |
Change in Canadian exports |
Korea |
814 |
818 |
818 |
835 |
817 |
ROW |
-466 |
-419 |
-374 |
37 |
-286 |
Total |
348 |
399 |
443 |
872 |
531 |
Change in Korean exports |
|
Canada |
816 |
821 |
822 |
853 |
820 |
ROW |
-404 |
-287 |
-149 |
841 |
-333 |
Total |
421 |
534 |
673 |
1,694 |
487 |
As can be seen, the impact of alternative closures on export trade
diversion is even greater than on the import side. For both Canada
and Korea, the expansion of productive capacity under the least
restrictive closure (iv) is sufficient to support not only the expansion
of bilateral trade under the CKFTA but also additional exports to
third parties. Conversely, under the most restrictive closure rule
with fixed supply of labour and capital, a larger part of the bilateral
trade stimulated by the CKFTA in fact requires a reduction in Canadian
and Korean exports to third parties. This largely reflects the resource
constraints that are assumed in this simulation. Productive resources
are assumed to be fixed in supply and fully used in the both the
pre-FTA context and the post-FTA context. Accordingly, the additional
production to support increased exports to the FTA partner must
come from increased efficiency of production; insofar as the efficiency
gains induced by the FTA are insufficient, the implication is diversion
of shipments from domestic or third-country markets to the FTA partner.
The empirical literature does not offer a consensus opinion on
the extent of trade diversion caused by FTAs. The “conventional
wisdom” has been that the trade-creation effect has dominated
the trade-diversion effects. Direct attempts to measure whether
FTAs reduce the amount of trade with third parties using gravity
models have generally failed to show significant negative affects,
although different studies have reached opposite conclusions on
this point18. Our central scenario, which has only comparatively modest
amounts of trade diversion, is thus not out of line with the empirical
literature.
Impact on GDP
Table 9 compares the changes in GDP as a result of the CKFTA for
Canada, Korea and other trading partners, under the alternative
closure assumptions; all data in this table are on the original
GTAP 6.0 basis, based on 2001 data and expressed in 2001 U.S. dollars.
Table 9: Changes in GDP as a result of the CKFTA under
Alternative Closures, Selected Regions, in 2001 US$ millions
|
Labour & capital fixed (i)
|
Labour flexible, capital fixed (ii)
|
Labour fixed, capital flexible (iii)
|
Labour and capital flexible (iv)
|
Central Scenario (v) |
|
US$ |
% ch |
US$ |
% ch |
US$ |
% ch |
US$ |
% ch |
US$ |
% ch |
Canada |
460 |
0.064% |
797 |
0.111% |
557 |
0.078% |
1,921 |
0.268% |
815 |
0.114% |
Korea |
104 |
0.024% |
653 |
0.152% |
462 |
0.108% |
2,963 |
0.691% |
296 |
0.069% |
USA |
-564 |
-0.006% |
-481 |
-0.005% |
-448 |
-0.004% |
130 |
0.001% |
-412 |
-0.004% |
EU |
-124 |
-0.002% |
-132 |
-0.002% |
-85 |
-0.001% |
-5 |
0.000% |
-89 |
-0.001% |
Japan |
-72 |
-0.002% |
-84 |
-0.002% |
-33 |
-0.001% |
28 |
0.001% |
-45 |
-0.001% |
Mexico |
0 |
0.000% |
-1 |
0.000% |
1 |
0.000% |
-2 |
0.000% |
-2 |
0.000% |
Mercosur |
-32 |
-0.004% |
-30 |
-0.004% |
-19 |
-0.002% |
20 |
0.002% |
-27 |
-0.003% |
Caricom |
-9 |
-0.009% |
-8 |
-0.007% |
-7 |
-0.007% |
2 |
0.002% |
-8 |
-0.008% |
Andean |
-4 |
-0.002% |
4 |
0.001% |
5 |
0.002% |
52 |
0.018% |
1 |
0.000% |
China |
-92 |
-0.008% |
-86 |
-0.008% |
-81 |
-0.007% |
-36 |
-0.003% |
-86 |
-0.008% |
India |
-39 |
-0.008% |
-40 |
-0.009% |
-36 |
-0.008% |
-35 |
-0.007% |
-37 |
-0.008% |
Singapore |
0 |
0.000% |
1 |
0.001% |
1 |
0.001% |
4 |
0.005% |
0 |
0.000% |
Australia |
-32 |
-0.009% |
-23 |
-0.006% |
-21 |
-0.006% |
32 |
0.009% |
-26 |
-0.007% |
SACU |
-3 |
-0.002% |
-2 |
-0.002% |
-2 |
-0.001% |
4 |
0.004% |
-3 |
-0.002% |
ROW |
-154 |
-0.004% |
-91 |
-0.002% |
-93 |
-0.002% |
257 |
0.007% |
-112 |
-0.003% |
Total |
-560 |
-0.002% |
478 |
0.002% |
202 |
0.001% |
5,336 |
0.017% |
266 |
0.001% |
For Canada, the simulations suggest the CKFTA would result in an
increase in the value of GDP of between 0.064% in the standard closure
scenario (labour and capital supply both fixed) to 0.268% in scenario
(vi) where both capital and labour supply are flexible. In the central
scenario (labour supply elasticity = 1, capital supply flexible),
the GDP gain for Canada is 0.114%.
