Category: Publications

Benefits of Removing Barriers to International Trade and Investment in OECD Countries and Liberalizing Markets of Goods

Hatice Kökden (*)

The liberalization of goods’ markets, the liberalization of international trade and the removal of barriers to international investment are among the key factors in terms of increasing economic efficiency and thus raising the standard of living in OECD countries, as well as in the rest of the world. Although OECD countries are generally better off in these aspects than other parts of the world, significant differences in these parameters between these countries and especially the US and the EU support the argument that large trade and income gains can be achieved if these differences are eliminated. Based on this argument, with a project carried out in two stages within the OECD, a project consisting of two stages, attempted to estimate the gains for the member-states from liberalization and removal of barriers in the international investments and trade.

The first stage attempted to estimate the effects of liberalization applied to the international trade and investments by the EU and the US. The second stage attempted to forecast the impact of these liberalization efforts if all of the OECD members applied these liberalization measures.

The report is based on a set of data sets evaluating the situation of OECD member countries in terms of goods’ market regulations, foreign trade and international investments. Of these, PMR (Indicators of Product Market Regulation) was created in 2003 with a survey study to measure the state of regulation in product markets in all OECD member countries. In this context, the extent to which product markets are subject to regulation, the level of public control, the obstacles to entrepreneurship, and the obstacles to investment and trade have been examined and the situation of the countries has been determined in these respects. The data that form the basis of the section on barriers to international investments are the results of a 2001 study on restrictions on foreign investments in member countries. These restrictions are mainly restrictions on the ownership of a companies by the foreigners, employment of the foreign personel as well as operational independence. Regarding foreign trade, bilateral tariff rates applied in OECD member countries were used on the basis of the most favored nation (MFN) with average trade weighted in 2003.

The main method followed by the study is to estimate the earnings to be obtained in terms of national income and foreign trade when the parameters of the “reference” country are approached in the three elements listed above (regulation of the product market, liberalization of foreign capital and foreign trade) by comparing each country or group of countries with the “reference” country at its best in these three elements. In the study, it was assumed that removing barriers to foreign trade and investment was implemented globally. Therefore, the impact of liberalization in both cases is spreading all over the world. On the other hand, it is assumed that reforms in the goods’ market will strengthen competition and countries will benefit from both reforms in the domestic goods’ market and reforms in the countries they trade with.

In the study, the analysis of the effect of reforms on foreign trade and production is made based on the results of some previous regression analysis carried out by the OECD on the determinants of economic growth, foreign trade and the drivers of direct foreign capital, as well as the results of the general equilibrium analysis of the GTAP (Global Trade Analysis Project).

The study primarily analyzes the level of integration among OECD member states. In this context, it has been observed that foreign trade between OECD member countries has increased at a higher rate than economic growth in the last two decades, however, this increase consists mostly of the commodity trade rather than service trade; similarly, international investments have increased rapidly, however, this increase is due to the change of ownership through company mergers and privatization rather than new investments; in contrast to international trade, foreign direct investments are concentrated in the service sector rather than the goods-producing sector; the activities of foreign companies’ affiliated companies in the domestic markets have increased in parallel with the increasing trends of foreign direct investments, however, the impact of foreign companies’ affiliated companies on the employment of the manufacturing industry and services sector has been limited; recent foreign trade, foreign investments and the increase in the activities of affiliated companies have increased the interdependence of OECD economies; multilateral investment and trade agreements continue to form an obstacle to the integration of trade and investments between national economies, while reducing the official barriers to those. These obstacles may be obstacles that directly affect integration such as tariffs, non-tariff barriers, obstacles to foreign ownership of the company, as well as indirect obstacles such as internal regulations that may affect the production costs of the exporter and thus the competitiveness of the international markets, or regulations that increase costs in the service sectors subject to trade that use domestic and foreign inputs in production.

After analyzing the level of integration among OECD members, barriers to competition in domestic markets were addressed through the aforementioned PMR indicators. In this context, OECD member countries were divided into three groups in terms of 2003 PMR indicators:

• In most English-speaking countries and Nordic countries, regulatory barriers to competition were found to be relatively low.

• It has been observed that these obstacles are relatively high in low-income member countries such as Mexico and Turkey, as well as in Eastern European countries such as Poland, Hungary and the Czech Republic and Southern European countries.

• Other European countries and OECD member countries in Asia were found to have moderate policies in terms of restrictive elements of competition.

