I. Introduction

The currents underlying trade liberalization are presently at a fascinating juncture—midway through an ambitious round of multilateral trade negotiations, alongside a renewed frenzy of forging regional agreements. The world’s largest economy, the United States, provides one of the starkest representations of this phenomenon, tabling bold proposals at the World Trade Organization (WTO) for global reductions in tariff and nontariff barriers while simultaneously launching discussions for free trade areas (FTAs) with partners in the Americas, Africa, the Pacific, and the Middle East.

The present momentum toward regionalism is so well advanced in the United States and elsewhere² that there is very little debate as to whether the policy itself should be pursued; instead, discussion tends to turn on “second-order” questions such as what other countries should be included and how fast the arrangements could be concluded. This paper examines the principal issues raised by the U.S. emphasis on regional and bilateral trade links, drawing lessons from simulations of three free trade arrangements with the United States. The simulations also give insight into the implications of pursuing a strategy of “additive regionalism”(successively concluding FTAs with major trading partners), the potential effects of FTAs on incentives to participate in multilateral liberalization, and the importance of liberalization of agriculture and textiles and clothing.

The paper is laid out as follows. Section II reviews the scope of current and proposed arrangements, exploring in particular the current trading relationships. Section III lays out the main issues of concern with regards to the new arrangements and some of the features that they should encompass in order to complement global market opening. In order to concretize the analysis, Section IV presents the results and implications of stylized simulations of three FTAs—United States/Chile, United States/Central America, and United States/Australia—and a review of other similar studies. Section V concludes.

II. The Scope of U.S. Free Trade Arrangements

The United States has embarked on a new thrust to increase its participation in regional and bilateral trading arrangements over the next few years. Following the long-standing (since 1985) FTA with Israel, the United States established an FTA with Canada in 1989 which subsequently evolved into the North American Free Trade Agreement (NAFTA) by including Mexico in 1993. Since then, an FTA was set up with Jordan in 2001, and arrangements with Singapore and Chile have been signed. The U.S. administration has formally stated its intention to launch FTAs with Morocco, the five countries of the Central American Free Trade Agreement (CAFTA) (Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua), Australia, and the members of the Southern African Customs Union (SACU: Botswana, Lesotho, Namibia, South Africa, and Swaziland) before the end of 2004. Negotiations are also continuing to form the Free Trade Area of the Americas (FTAA) with 33 other democratic nations of the Western Hemisphere by 2005.³

More recently, the U.S Administration has unveiled the broad outlines of a strategy to enhance trading relations with the Middle East. The key components of this program involve: (a) expanding the U.S. Generalized System of Preferences (GSP) to the poorer countries of the region; (b) assisting Middle East countries which are not yet members of the WTO (such as Saudi Arabia) to join; (c) completing the FTA with Morocco and possibly “docking in” other countries to the treaty; (d) launching new FTAs with selected countries—initially Egypt and Bahrain; and (e) eventual establishment of a free trade agreement between the Middle East countries (as a bloc) and the United States.

For the United States, part of the fresh excitement with forging new bilateral and regional trade ties is linked to geopolitical and security considerations, in which trade agreements are seen as a vehicle for deepening political relationships and/or combating terrorism—a prime consideration in the treaties with the Middle East nations. Free trade areas are also viewed as helping to increase market access for U.S. exporters by jumping over high trade barriers (e.g., in SACU), as well as countering preferences in other bilateral/regional accords to which the United States is not party, e.g., Mexico/Chile, Canada/Chile, or the various European Union agreements. The Administration has also argued that this approach can complement multilateral trade liberalization by helping to forge common negotiating positions with partners, or compensate for slow progress in these negotiations.

Trade in goods per se, except perhaps in specific sectors, appears not to be a dominant driving force for the United States—as Table 1 shows, apart from NAFTA members, U.S. exports of goods to other potential partners are not significant as a share of total exports—less than 3 percent for Australia, Bahrain, Chile, Egypt, Israel, Jordan, Morocco, Singapore, SACU, and CAFTA individually. On the other hand, the partners rely much more on their trading relationship with the United States and the shares of exports to the U.S. market have generally increased over time (Table 2), for example, to over one-third of Israeli exports and about one-half of CAFTA’s exports. Although the U.S. market is not currently a principal destination for Middle Eastern countries’ exports, the jump in the share of Jordan’s exports to the United States from 1 percent to 10 percent between 1997/99 and 2000/02 shows the latent potential for rapid expansion of trade flows under FTAs.

Table 1.

United States: Existing and Proposed Free Trade Arrangements

(Data refer to 2002)

Source: IMF, Direction of Trade Statistics. Notes: NAFTA denotes North American Free Trade Agreement; CAFTA denotes Central American Free Trade Agreement; SACU denotes Southern African Customs Union; and FTAA denotes Free Trade Area of the Americas.

Table 1.

United States: Existing and Proposed Free Trade Arrangements

(Data refer to 2002)

			Year of Agreement	U.S. Exports to Partner (US$m)	As Percent of Total U.S. Exports	Partner Exports to United States (US$m)	As Percent of Total Partner Country Exports
Israel			1985	7,039	1.0	11,494	39.3
NAFTA			1993	258,330	37.3	345,059	85.8
	Canada			160,799	23.2	221,292	87.7
	Mexico			97,531	14.1	123,767	82.7
Jordan			2001	404	0.1	398	14.5
Singapore			2003	16,221	2.3	19,106	15.3
Chile			2003	2,612	0.4	3,484	19.1
Morocco			2003	566	0.1	386	4.8
CAFTA			2003	9,840	1.4	11,325	49.9
	Costa Rica			3,132	0.5	3,036	31.5
	El Salvador			1,665	0.2	1,853	63.3
	Guatemala			2,042	0.3	2,706	58.7
	Honduras			2,565	0.4	3,088	69.5
	Nicaragua			438	0.1	643	59.4
Australia			2004	13,084	1.9	6,248	9.6
SACU			2004	2,525	0.4	3,802	12.8
Bahrain			2005	419	0.1	381	4.5
Egypt			2005	2866	0.4	1,288	18.4
FTAA			2005	309,516	44.7	411,085	67.5
	Of which:
		Argentina		1,591	0.2	3,120	10.9
		Brazil		12,409	1.8	15,202	24.3

Source: IMF, Direction of Trade Statistics. Notes: NAFTA denotes North American Free Trade Agreement; CAFTA denotes Central American Free Trade Agreement; SACU denotes Southern African Customs Union; and FTAA denotes Free Trade Area of the Americas.

View Table

Table 1.