Applying these percentage changes to the size of Canada’s
GDP as it was in 2005 ($1,369 billion), the corresponding range
is from $876 million to $3.7 billion, with the central scenario
estimate at $1.6 billion19.
The value of Korean GDP would increase by between 0.024% and 0.691%
across the five scenarios, with the central scenario estimate at
0.059%. Scaled to the size of Korea’s economy in 2005 ($955
billion), this amounts to a range of between $229 million and $6.6
billion, with a central scenario estimate of $659 million.
Whereas the trade impacts generated by the model are relatively
stable across the alternative scenarios (with the bilateral trade
impacts showing almost no sensitivity), the estimated GDP gains
vary greatly across the scenarios and thus depend heavily on the
assumptions made by the modeller concerning the supply response
of the economy to the incentives created by liberalized trade.
Empirical estimates of the relationship between expanded trade
and economic activity suggest a strong impetus to GDP growth but
overall smaller gains in GDP than in trade: “Research reported
elsewhere … using a variety of alternative techniques, suggests
that annual GDP gains to each partner would amount to 20% of the
expanded [bilateral] trade… These gains reflect the adoption
of improved production methods in response to competitive pressures,
the exit of less efficient firms, scale and network economics, reduced
mark-up margins, more intensive use of imported inputs, and greater
variety in the menu of available goods and services.”20
Applying this rule of thumb to the estimated increase in the trade
share of GDP for Canada and Korea generated in the central scenario
closure scenario, the implied GDP gain would equal about $276 million
for Canada and $504 million for Korea. The estimated GDP gain for
Korea in the central scenario matches up well with this simple rule
of thumb; the gain for Canada is, however, substantially higher.
In considering the plausibility of the size of the estimated GDP
gain for Canada, we take note of the following two considerations:
-
Given the structural features of the Canadian and Korean economies
that would be affected by an FTA, the GTAP simulations show
higher gains for GDP for Canada than for Korea under all the
alternative closures, save for that where the constraints on
both labour and capital are fully relaxed (iv)21.
-
The estimated GDP gain for Canada is estimated to be substantially
larger ($876 million) in the most restrictive closure scenario
in which trade diversion effects are very large. The estimated
GDP gain inferred from the rule of thumb would therefore require
an implausibly larger trade diversion effect.
On these grounds, we conclude that the estimated GDP impact for
Canada, which is larger than Korea’s gain, and is consistent
with only modest degrees of overall trade diversion, is in the right
ballpark.
For most third parties, the proposed CKFTA is estimated to have
a negative impact on GDP under the restrictive standard closure
(i). However, the size of the negative impacts diminish as the constraints
on the production capacity in both Canada and Korea are relaxed
under less restrictive closure rules (ii)-(iii) and (v), and turn
into positive gains for many regions under the least restrictive
scenario (iv). For instance, the United States is shown to have
a reduction of GDP by US$564 million under the standard closure
rule; however, in the least restrictive scenario (iv), it has a
positive GDP gain of US$130 million. Under the central scenario,
the GDP impacts on third parties are, for the most part, negative
but negligible; and global GDP impacts are overall modestly positive,
dominated by the gains experienced by Canada and Korea. This latter
outcome is consistent with the positive association between trade
liberalization and global growth.
