Measuring the impact of CCFTA on Canadian exports to Chile … · 2014-08-08 · Measuring the...

Measuring the impact of CCFTA on Canadian exports to

Chile trough product diversification, new entry and

margin of trade ∗

Marcel C. Voia

Department of Economics

Carleton University

Ottawa, Ontario

CANADA K1S 5B6

[email protected]

Zhiqi Chen

Department of Economics

Carleton University

Ottawa, Ontario

CANADA K1S 5B6

z [email protected]

April 22, 2013

Abstract

Trade agreements are viewed as instruments to improve bilateral relationship between

countries and induce economic integration and growth. The results of the analysis of the

free trade agreement between Chile and Canada(CCFTA) can be used to understand the

short and long run dynamics of trade agreements between two small economies one devel-

oped and the other one developing. The analysis employs nonparametric decompositions

to evaluate the impact of product diversification and the margins of trade and a regression

discontinuity approach to evaluate the impact of the CCFTA for the Canadian exporters

to Chile. The results show that there is an effect of trade liberalization as more firms and

products enter the Chilean market after the implementation of the CCFTA. The effect

becomes more significant after the tax drops towards zero and seems to be driven by the

intensive margin of trade. On the other hand, the new firms/products entry do not explain

the results on the sale/value, which are changing in a less pronounced way. This result can

∗The assistance and hospitality of Statistics Canada Business and Labour Market Analysis department isgratefully acknowledged. We are especially indebted to Shenjie Chen and Emily Yu from Foreign Affairs andInternational Trade Canada for their continuous support and suggestions and to Youssef Budribila for excellentresearch assistantship.The contents of this paper have been subject to vetting and pass the Disclosure Rules andRegulations set forth by Statistics Canada. All errors are our own.

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be explained by the endogenous re-allocation of the resources that overlap with subsequent

trade agreements that Chile signed with USA and European Union.

Key Words: Trade Agreements; Evaluation of CCFTA, Nonparametric Decompositions,

Regression Discontinuity.

JEL Classification: F12, F13.

1 Introduction

Beginning with the second half of the last century, we observed an increase in the economic inte-

gration across borders and also an increase in growth in international trade due to an increase in

exchanges at the establishment of commercial enterprises. This dynamic was accompanied by a

series of multinational agreements on international trade and economic cooperation that resulted

in an unprecedented economic development. These agreements were viewed as instruments used

to facilitate a stable and predictable environment for global market participants.

In 1997, Canada and Chile signed a free trade agreement. This agreement was the second in

importance after NAFTA (1994) and was the first agreement signed with a country from South

America considered an emerging economy. There are few stylized facts suggesting that after

this agreement both the exports and the imports to and from Chile increased in a significant

way.

Firstly, the bilateral trade in goods has increased by 226% (growing from $718 million in

1997 to $2.34 billion in 2006); secondly, bilateral trade in services reached $164 million in 2005;

and thirdly, Canadian investments in Chile reached $5.17 billion in 2006 (information taken

from Foreign Affairs and International Trade Canada website). In terms of export gains from

the trade agreement, the Canadian manufacturing industries benefited the most, in particular

the winning industries were: Chemical Manufacturing, Plastic and Rubber Products Manufac-

turing, Fabricated Metal Products, Machinery Manufacturing (highest increase), Computer and

Electronic Products, Transportation Equipment, Machinery Equipment and Supply. In terms

of exported products Canada benefited from ores, machinery and equipment, mineral fuels and

oils, iron and steel products, plastics, chemical products, pharmaceutical products, precision

and medical equipment, and tools of base metal.

Consequently, it is important to understand what drives these changes in the behavior of

Canadian exporters. Understanding the effects of this agreement is helpful as they will give a

picture of what to expect from other bilateral trade agreements that were signed more recently

and from agreements that will be signed in the future. However, we should be aware that

each individual agreement has its own initial conditions and dynamics and even if many theo-

ries were developed recently to explore more sophisticated conditions of the trade agreements,

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these theories may not be able to fully explain different observed outcomes from different trade

agreements.

Having this in mind, this project investigates the effect of Canada-Chile Free Trade Agree-

ment (CCFTA) on Canadian Exporters by answering two important questions: 1. Did the

CCFTA increase the diversification of products and induced more entry on the export market?

2. Was the intensive or the extensive margin of trade the most important factor that changed the

dynamics of firms and of their products? Answering these questions can help build a benchmark

measure of performance that will help Canada’s negotiations in other trade agreements. Under-

standing the dynamics of exporters associated with a trade agreement is also very important

for policy makers as exporting has been considered an important tool to improve productivity,

especially for a small open economy like Canada. This is especially important for Canada as it

is well documented that productivity was suffering for the past two decades and Canada started

to fall behind on this particular aspect of the economy . The exporters are viewed as able

to acquire new technology and managerial decisions from their international contacts that are

important drivers of productivity changes. Therefore, it is important for the policy makers to

understand the factors that determine changes in the behavior of exporters due to a change in

a new trade policy.

