Gains from Trade Versus Adjustment Costs: the Economic Partnership Agreement and the Pacific Agreement on Closer Economic Relations
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Gains from trade versus adjustment costs: The Economic Partnership Agreement and the Pacific Agreement on Closer Economic Relations by Uwe Kaufmann A thesis submitted in fulfillment of the requirements for the degree of Masters of Commerce School of Economics Faculty of Business and Economics The University of the South Pacific June, 2008 © Uwe Kaufmann 2008 Declaration This thesis contains my own work except where otherwise indicated. Uwe Kaufmann June 2008 ii Acknowledgements I would like to thank my Supervisor, Dean of the Faculty of Business and Economics of the University of the South Pacific, Professor Biman Chand Prasad for his advice, the stimulating discussions, his support and understanding during my studies of the Masters of Commerce program. Thank you also for making my studies at the University of the South Pacific successful. I am further grateful to my advisors Professor Ronald C. Duncan, Professor B. Bhaskara Rao, Dr. Haruo Nakagawa and Rup Singh. Without the encouragement of Professor Ron Duncan, I would have never thought about commencing my studies in the Pacific region. I am very grateful for his support throughout my studies at the University of the South Pacific, his help and introduction to the important areas of research in the Pacific Islands. Professor Duncan made me understand the problems of development economics, the obstacles to sustainable growth of developing countries and pointed out the importance of the aspects of this thesis. Thank you for all the interesting and helpful discussions, your advice and much more! I am very grateful for all your help! Professor Rao was my Professor and supervising Professor in three courses of my postgraduate studies at the University of the South Pacific and helped me in the field of international economics and econometrics and supported me whenever I was in need for clarification or any kind of help (including Sunday afternoons). He encouraged me to write research papers to improve my writing skills, therefore I am very grateful. Dr. Nakagawa deserves a lot of thanks for his ongoing support in econometric areas, questions and help and for always providing me with necessary data for my economic research – Thank you for this, Haruo, as well as for your friendship! Rup Singh taught me applied econometrics and introduced me to several econometric methods and time series econometrics. He called up my interest in the fields of econometric research on the PICs. iii I also would like to thank the staff and students of the Pacific Institute of Advanced Studies in Development and Governance at the University of the South Pacific for their support throughout my studies at the University of the South Pacific: Seraseini Colata, Dr. Frank Thomas, Feue Tipu, and all the others. I would also like to thank Professor Mahendra Reddy, Marjorie Bola and all the others of the Faculty of Business and Economics. I appreciate the help of Dr. Prakash of the Faculty of Arts and Law of the University of the South Pacific by giving me editorial advice. Thank you! Last but not least, thank you also Nicola Schwaebel for all your unconditional support and your friendship. Thank you so much! This thesis is dedicated to my parents for their ongoing and unconditional support – thank you. iv Abstract The Pacific Island Countries (PICs) are finally in the wake of trade liberalization. In December 2007, Fiji and Papua New Guinea signed an Interim Partnership Agreement (IPA) with the European Community (EC), which promises gradual trade liberalization between the two Pacific countries and the EC. The IPA triggers the Pacific Agreement on Closer Economic Relations (PACER). PACER, similar to IPA promises gradual trade liberalization between PICs and Australia and New Zealand. One of the best known issues of trade liberalization is the reduction and/or elimination of tariffs. The resulting tariff revenue losses of the developing countries are used, more and more often, to criticize advanced, developed countries for their demand of freer trade. Instead, the real impact of trade liberalization, of IPA (EPA) and PACER, remains undetected and also underestimated. This may have several reasons. For once, because it serves the protected industries to build up a negative picture of the agreements due to the threat of tariff revenue loss. Also, NGOs simply do not understand the obstacles to trade many PICs face. Therefore, both agreements IPA and PACER are analyzed. It is found that they precisely address all common barriers to trade identified by the World Trade Organization. This thesis argues that trade liberalization offers the possibility for these Pacific countries to overcome trade and economic