Impact on Household Economic Welfare
The most widely reported measure of the economic benefits or costs
of a policy change in computable general equilibrium model simulations
is known as “equivalent variation”; this is the amount
of money that would make the household sector as well off in the
pre-policy shock scenario as in the policy shock scenario22.
Table 10 reports the economic welfare gains generated in the simulation
for Canada, Korea and other countries/regions, broken down into
three main components:
-
Changes in allocative efficiency that arise from the reallocation
of production inputs (labour and capital) to their most effective
applications induced by the reduction in the level of tariff
distortions in the FTA partner economies.
-
Changes in the terms of trade (the ratio of export to import
prices) induced by the impact of the FTA on prices of goods
and services in each country.
-
Changes in the availability of factor endowments such as labour
and capital induced by the FTA under alternative scenarios.
This applies to Canada and Korea only; in other regions, the
supply of labour and capital in other countries remains fixed.
For purposes of this international comparison, the data are presented
in terms of the original GTAP data – i.e., in 2001 US$ scaled
to the size of the various economies in 2001.
Table 10: Regional Household Economic Welfare Impacts,
in 2001 US$ millions
|
Labour & capital fixed (i)
|
Labour flexible, capital fixed (ii)
|
Labour fixed, capital flexible (iii)
|
Labour & capital flexible (iv)
|
Central Scenario (v) |
Canada (total) |
143 |
514 |
280 |
1,868 |
586 |
Allocative efficiency |
15 |
192 |
57 |
753 |
192 |
Terms of trade |
139 |
129 |
113 |
8 |
90 |
Endowment |
0 |
203 |
117 |
1,103 |
308 |
Korea |
-2 |
632 |
321 |
2,979 |
201 |
Allocative efficiency |
-74 |
62 |
-10 |
545 |
-32 |
Terms of trade |
87 |
54 |
33 |
-202 |
70 |
Endowment |
0 |
525 |
308 |
2,611 |
176 |
U.S. |
-130 |
-118 |
-104 |
2 |
-92 |
Allocative efficiency |
-7 |
-8 |
-8 |
-13 |
-8 |
Terms of trade |
-111 |
-97 |
-86 |
28 |
-73 |
ROW |
-121 |
-95 |
-70 |
110 |
-101 |
Allocative efficiency |
-44 |
-51 |
-37 |
-38 |
-43 |
Terms of trade |
-115 |
-85 |
-61 |
166 |
-86 |
Total |
-110 |
922 |
427 |
4,960 |
594 |
Allocative efficiency |
-110 |
194 |
3 |
1,247 |
110 |
Terms of trade |
0 |
0 |
0 |
0 |
0 |
Endowment |
0 |
728 |
424 |
3,713 |
485 |
Note: Allocative efficiency, terms of trade, and endowment
effects do not add exactly to the total. The GTAP welfare calculation
also includes a term that reflects the price differentials between
saving and investment.
As in the case of the GDP impacts, the estimated economic welfare
gains vary considerably across the alternative closure scenarios.
The simulations suggest that Canadian households would derive an
economic welfare benefit of between US$143 million and US$1.9 billion,
with our central scenario estimate at US$586 million. Scaled to
the size of Canada’s economy in 2005, the corresponding range
is between $266 million under the most restrictive assumptions and
$3.5 billion under the least restrictive assumptions; the central
scenario estimate is $1.1 billion23.
For Korea, the results range from a negligible loss under the most
restrictive closure scenario to a gain of almost US$3 billion in
the least restrictive scenario24. Most other regions, and the global
economy as a whole, would incur losses due to trade diversion under
the most restrictive scenario; however, the outcomes for third parties
improve sharply under less restrictive scenarios; for the global
economy as a whole, economic welfare improves as resource constraints
in Canada and Korea are relaxed.
With regard to the sources of gains/losses, this is influenced
heavily by the closure assumption. If capital and labour are fixed,
as they are in scenario (i), increased demand largely results in
increases in wages and in returns to capital; these higher factor
costs are passed on in the form of higher prices which are reflected
in the model’s accounting as terms of trade gains. In scenarios
in which higher factor prices induce greater labour and capital
supply, the smaller become the net increases in wages and returns
to capital; in welfare accounting, the gains attributed to terms
of trade decline while the gains attributed to increases in allocative
efficiency and endowments increase. Under the least restrictive
scenario (iv), the endowment effect overwhelms all other gains,
accounting for roughly 60% and 80% of the total welfare gains for
Canada and Korea, respectively.