In searching to answer our questions of interest, the following findings are outlined:

• There is a trade liberalization effect that is driven in the short run by the intensive margin

of trade, while in the long run the intensive margin dies off and the extensive margin of

trade picks up.

• The extensive margin of trade picks up after the taxes are removed which also overlaps

with a period where other trade agreements are signed by Chile (with EU and USA).

• The results are driven by an increasing number of new Canadian firms and products

entering the Chilean market after 2002.

• The results also show that the new firms/products entry do not explain the results on the

sales and value of exports, which are changing in a less pronounced way.

• The regression discontinuity design used to test short and long term impacts of CCFTA

as well as the indirect impact of other trade agreements between Chile and Europe and

USA show that the impact of the CCFTA on the value of exports is less important than

the impact of CCFTA on the total sales.

• Scale effects may be generated by CCFTA.

• The manufacturing industry is the net winner of this Trade Agreement.

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2 Literature Review

The literature on trade agreements discusses topics as: trade creation and diversion, scale effects

and other effects that are not directly quantifiable, and also the effects of trade agreements on

the regional and global integration.

Viner, T. (1950) and Meade J. (1955) are the first to explain the expansion of FTA by

looking at the effects of trade creation which improves overall welfare (in this case the partner

country’s firms are producing at higher cost than the cost of production by domestic firms)

and diversion which reduces the welfare (here the cost of production is reversed). These two

offsetting characteristics of trade are very hard to disentangle.

Another venue of research is based on the relative difference between the price of exports

versus the price of imports, which in literature is called terms of trade. This literature is focused

on the impact of the terms of trade on the export specialization and its impact on the volatility

of trade. The literature shows that commodity prices are more volatile than manufacturing

prices, and, therefore, countries that specialize in commodities have more volatile economies

than countries that are specialized in manufacturing. This may lead to a deterioration of the

terms of trade which will lead to welfare losses. The question resulted from the terms of trade

literature is mainly used in development literature. Williamson et al. (2008,2011) look at the

long horizon effect of the terms of trade, while Irwin (2005) and ORourke (2007) focus on the

terms-of-trade deteriorations across the Atlantic economy, and hence to sizable welfare losses.

The Scale Effects literature focus on the extent the FTA is integrating the markets with

effects on the growth of the markets. Balassa B. and Grubel H. (1967, 1970) produced the first

papers to discuss the economies of scale and the possibility of product differentiation. Their ideas

were later theorized by Krugman P. (1980) which used a one sector model to prove his theory.

Later works by Helpman E. (1981) introduced multiple sector models. This literature is part of

the ”new trade theory” that explains the rising intra-industry trade in differentiated products

among countries at similar income levels and the ”new new trade theory that refers mostly to

the micro level impacts as it is argued that FTA offers firms an opportunity to take advantage

of economies of scale, which may lead to cost reductions due to increases in production. It is

also argued that an increase in the intensity of competition due to FTA will potentially induce

firms to be more efficient and increase their productivity.

H.J. Wall (2003) argued that Canadian firms were lobbying for support for trade agreements

with the United States in order to exploit economies of scale and increase their exports to the

countries in North America and to the rest of the world.

The impact of economies of scale due to the increase in production has also a positive impact

on the volume of trade in inputs and intermediate goods as these goods may need to be imported

from inside the FTA, or outside it. FTA was also shown to attract investment, including foreign

direct investment (FDI). Therefore, in the long run, changes in trade flows can lead to firm

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relocation between member countries of an FTA based on comparative advantages. Further,

the economies of scale can be also captured by the multi-product destination exporter model

of Bernard, Redding and Schott (2009). Consequently, the economies of scale due to FTA

generate dynamics with significant impact on the economies that are engaged in trade that lead

to increase in production and efficiency which lead to higher productivity.

The literature about preferential trade agreements is focused on issues related to the regional

integration. After early 1990s, the regional trade agreements (RTA) grew significantly. Today

many countries are members of more than one RTA. Different regions were created characterized

by integration across the North-South and schemes that involve both developing and industri-

alized countries. Some of the new agreements have even members that are from more than one

of the world’s geographic regions, while other agreements are of large geographical scale that

include continents or relationships across continents.

Bhagwati and Panagariya (1996) criticized the development approach among the developing

countries suggesting that the larger the share of third country imports in total imports, the

bigger the tariff revenue loss when a region is formed. Consequently developing countries, which

are more trade dependent outside the formed region and have higher initial tariffs will lose more

when a region is formed because more tariff revenue is redistributed away from them. This will

generate high costs in terms of trade diversion which will increase the probability that the RTA

as a whole will lose.

On the other hand Venables, (1999) suggests that schemes of North-South integration type

are likely to be more beneficial to developing countries as industrialized countries are more

efficient global suppliers and the costs of trade diversion will be minimized. Schiff and Winters

(2003) expand on this finding by pointing out that even small cost disadvantages for Northern

firms can be costly for Southern partners because of the large amount of trade that is involved.

