NBER WORKING PAPER SERIES CHINA AND THE TPP: A NUMERICAL SIMULATION ASSESSMENT OF THE EFFECTS INVOLVED. Chunding Li John Whalley

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1 NBER WORKING PAPER SERIES CHINA AND THE TPP: A NUMERICAL SIMULATION ASSESSMENT OF THE EFFECTS INVOLVED Chundng L John Whalley Workng Paper NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambrdge, MA May 2012 We are grateful to the Ontaro Research Fund for fnancal support and to a semnar group at UWO for comment and dscussons. The vews expressed heren are those of the authors and do not necessarly reflect the vews of the Natonal Bureau of Economc Research. NBER workng papers are crculated for dscusson and comment purposes. They have not been peerrevewed or been subject to the revew by the NBER Board of Drectors that accompanes offcal NBER publcatons by Chundng L and John Whalley. All rghts reserved. Short sectons of text, not to exceed two paragraphs, may be quoted wthout explct permsson provded that full credt, ncludng notce, s gven to the source.

2 Chna and the TPP: A Numercal Smulaton Assessment of the Effects Involved Chundng L and John Whalley NBER Workng Paper No May 2012 JEL No. C68,F47,F53 ABSTRACT The Trans-Pacfc Partnershp (TPP) s a new negotaton on cross border lberalzaton of goods and servce flows gong beyond WTO dscplnes and focused on ssues such as regulaton and border controls. Though the US, Australa and other pacfc countres are ncluded, Chna s notable for ts excluson from the process thus far. Ths paper uses numercal smulaton methods to assess the potental effects of a TPP agreement on Chna and the other partcpatng countres. We use a numercal fve-country global general equlbrum model wth trade costs and monetary structure ncorporatng nsde money to allow for mpacts on trade mbalances. Trade costs are calculated usng a method based on gravty equatons. Smulaton results reveal that Chna wll be hurt by TPP ntatves, but the negatve effects are relatvely small gven the geographcal and commodty composton of Chna s trade. Other non-tpp countres wll be hurt but member countres wll all gan. Japan s jonng TPP would be benefcal to both herself and all other TPP countres, but negatve effects on Chna and other non-tpp countres wll ncrease further. If Chna takes part n TPP, t wll ncrease Chna s and other TPP countres gan, but non-tpp countres wll be hurt more. As a regonal free trade arrangement, TPP effects are dfferent from global free trade effects whch wll beneft all countres (not just member countres) n the world, and the postve effects of global free trade are stronger than TPP effects. Chundng L Insttute of World Economcs and Poltcs Chnese Academy of Socal Scences No.5 Janguomennedaje Bejng, PRC Postcode: cl428@uwo.ca John Whalley Department of Economcs Socal Scence Centre Unversty of Western Ontaro London, ON N6A 5C2 CANADA and NBER jwhalley@uwo.ca

3 1. Introducton The Trans-Pacfc Partnershp (TPP) s a proposed nne-country Asa-Pacfc free trade arrangement beng negotated among the Unted States (US), Australa, Brune, Chle, Malaysa, New Zealand, Peru, Sngapore and Vetnam. The am s to go beyond WTO lberalzaton and focus on ssues of regulaton and border controls. As such t dffers from tarff based lberalzaton n there beng no revenues nvolved wth the border measures. They also compound wth conventonal tarffs. The ntuton, therefore, s that larger gans may accrue to the mportng countres compared to prevously studed lberalzaton. The negotatng partners have agreed that ths proposed lvng agreement cover new trade topcs and nclude new members that are wllng to adopt the proposed agreement s hgher standards. To that end, Japan, Canada and Mexco all have stated that they would have an nterest n jonng the negotatons. Ths free trade pact, even wthout Mexco and Canada, would affect 600 mllon people n countres that produce 20 trllon US$ of annual economc output (COC, 2011). As a bg country n the Asa-Pacfc area, Chna has not been nvted to take part n the TPP ntatve. Here we analyze how a TPP arrangement could potentally affect both Chna and other partcpatng and non-partcpatng countres f ths proposal resulted n a true free trade agreement (FTA) among partcpants. The answer to ths queston s mportant for polcy makng and related research, and depends crtcally both on the sze of barrers nvolved and ther negotablty. Present lterature on TPP 3

4 s lmted and s mostly analytcal or smple newsletters and comments, such as Wllams (2012), James (2010), Lews (2011), and Ezell and Atknson (2011). Few numercal methods have been used to capture potental TPP effects for other countres and the whole world, except Petr et al (2011) and Itakura and Lee (2012). Our pont of departure s to use numercal general equlbrum smulaton methods to explore TPP effects on both Chna and other countres. We use a fve-country (Chna, US, Japan, other TPP countres and the rest of world (ROW)) Armngton type global general equlbrum model. Each country produces two-goods (Tradable goods and Non-tradable goods) and has two-factors (captal and labor). The model captures trade costs and uses a monetary structure of nsde money both so as to also endogenously determne trade mbalance effects from the trade ntatve and also allow calbraton to a base case capturng Chna s large trade surplus. We use a trade cost calculaton method that recognzes lmtatons of data by usng an estmaton treatment that follows Wong (2012) and Novy (2008). We capture endogenously determned trade mbalances by ncorporatng both current consumpton and expected future ncremental consumpton from savng nto the model usng an analytcal structure attrbuted to Patnkn (1947), also adopted n Archbald and Lpsey (1960), and used more recently n Whalley et al (2011) and L and Whalley (2012). We calbrate the model to 2010 data and use counterfactual smulatons to explore TPP effects. Our smulaton results show, not surprsngly, that the TPP ntatve wll hurt Chna, but these effects are relatvely small under the present TPP proposal, and so 4

