This is how trade agreements can benefit you as well as your country

Over the past two decades, there has been a surge in the number of trade agreements. Economists have studied the economic consequences of these agreements in some depth, focusing on their impact on variables such as trade flows, productivity, firm exit and entry, employment, and wages (e.g. Pavcnik 2002, Trefler 2004, Baier and Bergstrand 2007, Topalova and Khandelwal 2012).

One area that has been somewhat neglected by recent research is the impact of trade agreements on consumers. A central tenet of international economics is that lowering trade barriers increases welfare. Trade agreements between countries lower trade barriers on imported goods and, according to theory, they should provide welfare gains to consumers from increases in variety, access to better quality products and lower prices.

While economists have tried to quantify the overall gains from openness (e.g. Costinot and Rodriguez-Clare 2014), there is not much evidence for actual trade agreements, and little is known about the relative importance of the channels through which trade agreements affect welfare. In light of recent public and political opposition to new agreements (such as the EU-Canada Comprehensive Economic and Trade Agreement or the Transatlantic Trade and Investment Partnership, the proposed agreement between the EU and the US), it is important to understand how past trade agreements have affected consumers.

In recent work, we study the consumer impact of trade agreements negotiated by the EU between 1993 and 2013 (Berlingieri et al. 2018). The EU provides an interesting case study in this context as it is the biggest trading bloc in the world and has been a prolific negotiator of trade agreements over the past two decades.

We provide estimates of the overall impact on consumer welfare of 39 trade agreements implemented during our sample period, and decompose the total effect into contributions arising from changes in prices, quality and variety. Throughout, we define the EU as the 12 member states before the 1995 enlargement (the EU12) to maintain a consistent group of countries for the analysis.

We start by constructing measures of prices, quality, and variety. Prices and the number of origin countries for each product (our measure of variety) are readily observed in international trade data.

Measuring quality is more challenging and we follow recent approaches in the literature (e.g. Khandelwal et al. 2013), which take a broad view of quality as all product characteristics that increase demand while holding price constant. So quality can be captured by measuring market share differences between products once differences in prices have been controlled for.

For example, suppose we observe in our data that 21-inch LCD televisions imported from Korea into the EU12 have the same price as those from Japan, but Japan’s market share is 20% and Korea’s is 10%. Then the quality estimate for Japan will be higher. If the price of Japanese LCD TVs is higher, then we would need to control for the price difference, and this would reduce the quality estimate for Japan.

With measures for prices, variety and quality of EU12 imports in hand, we next evaluate how these have changed with the implementation of trade agreements. We compare the evolution of the three variables for the group of countries that signed trade agreements with the EU with a control group of countries that have not.

We have experimented with a wide range of variations of this approach, but the results are always very similar: trade agreements increase quality but they do not have much impact on prices and variety. Our baseline findings indicate that the EU’s trade agreements increased the quality of imported goods from trading partners by around 7% over a five-year period.

These results highlight the importance of taking quality into account. A naive approach that only looks at the impact of trade agreements on (non-quality-adjusted) prices might erroneously conclude that trade agreements have no impact on consumers. At least for the trade agreements implemented by the EU, the entire effect works through changes in quality. Once we adjust prices for quality, we find that trade agreements lowered quality-adjusted prices by close to 7%.

While our approach does not allow us to identify the exact sources of these quality improvements, we discuss potential mechanisms. One explanation, which is consistent with a growing literature using firm-level data, is that foreign exporters upgrade quality in preparation for serving the EU market after the implementation of trade agreements (Verhoogen 2008, Iacovone and Javorcik 2012).

Our overall results conceal a substantial amount of treatment effect heterogeneity across EU countries, trading partners and types of trade agreements. For example, higher-income EU countries (Belgium/Luxembourg, Ireland, the Netherlands, and the UK) saw much stronger increases in quality than other EU countries. Indeed, for the group of lower-income EU countries (Greece, Portugal, and Spain), the impact of trade agreements worked almost exclusively through a reduction in prices rather than increased quality.

In a final step, we use our results to compute the implied change in the EU12’s consumer price index (CPI). We note that while our CPI is not directly comparable with the CPI figures published by statistical agencies due to methodological differences, it shares the same goal of measuring changes in the purchasing power of consumers.

We compute the overall CPI impact of the EU's trade agreements by comparing the current situation with a counterfactual scenario in which the EU has not signed any trade agreements. Comparing the CPI in the two scenarios allows us to answer the question by how much poorer EU12 consumers would have been in real terms without the agreement-based trade liberalisation over the past two decades.

We find that the cumulative reduction in the CPI during the period 1993-2013 due to trade agreements was 0.24% in our baseline estimate. Of this overall effect, we attribute around 55% to the direct effect on the prices and quality of imported products. The remaining 45% is due to reductions in the quality-adjusted price of imports of intermediate inputs, which lowers the prices of domestic goods. While this is not a large effect, it still amounts to substantial savings for EU consumers of around €24 billion per year.

We consider this estimate to be a lower bound on the actual welfare gains from trade agreements for a number of reasons.