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8.2 Dynamic productivity effects
8.4 Bilateral Trade: Merchandise Goods
This chapter investigates the likely economic impact of a future China - New Zealand Free Trade Agreement (FTA). The modelling results strongly support the propositions advanced throughout this Joint Study, i.e. that both China and New Zealand will gain from an FTA. The modelling also indicates a direct correlation between the size of the gains and the scope and ambition of any FTA outcome. Gains would, for instance, still be significant and positive from a tariff only arrangement, but they would increase substantially if key non-tariff measures were also covered by any agreement. Significant liberalisation of services and investment regulation would also have a further positive impact on the Chinese and New Zealand economies.
The possible economic impacts of a China - New Zealand FTA were estimated for this Joint Feasibility Study using the intertemporal global general equilibrium model APG - Cubed. APG - Cubed is a dynamic model, and hence allows observation of the effects of any China - New Zealand FTA over time. The APG - Cubed economic model is forward looking (that is, economic agents have expectations and act in response to announced policy decisions), and considers both the real and financial sectors (including international investment links and/or flows between countries).16 By including the financial sector, APG - Cubed can provide a sophisticated and representative evaluation of the FTA on the macro-economy and welfare.
An economy-wide framework is the best tool available for quantifying the possible economic impacts of the FTA. By definition, economic models are a simplification of reality and rely on numerous assumptions about economic parameters, behaviour and relationships. As such, the initial and indicative modelling results reported here should be used only to infer the outcome of the FTA and the magnitude of such impacts (small or large).
Most models utilise a "baseline" or "business-as-usual" scenario against which results can be reported. This involves projecting the complete economic and trading relationship of economies into the future, using the best available information at the time. This baseline scenario may not be completely accurate in all respects over the time period being modelled (though it is based on the best available information). It nevertheless provides a point of comparison against which to measure changes against. Importantly, results of a scenario change can be reported as a percentage or absolute (i.e. dollar value) change from the baseline or a "deviation from the baseline" i.e. a move away from business-as-usual conditions. The baseline is dynamic. It assumes growth from factors other than the future FTA in the two economies and bilateral trade flows over the period being modelled. In the case of the modelling reported in this chapter, the baseline or business-as-usual scenario is one in which there is no FTA between China and New Zealand. Consequently, all movements from that baseline are gains or losses as a consequence of the FTA between China and New Zealand.
The scenario investigated is the immediate removal of all trade barriers, tariff and unnecessary non-tariff17 measures against bilateral merchandise and service trade in 2007. When reporting the macroeconomic results below, this chapter details the static gains from the FTA and subsequently the static gains combined with the benefits derived from dynamic productivity. It is of course acknowledged that the final outcome of a China-New Zealand FTA is subject to negotiation.
Trade liberalisation and the accompanying increase in openness to trade is widely understood to promote productivity increases and economic growth within a country through an increase in the efficient allocation of resources between countries, and indeed encourages the efficient allocation of resources between sectors of the economy. This is generally understood to refer to the gains to economies from improvements in allocative efficiency arising from the removal of trade barriers, particularly, for instance, tariffs. These changes help generate improvements in the level of productivity and output as a consequence of the reallocation of resources between sectors of the economy. Allocative gains represent a traditional theory on productivity gains from trade liberalisation and suggest that countries that liberalise the most benefit the most.
More recently, however, work at the World Bank and elsewhere has indicated that there are other gains from trade openness that cannot be solely attributed to allocative efficiency changes. These are known as second-order and are frequently more substantive and have longer lasting effects over time. They result from the other benefits arising from openness to trade. Specifically, trade reform will increase competition with positive spill-overs for the wider economy. Businesses are encouraged through competition to use better technology and improve their business practices including through innovation and/or quicker adoption of new ideas, improved business processes and so on. These improvements to productivity in terms of efficiency as a consequence of improved work practices (as opposed to resource re-allocation) are referred to as "dynamic productivity gains". The literature on dynamic efficiency gains from trade openness is relatively recent and dates to the late 1990s when trade economists sought to explain why economies with no or very low tariffs were still experiencing net improvements across their economies, despite the fact that the static gains (i.e. derived from tariff liberalisation) were now non-existent or minimal. Economic modellers have made significant improvements in their modelling techniques such that they are better able to understand, explain and determine the size of the link between competition (and its positive spill-overs) and dynamic productivity growth. Moreover, there is general agreement that dynamic gains are not only important over time, but if they are not fully reported there is the potential to under-estimate the net benefits to the economy.
