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The FTA

April 30th, 2004

I’ll be participating in a Senate Roundtable on the proposed FTA with the United States next week, and things have been livened up with the release of a new study from the Centre for International Economics with the following optimistic bottom line

The most probable effect on macroeconomic welfare after a decade, as represented by real gross national product (GNP), is an increase of $5.6 billion per year above what it might otherwise be.

Not surprisingly I think this is estimate is way of the mark (warning: big JPEG coming up).

You can read the whole report (PDF) file here, but most of what you need to know is in this graphCIEgraph
As can be seen from this graph, the gains from the trade part of the deal are small. Goods and services are not broken out separately in the figure or (as far as I can tell so far) in the report as a whole, but it’s pretty clear that the net impact on the goods sector in the medium term is small (well below 0.1 per cent of GDP or about $750 million per year). It might even be negative, which would be consistent with my estimates.

I haven’t had time to look at the estimated gains from services, but I thought these were overstated in the previous report (though in part this was because they encompassed dynamic gains, discussed below).

The big gains in the picture come from two main sources. The first is so-called “dynamic gains” from liberalisation. I’ve pointed out many times that such gains are little more than a pious belief held by advocates of free-market reform. They have no basis in neoclassical economic theory and no real supporting evidence. The report is gracious enough to cite my objections, but goes on to ignore them.

The second, arising from another topic in which I’ve been very interested for a long time, is the idea that capital market liberalisation will reduce the equity risk premium and therefore increase economic welfare. For the moment, I’ll just say that this claim is highly problematic.

I know this blog has some readers from the CIE[1] and I’ll be interested in developing the debate

fn1. Full disclosure. I worked there myself in the late 1980s, and am friendly with a number of people there.

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  1. gordon
    April 30th, 2004 at 16:20 | #1

    It’s interesting to see that an outfit (the CIE) which previously trumpeted the $4bn. trade benefits of the the FTA are flexible enough to remain supporters even after their original forecasts have collapsed. The support remains, only the rationale has changed! In your post of 15 April (“Investment and the FTA”) you said: “There is no reason to expect benefits from further deregulation of capital markets and especially not from “standstill” commitments that prevent us from ever learning and implementing the lessons of the 1980s and 1990s.” I agree, and hope that further discussion will illustrate the costs to Australia of this NAFTA-esque agreement.

  2. April 30th, 2004 at 16:53 | #2

    The FTA is all about Howard claiming that his military support for US adveturism has an FTA sweetheart-contract economic pay-off.

    Howard was correct to fall into step with the US in the Gulf War, but he should not pretend that it was anything other than “past consideration” for Timor, rather than a downpayment on the FTA.

  3. April 30th, 2004 at 22:24 | #3

    How does the CIE go from an est. US$2 billion/year benefit to a massive US$5.6 billion/year, when its initial report said our biggest gains would come from sugar and dairy, and neither was fully freed up?

  4. Brian Bahnisch
    May 1st, 2004 at 00:23 | #4

    At least the CIE report appears to be written in accessible language. Still it will take me some time to read as time is what I don’t have.

    One query. I’ve heard government apologists mention access to the American (Federal) govt procurement market as a potential boon. The Report estimates the size of this market to be A$200 billion. It guestimates our share as $200 million, up from $50 million at present.

    Recently I read an article in BRW, I think, which mentioned that the US were enforcing very restrictive visa quotas on skilled workers. Whereas there had been some relaxation to other free trade partners, no such favours were forthcoming to Australia. As a result the quota had been exhausted in seven months, from memory.

    Will this draconian and bloody-minded restriction inhibit or prevent increased penetration of the Govt procurement market?

    Does such a restriction adversely affect other aspects of the FTA?

    Was not the freer movement of professionals and skilled workers to be one of the major benefits of the FTA?

  5. Harry Clarke
    May 1st, 2004 at 09:44 | #5

    The main issue in CIE is the claimed 5 points reduction in capital costs via the reduction in the equity premium in encouraging more capital, higher wages and higher incomes net of interest. (Gordon, these also account for the major gap between initial and current benefit forecasts).

    The 5 points figure is small given the claimed 120 points extra equity premium claimed between Australia and US equity markets. But the effects of the loosening restrictions on US investment are not striking — it is difficult to judge since you cannot just look at past application knockbacks. But Australian capital markets do appear quite open despite CIE’s comparisons with other countries.

    The numbers here should be put in context — FTA causes a .7% increase in GNP after 10 years of which about 60% is a consequence of the equity premium effects. No dramas and any market liberalisation should deliver some benefits.

