a thesis submitted to the faculty of the graduate school of the university of colorado in partial fulfillment of the requirements for the degree of doctor of philosophy department of economics

It suggests that although it is more likely to see the positive effect of the GATT/WTO on international trade in developed countries than to do the same in developing countries, the trad

Trade Effects of the WTO and Anti-dumping Policy in Developing Countries

by

Khai Cong Dinh

M.A., Economics, University of Colorado at Boulder, 2005 M.S., Economics, University of Asia and the Pacific, the Philippines, 1997 B.A., Economics, University of Economics, Vietnam, 1990

A thesis submitted to the Faculty of the Graduate School of the University of Colorado in partial fulfillment

of the requirements for the degree of

Doctor of Philosophy Department of Economics

2009

This thesis entitled:

Trade Effects of the WTO and Anti-dumping Policy in Developing Countries

By Khai Cong Dinh

has been approved for the Department of Economics

Dinh, Khai Cong (Ph D., Economics)

Trade Effects of the WTO and Anti-dumping Policy in Developing Countries

Thesis directed by Prof Wolfgang Keller and Prof Keith Maskus

The first chapter of this dissertation is devoted to extensively review literature on the impact of trade liberalization under GATT/WTO on international trade in developed and developing countries It suggests that although it is more likely to see the positive effect of the GATT/WTO on international trade in developed countries than to do the same in developing countries, the trade-promoting role of the GATT/WTO is expected to

be found in developing WTO members, at least in some sectors

Chapter 2 develops a model to test the hypothesis of whether or not the WTO has promoted international trade in developing WTO members The contribution of this chapter into the existing economic literature is that this study investigates the effect of GATT/WTO membership on international trade in different types of goods, differentiated and homogeneous, in developing country members I find that WTO membership has associated with expanded imports of products which are of primary export interest to developing countries I also find that joining the GATT/WTO in a period had a bigger impact on imports of different types of goods in developing countries than already being

in the GATT/WTO since applicants are required to make more serious commitments on tariff liberalization and market access before they get approved to accede to the WTO than the existing developing country members

Chapter 3 uses a cross-country sample of newly available disaggregated data to empirically examine trade effects of anti-dumping (AD) cases initiated between 1995 and

2003 in “new AD user” developing countries I find that there is very limited trade diversion caused by AD petitions in developing countries due to a reason unique to these countries; that is, while AD activities in developing countries reduce imports from named countries relatively high tariff barriers and quantitative restrictions in these countries impede imports from non-named countries This is probably the most relevant reason to explain the outbreak of AD laws and their escalating use in developing countries

Dedication

To my parents, parents-in-law, wife, and sons

Acknowledgements

I would like to acknowledge the Vietnamese Ministry of Education and Training and many individuals who gave me special supports and encouragement to complete my dissertation

I would like to express my deep gratitude to my advisors, Professor Wolfgang Keller and Professor Keith Maskus, who gave me valuable comments and suggestions on

my dissertation I owe special thanks to Professor Maskus who spent his precious time to shape the framework of my projects and encouraged me to pursue further goals in my academic career I am also indebted to Professor Hale Utar for her discussions and comments on my dissertation, especially chapter 3

Thanks also go to Nam Hoang, Duong Nguyen, Ha Nguyen, Hang Nguyen, David Pinto, and Said Boakye for their encouragement and friendship

All the achievements I have obtained today are dedicated to my parents who have always believed in my abilities and have always been by my side to give me wonderful support and encouragement, to my parents-in-law who have always been a great help, and to my wife and sons whose love has given me strength and confidence to pursue higher goals in my life

Contents

Chapter

1 The Impact of the World Trade Organization on International Trade 1

1.1 Introduction……… 1

1.2 The Gravity Equation: Some Theoretical Foundations………… 3

1.3 Tariff Liberalization in Developed and Developing Countries… 16

1.4 Effects of Tariff Liberalization on International Trade………… 19

1.5 Effects of the GATT/WTO on International Trade……… 36

1.6 Summary and Suggestions for Future Research……… 41

2 Do Developing Countries Enjoy Their Membership in the WTO? 43

2.1 Introduction ……… 43

2.2 The Estimation Model……… 49

2.3 Data……… 52

2.4 Econometric Results and Discussion on Empirical Findings…… 53

2.4.1 Basic Results……… 53

2.4.2 Do Newly-Joined Developing Country Members Benefit from the WTO? 58

2.5 Conclusion……… 62

3 Trade Effects of Antidumping Policy in Developing Countries………… 64

3.1 Introduction……… 64

3.2 The Proliferation of AD Policy and AD Activities in Developing Countries……… 71

3.3 Literature Review on Trade Destruction and Trade Diversion

of AD Policy……… 73

3.3.1 Trade Destruction Effects of AD Actions……… 73

3.3.2 Empirical Studies on Trade Diversion of AD Policy… 75

3.4 Estimation Model and Estimation Strategy……… 83

3.5 Data……… 85

3.6 Econometric Results and Discussion of Empirical Findings…… 86

3.6.1 Benchmark Results….……… 86

3.6.2 Trade Diversion Effects of AD Cases in the Major AD Filing Sectors in Developing Countries……… 87

3.6.3 Discussion on the Empirical Findings……… 92

3.7 Conclusion and Policy Implications……… 110

Bibliography 113

Appendix A 120

2.5 Effects of the GATT/WTO on imports of different goods

in newly-joined and old developing WTO members………… 60 3.1 Antidumping initiation between 1994/95 and 2002/03

(July/June) by reporting countries……… 65 3.2 Sectors most frequently involved in AD cases between 1995

and 2003……… 69 3.3 Country-wise break-up of AD one-country one-product cases,

1995-2003……… 70 3.4 Impact of AD Actions on Values of Imports in the Six

Developing Countries……… 88 3.5 Impact of AD Actions on Quantity of Imports in the

