The back of the envelope model of the FTA
Following up on the snippet below, I’ve done an estimates of the impact of the proposed Free Trade Agreement between Australia and the US, as it affects merchandise trade. My bottom line is that Australia loses about $1 billion per year, of which $800 million is a net transfer of tariff revenue to the US and $200 million is the deadweight cost of replacing the lost tariff revenue, net of reductions in the domestic deadweight cost of tariffs.
This estimate may be contrasted with the most optimistic one publicised before the FTA was signed, a benefit of $4 billion over 10 years or $400 million per year, IIRC.
I’d like to thank everyone who’s contributed to the debate so far, notably Harry Clark, Uncle Milton, John Humphreys and PM Lawrence. The discussion has helped me to sharpen up my own thoughts. Obviously what I’ve done is very preliminary, and I’d welcome more comments.
Here’s a sketch of how I worked this out
Total Aust imports subject to tariff $100 billion
US share $20 billion
Total Aust exports to US $10 billion
Tariffs removed on 50 per cent of Australian exports
Average tariff rate 6 per cent in both countries
US elasticity of supply to Australia 2
Australia elasticity of supply to US 2
Rest of World elasticity of supply to Australia 2
Demand elasticity Australia -0.5
Marginal deadweight cost of taxation (including tariffs) 25 per cent
h5. Equilibrium price changes
No change in world price
No change in domestic US prices
US and world goods not perfect substitutes, hence elasticity of ROW supply is relevant as modelled
Change in Australian price can be approximated by change in tariffs on US goods multiplied by US share, giving a 1 per cent reduction.
Price received by US suppliers rises by 5 per cent
h5. Equilibrium quantity changes
US exports to Australia increase by 10 per cent (= 2 per cent of Australian consumption) or $2 billion
Australian consumption of imports increases by 0.5 per cent ($500 million)
Rest of world exports decline by 2 per cent (=1.5 per cent of Australian consumption) = $2 billion
Australian exports to US increase by 6 per cent ($600 million)
h5. Revenue effects
Australian tariff revenue reduced by $1.3 billion of which
- $1.1 billion accrues to US exporters
- $0.2 billion to Australian consumers
Tariffs paid by Australian exporters reduced by $0.3 billion
Net transfer from Australia to US is $800 million
Resource allocation welfare effects (net of transfers)
Gain in consumer surplus from reduction in tariffs paid by Australians is 25 per cent of $200 million or $50 million. Additional deadweight loss from standard trade theory is bounded above by $50 million. Welfare cost of replacing tariff revenue is 25 per cent of $1.3 billion or about $300 million. Net loss of welfare $200 million.
h3. Total impacts
h3. Transfer to US = $800 million
h3. Resource allocation effect = $200 million
h3. Total welfare loss = $1 billion.