United States: Existing and Proposed Free Trade Arrangements

(Data refer to 2002)

			Year of Agreement	U.S. Exports to Partner (US$m)	As Percent of Total U.S. Exports	Partner Exports to United States (US$m)	As Percent of Total Partner Country Exports
Israel			1985	7,039	1.0	11,494	39.3
NAFTA			1993	258,330	37.3	345,059	85.8
	Canada			160,799	23.2	221,292	87.7
	Mexico			97,531	14.1	123,767	82.7
Jordan			2001	404	0.1	398	14.5
Singapore			2003	16,221	2.3	19,106	15.3
Chile			2003	2,612	0.4	3,484	19.1
Morocco			2003	566	0.1	386	4.8
CAFTA			2003	9,840	1.4	11,325	49.9
	Costa Rica			3,132	0.5	3,036	31.5
	El Salvador			1,665	0.2	1,853	63.3
	Guatemala			2,042	0.3	2,706	58.7
	Honduras			2,565	0.4	3,088	69.5
	Nicaragua			438	0.1	643	59.4
Australia			2004	13,084	1.9	6,248	9.6
SACU			2004	2,525	0.4	3,802	12.8
Bahrain			2005	419	0.1	381	4.5
Egypt			2005	2866	0.4	1,288	18.4
FTAA			2005	309,516	44.7	411,085	67.5
	Of which:
		Argentina		1,591	0.2	3,120	10.9
		Brazil		12,409	1.8	15,202	24.3

Source: IMF, Direction of Trade Statistics. Notes: NAFTA denotes North American Free Trade Agreement; CAFTA denotes Central American Free Trade Agreement; SACU denotes Southern African Customs Union; and FTAA denotes Free Trade Area of the Americas.

Table 2.

Evolution of Trade: United States and Free Trade Partners

(percent of partner exports to United States)

Source: IMF, Direction of Trade Statistics Notes: NAFTA denotes North American Free Trade Agreement; CAFTA denotes Central American Free Trade Agreement; SACU denotes Southern African Customs Union; and FTAA denotes Free Trade Area of the Americas.

Table 2.

Evolution of Trade: United States and Free Trade Partners

(percent of partner exports to United States)

			1990–93	1994–96	1997–99	2000–02
Israel			30	31	35	38
NAFTA			78	82	86	87
	Canada		78	82	86	88
	Mexico		78	84	87	87
Jordan			1	1	1	10
Singapore			21	18	19	16
Chile			17	15	15	18
Morocco			3	3	4	5
CAFTA			43	38	35	45
	Costa Rica		49	40	20	21
	El Salvador		33	29	20	35
	Guatemala		38	33	51	58
	Honduras		52	47	50	70
	Nicaragua		25	39	40	43
Australia			10	6	9	10
SACU			7	5	7	12
Bahrain			4	3	2	5
Egypt			10	13	12	13
FTAA			60	62	66	70
	Of which:
		Argentina	11	9	9	11
		Brazil	21	20	19	24

Source: IMF, Direction of Trade Statistics Notes: NAFTA denotes North American Free Trade Agreement; CAFTA denotes Central American Free Trade Agreement; SACU denotes Southern African Customs Union; and FTAA denotes Free Trade Area of the Americas.

View Table

Table 2.

Evolution of Trade: United States and Free Trade Partners

(percent of partner exports to United States)

			1990–93	1994–96	1997–99	2000–02
Israel			30	31	35	38
NAFTA			78	82	86	87
	Canada		78	82	86	88
	Mexico		78	84	87	87
Jordan			1	1	1	10
Singapore			21	18	19	16
Chile			17	15	15	18
Morocco			3	3	4	5
CAFTA			43	38	35	45
	Costa Rica		49	40	20	21
	El Salvador		33	29	20	35
	Guatemala		38	33	51	58
	Honduras		52	47	50	70
	Nicaragua		25	39	40	43
Australia			10	6	9	10
SACU			7	5	7	12
Bahrain			4	3	2	5
Egypt			10	13	12	13
FTAA			60	62	66	70
	Of which:
		Argentina	11	9	9	11
		Brazil	21	20	19	24

Source: IMF, Direction of Trade Statistics Notes: NAFTA denotes North American Free Trade Agreement; CAFTA denotes Central American Free Trade Agreement; SACU denotes Southern African Customs Union; and FTAA denotes Free Trade Area of the Americas.

Much of the economic impetus for the FTAs therefore lies outside of merchandise trade. The United States, as the world’s principal exporter of services, has a particular vested interest in market opening in this area. Rules on liberalizing services as well as on such matters as intellectual property rights, the environment, labor standards and provisions for uninhibited capital transfers are now standard components of the new genre of FTAs. Many of the partners of the United States in fact view the likely stimulus to direct foreign investment as even more critical than market access in goods, especially since their goods may already have preferential entry terms to the United States although on a discretionary basis (such as under the GSP, Caribbean Basin Initiative (CBI), and African Growth and Opportunity Act (AGOA)).

III. Principal Issues in the New Regionalism

The combination of economic, political and security motivations has clearly been strong enough to drive the pursuit of FTAs with the United States, and there is little discussion now about changing course. Accepting this momentum as given, it is nonetheless important to take into account several factors as the strategy is implemented. Six principal concerns can be distilled, related to possibilities of trade diversion, a slackening of the drive towards multilateral liberalization, the higher cost of nonparticipation as FTAs proliferate, high administrative costs, vulnerabilities associated with reliance on regional preferences, and integrating new components into FTA, such as on capital flows, labor and the environment.

(i) A standard concern in the economic analysis of preferential trade arrangements is the possibility that, as trade barriers are lowered between partners, trade may be diverted away from lower-cost suppliers that are not members of the arrangement.⁴ This is because the higher tariff on their goods may now make them more expensive than imports from members (which may be produced at a higher cost but now incur a lower or zero tariff). The welfare losses from trade diversion are related to the fact that when the importing country buys from a costlier source, resources are shifted towards less efficient producers. On the other hand, the possibility of trade creation must also be acknowledged, whereby because of a reduction in tariffs, imports from partners may actually supplant costly local production.⁵ Overall, therefore, the net welfare effect on members and the global economy of a preferential trade arrangement is uncertain.

(ii) Concentration on building bilateral and regional alliances may distract from and dilute the momentum towards multilateral trade liberalization. Failure to meet several deadlines at the WTO, culminating in the deadlock at the Cancún Ministerial meetings in September, has already shaken confidence in the pace and eventual content of the Doha Development Agenda. In this climate, the U.S. leadership role is key and its focus on bilateralism/regionalism may influence other countries to reduce their willingness to offer concessions on a multilateral basis, and instead save their offers for bargaining at a regional level. Similarly, the United States may find itself tempted to reserve some preferences for the FTAs. For example, if implemented globally, its WTO proposal to cut and harmonize tariffs on industrial goods between 2005 and 2010 and eliminate them by 2015⁶ would reduce the relative attractiveness of FTAs. Moreover, since countries, especially small ones, often face constraints on negotiation resources, pursuit of FTAs could divert scarce resources away from multilateral negotiations.