Six Developing Countries……… 89 3.6 Impact of AD Actions on Unit Value of Imports in

the Six Developing Countries……… 90

3.7 Impact of AD Actions on Values of Imports in Major

AD Filing Sectors in the Six Developing Countries………… 93 3.8 Impact of AD Actions on Quantity of Imports in Major

AD Filing Sectors in the Six Developing Countries……… 95 3.9 Impact of AD Actions on Unit Value of Imports in Major

AD Filing Sectors in the Six Developing Countries… ……… 97 3.10 Unweighted Average MNF Applied Tariff Rates (6-digit HS) 99 3.11 Impact of AD Actions on Values of Imports in Turkey

and the Other Developing Countries……… 104 3.12 Impact of AD Actions on Quantity of Imports in Turkey and

the Other Developing Countries……… 106

However, Rose (2004) shows that GATT/WTO members do not have significantly different patterns of trade than non-members; the GATT/WTO has not systematically played a strong role in encouraging trade It is really a surprising finding since tariff barriers in developed and developing WTO members have been removed substantially through GATT/WTO multilateral and bilateral trade negotiation rounds For instance, thanks to the GATT/WTO’s efforts unweighted average applied tariff rates in developed countries have fallen from high double-digit levels to 6.3 percent in 1995 and around 3.5 percent in 2005 For developing countries, they were 16.6 percent in 1995

1 Taken from http://www.wto.org/english/res_e/doload_e/inbr_e.pdf

and 10.6 percent in 20052 Developed countries increased the number of imports whose tariff rates were “bound” from 78 percent of product lines to 99 percent after the Uruguay Round while the increase in developing countries was from 21 percent to 73 percent3 These substantial tariff reductions under GATT/WTO are expected to stimulate international trade in both developed and developing WTO members

There are many empirical studies which find the positive effect of tariff liberalization on international trade in developed countries For instance, Prewo (1978) empirically examines the effect of tariff reductions on aggregate bilateral trade flows among eighteen OECD countries for the years 1958 to 1974 and finds that tariff reductions promoted trade among these countries Rose (1991) also finds the positive effect of tariff reductions on the growth of the trade ratio in twelve OECD economies from 1951 to 1985 Baier and Bergstrand (2001) show that approximately 25 percent of the mean growth of trade in eighteen OECD countries could be explained by tariff-rate reductions In contrast, there are few empirical studies on the effect of tariff liberalization

on international trade in developing countries due to unavailability of tariff data Therefore, Subramanian and Wei (2007) use a gravity estimation model with appropriate dummy variables to measure the effect of the GATT/WTO on international trade in both developed and developing countries Their empirical findings show that while the GATT/WTO has significantly promoted trade in developed countries its trade-promoting role in developing countries has been very limited

The above analysis indicates that little is known about trade effects of the GATT/WTO in developing countries Therefore, a further investigation on the hypothesis

of whether or not the GATT/WTO has promoted international trade in developing countries would be interesting This chapter is devoted to extensively review literature on the effect of trade liberalization under GATT/WTO on international trade to show that it

is rational to expect significant effects of the GATT/WTO on international trade in developing WTO members It is aimed at making some suggestions for further research

to better understand trade effects of the GATT/WTO in these countries

Since most of empirical studies on effects of the GATT/WTO on international trade in economic literature use a gravity estimation model, therefore, the second section

in this chapter is devoted to discuss some theoretical foundations of the gravity equation The third section presents outstanding achievements of the GATT/WTO in tariff liberalization The fourth section reviews some literature about effects of tariff reductions

on international trade The fifth section discusses effects of the GATT/WTO on the world trading system The last section summarizes the chapter and makes some suggestions for further study

1.2 The Gravity Equation: Some Theoretical Foundations

The gravity equation has been long considered as a very successful empirical model to explain trade flows between two countries, or two regions Basically, in this model trade flows from country i to country j can be explained by income in each country, economic distance between i and j, and other economic forces that either support

or impede the flows between two countries The gravity equation is generally specified as

ij ij ij j i

0

β β β ββ

where Mij is the dollar flow of goods from country or region i to country or region j, Yi

and Yj are incomes in i and j, Dij is the economic distance between countries (regions) i and j, Aij is any other factor either supporting or impeding trade between i and j, and uij is

a log-normally distributed error term with E(ln uij)= 0 This specification was first used in Timbergen (1962), Poyhonen (1963), however, they only gave intuitive justification for it (Deardroff, 1998) Therefore, although considered as the successful model in empirical studies on bilateral trade flows, it was said that an estimated gravity equation did not have

a theoretical foundation

The first attempt to derive the gravity equation from economic theory was made

by Anderson (1979) In this paper, he first assumes: Cobb-Douglas (and then CES preferences in an appendix) homothetic preferences identical across countries, perfect product specification under the assumption that each country produces only one specialized good, perfect competition, and the same prices in all countries Using an expenditure system under constraint given by the importing country’s income and the exporting country’s income, he derives a restricted gravity equation in which the trade flow from i to j is a function of only each country’s income with unit income elasticities

To make the gravity equation more sensible, he assumes that all countries produce a traded and a nontraded good Preferences for traded goods are identical across countries and homothetic, with the traded-goods share now being a function of income and population A full set of national tariffs in each country and transport costs proxied by distance are also incorporated in the model The gravity equation derived under the above assumptions is an unrestricted (non-unit income elasticity) one which shows that after controlling for size, the trade flow from country i to country j depends on their bilateral

trade barrier relative to an income-weighted average of barriers between country i and all the trading partners Obviously, the average trade cost term will be missing in Eq (1.1) if the gravity equation is not derived from economic theories This implies both that without the average trade cost term an estimation of Eq (1.1) suffers from omitted variables biased and that comparative statics analysis is unfounded (Anderson and Wincoop, 2003)

