PwC’s problematic case for the TPPA – Jomo Kwame Sundaram

Source: The Malaysian Insider

Jomo Kwame Sundaram. Source: IFPRI (https://www.flickr.com/photos/ifpri/); taken from TPPDebate.org
Jomo Kwame Sundaram. Source: IFPRI (https://www.flickr.com/photos/ifpri/); taken from TPPDebate.org

As is well-known, Pricewaterhouse Cooper (PwC) was commissioned by the Ministry of International Trade and Industry (Miti) to produce one of two government commissioned studies on the Trans-Pacific Partnership Agreement (TPPA).

The 2015 PwC Study on potential economic impact of TPPA on the Malaysian Economy and selected key economic sectors is the major reference for any serious consideration of the likely consequences of Malaysia’s participation in the Trans Pacific Partnership (TPP). It therefore deserves some careful scrutiny, but a short and selective review cannot do full justice to or more importantly, the 6,350 page TPPA document itself.

The PwC study claims net economic gains for Malaysia from the TPPA on rather dubious premises. These include a GDP increase of US$107 billion to US$211 billion between 2018 and 2027, if all TPPA countries eliminate tariffs and reduce non-tariff measures (NTMs) by 25% to 50%; more than 90% of these gains are supposed to come from the reduction of NTMs.

The study was undertaken on the basis of information available before the agreement was fully negotiated in October last year. While this is crucial to recognise, it would be unfair to criticize the study for not fully anticipating the final text, and its full implications.

Trade balance

Contrary to many suppositions, the PwC study expects that the TPPA will reduce Malaysia’s trade surplus*.

The study said: “The trade surplus will be smaller at US$29.7 billion to US$35.1 billion than in the baseline scenario (US$41.9 billion), where TPPA does not exist.

“Export gains range from US$75 billion to US$116 billion over 2018. Import gains range from US$130 billion to US$225 billion over 2018.

“In the event Malaysia does not participate in the TPPA, the trade balance is projected to remain largely unchanged from the baseline scenario. In the non-participation case, the slight increase in the trade surplus in 2027 is due to the larger decline in import growth relative to export growth.”

Thus, the PwC report expects Malaysia’s trade surplus to increase if does not join the TPP, and to fall by US$2 billion to US$12 billion in 2027 if it joins.

The binary choice here implies that Malaysia has no other policy options, and must choose between joining the TPPA and doing nothing. There is no serious consideration of alternative policies for structural transformation, including learning from the rapid industrialisation and productivity growth experiences of the first-tier East Asian newly-industrialised economies.

There is also no serious consideration of the effects of TPPA financial liberalisation on the capital account, how it may be affected by the reduced current account surplus, as well as the full implications of the drastically reduced scope for national prudential regulation demanded by the TPPA’s demands for greater financial liberalisation determined by the Pacific trade pact’s dominant partner, that is the United States.

The greater growth of imports over exports implies greater domestic market competition, potentially displacing many domestic firms, with various employment and other effects.

The PwC study admits assuming full employment and therefore being unable to consider employment and related distributional impacts.

Instead, its computable general equilibrium (CGE) modelling methodology assumes that labour displaced from sectors where imports rise is immediately and fully absorbed by increased employment in other sectors where exports rise regardless of skill mismatches, etc.

(While the UN’s Global Policy Model does not expect greatly increased unemployment in TPP developing countries, such as Vietnam and Malaysia, the greater concern is with the likely more labour-intensive and lower wage jobs created by greater TTPA area specialisation.)

Uneven gains

Surprisingly to many, the PwC study projects that “in all scenarios with the TPPA being implemented, there is a slight decline in output for crops as well as vegetable oils and fats”.

This is presumably due to increased competition from subsidised agricultural imports from other TPP countries after Malaysia removes its tariffs on farm products from other participating countries.

“The benefit from tariff cuts is projected to be small, raising wage growth by only 0.08 ppt. In contrast, wage growth is projected to be largely unchanged in the event of non-participation in the TPPA”.

Meanwhile, there is nothing in the TPPA to check, let alone reverse the US’s huge and growing WTO-compliant (“green box”) domestic farm subsidies. The October 2015 TPPA agreement does not require any reduction in these already high, and still ballooning domestic agricultural subsidies, even though they effectively displace agricultural production and exports by other TPP countries.

Higher imports of intermediate products may reduce domestic value-added content in exports and displace existing domestic supply chains. The study also acknowledges that: “Downstream companies that rely largely on non-TPPA inputs could relocate out of Malaysia”.

The study also ignores the “yarn forward” rule in the TPPA which makes virtually negligible any significant increase in textile and garments exports from Malaysia and Vietnam to the US. As a consequence, the only US government study of the TPP’s likely impact projects additional one-time growth of only 0.01% after 10 years by 2025.(Refer Table 8 of USDA study)

The study implicitly acknowledges that the TPPA will mainly benefit a small number of big Malaysian firms. The study survey of the private sector mainly covered such firms with the capacity to invest significantly in other TPPA countries.

The TPP’s impact on SMEs is minimally covered by the study, but is probably of greatest concern to much of the Malaysian private sector.

NTM reduction gains

“Reduction in NTMs include reduction in quotas, subsidies, trade defence measures, export restrictions, and technical measures”.