When evaluated in terms of restrictions on foreign capital investments as of 2001, the study has found that the number of economic restrictions is generally lower in the EU and USA. The low restrictions on foreign capital in European countries are mostly attributed to the absence of such restrictions within the EU framework. Iceland, Mexico, Turkey and Canada are among the countries with the highest foreign capital constraints, while Japan, Korea and Australia are beyond the OECD average in this respect.

In terms of tariff barriers to foreign trade as of 2003, it has been observed that bilateral tariff rates have decreased significantly throughout the OECD with regional free trade agreements and multilateral trade liberalization. However, it has been observed that customs tariffs are relatively high among OECD members such as Mexico, Poland, Korea, Turkey and Hungary. In terms of non-tariff barriers, it is seen that obstacles such as quantity and price control measures have been largely eliminated by multilateral trade negotiations in the recent period. The remaining cross-border and non-tariff barriers were excluded from the analysis, taking into account the limited data availability as well as the trustworthiness of this data. When the regulations at the sectoral level and the obstacles applied at the border are examined, it is seen that the obstacles to international integration are mainly concentrated in certain sectors. While the manufacturing industry sector presents an image free of such obstacles, it has also been observed that such obstacles are concentrated in the services and agricultural sectors It has been determined that the sectors with the highest regulation among the service sectors are the railway transportation, natural gas and postal services sectors. Although the telecommunications sector and the transport sector are seen as relatively low-regulated sectors across the OECD, there are still differences between the countries. While the transport sector is subject to higher regulation in Greece, Italy and the Czech Republic, the telecommunications sector is heavily regulated in Turkey and Iceland. After this stage, the project moved on to the stage of determination of the differences between the countries referenced above according to the best practice criteria. The OECD countries subject to the least restrictions and regulation in these areas have been identified as “reference” countries. The determination of “reference” on product market regulation for the domestic market has been through two sub-components. In order to determine the control of the public over economic life, the size and area of public economic enterprises and the control of the public over the work of the private sector were examined, and Australia was selected as the least restrictive and least intrusive “reference” country in both areas. In terms of barriers to entrepreneurship, no OECD country has been a “reference” in all of these barriers. While Denmark and Ireland were the countries with the lowest administrative burdens on start-ups, Canada was found to be in the best situation in terms of administrative transparency. Ireland and England, on the other hand, were determined as the countries with the lowest barriers to the competitive market. The sectors in which reforms should be concentrated differ from country to country. In general, countries whose goods’ markets are heavily regulated need to apply reforms in sectors other than manufacturing. On the other hand, in terms of restrictions on foreign capital, “best practice” countries are determined separately for all sectors. In terms of customs tariffs, a level where “customs tariffs are close to or are 0” has been taken as the “reference” situation.

After determining the countries considered as “reference” in the study, it was assumed that the countries implemented a reform program to close the difference with the reference country in each area. It is thought that by subjecting the goods markets to regulatory reform, countries will contribute to the competition in their domestic markets; increasing competition can provide both one-time and continuous increases in multi-factor productivity (MFP); with the liberalization of foreign trade and foreign investments, resources will flow freely and according to the efficiency criterion between countries; and with the expansion of the addressed markets, companies can benefit from economies of scale by increasing the scale of production. Three different approaches have been used to estimate the economic benefits of countries implementing reforms in the three areas listed above.

1. Estimating the impact of reforms on total foreign trade and accordingly on per capita national income by using the results of the econometric analyzes previously made by the OECD with panel data on the determinants of economic growth and foreign trade,

2. Estimating the impact of reforms on production through productivity increase by using the econometric techniques developed by the OECD on the relationship between product market regulations and productivity,

3. Estimating the impact on foreign trade and production by running the GTAP general equilibrium model under two scenarios. In the first scenario, the static effect of reducing customs tariffs on production and foreign trade was estimated, and then productivity increases obtained from the second approach were added to this scenario.

Phase I

In the first phase of the study, the effects of the greater integration of the EU and US economies, the removal of barriers to the goods market entry, foreign investments and foreign trade in these countries both on these two units and on third countries are analyzed. In this context, first of all, the difference between the USA and the EU in terms of goods market regulation is evaluated and the techniques listed above are applied under the assumption that this difference will be closed and customs and investment barriers will be removed both against each other and against third countries. According to the first stage results of the analysis, as a result of the reforms implemented by the EU and the US in three areas, the potential of the EU to increase its exports to the OECD by 30% and the US to increase its exports to the OECD by 20% was observed as well. A significant part of the total impact on exports is due to the decrease in regulation in domestic markets.

