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Assessment Of EU/ Mercosur Free Trade Agreement

09 December 2011

After speculation over the impacts of a free trade agreement between the EU and Mercosur, the official impact assessment by the European Commission is that any deal with Mercosur would leave EU producers out of pocket.

Drawing upon simulations made with two different models of two alternative hypothetical versions of a bilateral free trade agreement, the report highlights the impacts if the agreement was to be implemented.

The CGE model, GLOBE, simulates the economy-wide impacts of the trade policy changes involving all sectors of the two regional blocks. The partial equilibrium model, CAPRI, simulates only the impacts generated by changes in agricultural trade policy and incurred by the agricultural sectors of the two regions.

However, CAPRI considers individual agricultural products in more detail and can generate the territorial distribution of their production within the EU at the NUTS two regional level. Five hypothetical scenarios are simulated, and are compared with the reference (‘no-change’) scenario for the year 2020. The EU comprises the current 27 Member States and Mercosur is composed of its current members, Argentina, Brazil, Paraguay and Uruguay.

The first scenario investigated is based on the EU negotiating offer made to the countries of Mercosur in 2004, whereas the second scenario reflects the Mercosur request of 2006. These scenarios involve tariff abolition or reduction by both parties, and extensions to bilateral TRQs on the part of the EU. The extent of these concessions depends on the scenario.

The other three scenarios all assume that an agreement has been reached in the Doha Round multilateral negotiations, based on the revised draft modalities presented to the WTO Agriculture Committee in December 2008. The third scenario simulates a Doha Round agreement as the only set of trade policy changes with respect to the reference scenario. The fourth scenario looks at the impacts of the EU’s proposal, but with smaller TRQ increases compared to its no-Doha version, in this post-Doha context. The fifth scenario assumes that the deal proposed by Mercosur is implemented, again in the post-Doha setting. The details of Mercosur’s request are independent of whether a Doha Round agreement is in place or not.

It should be borne in mind that the version of a Doha Round agreement simulated by GLOBE does not allow the developed countries to exempt any sensitive products from the standard Doha tariff cuts. On the other hand, the CAPRI post-Doha simulations assume that the sensitive products of the developed countries retain some extra protection but that they are required to open new multilateral TRQs or extend existing ones in order to grant some additional controlled market access for these products.

The simulations show that, as far as agriculture is concerned, there are significant losses to EU producers and gains to Mercosur producers in all scenarios, including the Doha-only scenario. These effects are more pronounced under the scenarios based on the Mercosur request. GLOBE results show that the gains in the EU manufacturing sector outweigh the losses to the EU agrifood sector, leading to an overall increase in GDP. This increase ranges from €8.9 billion (first scenario) to €66.0 billion (fifth scenario). Non-agrifood production in Mercosur, particularly in the manufacturing sector, falls in all scenarios.

CAPRI simulates the welfare changes generated by the agricultural sector only (without food processing), including losses to agricultural producers, gains in consumer surplus due to any food price falls and any changes in the government budget triggered by the policy changes. The CAPRI results indicate very small falls in total EU welfare for the two scenarios without a Doha-Round agreement, and slightly larger increases (0.01-0.02 per cent) for the post-Doha scenarios. The largest increase in EU welfare (0.02 per cent) occurs for the scenario depicting the EU offer in the post-Doha context.

However, EU agricultural producers lose income in all scenarios and their losses increase progressively from scenario to scenario. The total loss to EU agricultural producers for the scenario corresponding to Mercosur’s request post-Doha is €7.75 billion, or 3.21 per cent, relative to the reference scenario. By contrast, EU food consumers have a welfare gain. In Mercosur, food consumers and the manufacturing sector suffer losses. Although this is not shown by either model, it is clear that on a per capita basis the losses to EU agricultural producers far outweigh the gains to those accruing in EU manufacturing (GLOBE) or to EU food consumers (CAPRI).

It is important to note that underlying this stylised breakdown of gains and losses to various stakeholder groups it is assumed that higher returns and price changes arising from the changes in trade policy are passed on by trading companies and the food supply chain to primary producers and consumers, respectively. Assumptions about who captures the substantial rents made possible by the tariff-rate quotas granted by the EU for market access of agricultural products are also relevant to these bottom-line conclusions.