5 wll not have large effects on Chna. Other non-tpp member countres wll be hurt as well. Total world producton and welfare wll ncrease under a TPP regonal free trade ntatve and a TPP wll beneft member countres and the effects are sgnfcant and comparatvely promnent. Among these TPP countres, other TPP countres (OTPPC) n the model wll gan proportonally more than the US from ths regonal arrangement because of ther large ntra Pacfc trade. We also evaluate a partal non-tarff barrers elmnaton scenaro as senstvty analyss, and also change elastctes and upper bound values n the monetary structure. Results suggest that our smulaton results are reasonably robust. We have also smulated the effects that could follow f Japan jons the TPP, and fnd that these would be benefcal both for Japan and for all other TPP countres, but the negatve effect on non-tpp countres (lke Chna and ROW) would ncrease. We have also evaluated the scenaro of Chna jonng the TPP, and fnd that Chna and other TPP countres wll all gan, but non-tpp countres wll be hurt. We also compare TPP effects to global free trade effects n the model, and fnd they are dfferent. Frstly, global free trade benefts all countres n the world, but TPP benefts just member countres; second, global free trade postve effects are consderably hgher than TPP free trade effects. The remanng parts of the paper are organzed as follows: Part 2 ntroduces the TPP ntatve and ts development; Part 3 s the global general equlbrum model specfcaton; Part 4 s our calculaton of trade costs and TPP barrers change; Part 5 presents data and reports parameters from calbraton; Part 6 reports smulaton results for sx dfferent scenaros. The last part offers conclusons and remarks. 5

6 2. The TPP Intatve and Its Development The Trans-Pacfc Partnershp (TPP), also known as the Trans-Pacfc Strategc Economc Partnershp Agreement (TPPA), s a multlateral free trade agreement (FTA) that ams to further lberalze the economes of the Asa-Pacfc regon. Current negotatng partners nclude Australa, Brune, Chle, Malaysa, New Zealand, Peru, Sngapore, the Unted States, and Vetnam, a total of nne countres. Although all orgnal and negotatng partes are members of the Asa-Pacfc Economc Cooperaton (APEC), the TPP s not an APEC ntatve. However, t s consdered to be a step towards the proposed Free Trade Area of the Asa Pacfc (FTAAP), an APEC ntatve. The country member relatonshps between TPP and APEC are shown n Fgure 1. Fg.1 Country Members of TPP and APEC APEC Countres Not In TPP Chna Hong Kong, Chna Indonesa South Korea Papua New Gunea Phlppnes Russa Tawan Thaland TPP Countres In APEC Australa Brune Chle Malaysa New Zealand Peru Sngapore USA Vetnam Potental Addtonal TPP Countres In APEC Japan Canada Mexco Source: Compled by authors. The TPP grew out of the Pacfc Three Closer Economc Partnershp (P3-CEP). Its negotaton was launched on the sdelnes of the 2002 APEC Leaders Meetng n Los Cabos, Mexco, by Chlean Presdent Rcardo Lagos and Prme Mnsters Goh 6

7 Chok Tong of Sngapore and Helen Clark of New Zealand. Brune frst took part as a full negotatng party n the ffth round of talks n Aprl 2005, after whch the trade bloc became known as the Pacfc-4 (P4). The objectve of the orgnal agreement was to elmnate 90% of all tarffs between member countres by January 1, 2006, and reduce all trade tarffs to zero by It was also to be a comprehensve agreement coverng all the man components of a free trade agreement, ncludng trade n goods, rules of orgn, trade remedes, santary and phytosantary measures, techncal barrers to trade, trade n servces, ntellectual property, government procurement and competton polcy (Wkpeda, 2012). After the P4 negotatons fnshed n 2005, ts partes agreed to begn negotatng on fnancal servces and nvestment whch were not covered by the orgnal agreement wthn two years of ts entry nto force. When these negotatons began n March 2008, the US joned the group pendng a decson on whether to partcpate n a comprehensve negotaton for an expanded TPP agreement. In September 2008, the US announced t would partcpate fully n the negotatons, and Australa, Peru, and Vet Nam also joned (NZMFAT, 2012). In November 2009, US Presdent Obama affrmed that the US would engage wth TPP countres. Negotatons for an expanded agreement began n March 2010 (Fgure 2). Durng the thrd round n Brune n October 2010, Malaysa joned the negotatons. Meanwhle, Japan, Canada and Mexco have all more recently expressed an nterest n jonng the TPP negotatons. We report nformaton on these rounds of negotaton n Table 1. 7

8 Fg. 2 The Hstory of TPP P3-CEP (P3) Pacfc-4 (P4) TPP Proposal TPP 2002 n Los Cabos, Mexco Aprl , proposed by the US March 2010 Chle, Sngapore, New Zealand P3 + Brune P4+US+Australa +Peru+Vet Nam P4+US+Australa +Peru+Vet Nam +Malaysa Source: Compled by authors. Table 1 11 Rounds of TPP Negotatons Round Round Tme Place No. No. Tme Place round 1 Mar , 2010 Melbourne, Australa round 7 June 20-24, 2011 Ho Ch Mnh, Vet Nam round 2 June 14-18, 2010 San Francsco, US round 8 Sep. 6-15, 2011 Chcago, US round 3 Oct. 4-9, 2010 Darussalam, Brune round 9 Oct , 2011 Lma, Peru round 4 Dec. 6-10, 2010 Auckland, New Zealand round 10 Dec. 5-9, 2011 Kuala Lumpur, Malaysa round 5 Feb , 2011 Santago, Chle round 11 Mar. 1-9, 2012 Melbourne, Australa round 6 Mar. 24-Apr. 1, 2011 Sngapore / / / Source: compled by authors. The objectve of the TPP negotatons remans to develop an FTA agreement whch wll be able to adapt and ncorporate current ssues, concerns and nterests of members. Workng groups have been establshed n the followng areas: market access, techncal barrers to trade, santary and phytosantary measures, rules of orgn, customs cooperaton, nvestment, servces, fnancal servces, telecommuncatons, e-commerce, busness moblty, government procurement, competton polcy, ntellectual property, labor, envronment, capacty buldng, trade remedes, and legal and nsttutonal ssues. A unque departure from other FTAs s the group s addtonal focus on cross-cuttng horzontal ssues such as regonal ntegraton, regulatory coherence, compettveness, development and small and medum enterprses (SMEs). 8

