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Trade Opportunities of an Fta Between Colombia and Turkey

Working paper by Daniel Gómez-Abella; Catherine Pereira-Villa; Loly-Aylú Gaitán-Guerrero, 2013

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The objective of this article is to explore the opportunities for growth, diversification and competition present in trade between Colombia and Turkey, as well as the ones that would result from a free trade agreement. It uses five indicators to characterize trade and trade policy. Disaggregated data from 2010 is used to conduct partial equilibrium simulations yielding estimates on trade, welfare and income effects. The paper shows that Turkish and Colombian consumers would gain in terms of welfare while Turkish tax revenues would fall more than those of Colombia.

Trade opportunities of an FTA between Colombia and Turkey*

(Working paper)

Daniel Gómez-Abella1

Catherine Pereira-Villa2

Loly-Aylú Gaitán-Guerrero3



Abstract

The objective of this article is to explore the opportunities for growth, diversification and competition present in trade between Colombia and Turkey, as well as those specific ones that would result from a free trade agreement. Five indicators are calculated to characterize trade and trade policy. Disaggregated data from 2010 is used to conduct partial equilibrium simulations yielding estimates on trade, welfare and income effects. The results show that a tariff reduction would result in a trade increase of 3.7% during the first year, mostly reflected in Colombian imports of textiles and exports of bananas. There would also be net trade creation effects, and trade diversion would affect the European Union, the United States and Ecuador. Turkish and Colombian consumers would gain in terms of welfare and Turkish tax revenues would fall more than those of Colombia.



Keywords: preferential trade agreement, trade creation, trade diversion, welfare effect, partial equilibrium simulation.



JEL Classification: F15

Introduction

In recent years, Colombia´s trade policy has focused on consolidating economic integration with the world. Thus, the Colombian government has defined along with its trade partners a busy schedule of free trade negotiations which involve fifty countries and thirteen agreements by the year 2014.

At present, Colombia has FTA with Peru, Ecuador and Bolivia (Andean Community); Mexico; Chile; Argentina, Brazil, Uruguay and Paraguay (Mercosur), El Salvador, Honduras and Guatemala (Northern Triangle); Switzerland; Canada; United States of America. In addition, Colombia also has agreements with the European Union, the European Free Trade Association and is negotiating agreements with South Korea, Panama and Turkey.


The negotiation with Turkey began with the first round of negotiations on May 30th 2011, and involves the following chapters: market access in goods, rules of origin, customs procedures, sanitary and phytosanitary standards, technical standards, trade protection, intellectual property, competition policy, trade and sustainable development, temporary entry of businessmen and women, dispute settlement and cooperation.

Particularly, this FTA is a part of Colombia´s strategy to reach out to countries in Asia and be part to the Organization for Economic Cooperation and Development (OECD). Turkey which has a population of 71 million­­ -36 % larger than that of Colombia- heads OECD economic growth forecasts for 2011-2017. In addition, it would be the first FTA between Colombia and an emerging economy with a large populations, political stability and high growth expectations over the next decade.

In 2010, bilateral trade between Colombia and Turkey was US$ 271.4 million, of which US$ 214.6 million were Colombian exports of coal, sugar polymers of propylene, leather goods, cosmetics, textiles and apparel. In this context, this paper uses a partial equilibrium model to simulate the tariff relief for both countries and analyze its trade, revenue and welfare effects.

Based on these results, it is possible to establish which sectors will face increased competition in their markets, estimate changes in welfare of consumer that have access to cheaper imports and identifying the countries that may benefit or not by the FTA.


The paper has four sections, the first section describes bilateral trade, the second section contains the theoretical framework and the model used, and the third section describes the simulated scenarios and presents the results. Finally, the fourth section presents the main conclusions of the research.