Different from Anderson (1979), Bergstrand (1985) shows that a gravity equation similar to Eq (1.1) can be generated from a general equilibrium (GE) framework with necessary assumptions He uses CES preferences over Armington-differentiated goods as

in Anderson (1979) However, the difference is that he allows the elasticity of substitution between domestic and importable goods and among importables to differ The reason is that there exist costs of distribution and marketing to tailor each country’s product to each national market These costs are captured by a constant-elasticity-of-transformation that allowseach country’s producer to treat export supplies to each market

as imperfect substitutes A GE model of world trade is derived from utility- and maximizing agent behavior in N countries assuming a single factor of production in each country The derived model shows that the trade flow from i to j is a function of all countries’ resource availabilities for a given year as well as trade barriers and transport-cost factors among all pairs of countries However, that specification is not a gravity equation since it does not include exporter and importer incomes as in Eq (1.1) To derive a gravity equation which includes incomes as exogenous variables from the system, he first assumes that the market for the aggregate trade flow from i to j is small relative to other markets This small market assumption allows exporter income (Yi),

profit-importer income (Yj), and certain price terms to be treated as exogenous The second assumption is identical utility and production functions across countries, which ensures all parameters in trade flow and price equations to be constant across all country pairings From those two assumptions he derives the “generalized” gravity equation for bilateral trade in which the trade flow from country i to j is a function of exporter and importer incomes treated as exogenous, bilateral trade barriers, transport-cost factors among all pairs of countries, and some price indices Price indices in Bergstrand’s (1985) gravity equation are absent in Eq (1.1) This shows that a gravity equation if not derived from economic theory may exclude some important variables

To test the assumption of product differentiation the author estimates the system

by using dummy variables indicating the presence of preferential trading agreements to proxy for the tariff variable, the distance between economic centers of i and j and a dummy for adjacency to proxy for the transport-cost factor, and GDP deflators to approximate the price indices His empirical estimates support the assumption that goods are not perfect substitutes and that imports are closer substitutes for each other than for domestic goods

In an attempt to derive a gravity equation that is consistent with modern trade theories, Bergstrand (1989) develops a general equilibrium model of world trade with two differentiated-product industries and two factors (capital and labor) to see how the gravity equation, including exporter and importer populations and incomes, fits in the Heckscher-Ohlin (H-O) model of inter-industry trade and the Helpman-Krugman (1985) and Markusen (1986) models of intra-industry trade To derive the demand equation he first solves for the consumer’s maximization problem using a “nested” Cobb-Douglas-

CES-Stone-Gary utility function subject to an income constraint The derived market demand curve relates bilateral trade flows and national income, per capita income, and prices Countries with similar per capita incomes will have similar demands, as suggested

in Linder (1961) To derive the supply equation he assumes that each firm in each of the two industries produces a uniquely differentiated product in a market that can be characterized as Chamberlinian monopolistic competition That means product differentiation among firms rather among countries as in Anderson (1979) He assumes further that each monopolistic competitive sector has different factor proportion, which is

a combination of the perfectly competitive H-O model and the one-sector monopolistically competitive model of Krugman (1979) Each firm distributes its product

to domestic and foreign markets under diminishing returns, similar to Krugman (1987) Using the market clearing condition, he derives the gravity equation which shows that the value of the trade flow from i to j can be explained by exporter i’s income and capital-labor ratio, importer j’s income and per capita income, trade barriers, transport-cost factor, exchange rates, and price terms In the typical estimated gravity equation, exporter GDP is a proxy of i’s national output expressed in terms of units of capital Exporter GDP per capita is a proxy of i’s capital-labor endowment ratio Importer GDP is j’s national output Importer GDP per capita is j’s per capita income Distance is interpreted

as the c.i.f./f.o.b factor Hence, Aij in Eq (1.1) should include measures of j’s tariff rate

on i’s exports, the bilateral exchange rate, and the two complex price terms His empirical findings show that including importer and exporter incomes and per capita income in the gravity model is consistent with modern trade theories of inter-industry and intra-industry trade

It is easy to recognize that none of the gravity models above are directly derived from the Heckscher-Ohlin (H-O) model Therefore, it used to be claimed that the H-O model is incapable of providing a theoretical foundation for a gravity equation However, Deardorff (1998) proves that a gravity equation can be derived from two cases of the H-O theory The first is frictionless trade In this case, since all impediments to trade in homogeneous goods are absent therefore producers and consumers are indifferent among trading partners As a result, patterns of bilateral trade are not determined Deardorff resolves this indeterminacy by random drawing in which producers in each industry put their output into a world pool for their industry; then consumers choose randomly their desired levels of consumption from these pools If consumers draw from these pools in small increments, then the law of large numbers will allow us to predict quite accurately what their total choices are by using expected values The expected trade flows will correspond exactly to the simple frictionless gravity equation whenever preferences are identical and homothetic Generalizing the result to arbitrary preferences, he finds that this gravity equation still holds on average, but that individual trade flows will exceed or fall short of it depending on a weighted correlation between the exporter’s and the importer’s deviations from the world average supplies and demands This in turn is suggestive of how particular non-homotheticity in demand can interact with factor endowments and factor proportions to cause countries to trade excessively with countries like themselves

The second case is impeded trade in which the author assumes that each country produces and exports different goods Different from Anderson (1979) and Bergstrand (1985) he motivates the differentiation among products by the H-O model’s case of non-