Table 1Increase in Export Levels of Panel Data Regressions and Reforms to be Implemented in the EU and the USA (%)

The fact that the EU and the US reduce customs tariffs to third countries as well as to each other, remove restrictions on foreign capital and reduce regulatory rules in domestic product markets positively affects the other economies of the OECD as well as these two economies. In this context, it is predicted that the reform program implemented by the EU and the US and the liberalization of foreign trade and foreign capital will increase Turkey’s exports by more than 20%. On the other hand, it is noteworthy that similar reforms will create increases in the level of per capita national income. In this way, it is estimated that there will be a 3.1 percent increase in national income in the USA and 3.5 percent in the EU. For Turkey, reforms in the EU and the US could lead to a 1.6 percent increase in per capita income.

Table.2. Increase in Per Capita National Income Levels of Panel Data Regressions and Reforms to be Implemented in the EU and the USA (%)

On the other hand, the results of the analysis of the reforms to reduce the regulation of the goods’ market in the EU and the USA, the productivity increase that can be created in these countries and its effect on national income are given below. According to these results, the productivity increase that can be created in the EU, especially through the reduction of the public sector, and the corresponding increase in production are significant. Among the EU members, France is one of the countries most affected by the reforms. In the USA, this effect lags far behind the EU, as the weight of the public sector in the economy is far behind the EU average.

Table 3. Impact of EU and US Product Market Reforms on Multi-Factor Efficiency and Per Capita National Income (%)

The results of the analysis made with the GTAP model to measure the effect of reforms in the EU and the USA are given below. The GTAP model predicts the impact of reforms on production in the United States and lower than panel data regression estimates.

Table 4.Estimated Effects of EU and US Reforms with GTAP Model (%)

Phase II

As stated before, in the second stage of the study, the analysis made in the first stage was extended to all OECD member countries; it was assumed that product market reforms were implemented by all OECD member countries, and restrictions on foreign capital and foreign trade were lifted both among member countries and against third party states.

According to the results of the regression analysis made using this panel data, it has been revealed that the implementation of a reform program including the product market, foreign trade and foreign investments will increase the volume of gross external trade by 40% in all of the OECD countries; the most important part of this growth will be due to the reduction of goods’ market controls and regulations. This effect occurs through the reduction of the regulations applied in the domestic goods’ market, increasing the competitiveness of the exporting company and improving the conditions of access to the exports. While the countries that benefit the most from this reform package are the countries that regulate the most in domestic production markets at the beginning, countries such as Australia, where regulation is low, mostly benefit from the improvement in their commercial partners. The increase in trade from the removal of tariff barriers and the liberalization of foreign investments lagged behind the benefit of reducing regulations by 12 percent across the OECD. It is estimated that there will be an increase of around 40 percent in foreign capital stock across the OECD in this process; Korea, Turkey, Poland, Mexico and New Zealand are among the countries that will contribute the most to the foreign capital increase. The increase in foreign trade created by these reforms will also be reflected in the level of national income per capita. The increase in income to be provided within this framework was found to be above 4 percent for the USA, the EU and Japan, while it was estimated to be 4.8 percent for Turkey. For Turkey, 3.1 percentage points of this impact is due to regulatory reforms.

Table 5.National Income Increases Per Capita Through Trade Growth Created by Reforms (%)

Using the second approach, considering the effect of the productivity increase created by the reforms on the per capita national income, it is estimated that the regulatory reforms in the domestic markets will increase the multi-factor efficiency by 2 percent throughout the OECD, and this benefit will be mostly observed in Poland, Hungary and Turkey. This group will be followed by the EU countries (Italy, Greece, France, Spain and Portugal) whose domestic markets are the most regulated.

Table 6. Impact of the Product Market Reforms on Multi-Factor Efficiency and Per Capita National Income (%)

The extent to which the multi-factor productivity increase will affect the production increase will vary depending on whether the use of labor and capital inputs increases with productivity increases. Under the assumption that there is no increase in these two factors of production, the increase in production will be equivalent to a multi-factor increase in productivity. However, since the increase in multi-factor efficiency will also increase the profitability of investments, the use of the capital factor generally leads to an increase. The results of the first approach were also tested with the GTAP model, which is the third approach, by applying similar tariff discounts, the effect of these discounts on production was examined and it was observed that these results were lower than the results of the regressions performed with panel data. The GTAP model has not predicted any impact for many countries.