9 TPP member countres are home to more than 500 mllon people; one ffth of APEC s populaton. The nne partcpatng economes account for 17.8 trllon USD, or just over half of APEC s GDP. The TPP economes account for 36% of total goods trade and 47% of total servce trade n APEC. These economes also accounted for 62% of outward FDI and 58% of nward FDI n the APEC regon (NZMFAT, 2012). Ths regonal FTA could have sgnfcant mpacts on the global economy. 9

10 3. Model Specfcaton To assess the potental mpacts of TPP both on Chna and other countres, we use a general equlbrum model wth both nternatonal trade n goods and trade costs. Our global general equlbrum model has fve countres and each country produce two goods wth two factors. These fve countres are Chna, the US, Japan, other TPP countres (OTPPC) and the rest of the world (ROW). The two goods are tradable goods and non-tradable goods and are treated as heterogeneous across countres. The two factors n each country are labor and captal, whch are ntersectorally moble but nternatonally mmoble. To ths we add monetary structure usng nsde money followng Whalley et al (2011) and L and Whalley (2012). Ths allows for the endogenous determnaton of changes n trade mbalances for trade n goods followng a TPP ntatve, whch are offset through nter-temporal trade across countres n money; and also allows for a calbraton to a base case where Chna has a large trade surplus. Ths monetary structure bulds on Azarads (1993) where there s extensve dscusson of smple overlappng generaton models wth nsde money. Here, n addton, nteractons between monetary structure and commodty trade are needed, and hence motvates models wth smultaneous nter-temporal and nter-commodty structure. In our general equlbrum model wth monetary structure, we assume there are two goods n each perod and allow nter-commodty trade to co-exst wthn the perod along wth trade n debt n the form of nsde money. We use a sngle perod 10

11 model where ether clams on future consumpton (money holdng) or future consumpton labltes (money nsuance) enter the utlty functon as ncremental future consumpton from current perod savngs. Ths s the formulaton of nsde money used by Patnkn (1947, 1971) and Archbald and Lpsey (1960). Ths can also be used n a mult-country model structure wth trade n both goods and nsde money. On the producton sde of the model, we assume CES technology for producton of each good n each country (Fgure 3) l l l 1 1 l l l l l l l l l 1 Q [ ( L ) (1 )( K ) ], country, l goods (1) where l Q s the output of the lth ndustry (ncludng tradable goods and non-tradable goods) n country, l L and K l are the labor and captal nputs n sector l, l l l s the scale parameter, s the dstrbuton parameter and s the elastcty of factor substtuton. Frst order condtons for cost mnmzaton mply the factor nput demand equatons, K l l l L (1 ) l l l Q l w (1 ) l 1 [ [ ] (1 )] l l K w (2) l l l l l l (1 ) 1 l l K Q w L [ (1 )[ ] ] l l L (1 ) w (3) where K w and L w are the prces of captal and labor n country. On the consumpton sde, we use the Armngton assumpton of product heterogenety across countres, and assume clams on future consumpton enter preferences and are traded between countres. Each country can thus ether ssue or 11

12 buy clams on future consumpton usng current perod ncome. We use a nested CES utlty functon to capture consumpton (Fgure 3) ( T, NT, ) [ 1 ( T ) 2 ( NT ) 3 ( ) ] U X X Y X X Y, country (4) Where NT X denotes the consumpton of non-tradable goods n country, T X denotes the consumpton of composte Armngton tradable goods n country, and Y denotes the nsde money for country. Addtonally 1, 2 and 3 are share parameters and s the top level elastcty of substtuton n consumpton. Fg. 3 Structure of Producton and Consumpton Functons Producton Functon (CES) Consumpton Functon (Nested CES) Tradable and Non -tradable Goods Consumpton Level 1 Non-tradable Goods Tradable Goods Insde Money Labor Captal Level 2 Chna US Japan OTPPC ROW Source: Compled by authors. The composte of tradable goods s defned by another nestng level reflectng the country from whch goods come. We assume ths level 2 composte consumpton s of CES form and represented as, 1 ' 1 ' T ' T ' ' 1 j j j X [ x ], j country (5) Where T x j s the consumpton of tradable goods from country j n country. If j ths denotes that ths country consumes ts domestcally produced tradable goods. j s the share parameter for country js ' tradable goods consumed n country. ' s the elastcty of substtuton n level 2 preferences n country. We assume a representatve consumer n country wth ncome as I. The 12