This leads to a substantial transfer of rents from Southern consumers to the Northern exporting

firms.

There is also a less developed literature about the non-quantifiable effects of FTA. A 2000

World Bank publication discusses a variety of additional effects that may result from regional

integration agreements. These RTA can generate spillovers in different areas of collaboration.

Some of the non-quantifiable effects refer to an increase in the economic security among mem-

bers; the FTA members can pool their bargaining power and negotiate more efficiently in the

international arena; RTA can induce more permanent domestic reforms that are due to the

increased possibilities for cooperation in environmental or technological assistance projects.

To study empirically the effects of the trade agreements, different methodologies were intro-

duced. Here we should emphasize the gravity models, welfare calculations and nonparametric

decompositions, which were introduced to assess the trade creation effects, welfare gains and

losses and the contributions of intensive and extensive margins of trade. While these method-

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ologies provide specific informations about the results of the trade agreements conditional on

the question of interest, it is important to emphasize that a comprehensive answer of the ef-

fects of the trade requires the usage of a combination of available and new methods in order to

maximize the information available in a given data set. Therefore, the up to date findings on

trade agreements are the result of specific methodologies that were employed to answer specific

questions. Consequently, with the use of a gravity model, the work by Baier and Bergstrand

(2007) show that trade agreements double trade between partner countries over 10 years., while

recent research on trade diversion by Freund and Ornelas (2010) show that trade diversion may

be specific to some agreements but was not viewed as key factor for the terms of trade. Other

older focused studies as the one by Trefler (2004) found that that trade diversion for the Canada-

United States free trade agreement was negligible. To asses the welfare gains of trade Arkolakis,

Costinot, and Rodriguez-Clare (2009) suggest a simplified calculation that can be captured via

two important variables: share of expenditure on domestic goods and the trade elasticity. The

recent research shifts focus on testing the new theories associated with trade agreement that

focus on firms. As the micro data on firms is sometimes scarce, these theories are still tested.

In particular we should mention the paper by Melitz and Trefler (2012) who assessed the pro-

ductivity gains from the reallocation of resources from less-efficient firms to more-efficient firms

within the same industry in freer trade.

From these empirical research findings, one can provide insights into specific aspects of the

trade agreements, but cannot give a comprehensive answer about the overall effects of any given

trade agreement. In line with the new theories of trade, this report will set focus on firm level

data in particular the Canadian exporters to Chile and will focus on quantifying the economies

of scale associated to the CCFTA using a nonparametric analysis and recent developments in

treatment effects literature that are used to evaluate the effects of different policies. We should

note that the proposed analysis was conditioned by the nature of available data provided by

Statistics Canada.

3 Available Data

The data used in this study is from the Export Registry (1995-2005) and covers the universe

of Canadian exporting firms that have at least one shipment to a foreign market from 1993

to 2005. The Export Registry is linked with the Longitudinal Employment Analysis Program

(LEAP) data and the Corporate Tax Statistical Universal File (T2SUF). The LEAP database

is an administrative database created by the Business and Labour Market Analysis (BLMA)

division at Statistics Canada that provides longitudinal data on the behaviour of employment

levels of Canadian businesses (Baldwin, Dupuy and Penner, 1992). It covers the period 1984

to 2007, and makes use of administrative tax records from the Business Register and from the

6

Survey of Employment, Payrolls and Hours (SEPH) to generate employment profile of businesses

over time. The T2SUF file includes all incorporated firms that file a T2 tax return with the

Canada Revenue Agency (CRA). The T2 file provides data on sales, gross profits, equity and

assets for all incorporated firms in Canada. The linked data provided to us contain only the

information of sales. Finally, the length of the linked data is asymmetric with respect to the

time of the CCFTA agreement, as more years of data are available post agreement than prior

agreement.

The final data set has the following information:

• firm characteristics on a yearly basis, here we include: size (number of employees), labour

productivity (sales per worker), see Bernard and Jensen (1995, 1999), which have been

found to be important drivers of firms export Decisions. The firm’s age is an important

variable for the study (see Agarwal et al. 2002, Cefis and Marsili 2005, Disney et al. 2003,

Esteve et al. 2004, Thompson 2005). The age of the firm can be determined from the

LEAPs data. Other firms specific variable that is important for the study is the country

of ownership (see Audretsch and Mahmood 1995, Mata and Portugal 2002). This variable

is informative as a trade agreement between Canada and Chile may induce foreign firms

to entry in Canada and benefit from this agreement.

• product characteristics on yearly basis. The information is obtained from a product code

that is classified at 8-digit Harmonized Schedule (HS8). As the data does not provide

product-specific characteristics these characteristics need to be identified in order to dis-

tinguish between the core product and the marginal product.

• industry characteristics. The database provides information with regard to the industry

to which an exporter is classified at 6-digit North American Industry Classification Code

(NAICS6).

