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
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
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)
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
Scale economies• Assumptions
– Scale economies are internal to the firm
– Firms have homothetic technologies
• Implementation Z*scaleZZCDR1
CDRZx
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
CDR1
CDR
Input level on a per firm basis
Endogenous “change” in CRTS technology: observationally equivalent to IRTS
Oligopoly Behavior
εn
1)M1(
P
MCP 1
i,rr
i
i,r
iiiS
X
Xσ)(1σP/Xε
Where:
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 = ESUBMEquation 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
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
The Consequences of Imperfect Competition and Scale Economies for Welfare
dxaXdXatpdpmdmtVdV xE ][/
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:
Money metric Change in Welfare
Terms of Trade Effect
Trade Volume = Allocative
Efficiency Effect
Scale Effect
Profit Shifting Effect
Decomposition of Welfare EffectsFTA Multilateral Liberalization
No Entry Entry No Entry Entry
Allocative effect
623 680.85 622.04 656.68
Endowment effect
0 0 0 0
Scale economies
-315 66.19 -18.74 83.09
Terms of trade effect
-588 -650.13 -172.92 -194.25
IS_E -70 -71.57 -15.8 -17.53
Transfer from EU
182 182 - -
EV_ALT -167.3 25.27
EV -349.3 +182 = -167.3
25.27 414.59 527.99
Decomposition of allocative efficiency effects
FTA Multilateral Liberalization
No Entry Entry No Entry Entry
Pfact tax 0 0 0 0
Profit shifting tax 154.42 130.35 8.08 -8.71
Input tax -27.72 -40.68 -1.54 -4.83
Consumption tax -72.74 -24.93 9.6 17.78
Government tax 0 0 0 0
Export tax 117.53 134.29 44.82 49.36
Import tax 451.66 481.59 561.09 603.07
Total 623.17 680.61 622.06 656.68
Profit shifting for selected industries (FTA)
welcont dvol Tax rate (before) Tax rate (after)
No Entry
Motor vehicles 151.64 -436.322 -26.907265 -50.188042
Paper 21.54 -214.232 -7.463223 -13.99107
Light manuf -13.08 245.429 -5.8808 -5.082143
Total for all sectors
154.42
Entry
Motor vehicles 195.56 -738.14 -26.9073 -26.864
Paper 21.61 -296.04 -7.463 -7.463
Light manuf -16.963 297.605 -5.881 -5.880
Wearing apparel -1.017 1118.753 -0.0937 -0.0937
Total for all sectors
130.35
Impact of FTA on Industrial Structure without Entry/ExitPresentation Structure
1. Changes in Production Structure
2. Behavior of Firms with Respect to Changes in Mark -Up
3. How Scale Economies Define this Behavior
Results of Selected industries: Production & Prices
Name qo Mark Up ps pmTextiles -1.135 0.834 -10.505 -10.938Apparel 7.604 0.999 -6.235 -6.514Wood Pr -23.429 1.101 -2.506 -11.647Motor veh -39.024 0.799 6.237 -10.236Light mnf 10.384 0.799 -7.005 -6.298
Behavior Of Firms: Production , Mark-up
Name Scale qva aoTextiles 0.239 -0.916 -0.221Apparel 0.012 7.515 0.083Wood Pr 0.129 -20.761 -3.367Motor veh 0.34 -29.114 -13.983Light mnf 0.175 8.838 1.42
Behavior of Firms: Scale economies
Name CDR Elasiticity Zeta ScaleTextiles 0.193 3.771 0.185 0.239Apparel 0.012 3.987 0.617 0.012Wood Pr 0.114 2.221 0.735 0.129Motor veh 0.254 5.306 0.542 0.34Light mnf 0.149 4.189 0.307 0.175
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
• 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
• 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.