13 budget constrant for ths consumer s consumpton s P X pc X pc Y I (6) T T NT NT Y Here, Y represents both nsde money (debt) held by country, and also country s ' trade mbalance. Y 0 mples a trade surplus (or postve clams on future consumpton); Y 0 mples a trade defct or future consumpton labltes (effectvely money ssuance), and Y 0 mples trade balance. For trade defct countres, utlty wll decrease n nsde money snce they are ssuers. In order to capture ths gven that Y 0 for these countres, we use an upper bound 0 0 Y n the utlty functon n a term [ Y Y ] followng Whalley et al (2011) and assume that Y 0 s large enough to ensure that Y 0 Y 0. We use the transformaton 0 y Y Y to solve the optmzaton problem, and the utlty functon and budget constrant become T NT T NT 1 (,, ) [ 1 ( ) 2 ( ) 3 ( ) ] MaxU X X Y X X y st.. P X pc X pc y I pc Y I T T NT NT Y Y 0 * (7) The optmzaton problem (6) above yelds X X y I ( ) [ ( ) ( ) ( ) ] * T 1 T T 1 NT 1 Y 1 P 1 P 2 pc 3 pc I ( ) [ ( ) ( ) ( ) ] * NT 2 NT T 1 NT 1 Y 1 pc 1 P 2 pc 3 pc I ( ) [ ( ) ( ) ( ) ] * 3 Y T 1 NT 1 Y 1 pc 1 P 2 pc 3 pc (8) (9) (10) Where T P, NT pc and Y pc are separately consumpton prces of composte tradable goods, non-tradable goods and nsde money n country. For the composte tradable goods, they enter the second level preferences and come from dfferent 13

14 countres, and the country specfc demands are x ( X P ) T T T j j ' T T pcj j pcj j ' (1 ) ( ) [ ( ) ] (11) where T pc j s the consumpton prce n country of tradable goods produced n country j, X P s the total expendture on tradable goods n country. The T T consumpton prce for the composte of tradable goods s 5 T T j pcj j 1 P 1 ' ' (1 ) 1 [ ( ) ] (12) Equlbrum n the model then characterzed by market clearng prces for goods and factors n each country such that Q T l x j T j l l l (13) K K, L L (14) The non-tradable goods market clearng condton wll gven later n the paper. A zero proft condton must also be satsfed n each ndustry n each country, such that l l K l L l p Q w K w L l T, NT (15) Where l p s the producer prce of goods l n country. For global trade (or money) clearance, we have Y 0 (16) We ntroduce trade cost for trade between countres. Trade costs nclude not only mport tarffs but also other non-tarff barrers such as transportaton costs, language barrers, nsttutonal barrers and etc. We dvde trade costs nto two parts n our model; mport tarff and non-tarff trade costs. We denote the mport tarff n country 14

15 as t, and non-tarff trade costs as N j (ad volume tarff-equvalent non-tarff trade costs for country mported from country j ). Ths yelds the followng relaton of consumpton prces and producton prces n country for country j ' s exports. T T pc (1 t N ) p (17) j j j Import tarffs wll generate revenues R, whch are gven by R p x t (18) T T j j j, j For non-tarff trade costs, they are dfferent from the mport tarff: they cannot collect revenue, and mporters need to use actual resources to cover the costs nvolved. In the numercal model, we assume that the resource costs nvolved n overcomng all other non-tarff barrers are denomnated n terms of domestc non-tradable goods. We ncorporate ths resource usng feature through use of non-tradable goods equal n value terms to the cost of the barrer. We thus assume reduced non-tarff trade costs (ncludng transportaton cost) wll thus occur under trade lberalzaton as an ncrease n non-tradable goods consumpton NR by the representatve consumer n mportng countres. The representatve consumer s ncome n country s thus gven by w K w L R I (19) K L and the demand-supply equalty nvolvng non-tradable goods becomes Q NT NR NT X (20) p NT where NR p x N (21) T T j j j j, j The TPP FTA wll thus reduce both mport tarffs and non-tarff trade costs 15

16 between member countres whch wll nfluence the whole world. Usng the general equlbrum model above, we can calbrate t to a base case data set and then smulate and explore TPP effects. 16

17 4. Trade Cost Calculatons We report our calculatons of trade costs n ths part whch provde trade cost estmates for use n our general equlbrum model. The methodology we use s from Novy (2008) and Wong (2012). We calculate and report ad valorem tarff-equvalent trade costs between countres for Chna, the US, Japan, other TPP countres (OTPPC), and ROW from 2000 to Trade Costs Defnton A broad defnton of trade costs ncludes polcy barrers (Tarffs and Non-tarff barrers), transportaton costs (freght and tme costs) as well as communcaton and other nformaton costs, enforcement costs, foregn exchange costs, legal and regulatory costs and local dstrbuton costs. Fgure 4 reports the structure of representatve trade costs used by Anderson and Wncoop (2004) to llustrate conceptually what s nvolved. Fg. 4 Representatve Trade Costs Trade Costs Transport Costs Border Related Trade Barrers Retal and Wholesale Dstrbuton Costs Freght Costs Transt Costs Polcy Barrers Language Barrer Currency Barrer Informaton Costs Securty Barrer Tarffs Non-tarff Barrers Source: Anderson and Wncoop (2004) and De (2006). 17