  1. Bilateral trade

Between 2002 and 2010, trade between Colombia and Turkey increased 16.3 times and grew at an average annual rate of 41.7 %. The value of Turkish imports from Colombia grew by 68.9 % annually and the value of Colombian imports from Turkey grew by 23.1 %. However, the share of the two countries’ trade over their total trade has been on average 0.3 %. (See Table 1)


Table 1: Bilateral trade between Colombia and Turkey (2002-2010)

Source: COMTRADE. Author’s calculations


Colombia exports to Turkey mainly coal, polymers of propylene and sugar, as well as manufacture of leather, cosmetics, textiles and clothing (see Table 2).


Table 2: Main Colombian exports to Turkey in 2010

Source: COMTRADE. Author’s calculations


Turkey sells to Colombia cotton yarns, pieces of artillery, products of the self-propelling industry, oxides of lead, panels, consoles, devices and auto parts (see Table 3).


Table 3: Main Colombian imports from Turkey in 2010

Source: COMTRADE. Author’s calculations



In order to evaluate the similarity between exports by Colombia and Turkey, a Similarity Index (SI) was calculated; the index yields results between zero and one. The closer the index is to zero, it indicates that countries have completely different trade structures. The index for Colombia and Turkey shows low and decreasing values from 2007 onwards; this indicates that there are differences among the products exported to the world and therefore, there is evidence of a low degree of competition and a greater distance between their productive structures in recent years (see Graph 1).



Graph 1: Similarity Index form Colombia and Turkey

Source: COMTRADE. Author’s calculations



In order to analyze the comparative advantages present in Colombia and Turkey’s trade, a Revealed Comparative Advantage Index (RCAI) was estimated. The index takes positive or negative values; when the index is positive it indicates the existence of a competitive industry with potential, and when it is negative it indicates an importing sector lacking in competitiveness versus other markets.


A positive indicator was estimated for Colombia in chemical products and related industries; plastic and rubber; mineral products; textiles and leather manufactures (see Table 4).


Table 4: Products with positive RCAI for Colombia

Source: COMTRADE. Author’s calculations



For Turkey, the index is positive for textile materials and products; chemical products and connected industries; manufactures of stone and printed labels, among others (see Table 5).


Table 5: Products with positive RCAI for Turkey

Source: COMTRADE. Author’s calculations



In addition a Trade Intensity Index (TII) was used to determinate if the trade value between the two countries is higher or lower than expected, given their share of world trade. An index greater than one indicates that bilateral trade is higher than expected given the importance of partner country in world trade.


Figure 2: Trade Intensity Index

Source: COMTRADE. Author’s calculations


The TII shows that bilateral trade has been less than expected given their shares in world trade. During the period, on average the TII of Colombia with Turkey was 0.4 while the average of Turkey with Colombia was 0.2.


In addition, the Complementary Trade Index (CTI) provides useful information about the perspectives for trade, as it quantifies to what extent a country´s imports and exports match those of his partner. The index is zero when the goods exported by a country are not imported by the other and the index is 100 when exports and imports match exactly.


Graph 3: Complementary Trade Index

Source: COMTRADE. Author’s calculations



Turkey has a higher CTI with Colombia than Colombia has with Turkey; while the rate for Colombia averaged 41.1 and decreased by 1.9 % annually that of Turkey averaged 54.5 and grew by 2.1 % a year.


Finally, the Ballassa Index (BI) is calculated in order to measure the degree of importance of an export product in one market compared with the same product’s exports to the world. If the index is above 0.3, it shows that some advantages for that product are present. The estimated BI for Colombia are shown below (see Table 6).


Table 6: Products with positive BI for Colombia

Source: COMTRADE. Author’s calculations



Turkey has a greater number of products with positive and favorable BI; Denim products and the kind used on busses or trucks have positive RCAI as well as a positive IB.


Table 7: Products with positive BI for Turkey

Source: COMTRADE. Author’s calculations







  1. Theoretical Framework and Modeling


In general, free trade agreements have immediate effects or initial impacts as a result of tariff reductions in products traded. Partial equilibrium modelling is useful to carry out ex ante analysis of these comparative static effects on trade creation and diversion, welfare and tarrif revenues.