  6. Harry Clarke
    May 1st, 2004 at 12:56 | #6

    The CIE estimates of the reduced equity premium consequence on FTA and the effects of this on income are, as they recognise, ‘back of the envelope’. Nitpicking criticisms of them raise the inevitable question of ‘how one might do better?’. But I am still surprised that such rough computations are the main drivers of the bottom line reported in the press.

    Interesting parts of the report to me were claimed small costs to Australians of commitments made with respect to PBS and intellectiual property. These can be more readily analysed.

  7. May 3rd, 2004 at 12:11 | #7

    Q – you report the GNP number, but put up the chart for GDP. Not that it makes much difference. I’m sure you agree (as the report says) that GNP is the more appropriate number.

    It might also be of interest for readers to note that “sensitivity analysis over the most probable range of estimates indicates that there is a 95 per cent chance the extra welfare of Australians could lie between $1.1 billion and $7.4 billion per annum in 20 years time once all liberalisation and effects have worked through” (p x)

    The old report and the new report aren’t comparable for a number of reasons. Some of these are outlined in Chart 4 (p x).

    Info on the split between merchandise and services is available. Most especially, you’ll be interested in chart 7.1 on page 83 – which splits up merchandise trade, services trade and government procurement – and also splits up the results by trade creation, trade diversion, changed taxes, terms of trade, technical efficiency, capital accumlation and foreign income flows.

    You’ll find that the services benefit is more modest that the benefit that was reported in the previous CIE report – for a number of reasons – and that the total impact of merchandise liberalisation is a small positive.

  8. Aaron
    August 25th, 2004 at 10:51 | #8

    Ross Gittins’ in his article ‘The protectionist’ argues the recent AUSFTA is a deal that greatly contradicts its name. Gittins argues that this recent bilateral trading agreement will not liberate trade simply divert it from other countries Australia trades with.

    Gittins also has a viewpoint that nations before entering negotiations to such deals, consciously decide to employ a Machiavellian type attitude throughout the course of negotiations. He makes this point through telling the reader that FTAs are not decided by the ‘rational economists’ but the ‘protectionists’.

    Gittins’ final opinion is that the actual economic benefits or detriments for the Australian economy will not be insignificant.
    Counter Argument:
    Although Gittins has some notable points he over simplifies many of the issues involved with free trade. Gittins’ point that protectionists decide FTAs is accurate. It would be blindly optimistic to even hope that countries would simply send ‘rational economists’ to these deals in order to agree on a ‘fair for all’ set of guidelines for bilateral trade. For this reason it is only natural that nations become ‘protectionists’ in negotiation and simply try to get as much as possible and give as little as possible.

    Gittins’ second point that the AUSFTA is simply a diversion of trade is correct. The reason that is will divert trade is because the incentives of trading with America will; or at least can out way those incentives affiliated with trading with another nation or region such as Asia or the EU. Despite Gittins’ cynical and dismissive approach to such an occurrence, from Australia’s point of view there is no disadvantage in such happenings.

  9. Aaron
    August 25th, 2004 at 10:53 | #9

    Ross Gittins’ in his article ‘The protectionist’ argues the recent AUSFTA is a deal that greatly contradicts its name. Gittins argues that this recent bilateral trading agreement will not liberate trade simply divert it from other countries Australia trades with.

    Gittins also has a viewpoint that nations before entering negotiations to such deals, consciously decide to employ a Machiavellian type attitude throughout the course of negotiations. He makes this point through telling the reader that FTAs are not decided by the ‘rational economists’ but the ‘protectionists’.

    Gittins’ final opinion is that the actual economic benefits or detriments for the Australian economy will not be insignificant.
    Counter Argument:
    Although Gittins has some notable points he over simplifies many of the issues involved with free trade. Gittins’ point that protectionists decide FTAs is accurate. It would be blindly optimistic to even hope that countries would simply send ‘rational economists’ to these deals in order to agree on a ‘fair for all’ set of guidelines for bilateral trade. For this reason it is only natural that nations become ‘protectionists’ in negotiation and simply try to get as much as possible and give as little as possible.

    Gittins’ second point that the AUSFTA is simply a diversion of trade is correct. The reason that is will divert trade is because the incentives of trading with America will; or at least can out way those incentives affiliated with trading with another nation or region such as Asia or the EU. Despite Gittins’ cynical and dismissive approach to such an occurrence, from Australia’s point of view there is no disadvantage in such happenings.

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