18 Trade costs are reported n terms of ther ad valorem tax equvalent. They are large, even asde from trade polcy barrers and even between apparently hghly ntegrated economes. The tax equvalent of representatve trade costs for rch countres s about 170% and ths ncludes all transport, border-related and local dstrbuton costs from foregn producer to fnal user n the domestc country (Anderson and Wncoop, 2004). Trade costs also have large welfare mplcatons. Current polcy related costs are often more than 10% of natonal ncome (Anderson and Wncoop, 2002). Obstfeld and Rogoff (2000) commented that all the major puzzles of nternatonal macroeconomcs hnge on trade costs. Other studes estmate that for each 1% reducton of trade transacton costs world ncome could ncrease by 30 to 40 bllon USD (APEC, 2002; OECD, 2003; De, 2006). 4.2 Methodology Here, we have calculated trade costs for prospectve TPP partcpants, Chna, and other non-partcpants followng the approaches n Head and Res (2001), Novy (2008) and Wong (2012). Ther method s to take the rato of blateral trade flows over local trade, scaled to some parameter values, and then use a measure that capture all barrers. Some papers have argued that ths measure s consstent wth the gravty equaton and robust across a varety of trade models (Novy, 2008; Wong, 2012). The gravty equaton s one of the most robust emprcal relatonshps n economcs whch relates trade between two country to ther economc sze, blateral trade barrers, costs of producton n exporter countres, and how remote the mporter 18

19 s from the rest of the world (Wong, 2012). Some recent studes have provded the mcro foundatons for the gravty equaton, for example Anderson and Wncoop (2003), Eaton and Kortum (2002) and Chaney (2008). The measure of trade barrers used here s based on the gravty equaton derved from Chaney s (2008) model of heterogeneous frms wth blateral fxed costs of exportng. Trade barrers can take two forms n the model, a varable trade barrer r and a fxed cost of exportng F r. The varable trade barrer r s an ceberg cost. In order to delver one unt of good to from r, 1 unt of good has to be delvered. The gravty equaton supported by ths model s: r X r Y ( 1) Yr wr r 1 ( ) Fr (22) Y Where X r s mport of country from country r. Y, Y r and Y are the economc szes of both countres and the total world, w r s labor costs, r s varable trade costs and F r s the fxed cost of exportng. The Pareto parameter governs the dstrbuton of frm productvtes. s the elastcty of substtuton n preferences. s a remoteness measure for the mportng country whch captures trade dverson effects. The mechansm s that the further away s from the rest of the world, the more lkely that r could export more to due to less competton from thrd party countres n the mporter country. Ths has a smlar nterpretaton to the multlateral resstance term n Anderson and Wncoop (2003). We can relate data on trade flows to unobservable trade barrers by takng ratos of blateral trade flows of two regons over local purchases of each of two countres: 19

20 X X X X F F ( 1) 1 ( ) ( ) (23) F F r r r r r r rr rr rr Ths equaton reveals the relatonshp between observable trade data and unobservable trade barrers and elmnates the need to worry about the omsson of unspecfed or unobserved trade barrers. If the fxed costs of exportng are not blaterally dfferentated ( Fr F r ) or s they are constant across locatons ( Fr F ), the fxed costs drop out of ths measure and the measured trade costs would smply be nterpreted as varable trade costs, as n models wthout fxed export costs such as Eaton and Kortum (2002) and Anderson and Wncoop (2003). For smplcty of exposton, we normalze own trade costs to 1,.e. 1 and F 1. Defnng the geometrc average of trade costs between the country par and r as t r 1 2 Xr Xr ( ) (24) X X rr we then get a measure of the average blateral trade barrer between country and r : X ( ) X rr r ( ) ( r r ) ( Fr Fr ) Xr Xr t (25) Data for ths equaton s relatvely easy to obtan, and so we have a comprehensve measure of trade barrers, and the ad valorem tarff-equvalent blateral average trade cost between country and r can be wrtten as t r 1 2 X Xrr tr 1 ( ) 1 (26) X X r r Usng the trade costs equaton above, we can calculate actual trade costs between 20

21 countres n our general equlbrum model, whch are needed n buldng a benchmark data set for use n calbraton and smulaton. 4.3 Data and Results of Calculatons We need to calculate trade costs between each country par for Chna, the US, Japan, other TPP countres (OTPPC) and ROW. OTPPC denotes the summaton of 8 TPP countres: Australa, Brune, Chle, Malaysa, New Zealand, Peru, Sngapore and Vetnam. For the ROW, we use world total mnus Chna, the US, Japan and OTPPC to yeld the data we use n calculatons. For trade costs, n equaton (26), X r and X r are separately exports and mports between countres and r. Ths trade data s from the UN comtrade database, and total world trade data s from WTO Internatonal Trade Statstcs Due to market clearng, ntranatonal trade X or X rr can be rewrtten as total ncome mnus total exports (see equaton (8) n Anderson and Wncoop(2003)), X y X (27) Where X s the total exports, defned as the sum of all exports from country, whch s X X (28) r, r r Ths data s from the UN Comtrade database also. For y, GDP data are not sutable because they are based on value added, whereas the trade data are reported as gross shpments. In addton, GDP data nclude servces that are not covered by the trade data (Novy, 2008). It s hard to get ths ncome data accordng to such a defnton, so here we use GDP data mnus total servce value added. We get GDP data from World 21

22 Bank database, and the servce share of GDP data from World Development Indcators (WDI) of World Bank database, we then calculate results for GDP mnus servces. We take the value of to be 8.3 as n Eaton and Kortum (2002). Table 2: Ad Valorem Tarff-Equvalent Trade Costs between Countres between Year Chna-US Chna-Japan Chna-OTPPC Chna-ROW Japan-USA Japan-OTPPC Japan-ROW USA-OTPPC USA-ROW OTPPC-ROW Notes: (1) Unts for above results are %; (2) OTPPC denotes other TPP countres except the US, ncludng Australa, Brune Darussalam, Chle, Malaysa, New Zealand, Peru, Sngapore and Vetnam. Source: Calculated by authors. Fg 5 Ad Valorem Tarff-Equvalent Trade Costs between Countres (Unt: %) Chna-US Chna-Japan Chna-OTPPC Chna-ROW Japan-US Japan-OTPPC Japan-ROW Japan-OTPPC US-ROW Notes: OTPPC denotes other TPP countres except the US, ncludng Australa, Brune Darussalam, Chle, Malaysa, New Zealand, Peru, Sngapore and Vetnam. Source: Compled by authors. Results are shown n Table 2 and Fgure 5. We only use trade cost data for