The results of both models suggest that, for each assumption about the state of the multilateral trading arrangements, the greater part of these effects is already achieved in the scenarios depicting the EU offer. The effect of the Mercosur request in each case is to marginally increase the welfare gains, compared with the EU offer, while accentuating the losses to EU agriculture and the gains to Mercosur agricultural exporters. In the terminology of the economist, the EU offer appears to achieve most of the potential efficiency gains, whilst the additional impact of the Mercosur request is largely to deepen the distributional changes. In the Doha-only scenario, the EU welfare changes are comparatively small in the CAPRI simulations, whereas with GLOBE a Doha Round agreement alone already achieves much of what can be expected with a Doha Agreement and a bilateral one. This difference is explained largely because, first, GLOBE also models changes in the non-agricultural sector and, second, does not recognise sensitive products for agricultural commodities. The CAPRI simulations assume the opposite on both counts.

At the level of individual commodities and commodity sectors, both models project a strong increase in EU imports from Mercosur of meat, particularly beef, in all the scenarios. The smallest increase for beef imports (5 thousand tons) occurs for the EU offer with no Doha agreement, and it rises to around a quarter of a million tons with the Mercosur request. Beef imports would be 288 thousand tons higher than in the reference scenario with a Doha agreement only, and as much as 524 thousand tons above the reference scenario with the Mercosur request post-Doha. In this last case, EU beef production is lower by around 280 thousand tons, with a loss valued at €4.6 billion euros. The total loss to the meat sector in this scenario is over €5.8 billion, of which €0.8 billion occurs in the poultry sector. The total volume of meat production lost is 600 thousand tons.

Despite the strong impacts on the beef sector in this scenario, EU meat exports to third country destinations increase, whilst Mercosur’s exports of beef to non-EU destinations decline. EU imports of vegetables and fruit from Mercosur are also higher with trade concessions. These impacts are comparable across all the scenarios involving a bilateral trade agreement, since the negotiating positions of both trading blocks envisage the abolition of tariffs on these items. The import increase is dominated by the increase for citrus and other fruits, and other vegetables. The models are not unanimous regarding the cereals sector: although they both predict very little change in wheat imports, CAPRI simulates strong increases for EU exports of wheat to Mercosur in all scenarios with a bilateral agreement. This result is not matched in the GLOBE results.

The models also differ regarding sugar imports, which are higher in the GLOBE simulations for the post-Doha scenarios whereas in CAPRI they fall by modest amounts. Both models predict a 100% fill-rate for the sugar TRQ even at the higher level requested by Mercosur. Moreover, they both indicate very large volumes of out-of-quota sugar imports in all five scenarios. This means that at the margin sugar imports almost certainly face the MFN tariff, and will not be influenced by an increase in the TRQ ceiling for intra-marginal imports. However, it is striking that with CAPRI, EU imports of sugar in all scenarios are 0.55-1.00 million tons higher than they are in GLOBE (in the reference scenario, CAPRI simulates sugar imports from Mercosur to be around 1.12 million tons higher than the GLOBE figure). This indicates that, according to CAPRI, sugar imports from Mercosur were already at a higher level before the trade liberalisation began.

The models also diverge from each other regarding the impacts of sugar trade with Mercosur on EU domestic production. In this respect, each model is consistent with its own prediction of what happens to the EU’s sugar imports: GLOBE predicts that EU sugar production falls by over 12 per cent in the two postDoha scenarios with a bilateral trade agreement, whereas in CAPRI EU production increases by negligible amounts. It is worth recalling that in the GLOBE post-Doha runs, no sensitive products are assumed. Therefore, tariffs for all products including sugar receive the standard tariff cut.

Hence, the change in access to the EU sugar market for Mercosur’s out-of-quota sugar imports is more favourable in GLOBE than in CAPRI, and this can explain at least part of the greater responsiveness of this import flow.

Both models predict that the TRQs for sugar are filled under all scenarios, and for rice for all scenarios except Doha-only (there is no bilateral rice TRQ in this scenario). However, whereas GLOBE predicts that the TRQ for other cereals would be filled under all scenarios with a bilateral agreement, and the one for wheat filled in the two scenarios corresponding to the EU offer, CAPRI simulations show significant under-fill for both these TRQs under all relevant scenarios.

It is less easy to compare the fill rates for the various meat TRQs between the models, since GLOBE combines beef with sheep and goat meat in one of its meat categories, and aggregates pork and poultry together in the other meat category, whereas CAPRI treats these meat products separately. However, to the extent that the results can be compared, they appear to agree that TRQs for beef are filled in all scenarios, but not those for sheep meat. With GLOBE, the aggregated TRQ for pork and poultry meat is always filled, but in CAPRI the individual TRQs for pork and poultry meat are both filled separately only in the fourth scenario, and in addition the poultry meat TRQ is filled in the Doha-only scenario. Otherwise, both these meats fail to achieve a 100% fill rate.

