A full and swift implementation of the WTO Trade Facilitation Agreement (TFA) has the potential to generate important global economic benefits but quantifying these poses serious challenges. This chapter draws on analysis using the OECD METRO model to document the channels through which trade facilitation reforms can benefit the global economy and the distribution of those potential benefits across country groupings and sectors over the short and longer term. Impacts on labour income and employment and welfare over the longer term are also explored.
Trade Facilitation and the Global Economy
Chapter 7. Economy-wide impacts of trade facilitation
Abstract
Beyond the reduction in worldwide trade costs, a full and swift implementation of the Trade Facilitation Agreement (TFA) has the potential to generate important global economic benefits. But how can these economy-wide benefits be measured? This chapter draws on analysis using the OECD’s METRO model (Box 7.1) to document the channels through which trade facilitation reform can benefit the global economy, and to discuss the distribution of potential benefits across country groupings at different levels of development, across different sectors and on different use markets (i.e. intermediate, household, government and capital).
Capturing the economy-wide impacts of trade facilitation
Border procedures and formalities can have economy-wide impacts through different channels, including price and efficiency effects. Price effects increase the price of traded products over what they would otherwise be, with a generally dampening effect on the level of trade. They can be either direct, as in payments of customs fees, or indirect, as in costs resulting from inefficient and burdensome trading processes, as well as border clearance delays. Efficiency effects can arise from distortions in the allocation of resources in the economy. Both price and efficiency effects generate welfare losses for consumers and producers in both importing and exporting countries (OECD, 2009).
The nature and magnitude of the effects may differ depending on the type of products traded. For highly perishable products, delays at the border can generate product losses or increased costs for storage and refrigeration, imposing depreciation and inventory holding costs (including high opportunity costs). Multi-stage production may be especially sensitive to lags and variability in timely delivery. Most large manufacturers are heavily dependent on frequent and timely delivery of raw materials and intermediate goods for their production processes. When consumer preferences are taken into account, speed and flexibility also play a key role – especially where there is uncertainty in the quantity likely to be demanded, product quality, or desired product characteristics (this is particularly the case for products subject to changing consumer preferences, such as fashion clothing items or fashionable toys). Moreover, if the product has a limited shelf life, then prolonged waits at the border could be enough to take the product out of the market (OECD, 2009; Walmsley and Minor, 2016).
Trade facilitation generates efficiency gains from reduced shipping losses
Time savings associated with the elimination of customs-related delays can have an effect on international trade by reducing both “spoilage” and inventory holding costs (Hummels, 2001). Inventory costs include not only the capital costs of the goods while they are in transit, but also costs related to the need to hold larger inventories to accommodate variation in arrival time. These latter costs have become increasingly important due to the use of “just in time” production techniques (Hertel et al., 2001). Speedy delivery is critical for goods subject to rapid depreciation and for which demand is uncertain, but is less important for bulk commodities and simple manufactures (Hummels et al., 2007).
Losses and costs associated with border inefficiencies, spoilage or inventory holding can be modelled following the widely-used iceberg cost approach. The idea behind this approach is that the costs of transporting a good are being paid for by a portion of the transported good, rather than any other resources (Samuelson, 1954). Like an iceberg, the value of the product “melts” away, as it is “towed” to more distant destinations. Inefficient trade procedures increase the cost of trade and drive a wedge between the price received by the producer of the good and the price paid by the consumer – a pure deadweight loss. Following this “sand in the wheels” approach (Fugazza and Maur, 2008) for depicting efficiency losses, various empirical studies have tried to account for both direct and indirect transaction costs associated with trade facilitation deficiencies, to translate trade facilitation improvements into technological progress in trading activities, and to capture the magnitude and sources of indirect transaction costs.
In essence, the approach assumes that implementation of trade facilitation reforms lowers the iceberg costs of trade – meaning that for the same amount of imports sent, more will arrive at their destination than prior to the reforms. This approach is appropriate when time delays lead to real costs for importing firms, such as when agro-food products spoil due to long delays in customs or when the delay of an imported intermediate triggers delays in the entire production process. In many cases, however, such time delays are an inconvenience, rather than a real cost. In those cases, using the iceberg approach alone is likely to overstate the impact of a full implementation of the TFA on real costs and hence real GDP (Walmsley and Minor, 2016).