23 n our numercal general equlbrum model, but to gve more nformaton on trade costs over tme, we have also calculated trade costs from 2000 to From the results, we can see that nearly all trade costs between countres have decreased as tme passes; except n 2009, because of the fnancal crss. All countres trade costs ncreased n that year and then decreased agan n For pars of country trade costs, Chna-US trade costs are hgher than Chna-Japan trade costs; and they are separately 33.38% and 28.45% (ad valorem tarff equvalent) n Japan-US trade costs are hgher than Chna-US trade costs; they are separately 37.43% and 33.38% n

24 5. Data and Parameters Calbraton We use 2010 as our base year n buldng a benchmark general equlbrum dataset for use n calbraton and smulaton followng the method set out n Shoven and Whalley (1992). There are fve countres n our model, and the OTPPC data s obtaned by addng Australa, Brune, Chle, Malaysa, New Zealand, Peru, Sngapore and Vetnam together, and ROW data s obtaned from total world values mnus values for Chna, US, Japan and OTPPC. For the two goods, we assume secondary ndustry (manufacturng) reflects tradable goods, and prmary and tertary ndustres (agrculture, extractve ndustres, and servces) yeld non-tradable goods. For the two factor nputs, captal and labor, we use total labor ncome (wage) to denote labor values for nputs by sector. All data are n bllon US dollars. We adjust some of the data values for mutual consstency for calbraton purposes. Chnese data are from Chna data onlne. We use producton and captal values to determne labor values by resdual for Chna. US data are from the Statstcs Database of Bureau of Economc Analyss (BEA), captal and labor data are from the nput-output table. Japan, OTPPC and ROW data are all from World Bank database (World Development Indcate). We use agrculture and servce share of GDP data and GDP data to yeld producton data of tradable goods and non-tradable goods, and use captal/gdp rato to yeld captal and labor nput n producton. We set the upper bound n our monetary structure, 0 Y, to equal 1000 n all countres; and change ths value n later senstvty analyss to check ts nfluence on smulaton results. These 24

25 data are lsted n Table 3. Table 3 Base Year Data Used for Calbraton and Smulaton (2010 Data) Item / Country Chna US Japan OTPPC ROW Total Producton Tradable Non-tradable Captal Labor Insde Money Endowment Tradable Non-tradable Tradable Non-tradable Y Y y captal labor Note: (1) Unts for producton, captal, labor, nsde money and endowments are all bllon US$, and labor here denotes factor ncome (wage). (2) We sum data for Australa, Brune, Chle, Malaysa, New Zealand, Peru, Sngapore and Vetnam to get OTPPC data. (3) We use world values mnus Chna, US, Japan and OTPPC to generate ROW values. Sources: Chnese data from Chna data onlne; US data from the Statstcs database of Bureau of Economc Analyss (BEA); Japan, OTPPC and ROW data are all calculated from WDI of World Bank database. Trade data between each par of countres are from the UN Comtrade database. We use ndvdual country total export and mport values to ndrectly yeld exports to and mports from the ROW. Usng producton and trade data, we can then calculate each country s consumpton values. All trade data are lsted n Table 4. Table 4: Trade between Countres (Unt: Bllon USD) Exporter Countres Chna US Japan OTPPC ROW Chna / US / Importer Japan / OTPPC / ROW / Notes: (1) OTPPC denotes other TPP countres except the US, ncludng Australa, Brune Darussalam, Chle, Malaysa, New Zealand, Peru, Sngapore and Vetnam. (2) We get OTPPC trade data by addng all eght other TPP countres trade data together. (3) We get the ROW trade data by deductng from each country s total export, total mport and total world trade value. Source: Unted Natons (UN) Comtrade database. We dvde trade costs nto two parts, mport tarffs and all other non-tarff barrers. We obtan each country s mport tarff data from WTO Statstcs Database. 25

26 For ROW, we cannot obtan ts mport tarff drectly, and so we use European Unon s tarff rate to denote these values. We calculate all other non-tarff barrers by usng trade costs (n Table 2) mnus mport tarffs. All mport tarffs and other non-tarff barrer values are lsted n Tables 5 and 6. Table 5: Import Tarffs for Countres n 2010 (Unt: %) Countres Chna US Japan Other TPP Countres ROW Import Tarff Notes: (1) Import tarffs here are smple average MFN appled tarff rates; (2) Tarffs for other TPP countres are the average tarff of 8 TPP member countres (except the US); (3) We use the mport tarff of European Unon to denote the tarff for the ROW. Source: World Development Indcate (WDI) of World Bank database. Table 6: Other Trade Costs Except Import Tarff (Ad Valorem Tarff-Equvalents) Countres Exporter Chna US Japan OTPPC ROW Chna / US 29.9 / Importer Japan / OTPPC / 4.8 ROW / Notes: (1) Unts are %; (2) OTPPC denotes other TPP countres except the US, ncludng Australa, Brune Darussalam, Chle, Malaysa, New Zealand, Peru, Sngapore and Vetnam. Source: Calculatons by authors. Varable/Country Share Parameters n Producton Scale Parameters n Producton Consumpton Share Parameters for Level 2 Table 7 Parameters Generated by Calbraton Chna US Japan OTPPC ROW T. N-T. T. N-T. T. N-T. T. N-T. T. N-T. K L Products From Consumpton Sde Chna US Japan OTPPC ROW Chna US Japan OTPPC ROW Composte T N-T Insde Money Note: T denotes tradable goods; N-T denotes non-tradable goods. Source: Calculated usng the model structure above and calbraton methods cted above by the authors. Consumpton Share Parameters for Level 1 26

