How does MERCOSUR affect other countries?

Responsible researcher: Viviane Pires Ribeiro

Paper Title: How Regional Blocs Affect Excluded Countries: The Price Effects of MERCOSUR

Authors: Won Chang and L. Alan Winters

Intervention Location: Brazil

Sample Size: 4 member countries

Major theme: Economic Policy and Governance

Variable of Main Interest: Import

Type of Intervention: Impact ofMERCOSUR on export prices

Methodology: Price game

The effects of Preferential Trade Agreements on welfare are more directly linked to changes in exchange prices, that is, the terms of trade. Chang and Winters (2002) employ a simple strategic pricing game in segmented markets to measure the effects of MERCOSUR on the prices of exports from “non-member” countries to Brazil: as Brazil exempts its MERCOSUR partners from tariffs, the pressure resulting competitiveness leads other exporters to reduce their prices. Working with detailed data on unit values ​​and tariffs, the authors find that the creation of MERCOSUR was associated with significant drops in the prices of non-member exports to the region.

Assessment Context

Preferential Trade Agreements (PTAs) have become an integral and enduring aspect of the multilateral trading regime. Between 1990 and 1997, eighty-seven preferential agreements were notified to the World Trade Organization (WTO), and almost all WTO signatories are currently members of at least one PTA. Despite this widespread existence, concerns remain about the welfare impacts of PTAs, especially in excluded countries. The effects of these preferential agreements on the volume and quantities of trade are studied quite frequently, but these variables are not a reliable guide to the welfare effects for third countries. The latter are more directly related to price effects, and there are few studies of these. In fact, no other published ex-post studies on the price effects of a PTA on its trading partners were identified.

Intervention Details

Chang and Winters (2002) analyze one of the most recent and controversial customs unions, MERCOSUR (between Argentina, Brazil, Paraguay and Uruguay). The authors examine the effect that MERCOSUR had on import prices from non-members, assuming that these countries export to two segmented markets, (1) Brazil and (2) the rest of the world, in a scenario of imperfect competition with differentiated products. The study focuses on the Brazilian import market, as it is a large market, and is by far the largest in MERCOSUR. It is considered that changes in Brazilian Most Favored Nations (MFN) tariffs have directly led to price changes by non-member companies exporting to Brazil, and that tariff preferences offered to members, e.g. Argentina, lead to additional “strategic” prices in the Brazilian market. Thus, the authors seek to identify these responses both in commodity import data from Brazil and in export data from its main suppliers abroad.

The trade data from which unit values ​​(such as value/quantity) were obtained were taken from the United Nations (UN) Comtrade database at the 6-digit level of the Harmonized System (HS). This data offers two major advantages over other sources. First, they are very disaggregated: more than 5,000 commodities are distinguished. This helps minimize heterogeneity within each heading, which in turn improves the quality of unit value data and reduces the need for tariff averaging within headings. Second, trade and tariff data match very well at the 6-digit level, because at this level the HS classification is universal across countries.

Tariff data was provided by the United Nations Conference on Trade and Development (UNCTAD) and the MERCOSUR Secretariat. The Common External Tariff (TEC) of 1995 and 1996, and the exceptions listed in the Ouro Preto Protocol agreement, are defined at the HS-8 digit level. To harmonize fare and price data, the authors truncated fare codes to up to 6 digits and took simple averages.

Methodology Details

To carry out the analysis, Chang and Winters (2002) present a model in which reduced-form estimation equations are derived and a comparative statics exercise to interpret their coefficients. The model has two companies, one “non-member” and the other “member”, exporting a differentiated product to the Brazilian market. The two companies respond to each other's prices (as well as their own tariffs, exchange rates and wages), playing a Bertrand pricing game in the Brazilian market. The game is explored by examining the relative prices of members and non-members in Brazil and, for certain exporters, the relative prices of exports to Brazil and other markets.

It is postulated that the export prices of non-member companies to Brazil are influenced not only by the tariffs they face, but also by the tariffs that their rivals in member countries face, through the latter's effect on their rivals' prices. In this way, both responses are estimated based on commodity export data from Brazil's main foreign suppliers.

Results

MERCOSUR nations made significant tariff adjustments during the years 1989 to 1996. In addition to unilateral reforms throughout 1989-95, they largely abolished tariffs on partner imports throughout 1991-95, as governed by the Treaty of Assunção, 1991. MERCOSUR's Common External Tariff (TEC) is based on the Ouro Preto Protocol, agreed, after much dispute, at the end of 1994 and implemented over the following two years. The different phases of these adjustments, plus the exceptions for both the CET and internal free trade, mean that the margins of preference in internal trade vary considerably both over time and between commodities. This helps to identify its effects empirically.

In this sense, empirical results indicate that the US exported around US$5.4 billion to Brazil in 1991. With partner tariffs falling on average 26 percentage points until 1996 and a coefficient of 0.445, this implies a loss of US $624.1 million that year. Similar losses occurred for the other countries that reported export data – Japan (with losses of US$58.8 million), Germany (US$236 million), Korea (US$13.7 million) and Chile (US$17. 3 million). These estimates are taken in crude form – for example, not all US exports may have been affected, and there may have been partially offsetting changes in quantities – but are indicative of the magnitudes of losses in export earnings that countries left out of the regional agreements may suffer. The estimates are quite similar when added to the set of goods.

Public Policy Lessons

One of the main influences on the well-being of any trading economy is its terms of trade, therefore issues related to trade policy must be related to this variable. But given its importance in theory, this question is rarely addressed in empirical studies. In this sense, Chang and Winters (2002) empirically show that regional integration affects the prices of traded goods. This is not surprising from a theoretical point of view, as mentioned previously, since price effects are at the heart of the analysis of international trade policy. It is new empirically – with the exception of previous work written by the authors themselves, which used less appropriate data and a weaker empirical test, there is no other ex-post empirical study of the price effects of integration.

Chang and Winters (2002) also show that the price effects of integration can be quantitatively significant for non-member exporters supplying an integrating market such as Brazil. An important policy implication is that even if Preferential Trade Agreements are intended only to facilitate trade between constituent territories and not to raise barriers to other contracting parties' trade with such territories, the other contracting parties may still be harmed. The effects of “non-members” have always been a concern, as is evident from the fact that both Article XXIV and the “Enabling Clause” contain language that suggests that non-members should not be harmed. Thus, the results of the study give empirical support to the well-known theoretical argument that, even if external tariffs remain unchanged by integration, non-member countries are likely to be harmed by regional integration.

References

Chang, W., & Winters, L. A. (2002). How regional blocs affect excluded countries: The price effects of MERCOSUR. American Economic Review , 92 (4), 889-904.