constraints, which hinder sustainable development. Existing empirical studies have found the Pacific nations as being trade open economies, making the goal of trade liberalization questionable. If the PICs are open to trade, no need for trade liberalization would exist, and the PICs would perform well. Unfortunately, the PICs have one of the lowest average growth rates of all developing countries and therefore, the thesis argues that the common used trade openness measurements are inappropriate. It is claimed that the PICs are not as open to trade as often predicted. If the trade openness measurement is used inappropriate, the results in an empirical study will be biased. v The thesis analyzes the trade relationship between the Pacific ACPs (PICs) and the European Community (Australia and New Zealand) over the last 30 years, using actual trade data and recent advancements in time series econometrics. The demand for trade offers both the determination of a continuing trade relationship between two nations or trading blocks and secondly gives the opportunity for trade policies; regarding the price and income responsiveness. It is found that the PICs have a strong trade relationship with both the EC and Australia & New Zealand. Additionally, Fiji’s demand for trade with the EC, and Australia and New Zealand is investigated. To overcome the obstacles to trade, adjustment and adjustment costs are unavoidable. Several reports are discussed for two reasons, once to address possible costs but also to identify the areas in which costs appear. These are areas where major reforms are inevitable (e.g. fiscal adjustment costs, costs for trade facilitation, costs for export diversification). In the end, the thesis wishes to show what IPA and PACER really mean for the PICs; what the major challenges are to comply with the agreements (including the potential adjustment costs), and in which way the PICs can gain or lose. vi Table of Content Declaration…………………...………………………………………………… ...ii Acknowledgements……………………...……………………………………... ..iii Abstract……..………………………………………………………………….. ...v Table of Content………..……………………………………………………… .vii List of Tables……………...…………………...………………………………....xi List of Charts……..……………………………………………………………. xvi List of Figures…..…………………………………………………...…………. xvii Abbreviations.…..…………………………………………………...…………. xviii 1. Introduction…………………………………………………………………. …1 1.1 Purpose and scope of the study……………………………………... …1 1.2 Outline of the study…………………………………………………. …4 2. Trade – Theory and Empirical Discussion……………………………………6 2.1 The Comparative Advantage………………………………………... …7 2.2 Obstacles to trade…………………………………………………… ..10 2.2.1 Trade Policy: Protectionism through import substitution (tariffs and quotas) and export promotion and the infant industry argument..10 2.2.1.1 Import Substitution……………………………………………… ..10 2.2.1.2 Export Promotion……………………………………………….. ..13 2.2.1.3 Non-tariff barriers to trade………………………………………. ..16 2.3 The World Trade Organization……………………………………... ..18 2.3.1 Some of the “more important” agreements in detail……………… ..20 2.4 Environment and trade……………………………………………… ..23 2.5 Conclusion of Chapter 2…………………………………………….. ..27 3. The economies of the Pacific Island Countries and their trade relationship…………………………………………………………………....29 3.1 The economies of the Pacific Island Countries……………………... ..29 3.1.1 PNG and Fiji………………………………………………………. ..38 3.1.1.1 Papua New Guinea……………………………………………… ..38 3.1.1.2 Fiji Islands………………………………………………………. ..43 3.1.2 Summary of Section 3.1…………………………………………... ..47 vii 3.2 The Pacific Island Countries and their trade relationship with the world…………………………………………………………………..48 3.2.1 Who are the major trading partners? What is being traded?............ ..48 3.2.1.1 Papua New Guinea……………………………………………… ..49 3.2.1.2 Fiji Islands………………………………………………………. ..51 3.2.1.3 “The others”……………………………………………………... ..53 3.2.2 Aggregated trade with the European Community, Australia and New Zealand………………………………………………………. ..56 3.2.2.1 Fiji Islands and its major trading partners in the EC, Australia and New Zealand………………………………………………... ..59 3.2.3 Summary of Section 3.2…………………………………………... ..62 3.3 Conclusion of Chapter 3…………………………………………….. ..64 4. Trade openness ………………………..…………………………………...... ..66 4.1 Literature review….…………...…………………………………….. ..66 4.2 The measurement(s) of trade openness……………………………… ..85 4.2.1 Trade openness – a cross country analysis of 210 countries for 2006…………………………………………………………… ..88 4.2.2 Trading across borders – a measurement for trade openness?......... ..90 4.3 Conclusion of Chapter 4……...……………………………………... ..94 5. Demand for Trade...…………………..…………………………………...... ..97 5.1 How strong is the PICs’ demand for trade?......................................... ..98 5.2 Demand, income and price elasticity………...……………………… ..99 5.2.1 Income elasticity……...…………………………………………… 101 5.3 Literature review on demand