Principal investigator: Viviane Pires Ribeiro
Paper Title: How Regional Blocs Affect Excluded Countries: The Price Effects of MERCOSUR
Authors: Won Chang and L. Alan Winters
Location of the Intervention: Brazil
Sample Size: 4 member countries
Main theme: Economic Policy and Governance
Main Variable of Interest: Import
Type of Intervention: Impact of MERCOSUR on export prices
Methodology: Price game
The effects of Preferential Trade Agreements on welfare are more directly linked to changes in the prices of exchange, i.e., the terms of trade. Chang and Winters (2002) employ a simple strategic pricing game in segmented markets to measure the effects of MERCOSUR on the prices of exports from “non-member” countries to Brazil: as Brazil exempts its MERCOSUR partners from tariffs, the resulting competitive pressure leads other exporters to reduce their prices. Working with detailed data on unit values and tariffs, the authors find that the creation of MERCOSUR was associated with significant drops in the prices of exports from non-members to the region.
Evaluation Context
Preferential Trade Agreements (PTAs) have become an integral and enduring aspect of the multilateral negotiating regime. Between 1990 and 1997, eighty-seven preferential agreements were notified to the World Trade Organization (WTO), and almost all WTO signatories are currently members of at least one PTA. Despite this widespread existence, concerns persist about the welfare impacts of PTAs, especially on excluded countries. The effects of these preferential agreements on trade volume and quantities are frequently studied, but these variables are not a reliable guide to welfare effects on third countries. The latter are more directly related to price effects, and there are few studies on these. In fact, no other published ex-post study on the price effects of a PTA on its trading partners has been identified.
Intervention Details
Chang and Winters (2002) analyze one of the most recent and controversial customs unions, MERCOSUR (between Argentina, Brazil, Paraguay, and Uruguay). The authors examine the effect that MERCOSUR has had on the import prices of non-members, assuming that these countries export to two segmented markets, (1) Brazil and (2) the rest of the world, in a scenario of imperfect competition with differentiated products. The study focuses on the Brazilian import market, as it is a large market and by far the largest in MERCOSUR. It is considered that changes in Brazilian tariffs of most-favored nations (mfn) have directly led to price changes by non-member companies exporting to Brazil, and that tariff preferences offered to members, for example, Argentina, lead to additional “strategic” price responses in the Brazilian market. Thus, the authors seek to identify these responses in both Brazilian commodity import data and export data from its main suppliers abroad.
The trade data from which unit values (as value/quantity) were obtained were taken from the United Nations (UN) Comtrade database, at the 6-digit level of the Harmonized System (HS). This data offers two major advantages over other sources. First, it is highly disaggregated: more than 5.000 commodities are distinguished. This helps minimize heterogeneity within each category, which in turn improves the quality of the unit value data and reduces the need for tariff averaging within categories. Second, trade and tariff data combine very well at the 6-digit level because at this level the HS classification is universal across countries.
The tariff data were provided by the United Nations Conference on Trade and Development (UNCTAD) and the MERCOSUR Secretariat. The Common External Tariff (CET) for 1995 and 1996, and the exceptions listed in the Ouro Preto Protocol agreement, are defined at the HS-8 digit level. To harmonize the tariff and price data, the authors truncated the tariff codes to 6 digits and took simple averages.
Methodology Details
To perform the analysis, Chang and Winters (2002) present a model in which reduced-form estimation equations are derived and a comparative statics exercise is used to interpret their coefficients. The model involves two firms, one "non-member" and the other "member," exporting a differentiated product to the Brazilian market. The two firms respond to each other's prices (as well as to their own tariffs, exchange rates, and wages), playing a Bertrand pricing game in the Brazilian market. The game is explored by examining the relative prices of members and non-members in Brazil and, for certain exporters, the relative prices of exports to Brazil and other markets.
It is postulated that the export prices of non-member companies to Brazil are influenced not only by the tariffs they face, but also by the tariffs faced by their rivals in member countries, through the effect of the latter on the prices of their rivals. Thus, both responses are estimated from commodity export data of Brazil's main foreign suppliers.
Results
The MERCOSUR nations made significant tariff adjustments during the years 1989 to 1996. In addition to unilateral reforms throughout 1989-95, they largely abolished tariffs on imports from partners throughout 1991-95, as governed by the Treaty of Asunción, 1991. The MERCOSUR Common External Tariff (CET) is based on the Ouro Preto Protocol, agreed upon, after much dispute, at the end of 1994 and implemented in the following two years. The different phases of these adjustments, plus exceptions for both the CET and internal free trade, mean that preferential margins in internal trade show considerable variations both over time and between commodities. This helps to identify their effects empirically.
In this sense, empirical results indicate that the US exported approximately US$5,4 billion to Brazil in 1991. With partner tariffs falling by an average of 26 percentage points until 1996 and a coefficient of 0,445, this implies a loss of US$624,1 million in that year. Similar losses occurred for the other countries that reported export data – Japan (with losses of US$58,8 million), Germany (US$236 million), Korea (US$13,7 million), and Chile (US$17,3 million). These estimates are considered crude – for example, not all US exports may have been affected, and there may have been partially compensatory changes in quantities – but they are indicative of the magnitudes of losses in export revenues that countries left out of regional agreements may suffer. The estimates are quite similar when added together for the entire range of goods.
Lessons in Public Policy
One of the main influences on the well-being of any trading economy is its terms of trade; therefore, issues related to trade policy must be linked to this variable. However, given its importance in theory, this issue is rarely addressed in empirical studies. In this sense, Chang and Winters (2002) empirically show that regional integration affects the prices of traded goods. This is not surprising from a theoretical point of view, as previously mentioned, since price effects are at the heart of the analysis of international trade policy. What is new empirically – with the exception of previous work by the authors themselves, which used less appropriate data and a weaker empirical test, there is no other ex-post empirical study of the price effects of integration.
Chang and Winters (2002) also show that the price effects of integration can be quantitatively significant for non-member exporters supplying an integrating market like Brazil. An important policy implication is that, even if Preferential Trade Agreements aim only to facilitate trade between constituent territories and not to raise barriers to trade between other contracting parties and those territories, the other contracting parties may still be harmed. The effects on “non-members” have always been a concern, as evidenced by the fact that both Article XXIV and the “Enabling Clause” contain wording suggesting that non-members should not be harmed. Thus, the study's results provide empirical support for the well-known theoretical argument that, even if external tariffs remain unchanged by integration, non-member countries are likely to be harmed by regional integration.
References
Chang, W., & Winters, L. A. (2002). How regional blocs affect excluded countries: The price effects of MERCOSUR. American Economic Review, 92