• macro variables at the industry level: Real Canada-Chile exchange rate at the industry

level over the period 1995-2005, computed as

RERit = ertCaIPPIitChIPPIit

where ert is the nominal exchange rate (Chilean Peso/Canadian Dollar), CaIPPIit is the

Canadian Industry Product Price Index for industry i at time t and ChIPPIit is the

Chilean Industry Product Price Index for industry i at time t.

For firms that enter the market before 1993, the data cannot identify the first year of a firm’s

entry and exit into and out of foreign markets (here Chile), number of years it exported, as well

as its value of exports, number of exporting destinations if different than Chile, and number of

7

products exported in each year. This information can be only identified for firms that enter the

market after 1993. Other information that is not available from the data includes: the export

penetration index at the industry level and market share size at the industry level, a measure

of debt per assets, the exposure to CCFTA as the domestic-shipment weighted average of tariff

reductions in the six-digit NAICS6 industries in which the firm was active in 1998, the actual

location of firms, macro variables at the industry level as the change in the difference in tariffs

between Canada and Chile specific to each industry.

The linked data provided by Statistics Canada covers a high proportion of the firms. How-

ever, the linking is not done uniformly for all available years. The most recent years are better

linked than the earlier years. We checked to see if the unlinked data can bias the trade effects

by plotting the data for the number of firms and products for the linked and unlinked data over

the period of interest (see Fig.1).

insert Fig.1 here

The graph shows that the unlinked firms and products are moving in a proportional way

with the linked firms and products, therefore the data that is available for this study should be

able to pin down the trade effect if present.

4 Methodology

4.1 Nonparametric Identification

4.1.1 Transition Probabilities using frequency distributions

As the focus of the study is the impact of the CCFTA on the margins of trade between Canada

and Chile, the analysis should start by identifying from non-parametric perspective if the agree-

ment has shifted the Canadian exporters’ market from different other Latin American countries

towards Chile. This analysis can start by looking at the entry-exit patterns of Canadian ex-

porters on the Chilean market relative to the Latin-American market. The information obtained

from this analysis will give us an idea about unconditional trends for the Canadian Exporters

after the introduction of the CCFTA.

One step transition probabilities are computed in order to determine the probability of

changing the markets from the neighboring Latin American Countries to Chile. In particular,

two transition matrices are computed, one for the data available prior the CCFTA and one for

the data available after the CCFTA. The computed probabilities are capturing:

pi,Chile = Pr(Firm is in Chile at time t|Firm was in country i at time t− 1)

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where i =Argentina, Barbados, Bolivia, Brazil, Columbia, Costa-Rica, Cuba, Dominican Repub-

lic, Ecuador, Guatemala, Jamaica, Peru, Paraguay, Trinidad and Tobago, Uruguay, Venezuela.

4.1.2 Identification of the Margins of Trade

To explore non-parametrically if the extensive (newer products) or the intensive margins (older

products) are driving the shift in the volume of exports observed in the data we can use a

decomposition of the growth in total sales of the exporting firms due to the older and newer

products as follows:If we define the value of exports in year t as Xt = ptxt, where pt is the

number of exported products and xt is the average value per product. The pt = ot + nt is the

sum of the old products ot and the new products nt. Now, we can express the export growth

from t to t+ 1 as

Xt+1 −Xt = pt+1xt+1 − ptxt = ot+1[xt+1 − xt]− dtxt︸︷︷︸extensive

+nt+1xt+1︸︷︷︸intensive

Similarly, the contribution of the older firms (the intensive margin) and the contribution of the

newer firms (the extensive margin) can be identified. The nonparametric decomposition of the

export growth rate of total sales can be expressed into the intensive margin and extensive margin

components using for example a similar method as the one described in Besedes, T. and Prusa,

T. J., (2011)) as follows: If we define as J the set of NAICS6 industries available in the data,

i− th is the year of service, the value of exports in year t as Xt = ntxt, where nt is the number

of exporting relationships and xt is the average value per relationship. The nt = st + εt is the

sum of the survived relationships st and the new relationships εt and ht is the hazard rate of a

relationship. Now, we can express the export growth from t to t+ 1 as

Xt+1 −Xt =∑j∈J

I∑i=1

[(1− hij,t+1

)nij,t]︸︷︷︸

survival−stayers

[xij,t+1 − xij,t

]︸︷︷︸deepening

−I∑i=1

[(hij,t+1

)nij,tx

ij,t

]︸︷︷︸failure

+ εj,t+1x0j,t+1︸︷︷︸

entry

where

(1− hij,t+1

)is the percentage of surviving relationships between t and t+1,

(1− hij,t+1

)nij,t

gives the total number of surviving relationships between t and t+1,[xij,t+1 − xij,t

]is the deepen-

ing of the growth of trade for surviving relationships,(hij,t+1

)nij,t is the number of relationships

that end in year t+1,(hij,t+1

)nij,tx

ij,t is th total value of the ended relationships and εj,t+1x

0j,t+1 is

the value of new entrants in year t+1. Further, to asses the conditional trends for the Canadian

Exporters on the Chilean market different conditional type models can be used.