27 There are no avalable estmates of elastctes for ndvdual countres on the demand and producton sdes of the model. Many of the estmates of domestc and mport goods substtuton elastcty are around 2 (Betna et al, 2006), so we set all these elastctes n our model to 2 (Whalley and Wang, 2010). We change these elastctes later n senstvty analyss to check ther nfluence on smulaton results. Wth these data, we calbrate the model parameters and report parameter values n Table 7. When used n model soluton these wll regenerate the benchmark data as an equlbrum for the model. Then, usng these parameters we can smulate the effects of TPP changes under dfferent scenaros. 27

28 6. Smulaton Results We report counterfactual smulaton results n ths part to assess the potental effects of TPP on Chna and other countres under dfferent scenaros. In our model, we dvde trade costs nto two parts, mport tarffs and other all non-tarff barrers. Accordng to the TPP negotaton targets, the am s to set up a free trade area, and for mport tarffs to be completely elmnated among partcpants after the negotaton of the TPP. In the meanwhle, TPP negotatons wll focus on nsttutonal areas, techncal and standard barrers, nvestment, servces and other mpedments, whch mples other all non-tarff barrers wll be reduced and, n the long run, even completely removed. In our smulaton analyss, we frst assume that the TPP wll completely elmnate tarff barrers (free trade), and then ether partally (wth weghts denotng the percentage by whch non-tarff barrers wll be reduced) or completely elmnate other all non-tarff barrers. We focus on effects on producton, welfare (utlty), export, mport and revenue and trade mbalances, and use percentage changes compared to 2010 data to show these effects. 6.1 Potental Effects of TPP on Chna and Other Countres We ntally use two dfferent scenaros to capture TPP effects, the frst assumes TPP elmnates all trade costs (ncludng tarff and other all non-tarff barrers) between members; the second assumes TPP only elmnates tarffs between member countres. Table 8 and Fgure 6 show these results. For Chna, producton, welfare, mport and revenue all wll be negatvely affected, 28

29 but exports and the trade mbalance ncrease. Under whole trade costs elmnaton, these effects are stronger than only under mport tarff elmnaton. When all trade costs are removed, Chna s welfare wll decrease %, producton wll decrease %, mports wll decrease % and revenues wll decrease about %; meanwhle, exports and the trade mbalance wll separately ncrease 0.132% and 2.439%. But when only mport tarffs are removed, Chna s welfare, producton, mport and revenue separately declne by %, %, % and %; and exports and the trade mbalance mprove separately by 0.04% and 0.609%. Ths suggests that TPP ntatves could have negatve effects on Chna but the mpacts are not severe. Table 8 TPP Effects on Indvdual Countres and the World (Unts: % Change) Item / Countres Chna US Japan OTPPC ROW World Whole Trade Costs Elmnaton Welfare Producton Export Import Imbalance Revenue Only Import Tarff Elmnaton Welfare Producton Export Import Imbalance Revenue Note: Changes n welfare ( Welfare) equal the change n total utlty; In order to show total world unbalance stuaton change, we use the sum of all countres absolute mbalance values change ( Imbalance for world) to reflect effects to world unbalance level. Source: Calculated and compled by authors. TPP member countres, US and other TPP countres (OTPPC), both gan from the FTA agreement. Ther producton, welfare, export and mport all ncrease and only revenues decrease. Comparatvely, OTPPC wll gan more than the US. For Japan, ts 29

30 total producton wll ncrease (gan) but welfare wll decrease (lose); revenue, export and mport all wll decrease (lose) but ther trade surplus wll ncrease also. ROW wll lose comprehensvely, ts total producton, welfare, export, mport and revenue all decrease and only ther trade surplus wll ncrease. Total world producton, welfare and trade all ncrease. Fg. 6 TPP Effects on Indvdual Countres Chna US Trade Costs Tarffs Trade Costs Tarffs exp mb mp prod rev wel exp mb mp prod rev wel Japan OTPPC Trade Costs Tarffs Trade Costs Tarffs exp mb mp prod rev wel exp mb mp prod rev wel ROW World Trade Costs Tarffs Trade Costs Tarffs exp mb mp prod rev wel exp mb mp prod rev wel Note: (1) Unts for above results are %. (2) The exp denotes export, mp denotes mport, mb denotes mbalance, prod denotes producton, rev denotes revenue, wel denotes welfare. (3) Trade Costs denote the case where TPP elmnate all trade costs between members; Tarffs denote the case where TPP elmnates just mport tarffs between members. Source: Calculated and compled by authors. In general, present TPP ntatves are benefcal for member countres, but wll hurt other countres outsde of the organzaton lke Chna, Japan and ROW. Although ths knd of regonal FTA s good for regonal trade lberalzaton but may form another knd of protectonsm to outsde countres. Addtonally, the effects of current cooperaton among TPP countres are small because trade between these member countres s not very bg. In the meanwhle, present TPP negotatons have not yet 30

