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GTAP Resources: Resource Display

GTAP Resource #1760

"Regionalism in World Agricultural Trade: Lessons from Gravity Model Estimation"
by Grant, Jason and Dayton M. Lambert


Abstract
ABSTRACT

INTRODUCTION
Regional integration arrangements have been the subject of considerable debate dating back to the 1950’s when Jacob Viner published his work on the “customs union issue” - an era known as the “first regionalism.” More recent growth in regional trade agreements (RTAs) has again sparked the interests of economic researchers. For example, over the last ten years the US has signed 13 free trade agreements. The EU has successfully increased its membership from 6 members in 1986 to 25 members in December of 2002. Other examples include Mercosur (The Southern Common Market) that was created in March 1991 and three Southern African trade agreements formed in 1992-1994. This latest resurgence is known as the “second regionalism.”

The proponents of regional trade agreements argue that they promote free trade. This school of thought views RTAs as “building blocks” towards multilateral trade liberalization. However, there are equally as many opponents who argue that RTAs divert trade from more efficient nonmember trading countries. This school of thought views RTAs as “stumbling blocks” that are likely to lower global welfare and divert import flows from lower cost suppliers.

Another issue raised by the formation of RTAs is their relationship with multilateral free trade. The proliferation of RTAs was concurrent with eight periodic multilateral negotiating rounds of the General Agreement on Tariffs and Trade (GATT). These negotiations dramatically reduced tariffs and other border protection measures on industrial products where the current Most Favoured Nation (MFN) tariff rate is estimated at less than 5%. However, the same is not true for trade in agricultural products where the current MFN tariff rate is estimated at 62%. In fact, due to its sensitive nature, agriculture was virtually excluded from all eight GATT rounds until the Uruguay Round (UR). Moreover, the trade negotiations in the UR needed a separate agreement to govern agricultural trade; the WTO Agreement on Agriculture (AoA).

Special treatment of agriculture is not uncommon in regional trade agreements. For example, the North American Free Trade Agreement (NAFTA) and Mercosur liberalized trade in agriculture but maintain trade barriers for sensitive products such as sugar, dairy and fruit and vegetable products. Mexico and Canada required a separate bilateral agreement within NAFTA for trade in dairy, poultry, eggs and sugar. At two extremes, the South Asian Preferential Trade Agreement (SAPTA) excluded agricultural trade altogether, whereas the EU customs union and the Closer Economic Relations (CER) agreement between Australia and New Zealand permit free trade in agriculture.

PURPOSE/OBJECTIVES

Typically, debates over the effects of RTAs have focused on welfare. However, to fully understand the effects of these agreements we seek to answer a more fundamental question of what effect these agreements have had on trade. Specifically, this study has three important objectives. First, we extend the standard gravity equation by exploiting the recently developed GTAP data set on land endowments as a key determinant of bilateral trade patterns in agriculture. Second, we estimate the extent of trade creation in RTAs for nine disaggregated agricultural commodities. Third, to the extent that RTAs were trade creating, we measure how much of this increase came at the expense of trade diversion with non-members.

RELEVANCE OF THE PAPER

There are two outcomes possible when a group of countries form an RTA; trade creation and trade diversion. In the case of trade diversion, higher cost imports from a bloc member replace lower cost foreign supplies and the RTA is said to be “trade diverting” from the most efficient supplier of that good. In the case of trade creation, if a member is originally trading with a relatively higher cost exporter before the RTA is formed, but the formation of the RTA displaces trade with lower cost exports from a member country, then the RTA is said to be “trade creating.” In the case of trade diversion, world trade is reduced and at least one country is made worse off. In the case of trade creation, world output rises and the RTA member is better off in terms of economic welfare without a corresponding welfare loss to the non-RTA member.

The gravity model has performed remarkably well as an empirical framework for measuring the impact of regional integration arrangements. This literature commonly reports that trade creation has occurred within RTAs. However, the current gravity literature on regional integration has focused almost exclusively on trade in non-agricultural products, and in many cases, agricultural trade has been excluded from the analysis. Yet, the special treatment of agricultural trade within preferential trading blocs and in the WTO negotiations suggests that agricultural trade within RTAs may not be trade creating. This study is an important contribution to the gravity literature on regional trade agreements in that it focuses exclusively on trade in agricultural goods at a disaggregated level.

EMPIRICAL METHODS

In the basic form of the gravity model, the logarithm of the volume of trade (VTij) between countries i and j is regressed on the logarithm of the economic size of the importing region i (GDPi) and exporting region j (GDPj) and the logarithm of the distance between them (DISTij). Using world agricultural trade data from the Comtrade database, we extend the standard gravity equation by incorporating land endowments to help explain bilateral trade patterns in agriculture and by defining variables that estimate the extent of trade creation and trade diversion in eight regional trade agreements.

We have selected eighteen years of data from 1985-2002 which covers all years in which these agreements were signed. Using an ex ante–ex post analysis, we test the null hypothesis that no significant trade creation or trade diversion occurred after the ratification of these agreements. Furthermore, the magnitude of a positive (negative) and significant trade creation/diversion coefficient allows us to determine the percentage increase (decrease) in trade creation within an RTA as well as trade diversion from a non-member. Finally, we highlight specific agricultural commodities that have consistently produced negative trade creation effects in all RTAs considered.






Resource Details (Export Citation) GTAP Keywords
Category: 2005 Conference Paper
Status: Published
By/In: Presented at the 8th Annual Conference on Global Economic Analysis, Lübeck, Germany
Date: 2005
Version:
Created: Grant, J. (5/1/2005)
Updated: Grant, J. (6/20/2005)
Visits: 2,394
No keywords have been specified.


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