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4.1.3 Identifying the Average Effects of the Trade Agreement - Regression Dis-

continuity Approach

To evaluate if there is a treatment effect in the neighborhood of the policy change, we implement

a regression discontinuity approach based on the method introduced by David Lee and Thomas

Lemieux (2009).

The main idea behind the regression discontinuity (RD) design is that firms that are just

below the cutoff (who did not receive the treatment enter Chile’s market before trade agreement)

were good comparisons to firms just above the cutoff (who did receive the treatment, enter Chile’s

market after the trade agreement). The identification of the trade effect in the neighborhood of

the free trade agreement can be explained with the following reduced form specification

yi = β0 + β1Treatmenti + δ(Tax) + εi

where Treatment = 0 if Tax >= 11, which is the Chilean tax for before CCFTA and Treatment =

1 if Tax < 11, which is the Chilean tax after CCFTA. The underlying assumption for the identifi-

cation of the treatment effect is that the δ(Tax) is continuous around the cutoff. The estimation

is performed at 1 year, 2 year and 3 year windows around the cutoff point. According to Hahn,

Todd and Van der Klaauw (2001) the treatment effect is identified as

β(z0) =limzz+0

Y (yi|zi = z−)− limzz−0Y (yi|zi = z)

limzz+0p(z)− limzz−0

p(z).

If the treatment is happening immediately (we have a discrete jump at the cutoff in the treat-

ment variable) than we have a sharp regression discontinuity and the denominator in the above

equation becomes equal to 1, while if the effect is fuzzy around the cutoff, the denominator will

be between 0 and 1. To determine what type of design we have we plot the number of total

products exported and the value of exports to Chile by windows of years to measure the changes

over a specific period of time (see Fig. 2 and Fig.3)

insert Figures: 2, 3 here

Looking at the graphs for the number of products we see a relatively sharp discontinuity at

the time of CCFTA implementation while for the export values the effect is not that visible.

A similar pattern is obtained if we plot the total number of firms exporting to Chile and their

total sales. An interesting finding is that indirect effects of subsequent trade agreements between

Chile and USA and Chile and European Union (2002 and 2003) are observed. However, these

effects are not sharp in nature as they are smoother. Consequently, we will use different window

lengths around the cutoff point to see how robust is the estimation of the potential jump in the

treated outcome around the trade agreement date. The same methodology will be used to asses

10

the indirect effect on the Canadian exporters of other agreements Chile made with Europe and

USA. Both the sharp and the fuzzy discontinuity designs will be used in the analysis.

The estimation of the about treatment parameter is done using local local polynomial re-

gression to the left and to the right of the discontinuity point as follows:

minβ(.)E(yi − α− β(zi))2K(

zi − z0h

),

where K(zi−z0h

)is a Kernel function that gives more weight to the observations that are close to

the discontinuity point and less weight further away from the discontinuity point. It is important

to note that RD evaluation provides also an answer to a specific question: in this particular

example what is the treatment effect of CCFTA for the Canadian Exporters when we evaluate

their exports and total sales values (Average Treatment Effect on the Treated - ATT). Te

advantages of this method over other methods that are evaluating the ATT (propensity score

matching for example) is that it provides a clean evaluation with minimal assumptions and

bypasses many of the questions related to different parametric model specifications, questions

that may be related to which variables to include in the model and their functional forms. One

limitation associated with this method is that other aspects of the impact distribution may be

of interest in an evaluation of the treatment effects of any given policy. However, we consider

this method fit for this analysis for its superior advantages and due to the specificity of our

question of interest.

5 Results

5.1 Unconditional Analysis

The results presented in this section are used to understand the patterns in data which will help

to explain the economies of scale due to product diversification, new entry and margin of trade

Firstly, by looking at the entry-exit patterns of Canadian exporters in the Chilean market

relative to the Latin-American market before and after the CCFTA, we can express the transition

probabilities into Chile of the firms that were previously exporting in other Latin American

countries. Figure 4 presents the results of the transitions into Chile before and after CCFTA. The

graph shows that, after CCFTA, there was a movement into Chile of exporters from bigger Latin

American countries: Argentina, Brazil, Columbia, Peru, Uruguay and a movement out from

Chile into smaller Latin American countries: Barbados, Bolivia, Cuba, Dominican Republic,

Ecuador, Paraguay and Trinidad Tobago. As the more productive firms tend to enter bigger

markets, the inflow of the firms from bigger countries may suggest that, once CCFTA was in

place, some of these firms started to see opportunities in the Chilean market. This transition into

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Chile of probably more productive firms may explain the outflow from Chile towards the smaller

markets of probably less productive firms. The inflow of firms into Chile from the neighboring

countries may explain part of the trends of entry into the Chilean market

insert Fig.4 here

Secondly, a look at the number of industries, firms and products associated to Chilean market