How Canada and Korea derive benefits from the CKFTA (i.e. whether
largely in the form of improved terms of trade or in the form of
improved allocative efficiency and/or increased endowments) determines
whether the impact on the rest of the world is positive or negative.
This can be understood intuitively on the following basis: since
one region’s export prices are another region’s import
prices, global terms of trade impacts must net out to zero. Accordingly,
improved terms of trade for Canada and Korea necessarily translate
into terms of trade deterioration in the rest of the world combined25.
Scenarios in which Canada and Korea extract gains in the form of
terms of trade improvement thus are necessarily worse for the rest
of the world than scenarios in which the gains come in the form
of improved allocative efficiency and/or increased supply capacity.
The estimated economic welfare gains for Canada in the central
scenario ($1.1 billion) are broadly consistent with the size of
the gain in GDP ($1.5 billion) and the size of the incremental bilateral
trade flows ($2.6 billion). The gains for Canada are greater than
for Korea; this is to be expected since the negative welfare impacts
of trade diversion for Korea should be greater given the overall
higher level of tariffs.
TRADE IN SERVICES
A specific estimate of the impact of services trade liberalization
under the CKFTA is not provided in this study. This reflects the
following considerations.
First, the General Agreement on Trade in Services (GATS), which
provides the framework for the liberalization of international trade
in services, classifies trade in services into 155 service types
and four modes of supply:
-
Cross-border supply: a service is supplied from a supplier’s
country of residence to a consumer’s country of residence.
-
Consumption abroad: a service is supplied through the movement
of a consumer to a supplier’s country of residence.
-
Commercial presence: a service is supplied through the movement
of a commercial organization to a consumer’s country of
residence.
-
Presence of natural person: a service is supplied through the
movement of a natural person to a consumer’s country of
residence.
Barriers to trade in services can be put in place in each of the
four modes of supply. The measurement of barriers to services trade
thus involves quantifying the trade restrictive effect of a wide
variety of domestic regulatory measures, which indirectly affect
trade in all four modes. Unlike the case of merchandise trade, for
which there exists a comprehensive and reasonably reliable data
set describing the height of border barriers, a comprehensive database
on the barriers to Canada-Korea services trade does not exist26. By
the same token, it is not possible to obtain an estimate of the
complete elimination of trade barriers, as was done above for goods
trade. An estimate of the services component of the CKFTA would
require before-the-fact knowledge of the specific measures that
would be subject to liberalization, and this is not available.
Second, given the various alternative modes for trade in services,
companies will tend to choose the path of least resistance—e.g.,
opting for commercial presence (mode 3) over cross-border provision
(mode 1), or vice versa, depending on which approach is less costly
in terms of regulatory compliance. It follows that liberalizing
one mode (e.g. cross-border trade) in a context in which another
mode is relatively unimpeded (e.g. commercial presence through inward
FDI) may yield little in the way of impacts since firms will have
already committed resources to the path of least resistance. In
other words, there is as much uncertainty about the market response
to a change in a restrictive measure as there is about the quantification
of the measure’s restrictive force.
Third, there are equivalent difficulties to evaluating the liberalizing
effect of specific negotiated changes to domestic regulations to
the difficulties involved in estimating the overall trade-impeding
effect of the regulatory framework.
Several elements of the negotiation agenda address services trade
in one mode or another: financial services, cross-border trade in
services, investment and temporary movement of persons. Other elements
of the negotiations that facilitate international commerce could
also be expected to impact to some extent on the ease of conducting
services trade between Canada and Korea. Absent specific estimates,
it can be inferred that the results for merchandise trade understate
the total trade impact, the impact on GDP and the impact on consumer
welfare.
INVESTMENT LIBERALIZATION
The GTAP scenarios elaborated above do not take into account measures
that might be included in a CKFTA to liberalize or facilitate direct
investment. To take into account the impact of investment liberalization,
a dynamic CGE model that includes FDI is required. Such a model
is being developed for Canada but is not yet available. At present,
it should be noted that the potential to expand two-way direct investment
between Canada and Korea appears to be reasonably strong, particularly
with regard to Canadian direct investment into Korea. This can be
inferred from an index measuring the overall level of investment
restrictiveness in the two countries in terms of tax equivalents.