Acknowledging the modest growth impact of trade liberalisation per se, the PwC study notes that “more than 90% of the economic gains are driven by the reduction in NTMs”, due to assumed cuts in NTMs, many of which were not realised in the October 2015 agreement.

After all, much of the “Predicted gains are dependent on the simulations where TPPA participation eliminates tariffs and reduces NTMs by 25-50% over 2018”.

While removal of NTMs should bring trade gains, estimating their investment and growth impacts requires quantifying them**.

The PwC study does so – very controversially – by attributing “tariff equivalence” to various different types of NTMs to simulate the effects of reducing such proxy tariffs.

With such a methodology, one can expect that the higher the tariff equivalence, the higher will be the estimated gains from reducing these proxy tariffs.

Given the significance the report attributes to the reduction of NTM measures, it is critical to carefully consider how it makes these estimates and the implications of doing so.

The study does not disclose the tariff equivalents and other methodological assumptions used for different NTMs and for various countries, only asserting that “NTMs in Malaysia’s manufacturing sector is equivalent to a 22.1% tariff, while NTMs in the manufacturing sectors of the other TPPA countries averaged to be equivalent to a 11.8% tariff”.

As the October 2015 TPPA deal fell significantly short of the scenario assumed in the PwC study, its controversial methodology is so fundamental to its claims of significant growth gains for Malaysia from reducing NTMs and there is little serious consideration of the risks and costs of joining the TPPA, it is crucial that the estimates of gains be reconsidered in light of the TPPA’s actual provisions.

While Malaysia is expected to participate in the TPPA signing ceremony in New Zealand early next month, it is crucial for the country’s future and public interest that Parliament and the public have adequate opportunity to more carefully consider the document and its likely full implications for the Malaysian economy in the short-, medium- and long-term.

The PwC’s problematic TPPA benefits methodology

As the report acknowledges: “A CGE model is an equilibrium model, and typically assumes full employment. Thus, the focus of the model is on overall economic welfare rather than job creation”.

A growing literature criticizes CGE models, challenging the results reached by using them. Several issues are especially relevant here.

The very nature of CGE models necessarily lead to the foregone conclusion that trade liberalisation will increase “overall gains”***, as the “price system” will always ensure the improved overall well-being of all.

Most CGE models assume that “full” employment of labour is constantly achieved everywhere, precluding, from the outset, any consideration of employment effects.

The CGE methodology has no way to consider, let alone predict employment impacts, eg. to consider which wages grow and fall, and the workers affected. This indirect means of assessing the impact on wages of unskilled workers and employment is dubious, to say the least.

They also assume that each economy always adjusts smoothly, thanks to a completely flexible tax incidence impact on households, eg. Malaysia will easily compensate for any lost government revenue, say from tariff elimination, by simply increasing other taxes.

CGE models’ standard Armington assumption (of unique country-specific product specialisation) is not only unrealistic, but systematically underestimates the potential for domestic displacement due to cheaper imports.

CGE models estimate “static gains” or “long-term gains”, ignoring short-term “adjustment costs”, thus overestimating “total gains”. Most CGE models provide static results, i.e. “before” and “after” an actual change or a simulated one. Yet, the report offers “long term” projections, especially after ten years, by assuming away disruptions, such as employment losses, due to domestic production drops.

According to the study, reductions of non-trade measures (NTMs) will be higher for Malaysia compared with other TPP countries. This will necessarily entail both short- and long-term macroeconomic and social adjustment costs, such as those due to unemployment, public revenue losses and changes to the current account.

By completely ignoring such costs, the gains from reducing NTMs are again overestimated.

As the report acknowledges, “The robustness of the CGE results are also subject to data limitations and the assumptions of the economic model”.

All this suggests that far greater caution is urgently needed in considering the most serious, yet unfortunately still biased, partial and problematic case made so far for Malaysia joining the TPPA. – January 24, 2016.

* Jomo Kwame Sundaram is the assistant director-general and coordinator for Economic and Social Development of the United Nations’ Food and Agriculture Organisation.

* This is the personal opinion of the writer, organisation or publication and does not necessarily represent the views of The Malaysian Insider.

Footnotes:
* The faster rise of imports compared to exports will reduce Malaysia’s trade surplus vis-à-vis other TPPA countries as argued earlier by Rashmi Banga. Trans-Pacific Partnership Agreement (TPPA): Implications for Malaysia’s Domestic Value-Added Trade. UNCTAD Background Paper No. RVC-12, Geneva, January 2015.

** The World Trade Organization acknowledged some problems with different methods for estimating the tariff equivalents of specific NTMs; see “World Trade Report 2012: Trade and public policies: A closer look at non-tariff measures in the 21st century“.
UNCTAD has noted that “NTMs are relatively more restrictive in high- and middle-income countries”; see UNCTAD. Non-Tariff Measures to Trade: Economic and Policy Issues for Developing Countries. Geneva, 2012.

*** See Lance Taylor and Rudiger von Arnim (2006). “Computable General Equilibrium Models of Trade Liberalization: The Doha Debate”. New School for Social Research for Oxfam, Oxford. Also see Jomo K. S. and Rudiger von Arnim. “Trade liberalization for development?”. Economic and Political Weekly 43 (48), 29, November 2008: 11-12.


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