This chapter reports both the static gains from a future FTA and subsequently the dynamic productivity and static gains combined throughout the discussion below. This allows the reader to see two sets of results: the static gains to both economies from liberalisation through an FTA; and the benefits when static and dynamic productivity gains are combined.
The change in GDP is a commonly used measure of the change in economic welfare resulting from trade liberalisation. Changes in real GDP, however, reflect adjustments in the overall level of economic activity and not changes in (net) national income or welfare per se. Given the likely change in income flows as a consequence of a future FTA between China and New Zealand, the change in real consumption is also used as an indicator of the benefits of the agreement because this captures the income flows accruing to domestic residents (that is, foreigners' earnings are excluded). This chapter therefore reports both the changes in real GDP and in real consumption as a consequence of a FTA.
As noted in chapter three of this Joint Study, trade liberalisation through an FTA offers significant potential benefits to both China and New Zealand. Charts 1 and 2 below show the possible macroeconomic effects (resulting from the static gains) of an FTA between China and New Zealand on production (real GDP) and welfare (real consumption). The results suggest that real GDP and consumption for both economies rise above the baseline if an FTA commences in 2007. Over a ten-year period, New Zealand's real GDP and real consumption will be 0.15 and 0.35 percent higher than it would be in the absence of a China - New Zealand FTA. China's real GDP and real consumption will rise by 0.001 and 0.006 percent respectively under similar conditions.
1. Changes in real GDP resulting from static gains (assuming immediate and comprehensive liberalisation by both sides)
Data source: APG-Cubed modelling simulation.
2. Changes In Real Consumption Resulting From Static Gains (Assuming Immediate And Comprehensive Liberalisation By Both Sides)
Data source: APG-Cubed modelling simulation.
The gains from a future FTA including benefits derived from static and dynamic productivity gains combined are reported in charts 3 and 4 below. These suggest that, as with the results reporting the benefits derived from the static gains, real GDP and consumption for both economies rise above the baseline levels if the proposed FTA commences in 2007. Over a ten-year period, New Zealand's real GDP and real consumption will be, respectively, 0.25 and 0.55 percent higher than the baseline levels. China's real GDP and real consumption will increase by 0.07 and 0.17 percent respectively as a consequence of a future FTA between China and New Zealand.
3. Changes In Real GDP - Including Static And Dynamic Productivity Gains (Assuming Immediate And Comprehensive Liberalisation By Both Sides)
Data source: APG-Cubed modelling simulation.
4. Changes In Real Consumption - Including Static And Dynamic Productivity Gains (Assuming Immediate And Comprehensive Liberalisation By Both Sides)
Data source: APG-Cubed modelling simulation.
In all four charts shown, real GDP and consumption experience a decline below the baseline in the years immediately preceding the commencement of an FTA. This occurs as a result of the behaviour "forward-looking expectations" assigned to economic agents in the APG-Cubed economic model. The model assumes that an FTA will be implemented in 2007. Economic agents (i.e. households, businesses) will therefore know that in a few years time, products from China and New Zealand will be cheaper. Hence there may be some delay today in purchasing capital items and the like (as they will be cheaper in 2007). This, combined with the adjustment costs associated with trade liberalisation (which APG-cubed assumes are incurred in the period before an FTA is implemented, but after an agreement is announced), sees income and hence GDP and consumption contracting slightly in the few years immediately preceding implementation of the FTA. As implementation approaches, however, and the process of structural adjustment begins to come to an end, economic agents expect that future income will be higher as a result of the FTA. The APG-cubed model assumes that as economic agents can borrow and lend money with the expectation of higher future income, agents borrow money and bring forward future consumption, which acts as a stimulus to economic activity (GDP and output) and raises welfare (consumption).
Chart 5 below shows in tabular form some of the results of the modelling derived from charts 1-4 and also charts 7-8 below.
