This Selected Issues paper analyzes the United State’s (U.S.) household savings role in supporting the U.S. recovery; and focuses on the market for single-family housing, and the importance for household balance sheets. It discusses the underfunding of corporate pension plans, macroeconomic, and policy implications; the U.S. fiscal position, and reviews the causes of the fiscal crisis. It examines the impact of energy shocks, energy policy, and the taxation role. It analyzes the growth in linkages between the United States and other G-7 countries, and the regional and bilateral trade links issues.

Abstract

This Selected Issues paper analyzes the United State’s (U.S.) household savings role in supporting the U.S. recovery; and focuses on the market for single-family housing, and the importance for household balance sheets. It discusses the underfunding of corporate pension plans, macroeconomic, and policy implications; the U.S. fiscal position, and reviews the causes of the fiscal crisis. It examines the impact of energy shocks, energy policy, and the taxation role. It analyzes the growth in linkages between the United States and other G-7 countries, and the regional and bilateral trade links issues.

X. The United States and the New Regionalism/Bilateralism1

1. The currents underlying trade liberalization are at an important juncture—midway between an ambitious round of multilateral trade negotiations and a sharp rise in efforts to forge regional free trade zones. The United States, for example, has tabled bold proposals at the WTO for global reductions in tariff and nontariff barriers, while simultaneously launching discussions for free trade areas with partners in the Americas, Africa, the Pacific, and the Middle East. The push toward bilateral and regional free trade areas has been evident elsewhere in the world with the EU and Asian nations also pressing hard in this area.2

2. This paper examines a number of issues related to the U.S. emphasis on regional and bilateral trade links. Following a review of the scope of current and proposed arrangements, the key issues implications of this strategy are analyzed. Stylized simulations of the welfare gains of these arrangements are presented, followed by some concluding observations.

A. Recent Developments

3. Regional and bilateral trading arrangements have become a major focus of U.S. trade policy. A free trade arrangement (FTA) with Israel in 1985 was followed by an FTA with Canada in 1989, which subsequently included Mexico as the North American Free Trade Area (NAFTA) in 1994. More recently, an FTA was concluded with Jordan in 2001, and arrangements have been signed (but not yet ratified) with Singapore and Chile. The United States is also aiming for FTAs with Morocco, the Central America Free Trade Area (CAFTA), Australia, the Southern African Customs Union (SACU), and negotiations are underway to complete a Free Trade Area of the Americas (FTAA) by 2005.3 The U.S. Administration has also announced a strategy—which would include FTAs—to enhance trading relations with the Middle East.4

4. U.S. interest in these arrangements appears based on a range of considerations. Besides providing greater market access for U.S. exporters, FTAs are viewed as a complement to broader geopolitical and security goals. The United States also considers bilateral and regional agreements helpful in spurring progress toward liberalization among nonparticipants and at the multilateral level, a process that has been termed “competitive liberalization.”5

5. Reflecting this broader view, U.S.-sponsored FTAs have not been limited to countries with strong merchandise trade links with the United States. Except in the case of NAFTA members, U.S. exports of goods to FTA partners have typically represented well under 3 percent of total U.S. exports (Table 1). At the same time, however, the United States often represents an important export market for FTA partners (Table 2). Even where this is initially not the case, the increase in the share of Jordan’s exports going to the United States, from 1 percent to 10 percent between 1999 and 2001, illustrates the potential effect of FTAs on trade flows.

Table 1.

United States: Existing and Proposed Free Trade Arrangements1

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Source: IMF, Direction of Trade Statistics.

Data refer to 2001.

Table 2.

Evolution of Trade: United States and Free Trade Partners

(Exports to the United States, in percent of total exports)

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Source: IMF, Direction of Trade Statistics.

6. In addition to merchandise tariff reduction, recent U.S. FTAs have emphasized liberalization in services, as well as other aspects of trade and investment flows. For example, rules on trade in services, as well as issues related to intellectual property rights, environmental standards, labor standards, and provisions for uninhibited capital transfers, are now common features of U.S. FTAs. For many participants, the potential stimulus to foreign direct investment is viewed as even more important than market access in goods, especially as many of these countries already have preferential access to the U.S. market, including under the GSP, Caribbean Basin Initiative, and African Growth and Opportunity Act (AGOA).

