Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion Renegotiation of Trade Agreements and Firm Exporting Decisions: Evidence from the Impact of Brexit on UK Exports Meredith A. Crowley Oliver Exton Lu Han University of Cambridge July 2018
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Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Renegotiation of Trade Agreements and FirmExporting Decisions: Evidence from the Impact
of Brexit on UK Exports
Meredith A. CrowleyOliver Exton
Lu Han
University of Cambridge
July 2018
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Disclaimer
This work contains statistical data from HMRC which is CrownCopyright. The research datasets used may not exactly reproduceHMRC aggregates. The use of HMRC statistical data in this workdoes not imply the endorsement of HMRC in relation to theinterpretation or analysis of the information.
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Renegotiation of trade agreements
Countries regularly negotiate new, more liberal trade agreements:
• Canada-EU, CP-TPP, KORUS
Recently, several trade agreements have announced renegotiation:
• UK in EU, US in NAFTA, KORUS
with threats that collapse of negotiations will lead to tariffincreases.
Research question:What is the impact of the renegotiation of a trading relationship(and its implied uncertainty about future trade policy) on firmentry into and exit from exporting?
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Summary of results
UK firm entry into the EU fell dramatically for products that wouldface increases in tariffs if negotiations breakdown.• A 10 percentage point increase in the threat point tariff
decreases the entry rate by 10.1 ppt and increases exit rate by4.9 ppt.• Products facing extreme threat point tariffs experience a 25.3
ppt decline in relative entry rate.• Products facing high threat point tariffs experience a 12.3 ppt
decline in relative entry rate.
• Partial equilibrium aggregation: entry into (exit from) the EUby UK firms would have been 5.1% higher (4.3% lower) in2016 if there had been a guarantee that EU import tariffs onUK exports would remain at zero post-Brexit.
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Theory and empirics on trade policy uncertainty
• Trade policy uncertainty• Handley (2014), Handley and Limao (2015), Pierce and Schott
(2016), Handley and Limao (2017), Crowley, Meng and Song(2018).
• Trade agreement design and renegotiation• Bagwell and Staiger (1999), Maggi and Rodgriguez-Clare
(2007), Horn, Maggi and Staiger (2010), Maggi and Staiger(2011), Maggi and Staiger (2015), Limao and Maggi (2015).
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Outline
Introduction
Theoretical motivation
The Brexit referendum
Empirical model
Data
Results
Conclusion
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Firm exporting decisions under trade policy uncertaintyModel from Handley and Limao (2017)
Consider the problem of a firm with marginal production costs cthat must decide whether or not to enter into exporting to aforeign market with its product h under tariff τsh in policy state swith fixed cost of entry Kh. The per-period operating profits are:π(τsh).
A firm enters if its production costs are below the cost thresholdc ≤ ccertainsh , where ccertainsh is given by:
ccertainsh =
(ash
(1− β)Kh
) 1σ−1
.
For the marginal firm, with c = ccertainsh , the discounted value ofprofits exactly equals the sunk cost to enter into exporting:
π(τsh, ccertainsh )
1− β= Kh.
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Trade policy uncertainty
The probability that two countries choose to renegotiate the termsof their trading relationship is γ.
• Renegotiation (s=R): A state with uncertainty about theeventual outcome of renegotiations.
After renegotiation, two outcome states are possible:
• Free Trade (s=FT): Outcome state with zero tariffs on allproducts. Probability: λFT = 1− λWTO
• Threat point tariffs (s=WTO): Outcome state with threatpoint tariffs on all products. Probability: λWTO
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
A marginal firm with c = cUR,h just satisfies entry condition:
Πw (τR,h, cUR,h) = Πe(τR,h, c
UR,h)− Kh
Uncertainty factor
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Theoretical results and mechanisms
Result: Entry rate is lower in the uncertain renegotiation regime inwhich tariff increases are possible, τWTO,h > τR,h and u(γ) > 0.
Implications of trade policy uncertainty:
1. Products that face higher threat point tariffs τWTO,h havelower cost cutoffs (so higher cost firms do not enter).[cross-sectional]
2. Increased probability of entering into renegotiation γ lowersthe cost cutoff (so higher cost firms do not enter).[inter-temporal]
3. Increased probability that negotiations break down λWTO
lowers the cost cutoff (so higher cost firms do not enter).[inter-temporal]
Endogenous exit
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
BrexitA switch to a less certain trade policy environment
On 23rd June 2016 the British electorate voted to ‘Leave’ theEuropean Union:
• Government announced that UK would leave Customs Union.
• UK began negotiations with the EU with aims to ensurecontinued tariff free access to EU markets.
• Outside option or threat point (if no deal is reached) is forUK-EU bilateral trade to be conducted under WTO rules.
• Under WTO rules, UK exports to EU would be charged EU’sexternal tariff rates (defined by EU’s WTO tariff schedule).
Brexit can be interpreted as an unexpected increase to theprobability of a new set of tariffs (γ = 0.3→ γ = 1).
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Brexit vote• Pre-referendum, the probability of renegotiating the UK-EU
trade relationships was 30%. Post-referendum, certain.