)()(
)()(
xTC
FC
xAC
xMCxACCDR
ZCDR
CDRZ
CDRx ˆ
11ˆ
1
1ˆ
Change in mark-up over MC after FTA
(%)
Mark-up over AC
(Constant)
Number of Firms After FTA (%)
Import Tariff
before FTA(%)
Increase of Imports
From EU to Morocco
(% with respect to Original
Outputvalue)
Increase of Outputs in Morocco Industries(% with respect to
Original Outputvalue)
Meat product 0.788 0.799 -13.84 172 199.6 -13.2Vegetable oils &
fat -0.305 0.956 1.07 14.8 12.6 2.9Dairy product 0.4 1.097 -24.75 54.3 33.4 -29.6
Sugar 0.063 1.258 1.41 148 1.5 1Other food
product -0.276 0.94 -1.64 42.3 1.4 1.1Beverrage and
Tobacco -0.904 1.571 -9.28 52.6 10.9 -0.5Textiles -0.276 0.834 0.6 30.2 27.9 1.7
Wearing Apparel -0.278 0.999 -12.65 33.1 16 14.3Wood product -0.195 1.037 -34.82 48.9 30.1 -35
Paper & publishing 0.404 0.931 -18.73 40 11.5 -18.9
Chemical products -0.349 1.003 -11.2 30.3 12.3 -9.3
Metal products -0.316 1.033 -21.75 30.8 15 -19.4Motor vehicle 3.53 0.789 -61.41 26.9 35.6 -52.1
Light manufacturing -1.073 0.944 4.41 11.9 13.3 11.8
Other manufacturing -0.518 1.101 -32.32 42.2 31.3 -32.6
Morocco-EU FTA: Entry, Full employment Scenario 1: Base transfer = $182 mln.
Scenario 2: No transferScenario 3 : Doubled transfer = $364 mln.
Welfare decomposition Base Transfer No Transfer Doubled transfer
Total welfare 213.2 -16.3 442.76
Allocative Efficiency 683.3 659.3 707.4
Labor endowment 0 0 0
Scale economies (technical change) 65.9 68.8 62.9
Terms of Trade -647.8 -670.9 -624.8
Investment-savings effect -71.4 -73.2 -69.5
Transfer payment 183.2 0 366
Sector output change: FTA Mexico-US Entry scenario by transfers
-80
-70
-60
-50
-40
-30
-20
-10
0
10
20
Sectors
Sec
tor
ou
tpu
t % c
han
ge
Base transfer
Zero transfer
Double transfer
Morocco-EU FTA: Entry, Full employment
Selected sectors Base transfer No trasfer Doubled transferWearing apparel (Wal)
Output percentage change 14.26 15.26 13.27Output value change 8899.32 8977.02 8822.1Percentage change in no. of firms -12.6456 -12.2727 -13.0108
Wood products (wdp)Output percentage change -33.68 -33.57 -33.8Output value change 570.67 571.63 569.68Percentage change in no. of firms -34.8172 -34.71 -34.9262
Sugar (sgp)Output percentage change 0.8 0.58 1.02Output value change 1105.45 1103.01 1107.85Percentage change in no. of firms 1.4119 1.4769 1.3449
Beverages and Tobacco products (btp)Output percentage change -0.33 -0.13 -0.54Output value change 514.66 515.72 513.6Percentage change in no. of firms -9.2773 -9.0904 -9.4657
SHRDM and SHRXMD do not significantly change in all three scenarios
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
MOROCCO – EU FTAEXPERIMENT: NO ENTRY, FULL EMPLOYMENT, TAX REPLACEMENT
Base 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
-600
-400
-200
0
200
400
600
800
1000
Base Scenario 1 Scenario 2
We
lfa
re
MOR EU
-800
-600
-400
-200
0
200
400
600
800
1 a
lloc_
A1
2 e
nd
w_
B1
3 t
ech
_C
1
4 p
op
_D
1
5 t
ot_
E1
6 I
S_
F1
7 p
ref_
G1
To
tal
We
lfa
re
Base Scenario 1 Scenario 2
Welfare Decomposition
Effect of Transfer on Private household Demand
0
0.2
0.4
0.6
