Trade Policy and Export Diversification: What Should Colombia Expect from the FTA with the United States?

Abstract

Sectoral concentration of exports has been a longstanding matter of concern for policymakers in developing countries. According to economic theory and recent empirical evidence, improved market access through trade agreements is likely to favor export diversification. In this article, it is assessed whether this has been the case for Colombian exports to the United States and whether an FTA with the United States would help Colombia diversify their exports. We find that lower tariffs have indeed favored exports of new products from Colombia. Predictions suggest that the FTA is likely to induce further diversification, but only up to a certain point.

Keywords:

• trade policy
• export diversification
• Colombia

Acknowledgments

We gratefully thank the editor, two anonymous referees, Álvaro Andrés Perdomo, Francesca Castellani, Marcela Meléndez, Mauricio Mesquita Moreira, and Victoria Florez Toro for their helpful comments. We also thank Diana Marcela Gómez, Pedro Martínez Alanís, Paulo Rodrigues Bastos, Jerónimo Carballo, and Ramiro Pascual for their excellent research assistance. Finally, we owe gratitude to Carlos Gutierrez Jr. for his excellent editorial assistance. The views and interpretations in this document are those of the authors and should neither be attributed to the Inter-American Development Bank, its executive directors or its member countries nor to the Departamento Nacional de Planeación (National Department of Planning). Other usual disclaimers also apply.

Notes

¹From a theoretical point of view, governments should intervene to promote diversification only if there is a discrepancy between social and private costs due, for example, to uncertainty (see, e.g., Brainard & Cooper 1968), and if the social net benefits of a program fostering diversification are larger than those associated with the statu quo.

²ATPA is the acronym of Andean Trade Promotion Act, whereas ATPDEA is that for Andean Trade Promotion and Drug Erradication Act.

³This article focuses on the direct impact of tariff barriers on trade in goods. Admittedly, FTAs may cover other areas such as services and foreign direct investment, which may also affect the countries' potential for productivity enhancement and diversification (see, e.g., Light 2004).

⁴Three main mechanisms can be identified for this effect. High export specialization implies high sensitivity to sector-specific shocks and thus to high volatility of export revenues and growth rates. This in turn affects the import capability of the country, leads to in underinvestment when investors are risk averse, and results in lower long term growth rates (see, e.g., Bleaney & Greenaway 2001; Dawe 1996; Fatás 2002). On the other hand, assuming that there is a preference for variety, lower export diversification implies lower export levels (see Funke & Ruhwedel 2001). Finally, high concentration limits productivity growth since it does not induce an increase in the efficiency with which inputs are used (see Feenstra and Kee, 2004a) nor in learning by exporting (see Agosin 2006; Al-Marhubi 2000).

⁵First, it has been argued that specialization in primary products does not favor convergence due to the relatively low rate of technological progress in the primary sector and the secular declining trend of the relative prices of its products (see Prebisch 1950; Singer 1950). Second, countries in which natural resources account for a large share of their exports are particularly likely to suffer from “Dutch disease”(see, e.g., Corden 1980). Lastly, high reliance on exports of primary products tends to be associated with high terms of trade volatility, which has negative repercussions on exports and investment and thereof on economic growth (see Gylfason 2001). This is especially true for countries with restrictions on access to international financial markets and where the depth of domestic financial systems is still relatively low (see Caballero 2000). The economic literature offers additional arguments for the link between dependence on exports of natural resources and growth (see, e.g., Gylfason 2004;Persson & Tabellini 1994).

⁶See, e.g., DEE-DDE (2003), Light and Rutherford (2003), Cárdenas and García (2004), Gracia and Zuleta (2004), Monteagudo et al. (2004), Botero (2005) and Martín and Ramírez (2005).

⁷Following Hummels and Klenow (2005, working paper version of 2002), Hillberry and McDaniel (2002) decompose the North American Trade Growth since NAFTA into changes in traded varities and changes in products already traded, further divided into quantity and price changes. They find that the the extensive margin of United States imports from Mexico has significantly increased since 1993.

⁸ Muskerji (2009) and Sandrey and van Seventer (2004) have used the methodology developed by Kehoe and Ruhl (2004) to investigate how the extensive margin has changed during India's trade liberalization over the 1990s and as a consequence of the deeper economic integration between Australia and New Zealand starting in 1988, repectively.

⁹Nevertheless, this tariff database has some limitations (see Feenstra et al. 2002). It does not include information on quotas, antidumping duties or special duties, rules of origin (which are import to determine elegibility for tariff programs), and “product sharing” arrangements (under which tariffs are only levied on foreign value added).

¹⁰Ad valorem equivalents are estimated from import unit values.

¹¹Table AI in Appendix A lists United States bilateral trade agreements. Schott (2006) performs a comparative analysis of these trade policy initiatives, whereas Moore and Bellotti (2007) compare their trade and investment potential with those of alternative potential agreements.

¹²Reform periods can be considered end-1970s to mid-1980s for Chile and mid-1980s for Mexico.