(iii) As more countries get into regional arrangements, the cost of nonparticipation mounts. Consequently, although some countries may prefer the multilateral route, they may gauge that, without similar arrangements, they could be at a competitive disadvantage. In this regard, the characterization of the U.S. strategy by USTR officials as one of “competitive regionalism” whereby countries vie for access to the large U.S. market may indeed be apt. The proposed arrangements with Chile and CAFTA have already sparked a flurry of interest among nonparticipants in the Americas, such as Colombia, in having their own bilateral agreements with the United States. U.S. activity in the Western Hemisphere is also having repercussions in the Pacific.⁷ Arguments have been made that the U.S. approach could catalyze other regions to establish competing, and possibly protectionist, FTAs.⁸

(iv) A plethora of, sometimes overlapping, trade agreements could add considerable administrative cost and confusion due to the need to negotiate separate agreements, and establish and police various rules of origin and preference margins. In the case of the SACU, for example, there is a wide variety of trade practices among members and a single U.S./SACU FTA would represent a considerable challenge in terms of harmonizing the various laws and administrative practices within this region (Leith and Whalley, 2003).⁹ It also must be emphasized that, while the administrative cost of establishing FTAs could be high, the preference benefit may be actually very short-lived in some cases. Preference margins of participants could be seriously eroded in light of the upcoming liberalization of the global textile market at the beginning of 2005, progress in advancing the Doha Agenda, and as the number of FTAs with the United States grows.

(v) Reliance on preferential liberalization could potentially increase vulnerability since the preferences could be modified or withdrawn, for political or other reasons.¹⁰ Even if preferences are not affected by such factors, their effects can change rapidly over time as new FTAs proliferate and margins of preference are eroded. A more stable system would be the multilateral reduction of trade barriers within a set of common rules.

(vi) The current genre of U.S. FTAs features relatively new elements, such as agreements on labor standards, the environment, intellectual property rights and capital movements.¹¹ Integration of such elements into trade treaties may risk overburdening the arrangements, especially if nonperformance attracts trade sanctions. For example, in the U.S.-Chile and U.S.-Singapore Agreements, limits and penalties are established on restrictions of capital transfers¹²—in principle, bilateral efforts that proscribe the temporary imposition of capital controls in crisis could undermine the effectiveness of any broader strategy to implement emergency measures. Unless carefully designed and managed, insistence on strict labor, intellectual property and environmental standards could work to restrict trade, especially in countries where institutions are weak.

In general, trade liberalization on a multilateral basis is preferable to regional/bilateral schemes in avoiding trade diversion and the complications accompanying a large amount of overlapping preferential arrangements. Regional agreements may nonetheless provide helpful opportunities to promote trade liberalization, especially when political and other factors impede unilateral or multilateral approaches. The key to ensuring that these arrangements have favorable effects is to strive toward maintaining relatively low external barriers in order to minimize trade diversion. Typically, regional agreements are likely to offer the greatest benefits, and to entail less diversion, if they have the following characteristics:¹³

• They are diverse in regional coverage. Diversity is associated with greater complementarity of trade patterns, and greater trade with advanced countries may bring advantages to developing countries through increased investment flows and technology transfers.¹⁴ This suggests that the benefits of North-South arrangements may exceed those of South-South arrangements (World Bank, 2000).

• They are comprehensive in their coverage of products. FTAs are likely to bear greater fruit if they are extended beyond manufactured trade, and include agricultural products and services.¹⁵ Even more benefits can potentially derive from comprehensive approaches that liberalize foreign direct investment, strengthen competition policy and improve regulatory frameworks. However, the emphasis should be on assisting countries toward these objectives, rather than using the threat of trade sanctions to spur action.

• FTAs may play an important role in helping lock in broader reform agendas among participating countries. For example, FTAs appear to have been helpful in encouraging reforms in the area of investment protection and customs administration. At the same time, however, care is needed to ensure that reforms are consistent and appropriate for countries’ stage of development.

The U.S. model for bilateral and regional trade arrangements meets many of the criteria for maximizing the potential benefits. For example, as part of the negotiation of the FTAA, timetables are to be established for removal of all trade restrictions on manufactured goods, agriculture and services. Hemisphere-wide rules would be established for intellectual property rights, subsidies, antidumping, countervailing duties, government procurement, investment, competition policy and dispute settlement. Two major challenges remain, however. One is to ensure that these efforts do not undermine the momentum for multilateral liberalization, which would still be the first-best alternative. The other is to tailor these rules to suit the development needs of developing countries involved in a U.S. FTA (such as in the area of capital controls) and avoid using trade remedies as a protectionist instrument.

IV. Simulations of Free Trade Arrangements with the United States

A. The Global Trade Analysis Project (GTAP) Model

The Global Trade Analysis Project (GTAP) model used in this paper is a comparative static, global general equilibrium model based on neo-classical theory.¹⁶ Firms maximize their profits while consumers maximize their utility. All markets are assumed to be perfectly competitive, and constant returns to scale prevail in all production and trading activities. Firms use both a composite of primary factors and a composite of intermediates to produce their output according to Leontief production technology. The primary factor composite is a constant elasticity of substitution (CES) function of labor, capital, land and natural resources, while the intermediate composite is a Leontief function of material inputs, which are in turn CES blends of domestically produced goods and imports. Imports are sourced from all regions, with their share depending on trading prices (the Armington approach).

On the demand side, each country or region is assumed to have a “super” household disposing of regional income in fixed proportions in the form of private consumption, government expenditure and savings. Household consumption is assumed to be a constant difference in elasticities (CDE) function of various consumer goods while government expenditure is based on a CES function of various commodities. Both household and government consumption are CES blends of domestically produced goods and imports, which are in turn sourced from all trading regions based on the Armington approach.

In closing the model, regional savings are assumed to be homogenous and contribute to a global pool of savings, which is then allocated among regions for investment in response to changes in regional expected rates of return. These changes are assumed to be equalized across regions, thus giving rise to capital (i.e., savings) mobility across regions. This allows for greater changes in the trade balance as a result of trade liberalization and tends to dampen the terms of trade effects. In contrast to savings, capital stocks are assumed to be immobile across regions, although they are perfectly mobile within a region, as is labor. Land and natural resources are industry-specific, and only limited transformation of their uses among industries is possible. The supply of all factors of production is assumed to be constant, and hence factor prices adjust to clear factor markets.

The simplicity of the GTAP model makes its simulation results relatively easy to interpret, but limits its capacity to deal with more complex economic issues, such as the adjustment path over time and long-term effects of trade policies associated with investment accumulation, technology and productivity change. Also absent in the model are adjustment costs associated with trade liberalization. These limitations must be kept in mind when interpreting the results presented in this paper.