5. Macroeconomic Effects For Both Economies At 2017 And 2027, Assuming Immediate And Complete Liberalisation By Both Sides With Static Gains And With Static And Dynamic Productivity Gains.
| China | New Zealand | |||
| Total
change (US$) 2007-2027 |
Percentage
change at 2017 |
Total
change (US$) 2007-2027 |
Percentage
change at 2017 |
|
|
||||
| Real GDP (with static gains) | <200m | 0.001 | 1.3b | 0.15 |
| Welfare/consumption (with static gains) | 870m | 0.006 | 1.6b | 0.35 |
| Real
GDP (with static and dynamic productivity gains) |
14.68b | 0.17 | 1.93b | 0.25 |
| Welfare/consumption (with static and dynamic productivity gains) | 24.7b | 0.07 | 2.3b | 0.55 |
Charts 5 (above) and 6 - 7 (below) support the perspective advanced in chapter three, i.e. that an ambitious FTA process offers the greatest benefit to both sides. The static gains from a full and comprehensive FTA that involves immediate and complete liberalisation on both sides is estimated to improve welfare (real consumption) in New Zealand by US$1.6 billion and by US$870 million in China over a twenty-year period. Again, including the static gains derived from the liberalisation process, there is a net benefit to both economies in real GDP terms. Real GDP is expected to rise by US$1.3 billion for New Zealand and about US$200 million for China. Results are presented in net present value (NPV) terms, which allow a current value to be placed on gains that may not be experienced until some time in the future.
When dynamic productivity gains are included, the picture is further enhanced for both sides. Welfare (real consumption) in New Zealand is expected to rise by more than US$2 billion and by US$24 billion in China over a twenty-year period. Real GDP is also expected to improve by US$1.93 billion for New Zealand and US$14.68 billion for China. Results are again presented in net present value (NPV) terms.
China has higher gains in absolute terms than New Zealand. This is not surprising. The Chinese economy is more than 20 times greater than the New Zealand economy and, as a consequence, a small percentage change equates to a relatively large absolute change. Dominant gains from dynamic productivity improvement in China come from the large and immediate reduction of all China's tariffs and unnecessary non-tariff barriers. Although trade liberalisation happens on a bilateral basis in the case of a China - New Zealand FTA, the resultant productivity improvements apply to the whole economy and hence have a more profound and longer lasting impact on China. That is, an FTA not only improves China's competitive position in the New Zealand market, but also in all markets (both domestic and international) as a result of the productivity gains.
It is clear that New Zealand also gains significantly in macroeconomic terms from an FTA. It is notable, for instance, that while the absolute gain may favour China, the percentage change of the results of both the simulation with static gains and that with static and dynamic productivity gains suggests a significant proportionate increase in New Zealand's GDP and welfare. Given the smaller size of the New Zealand economy, the percentage change in GDP and real consumption is particularly important and beneficial to the economy's growth prospects over time.
Charts 6 and 7 below represent an alternative way of reporting some of the results tabulated in chart 5 above. These charts allow the specific identification of static and dynamic gains and the absolute gains to each economy in real GDP (production) and real consumption (welfare) for both countries are reported.
6. New Zealand: Real GDP And Consumption Gains From The FTA Including Static And Dynamic Gains (Assuming Immediate And Comprehensive Liberalisation By Both Sides)
7. China: Real GDP And Consumption Gains From The FTA Including Static And Dynamic Gains (Assuming Immediate And Comprehensive Liberalisation By Both Sides)
Chapters three and four of this study reported the expectation that an FTA between China and New Zealand would increase bilateral trade flows between both countries in merchandise goods and services. The modelling results strongly support this proposition.
It is interesting to note that the changes in bilateral trade between China and New Zealand do not appear to be affected by the impact of dynamic productivity gains. This is for two inter-related reasons. First, although both countries have lower production costs and thus export prices in the presence of dynamic productivity gains, the higher total exports go to third countries rather than to one another. Second, the dynamic productivity gains are generally spread across the wider economy and therefore those gains derived from the bilateral trading relationship alone are always going to be relatively small for both countries (and the modelling results suggest that they are statistically insignificant). For China the dynamic productivity gains derived solely from bilateral trade with New Zealand are insubstantial because New Zealand accounts for a very small fraction (in percentage and absolute terms) of China's overall trade. For New Zealand, the dynamic productivity gains affecting bilateral trade are also insignificant, primarily because, while China is a more significant trading partner for New Zealand than New Zealand is for China, the dynamic productivity gains are focused in the few remaining high tariff sectors in New Zealand. These sectors are simulated in the APG-cubed model as comprising a small component of the highly aggregated "non-durable manufacturing sector". Consequently, as with China, the model's generation of dynamic productivity gains affecting bilateral trade flows alone are therefore impossible to specifically identify and statistically insignificant for both countries.