(Figures 5,7 and 8) before and after the free trade agreement suggests that there is a positive

trade effect that is visible locally around the CCFTA. As pointed earlier (in the methodology

section), these categories of outcomes show a sharp change around the free trade agreement

and a smooth change around the subsequent agreements between Chile and USA and Chile and

European Union.

insert Figures 5, 7 and 8 here

Test of discontinuities around these dates of interest were performed and the results confirm

the existence of these discontinuities. As the graphical representations suggest, a sharp regression

discontinuity design should be applied when the trade effects on new firms and products is tested

around CCFTA. To test the indirect effects associated with the subsequent agreements signed by

Chile with USA and European Union a fuzzy regression discontinuity design should be applied.

Further, a detailed analysis at the industry distribution level is presented in Figure 6.

insert Figures 6 here

The results of the Industry analysis, which is used to pin down the industries that benefited

from the CCFTA show that:

• there is a relative stable number of industries in the neighborhood of the CCFTA, with

visible changes on longer horizons and

• some industries grew more than others (especially the manufacturing ones):

– Chemical Manufacturing

– Plastic and Rubber Products Manufacturing

– Fabricated Metal Products

– Machinery Manufacturing (highest increase)

– Computer and Electronic Products

– Transportation Equipment

– Machinery Equipment and Supply

12

Next, an investigation of the value of exports and total sales of Canadian exporters to Chile

(Figures 9 and 10) show different patterns than the other outcomes and also different patterns

among themselves. There is no obvious jumping pattern at the time of the trade agreement

for sales, but rather a period before the agreement, while the value of exports has a longer lag

response.

insert Figures 9 and 10 here

Thirdly, we want to measure the margin of trade associated to the entry on the new firms,

new products and their relative effect. In other words we look at the extensive margin of trade.

Figures 11, 12 and 13 are showing these results.


The results observed in these graphs can be summarized as follows:

• The intensive margin associated with the older products is the one that is driven by the

free trade initially, but changes with time.

• When we mix the margin of trade between firms and products, the result becomes very

interesting. The new firms are bringing in more older products than older firms bringing

in new products immediately after the free trade.

• However, if we look on longer horizons after the free trade agreement, the contribution

of the new firms with new products increase almost exponentially towards the end of the

observed period.

As a result of the above findings we can conclude that the new firms and the new products are

driving the long run effect of the trade, while the older firms and products are driving the short

run effect of the trade (the intensive margin drives the short run and the extensive margin drives

the long run). In what follows we present a potential theoretical explanation of our findings.

5.2 Intensive Margin of Trade Liberalization in the Short-Run and

Long-Run. A Diagrammatic Illustration.

The following discussion using graphical representations helps at explaining the empirical find-

ings from the previous section. In the diagram from Figure 14, MC and AC denote an exporter’s

marginal cost curve and average cost curve, respectively.

insert Figure 14 here

13

Before the trade agreement, the firm faces trade costs t per unit. The demand curve for the

firm’s product in the export market is represented by D, and the corresponding marginal revenue

curve is given by MR. The amount of export, q0, is determined by the firm’s profit-maximization

condition, MR = MC + t.

Suppose the trade agreement removes the trade costs t (see Figure 15).

insert Figure 15 here

In the short run, the number of exporters is fixed. Hence, there is no change in the firm’s

demand curve and marginal revenue curve. The amount of export, q1, is determined by the

condition MR = MC. Note that the firm’s profits go from zero to positive as a result of

trade liberalization. In the long run, positive profits attract entry, and the entry of additional

firms shifts downward the demand curve of each incumbent firm. This pushes down the firm’s

marginal revenue curve, reducing the volume of export to below q1. The diagram on Figure 15

illustrates a very special situation where the demand curve has shifted downward so much that

the incumbents volume of export falls back to q0 in the long run. In the diagram, D is the new

demand curve facing the incumbent firm, and MR is the corresponding marginal revenue curve.

The MR curve intersects the MC curve at the quantity q0.

5.3 Measuring the Effects of CCFTA using the Regression Discon-

tinuity (RD) Design Analysis

The RD analysis requires a sharp design evaluation at the CCFTA and a fuzzy design evaluation

at the subsequent free trade agreements (the ones that are potentially observed in the data

between Chile and EU/USA). The results of this analysis will provide a measure of the Average

Treatment Effects on the Treated (ATT). In this case we will evaluate the ATT effects for the

Canadian Exporters to Chile of their export and total sales values.

The results of the analysis are presented in Table 1.

In summary, the findings of this analysis show that CCFTA generated the following effects:

• There is a direct positive long term impact for exporters on their export values (about 54

million dollars).

• There is an indirect positive long term impact for exporters on their total sales value

(about 1 billion dollars).

• The ATT is much larger for sales than for export values, implying positive scale effects.