The GTAP database provides data on key trade policies, as well as on other essential data for a large number of countries and commodities.¹⁷ The base year for the data is 1997, and for this reason, some recent preferential arrangements are not incorporated in the database. We have updated the tariff levels in the case of Chile to bring them to the levels just before the signing of the Chile-U.S. FTA. The elasticities used in the simulations are presented in Annex Table 2. Sensitivity tests with respect to these elasticities will be discussed later on.

In the remainder of this section, we present the results of simulations of three free trade arrangements: United States/Chile, United States/Central America (CAFTA); and United States/Australia. The simulations involved removing all tariffs on goods as well as bilateral textile and clothing quotas between the partners in the arrangements. The impact on several key economic variables was then analyzed, in particular on welfare, output, terms of trade and trade flows not only of partners but also of excluded countries/regions of interest (See Table 3). The global general equilibrium setting underlying the changes in these variables allowed us to capture some rich and interesting interactions that may not have been evident in a partial equilibrium or single-country analysis. In interpreting the applicability of the results, it is important to recall that dynamic gains are not incorporated in the static GTAP framework, while nongoods provisions of the U.S. FTAs (on services, investment, intellectual property, etc.) could also have meaningful impacts—such factors could be key in determining the overall appeal of the FTAs.

Table 3.

Simulations of Effects of Free Trade Arrangements with the United States

Source: Estimates from Global Trade Analysis Project (GTAP) simulations of full bilateral tariff removal in all sectors, and removal of textile and clothing quotas.

^1/Measure of welfare change in US$million.

Note: CAFTA denotes the Central American Free Trade Agreement

Table 3.

Simulations of Effects of Free Trade Arrangements with the United States

	United States-Chile			United States-CAFTA			United States-Australia
	Equivalent Variation 1/	GDP	Terms of Trade	Equivalent Variation 1/	GDP	Terms of Trade	Equivalent Variation 1/	GDP	Terms of Trade
	(US$m)	(% ch)	(% ch)	(US$m)	(% ch)	(% ch)	(US$m)	(% ch)	(% ch)
Australia	-3.7	0.00	0.00	-36.5	0.00	-0.03	-1.2	-0.03	0.18
Canada	-24.3	0.00	-0.01	-270.0	0.00	-0.11	-50.9	0.00	-0.02
United States	218.2	0.00	0.02	964.1	0.01	0.06	404.0	0.00	0.04
Chile	4.1	-0.07	0.31	-26.8	-0.01	-0.09	-4.1	0.00	-0.02
Mexico	-23.1	0.00	-0.02	-267.7	-0.01	-0.23	-15.1	0.00	-0.02
Argentina	-15.5	0.00	-0.03	-32.0	0.00	-0.06	-4.2	0.00	-0.01
Brazil	-59.8	0.00	-0.03	-123.4	-0.01	-0.07	-15.4	0.00	-0.01
CAFTA	-13.5	-0.01	-0.02	3,858.9	1.49	4.63	-19.9	-0.01	-0.03
Rest of Latin America	-20.9	0.00	-0.02	-231.0	-0.03	-0.22	-11.3	0.00	-0.01
Japan	-31.6	0.00	-0.01	-511.6	0.00	-0.06	-137.9	0.00	-0.02
Rest of Asia	-63.3	0.00	0.00	-1,672.2	-0.03	-0.06	-209.5	0.00	-0.01
Sub-Saharan Africa	-4.4	0.00	0.00	-27.6	0.00	-0.02	-3.4	0.00	0.00
Midde East/North Africa	-13.7	0.00	0.00	-180.4	0.00	-0.04	-22.0	0.00	0.00
European Union	-96.3	0.00	0.00	-990.6	0.00	-0.02	-155.2	0.00	0.00
Rest of the world	-6.6	0.00	0.00	-232.9	0.00	-0.03	-13.5	0.00	0.00
World	-154.4	0.00	0.00	220.2	0.00	-0.03	-259.6	0.00	0.00

Source: Estimates from Global Trade Analysis Project (GTAP) simulations of full bilateral tariff removal in all sectors, and removal of textile and clothing quotas.

^1/Measure of welfare change in US$million.

Note: CAFTA denotes the Central American Free Trade Agreement

View Table

Table 3.

Simulations of Effects of Free Trade Arrangements with the United States

	United States-Chile			United States-CAFTA			United States-Australia
	Equivalent Variation 1/	GDP	Terms of Trade	Equivalent Variation 1/	GDP	Terms of Trade	Equivalent Variation 1/	GDP	Terms of Trade
	(US$m)	(% ch)	(% ch)	(US$m)	(% ch)	(% ch)	(US$m)	(% ch)	(% ch)
Australia	-3.7	0.00	0.00	-36.5	0.00	-0.03	-1.2	-0.03	0.18
Canada	-24.3	0.00	-0.01	-270.0	0.00	-0.11	-50.9	0.00	-0.02
United States	218.2	0.00	0.02	964.1	0.01	0.06	404.0	0.00	0.04
Chile	4.1	-0.07	0.31	-26.8	-0.01	-0.09	-4.1	0.00	-0.02
Mexico	-23.1	0.00	-0.02	-267.7	-0.01	-0.23	-15.1	0.00	-0.02
Argentina	-15.5	0.00	-0.03	-32.0	0.00	-0.06	-4.2	0.00	-0.01
Brazil	-59.8	0.00	-0.03	-123.4	-0.01	-0.07	-15.4	0.00	-0.01
CAFTA	-13.5	-0.01	-0.02	3,858.9	1.49	4.63	-19.9	-0.01	-0.03
Rest of Latin America	-20.9	0.00	-0.02	-231.0	-0.03	-0.22	-11.3	0.00	-0.01
Japan	-31.6	0.00	-0.01	-511.6	0.00	-0.06	-137.9	0.00	-0.02
Rest of Asia	-63.3	0.00	0.00	-1,672.2	-0.03	-0.06	-209.5	0.00	-0.01
Sub-Saharan Africa	-4.4	0.00	0.00	-27.6	0.00	-0.02	-3.4	0.00	0.00
Midde East/North Africa	-13.7	0.00	0.00	-180.4	0.00	-0.04	-22.0	0.00	0.00
European Union	-96.3	0.00	0.00	-990.6	0.00	-0.02	-155.2	0.00	0.00
Rest of the world	-6.6	0.00	0.00	-232.9	0.00	-0.03	-13.5	0.00	0.00
World	-154.4	0.00	0.00	220.2	0.00	-0.03	-259.6	0.00	0.00

Source: Estimates from Global Trade Analysis Project (GTAP) simulations of full bilateral tariff removal in all sectors, and removal of textile and clothing quotas.

