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The EU-Morocco FTA under imperfect competition and economies of scale

The EU-Morocco FTA under imperfect competition and economies of scale. Presented by Natalia Tourdyeva, Dereje Megeresa, Kate Harback, Nicole Nance, Sunitha Raju, Young-Han Kim, Santosh Joshi, and Kledia Dallto. 15th Annual Short course in Global Economic Analysis, August 4-10, 2007.

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The EU-Morocco FTA under imperfect competition and economies of scale

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  1. The EU-Morocco FTA under imperfect competition and economies of scale Presented by Natalia Tourdyeva, Dereje Megeresa, Kate Harback, Nicole Nance, Sunitha Raju, Young-Han Kim, Santosh Joshi, and Kledia Dallto 15th Annual Short course in Global Economic Analysis, August 4-10, 2007

  2. Background • A Comparative Analysis of the EU-Morocco FTA vs. Multilateral Trade Liberalization, by Aziz Elbehri and Thomas Hertel • FTA vs. Multilateral Liberalization Scenario • Firm Entry vs. No Entry • Full Employment vs. Unemployment • Tax Replacement

  3. Agenda • Group 1: Introduction & Theory (Natalia and Dereje) • Group 2: The Impact on Industrial Structure (Sunitha and Young-Han) • Group 3: The Impact of Transfer Payments (Kledia and Santosh) • Group 4: The Impact of Tax Replacement (Kate and Nicole)

  4. Motivation of the paper • Presence of imperfect competition can influence outcomes of trade reforms • 8 of 15 two digit industries have 4-plant concentration ratios above 70% in Morocco • Potential for exit/entry (industry rationalization) • Potential for significant changes in employment • Monetary transfer as a part of the FTA

  5. Equation O_SCALE # computes output scaling effect for increasing returns sectors #(all,i,OLIG_COMM)(all,r,REG)OSCALE(i,r) = [SCALE(i,r)] * [qva(i,r) - firms(i,r)] - ao(i,r); = 0 Endogenous “change” in CRTS technology: observationally equivalent to IRTS Input level on a per firm basis Scale economies • Assumptions • Scale economies are internal to the firm • Firms have homothetic technologies • Implementation

  6. Oligopoly Behavior Equation SUPPLYPRICES# links pre- and post-tax supply prices for oligopolistic industries #(all,i,OLIG_COMM)(all,r,REG)ps(i,r) = to(i,r) + pm(i,r) - p_AC_MARKUP(i,r); Power of a.v. subsidy Markup acts like a tax = - subsidy M = power of markup over MC n= number of firms i = perceived market demand elasticity • Assumption: • The elasticity of substitution among imports is assumed to be equal to that between domestic and imported goods i.e. ESUBD = ESUBM Where:

  7. CRTS vs IRTS • Many CGE analysis of FTAs assume perfect competition and constant returns to scale • Advocates of FTAs often argue that the gains will be larger if imperfect competition and increasing economies of scale are incorporated in the analysis • However, the theory is by no means conclusive • It is equally possible that the gains will be smaller (or losses larger) when these features are taken into account

  8. The Consequences of Imperfect Competition and Scale Economies for Welfare They are an important part of the welfare analysis in many trade liberalization scenarios. The following welfare decomposition for a small, open economy highlights this fact: Terms of Trade Effect Money metric Change in Welfare Scale Effect Trade Volume = Allocative Efficiency Effect Profit Shifting Effect

  9. Decomposition of Welfare Effects

  10. Decomposition of allocative efficiency effects

  11. Profit shifting for selected industries (FTA)

  12. Impact of FTA on Industrial Structure without Entry/ExitPresentation Structure • Changes in Production Structure • Behavior of Firms with Respect to Changes in Mark -Up • How Scale Economies Define this Behavior

  13. Results of Selected industries: Production & Prices

  14. Behavior Of Firms: Production , Mark-up

  15. Behavior of Firms: Scale economies

  16. The impacts of FTA on Market structure with Entry/Exit • Motivation (Questions) • Is Globalization a really Nasty One Concentrating Economic Power? • What about a country like Morocco (as a Small Open Economy with Imperfectly competitive Industries)? • What is the impacts on industrial structure when firms can enter and exit freely? • Oligopoly & Free Entry? • By setting Number of firms in oligopoly markets as an endogenous variable, • Profit Ratio of Oligopoly firms (Markup over average cost) set as fixed, • We examine how market structure of each industry is affected by FTA

  17. What happened? • Numbers of Firms in highly protected industries has gone down sharply (Ex: Wood products, Dairy products, etc) - even including the profit making firms with positive Mark-up over AC • With Imperfect competition with higher Fixed cost and oligopoly market structure, firms might make loss even before FTA • Changes in markup over MC is heavily influenced by increased imports • Market structures of small open economy is dominated by the changes in trade structure

  18. Secrets: • ao: Rate of Changes of Economies of Scale as endogenous variable (x^-z^) • to: rate of changes of mark-up as endogenous v.r.

  19. Morocco-EU FTA: Entry, Full employmentScenario 1: Base transfer = $182 mln.Scenario 2: No transferScenario 3 : Doubled transfer = $364 mln.

  20. Morocco-EU FTA: Entry, Full employment

  21. Morocco-EU FTA: Entry, Full employment • Transfer from EU is not affecting industrial structure significantly • Bigger transfers could produce bigger effects on industry • Focus should be put on demand side of analysis

  22. MOROCCO – EU FTAEXPERIMENT: NO ENTRY, FULL EMPLOYMENT, TAX REPLACEMENTBase Case: Transfer of $182 millions from EU to MoroccoScenario 1: Transfer of $0 from EU to MoroccoScenario 2: Transfer of $ 386 millions from EU to Morocco Change in Welfare due to different transfer

  23. Welfare Decomposition

  24. Effect of Transfer on Private household Demand

  25. Examining Tax Replacement Motivation: With tax replacement, you introduce a policy change at the same time you implement the FTA. To understand the pure impact of the FTA, run the model without tax replacement—or what is the impact of tax replacement. NOTE: FTA, no entry, full employment

  26. Tax Replacement in the Model

  27. Tax Replacement: Impact on Tax Revenue Tax revenue lost with tariff removal & no endogenous increase in tp Note: Tax revenue replacement is carried out on the ratio of taxes to income, not dollar for dollar.

  28. Tax Replacement: Impact on Welfare

  29. Tax Replacement: Impact on Welfare The consumption tax changed endogenously to maintain the ration of taxes to income, reducing welfare.

  30. Conclusions: What has the group learned? • The assumptions we make about imperfect competition affect the welfare results of the model. It is not obvious whether this impact will be positive or negative for welfare. Further, understanding the impact of the transfer requires differencing EV and EV_ALT. • The sectoral make up of the Moroccan economy would be significantly different under a multilateral agreement that did not exempt agriculture than under the FTA with EU.

  31. Conclusions: What has the group learned? • Transfer payments have little impact on the industrial make up of the Moroccan economy. However, they do impact through the demand side. • Tax revenue lost from the tariff removal is significant, so replacing it is realistic. However, tax replacement through the consumption tax creates a reduction in allocative efficiency.

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