How the US and EU could boost trade by 50%

The TransAtlantic Trade and Investment Partnership (TTIP) negotiations have become a full-blown political issue. This is understandable. The two largest economic entities in the world – already highly integrated – are negotiating a deep integration agreement, going beyond what has been done previously in any agreement except the EU’s Single Market programme. This makes TTIP different. Can economists say anything about the likely economic impact of such an agreement?

Size is not what you think

Much has been said about the size of the two economies which together account for almost half of world GDP and a third of world trade. However, the TTIP is to some extent a desperate attempt by both the EU and the US to retain as much as possible their leadership in world trade.

• Strictly speaking, TTIP would only affect bilateral trade between the EU and the US, which in 2011 represented 4.4% of world trade.

Indeed, the EU-US share in world trade has declined sharply in this century. This is to be compared with the corresponding figure for the ASEAN+6 countries of 16%.

• On current trends, the EU and the US would jointly account for only 22% of world trade in 2035, compared to 37% for ASEAN+6, and trade between ASEAN+6 members (17%) would dwarf that between transatlantic partners (2.4%).

TTIP will not reverse this, but it may allow the signatories to continue to play leading roles in world trade through the setting of norms, standards, and other rules. This is precisely what the TTIP is about – establishing coherence among existing rules and finding ways of defining new rules in common.

Note that the TTIP should be thought of as a continuation of a long-standing – although less visible – effort to progress on the regulatory front. Several targeted agreements have been signed, including the US-EC Mutual Recognition Agreement and its six sector annexes in 1998, the US-EC understanding on Safe Harbor Principles for Data Privacy Protection in 2000, and many other examples. A number of institutions have been built to foster dialogue and cooperation including the Transatlantic Business Dialogue, the Transatlantic Consumer Dialogue, and the Transatlantic Economic Council set up in 2007, in the wake of what has come to be known as the “Merkel initiative” for a new transatlantic partnership.

A new type of negotiations challenging economists

Tariffs applied to partner exports are low (on average) on both sides, i.e. 2% in the US and 3% in the EU. Some tariff peaks for sensitive products persist (mainly among dairy products, clothing, footwear, and steel items for the US, and meat products in the EU). Phasing out those tariffs will meet internal resistance but is not a big deal at the macroeconomic level.

More important are the non-tariff measures that must be negotiated, such as regulation of services, transport, public procurement, geographical indications, and investment. Two emblematic issues – chlorine-rinsed chicken and investor-state dispute settlement – are raising fears in Europe of a downgrading of standards, or even worse, the possibility of foreign influence being imposed on domestic constituencies. Not to speak of public services, audio-visual services, communications and data security which were excluded from the beginning.

Non-tariff measures include import bans, certification requirements for a variety of products ranging from toys to cars to pacemakers, information on the properties of chemical substances, labelling and packaging requirements, upper limits on the concentrations of pesticide residues, and meat traceability requirements. In most cases, the corresponding regulation has a legitimate purpose, such as ensuring consumer information, improving product safety, or preserving the environment. However, cross-country differences related to these measures can deliberately or not, impose additional costs on exporters. Some of these costs may be caused by substantial differences, others may be the result of different application modalities, whether certification methods, labelling requirements, or ways of measuring technical characteristics.

There are different ways to address these regulatory issues. Differences in technical standards to an extent can be resolved by mutual recognition. There are already mutual recognition agreements in place for seven areas (e.g. medical devices), that is, certification provided on one side of the Atlantic is valid on the other side. This prudent approach has not proved entirely satisfactory, and the private sector is eager to embark on a real mutual recognition of standards.

Mutual recognition becomes especially problematic in the area of sanitary and phytosanitary measures, which often mirror collective preferences. In fact, even the conservative approach of mutual recognition of accreditation bodies is not part of the existing agreement on food products. In the case of food products, the simple formula “what’s good for us is good for you” does not apply between Europe and the US.