^1/Measure of welfare change in US$million.

Note: CAFTA denotes the Central American Free Trade Agreement

B. United States/Chile

The United States is an important trading partner for Chile, purchasing about 19 percent of Chilean exports and providing 20 percent of imports. Chile has a low and mostly uniform MFN tariff of 6 percent, which is waived in a number of cases because of Chilean participation in regional and bilateral arrangements.¹⁸ Our simulation results show that, if the U.S.-Chile FTA were confined only to goods, then both Chile and the United States would experience small welfare gains (Table 3).¹⁹ The results also show that aggregate global welfare does not rise as a result of the FTA—given that both the United States and Chile have relatively low protection, there is actually little scope for enhancing global resource allocation from tariff elimination between these two countries.

In terms of trade flows Chilean exports of processed crops, and to a lesser extent basic crops and textiles and clothing, would receive a boost (Table 4). Some trade diversion, which explains the smallness of the welfare gain, is evident in the altered structure of Chilean imports as machinery and equipment and basic manufactures from the United States would replace some lower cost imports mainly from the European Union,²⁰ Japan and the rest of Asia. There is little diversion from Argentina (which provides about 16 percent of Chilean imports) because of the product composition—imports from this source do not compete as much with the United States, unlike the case of Japan, which is a much smaller partner to Chile (4 percent of imports) but whose exports, mainly machinery and equipment, compete with the United States.

Table 4.

Effects of Free Trade Arrangements with the United States on Trade Flows ^1/

^1/Global Trade Analysis Project (GTAP) simulations of full bilateral liberalization of all sectors, including removal of textile and clothing quotas. CAFTA denotes Central American Free Trade Agreement. Abbreviations: AUS: Australia; CAN: Canada; USA: United States; CHL: Chile; MEX: Mexico; ARG: Argentina; BRA: Brazil; LTN: rest of Latin America; JPN: Japan; ASIA: rest of Asia; EU: European Union; ROW: rest of world.

Table 4.

Effects of Free Trade Arrangements with the United States on Trade Flows ^1/

United States-Chile (US$m)
	Chilean exports		Chilean Imports
	USA	Total	AUS	CAN	USA	MEX	ARG	BRA	CAFTA	LTN	JPN	ASIA	EU	ROW	Total
Crops	194	81	0	1	37	0	3	0	0	2	0	0	0	0	44
Livestock	0	-5	0	0	3	0	0	0	0	0	0	0	0	0	2
Other primary agriculture	-4	-25	0	0	1	0	0	0	0	0	0	0	0	0	1
Processed animal prods.	6	-3	0	0	6	0	7	0	0	2	0	1	1	0	17
Processed crop prods.	574	436	0	0	59	0	-1	0	-1	-1	0	0	-1	0	53
Minerals	1	6	-3	-2	40	0	-18	0	0	-8	0	-2	0	-10	-3
Textiles & clothing	206	204	0	0	133	-4	-3	-2	0	-4	0	-31	-9	-1	79
Basic manufactures	151	122	-3	-8	850	-43	-49	-54	-7	-44	-15	-84	-152	-28	362
Machinery & equipment	5	30	-8	-30	1,964	-148	-34	-166	-1	-7	-271	-300	-603	-53	342
Services	-12	-82	1	1	8	0	0	0	0	0	2	6	17	5	42
Total	1,121	765	-13	-38	3,101	-195	-96	-222	-9	-60	-284	-410	-749	-86	940
United States-CAFTA (US$m)
	CAFTA exports		CAFTA Imports
	USA	Total	CAN	USA	CHL	MEX	ARG	BRA	CAFTA	LTN	JPN	ASIA	EU	ROW	Total
Crops	1,515	195	10	1,252	1	8	7	2	-50	8	0	9	14	2	1,262
Livestock	-2	-36	0	115	0	0	0	0	-12	-1	0	-1	-1	0	99
Other primary agriculture	-65	-151	0	47	0	1	0	0	-5	1	0	2	1	1	49
Processed animal prods.	82	-49	-10	978	-1	-5	-29	-5	-86	-1	0	-30	-76	-10	726
Processed crop prods.	6,253	5,034	-17	2,566	-11	-29	-4	-7	-285	-35	-2	-12	-152	-12	1,999
Minerals	66	66	-5	6	0	-105	-1	-7	-4	-355	0	-1	-3	-145	-620
Textiles & clothing	14,274	13,951	-10	8,068	-3	-123	-1	-13	-201	-50	-14	-1,155	-151	-39	6,309
Basic manufactures	182	-2,119	-40	5,274	-9	-177	-9	-34	-1,111	-177	-26	-153	-449	-120	2,969
Machinery & equipment	-47	-1,036	-46	6,608	-2	-116	-5	-89	-197	-15	-1,652	-591	-638	-128	3,130
Services	-826	-4,347	49	1,074	4	20	9	23	-10	17	157	271	649	219	2,482
Total	21,431	11,508	-69	25,988	-19	-526	-34	-130	-1,960	-608	-1,537	-1,661	-806	-233	18,405
United States-Australia (US$m)
	Australian exports		Australian imports
	USA	Total	CAN	USA	CHL	MEX	ARG	BRA	CAFTA	LTN	JPN	ASIA	EU	ROW	Total
Crops	65	-159	0	21	0	0	0	1	0	0	0	5	1	3	31
Livestock	1	-64	0	2	0	0	0	0	0	0	0	2	0	0	5
Other primary agriculture	111	7	0	0	0	0	0	0	0	0	0	1	0	0	2
Processed animal prods.	430	293	0	13	0	0	0	0	0	0	0	4	3	1	21
Processed crop prods.	1,443	1,368	-1	178	-1	0	0	-1	-1	-1	-1	-27	-21	-4	120
Minerals	14	9	0	0	0	0	0	0	0	0	0	-8	0	-11	-20
Textiles & clothing	425	431	-2	748	0	-1	0	-1	0	-1	-9	-292	-54	-29	358
Basic manufactures	191	-5	-12	1,259	-1	-2	-1	-6	0	-1	-55	-247	-230	-58	646
Machinery & equipment	364	322	-28	2,999	0	-3	0	-5	0	0	-549	-601	-680	-63	1,069
Services	-70	-341	3	37	0	2	0	1	1	1	11	21	55	17	150
Total	2,974	1,860	-41	5,257	-2	-5	-1	-11	0	0	-604	-1,144	-926	-143	2,382

^1/Global Trade Analysis Project (GTAP) simulations of full bilateral liberalization of all sectors, including removal of textile and clothing quotas. CAFTA denotes Central American Free Trade Agreement. Abbreviations: AUS: Australia; CAN: Canada; USA: United States; CHL: Chile; MEX: Mexico; ARG: Argentina; BRA: Brazil; LTN: rest of Latin America; JPN: Japan; ASIA: rest of Asia; EU: European Union; ROW: rest of world.