As for dairy products, GLOBE deals with these commodities as an aggregate category and shows that their combined TRQ is not filled under any of the scenarios. By contrast, CAPRI results indicate that the small TRQ for butter offered by the EU would be filled, but that the much larger one requested by Mercosur would fall just short of being filled. The fill rates for the other separate dairy TRQs (milk powder and cheese), cannot be modelled in CAPRI for the reason in section 7.1. Overall, it has to be concluded that, although both models suggest that overall the TRQ limits requested by Mercosur appear to be in excess of what Mercosur trade could effectively fulfil by 2020, this suggestion receives more support for more products in the CAPRI results than in the GLOBE results.

The pattern for oilseeds and oils shows that, with more liberalised trade between the two blocks, the EU’s imports of oilseeds would be lower, but vegetable oil imports would increase considerably. EU exports of oilseeds and vegetable oils are very low in the reference scenario, and hence export adjustments remain small in volume. The changes in EU imports of oilseeds and oils largely involve soy beans and soy oil, whereas the adjustments in EU production in the oilseed and vegetable oil sectors concern rape seed and sunflower seed. There is a substantial increase in exports of olive oil in all scenarios.

It is important to note that changes in the cereals and oilseeds sectors are the combined effect of direct adjustments due to increased market access and indirect impacts through changes in feed use as a result of the large impacts in the livestock sectors of the two trade blocks. The balance sheets for the main products indicate that a bilateral agreement lowers EU meat production but increases EU meat consumption. In the Mercosur-only scenarios, all the expansion comes from poultry meat, whereas in the post-Doha context, there is a shift towards both beef and poultry and away from pork and sheep meat. Mercosur meat consumption is lower in all scenarios because of higher consumer prices. The same pattern is observed for citrus fruit: consumption increases in the EU despite lower production but it is lower in Mercosur.

GLOBE provides evidence on changes in economy-wide factor incomes in the different scenarios. The pattern of the changes is consistent across the five scenarios, with the size of the changes depending on the degree of trade liberalisation. In both EU15 and EU12, factor incomes increase by very small percentages except for land, whose total income falls consistently. These changes are all smallest in the scenarios with no Doha Round agreement, increase substantially in the Doha-only scenario, and are largest for the Mercosur request in the post-Doha context. However, despite increases at the level of the whole economy in total factor income for unskilled and skilled labour, and for capital, the income of these factors employed within agriculture falls, and more steeply in EU15 than in EU12.

All factor incomes in Mercosur have larger percentage gains than in the EU. For each of the factors, the highest percentage gains occur when the factor concerned is employed in agriculture. However, it is notable that the returns to labour and capital employed in the food industry are systematically lower under the Mercosur request than for the EU offer.

One indicator of the economic impact on agriculture at Member State level is revenue from all agricultural activities per hectare of utilised agricultural area. This measure has been used to compare the impacts of the five policy scenarios. Under the scenarios without a Doha Round agreement, the impacts are negative for all except a few of the New Member States (seven with the EU offer, five with the Mercosur request).

Ten Member States have reductions of between one and two per cent, but Luxembourg and Ireland experience deeper reductions. In the post-Doha context, these impacts are all larger, and more negative. A small number of Member States, in particular the Baltic States, Hungary and the Czech Republic, experience only minor downward impacts on agricultural revenue. However, 19 Member States have declines of more than two per cent under the Mercosur request. Ireland, the United Kingdom, Luxembourg and Austria all register falls of four per cent or more.

At NUTS two level, the distribution of the production and revenue falls for individual products depends both on the pattern of specialisation for the product and the regional competitive advantage in its production. The largest percentage falls in revenue are observed for regions specialising in livestock production. In a few regions, falls in beef production are as much as nine per cent and the decrease in revenue from beef exceeds 20 per cent in some regions.

In summary, the model results indicate that the economic losses and the adjustment pressures arising from a bilateral trade agreement between the EU and the countries of Mercosur would, as far as the EU is concerned, fall very heavily on the agricultural sector. The gains to other sectors would be widely diffused and, given the very small magnitude of these gains relative to the EU economy as a whole, would be easily absorbed without imposing an adjustment burden. The aggregate welfare changes for the EU, whether measured across the whole economy or on a partial basis with respect to the activities agricultural production and food consumption, would be small.

However, the trade-off involved in the redistribution of income between agriculture and the rest of the economy is steeper in the scenarios depicting the Mercosur request compared with those involving the EU offer. The Mercosur request provokes a much greater downward impact on agriculture whereas the additional gains elsewhere (to non-agrifood sectors or to consumers) are relatively smaller.

December 2011

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