FPE and specialization rather than by the Armington assumption However, this is also a possible equilibrium of the H-O model Then he derives expressions for bilateral trade, first with Cobb-Douglas preferences and then with CES preferences for all goods The former yields the simple frictionless gravity equation exactly for trade valued c.i.f with

no role for trade costs or distance and the standard gravity equation with division by a transport factor for trade valued f.o.b The latter generates the gravity equation for trade valued f.o.b that includes in the right-hand side each country’s economic size and the bilateral economic distance between i and j relative to the average of all importing countries’ relative distance from i This case shows that bilateral trade flows are centered around the same values found in the Cobb-Douglas case, but they are smaller for countries that are a greater than average distance apart as measured by transport cost, and larger for countries that are closer than average

In general, the gravity equation derived from theoretical foundations in the mentioned papers shows that after controlling for size trade between countries is determined by relative trade barriers which are defined as the bilateral barrier between them relative to average trade barriers that both regions face with all their trading partners The more resistance to trade with all others a region is, the more it is pushed to trade with a given bilateral trade partner Anderson and Wincoop (2003) refer to this theoretical appropriate average trade barrier as “multilateral resistance” In the empirical gravity literature either the lack of any forms of “multilateral resistance” in the analysis

above-or including a “remoteness” variable related to distance to all bilateral partners as in Mc Callum (1995) causes omitted variable bias in estimation Therefore, Anderson and Wincoop (2003) emphasize that it is important to develop a method that consistently and

efficiently estimates a theoretical gravity equation and use the estimated general equilibrium gravity model to conduct comparative static exercises of the effect of trade barriers on trade flows

Basically, to derive a gravity equation Anderson and Wincoop (2003) use the CES expenditure system with the following assumptions The first assumption is that all goods are differentiated by place of origin Each region is specialized in the production of only one good The supply of each good is fixed The second assumption is identical, homothetic preferences, approximated by a CES utility function The nominal demand for country i goods by country j consumers satisfying maximization of the utility function subject to the budget constraint is as follows

) 1 ( − σ

ij w j i ij

P P

t y

y y

i t P

j j

i1 − σ =∑ σ − 1θ 1 − σ∀

(1.3)

j t P

i i

between i and j Obviously, for a given bilateral barrier between i and j, higher barriers between j and its other trading partners will reduce the relative price of goods from i and raise imports from i Higher multilateral resistance between i and other trading partners will lower the demand for i’s goods and therefore its supply price (pi), which raises the level of trade between i and j

The key difference between the above theoretical gravity equation and gravity models used in the empirical literature is the two “multilateral resistance” indices which are country i’s resistance to trade with all regions and country j’s resistance to trade with all regions The “multilateral resistance” variables are now a function of income shares (θ) and the bilateral trade barrier (tij) which in turn is a function of all bilateral trade barriers between i and j such as distance, border, language, etc Therefore, either missing these price indices in a gravity equation or misusing them causes biased estimation For example, the remoteness index used in Mc Callum’s (1995) does not capture any of other trade barriers that are the focus of the analysis Even if distance were the only trade barrier, its functional form in the remoteness index is disconnected from the theory

Unfortunately, the two “multilateral resistance” indices in Anderson and Wincoop (2003) are unobservable and these price indices in general can not be interpreted as consumer price levels In fact, we can solve for these price indices as an implicit function

of observables using the goods market-equilibrium conditions in Eq (1.3) and the trade cost function Then the right-hand side of Eq (1.2) can now be written explicitly as a function of observables and the gravity equation Eq (1.2) can be estimated with non-linear least squares An alternative to estimate Eq (1.2) is to replace the multilateral resistance terms with country-specific dummies since they are time-constant

unobservable variables and then estimate it using ordinary least squares This also leads

to consistent estimates of model parameters However, it is also necessary to note that the fixed-effects estimator is less efficient than the nonlinear least-squares estimator since the latter uses information on the full structure of the model

Helpman and Krugman (1985) also derive a version of the gravity equation They assume perfect specialization in production and then identical homothetic preferences Under these two assumptions, country i consumes a fraction si of every good that is produced in the world economy and it exports a fraction (1-si) of every good that it produces, with a fraction sj of its output being exported to country j Therefore, bilateral trade between country i and j is

GDP s s GDP s

industry in which every variety is produced with increasing returns to scale Further assume that these economies of scale are relatively small so that the industry can accommodate many producers, each one producing a different variety Then, in that market structure known as monopolistic competition every firm has to choose a variety and its pricing so as to maximize profits, taking as given the variety choice and pricing strategies of other firms in the industry Assume that every variety of the product is produced with the same production function and also enters into demand in the same way The cost function is assumed to be derived from an increasing-returns-to-scale technology (see Krugman 1980) The demand function depends on the structure of preferences When preferences are of the Spence-Dixit-Stiglitz type, a single producer competes equally with every other producer, and derives the same profit level for any variety choice that is not supplied by others If he were to choose a variety that is already supplied by another firm, he would have to share the market for this variety, thereby ending up with profits lower than those he could attain by adopting some other varieties Therefore, no variety will be produced by more than one firm/country

Second, in absence of transportation costs and tariff barriers, the Krugman model leads to the simple gravity equation similar to Anderson’s (1979) but the number of goods produced differs across countries of different economic size, and depends endogenously upon the level of fixed costs in production, the taste for variety, and factor endowments (Baier and Bergstrand, 2001)

Helpman-Obviously, perfect specialization is really an important assumption to derive a gravity equation However, Evenett and Keller (2002) interestingly raise a question that whether the predictions of the perfect specialization in the two important theories of

trade, the H-O theory and the IRS theory, are supported by the data and can account for the empirical success of the so-called gravity equation They address the identification problem by noting that in constant returns to scale (CRS) H-O world perfect specialization results only when bilateral differences in factor proportions are large enough In contrast, when product specialization is the result of IRS, the gravity prediction can be obtained even if there are no differences in factor proportions Furthermore, these models predict different types of trade: in the H-O model, trade occurs exclusively in goods produced with different factor intensities (inter-industry trade) while in the IRS model, some trade is intra-industry Consequently, they take samples with high shares of intra-industry trade in total trade as those in which IRS-based specialization might drive the gravity equation And those samples with low shares of intra-industry trade in total trade and large differences in factor proportions are those in which a model of H-O-based specialization might be behind the gravity equation