View Table

Table 4.

Effects of Free Trade Arrangements with the United States on Trade Flows ^1/

United States-Chile (US$m)
	Chilean exports		Chilean Imports
	USA	Total	AUS	CAN	USA	MEX	ARG	BRA	CAFTA	LTN	JPN	ASIA	EU	ROW	Total
Crops	194	81	0	1	37	0	3	0	0	2	0	0	0	0	44
Livestock	0	-5	0	0	3	0	0	0	0	0	0	0	0	0	2
Other primary agriculture	-4	-25	0	0	1	0	0	0	0	0	0	0	0	0	1
Processed animal prods.	6	-3	0	0	6	0	7	0	0	2	0	1	1	0	17
Processed crop prods.	574	436	0	0	59	0	-1	0	-1	-1	0	0	-1	0	53
Minerals	1	6	-3	-2	40	0	-18	0	0	-8	0	-2	0	-10	-3
Textiles & clothing	206	204	0	0	133	-4	-3	-2	0	-4	0	-31	-9	-1	79
Basic manufactures	151	122	-3	-8	850	-43	-49	-54	-7	-44	-15	-84	-152	-28	362
Machinery & equipment	5	30	-8	-30	1,964	-148	-34	-166	-1	-7	-271	-300	-603	-53	342
Services	-12	-82	1	1	8	0	0	0	0	0	2	6	17	5	42
Total	1,121	765	-13	-38	3,101	-195	-96	-222	-9	-60	-284	-410	-749	-86	940
United States-CAFTA (US$m)
	CAFTA exports		CAFTA Imports
	USA	Total	CAN	USA	CHL	MEX	ARG	BRA	CAFTA	LTN	JPN	ASIA	EU	ROW	Total
Crops	1,515	195	10	1,252	1	8	7	2	-50	8	0	9	14	2	1,262
Livestock	-2	-36	0	115	0	0	0	0	-12	-1	0	-1	-1	0	99
Other primary agriculture	-65	-151	0	47	0	1	0	0	-5	1	0	2	1	1	49
Processed animal prods.	82	-49	-10	978	-1	-5	-29	-5	-86	-1	0	-30	-76	-10	726
Processed crop prods.	6,253	5,034	-17	2,566	-11	-29	-4	-7	-285	-35	-2	-12	-152	-12	1,999
Minerals	66	66	-5	6	0	-105	-1	-7	-4	-355	0	-1	-3	-145	-620
Textiles & clothing	14,274	13,951	-10	8,068	-3	-123	-1	-13	-201	-50	-14	-1,155	-151	-39	6,309
Basic manufactures	182	-2,119	-40	5,274	-9	-177	-9	-34	-1,111	-177	-26	-153	-449	-120	2,969
Machinery & equipment	-47	-1,036	-46	6,608	-2	-116	-5	-89	-197	-15	-1,652	-591	-638	-128	3,130
Services	-826	-4,347	49	1,074	4	20	9	23	-10	17	157	271	649	219	2,482
Total	21,431	11,508	-69	25,988	-19	-526	-34	-130	-1,960	-608	-1,537	-1,661	-806	-233	18,405
United States-Australia (US$m)
	Australian exports		Australian imports
	USA	Total	CAN	USA	CHL	MEX	ARG	BRA	CAFTA	LTN	JPN	ASIA	EU	ROW	Total
Crops	65	-159	0	21	0	0	0	1	0	0	0	5	1	3	31
Livestock	1	-64	0	2	0	0	0	0	0	0	0	2	0	0	5
Other primary agriculture	111	7	0	0	0	0	0	0	0	0	0	1	0	0	2
Processed animal prods.	430	293	0	13	0	0	0	0	0	0	0	4	3	1	21
Processed crop prods.	1,443	1,368	-1	178	-1	0	0	-1	-1	-1	-1	-27	-21	-4	120
Minerals	14	9	0	0	0	0	0	0	0	0	0	-8	0	-11	-20
Textiles & clothing	425	431	-2	748	0	-1	0	-1	0	-1	-9	-292	-54	-29	358
Basic manufactures	191	-5	-12	1,259	-1	-2	-1	-6	0	-1	-55	-247	-230	-58	646
Machinery & equipment	364	322	-28	2,999	0	-3	0	-5	0	0	-549	-601	-680	-63	1,069
Services	-70	-341	3	37	0	2	0	1	1	1	11	21	55	17	150
Total	2,974	1,860	-41	5,257	-2	-5	-1	-11	0	0	-604	-1,144	-926	-143	2,382

^1/Global Trade Analysis Project (GTAP) simulations of full bilateral liberalization of all sectors, including removal of textile and clothing quotas. CAFTA denotes Central American Free Trade Agreement. Abbreviations: AUS: Australia; CAN: Canada; USA: United States; CHL: Chile; MEX: Mexico; ARG: Argentina; BRA: Brazil; LTN: rest of Latin America; JPN: Japan; ASIA: rest of Asia; EU: European Union; ROW: rest of world.

Separate simulations were carried out to test the merits of the Chilean strategy of establishing free trade arrangements with its major trading partners, not only in the Americas but with Europe (and later Asian countries) in reducing potential trade diversion as their products would eventually be entering the Chilean market on the same terms. The results show that having the Chile-U.S. FTA implemented at the same time as the Chile-EU FTA would significantly reduce the trade diversion effect on welfare. A Chile-Japan FTA implemented at the same time would bring an additional welfare gain.²¹

It should be noted, however, that establishing an FTA with every trading partner is not the same as multilateral liberalization. There are additional costs associated with rules of origin with each FTA. However, the benefits of preferences that this country enjoys from FTAs can outweigh the costs of implementing rules of origin and reduce Chile’s incentives to join multilateral liberalization. Additional simulations indicate that for Chile, FTAs with the United States, EU, and Japan would generate a welfare gain considerably larger than the gain from full multilateral liberalization, because Chile would enjoy preferential access to these markets at the expense of other competitors.

E. The Role of Agriculture

In practice, virtually all FTAs have a phased approach towards liberalization and, in many cases, agriculture is given a fairly extended transition period. In the Chile-U.S. agreement, for example, there is a 12-year transition period for certain agricultural products. Table 5 summarizes the results of modifications of the earlier simulations to exclude agricultural liberalization. In comparing these to Table 3, it is striking that welfare for U.S. FTA partners is always smaller when agriculture is not covered—Chile could suffer a welfare loss, the benefit of a U.S.-CAFTA could be significantly reduced, and a negligible welfare loss for Australia could turn into a significant one. On the other hand, the impact on the United States is rather limited. At the global level, the exclusion of agriculture from the three FTAs now make all of them welfare reducing—even for U.S.-CAFTA.