For Canada, restrictions on inward FDI from the FTAP model database27
are evaluated to be equivalent to a 6.11% tax on foreign affiliates’
capital; the equivalent figure for Korea is 22.01%.
Absent specific estimates, it can be inferred that the GDP and
consumer welfare impacts reported above deriving from merchandise
trade liberalization likely understate the extent of gains in these
areas from such investment liberalization as might be forthcoming
pursuant to the CKFTA.
1. All monetary figures
are in Canadian dollars unless otherwise noted.
2. Johannes Van Biesebroeck,
“The Canadian Automotive Market,” May 20, 2006
3. For a full description
of the model, see Hertel, T. W. (1997). Global Trade Analysis: Modeling
and Ap-plications, Cambridge: Cambridge University Press.
4. See DFAIT, Canada-Korea
– Free Trade Agreement Negotiations.
5. For example, since July
2005, Korea has concluded agreements with Singapore, the European
Free Trade Association (EFTA) and the Association of Southeast Asian
Nations (ASEAN); has concluded negotiations with the United States;
and has trade negotiations under way with, among others, the European
Union. Canada, meanwhile, is also negotiating free trade with the
Central American Four (CA4), EFTA, and Singapore and exploring free
trade with the Andean Community, CARICOM,
and the Dominican Republic.
6. The comparative static
version of the Linkage model produced income gains for industrialized
countries under multilateral trade liberalization that were one
third larger using the trade elasticities in the Linkage model compared
to those in the GTAP 6.0 dataset. See Dominique van der Mensbrugghe,
“Estimating the Benefits of Trade Reform: Why Numbers Change,”
Chapter 4 in Trade, Doha, and Development: A Window into the Issues
(World
Bank ); at p. 71.
7. This is sometimes described
as reflecting a medium-term time horizon in which labour supply
is relatively “sticky.”
8. The closure rule in
which the rate of return to capital is fixed is sometimes described
as reflecting longer-run “steady-state” growth conditions,
For an example of the implications of fixing the return to capital
and al-lowing investment to adjust, see John P. Gilbert, “GTAP
Model Analysis: Simulating the Effect of a Korea-U.S. FTA Using
Computable General Equilibrium Techniques”. Gilbert
reports net economic welfare gains for Korea that are 2.7 times
larger, and for the U.S. that are 2.4 times larger, with this closure
compared to standard closure. For an example of the use of the labour
market closure rule under which the wage rate is fixed, see Joseph
F. Francois and Laura M. Baughman, “U.S.-Canadian Trade and
U.S. State-Level Production and Employment,” in John M. Curtis
and Dan Ciuriak (eds.) Trade Policy Research 2004 (Ottawa: DFAIT,
2004).
9. For a discussion of
the elasticity of supply of labour see John C. Ham and Kevin Reilly,
“Using
Micro Data to Estimate the Intertemporal Substitution Elasticity
for Labor Supply in an Implicit Contract Model,” July
2006. This study finds statistically significant in-ter-temporal
labour supply elasticities of 0.9 with the Panel Study of Income
Dynamics (PSID) data set and 1.0 with the Consumer Expenditure Survey
(CES) data set.
10. This is a well-established
result with the GTAP model. See Joseph F. Francois, Bradley J. McDonald
and H?kan Norström, “Liberalization and Capital Accumulation
in the GTAP Model,” GTAP Technical Paper No. 7, July 1996.
11. See Gilbert (op. cit.)
for a comparison of the impact of using alternative macroeconomic
closures in the context of modelling the U.S.-Korea FTA. The fixed
current account simulations substantially reduce the eco-nomic welfare
gains for Korea (to 3/5 the level of the simulation with flexible
current account) and marginally (by 5%) for the United States.
12. The methodology for
updating the protection data is that developed for the World Bank.
For a descrip-tion see Dominique van der Mensbrugghe, “Estimating
the Benefits of Trade Reform: Why Numbers Change,”
in World Bank, Trade, Doha, and Development: A Window into the Issues;
at p. 61.
13. International Monetary
Fund, World Economic Outlook, September 2006.