To develop gravity equation models they assume that there is balanced trade, zero trade and transportation costs, no trade in intermediate goods, and two countries with identical production technologies and that consumers in both countries have identical homothetic preferences Then they develop four models of gravity equation, two with perfect specialization (IRS and multicone H-O models) and two with imperfect specialization (IRS/unicone H-O and unicone H-O models)

To test the four models, first of all, they employ the index proposed by Grubel and Lloyd (1975) (GL), which measures the share of intra-industry trade in total trade, to split the bilateral imports observations into two sub-samples according to an arbitrarily chosen critical level of intra-industry trade, denoted GL* Those pairs in which GLij ≤

GL* belong to what is referred to as the low GL sample, and the remaining observations are parts of the high GL sample The samples differ in that they expect substantial amounts of trade based on product differentiation and IRS in the latter but not in the former Given the critical level GL*, it will be useful to sort the data, and form classes In the low GL sample they sort data according to each observation’s differences in factor proportions On the other hand, they sort the observations in the high GL sample according to their level of intra-industry trade

Then they regress the IRS model and the IRS/unicone H-O model in the high GL sample and the unicone and multicone H-O models in the low GL sample Econometric results show that predictions of the perfect specialization versions of both theories are rejected by the data and so are unlikely explanations for the success of the gravity equation Perhaps, this is in part related to the fact that the prediction of trade volume of both of these models holds only if the production of all goods is perfectly specialized, which is unlikely However, the authors find the evidence to support both the IRS/unicone H-O model and the unicone H-O model in which imperfect specialization is assumed

In the next section tariff liberalization under GATT/WTO in developed and developing countries will be discussed to show that although it is more likely to see the positive effect of the GATT/WTO on international trade in developed countries due to the fact that these countries have more actively participated in reciprocal trade liberalization than developing countries the trade-promoting role of the GATT/WTO in developing countries is expected to be found, at least in some sectors

1.3 Tariff Liberalization in Developed and Developing Countries

It is well-accepted that the GATT/WTO’s achievements are outstanding, especially in tariff liberalization Through multilateral and bilateral trade negotiation rounds tariff barriers have been removed substantially For instance, since negotiations began in 1947 unweighted average applied tariffs in developed countries have fallen from high double-digit levels to 6.3 percent in 1995 and around 3.5 percent in 2005 For developing countries, tariff reductions were more modest: 16.6 percent in 1995 and 10.6 percent in 20054 Developed countries increased the number of imports whose tariff rates are “bound” from 78 percent of product lines to 99 percent after the Uruguay Round while the increase in developing countries was still considerable: from 21 percent to 73 percent5 However, these data point out that although the fundamental principle of the GATT/WTO is that all rights and obligations should be applied uniformly it seems that developed countries actively participated in reciprocal MFN tariff-cut negotiations while developing countries were allowed to slowly undertake their obligations According to Michalopoulos (2000), it is because developing countries requested exemptions which stem from their unique development problems and challenges they have faced in the trade liberalization process First, developing countries believes that sustained economic growth could be obtained through industrialization However, they do not believe that liberal trade policies would promote industrialization and development because of the patterns of international specialization: developing countries mainly produce and export raw materials and primary commodities which are characterized by low price, income

elasticities of demand, and considerable price volatility; while they are dependent on imports for manufactures, especially capital goods and intermediate inputs needed for investment and industrialization Second, they further feel that liberal trade policies will harm domestic infant industries resulting in volatile export earning and deteriorating terms of trade Finally, it is thought that the development process is associated with balance of payments difficulties which could be addressed in the short term through trade controls Therefore, developing countries tried to request for changes in the multilateral trading system in four main areas: (i) improved market access for developing country exports of manufactures to developed markets, through the provision of trade preferences; (ii) non-reciprocity, or less than full reciprocity, in trade relations between developing and developed countries, in order to permit developing countries to maintain protection; (iii) flexibility in the application by developing countries members of GATT/WTO disciplines; (iv) stabilization of world commodity markets Developing countries emphasize the uniqueness of their development problems and the need to be treated differently and more favorable in the GATT, in part by being permitted not to liberalize their own trade and in part by being extended preferential access to developed country markets

The GATT adopted provisions to address those needs of developing countries in

1954 and 1955 Three main provisions were agreed, two of them relating to Article XVIII Article XVIII (B) was revised to include a specific provision to allow countries at

an ‘early stage of their development’ to adopt quantitative restrictions on imports whenever monetary reserves were deemed to be inadequate Article XVIII(C) was revised to allow for the imposition of trade restrictions (both tariffs and quantitative

restrictions) to support infant industries In 1964, the GATT adopted a specific legal framework that addressed the concerns of developing countries Three new Articles, XXXVI to XXXVIII, were introduced in Part IV dealing with Trade and Development The basic objective was that developing countries should not be expected to take on obligations inconsistent with their levels of development (non-reciprocity) Until the Uruguay Round, the reluctance of developing countries to take on obligations to liberalize was codified under the principle of special and differential This principle allowed developing countries not to actively participate in tariff liberalization in the various rounds of trade negotiations before the Uruguay Round As a result, one may expect that it is more likely to see the significantly positive effect of the GATT/WTO on international trade in developed countries than to do same in developing countries