B. Issues Arising from the New Regionalism

7. The U.S. emphasis on regional and bilateral FTAs is typically seen in a positive light, but concerns have been raised. These can be grouped into six key issues.

  • Trade diversion. One concern is that preferential trade arrangements may cause trade to be diverted away from lower-cost suppliers that are not members of the arrangement.6 If this were to occur, welfare losses would result, since the importing country buys from a costlier source and global resources are shifted toward less efficient producers. However, even if these costs occur, they may be outweighed by the benefits of trade creation, as tariff reductions cause imports from partners to supplant costly local production.

  • The impact on multilateral liberalization. Concerns have been raised regarding the possibility that regional and bilateral FTAs may dilute the momentum toward multilateral trade liberalization. Especially in light of difficulties in meeting the deadlines for the Doha Round, the fear is that countries may save their offers for ongoing negotiations of FTAs or that the United States may reserve preferences for FTAs. To some extent, this concern is mitigated by the United States’ ambitious WTO proposals for trade in industrial and agricultural goods, which would reduce the relative attractiveness of FTAs.

  • The costs of non-participation. Some analysts have cautioned that while some countries may prefer the multilateral route, they may be spurred into FTAs simply to avoid being “left behind.” The proposed FTAs with Chile and CAFTA have already sparked interest among nonparticipants in the hemisphere, including Colombia, in having their own bilateral agreements with the United States.7 The risk is that the U.S. approach could catalyze other regions to establish competing, and possibly protectionist, FTAs.8

  • Administrative costs. Overlapping trade agreements, and related differing rules of origin and preference margins, could be costly to negotiate and police.9 These administrative costs would need to be weighed against the fact that preference benefits may be short-lived, especially in view of the scheduled liberalization of the global textile market at end-2004, the Doha Round, and the growth of FTA participants.

  • Stability of the multilateral system. Some commentators have raised concerns that a series of bilateral and regional arrangements leaves open the possibility that preferences could be withdrawn, for political or other reasons.10 According to this view, a multilateral reduction of trade barriers within a set of common rules would yield a more stable and fairer system.

  • Scope of agreements. The fact that U.S. FTAs have tended to span a wide range of issues including labor, the environment, intellectual property rights and capital movements has raised questions about whether the agreements have become overburdened.11 Unless carefully designed and managed, the inclusion of labor, intellectual property, and environmental standards could work to restrict trade, especially in countries where legislation and enforcement are weak.

8. Nonetheless, regional agreements appear to 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, however, is to ensure that partners in the agreement strive toward maintaining relatively low external barriers—i.e., “open regionalism”—in order to minimize trade diversion. Typically, regional agreements are likely to offer the greatest benefits, and entail less trade diversion, if they have the following characteristics:

  • Regional diversity Export diversity may be associated with greater complementarity of product ranges across countries, and greater trade with advanced countries may bring advantages to developing countries through increased investment flows and technology transfers.12 This suggests, for example, that the benefits of North-South arrangements exceed those of South-South arrangements.

  • Comprehensive coverage of products. FTAs are likely to bear greater fruit if they are extended beyond manufactured trade, and include agricultural products and services. Even more benefits can occur under comprehensive approaches that liberalize foreign direct investment, strengthen competition policy and improve regulatory frameworks.

  • Reform momentum. 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 the countries’ stage of development.

9. The U.S. model for bilateral and regional trade arrangements meets many of these criteria. 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. The challenge remains, however, to ensure that these efforts do not undermine momentum for multilateral liberalization, which would still be the first-best alternative.

C. Simulations of Free Trade Arrangements with the United States

10. The welfare and other effects of three FTAs are examined below. The estimates—which cover United States-Chile, United States-Central America (CAFTA); and United States-Australia—were constructed using the Global Trade Analysis Project (GTAP) framework and assumed the removal of all tariffs on goods as well as textile and clothing quotas between the partners in the arrangements.13

11. In considering these results, it is important to recognize in advance the shortcomings of the analytical framework, which may cause the estimates to understate the benefits of FTAs. First, the GTAP framework does not fully take into account the dynamic gains that might result from trade liberalization, which some studies suggest could be twice as large as the static gains. Second, the model is unable to consider the effects of non-goods-related provisions of the FTAs (including with regard to services, investment, and intellectual property), which could have even larger effects.14 Third, the analysis also does not take into account the potential spillover effects between FTAs or the effects of multilateral liberalization.