Table 5.

Effects of Free Trade Arrangements with the United States, Excluding Agriculture ^1/

Source: Estimates from Global Trade Analysis Project (GTAP) simulations of full bilateral tariff removal in all sectors except agriculture, and removal of textile and clothing quotas. Note: CAFTA denotes the Central American Free Trade Agreement.

^1/Measure of welfare change in US$million.

Table 5.

Effects of Free Trade Arrangements with the United States, Excluding Agriculture ^1/

	United States-Chile			United States-CAFTA			United States-Australia
	Equivalent Variation 1/	GDP	Terms of Trade	Equivalent Variation 1/	GDP	Terms of Trade	Equivalent Variation 1/	GDP	Terms of Trade
	(US$m)	(% ch)	(% ch)	(US$m)	(% ch)	(% ch)	(US$m)	(% ch)	(% ch)
Australia	-4.0	0.00	0.00	-22.9	0.00	-0.02	-155.6	-0.03	- 0.06
Canada	-17.5	0.00	-0.01	-159.8	0.00	-0.07	-28.3	0.00	-0.01
United States	289.2	0.00	0.03	787.7	0.00	0.08	456.4	0.00	0.04
Chile	-104.2	-0.08	-0.15	-5.3	0.00	-0.01	-1.5	0.00	0.00
Mexico	-18.3	0.00	-0.02	-235.0	-0.01	-0.19	-11.7	0.00	-0.02
Argentina	-13.3	0.00	-0.03	-6.8	0.00	0.00	-1.9	0.00	0.00
Brazil	-51.8	0.00	-0.03	-74.3	0.00	-0.04	-9.8	0.00	-0.01
CAFTA	-6.2	0.00	-0.01	2,702.4	1.08	3.31	-7.8	0.00	-0.01
Rest of Latin America	-8.8	0.00	-0.01	-148.8	-0.02	-0.14	-4.7	0.00	0.00
Japan	-23.5	0.00	0.00	-473.8	0.00	-0.06	-79.4	0.00	-0.01
Rest of Asia	-49.6	0.00	0.00	-1,737.4	-0.03	-0.06	-149.3	0.00	-0.01
Sub-Saharan Africa	-4.1	0.00	0.00	-16.5	0.00	-0.02	-2.0	0.00	0.00
Midde East/North Africa	-13.7	0.00	0.00	-192.6	-0.01	-0.04	-19.1	0.00	0.00
European Union	-75.3	0.00	0.00	-739.1	0.00	-0.01	-132.2	0.00	0.00
Rest of the world	-7.0	0.00	0.00	-193.8	0.00	-0.03	-12.6	0.00	0.00
World	-108.0	0.00	0.00	-516.0	0.00	0.00	-159.6	0.00	0.00

Source: Estimates from Global Trade Analysis Project (GTAP) simulations of full bilateral tariff removal in all sectors except agriculture, and removal of textile and clothing quotas. Note: CAFTA denotes the Central American Free Trade Agreement.

^1/Measure of welfare change in US$million.

View Table

Table 5.

Effects of Free Trade Arrangements with the United States, Excluding Agriculture ^1/

	United States-Chile			United States-CAFTA			United States-Australia
	Equivalent Variation 1/	GDP	Terms of Trade	Equivalent Variation 1/	GDP	Terms of Trade	Equivalent Variation 1/	GDP	Terms of Trade
	(US$m)	(% ch)	(% ch)	(US$m)	(% ch)	(% ch)	(US$m)	(% ch)	(% ch)
Australia	-4.0	0.00	0.00	-22.9	0.00	-0.02	-155.6	-0.03	- 0.06
Canada	-17.5	0.00	-0.01	-159.8	0.00	-0.07	-28.3	0.00	-0.01
United States	289.2	0.00	0.03	787.7	0.00	0.08	456.4	0.00	0.04
Chile	-104.2	-0.08	-0.15	-5.3	0.00	-0.01	-1.5	0.00	0.00
Mexico	-18.3	0.00	-0.02	-235.0	-0.01	-0.19	-11.7	0.00	-0.02
Argentina	-13.3	0.00	-0.03	-6.8	0.00	0.00	-1.9	0.00	0.00
Brazil	-51.8	0.00	-0.03	-74.3	0.00	-0.04	-9.8	0.00	-0.01
CAFTA	-6.2	0.00	-0.01	2,702.4	1.08	3.31	-7.8	0.00	-0.01
Rest of Latin America	-8.8	0.00	-0.01	-148.8	-0.02	-0.14	-4.7	0.00	0.00
Japan	-23.5	0.00	0.00	-473.8	0.00	-0.06	-79.4	0.00	-0.01
Rest of Asia	-49.6	0.00	0.00	-1,737.4	-0.03	-0.06	-149.3	0.00	-0.01
Sub-Saharan Africa	-4.1	0.00	0.00	-16.5	0.00	-0.02	-2.0	0.00	0.00
Midde East/North Africa	-13.7	0.00	0.00	-192.6	-0.01	-0.04	-19.1	0.00	0.00
European Union	-75.3	0.00	0.00	-739.1	0.00	-0.01	-132.2	0.00	0.00
Rest of the world	-7.0	0.00	0.00	-193.8	0.00	-0.03	-12.6	0.00	0.00
World	-108.0	0.00	0.00	-516.0	0.00	0.00	-159.6	0.00	0.00

Source: Estimates from Global Trade Analysis Project (GTAP) simulations of full bilateral tariff removal in all sectors except agriculture, and removal of textile and clothing quotas. Note: CAFTA denotes the Central American Free Trade Agreement.

^1/Measure of welfare change in US$million.

F. Sensitivity Tests

While a number of assumptions in the model are important in driving the simulation results presented above, the elasticities of substitution in demand²⁷ play a central role. To a large extent, these elasticities determine the terms of trade effects, which in turn influence the welfare results. To test how sensitive our results are to these elasticities, we repeated our simulations with two alternative sets of elasticities. We first halve the values of the elasticities and then double them.

The exercise shows that our results presented earlier are robust (Table 6). While there are some expected changes in the magnitude of welfare results, in only one case has the result changed sign: in the lower elasticity case, Australia would gain marginally from an FTA with U.S. rather than lose slightly. It is generally true that as the values of elasticities increase, the impact of the FTAs becomes larger, especially with respect to the negative effects on third countries, whose exports to FTA countries are replaced with greater ease.

Table 6.

Welfare Effects of U.S. Bilateral Free Trade Agreements Under Different Elasticities of Substitution ^{1/ 2/}

Source: Simulations of the Global Trade Analysis Project (GTAP) model.

^1/These are elaticities of substitution between domestic goods and imports and those between sources of imports by country of origin.