In contrast, I expect that there exists a significant impact of WTO membership on imports in developing WTO members However, I believe that whether or not WTO membership has stimulated imports in developing countries depends on with which trading partners and which products developing WTO members trade This point of view

is based on an observation from Hertel and Martin (2001) that the average tariff rates imposed on imports of agricultural products in developing countries in general are much higher than those on imports of manufactures In addition, these tariff rates were lower on developing country imports of manufacturing goods from developed countries than those from other developing countries Therefore, I expect that positive effects of the GATT/WTO could be found on trade in products which developing countries are more interested in tariff liberalization of An investigation on effects of the GATT/WTO on

trade in different types of goods may provide better understanding on the trade-promoting role of the GATT/WTO in developing countries

1.4 Effects of Tariff Liberalization on International Trade

The GATT/WTO’s achievements in tariff liberalization presented above are remarkable However, the question is whether or not that tariff liberalization stimulates international trade is supported by the data This section is devoted to present the effect of tariff reductions on bilateral trade flows in some key empirical papers

Prewo (1978) examines structural changes in bilateral trade flows focusing on the geographical features such as tariffs and transport costs He points out that the structure

of bilateral trade flows are affected by changes not only in demand conditions but also in supply conditions, as well as in “trade resistance factors” Therefore, he attempts to derive a structural model incorporating all of the above aspects from Walrasian general equilibrium considerations In that model, bilateral demand and supply equations are specified to include real output, income, and price variables However, it is hard to solve for bilateral demand and supply in equilibrium and to estimate all the output, income, bilateral price, and substitution elasticities if there are many countries in the model Therefore, he introduces simplifying assumptions to allow incorporation of general equilibrium features by the joint in inclusion of demand and supply, and resistance factors but disregard the dynamic effects of price changes Assumptions he makes include: i) equilibrium bilateral trade flows are determined within a competitive supply and demand system Import and export are treated as excess demand and excess supply

respectively on the assumption that importables that are produced domestically and imports are perfect substitutes; ii) the total import demand of any given country is a function of its domestic real income, the relative price of importables to exportables, and factor prices The factor prices are assumed to be determined exogenously by the country’s resources endowment, capital, labor, and technological factors; and iii) the total export supply of any given country depends on that country’s final output, the relative price of importables to exportables, and factor prices The equilibrium pattern of bilateral trade flows is achieved by using those assumptions to specify a reduced form equation that is conceived on the basis of general equilibrium notions According to the author, although the model disregards disequilibrium and precludes an analysis of the dynamic aspects of the trade pattern, it focuses on a comparative analysis of static equilibria, and the estimations of the model with data for different points in time serves to indicate any systematic changes over time in the roles of the major economic determinants of the equilibrium trade pattern

The empirical model for the bilateral trade flows specified from the general equilibrium system above is estimated for seventeen year cross-sections of aggregate bilateral trade flows among eighteen OECD countries for the years 1958 to 1974 In this model, bilateral trade flow between country i and j is a function of GDP of country i and j and a vector of trade resistance factors for exports from i to j The trade resistance vector includes qualitative variables such as the same preferential trading group, common language, and common border, and quantitative variables such as transport costs and tariffs Transport costs are measured by the difference between c.i.f and f.o.b trade values representing the costs of freight and insurance However, the true c.i.f and f.o.b

values were unobserved at that time therefore he uses the geographical distance between the two commercial centers of i and j and the average unit value of exports from country

i Tariffs are the simple means that are calculated from Political and Economic Planning Atlantic Tariffs and Trade, George Allen and Unwin, London, 1962; and GATT, Basic Documentation for the Tariff Study, Geneva, 1974 Tariff for intermittent years are calculated by applying a 20 percent reduction for the Dillon Round in 1963 and a 40 percent reduction spread over 1968-1972 for the Kennedy Round EEC- and EFTA-tariffs are adjusted according to the time-table provided in Krause (1968)

Basically, econometric results show that tariff reductions in eighteen OECD countries promote trade among them However, the coefficients of the tariff variable have persistently fallen over the seventeen-year period This decline can be attributed to the elimination of tariffs within the EEC and EFTA and to the tariff reductions carried out in the framework of the Dillon and Kennedy Rounds

In this study, the author tries to measure effects of tariff reductions on bilateral trade in OECD countries by using actual data on tariffs However, it is easy to recognize that the estimation model in Prewo (1978) is a gravity model in which multilateral resistance terms are missing Therefore, the estimation is biased due to omitted variables

Rose (1991) measures impact of tariff reductions on bilateral trade when he tries

to answer the question why trade of OECD countries has grown faster than income during the postwar period He observes that the ratio of nominal exports plus imports to nominal GNP (hereafter, the trade ratio) for an average OECD country grew by over 1 per cent per annum from 1950 through 1985 He reasons that an increase in the trade ratio during the above-mentioned period is due to: i) tariff reductions (4 percent per annum);

ii) declines in the relative price of tradable to non-tradable goods (1 per cent per annum); iii) reductions in transport costs (0.1 per cent per annum); iv) convergence of capital/labor ratios and per capita levels of real income across countries; v) growth in international reserves; and vi) growth of real income To disentangle the relative importance of these factors he develops an empirical model in which a country’s trade ratio is a function of dispersion in the capital/labor ratio; dispersion in income per capita; tariff rate; transportation costs; relative price of tradeables to non-tradeables; real international reserves; real output; the terms of trade; and a set of dummy variables Dispersion is measured as the absolute value of the difference between a variable and its sample average The relative price of tradeable to non-tradeable goods is represented as the ratio of the PPI to the CPI Transport costs are proxied by the ratio of c.i.f to f.o.b imports The tariff rate is the ratio of tariff revenues to total imports The tariff data are mostly taken from data in Mitchell (1980) and updated using data from the IMF’s