United States-Chile FTA

12. The United States is already an important trading partner of Chile. Nearly 20 percent of Chilean exports are destined for the United States, and 20 percent of Chilean imports come from the United States. Chile has a low and mostly uniform MFN tariff of 6 percent, and is an active participant in other regional and bilateral arrangements.15

13. The simulation results—which focus solely on the effects of liberalizing goods trade—suggest that the FTA would yield modest welfare gains for both Chile and the United States (Table 3). Chilean exports of processed foods, and to a smaller extent basic crops and textiles and clothing, would receive a particular boost. The modest welfare gain and the small drop in Chile’s GDP reflect trade diversion as imports of U.S. machinery and equipment would replace lower cost imports from the EU, Japan, and the rest of Asia.16 The results, which are similar to those recently prepared by the USITC (2003), illustrate the merit of the Chilean strategy of also establishing free trade arrangements with its other major trading partners in order to reduce potential trade diversion.

Table 3.

Simulations of Effects of Free Trade Arrangements with the United States

(Percent change unless otherwise noted)

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Source: Fund staff estimates from GTAP simulations.

Measure of welfare change.

United States-CAFTA

14. The United States represents a key market for Central American exports. For example, around 70 percent of Honduras’ exports are destined for the United States. Many products already enter the United States under preferential arrangements, but barriers are relatively high in textile products and agriculture.

15. The simulations suggest that an FTA would have important welfare benefits for Central America. GDP would increase by as much as 1.5 percent, with smaller gains for the United States. The benefits would stem mainly from the boost in sales of textiles and clothing and processed food, which more than offset trade diversion from Japan, the rest of Asia, and Europe in machinery and equipment and textiles. Welfare gains would also result from trade creation—imports of basic manufactured imports from the United States would supplant higher cost CAFTA production, which would mean lower intra-CAFTA (duty-free) trade in these products. Because of the size of the region and the higher initial trade barriers, an agreement between the United States and CAFTA would have a greater impact on the rest of Latin America than a United States-Chile FTA.

16. However, the simulations do not take into account the effects of the scheduled global liberalization of textile and clothing quotas or the planned FTAA. Indeed, with the expiration of the Multifibre Agreement in 2005 and the FTAA expected to include hemisphere-wide liberalization, the sustained benefits to CAFTA of the FTA would be lower than estimated. This suggests the importance of CAFTA ensuring that the FTA preferences are used to spur efficiency enhancements in advance of these later trade policy developments.

United States-Australia FTA

17. Australia already has important trade ties with the United States. About 10 percent of Australian exports are destined for the United States, while Asia Pacific Economic Cooperation (APEC) countries account for 72 percent of its exports. Applied MFN tariffs currently average 4.3 percent, although tariffs on textile items are closer to 15 percent.

18. Reflecting already low existing tariff rates, an Australia-United States agreement would have a relatively small overall welfare and output effects. The staff simulations suggest that Australia’s GDP would drop slightly owing to the diversion of imports of machinery and equipment, basic manufactured products, and textiles from Japan, Asia, and the EU. The impact on other countries would also be small. Nonetheless, Australian producers of textiles and processed crops and animal (meat and dairy) products would reap significant gains. These results, based on a static model, are qualitatively similar to those presented by ACIL (2003), which show that full bilateral liberalization would reduce Australian GDP by 0.09 percent by 2010. In contrast, the Center for International Economics (2001) estimates that Australia’s GDP would rise by 0.33 percent by 2006 and 0.4 percent by 2010, assuming a 0.35 percent boost to services sector productivity as a result of a U.S.-Australia FTA.

D. Conclusion

19. The foregoing discussion and simulations suggest a number of cautionary notes. As noted previously, the estimates may underestimate the gains from FTAs, given that the dynamic benefits and the effects of liberalization in non-merchandise trade are not taken into account. At the same time, however, the estimates suggest that welfare gains for the United States are small but positive and that partner countries could suffer losses related to trade diversion. Especially where initial trade barriers are low (as in Chile and Australia), the gains from further liberalization in goods are limited. In all cases, nonmembers are adversely affected, including countries such as Mexico and Canada, which have prior FTAs with the United States. Countries that would benefit from FTAs could see these gains eroded as more such agreements come into force.

