CAFTA turns 10 (...almost)

This coming June marks the 10^th year since the ratification of CAFTA. Branching off John’s post, I decided to write about the Central American Free Trade Agreement and how it has affected Central America. The countries included in CAFTA are the Dominican Republic, Costa Rica, El Salvador, Guatemala, Nicaragua, and Honduras. CAFTA was first crafted as an expansion of NAFTA. This agreement set out to eliminate most of the tariffs and barriers to investment between the United States and Central America and also to enforce labor regulations within Central America.

Prior to the ratification of CAFTA there were many mixed views on the topic. Some individuals, primarily Bush supporters, liked the agreement because they believed it would help minimize the United States’ trade deficit and create jobs for those in Central America resulting in fewer immigrants moving to the United States. On the other hand, there were also many individuals who strongly disagreed with the agreement. These individuals were worried about a list of things including American jobs lost to cheaper labor in Central America and the increased volume of trade putting a larger burden on the region’s already “critical” environmental status. Ten years later and the effects of CAFTA seem to have caused more harm to the economies of Central America than good. (Here's a link discussing the main issues swirling around CAFTA before it was ratified.)

In the article I have linked in the title, Congresswoman Marcy Kaptur and Research Director for Public Citizen’s Global Trade Watch, Ben Beachy, discuss the effects of CAFTA. Ben starts the discussion by quoting a previous Representative, Tom Davis, who encouraged listeners to pass CAFTA in order to “ebb the growing flow of immigrants from South America and fight the ever-more-violent MS-13 gang.” For the rest of the article Beachy provides arguments as to how CAFTA has not accomplished nearly anything it was created to do for Central America. “Gang and drug-related violence in Central America has reached record highs and the ‘growing flow’ of immigrants from Central America has surged.” Beachy makes it quite clear that the argument of CAFTA being solely responsible for the rise in gang violence and increased immigration to the U.S. cannot be made. However, discussing some of the changes in Honduras, El Salvador, and Guatemala might lead one to believe CAFTA has not really benefited Central America.

After CAFTA was ratified, imports in Honduras, El Salvador, and Guatemala rose 78%. Farmers in these countries didn’t have the technology, land, or subsidies to compete with American companies and, therefore, caused many farmers in Central America to lose their jobs. People in these countries were also promised to find jobs in the textile industry due to CAFTA but since its ratification textile exporting to the United States has dropped 40% causing less creation of jobs than anticipated. This kind of financial distress for families is thought to be one of the primary reasons for higher gang activity in communities. Finally, Central America was promised to experience a boost in economic growth after CAFTA but this has not happened. Average growth rates in Honduras, El Salvador, and Guatemala in the years since CAFTA was ratified have fallen below the overall growth rate in Latin America.

To conclude, CAFTA seems to have hurt countries in Central America more than help them progress globally. When constructing trade policy, the U.S. should try to take a better look at how the agreement will affect those in the partnering countries.

 

Trade, Poverty and Employment

I have read this very interesting working paper about the impacts of trading with China on Argentina's poverty and welfare. It is a bit of a long and difficult read but I learned a lot from it and it had some very interesting information and I would recommend reading it. I will be summing it up a bit and share my thoughts on this paper.

In class we talk about how there are winners and losers in trade but I believe in most cases the overall welfare in both countries went up so I thought this paper would be very interesting. This paper talks about how during the 90's Argentina increase it's trade with China greatly especially in industrial sectors. With this increased competitions there were some negative effects. There were slow lagged declines in industrial employment but the studies in this paper find that trade with China only had small impacts on this.

Based on household surveys and the amount of trade that was being done with China the authors of the paper were able to determine that trade with a low wage country in this case China, would sightly reduce poverty and there also is a slight reduction in inequality in a developing country like Argentina. The authors also go into the importance of looking at tariffs, price changes and trade reforms and how they can greatly influence the results. Unfortunately this paper only goes into trade with a low wage country like china and a developing country like Argentina but does not touch on if non developed countries were to trade with China.

I think this paper does a great job of showing how the country importing from a low wage country will see benefits even though some will lose their jobs like Argentinians working in the industrial sector in this case.