14. Global Insight, Quarterly
Review and Outlook: Asia-Pacific, First Quarter 2006.
15. Trade statistics collected
by one country frequently differ from statistics measuring the same
trade flow collected by its trading partners. In the case of Canada-Korea
trade, a trade data reconciliation exercise conducted on the 2001
and 2002 bilateral trade data indicated that Canada’s bilateral
deficit and Korea’s bilateral surplus were both overstated.
The main source of errors in the data was underreporting of exports
due to non-filing of ex-port documents and indirect trade (e.g.
Canadian shipments to the U.S., which then are sent onwards to Korea
might be reported as exports to the U.S. in Canadian statistics,
overstating Canada-U.S. trade and understating Canada-Korea trade).
As Statistics Canada notes in its comment on the reconciliation
exercise “Customs offices are generally more attentive to
goods entering the country rather than leaving because of the requirement
for tariff assessment and the application of trade agreements. Consequently,
import data are usually more reliable than ex-port data.”
Accordingly, for unreconciled data such as the 2005 figures, the
most accurate measure of the balance is on the basis of import-import
data. For a fuller discussion see Sandra Bohatyretz, “Tiger
by the Tail? Canada’s Trade with South Korea,” in Canadian
Trade Review, Statistics Canada Catalogue No. 65-507-MIE, (2004).
16. In the simulation,
tariffs for sectors with zero trade (e.g. Canadian exports of rice)
are set to zero in or-der to avoid a spurious surge in exports/imports
upon tariff elimination. This is consistent with standard practice
in GTAP-model simulations.
17. Note: the bilateral
trade figures are not significantly influenced by the choice of
closure. Accordingly, we report only the results for the central
scenario for closure. As shown below, the main impact of alternative
closures is on the extent of trade diversion experienced by third
countries.
18. A 2003 study for the
Australian Productivity Commission contradicted this conventional
wisdom, find-ing that most FTAs reported to the WTO were trade diverting.
See Adams, R., P. Dee, J. Gali, and G. McGuire. 2003. “The
Trade and Investment Effects of Preferential Trading Arrangements—Old
and New Evidence.” Staff Working Paper. Australia Productivity
Commission. Canberra. However, a more recent review of this same
evidence using updated trade data reached the opposite conclusion,
namely that most FTAs were net trade creating. See Dean A. DeRosa.
2007. “The Trade Effects of Preferential Arrangements: New
Evidence from the Australia Productivity Commission.” Working
Paper 07-1, Peter G. Peterson Institute for International Econom-ics,
Washington, D.C., January 2003.
19. These figures are
not significantly impacted by the change in the expenditure composition
of Canada’s GDP between 2001 and 2005. A rough check on this
can be made by applying the percentage changes gener-ated in the
model simulation for individual components of GDP (i.e. consumer
expenditure, investment, gov-ernment spending, exports and imports)
to the levels of these GDP components in 2005 and recalculating
the total GDP change. Taking this into account marginally reduces
the gain in scenario (i) from $880.8 million to $872.9 million.
20. Dean DeRosa and John
Gilbert, “Estimates from Gravity and CGE Models,” Chapter
8 in Gary Clyde Hufbauer and Richard E. Baldwin, “The Shape
of a Swiss-U.S. Free Trade Agreement,” op cit.; at p. 238.
21. For both Canada and
Korea, the GDP gains under the least restrictive closure rules (iv)
are much bigger than those under the scenarios (ii)-(iii) and (v).
This may be understood intuitively on the following basis. When
a constraint is imposed on one of primary production factors (labour
or capital), economic growth is subject to diminishing returns.
When the constraints on all primary factors are removed under the
scenario (iv), however, the economy expands under constant returns
to scale, which generates a greater GDP impact.
22. This measure is technically
Hicksian equivalent variation calculated using pre-shock prices.
23. The scaling up from
2001 US$ figures to 2005 C$ figures is done as follows: the GTAP
figure for equivalent variation for Canada of $143.1 million in
2001 US$ is 0.035% of 2001 consumer expenditure. Ap-plying this
percentage to consumer expenditure of $760,380 million in 2005 yields
the above estimate of equivalent variation in 2005, expressed in
C$. The other figures are calculated in like fashion.