Trade creation arises from the impact that generates the tariff relief when reduces the price of certain products on a domestic market, which allows the consumers to purchase a greater quantity of imports. To the substitution of imports that becomes relatively more expensive by the imports from the benefiting partners of tariff reduction, refers trade diversion.


Viner (1950) showed that an increase in trade among members of a customs union does not always improve welfare. If trade is increased by trade creation is welfare improving, but the opposite would happen if the increase is associated with trade diversion.


The positive impact of trade creation is associated with commercial agreements that allow the substitution of domestic goods for imports from partners that establish the agreement, whose producers are more efficient than domestic ones. Trade diversion is associated with a negative impact when imports from a partner who is part of the agreement, replace imports from other partners with more efficient producers, but not part of the agreement.


Creation and trade diversion can also generate a price effect if the export supply elasticity is finite and therefore a reduction in the price causes a demand increase that generates an increase in the world price. The trade effect is the sum of trade diversion and trade creation, therefore, it is necessary to analyze each trade agreement individually. Krugman (1991, 1994) suggests that preferential trade agreements are generally positive when they are realized between natural trading partners and Bhagwati (1994) believes that effects of the agreements reflect the differences in the bargaining power of the signatory partners.


Basically, a tariff reduction for a normal good increases its imports and reduces its domestic production. This creates a positive impact on consumer surplus and negative on producer surplus and government revenue. These impacts determine the net effect on welfare. In general, the welfare effects can be more ambiguous when the member countries of the agreement are high cost producers, but are clear when the member is a low cost producer.


To estimate the effects of an FTA between Colombia and Turkey an ex-ante partial equilibrium model known as SMART was used, which is included in the World Integrate Trade Solution (WITS). This analytical tool known as the WITS/SMART model was developed by the United Nations Conference on Trade and Development (UNCTAD) and the World Bank.


The model allows researchers to simulate a trade policy change and to estimate the immediate effect or first impact. It is based on the work of Laird Yeats (1986), who developed a partial equilibrium model to quantify the trade, welfare and revenue effects that involves a tariff relief in an economy. Its formal modeling is explained by Jammes and Ollarreaga (2005) who present the suppositions and the formal development of the model.


WITS/SMART assumes perfect competition for a given good, different countries compete to supply a given home market. Export supply of a given good by a given country supplier is assumed to be related to the price that it fetches in the export market. The degree of responsiveness of the supply of export to changes in the export is given by the export supply elasticity.


The model relies on the Armington assumption in order to model consumer behavior, which assumes imperfect substitutions between different import sources. That is, goods imported from different countries, although similar, are imperfect substitutes. Thanks to the Armington assumption, a preferential trade agreement does not produce a solution where all imports demand would shift to the beneficiary of the preferential tariff.


The representative agent maximizes its welfare through a two stage optimization process. First, given a general price index, she chooses the level of total spending/consumption on a composite good. Then, within this composite good, she allocates the chosen level of spending among the different varieties of the good, depending on the relative price of each variety. The extent of the between variety allocate response to change in the relative price is determinate by the Armington substitution elasticity.


A change in trade policy affects not only the price index/level of the composite good but also the relative prices of the different varieties. One of the effects is the trade effect, which refers to the change in composition and imports value in the market economy.


The modeling implies that the increase in imports in the country that benefits from the tariff reduction is compensated by the decrease in imports from other partners. For the domestic market, the net trade effect corresponds only to the trade creation. Trade diversion is neutral and does not affect the total imported quantify, but it implies the reassignment of the market share of the exporting partners.


For the beneficiary’s trade partners, the trade diversion and trade creation is positive. For the other partners, the trade diversion corresponds to a negative effect and does not have a trade creation effect.


A tariff makes that in the domestic economy the price of the imported good is bigger than his world price, the government collects revenue and generate a loss of efficiency which represents the detriment of consumer welfare. With the elimination of the tariff, consumer surplus becomes higher; government revenue disappears and increases the imports quantity.