Quantitative assessment

Such a multifaceted negotiating agenda includes a number of areas that are not easily quantified. Economic modelling can be used to evaluate the economic consequences of an agreement in relation to both tariffs and the provisions related to non-tariff measures, including regulation of the services sectors (see Baldwin and Francois 1997 for a pioneering evaluation). Fontagné et al. (2013) conduct an assessment using MIRAGE, a Computable General Equilibrium model of the world economy developed by CEPII. While the TTIP’s beyond-tariff changes are complex and varied, this wide-ranging exercise relies upon strong simplifying assumptions about these measures and their trade consequences, as reflected in econometric estimates of their trade restrictiveness.

Our central scenario combines a progressive but complete phasing-out of tariff protection accompanied by an across-the-board 25% cut in the trade restrictiveness of non-tariff measures, for both the product and service sectors but excluding public and audio-visual services. The simulations suggest that trade in goods and services between the two signatory regions would increase by half as a result of the agreement, with an even larger impact on agriculture. We detect little trade diversion induced by the TTIP (Table 1).

Table 1. Reference scenario – Long term impact on TTIP on bilateral exports (%)

Note: trade in volume, percentage deviation from baseline in 2025.
Source: Fontagné et al. (2013).

Overall, the EU and the US would achieve similar GDP gains (+0.3%). These figures are more conservative than but not qualitatively different from those in the European Commission study published in March 2013 (resp. 0.5% and 0.4%, see CEPR 2013). The main conclusion lies elsewhere. Eighty percent of trade expansion, and more than 90% of real income gains, would come from non-tariff measure cuts. Regulatory coherence is the central issue.

Regulatory coherence is what matters

The effect of non-tariff measures on trade flows can be assessed econometrically and we can infer from this a fictitious import tariff rate that would reduce imports by the same amount as the non-tariff measure. Our baseline assessment makes use of two sources, Kee et al. (2009) for trade in goods, and Fontagné et al. (2011) for cross-border trade in services. We refer here to protection levels ranging from 30% to 50%. Ad-valorem equivalents based on a large-scale business survey compiled by Ecorys (2009) for the European Commission, point to higher levels in agriculture, lower levels in manufacturing, and significantly lower levels in services. The estimated impact changes when alternative measures of the trade restrictiveness of non-tariff measures are used (Table 2). In fact, much more research is needed for a better understanding of the economic impacts of non-tariff measures. However, existing studies suggest that the trade and welfare impacts of non-tariff measures are large and generally outweigh the impacts of tariffs.

Table 2.  Alternative scenarios – Impact on total exports

Note: trade in volume, percentage deviation from baseline in 2025. Alternative non-tariff measures as in CEPR (2013).
Source: Fontagné et al. (2013).

Trade policy has no legitimacy to modify regulation choices regarding food safety, financial stability, or air pollution, for instance. Accordingly, policymakers, so far, have been very clear that such choices will not be affected by the agreement. Thus, regulatory systems on both sides of the Atlantic must be made more cooperative and consistent, while avoiding undue interference with collective choices born out of well-established institutional systems. This will be challenging. But the potential reward may be worth the negotiating pain.

References

Baldwin R. & Francois J. (1997), Preferential Trade Liberalization in the North Atlantic, CEPR Discussion Paper 1611.

CEPR (2013), Reducing Transatlantic Barriers to Trade and Investment: An Economic Assessment, Report for DG Trade, March.

Ecorys (2009), Non-Tariff Measures in EU-US Trade and Investment – An Economic Analysis, Study for the European Commission, DG Trade.

Fontagné L., Gourdon J. & Jean S. (2013) Transatlantic Trade: Whither Partnership, Which Economic Consequences? CEPII Policy Brief, 2013-01.

Fontagné L., Guillin A. & Mitaritonna C. (2011), “Estimations of Tariff Equivalents for the Services Sectors”, CEPII Working Paper 2011-24.

Kee H., Nicita A. & Olarreaga M. (2009), Estimating Trade Restrictiveness Indices, Economic Journal 119: 172-199.

Published in collaboration with VoxEU

Author: Lionel Fontagné is Professor of economics in the Paris School of Economics, Université Paris I Panthéon Sorbonne. Dr. Sébastien Jean is Director of CEPII, the French leading think tank in international economics.

Image: A container ship departs Burrard Inlet in Vancouver, British Columbia March 6, 2009. REUTERS/Andy Clark (CANADA) – RTXCG59