Trade facilitation generates gains associated with speed of delivery
Border procedures also need to be assessed in the context of dynamic production networks and fast-evolving consumer tastes. In the case of agro-food products, spoilage may not only affect the product quantity arriving in the market (as in the iceberg approach), but also influence consumer willingness to pay for that product. Assuming that both the quantity and quality of these products will lessen along the way, their importers will factor this into the price they are willing to pay for the goods, so as to account for any losses selling them on to customers.
Timeliness is also important when demand is uncertain, a characteristic of “lean retailing” in modern textile or apparel supply chains (Evans and Harrigan, 2005). Long lags between ordering and delivery require firms to commit to product specifications and quantities to be supplied before they can be certain as to the extent of demand (Hummels and Schaur, 2013). Consumer tastes are volatile, and retailers face the prospect of having to liquidate vast inventories of unpopular clothing at the end of a selling season or of running short of suddenly popular styles. “Lean retailing” – the combination of low inventories and frequent restocking – offers a partial solution to these problems. With low inventories, stores will not be stuck with large amounts of unsold goods even if demand collapses; the essence of lean retailing is to respond rapidly to demand fluctuations instead of holding large inventories. For producers, lean retailing demands great flexibility. If they want to sell to lean retailers, producers must be able to adjust output rapidly and ship products quickly. The benefit for flexible producers is that they can charge a premium over their less flexible competitors, who can compete only on selling cost and not on timeliness (Evans and Harrigan, 2005). But importers and exporters cannot be flexible without smooth border procedures.
In order to capture the importance of timeliness for the user or consumer, Walmsley and Minor (2016) developed a willingness to pay approach for trade facilitation. Consistent with previous literature,1 the newly-developed alternative approach holds that consumers prefer goods delivered more quickly and are willing to pay more for them. This is true not only for final products, but also for intermediate goods throughout the supply chain. For firms, the ability to defer import decisions until better market knowledge is obtained, and then to receive those imports quickly once a decision has been made, has distinct advantages for retailers and importers (Walmsley and Minor, 2016). So, the willingness to pay approach explicitly treats the reduction in customs delays from the demand side as an increase in the consumer willingness to pay for faster delivery.
Quantifying the economy-wide impacts of trade facilitation and identifying the channels for these impacts and the implications for reform thus represents a major analytical challenge. The choice of the transmission mechanisms outlined above – willingness to pay or iceberg costs – can have important consequences for the estimated impacts in terms of GDP, trade, and welfare (Walmsley and Minor, 2016). A new approach to addressing this issue, by combining both the approaches above, is set out below.
A new approach to assessing the economy-wide impacts of trade facilitation reforms
A new approach to assessing the potential economy-wide impacts of full TFA implementation is to combine the two approaches described above in a single model, in this case, METRO, the OECD’s static multi-regional computable general equilibrium (CGE) model (Box 7.1). Under this new approach, trade facilitation reforms are depicted partly as reducing losses (“iceberg costs”) on the producer side, and partly as increasing “willingness to pay” on the consumer side. Both effects are likely to occur when trade facilitation measures are introduced: losses from shipping and clearance delays are likely to be reduced; and, in the context of GVCs and rapidly changing consumer preferences, firms and consumers are more willing to pay more for a product delivered faster and from which they therefore get greater use.
Box 7.1. The OECD METRO model
In 2015, the OECD launched a new global computable general equilibrium (CGE) trade model, known as METRO (ModElling TRade at the OECD). CGE models are computer simulation models that use data to explore the economic impact of changes in policy, technology and other factors. They show how different sectors inside one economy are linked and how multiple economies are connected to each other, as well as how resources such as labour, capital and natural resources are best allocated across all economic activities.1
The METRO database currently covers 61 economies across 57 economic sectors. It is based on the GTAP (Global Trade Analysis Project) database, but allows users to analyse global value chains (GVCs) by drawing on the OECD-WTO Trade in Value Added (TiVA) database. METRO more fully integrates structural policy issues into trade policy analysis, and features an extensive library of trade-related policies, including current border tariff rates and export restrictions, as well as domestic taxes and support. Using METRO, it is now possible to track trade flows by their use (i.e. intermediate, household, government and investment) and to trace bilateral links between source and destination markets, greatly enhancing the ability to model movements of goods and services, especially along GVCs.
Incorporating the TFIs into the METRO model allows analysis to capture how changes in trade facilitation policies affect interconnected modes of production. This provides a means of tracing and quantifying the economy-wide effects of trade facilitation reforms.