With the complete removal of trade barriers against each other's imports, total bilateral trade in goods and services between China and New Zealand rises for both countries above the baseline level. Chart 8 shows the results for both countries over time and chart 9 presents the average annual gains in tabular form.
8. Changes In Total Bilateral Trade (Assuming Immediate And Comprehensive Liberalisation By Both Sides)
Data source: APG-Cubed modelling simulation.
9. Average Annual Changes In Total Bilateral Trade (Assuming Immediate And Comprehensive Liberalisation By Both Sides)
| Change
in US$m (Annual average between 2007-2027) |
Percentage change (Annual average between 2007-2027) | |
| China to New Zealand | 40-70 | 5-11 |
| New Zealand to China | 180-280 | 20-39 |
Charts 8-9 indicate that New Zealand's exports of goods and services to China are expected to be between 20 to 39 percent higher than the baseline over a twenty-year period, while China's exports to New Zealand will increase by between 5 and 11 percent above the baseline. In very broad terms, the average annual change in New Zealand exports of goods and services to China is expected to be between US$180 million and US$280 million over twenty years; for China the gain is expected to be between US$40 million and US$70 million.
The difference between the magnitudes of changes in the two countries is a consequence of the relative importance/size of bilateral trade to each economy. More specifically, the differences are attributable to a combination of the relative market shares of both economies and the relative protection for both economies.
Chapter three of this Joint Study reported current and historical trade trends in a range of sectors of significance to both China and New Zealand. It also emphasised the opportunities for significant gains to both countries that an FTA might deliver in sectoral terms. The modelling results support this proposition. In addition to the overall increase in bilateral trade, higher bilateral flows occur in each of the six aggregated commodities (charts 10 and 11) - energy, mining, agriculture, durable manufacturing, non-durable manufacturing and services. The relatively high percentage increases in exports can translate into quite low absolute increases due to the small base level of exports for both economies. The charts reporting the sectoral outcomes provide the information for selected years i.e. 2007, 2012, 2017 and 2027.
10. Changes In New Zealand's Sectoral Exports To China (Assuming Immediate And Comprehensive Liberalisation By Both Sides) (Selected Years)
Data source: APG-Cubed modelling simulation.
Chart 10 shows that in percentage and absolute value terms, New Zealand's export of non-durable goods (e.g. processed foods, textiles, chemicals, plastics, vegetable oils and fats, wood products etc) to China increase most notably. This is a consequence of the assumed complete removal of protection of this sector. The positive changes in percentage and absolute value terms for New Zealand are followed by durable goods (electrical machinery, minerals etc), energy and services. However, because of the (vast) difference in the value of baseline exports between the different sectors shown, the absolute increase in non-durable goods exported to China dominates. This increase is the result of the relatively larger percentage change being applied to a larger base (right panel of chart 10). Moreover, it is important to note when considering these results that a high level of aggregation has been applied, i.e. each of the six sectors contains a very large number of products. In short, it is impossible to identify specific product changes or movements - rather a general trend only is observable across a range of broadly similar product categories.
11. Changes In China's Sectoral Exports To New Zealand (Assuming Immediate And Comprehensive Liberalisation By Both Sides) (Selected Years)
Data source: APG-Cubed modelling simulation.
Chart 11 above shows that China's exports of non-durable goods to New Zealand also increase the most. As with the change in New Zealand's trade flows, this is a consequence of the assumed complete liberalisation of the highest levels of New Zealand protection that, in APG-Cubed's representation, is the "non-durable goods" sector. The removal of all protection leads to higher trade in this sector with ongoing positive movement away from the baseline throughout the period. In percentage and absolute value terms, China's exporters of durable manufactured goods (e.g. machinery, electrical goods etc) are the next most important beneficiaries of an FTA, with agricultural product exporters and services traders experiencing more modest improvements over time.
The preliminary results from the modelling suggest that both sides make modest gains in the trade in services as a consequence of an FTA. This lends support to the proposition in chapter four that an FTA can help develop trade between the two countries in services delivery.