Market implied probability that the UK would leave the EU
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%Brexit referendum 23rd June 2016
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Empirical predictions for UK based firmsApplication of Brexit to Handley and Limao (2017)
EntryProducts facing higher threat point tariffs will experiencedecreased entry during renegotiation relative to products facinglower threat point tariffs.
ExitProducts facing higher threat point tariffs will experienceincreased exit during renegotiation relative to products facinglower threat point tariffs.
ExportersProducts facing higher threat point tariffs will experience fall innumber of exporters during renegotiation relative to productsfacing lower threat point tariffs.
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Empirical modelEntry
∆ entrantsh,t = b0 + b1τthreat pointh,t + ηh,t
Exit
∆ exitersh,t = b0 + b1τthreat pointh,t + ηh,t
Exporters
∆ exportersh,t = b0 + b1τthreat pointh,t + ηh,t
Growth measure: Davis and Haltiwanger (1992)
∆Yh,t =2(Yh,t − Yh,t−1)
(Yh,t + Yh,t−1)
where ∆Yht is the growth in the aggregate of outcome variable Y(exporters, entrants, exiters) for product h in time t.
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
UK customs data
• Information on the universe of firm exporting decisions isobtained from the UK HMRC Overseas Trade Statisticsdatabases.
Table 1: Total value and number of UK-based firms exporting to EU
Interpretation: Products facing a 10 ppt threat point tariff willhave 10.5ppt lower growth of entry into exporting than the 8.6%growth of entry in the zero tariff group, implying an overall growthrate of -1.9%.
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Analysis of UK based firms: Discrete tariff categoriesIncluding quotas
Table 5: Entry into/ exit from exporting to the EU: 2016 relative to 2015
Interpretation: Products facing the extreme threat point tariffsexperienced a 25.3 ppt decline in relative entry rate, compared to8.7% growth of products facing no increase in threat point tariffs.
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Partial equilibrium aggregation exercise
Firm-product entry in 2016 would have been 5.1% if UK firmswere guaranteed zero tariffs on exports to EU.
• Use regression coefficients and firm-product exporter statistics.
• Aggregating over categories finds 5,221 firm-products did notenter into the EU in 2016 relative to counterfactual.
• Using the average value of entrants (exporters) in 2015,reduced entry accounts for a £226 million (£1.4bn) loss ofexport value in 2016. [Aggregate exports to the EU were£140bn in 2016.]
Number of exiters would have been 4.3% lower in counterfactualwith a value of £182 million (£1.1 bn).
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Analysis of UK based firms: Tariff rateBroader definitions of entry
Table 6: Entry into exporting to the EU: 2016 relative to 2015
• Placebo test shows that there was no impact in first half of2016 before the referendum and increase in trade policyuncertainty.
Discrete categories
Introduction Theoretical motivation The Brexit referendum Empirical model Data Results Conclusion
Conclusion
This paper estimates the impact of the announcement of a tradeagreement renegotiation on firm exporting decisions.
We exploit the natural experiment of the leave vote of the Brexitreferendum on 23rd June 2016.
• Firm entry into (exit from) the EU significantly declines(increases) for those products facing higher threat point tariffsunder renegotiation regime, even with no change in appliedtariffs.
• Magnitudes are economically significant indicating a rapidresponse - aggregate entry would have been 5.1% higher andexit 4.3% lower in 2016 if UK firms were guaranteed zerotariffs on exports to EU, despite only 6 months ofpost-referendum exposure.
Appendix
Model assumptions
Model from Handley and Limao (2017):
• Consumers have CES preferences over differentiated goods.
• Continuum of monopolistically competitive firms producingvarieties v in industry h with heterogeneous productivity 1/c .
• Consumer prices pv include an ad valorem tariff, τsh = 1 + tsh,which differs across industries h in policy states s.
• Economic conditions summarized by ash = f (τ∗sh,E∗h ,P
∗h)
• Firms form rational expectations over future expected profitswith a discount factor β = (1− δ)(1 + R).
• Firms make entry decision into exporting in state s tomaximize expected profits net of sunk entry cost Kh.
Firm decisions under trade policy uncertainty
Entry cost cutoff for uncertain state, cUR,h, is proportional to the
deterministic cutoff, ccertainR,h , by an uncertainty factor U(ωh, γ):
cUR,h/ccertainR,h = U(ωh, γ) =
(1 + u(γ)ωh
1 + u(γ)
) 1σ−1
where
• γ is the probability of a new set of tariffs.
• ωh = (τWTO,h/τR,h)−σ is ratio of operating profits in hightariff state relative to uncertain renegotiation state.
• u(γ) = γλWTOβ/(1− β) is expected spell in high tariff state.
TPU
Endogenous exit
• Endogenous exit is not explicitly modelled as no per periodfixed cost to export, only sunk entry cost Kh.
• Firms that exogenously exit due to death shock haveopportunity to re-enter and not appear as Exiters.
• Following a trade policy regime shift that increasesuncertainty, the entry cutoff falls ∂cU1h/∂γ < 0. Thereforefirms with cUt,1h < c ≤ cUt+1,1h will enter before the tradepolicy regime switch and not re-enter if hit by exogenousdeath shock after the trade policy regime switch.
Analysis of UK based firms: Discrete tariff categories
Table 11: Entry into/ exit from exporting to the EU: 2016 relative to 2015