1. The METRO model builds on the GLOBE model developed by Scott McDonald and Karen Thierfelder (2013).
Source: OECD (2015).
Improved product delivery times thus change the incentives for economic agents and ultimately impact worldwide production and consumption patterns, including changes in prices of inputs and outputs, overall production, and trade of goods and services. Employment and wages can also be affected, depending on the adjustment possibilities in the labour market and on how labour is employed across sectors.2 These effects are explored further below.
In the short term, trade facilitation reforms bring efficiency-related gains
Over the short term, the ability of economies to adjust to changing market conditions is more limited; investment and government expenditures, for instance, are already committed. In addition, labour markets are more likely to be characterised by wage and other rigidities and unemployment. The analysis below of the efficiency effects of full implementation of the TFA in the short-term is based on these constraints.
Reducing inefficiencies and delivery delays increases GVC trade, especially for developing countries
Benefitting from GVCs depends not only on firms’ ability to manage exporting costs, but also whether they have access to competitively-priced inputs, know-how and technologies (Lopez Gonzalez, 2016). Firms using a higher share of imported intermediates can enhance their productivity – via both the use of more varieties of (and potentially more competitively priced) intermediates, and the technology transfers “embodied” in foreign intermediates – and this allows them to access new export markets.3
By significantly reducing trade transaction costs and clearance times, worldwide implementation of the TFA has the potential to increase world trade by 0.6% compared to the base.4 Trade increases in all sectors, including the agro-food sector, with manufacturing sectors showing the highest growth rates (Figure 7.1).
Trade in covered sector groups increases between 0.2 and 1%. Intermediates account for the largest share of this increase for the majority of selected sectors, in particular those sectors5 characterised by strong GVCs linkages where firms are likely to see further cost savings from “just-in-time” access to a higher variety of competitively-priced intermediate inputs. Broken down by country, intermediates also account for the largest increase in exports from developing and emerging economies, underscoring the new opportunities offered to these countries by GVCs to engage in global markets without having to develop complete products.
Trade also increases for countries at all levels of development (Figure 7.2), with the countries in the low income country (LIC), lower middle income country (LMIC) and OECD groups increasing exports more than imports (for LICs, the increase in exports is twice as high as the increase in imports). While the largest share of the increase in imports is goods and services for final consumption, increasing imports of intermediates appears to be particularly important in enhancing LICs’ competitiveness.
Figure 7.1. In the short-term, full implementation of the TFA would increase trade in all sectors
Trade effects by commodity (% changes by end use categories, short term)
Source: OECD METRO model simulation results.
Figure 7.2. Implementation of the TFA increases trade for countries at all levels of development, especially in intermediates
Impacts on imports and exports by income group (% changes to base, short term)
Source: METRO simulation results.
Falling input costs from trade facilitation reforms trigger production increases for all regions
Beyond trade, trade facilitation reforms generate positive effects on production by contributing to lowering overall input costs. This is the case across the large majority of sectors, with the exception of agro-food products (Figure 7.3) reflecting the agricultural sector’s relatively small share of use of intermediates relative to primary production factors.6 Lower costs for intermediate inputs are most pronounced in the machinery, transport and electronic equipment; heavy manufacturing; and transport service sectors. This indicates that importing also helps firms to remain competitive in the domestic economy, such that sectors not only benefit from lower costs for their own imported intermediates, but also from lower costs for domestically produced intermediates.
Figure 7.3. Implementation of the TFA lowers the costs of inputs for almost all sectors
Intermediate inputs costs, by sector and income group (% change to the base, short term)
Source: OECD METRO model simulation results.
Production increases across all countries and almost all sectors
Declining inputs costs lower output prices and generate a positive impact on both domestic and export demand, and this in turn stimulates production. Full implementation of the TFA sees overall output levels increase by up to 0.5% across all income groups, with the strongest increases for LICs and LMICs, followed by high income countries (HICs) outside the OECD area and countries in the Rest of the World (RoW) (Figure 7.4). OECD countries experience smaller trade and production effects compared to other selected regions because of their already high level of trade facilitation performance and faster clearance times.
Output expands the most for the agro-food and heavy manufacturing sectors, across all the developing and emerging economy groups (including LICs, LMICs, upper middle income countries, and RoW).7 A key share of this worldwide output increase comes from expansion of the services sectors, highlighting the importance of services both in connecting different production segments and as an increasingly important input to production processes. These “real” increases in output levels are complemented by the efficiency increase from improvements in trade facilitation (Figure 7.4) which reduce quality losses and shorten border processing time, increasing firms’ and consumers’ willingness to pay (WTP).