India foreign trade

India has made its stance clear that it will not easily give in to pressure from the Western world over trade protocols of the World Trade Organization.  India fears that agreeing to the trade facilitation agreement (TFA) could compromise its own food security.

            The TFA aims to fast track any movement of goods among countries by cutting down bureaucratic obligations. The problem with TFA runs in a clause that says farm subsidies cannot be more than 10 percent of the value of agricultural production. If the cap is breached, other members can challenge it and also go on to impose trade sanctions on the country.

            The developing countries would have a problem with the solutions offered by the developed countries as without the subsidies the food security of the developing nations could be seriously harmed. India agreed to the TFA only under the condition that temporary relief would be provided to the developing nations. It said no legal actions or sanctions would be imposed on the developing nations till 2017, by which time a solution would be worked out among the nations. However, this interim relief would not be appropriate if such subsidies would lead to trade distortions, by which one means, that prices of exports and imports cannot be affected by this.

            India is opposed because India's food security act, which is binding on the government by law, now, implies that the government will provide very cheap food to the most vulnerable part of the population at extremely low prices. Apart from providing subsidies to the consumers, through the public distribution system, it also provides subsidies to the producers of food grains. So it buys food grains from farmers at a minimum support price, and subsidies inputs like electricity and fertilizer.

            The first problem is with the 10% cap on subsidies, which will not be possible for India to achieve. Adding to the unfortunates is the fact that the 10% cap is calculated based on 1986-88 prices when the prices of food grains were much lower, so the cap has to be updated taking into account the present prices of food grain.

            The second problem is that even for providing subsidized food, India will have to open up its own stockpiling to international monitoring. It will not be able to add protein heavy grains like say, lentils, if it wants to, due to riders in the peace clause.

            Third, it might seem unfair to developing countries to not crack down on farm subsidies that the United States provides to its farmers to the tune of more than 20 billion per year. While the WTO is binding the developing countries to protocols, the issue of subsidies by developed giants like US seems to be off the table.

            India wants a permanent solution to the issue of public stock holding of food grains. China has supported India's stand on the ability to subsidies agricultural production and distribute it to the poor at low cost.

            WTO argues that if the developing countries continue to give prices to farmers, which are higher than the market prices, it might harm the poor farmers in other parts of the world. It also says the deal could add $1 trillion to global gross domestic product and 21 million jobs.

Boeing vs. Airbus

In class we took a look at a semi-realistic example of the prisoner's dilemma with Boeing  (BA) and Airbus (EADS). Within the commercial aviation industry BA and EADS are by and large the two most competitive and successful firms. The game theory model was determined by the willingness to compete in the large scale commercial aircraft sub sector of the industry which would account for the production of the Boeing 700 series and the Airbus 380 series. Now for simplicity's sake and in an effort to demonstrate the Nash Equilibrium's, we assumed that the performance of the two firms in production and sales were pretty similar if not equal. By doing so we came up with a prisoner's dilemma very similar to the one below:

Boeing/Airbus	DEVELOP	DON’T DEVELOP
DEVELOP	(-$10, -$10)	($50, $0)
DON’T DEVELOP	($0, $50)	($0, $0)

Since this model is based off of data from 2011 and previous, as of today the commercial aviation industry has changed its preferences. No longer are firms such as BA and EADS focusing on large transcontinental capable aircraft. Instead they are focusing on small regional/domestic aircraft such as the Boeing 737 series and the AirBus 320 series; and with good measure. Both of these lines of aircraft account for approximately 44% and 42% of total company revenue for BA and EADS respectively. Percentage of company revenues in no way is an accurate or sufficient measure in determining industry performance in the mid size aircraft sub sector; however, coincidentally the 2% difference in the percentage of total revenue that these aircraft lines produce for the two firms is a pretty good mirror of the actual performance of BA and EADS against each other in terms of: delivered aircraft, contractual backlog, and future contracts. This is to say that across the board BA holds an approximate 2% advantage over EADS in producing this particular type of aircraft. So as we shift the focus towards this production model versus the large scale aircraft model my question is how would this payout schedule look now with the given information about this sector?