¹³This figure shows a simple average of tariffs. Similar patterns are found using weighted averages. The same applies for Mexico and Chile.

¹⁴Nevertheless, it should be mentioned that Colombia is among the 14 exporters with the largest shares in 50% of these new products.

¹⁵This seems to have been associated with larger sectoral exports. The simple correlation between the growth of exports and the growth of the number of products exported across sectors over the sample period is 0.30. This is significantly different from zero at the 1% level.

¹⁶A main shortcoming of trade-weighted tariffs is that they fail to take prohibitive tariffs into account.

¹⁷Countries^, responses to a given tariff reduction are likely to be significantly different from each other as they are differently endowed (e.g., human capital) or differently prepared (e.g., better infrastructure) to take advantage of a certain market access improvement. In other words, the slope and not only the intercept may differ across countries. Hence, pooling across countries may lead to inaccurate estimates of the impact of tariffs on the probability of exporting, even when controlling for country specific effects.

²⁶The vectors of the time-varying variables in all years corresponding to the additional explanatory variables could not be incorporated along them as suggested by Wooldridge (2005) because the complexity of the resulting specification led to non convergence in the estimation procedure. Hence, we have estimated a specification including the initial value and one year lag of the dependent variable, tariffs, preferences, the corresponding vector of these variables in all years, the control variables described above, and year-fixed effects.

¹⁸Weighted averages with 1989 shares as weighting factors are potentially less affected by endogeneity problems and are therefore our preferred choice, so most estimations presented below correpond to averages with these weights.

¹⁹In this case, the random effects account for country heterogeneity.

²⁰Data on GDP and GDP per capita correspond to the purchasing power parity measure and are expressed in constant dollars of the year 2000. These data have been taken from the World Bank's World Development Indicators (WDI). Data on United States and partner countries' consumer price indexes and the exchange rate between the domestic currencies and the US dollar, which are employed to compute the real exchange rate, come also from the WDI. Finally, we use as distance measure the arithmetic mean of the bilateral distances between the largest cities of each exporter country and the United States calculated by CEPII. These inter-city distances are weighted by the share of the cities in the overall country population. The aforementioned additional explanatory variables, but real exchange rate, are added in natural logarithms terms.

²¹Preference margins are accordingly adjusted (assuming that, on average, tariff faced by other countries do not change). Note that estimated coefficients are also assumed to remain stable after complete trade liberalization takes place.

²²Similar predictions performed based on estimations using weighted averages of tariffs and preferences as explanatory variables (both with contemporaneous and 1989 shares as weighting factors) suggest that the expansion in the number of exported goods could be larger. More specifically, the set of exported products might rise by 40%. The chapters with the largest increases would be: articles of apparel and clothing accessories, not knitted or crocheted and knitted or crocheted; machinery and mechanical appliances; parts thereof; plastics and articles thereof; other made up textile articles; sets; worn clothing and worn textile articles, rags; footwear, gaiters and the like; parts of such articles; and articles of iron or steel.

²³ Gaylor (2003) examines the degree of diversification of exports to the United States from 19 selected Latin and American countries and concludes that this degree depends on the countries' size and social capabilities. Using bilateral product level data, Besedes and Prusa (2006) show that differentiated goods are more likely to survive (i.e., to be traded longer) in the United States market than homogeneous goods.

²⁴Thus, the removal of quotas on a large fraction of textile and cloth exports may affect countries' relative competitive positions and might have an impact on Colombia's actual and potential degree of diversification in two important sectors such as articles of apparel and clothing accessories, not knitted or crocheted; articles of apparel and clothing accessories, knitted or crocheted. In this regard, it can be mentioned for the sake of illustration that China's share of United States' imports of these sectors increased from 13% to 22% and from 7% to 14%, respectively, between 2004 and 2005.

²⁵In this setting, the random effects control for heterogeneity across products and the time dummies for all factors that are common across them.

²⁷Unless data from the start of the process are available, this amounts to specificying the relationship between the first observation in the sample and the individual specific effects. This depends on the model parameters and the distribution of the explanatory variables in periods before the first sample year, which is generally unknown (see Hu 2002).

²⁸A standard Poisson probability specification is as follows and the joint density of and is (see Hausman et al., 1984).

²⁹μ _c is also assumed to be independent of (n _c0, z_c ) and distributed Gamma(η, η). This implies that, for each t, has a Poisson distribution with mean . Applying the product rule, the density of can be obtained and then integrating out of Gamma(η, η), a density with the usual random effects Poisson form with Gamma(η, η) heterogeneity is derived.

³⁰In particular, μ _ci is specified as follows: μ _ci = α _c0 + α _c1 x _ci0 + z _ci α _c2 + ν _ci , where ν _{ci i} is independent of (x _ci00, z _ci ) and distributed as N(0, σ_ν ²). In this case, x_cit given (x _cit−1, …, x _ci0, z _ci , ν _ci ) follows a probit model with response probability: .