Regional gains vary, reflecting improved output in areas of comparative advantage for the selected regions. In Southeast and South Asia, the greatest expansion is in the heavy manufacturing, textile and wearing apparel, machinery, electronic and transport equipment, and services sectors. In South America and Sub-Saharan Africa, output increases in the agro-food sector, as well as heavy manufacturing and services. In other regions, such as North America and Europe, production increase is dominated by services. Across all regions, the expansion of manufacturing is strongly linked to a growing role for services (Figure 7.5).
Figure 7.4. By lowering input costs and raising efficiency, trade facilitation increases output across all regions
Production effects by income region and sector (% change to base, short term)
Note: The sectoral change represents the contribution to the overall production change of a country group. The efficiency effect (WTP) depicts the higher levels of utility resulting from faster delivery times. This applies for all production and welfare analysis charts.
Source: OECD METRO model simulation results.
Figure 7.5. Manufacturing gains across all regions, but the role of services is increasing
Production effects by geographical region and sector (% change to base, short term)
Source: OECD METRO model simulation results.
Over the long-term trade facilitation impacts resources allocation and wages
In the longer run, labour markets adjust to changing production needs through more flexible wage rates which sustain employment levels, so an assumption of full employment can be used. The longer-term scenario highlights the broader economic benefits that can stem from the efficiency spill-overs of trade facilitation reforms over a longer-term horizon, along with the associated impacts on the allocation of resources across sectors and on wages.
It leads to more efficient production and resource allocation
Over the longer term, improved worldwide trade facilitation performance would encourage specialisation and the reallocation of resources towards those activities that reflect a country’s comparative advantage, again leading to increased production. Increased efficiency and lower costs, including from greater use of imported intermediates, would intensify the competition faced by domestic producers, leading to more efficient allocation and use of resources.8 In a scenario where factors are free to adjust, increased competition would trigger production shifts both between and within regions. At the domestic level, certain sectors would grow by sourcing labour from other sectors. At the global level, intensifying competition in the world market may further increase price reductions triggered by trade facilitation.
In the longer run, the economic efficiency and competition gains spurred by trade facilitation would have positive effects on aggregate production across all regions, reaching up to 0.4% in Southeast Asia (Figure 7.6). As in the short-term, overall benefits from trade facilitation reforms would consist of both “real” production effects and increased willingness to pay derived from faster delivery times and reduced quality losses (reflecting increased utility for consumers and users). Production in Southeast Asia increases most in the machinery, transport and electronic equipment sectors, while South Asia shows potential to increase production in heavy manufacturing and textiles. There is also a key role for services (including transport services) for developing the production base in the Asian region. In Sub-Saharan Africa, notable increases would be experienced in the heavy manufacturing, motor vehicles and parts, and services sectors. Production in MENA is dominated by expansion in services, linked to the availability of cheaper imports of consumer goods, which encourages a shift in domestic production towards services.
Figure 7.6. In the long term, production shifts take place within and among regions
Production effects by geographical region and sector (% change to base, long term)
Source: OECD METRO model simulation results.
And increased incomes
In the long run, trade facilitation reforms would also translate into rising incomes (Figure 7.7). All labour categories in developing and emerging economies, skilled and unskilled, would experience higher returns in the range of 0.3%, with the largest effects in LICs, LMICs, HICs outside the OECD area, and RoW. In OECD countries, income effects are more modest, given their already high level of trade facilitation performance and faster clearance times.
The rise in income also leads to increasing consumption in all regions, by up to 0.3% in LICs. This is compounded by lower losses at the border and faster delivery, both of which increase efficiency and thus total demand.
Figure 7.7. In the developing world, trade facilitation raises labour income over the longer term
Labour income evolution in the long run
Source: OECD METRO model simulation results.
In the longer term, trade facilitation also leads to welfare gains
Increased efficiency of border procedures from full implementation of the TFA could potentially add between 0.04% and 0.41% to countries’ GDP, depending on the level of development. But these figures do not include gains arising from the utility increase from faster delivery; these can be captured by welfare analysis, which provides a useful lens for assessing economic impacts beyond output from trade facilitation reforms over the longer term.9 Using this analysis, full implementation of the TFA would see welfare increase by between 0.05 and 0.63% of total demand, depending on level of development and the assumptions used (Table 7.1 presents the slight variations between approaches).