While New Zealand may benefit marginally more than China as a consequence of an FTA (charts 1-4, 6-7 and 10-11 refer) this is, perhaps, not particularly surprising. The change for New Zealand is derived from a relatively low base and thus the percentage change appears greater than the actual absolute change, which is relatively modest. Moreover, another important reason explaining the relative difference in (small) gains to each economy from services liberalisation is that the barriers to service trade in New Zealand are already small, hence their removal has only a minimal effect for China. China's regulations on cross border trade in services are more substantial and, as one would expect, their further liberalisation sees the New Zealand service sectors modestly expanding their output. In terms of services trade occurring as a consequence of supply via commercial presence, for instance, this expansion is likely to be relatively limited - currently, New Zealand accounts for only a fraction (a maximum of 0.001 percent) of the FDI stock in China.
There is one important element in the next two sections that the model overlooks and is therefore unable to simulate. This is particularly relevant for the predicted changes in investment and services flows where the historical relationship has been relatively modest. This is the likelihood that an FTA between China and New Zealand will significantly improve the attractiveness to both countries' private sectors, and exporters in particular, of doing business with one another. It is expected therefore that one important outcome of an FTA will be the further expansion of bilateral confidence and therefore a sharp rise in interest in both economies with attendant positive spill-overs and multiplier effects for a significant expansion in bilateral services trade flows. These multiplier effects are significant and the model cannot simulate them.
Chapter five reported that the investment relationship between China and New Zealand is relatively small when compared with other relationships. It is, however, gradually expanding, with total investment stocks (total investment stock comprises direct, portfolio, and other investment stocks) between the two countries on the rise. The modelling work undertaken for this study is, however, based on scaled historical information and therefore may not adequately reflect the potential outcomes of an FTA. It is clear, for instance, that as reported in chapter five, both countries could substantively benefit from an increase in bilateral flows of investment, not least in terms of the exchange and transfer of knowledge, technology and export opportunities.
As a result of trade liberalisation through a China - New Zealand FTA, there is likely to be increased interest by investors in expanding bilateral investment in both economies. For both sides, investment from the other partner has historically been relatively small, especially when compared with each country's primary investment partners. The model assumes that the change in investment and capital stock as a consequence of an FTA is minimal, therefore the model has been unable to reveal any specific or significant likely effects. Charts 1-6, for instance, were able to identify and specify gains in broad trade terms, but not specifically changes in investment (negative or positive). That said, given that some gains from trade will partly reflect changes in allocative efficiency, including more efficient investment decisions, it may be possible to attribute at least part of the gain to both countries from the aggregated results of trade liberalisation. Thus, one can reasonably assume that these factors will trigger increases in bilateral investment flows.
It is also important to acknowledge that one weakness of the model is that its assumptions and simulated results are driven by the available historical data. The model is therefore unable to take into account the very important point that an FTA between China and New Zealand is likely to significantly increase Chinese and New Zealand investor confidence in each others' economies. The model's inability to account for this important factor means that the results appear, at first glance, to be modest. It is expected, however, that the improvement in private sector confidence as a result of the existence of an FTA between China and New Zealand is likely to trigger positive improvements in the atmosphere surrounding bilateral investment decisions. Importantly, the positive demonstration effect of the two Governments signing an FTA should not be underestimated. The effect of such an agreement is difficult to mathematically quantify, but it is generally understood that such frameworks may assist in encouraging investor confidence and interest. This may occur, for instance, through positive changes in risk premiums applied to the respective economies (as these affect bilateral investment decision-making), or by improvement in the prospect of loan approvals. These are all difficult measures to simulate, but important additional factors which the model cannot adequately represent in its simulations. Their importance to the bilateral commercial relationship should not, however, be underestimated. In sum, the existence of an FTA is expected to have a positive net effect on bilateral investment flows between China and New Zealand in ways that the model utilised for this study cannot fully replicate.
16
The model is able to simulate activity in the real and financial sector. It is
able to account for flows of assets between regions, consistent with the
flows of goods. The model specifies that money is required to undertake
transactions, and so the demand for money is a function of GDP and short
term nominal interest rates. The supply of money is exogenously chosen by
the central bank in each region. Asset markets are assumed to be integrated
across regions. The model allows for risk premiums on assets held in different
currencies. These are calculated as part of the baseline of the model and
are designed to replicate 2002. When undertaking simulations it is assumed
that risk premiums are independent of the shock under consideration. Full
documentation for the APG-Cubed
economic model [external link] online. back
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17
Non-tariff measures are captured to the extent they are reflected in the difference
between the domestic price and the world price. Please note also that the
border measures captured in the APG-Cubed model may not fully represent restrictions
to the trade in services. back
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