20. Thus, the estimates underscore some of the broader caveats that were raised above. The U.S. emphasis on FTAs is likely to be most beneficial if agreements are designed in a manner that minimizes trade diversion, and if the agreements do not dilute the momentum toward multilateral trade liberalization, spur competing regional trade blocs, or impose excessive administrative burdens. The simulations focused solely on merchandise trade, and to the extent that additional elements are introduced—such as labor, the environment, intellectual property rights, and capital flows—these should be designed in a manner that supports the broader thrust toward liberalization.

References

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1

Prepared by Alvin Hilaire. The GTAP simulations were conducted by Yonghzeng Yang and research assistance was provided by Dustin Smith.

2

For example, in the last five years, the EU has completed negotiations for FTAs with South Africa, Mexico, Chile, Croatia, Former Yugoslav Republic of Macedonia, and a number of Mediterranean partners, while negotiations continue with Mercosur, Syria and the Gulf Cooperation Council (Lamy, 2002).

3

Details are provided by the Office of the U.S. Trade Representative (USTR, 2003a).

4

Key components of the Middle East strategy include: (a) expanding the U.S. Generalized System of Preferences (GSP) to the poorer countries of the region; (b) assisting with WTO accessions of Middle Eastern countries; (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 Eastern countries (as a bloc) and the United States.

6

Panagariya (1999) describes a number of studies in which the trade diversion effect accompanying preferential trading arrangements is documented; some evidence also emerges from our simulations in Section C below.

7

A Report commissioned by the Australian Department of Foreign Affairs (CIE, 2001) sums up the situation: “The FTAA will constitute a powerful inducement for US investors to invest in Latin American markets. Australia has a keen interest in ensuring that Latin American countries do not secure an advantage over Australia in access to the US market. Especially given the likelihood of the US negotiating more FTAs in the future with more of Australia’s competitors, an Australian-U.S. FTA constitutes a potentially vital piece of negotiating insurance.”

8

Gordon (2003) considers the strategy a “high-risk” one, which could severely damage U.S. foreign policy and trade if restrictive trade blocs are erected in East Asia and other areas in response.

9

For example, Leith and Whalley (2003) point out that a wide variety of trade and regulatory practices exist among members of SACU, and negotiation of a U.S.-SACU FTA and harmonizing the various laws and administrative practices within this region would pose a considerable challenge. More generally, Bhagwati (2002) cautions on the potential “spaghetti bowl” effect of crisscrossing FTAs arising from different transition timetables and differing rules of origin.

10

Panagariya (2002) uses the examples of the GSP and AGOA to argue that preferential trade schemes not subject to WTO discipline can create damaging uncertainty.

11

For example, in the U.S.-Chile Agreement, limits and penalties are established on restrictions of capital transfers and there is no balance of payments safeguard clause. In principle, bilateral efforts that proscribe the temporary imposition of capital controls in crisis could undermine the effectiveness of any broader capacity to impose emergency measures on transactions. The U.S.-Canada FTA, NAFTA, and the GATS—which were the first comprehensive attempts at liberalizing controls on the cross border provision of services and investment—all provide for emergency measures.

12

For example, Krueger (1999) finds that NAFTA has not led to trade diversion in Mexico-U.S. trade. Olarreaga, et al. (2003) also illustrate the benefits of North-South trade-related R&D flows on productivity.

13

The GTAP model used in this paper is a comparative static, general equilibrium model based on neo-classical trade theory.

14

See, for example, Brown and Stern (2001).

15

Chile has already concluded separate treaties with Canada, Mexico, and Central America and has comprehensive market opening agreements with Bolivia, Venezuela, Colombia, Ecuador, and Peru. Chile is an associate member of MERCOSUR and signed an FTA with the European Union in 2002. Free trade arrangements with South Korea, Japan, and Singapore are also reportedly under discussion.

16

There is little diversion from Argentina—which is a major supplier of Chile—because its exports compete less directly with the United States. To the extent that there is trade diversion, it is concentrated in manufactured goods. The GTAP database utilizes data as of 1997 and, therefore, does not include the Chile-EU agreement; thus, the results may overestimate trade diversion from the EU.