The change in the tariff income collection corresponds to the revenue effect, whiles the additional consumer surplus implied by the increase in imports, corresponds to the welfare effect.


Partial equilibrium permits an analysis at a fairly disaggregated level and the approach to market access analysis has limited data requirements; data include trade flows, tariffs, non-tariff equivalents and a couple of elasticities contained in WITS databases.



  1. Simulations and Results


    1. Simulated scenarios



In order to estimate the impact of the FTA between Colombia and Turkey, a generalized elimination is simulated based on bilateral trade at the six digit level during 2010. The purpose of this simulation is to provide an overview of the FTA in terms of the market access.


Two additional scenarios were simulated which contemplate changes in elasticity parameters which reflect the behavior of consumers, specifically the elasticity of export supply, import demand elasticity and the Armington substitution elasticity.

The database used is the United Nations’ COMTRADE, which contains annual statistics of imports and exports to over 160 countries and Trade Analysis and Information System (TRAINS), that contains information on trade control measures (tariff) by product for more than 140 countries and imports of goods classified under the Harmonized System (HS).


The supply elasticity is assumed infinite i.e. export partners behave as price takers and changes in import demand happens via quantity adjustments; Import elasticity is the same for all countries but vary for each item. The value of the Armington substitution elasticity is 1.5, which means that products from the different partners are imperfect substitutes.


    1. Results


This section presents the results of the simulated scenarios for the effects of trade creation, welfare effect and revenue effect. Trade effects correspond to the impact on the flow of imports, the welfare effect is associated to the variation of the consumer’s surplus and the revenue effect is related to change in government income.






      1. Impact on Colombia


Table 8 presents the results obtained from the decomposition effect on trade creation and trade diversion for Colombia, by trade partner. The results indicate that the tariff relief generates an increase in Colombian imports equivalent to US$ 7.02 million.


Imports from Turkey would increase by US$13.89 million, while imports from its other trading partners would be reduced, mainly those from the European Union (US$ 1.29 million), USA (US$ 1.24 million), and China (US$ 1.10 million).


Table 8: Colombian trade effect by partner

Source: WITS. Author’s calculations


In the European Union, the largest trade diversions are registers by Spain, Germany and Italy (Table 9).


Table 9: Colombian trade diversion by members of the European Union

Source: WITS. Author’s calculations


Table 8 shows the products that have the greatest trade effects as well as the corresponding welfare effect, revenue effect and percentage change in imports; cotton product: Woven fabrics of denim has the largest increase in its imports with a share of 10.95% from trade effect.

Table 10: Colombia´s Trade, welfare and revenue effects by subtitle

Source: WITS. Author’s calculations


The Colombian consumer surplus would increase by US$ 918,000 and the government would stop collecting US$ 7.25 million. The total Colombian imports oes not register a significant percentage change.


By chapter, it is 52 (cotton) which registers the largest trade effect, welfare effect and revenue effect. With chapters 62 (art of cloths and clothes of access; except of point) and 93 (weapon and ammunitions, his parts and accessories) it concentrates 46.23 % of the trade effect and 52.74 % of the welfare effect. Furthermore, with the chapters 89 (ships and other floating structures) and 85 (Machinery electrical, devices and electrical material and his parts.) it represents 41.09 % of the effect revenue effect (Annex 1).


      1. Impact on Turkey


The tariff relief in Turkey would increase its imports in US$ 3.13 million, result of a trade creation with Colombia equivalent to US$ 7.07 million, and trade diversion of US$ 3.93 million. The largest diversion corresponds to the imports from Ecuador that would be reduced by US$ 3.18 million (Table 19).


Table 11: Turkish trade effect by partner

Source: WITS. Author’s calculations



The product banana fresh or dried, concentrate near 100% of trade, welfare and revenue effect. The Turkish consumer welfare increase in US$ 4.25 million and government stop collecting US$ 11.86 million (Table 12)


Table 12: Turkey´s Trade, welfare and revenue effects by subtitle

Source: WITS. Author’s calculations





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