Table 7. The Effect of Tariff Discounts on Exports and National Income Per Capita with GTAP Model (%)

It is stated that one reason for the small effect estimated with the GTAP Model is that the benefit estimated with this technique can only capture the static results of the distributional efficiency. Given the current low level of tariffs across the OECD, the overall impact may be small, as dynamic effects do not take effect. From the table above, it is seen that the increase in exports in the GTAP model does not automatically lead to an increase in the Gross Domestic Product. In the EU, it is observed that a lower export increase than the US translates into a higher GDP increase than the US. This phenomenon is attributed to the fact that the way of using resources in the EU is less optimal than in the USA, so it has a greater potential to increase distributional efficiency than in the USA.

The study performed a final control exercise regarding the estimation of the benefits of reducing barriers in the domestic product markets, adapting the predictions for the increases in multi-factor efficiency provided in the previous section to the GTAP model and running the model under the “decrease in tariffs” scenario. According to these results, GDP growth occurs in parallel with productivity increases in all of the OECD countries.

Table 8. The Effect of Tariff Discounts on Exports and National Income Per Capita with GTAP Model (%)

RESULT

This study, which aims to measure the benefits of liberalizing domestic product markets and reducing barriers to foreign trade and foreign capital, reveals that comprehensive reform packages on these issues can significantly increase foreign trade and production among the OECD members. In the first phase of the study, the assumption is that the EU and the USA will go the route of further economic integration, in this case, it is observed that our country will benefit from both the removal of obstacles to foreign capital and foreign trade imposed on it and the reforms applied to the goods’ markets in the USA to contribute to the productivity and production of these countries. In the second stage, in addition to foreign trade and foreign capital liberalization, OECD member countries other than the EU and the USA were assumed to reform their product markets. Thus, in addition to the first stage effects, our country benefits from the return of the reforms it will implement and the impact of the internal reforms of its OECD member trade partners outside the EU and the US. Depending on the technique applied, it is estimated that Turkey will benefit from the integration of the USA and the EU in the range of 0-1.6 percent in terms of per capita national income; by implementing an OECD-wide reform program, including itself, and from the greater integration of OECD economies in the range of 0.4-3.9 percent. The lower limit of the range consists of estimates of the GTAP model and this model, which is mentioned above, does not reflect dynamic effects. Therefore, it is a more likely that the return that can be achieved around the upper limits of the ranges given above.

However, as clearly stated in the study, it would be useful to approach these results based on econometric analysis with caution. In this regard, the study advises to consider the following issues in particular: Firstly, since econometric analyses are based on historical experience and the marginal return on new reforms is likely to be below that of the old reforms, the impact of liberalization in these analyses may have been predicted above what could actually happen. Basically the reforms this time around will bring less growth than they did when economic liberalism was a novel thing. Secondly, member states may have undergone a serious reform process since the date of collection of the data input for this study, so the reform package assumed in the study may have been assumed to be very large since it could actually be implemented. In contrast, since the effectiveness resulting from efficiency gains is not included in the GTAP model, it is possible for the GTAP model to underestimate the consequences of reforms that may actually occur. In addition, there may be some productivity gains in the reform process that will be brought about by the acceleration of innovation and that cannot be achieved with the models implemented. Finally, by reforming the labor market and financial markets, the benefits that can be derived from the reform of the product market can be increased immesuarably. With this study, it has been revealed that our country will be one of the countries that will benefit the most from the OECD-wide liberalization in the fields of product markets, foreign trade and foreign capital. Due to the fact that the data set used is based on surveys conducted in 2001 and 2003, it is seen that this study cannot take into account the recent liberalization of product markets, foreign capital legislation and the decrease in public control over the economy in parallel with the acceleration of privatization in Turkey. Considering the aforementioned developments, it can be concluded that we have started to observe the benefit predicted by this study in the high growth performance of Turkey over the last four years, which, in addition to the correct macroeconomic policies, is a function of the liberalization of product markets and the significant removal of foreign capital restrictions.

Source:

OECD (2005) “The Benefits of Liberalizing Product Markets an Reducing Barriers to International Trade and Investment: The case of the United States and the European Union”, OECD Economics Department Working Paper No:432

OECD (2005) “The Benefits of Liberalizing Product Markets an Reducing Barriers to International Trade and Investment in the OECD”, OECD Economics Department Working Paper No:463

(*) Economic Consultant, Permanent Representation of the OECD

Translated by: Doruk Arslan

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