14

Table 1: ATT (in thousands of dollars) exports and sales at 1997 and 2002

Treatment Window Outcome Coef Std Error p-value1997 1 year exports 27385.88 8717.32 0.0021997 2 years exports 53858.5 15782.3 0.0011997 3 years exports 54712.8 15667.4 0.0001997 all years exports 54427.8 15700.3 0.0011997 1 year sales 929835 259746 0.0001997 2 years sales 1014891 510456.9 0.0471997 3 years sales 1030641 512212 0.0441997 all years sales 1021313 510984.7 0.0462002 1 year exports -11363.2 6339.5 0.0732002 2 years exports -7657.97 11131.5 0.4912002 3 years exports -7486.4 11141 0.5022002 1 year sales -52407.8 32786.1 0.112002 2 years sales -32318.4 63.624.9 0.6282002 3 years sales -30901.8 63748.9 0.628

The subsequent trade agreements made by Chile with EU/USA generated the following

effects:

• There is a direct negative short term impact for exporters on their export values (about

11 million dollars in the first year, no significant effect after the first year)

• There is no indirect negative (short or long) impact for exporters on their total sales value

(ATT negative but not statistically significant)

• The subsequent trade agreements have only a marginal impact on the export and sale

values of Canadian exporters as their effect is not lasting.

Robustness checks were also performed using conditional RD analysis where the control

variables were firm size and firm productivity. The results of the conditional RD analysis do not

change the results for ATT, which means that the unconditional results are not endogenously

driven.

The fact that we do not observe significant effects of the subsequent trade agreements suggest

that the ATT obtained for the actual CCFTA was not altered by those agreements. Also, the fact

that the ATT was stable over different window lengths and no other discontinuity was identified

for the period of investigation and that controlling for different other factors did not change the

results of the analysis may point out that the ATT measure was consistently estimated.

Graphical representations of the above analyses are found in Figures 16, 17 and 18.


15

The graphical representations show the discontinuity for both outcome variables: export and

total sales values associated with the CCFTA and the lack of discontinuity when other trade

agreements took place. These graphical representations also confirm the long-run numerical

findings of the actual RD analysis. The graphs for both the export values and total sales show

that while the trade agreement is visible in short run, in long run the preference erosion due to

new trade agreements may be present. However, the long-run effects seems to be stable.

6 Conclusion

The project Measuring the impact of CCFTA on the trade between Canada and Chile through

product diversification, new entry and margin of trade contributes to the understanding of the

impact of the free trade agreement between Chile and Canada(CCFTA) in the following way:

First, using transition probabilities to look at the entry-exit patterns of Canadian exporters in

and out of the Chilean market relative to other Latin-American countries, the results show that

after the CCFTA, there was a movement into Chile of exporters from bigger Latin American

countries: Argentina, Brazil, Columbia, Peru, Uruguay and a movement out from Chile into

smaller Latin American countries: Barbados, Bolivia, Cuba, Dominican Republic, Ecuador,

Paraguay and Trinidad Tobago. As the more productive firms tend to enter bigger markets, the

inflow of the firms from bigger countries may suggest that, once CCFTA was in place, some of

these firms started to see opportunities in the Chilean market. These transitions into Chile of

probably more productive firms may explain the outflow from Chile towards the smaller markets

of probably less productive firms. The inflow of firms into Chile from the neighboring countries

may explain part of the trends of entry into the Chilean market that were identified with the

next set of results.

Second, the results show that there is a trade liberalization effect that is driven in the short

run by the intensive margin of trade, while in the long run the intensive margin dies off and the

extensive margin of trade picks up. The extensive margin of trade picks up after other trade

agreements are signed by Chile (with EU and USA). Therefore, the effect of preference erosion

due to subsequent trade agreements that increase the extensive margin of trade and do not affect

the intensive margins can be explained by assuming that individual’s utility function follows a

Constant Elasticity of Substitution, and that consumers in Chile would like to take an infinite

number of varieties of products on that ground. This result can be explained by the fact that we

observe both more new Canadian firms and products getting in despite the preference erosion.

A detailed industry distribution analysis of the number of firms that are entering/exiting

Chile show that the industries that were actually contributing to the results of the extensive

margin of trade were the manufacturing ones: Chemical Manufacturing, Plastic and Rubber

Products Manufacturing, Fabricated Metal Products, Machinery Manufacturing (highest in-

16

crease), Computer and Electronic Products, Transportation Equipment, Machinery Equipment

and Supply.

Firm and product level analyses show that the intensive margin associated with the older

products is the one that is driven by the free trade initially, but changes with time. The new

firms are bringing in more older products than older firms bringing in new products immediately

after the free trade. However, if we look on longer horizons after the free trade agreement, the

contribution of the new firms with new products increase almost exponentially towards the end

of the observed period (2008). As a result the new firms and the new products are driving the

long run effect of the trade, while the older firms and products are driving the short run effect

of the trade (the intensive margin drives the short run and the extensive margin drives the long

run). The results also show that the new firms/products entry do not explain the results on the

sales and value of exports, which are changing in a less pronounced way.