31 reached agreement and they may need a long tme to negotate and may even not reach agreement. Therefore, the TPP ntatve for now does not provde a major economc challenge to Chna and other non-tpp countres. 6.2 Effects of TPP under Gvng Weghts to Non-tarff Barrers Elmnaton Other non-tarff barrers nclude transportaton costs and some other costs that cannot be reduced by a TPP negotaton, such as added transportaton costs, so t may not be realstc to assume that a TPP can remove all other non-tarff barrers. We therefore gve weghts to other non-tarff barrers elmnaton by assumng that TPP just removes part of non-tarff barrers. We use weghts 20%, 40%, 60% and 80% to explore four dfferent cases, whch means that TPP can remove separately 20%, 40%, 60% and 80% of other all non-tarff trade barrers. We report these results n Table 9 and Fgure 7. Fg. 7 TPP Effects on Chna When Non-tarff Barrers Are Just Partally Elmnated Weght=20% Weght=40 export mbalance mport producton revenue welfare export mbalance mport producton revenue welfare Weght=60% Weght=80% export mbalance mport producton revenue welfare export mbalance mport producton revenue welfare Note: (1) Unts for above results are %. Sources: Compled by authors. 31

32 Table 9 TPP Effects When Weghts Gven to Non-tarff Barrer Elmnaton (%) Item / Countres Chna US Japan OTPPC ROW World Item / Countres Chna US Japan OTPPC ROW World Weghts = 20% Weghts = 60% Welfare Welfare Producton Producton Export Export Import Import Imbalance Imbalance Revenue Revenue Weghts = 40% Weghts = 80% Welfare Welfare Producton Producton Export Export Import Import Imbalance Imbalance Revenue Revenue Note: (1) Unts for all results are %. (2) The change n welfare ( Welfare) equal the change n total utlty. (3) In order to show total world unbalance stuaton change, we use the sum of all countres absolute mbalance values change ( Imbalance for world) to reflect effects to world unbalance level. Source: Calculated and compled by authors. 32

33 TPP mpacts are smlar to those n Table 8, but the ntensty of the effects becomes stronger as weghts ncrease. We can take Chna s welfare varatons as an example. Ths wll change separately by %, %, % and % when weghts equals 20%, 40%, 60% and 80%. In summary, TPP effects shown n ths part are as follows: Chna, Japan and ROW wll have a reducton n total producton, welfare and trade. The US and OTPPC wll gan from ths FTA agreement. Total world producton and welfare wll ncrease. All countres revenue wll decrease. TPP effects are relatvely robust even f we assume that TPP can just partally remove other non-tarff barrers. For the TPP nfluence on Chna whch we focus on n ths paper, t s clear that t wll hurt Chna, but the effects are not severe. Meanwhle, t s Chna s exports wll ncrease and mports wll decrease whch means that the trade surplus wll ncrease. Ths result comes n part from the mport ncrease by ROW from Chna. 6.3 Senstvty Analyss of TPP Effects We perform senstvty analyss by changng the values of elastctes and upper bound money to check the robustness of TPP effects. We change elastctes n both producton and consumpton to separately equal 0.6, 1.6 and 2.6, and change the upper bound Y 0 to 2000, 3000, and We then recalbrate parameters and smulate TPP effects. For smplcty, we only check the senstvtes of TPP effects for the whole trade costs elmnaton case, whch s the man result for ths paper. These results are reported n Table 10 and Fgure 8. 33

34 Table 10 Senstvty Analyss for Whole Trade Costs Elmnaton Results (%) Item / Countres Chna US Japan OTPPC ROW World Item / Countres Chna US Japan OTPPC ROW World Elastcty=0.6 [5] Upper Bound=2000 Welfare Welfare Producton Producton Export Export Import Import Imbalance Imbalance Revenue Revenue Elastcty=1.6 [5] Upper Bound=3000 Welfare Welfare Producton Producton Export Export Import Import Imbalance Imbalance Revenue Revenue Elastcty=2.6 [5] Upper Bound=4000 Welfare Welfare Producton Producton Export Export Import Import Imbalance Imbalance Revenue Revenue Note: (1) Unts for all results are %. (2) The change n welfare ( Welfare) equal the change n total utlty. (3) In order to show total world unbalance stuaton change, we use the sum of all countres absolute mbalance values change ( Imbalance for world) to reflect effects to world unbalance level. (4) Insde money change wth 1000 varaton s a sutable change for senstvty analyss. (5) These cases refer to changes n both producton and consumpton elastctes, and n all countres. Source: Calculated and compled by authors. 34

35 Fg. 8 Senstvty Analyss Results For TPP Effects to Chna Elastctes=0.6 Elastctes=1.6 Elastctes=2.6 export export export mport producton mport producton mport producton revenue utlty revenue utlty revenue utlty Upper Bound=2000 Upper Bound=3000 Upper Bound=4000 export export export mport producton mport producton mport producton revenue utlty revenue utlty revenue utlty Note: (1) Unts for above results are %. Sources: Compled by authors. Comparng senstvty results wth the basc results n Table 8, we fnd that all mpacts (postve or negatve) are of the same sgn except for producton, mport and revenue changes for Chna, welfare changes for Japan, and welfare, export and mport changes for ROW under elastctes equal to 0.6. These results suggest that TPP mpact results on Chna and other countres are reasonably relable and robustness. We take the effects on Chna as an example to compare dfferent nfluences under dfferent elastctes and upper bound money values (Fgure 8). We fnd that Chna s producton wll decrease except when elastctes equal 0.6, welfare wll decrease and change between and except when elastctes equal 0.6, export wll ncrease expect when elastctes are small (0.6), mports wll decrease except when elastctes equal 0.6, and revenues wll decrease except when elastctes equal 0.6. All senstvty analyze results show TPP effects are benefcal for member 35