24. The small decline
in household economic welfare for Korea in the most restrictive
scenario contrasts with the gain in GDP reported earlier for the
same scenario. This result reflects the fact that GDP gains are
re-ported taking into account the relative price changes induced
by the FTA while equivalent variation, the meas-ure of household
economic welfare, does not take these price changes into account.
Since Korea experiences terms of trade gains but allocative efficiency
losses the choice of post-shock versus pre-shock prices in doing
such a calculation can result in one measure being positive and
the other negative if both are relatively close to zero.
25. The widespread losses
in terms of trade in the most restrictive closure scenario reflect
the loss of exports to Canada and Korea due to preference erosion.
Since most countries have exports to Canada and Korea, they all
tend to be affected in this manner. Mechanically, the loss of exports
to Canada and Korea results a price de-cline of production in other
countries to restore equilibrium; this is only partially offset
by the extent to which Canadian and Korean imports are reduced (since
these imports are also higher priced in the shock scenario) and
replaced by domestic production abroad or from third-party imports.
The Armington assumption is an essential factor here: the imperfect
substitutability of goods according to location of production allows
relative increases in prices of Canadian and Korean products—if
there were perfect substitutability, competitive forces would negate
these terms of trade effects.
26. For a detailed review
of the issues facing the quantification of services trade barriers
and estimating the impact of services trade liberalization, with
specific reference to the Canadian context, see the trio of articles
in Part II of John M. Curtis and Dan Ciuriak (eds.) Trade Policy
Research 2002 (Ottawa: Department of Foreign Affairs and International
Trade, 2003): Brian R. Copeland, “Benefits and costs of trade
and investment liberali-zation in services: Implications from trade
theory”; Zhiqi Chen and Lawrence Schembri, “Measuring
the Barri-ers to Trade in Services: Literature and Methodologies”;
and Shenjie Chen, “Trade and Investment in Canada’s
Services Sector: Performance and Prospects.”
27. For background on
the FTAP model and data see, Australian Productivity Commission
“The
Structure of the FTAP Model”.
28. Johannes Van Biesebroeck,
“The Canadian Automotive Market,” May 20, 2006; p 75.
According to up-dated information, Hyundai production in North America
is slated to grow from 91,218 units in 2005 to the 450,000 range
by 2012. The Kia plant has since been confirmed, with production
slated to start in 2010 building to about 250,000 units by 2012.
Source: Ward’s AutoInfoBank.
29. According to Ward’s
AutoInfoBank, the share of Nissan automobiles sold in Canada directly
imported from Japan declined from 99.9% in 1990 to 33.2% in 2005.
30. Source: Wards Automotive
Infobank.
31. A number of major
Korean suppliers have already located near the Alabama plant, following
the pattern of the Japanese suppliers.
32. The calculation is
as follows: Hyundai and Kia accounted for 71.5% of Korean auto imports
into Can-ada in 2005 by number of units. Assuming the non-Hyundai-Kia
production destined for Canada (which ac-counted for 28.5% of Korean
auto imports in 2005) remains in Korea, the level of Korean-sourced
units sold in Canada in the post-transplant “equilibrium”
as a share of the pre-transplant level is then .716*.35 +.284 =
.535. Autos account for 92% of Korean shipments to Canada and parts
8%; accordingly the value of Korean total automotive shipments in
the post-transplant “equilibrium” as a share of the
pre-transplant automotive shipments = .535*.92 plus .08 = .572.
In the GTAP 6.0 database, the trade weighted tariff rate for Canada’s
imports of Korean automobile products was 5.8%. The FTA impact is
then calculated by reducing the level of border pro-tection by 57.2%
from 5.8% to 2.5%.
33. In 2005, Canada exported
$279 million worth of dairy products, of which $149 million went
to the U.S. Exports to Korea amounted to only $9 million, or about
3.5% of total Canadian exports of dairy products; of this total,
$7.9 million were products consisting of natural milk constituents,
and the remaining $1 million were cheese and ice cream.
34. For a review of the
case history, see Report of the Panel, Canada – Measures Affecting
the Importation of Milk and the Exportation of Dairy Products, WT/DS103/RW,
WT/DS113/RW, 11 July 2001, p. 11, para 3.2.
35. Ibid,, p. 66, para
7.2.
36. Not elsewhere specified
or included
|