Table 7.1. Trade facilitation raises welfare over the longer term
GDP and welfare effects by country income grouping
1. Accounting for both decreasing losses on the supply side and increased utility from faster delivery times on the demand side.
2. Accounting only for decreasing losses.
3. Accounting only for increased utility from faster delivery times.
Source: OECD METRO model simulation results.
Welfare increases across all selected income groups and major economic agents (including households, government and investment) (Figure 7.8), much of which stems not only from household consumption, but from the higher utility triggered by faster delivery times. LICs and RoW benefit the most, with welfare increases of 0.5 and 0.6% of total demand. Increasing household consumption in LICs is counterbalanced by a negative effect on household savings, suggesting a need for further inward FDI to compensate for the declining pool of domestic capital.
Figure 7.8. Countries at all levels of development experience welfare gains
Welfare decomposition by income groups (long term)
Source: OECD METRO model simulation results.
A closer look at welfare impacts indicates that, across all groups covered, increases in welfare over the longer term are driven by overall utility gains and technological changes, followed by allocative efficiency effects reflecting a more efficient allocation of resources in domestic economies (Figure 7.9).
Figure 7.9. Longer term welfare gains are driven by technological changes and utility gains
Further decomposition of welfare effects, by income groups
Source: OECD METRO model simulation results.
Figure 7.10. Over the longer term, welfare increases in all regions
Welfare decomposition by geographical regions
Source: OECD METRO model simulation results.
Over the longer term, trade facilitation reforms also lead to welfare increases in all selected geographical regions (Figure 7.10). Sub-Saharan Africa, Southeast Asia, South Asia, MENA, and Central America and the Caribbean experience welfare gains between 0.4 and 0.5% of their original regional demand. Effects are lower for South America and the Rest of Europe and Central Asia at 0.2%, and for Europe, North America, and East Asia and the Pacific at 0.1%. Households experience the largest welfare gains, followed by governments. The distribution of economy-wide benefits across regions and sectors heavily favours developing countries, particularly if they pursue ambitious WTO TFA implementation.
The longer run analysis highlights the broader economic benefits stemming from trade facilitation reforms, in terms of efficiency spill-overs and the associated impacts on the allocation of resources across sectors and on wages.
Overall, analysis based on the TFIs shows that implementation of the TFA can benefit all countries, as both exporters and importers of goods, by enabling better access to inputs for production and greater participation in the GVCs that characterise international trade today. Economies that currently face the biggest challenges in trade facilitation stand to reap the greatest benefits from implementation, with the nature and extent of those benefits depending on the extent and timeframes for implementation.
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Notes
← 1. This refers to literature on importers’ willingness to pay to reduce shipping times; see, for example, Hummels et al., 2007 and Hummels and Schaur, 2013.
← 2. Labour markets are currently characterised by rigid wages and unemployment, warranting the use of an unemployment assumption in the short term. This assumption would better depict economies with significant labour market rigidities and a larger pool of unemployed workers. In the long run, it is assumed that labour markets may be more likely to adjust to imbalances by adjusting wage rates while sustaining employment levels through a highly flexible and mobile labour force, and hence a fixed labour-supply assumption is used.
← 3. Imported intermediates from developed countries are found to provide a greater boost to productivity and exporting propensity (Bas and Strauss-Kahn, 2014).
← 4. The base refers to the 2011 data used in the METRO model to reflect the structure of the world economy.
← 5. Mining and extraction; paper and paper products; heavy manufacturing; motor vehicles and parts; and machinery, electronic and transport equipment.
← 6. Increasing demand for agricultural production increases demand for arable land and this in turn increases agricultural output prices. The food sector uses mainly agricultural goods as intermediate inputs for which prices for domestic supply have increased. This specific impact dominates the overall effect.
← 7. The rise in production is triggered by an increase in demand. Although the increasing production costs in agriculture dampen the positive demand effect in this sector, the overall impacton agro-food output is positive.
← 8. If streamlining of cumbersome border procedures were to increase competition, cheaper imports would put pressure on local firms to increase their efficiency and reduce production costs. Similarly, firms competing in the domestic market would also experience efficiency gains from accessing lower cost inputs.
← 9. The regional “Equivalent Variation” (EV) is used to enable utility increases to be captured. The EV measures the amount of money that a household and government would need in order to reach the same level of utility without the policy change. The measure depicted here is relative to total regional final demand (absorption) in the base situation.