^2/See Annex Table A. 2 for central elasticities of substitution. In this table the lower (higher) elasticities are half (double) the values of the central elasiticities.

Note: CAFTA denotes the Central American Free Trade Agreement.

Table 6.

Welfare Effects of U.S. Bilateral Free Trade Agreements Under Different Elasticities of Substitution ^{1/ 2/}

	U.S.-Chile FTA			U.S.-CAFTA FTA			US.-Austraha FTA
	Lower elasticities	Central elasticities	Higher elasticties	Lower elasticities	Central elasticities	Higher elasticties	Lower elasticities	Central elasticities	Higher elasticties
Australia	-4	-4	-4	-39	-36	-42	81	-1	-129
Canada	-27	-24	-27	-269	-270	-301	-54	-51	-67
United States	243	218	118	1,053	964	535	418	404	300
Chile	31	4	58	-22	-27	-30	-3	-4	-7
Mexico	-25	-23	-31	-238	-268	-326	-19	-15	-19
Argentina	-15	-15	-24	-32	-32	-39	-4	-4	-7
Brazil	-50	-60	-91	-116	-123	-172	-14	-15	-31
CAFTA	-12	-14	-30	3,018	3859	7562	-15	-20	-50
Rest of Latin America	-17	-21	-39	-177	-231	-348	-8	-11	-29
Japan	-34	-32	-42	-493	-512	-672	-115	-138	-292
Rest of Asia	-50	-63	-196	-1,091	-1672	-2844	-165	-210	-405
Sub-Saharan Africa	-4	-4	-6	-21	-28	-46	-2	-3	-7
Midde East/North Africa	-9	-14	-25	-164	-180	-276	-16	-22	-40
European Union	-97	-96	-117	-1,040	-991	-1041	-165	-155	-201
Rest of the world	-4	-7	-16	-210	-233	-317	-13	-14	-27
World	-74	-154	-471	160	220	1645	-97	-260	-1011

Source: Simulations of the Global Trade Analysis Project (GTAP) model.

^1/These are elaticities of substitution between domestic goods and imports and those between sources of imports by country of origin.

^2/See Annex Table A. 2 for central elasticities of substitution. In this table the lower (higher) elasticities are half (double) the values of the central elasiticities.

Note: CAFTA denotes the Central American Free Trade Agreement.

View Table

Table 6.

Welfare Effects of U.S. Bilateral Free Trade Agreements Under Different Elasticities of Substitution ^{1/ 2/}

	U.S.-Chile FTA			U.S.-CAFTA FTA			US.-Austraha FTA
	Lower elasticities	Central elasticities	Higher elasticties	Lower elasticities	Central elasticities	Higher elasticties	Lower elasticities	Central elasticities	Higher elasticties
Australia	-4	-4	-4	-39	-36	-42	81	-1	-129
Canada	-27	-24	-27	-269	-270	-301	-54	-51	-67
United States	243	218	118	1,053	964	535	418	404	300
Chile	31	4	58	-22	-27	-30	-3	-4	-7
Mexico	-25	-23	-31	-238	-268	-326	-19	-15	-19
Argentina	-15	-15	-24	-32	-32	-39	-4	-4	-7
Brazil	-50	-60	-91	-116	-123	-172	-14	-15	-31
CAFTA	-12	-14	-30	3,018	3859	7562	-15	-20	-50
Rest of Latin America	-17	-21	-39	-177	-231	-348	-8	-11	-29
Japan	-34	-32	-42	-493	-512	-672	-115	-138	-292
Rest of Asia	-50	-63	-196	-1,091	-1672	-2844	-165	-210	-405
Sub-Saharan Africa	-4	-4	-6	-21	-28	-46	-2	-3	-7
Midde East/North Africa	-9	-14	-25	-164	-180	-276	-16	-22	-40
European Union	-97	-96	-117	-1,040	-991	-1041	-165	-155	-201
Rest of the world	-4	-7	-16	-210	-233	-317	-13	-14	-27
World	-74	-154	-471	160	220	1645	-97	-260	-1011

Source: Simulations of the Global Trade Analysis Project (GTAP) model.

^1/These are elaticities of substitution between domestic goods and imports and those between sources of imports by country of origin.

^2/See Annex Table A. 2 for central elasticities of substitution. In this table the lower (higher) elasticities are half (double) the values of the central elasiticities.

Note: CAFTA denotes the Central American Free Trade Agreement.

V. Summary and Conclusion

A distinguishing component of current U.S. trade policy is the emphasis on establishing FTAs with partners spanning the globe from the Americas through Africa, the Middle East, and the Pacific. For the United States, enhancing merchandise exports is often not the dominant consideration, as expanding trade in services, protection of intellectual property rights, and geopolitical and security concerns also enter the equation. Similarly, for its partners, the potential for attracting direct foreign investment and technology transfer from the United States is generally a major driving force behind the FTAs. As the process unfolds, care must be taken to deal with several possible risk factors, such as (i) the welfare costs of trade diversion; (ii) diluting the momentum toward multilateral trade liberalization; (iii) the rising cost of nonparticipation; (iv) high administrative costs and confusion in overlapping arrangements; (v) vulnerabilities related to reliance on preferential access compared with a set of established multilateral rules; and (vi) overburdening trade arrangements with new elements, such as labor standards, the environment, intellectual property rights, and restrictions on capital movements.

Stylized simulations of stand-alone FTAs with the United States, involving complete free trade in goods, highlight several of these issues. For the United States, the gain from each agreement is small, although nonnegative since, with its large size and diversified trade structure, trade diversion is quite limited. For the partners of the United States, their exports rise in industries where they have comparative advantages, but this gain must be balanced against the possible diversion of imports from lower-cost sources. In general, welfare losses are experienced by nonmembers of the new FTAs, which see their trade contract—this includes countries like Mexico and Canada which have prior FTAs with the United States. These results are broadly consistent with other, similar studies.

Three important implications emerge from this analysis. First, initial improvements in market access enjoyed by participants in FTAs with the United States could be progressively eroded and subsequently increase adjustment costs, because of several factors—many of the FTAs are coming together over a short period; major global quota reductions in textiles and garments are scheduled over the next couple of years; and the current round of multilateral trade negotiations may result in lower most-favored-nation barriers. Second, facing this prospect of preference erosion, countries would have reduced incentives to participate in multilateral liberalization. For a small country, benefits from an FTA with major markets can be larger than those from multilateral liberalization, even though the former are obtained at the expense of third countries. And, finally, welfare benefits to FTA participants could be substantially reduced if sensitive sectors, such as agriculture, are excluded from bilateral liberalization. Where there is insufficient complementarity in trade structure between FTA partners, such exclusion could ultimately result in overall welfare losses.