An analysis of sales and value of exports show different patterns. There is no obvious jumping

pattern at the time of the trade agreement for value of exports and total sales, but rather a

period after the agreement. The total sales have a longer lag response than the value of exports.

These results can be explained by the endogenous re-allocation of the resources that overlap

with subsequent trade agreements that Chile signed with European Union and USA.

Finally, a regression discontinuity design was employed to test short and long term impacts of

CCFTA as well as the indirect impact of other trade agreements between Chile and Europe and

USA. The results of the analysis reveal that the impact of the CCFTA on the value of exports

is less important than the impact of CCFTA on the total sales. This result may be driven by

the scale effects generated by CCFTA. The analysis also show that there is a direct positive

long term impact for exporters on their export values (about 54 million dollars), while there is

an indirect positive long term impact for exporters on their total sales value (about 1 billion

dollars). The Average Treatment on the Treated (ATT) effect is much larger for sales than

for export values, implying positive scale effects. Subsequent trade agreements made by Chile

with EU/USA generated the following effects: There is a direct negative short term impact

for exporters on their export values (about 11 million dollars in the first year, no significant

effect after the first year) There is no indirect negative (short or long) impact for exporters on

their total sales value (ATT negative but not statistically significant). The subsequent trade

agreements have only a marginal negative impact on the export and sale values of Canadian

exporters as their effect is not lasting.

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8 Apendix

8.1 Figures

21

0

200

400

600

800

1000

1200

1400

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Axi

s Ti

tle

Number Candian Firms & Products : Export to Chile_Linked and Unliked datas

Total Firms_Unlinked Total Products_Unlinked Total Firms_Linked Total Products_Linked

Figure 1: Firms and Products - linked and unlinked data

22

0

100

200

300

400

500

600

700

800

93-96 94-96 95-96 96 97 98 98-99 98-00 98-01 98-02 98-03 98-04 98-05 98-06 98-07

258.5

289 304.5

374

418

460 472

482.6666667 489.5 507

547.8333333

600.5714286

649.75

694.8888889

725.8

758.9090909

Number of Products by Windows

Figure 2: Number of Exported Products to Chile by Window

23

0

50000000

100000000

150000000

200000000

250000000

93-96 94-96 95-96 96 97 98 98-99 98-00 98-01 98-02 98-03 98-04 98-05 98-06 98-07 98-08

Values by Windows

Figure 3: Value of Exports by Window

24

0

2

4

6

8

10

12

14

16

18

20

Axi

s Ti

tle

Transition to Chilie before and after 1997

Before 97 After 97

Figure 4: Transition Probabilities into Chile before and after CCFTA

25

-20

0

20

40

60

80

100

120

140

160

180

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

56

71

78

110

119

126 123 124

128 131

147

160

166

154

160

176

0

15

7

32

9 7

-3

1 4 3

16 13

6

-12

6

16

Number of Industries (by leapnaics)

Number of Industries (by leapnaics) New industries

Figure 5: Number of Industries

26

1993

1996

1999

2002

2005

2008

0

50

100

150

200

250

300

350

400

450

500

11

1

11

5

22

1

31

1

31

5

32

3

32

7

33

4

33

9

41

4

41

8

44

3

44

7

45

3

48

3

49

3

51

8

52

4

53

3

56

2

71

1

72

2

91

1

Figure 6: Distribution of Industries

27

-100

0

100

200

300

400

500

600

700

800

900

1000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

85 104

140

299

356

419

382

420 430

465

622

747

798 821

846

944

0 19

36

159

57 63

-37

38 10

35

157

125

51 23 25

98

Number of Canadian Firms Exporting to Chile from 1993 to 2008

Number of Firms New Firms

Figure 7: Number of Firms

28

-200

0

200

400

600

800

1000

1200

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

167

258 235

374

418

460 484

504 510

577

752

917

994

1056

1004

1090

0

91

-23

139

44 42 24 20 6

67

175 165

77 62

-52

86

Number of Products Exported by Canadian Firms to Chile (by leapnaics)

Number of Products New Products

Figure 8: Number of Products

29

-1E+08

0

100000000

200000000

300000000

400000000

500000000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Values of Export and Marginal values

Value of Exports to Chile by Canadian Firms Marginal Values

Figure 9: Export Values

30

-1E+12

-5E+11

0

5E+11

1E+12

1.5E+12

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Sales

Sales Marginal sales

Figure 10: Sale Values

31

0

100

200

300

400

500

600

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Firms distribution Old_Old Old_New

New_Old New_New

Figure 11: Firms - old and new

32

0

100

200

300

400

500

600

700

800

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Product distribution

old_old old_newnew_old new_new

Figure 12: Products - old and new

33

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

300,000,000

350,000,000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Value of Exports to Chile

Old Firm-Old Product Old Firm-New Product

New Firm-Old Product New Firm-New Product

Figure 13: Export Values - old and new

34

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