Boeing/Airbus	DEVELOP A320 Series	DON’T DEVELOP A320 Series
DEVELOP 737 Series
DON’T DEVELOP 737 Series

(A closely related Cornell University blog article which inspired this post is available here:Cornell University Blog )

Problem Set Key and Office Hours

Here's a link to the Problem Set solutions from Chapter 8. I have some minor quibbles with the book's treatment of a few of those questions, but those quibbles are mostly based on some more advanced models than what we have learned.
I will not be holding office hours today or tomorrow. Home with a sick kiddo.
Final note: Deb Bennett, Program Coordinator for the DBA and MFIN programs, will be proctoring the first half of your final exam because I'm booked at that time for a meeting with three of the Universities high-ranking administrators and their staffs (and I swear it's not because I'm in trouble!). I don't expect there to be any problems with the exam, but in case one or two things slip through that require clarification, please wait until I am there at around 4 to answer your questions.
This is a test to see if editing this changes the date.

The structure of optimal tariffs

We have discussed in class that a tariff can increase a country's welfare if the term of trade gain exceed the total dead weight losses. It is possible because a tariff imposed by the large country can influence the world price thus increase its term of trade. How to determine the optimal tariff is a very tricky question for a policy maker. When imposing a tariff that is good for the country itself, other countries might retaliate. A optimal tariff for one country might not be the optimal tariff for its trading partner. 

The link article is a paper about how to determine the optimal tariff level in a two-country economic with more than two traded goods. The paper examines the structure of the Nash equilibrium tariff rates within the same trade group in a model with an asymmetric structure that allows general utility and production functions. It assume the condition that equilibrium tariff rate are uniform in both countries, and explore the relative size of the equilibrium tariff rates in each country when the uniform tariff condition is not satisfied. The paper found out that the elasticity of compensated excess demand for goods is a key factor of determining the equilibrium tariff.

What make this model meaningful is that it can be extend to more than two countries. In the paper, the model assume that the home (foreign) country exports (imports) only one good, but it can be extend to more goods which make this model useful for customs unions and trading blocs that use a common external tariff. This paper can be regarded as an investigation of the structure of common external tariff rates on different traded goods by assuming that the country is an entity of a customs union.

In all, the theory of the optimal tariff and its implications play an important role in tariff-imposing countries, it give the policy maker an idea of how to set a tariff. Besides, the theories are useful and suggestive for trading blocs and multilateral trade agreements for setting an common external tariff.

NAFTA Turns 20

The article linked in the title of this post is a review of how NAFTA came to be, and the effects of it over the past 20 years.  The North American Free Trade Agreement (NAFTA) was created to remove trade restrictions between Canada, Mexico, and the U.S.  Although this agreement seems very reasonable to us now, there were some opponents to its creation. These opponents of NAFTA argued that the U.S. would lose many jobs to Mexico as companies sought lower production costs there.  Those that supported the agreement suggested that it would create large economic gains for America. It was also said to lower the income disparity while creating thousands of jobs in the region.

So how well did NAFTA work?  It is hard to say exactly what the true impact was because of availability of data and the theoretical process of generating results from economic models.  However, the paper gave some numbers on increases in exports, what is traded, and how much of it.  With the enforcement of NAFTA, U.S. exports to Mexico have increased by 444% while exports to Canada have increased by a modest 200%.  The top import items from NAFTA partners include crude oil, cars, and car parts.  Approximately $100 billion worth of crude oil alone was traded between the partners in 2013.  The U.S. is the number one buyer of Canadian goods and supplier of imports.  The trade with Mexico has increased so much more than Canada due to NAFTA because the U.S. was already trading nearly duty free with Canada since 1989.  Although our trade with Mexico has increased, the U.S. has lost nearly 20% of its trade market-share of Mexican imports to China. 

The final point the paper made is how to improve our free trade agreement.  One idea is to emphasize the trade of intermediate goods and supply chains.  This pertains to improvements in border infrastructure in order to improve efficiency of cross-border trade.  The main concern here is the Mexican border, and the excessive time that it can take for Mexican businesses to transport goods into the U.S.  The other idea deals with regulatory cooperation in the areas of trade, transportation, economic growth, and security.  They have already made efforts towards this by starting a series of meetings known as the North American Leaders Summits.  Although communications have increased on these topics, success has been limited due to the absence of binding agreements.  So how do you think the North American Free Trade Agreement could be improved?