Government Finance Statistics

The model is estimated for two groups of the OECD countries: a group of seven small open economies and a group of five large economies from 1951 to 1985 Econometric results show that reductions in tariff barriers are strongly associated with increases in the trade ratio, consistent with the prediction of neoclassical theory

Baier and Bergstrand (2001) try to develop a more convincing model to answer the similar question raised by Rose (1991), “Why has world trade grown?” Krugman (1995) suggests that the growth of world trade is due to technology-led declines in transportation costs, policy-led multilateral and bilateral trade liberalization, and increased similarity of countries’ income Feenstra (1998) also gives four possible

explanations on the growth of world trade The first three explanations are similar to Krugman’s (1995) The fourth is increased outsourcing; as the production process disintegrates internationally and multinational firms become more vertically specialized, intermediate goods cross borders multiple times increasing world trade relative to output Based on those explanations, Baier and Bergstrand (2001) develop a gravity model to disentangle from one another the relative effects of transport-cost reductions, tariff liberalization, and income convergence on the growth of world trade among several OECD countries between the late 1950s and the late 1980s

Their gravity equation incorporates the relative importance of expenditure constraint emphasized by Anderson (1979), market structure emphasized by Helpman and Krugman (1985), and distribution costs emphasized by Bergstand (1985) as follows

First, in each country the representative consumer maximizes a elasticity-of substitution (CES) utility function subject to a budget constraint where prices

constant-of the imported products reflect ‘iceberg’ transportation costs and ad valorem tariffs The constrained utility maximization yields the import demand function of country j for the product of the representative firm in country i (xij)

j ij C j j

where Ij is nominal income in j, σ is the elasticity of substitution in consumption (σ>1),

PCj is the standard Dixit-Stiglizt price index, ( )1 /( 1 )

k p ijk , and pijk is the landed price in country j of the product of firm k in country i inclusive of tariffs Assuming identical producers k in country i (k=1, …., ni), pij = pij(1+tij) where pij is the c.i.f price expressed in terms of the numeraire and tij is the ad valorem tariff rate

Second, the representative firm in country i maximizes profits subject to two technology constraints The first constraint is that the production of goods has fixed (α) and constant marginal ( ) costs given by the linear cost function:

i

where li denotes labor used by the representative firm in country i and yi denotes output

of the firm The second constraint is that the potential presence of costs in distributing the product to each market causes the representative firm to treat each potential market’s supply as an imperfect substitute, captured formally by the constant-elasticity-of- transformation (CET) function:

) 1 /(

1

/ 1 (

γ γ γ γ

F

P = σ/( −σ 1)φ (1.9) where Wi is the marginal production cost of the representative firm, Wi is the wage rate, and PFi is a CET index of the firm’s prices The second condition is that under monopolistic competition firms earn zero profits, which implies:

(α ϕ)(σ ) ψ

γ γ γ

1

/ 1 (

N j ij

The presence of a potentially finite elasticity of transformation of output among destination markets allows this model to be solved for the bilateral export supply functions of the representative firm Combining, from the firm’s first-order conditions,

) /(

) 1 ( )

/(

) /(

//

11

σ γ γ σ

σ γ σγ σ

γ γ σ σ

γ γ σ γ γψ

+

−

+

− +

+

− +

ij ij

j i ij

i

ij

P P P P

t a

Y Y x

σ σ

σ σ

γ γ σ σ

θθ

+

+ +

=

+ +

++

=

∑

/

1 /

1

/ 1 1

/ 1 (

//

11

//

11

N

j

C j F j C j F i ij ij

j

C j F j C j F i ij ij

j w

j

i

ij

P P P P t a

P P P P t a

X = in Anderson (1979) that allows transport costs and tariff barriers to be non-zero, prices to be non-

6

1/(1+aij)= (1-δij) where δij is a fraction of goods ‘falling into the ocean’ when goods are transported from i

to j

unity, and elasticity of transformation to be non-infinity In the special case when the elasticity of transformation (γ) is set equal to infinity and prices are set equal to unity, Eq (1.13) reduces to Eq (16) in Anderson (1979) and Eq (18) in Deardorff (1998) If

aij=tij=0, Eq (1.12) reduces further to the frictionless gravity equation

Eq (1.12) is specified in a form that can be used to evaluate econometrically the rates of real income growth, real income convergence, and declining tariff rates and transport costs in explaining real trade flow growth as follows

) /(

) 1 (

) /(

) 1 ( )

/(

) 1 )(

1 ( 2

) /(

) 1 (

//

11

σ γ γ σ σ σ

γ σ

σ γ γ σ σ

γ γ σ σ

γ γψ

+ +

−

− +

−

+ +

− +

+

− +

+

=

C j F j C j F i j

ij ij

j i j i cif

ij

P P P P Y

t a

s s Y Y X

(1.14) where X ij cif denotes the real trade flow (the nominal c.i.f value of the trade flow divided

by the exporter’s deflator), Yi (Yj) denotes real GDP of country i(j), si (sj) denotes i’s(j’s) share of the two countries real incomes

The estimation model is derived to study the growth of world trade as follows

C j F j C j F i j

ij

ij j

i j

i cif

ij

PX

P P P P Y

t

a s

s Y

Y X

εβ

ββ

β

ββ

ββ

σ

++

∆++

∆+

+

∆+

∆++

∆+

/ 1

6 5

4

3 2

1 0

log

//

loglog

1log

1loglog

loglog

(1.15)

where εij is a normally distributed random error In this estimation model, the effect of bilateral income growth is captured by variation in the term (Yi+Yj); the effect of income convergence is captured by variation in sisj; the effects of transport cost and tariff rate changes are captured by the gross c.i.f.-f.o.b factor (1+aij) and gross tariff rate (1+tij); and

the coefficient estimate of Yj indicates whether or not the elasticity of transformation of output across markets is finite

