A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Balistreri, Edward J.; Jensen, Jesper; Tarr, David Article What determines whether preferential liberalization of barriers against foreign investors in services are beneficial or immizerising: Application to the case of Kenya Economics: The Open-Access, Open-Assessment E-Journal Provided in Cooperation with: Kiel Institute for the World Economy (IfW) Suggested Citation: Balistreri, Edward J.; Jensen, Jesper; Tarr, David (2015) : What determines whether preferential liberalization of barriers against foreign investors in services are beneficial or immizerising: Application to the case of Kenya, Economics: The Open-Access, Open- Assessment E-Journal, ISSN 1864-6042, Kiel Institute for the World Economy (IfW), Kiel, Vol. 9, Iss. 2015-42, pp. 1-134, http://dx.doi.org/10.5018/economics-ejournal.ja.2015-42 This Version is available at: http://hdl.handle.net/10419/123096 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Balistreri, Jesper Jensen, and David Tarr Abstract Despite the fact that many modern preferential trade agreements include commitments to foreign investors in imperfectly competitive services sectors, the literature has not established conditions under which these agreements are beneficial or harmful. The authors fill that void by developing a model with monopolistic competition and foreign direct investment in services with Dixit-Stiglitz endogenous productivity effects from additional varieties. They specify a numerical model, with probability distributions of all parameters. The model is executed 30,000 times, and results are reported as probability of an outcome, based on the sample distribution. In order to ground the results in reality, the authors apply the model to Kenya. They show that preferential commitments in services could be immizerising. Losses are more likely the greater the share of initial rent capture on the services barriers in the home country and the more technologically advanced are the excluded regions relative to the partner region. JEL F12 F13 F14 F15 F23 F47 C68 L16 Keywords Immizerising services liberalization; preferential liberalization; multinationals; monopolistic competition; foreign direct investment; endogenous productivity effects Authors Edward J. Balistreri, Colorado School of Mines, 1500 Illinois Street, Golden, CO 80401, USA, [email protected] Jesper Jensen, Jensen Analysis, Agern Alle 3, 2970, Hørsholm, Denmark, [email protected] David Tarr, Former Lead Economist, The World Bank, 1818 H Street, NW, Washington, DC 20433, USA, [email protected] Citation Edward J. Balistreri, Jesper Jensen, and David Tarr (2015). What Determines Whether Preferential Liberalization of Barriers against Foreign Investors in Services Are Beneficial or Immizerising: Application to the Case of Kenya. Economics: The Open-Access, Open-Assessment E-Journal, 9 (2015-42): 1—134. http:// dx.doi.org/10.5018/economics-ejournal.ja.2015-42 Received May 19, 2015 Published as Economics Discussion Paper July 1, 2015 Revised September 25, 2015 Accepted October 12, 2015 Published November 24, 2015 © Author(s) 2015. Licensed under the Creative Commons License - Attribution 3.0 1 Introduction Since the early 1990s, regional trade agreements have surged; 283 have been notified to the WTO and were in force as of February 2010.1 Commitments to foreign investors in services are now key aspects of modern FTA agreements negotiated with the EU and the US, and in some other agreements. The literature, however, contains neither analytical nor numerical results on the general equilibrium welfare impacts of preferential commitments to foreign investors in the presence of imperfect competition in services sectors.2 Given that commitments to foreign investors in services sectors (many of which are imperfectly competitive) are key aspects of modern FTA agreements, the objective of this paper is to determine if such agreements can be immizerising, and the conditions that make it more or less likely the agreements are beneficial. Further, we develop a numerical general equilibrium framework to assess these agreements in practice. It is well known that the welfare effects of preferential trade in goods are ambiguous, with welfare losses possible in perfectly competitive models due to the loss of tariff revenue on the decline in imports from excluded countries. In services, however, there typically is no tax revenue on barriers to foreign investors, leading some experts to suggest that gains from preferential liberalization of services are much more likely than in goods (Mattoo and Fink, 2002). But Mattoo and Fink acknowledge that if the home country is capturing rents from the barriers, these rents play the same role in preferential liberalization of services as tariffs in goods, leading to possible losses.3 And despite the fact that key sectors in the negotiations are characterized by imperfect competition (like banking, insurance _________________________ 1 See http://www.wto.org/english/tratop_e/region_e/region_e.htm. This does not include a significant number of regional agreements that are in force (among developing countries) that have not been notified to the WTO. 2 There have been several numerical modeling papers in recent years that examine FDI in services, without a regional dimension, including Markusen et al. (2005), Konan and Maskus (2006), Rutherford and Tarr (2008), Brown and Stern (2001), Dee et al. (2003), Jensen et al. (2007, 2010), and Balistreri et al. (2009). 3 See Jensen and Tarr (2010) for a detailed analytical treatment. www.economics-ejournal.org 2 and telecommunications), there has not been any analytical work assessing the welfare impacts with imperfect competition.4 Any modeling effort must take into account the mounting evidence on the productivity gains of FDI in services.5 The essential features of the problem, however, (general equilibrium, imperfect competition, foreign direct investment and endogenous productivity effects) make the model sufficiently complex that analytic solutions are exceedingly difficult. Consequently, we construct a numerical model which contains these features (endogenous productivity effects from Dixit-Stiglitz variety effects) and specify probability distributions of all parameters. We execute the model 30,000 times, where each simulation is based on a random draw of all the parameter values. The results are reported as probability of an outcome, based on the sample distribution. In order to ground the results in reality, we apply the model to Kenya, a developing country that is facing a range of regional trade agreements that include services, including the Economic Partnership Agreements with the European Union and the Tripartite Free Trade Agreement among the Common Market for Eastern and Southern Africa (COMESA), the East African Customs Union and the South African Development Community (SADC).6 We build on the 55 sector small open economy model of Kenya by Balistreri et al. (2009), but decompose the rest of the world into the European Union, our Africa region and the Rest of the World. In each imperfectly competitive sector, firm types differ by sector and region. Based on the now extensive econometric literature begun by Coe and Helpman (1995), we allow the Dixit-Stiglitz endogenous productivity effects to vary by the level of development of the partner region, and by sector. _________________________ 4 Mattoo and Fink (2002) develop analytic results that show that due to “first mover” advantages, preferential liberalization in services could result in reduced gains from subsequent multilateral liberalization. But they do not show a case of where the preferential liberalization, ceteris paribus, results in welfare losses. 5 See Francois and Hoekman (2010) for a survey of more than a dozen empirical studies that support this finding. Also see the survey in Jensen and Tarr (2010) for additional studies. Support comes from a variety of sources including studies that use firm level data, such as Arnold et al. (2011) for the Czech Republic and Fernandes and Paunov (2012) for Chile, and studies that