0.8
1
1.2
1 g
rn
14 d
rp
16 o
fp
2 v
fn
3 o
sd
4 s
gr
5 p
fb
6 o
ag
8 f
sh
13 v
of
15 s
gp
12 m
tp
7 lvk
18 t
xt
17 b
tp
19 w
al
27 u
tl
25 lm
n
26 o
mn
28 s
rv
24 m
vt
10 c
og
9 f
or
11 m
nr
20 w
dp
21 p
ap
22 c
hm
23 m
mp
Private Consumption Demand (With increasing Income Elasticities)
Dif
fere
nc
e in
Pe
rce
nta
ge
ch
an
ge
of
SC
2 c
om
pa
re t
o B
C
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
Tax Replacement in the Model
With Tax Replacement: GDPSRCBase 1 fact 2 tax 3 depr Total1 MOR 30658.42 3730.4 3842.63 38231.452 EU 6200481 809045.7 945928.4 79554553 ROW 17128458 1522376 2336848 20987682Total 23359598 2335153 3286619 28981370
Update 1 fact 2 tax 3 depr Total1 MOR 30902.17 3782.73 3634.85 38319.762 EU 6202360 809265.5 946120 79577463 ROW 17126558 1522203 2336642 20985404Total 23359820 2335252 3286397 28981468
Tax Difference: 52.33
Without Tax Replacement: GDPSRCBase 1 fact 2 tax 3 depr Total1 MOR 30658.42 3730.4 3842.63 38231.452 EU 6200481 809045.7 945928.4 79554553 ROW 17128458 1522376 2336848 20987682Total 23359598 2335153 3286619 28981370
Update 1 fact 2 tax 3 depr Total1 MOR 31009.91 1575.56 3641.4 36226.872 EU 6202359 809257.1 946117.7 79577343 ROW 17126462 1522183 2336629 20985274Total 23359830 2333016 3286388 28979234
Tax Difference: -2154.84
Tax Replacement: Impact on Tax Revenue
Note: Tax revenue replacement is carried out on the ratio of taxes to income, not dollar for dollar.
Tax revenue lost with tariff removal & no endogenous increase in tp
TAX REPLACEMENTwelfare 1 alloc_A1 3 tech_C1 5 tot_E1 6 IS_F1 Total1 MOR 623.17 -314.77 -587.52 -70.18 -349.312 EU 84.81 8.04 757.49 -5.2 845.133 ROW -41.64 5.96 -167.05 75.74 -126.98
NO TaxRepwelfare 1 alloc_A1 3 tech_C1 5 tot_E1 6 IS_F1 Total1 MOR 736.09 -339.18 -577.71 -74.58 -255.382 EU 79.92 8.12 741.92 -4.29 825.673 ROW -50.86 5.86 -178.93 76.97 -146.96
NO TaxRep MINUS TaxRepwelfare 1 alloc_A1 3 tech_C1 5 tot_E1 6 IS_F1 Total1 MOR 112.92 -24.41 9.81 -4.4 93.932 EU -4.89 0.08 -15.57 0.91 -19.463 ROW -9.22 -0.1 -11.88 1.23 -19.98
Tax Replacement: Impact on WelfareWelfare (EV)
TaxRep NO TaxRep DifferenceMOR -166.88 -73.03 93.85EU 663.03 643.57 -19.46ROW -126.98 -146.97 -19.99
Tax Replacement: Impact on Welfare
Welfare Decomp by Tax Type
With Tax Replacement1 pfacttax 2 prodtax 3 inputtax 4 contax 5 govtax 6 xtax 7 mtax Total
1 MOR 0 154.42 -27.7 -72.74 0 117.53 451.66 623.172 EU 2.66 9.17 21.95 73.62 0 -23.08 0.58 84.93 ROW 0.32 1.89 -16.53 -5.45 -0.05 -14.87 -6.94 -41.63Total 2.98 165.47 -22.28 -4.57 -0.05 79.57 445.3 666.44
Without Tax Replacement1 pfacttax 2 prodtax 3 inputtax 4 contax 5 govtax 6 xtax 7 mtax Total
1 MOR 0 169.03 -27.81 4.17 0 115.27 475.44 736.12 EU 1.01 9.5 19.63 71 0 -24.21 3.09 80.023 ROW 0.25 1.83 -18.6 -6.92 -0.05 -13.6 -13.77 -50.86Total 1.25 180.36 -26.78 68.24 -0.05 77.47 464.76 765.25
The consumption tax changed endogenously to maintain the ration of taxes to income,
reducing welfare.
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.
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.
