EPA Review Annex Documents - DFID

creation) but can also lead to imports being diverted from more efficient sources as a result
of the preferences granted (trade diversion). Whilst trade creation is welfare enhancing,
trade diversion reduces global welfare. The net effect of a preferential agreement is then the
balance between these two forces. However, the ambiguity of these trade effects extends
also to the differentiated effect that these incur on actors in the economy. Whilst the welfare
enhancing effects of trade creation on consumers are easy to grasp, the replacement of
domestic production with imported goods is also likely to have negative effects on producers
and possibly on employment. Similarly, the inefficient source switching due to trade diversion
can have a positive effect on consumers who are now acquiring a good at a lower price than
they were before the preferences where granted. 79 This suggests that quantifications of
trade creation and trade diversion are to be interpreted with certain caution. 80 Adding to
these effects, and of particular relevance to ACP countries given the importance of tariff
revenue takings in overall government revenue, one must also consider the extended impact
of loss of tariff revenue as a result of a reciprocal trade agreement. Given the importance of
the EU as an origin market for imports and the possible scope for trade diversion, ACP
countries will be vulnerable to strong budgetary constraints. Mitigating these is likely to
require fiscal re-structuring.
The dichotomy of the trade creation and trade diversion effects has been the rhetoric of
preferential trade analysis for many years. However, it is important to note that it provides a
diluted picture of the actual effects of a trade agreement. Recently, economists have begun
thinking about the dynamic impact of trade liberalisation and more particularly the deep
integration implications of trade agreements. Deep integration issues generally involve
cooperation on competition policy; intellectual property rights (IPR); sanitary and
phytosanitary (SPS) issues; technical barriers to trade (TBT); certification; standardisation;
government procurement; services; rule of law and other such matters. These incur changes
in the competitive and investment climate which can lead to increased productivity through
exploitation of economies of scale or through technology transfers. They may also allow for
increased fragmentation of production structures across national borders and can promote
niche specialisation. These seldom understood effects are likely to be more welfare
enhancing than the traditional effects of preferential liberalisation, yet they are harder to
capture empirically.
Whilst there is little by way of deep integration provisions in the EPA agreements, there are
some loosely defined soft law provisions setting pathways for future cooperation. In this
respect, the EPAs contain provisions for cooperation on SPS and TBT matters as well as
talk of supra-national institutions that could harmonise regional standards. The effects of
such provisions are hard to quantify but this is not a reason to ignore them. These are to be
evaluated with respect to the cost of negotiation and the future potential gains that can be
derived from these provisions.
b. Methodologies Used to Assess Preferential Liberalisation
Three widely accepted methods can be used for assessing the impact of preferential
liberalisation. Each has its strength and weakness and the choice of one over the other will
have consequences on the results obtained. Simulation models tend to be the preferred tool
for the analysis of the EPAs. These can take on a Partial Equilibrium (PE) or a (computable)
General Equilibrium (CGE) approach. The former has the advantage of quantifying the
impact of changes in trade policy at the highest levels of disaggregation whilst the latter’s
key strength resides in providing an approach which takes into consideration the
transmission of price changes across the economy and across countries. ECA (2005) and
79
Trade diversion then becomes an opportunity cost of not engaging in multilateral liberalisation.
80
Furthermore, the trade creation and diversion effects will also depend on price transmission
mechanism.
32