There are some data constraints First, data on PFi/PCj and PFj / PCj are unavailble Therefore, they use the two countries’ GDP deflators to proxy for those relative price indices Second, some constraints were faced estimating gross tariff-rate reductions They want to have bilateral measures of changes in ad valorem tariff rates as suggested in the empirical equation The only source of such measures is data prepared in Prewo (1978) Prewo calculated annual bilateral average tariff rates for 18 OECD countries for years

1958 through 1974, the last year being one in which Kennedy Round tariff reductions had been fully phased in but Tokyo Round tariff reductions had not yet been implemented Deardorff and Stern (1986, 1990) provide measures of pre- and post Tokyo Round average (multilateral) tariff rates for 18 OECD countries Using changes in average multilateral tariff rates from Deardorff and Stern (1986, 1990), they extended the Prewo (1978) average bilateral tariff rate data to 1987 (the year in which Tokyo Round tariff reductions had been fully phased in)

Empirical results suggest that approximately 65% of this growth could be explained by real GDP growth, 25% by tariff-rate reductions and preferential trade agreements, 8% by transport-cost declines, and non by real GDP convergence

The above estimation model explains approximately 40% of the variance in trade flow growth in the sample Income growth and convergence, tariff-rate decreases, and transport-cost declines are discussed and can explain well the growth of world trade However, increased vertical specialization and outsourcing of intermediate production mentioned by Feenstra (1998) has not been examined here This factor could provide a

more powerful explanation for the growth of world trade In vertical specialization, goods are produced in multiple stages of a production sequence in different countries Tariffs are incurred each time goods in process cross a border Therefore, tariff liberalization could reduce trade costs substantially and lead to magnified increases in world trade Vertical specialization is examined in Yi (2003)

Yi (2003) observes two features that challenge the standard trade model First, since the early 1960s the tariff barriers reduced by only about 11 percentage points on manufacturing goods through the Kennedy, Tokyo, and Uruguay Rounds but the world manufacturing export share of output has risen by a factor of 3.4 (see WTO 2000) The elasticity of exports with respect to tariffs was about 20 between 1962 and 1999, which is much larger than what standard trade model would imply This is what he calls a quantitative puzzle Second, the response of exports to tariffs has increased sharply since the mid 1980s Between 1962 and 1985, the elasticity of trade with respect to tariffs was

7, whereas between 1986 and 1999 it was 50 This non-linear effect is a qualitative puzzle from the perspective of the standard models

The question is whether the standard trade models such as the Dornbusch, Fischer, and Samuelson (1977) Ricardian model, the basic monopolistic competition model (see, e.g., Krugman 1980), and the international real business cycle model can explain both the magnitude and the nonlinearity of the growth of trade? To answer that question Yi (2003) examines trade effects of a tariff reduction from 15 percent to zero in each model above The three paradigms cannot generate any of the nonlinearity of observed trade growth And they cannot match the magnitude of trade growth unless the elasticity of substitution between domestic goods and imported goods is 12 or higher,

which is counterfactually high The elasticities that are typically estimated or employed

in simulations/calibrations are on the order of two or three Actually, it is possible to modify the standard models to generate larger magnitudes, as well as nonlinear trade growth Non-homothetic preferences can lead to a nonlinear relation between tariffs and trade growth If the income elasticity of demand for traded goods is greater than one and greater than the income elasticity of demand for nontraded goods, lower tariffs, to the extent that they increase income, will lead to larger (possibly nonlinear) increases in trade than predicted by homothetic models However, Bergoeing and Kehoe (2001) apply non-homothetic preferences in a model in which income growth is driven by gains in TFP Their calibration results show that non-homothetic preferences can explain only a little more relative to homothetic preferences They conclude that changes in trade policy may

be needed to explain the growth of trade

Yi (2003) believes that vertical specialization can generate both magnified and non-linear responses to tariff reductions should include Basically, vertical specialization

is defined as: (i) goods are produced in multiple, sequential stages; (ii) two or more countries provide value added in the good’s production sequence; and (iii) at least one country must use imported inputs in its stage of the production process, and some of the resulting output must be exported Clearly, vertical specialization involves increasing interconnectedness of production processes in a sequential, vertical trading chain stretching across many countries, with each country specializing in particular stages of a good’s production sequence Vertically specialized goods or goods in process cross multiple international borders while they are being produced Each time these goods in process cross a border, a tariff is incurred Consequently, global reductions in tariffs lead

to a magnified reduction in the cost of producing these goods In addition, because of tariff reductions, countries realize that it may be more efficient for goods that were previously produced entirely in one country to now become vertical specialized Therefore, trade in vertically specialized goods grows by more than trade in regular goods, and trade growth overall is higher than what would be predicted by standard trade models Vertical specialization can also generate a nonlinear trade response to tariffs For example, if tariff rates are very high there is no vertical specialization When tariffs fall substantially at a critical rate vertical specialization starts to occur At this point trade surges generating a nonlinear response

The model that describes the intuition for how vertical specialization propagates the effects of tariff reductions is developed by incorporating a Dornbusch-Fischer-Samuelson Ricardian international trade framework to a standard dynamic macroeconomic framework According to the author, there are three reasons for him to choose a Ricardian framework First, recent work shows that Ricardian technological differences are relevant in explaining trade patterns Second, there is little empirical evidence that clearly favors the monopolistic competition model against other models Third, it is desirable to have a model of trade in which firms choose whether to use domestic or imported inputs, that is, a model in which vertical specialization occurs endogenously The model includes two countries and two factors of production, capital and labor Each country consumes and invests a single nontraded final good The final good is produced in three sequential stages In both the first and the second stages, a continuum of goods along the unit interval is produced These goods are tradable, and both countries possess technologies for producing both stages Hence, there are four