What’s Trade Got To Do With It?Published: February 11, 2004 in Knowledge@Emory
The respective merits of regional trade agreements are hotly debated in economic circles, confirms Jay Lyle, a principal with Computer Sciences Corp. Lyle studied free-trade agreements in a global economics Executive MBA class at Emory University’s Goizueta Business School. The class is led by Jeff Rosensweig, director of the Global Perspectives Program, and a professor of international business and finance at Goizueta.
“Understanding the impact of trade agreements is a strategic necessity for executives that are responsible for growth strategies,” observes Rosensweig. “Most of the world’s income and production is generated by nations who participate as active members in preferential regional trade area. Beyond the key ones studied by Lyle’s group, we can think of the European Union.” The Goizueta program approaches the implications of these trade pacts from a macro perspective in Rosensweig’s course, and from a firm-level perspective in such courses as multinational enterprise, taught by L.G. Thomas, professor of organization and management at Goizueta.
Lyle and four other team members conducted a month-long comparative study of NAFTA and Mercosur, the Brazil-led Southern Common Market. The Mercosur, or the "Mercado Comun del Sur" (Southern Common Market) was created in March 1991, by Argentina, Brazil, Paraguay and Uruguay when they agreed to form a customs union. Customs unions and free trade areas are both forms of trade agreements, Lyle explains, meant to liberalize trade in a manageable political and geographical scope. The team presented its research in the paper, “A Comparison of the Effects of NAFTA and Mercosur.”
“From an economic perspective, free trade is always good and we wanted to test the proposition that free trade is indeed good and determine whether, for instance, NAFTA had had a positive effect,” notes Lyle, who has completed his studies and settled back into his job at Computer Sciences Corp. The group’s analysis sought to determine whether the perceptions that NAFTA is more successful than Mercosur are accurate, defining success to mean an increase in member country exports, on the assumption that trade, according to the theory of comparative advantage, increases general welfare. They also compared the relative success of the two agreements and explained the differences they observed.
Following a detailed look at the origins of NAFTA and Mercosur, Lyle and his team set out to evaluate the respective performances of NAFTA and Mercosur by measuring the effect of membership on member country exports. “First we did a study comparing NAFTA to Mercosur,” explains Lyle. “We then controlled for other influences using a gravity model. The point of the gravity model is to look specifically at interactions between countries.” The simplest test for an effect on exports might be a cross-section of nations in a given year, showing the difference between member and non-member countries, but the wide disparities in national income, education, infrastructure, political stability, and other factors seemed to make such an approach unworkably complex, write the authors. The easiest solution, they concluded, seemed to be a time-series analysis, which holds country variables constant. The team’s second model used 30 years of country data for 22 nations in the western hemisphere to calculate a coefficient for the effect of joining NAFTA or Mercosur.
A major challenge of the study, admits Lyle, was the difficulty of finding data for country-to-country comparisons. Even so, the international economics team reached some clear conclusions about the effects of NAFTA and Mercosur. “Experimentally, the results seemed to show that clearly NAFTA made a difference, a positive difference,” explains Lyle. “Mercosur did as well, but NAFTA seemed to be quite a bit more positive than Mercosur. Then the question is, why? One of the main qualitative differences is the fact that NAFTA includes the U.S., the biggest economy in the world by far. It’s going to have a bigger effect.”
The takeaway, suggests Lyle, is that determining whether or not free trade agreements are good or bad depends on the qualitative circumstances and the set-up of the agreement. The clearest illustration of that, continues Lyle, is a look at the Andean Pact, a third trade agreement involving countries such as Peru and Bolivia that were not rich enough to get into Mercosur. “The data suggests that their joining the Andean Pact actually had a negative correlation on GDP [Gross Domestic Product] and trade, which was a little bit surprising because no matter how weak the trade agreement is, it should exert some positive force,” says Lyle. “They joined the Andean Pact and didn’t join Mercosur or NAFTA, so the negative effect is the fact that as these trade agreements come into being, some countries get frozen out. It’s known as the innocent bystander effect. Two countries enter into an agreement. If the third country was trading with those two countries, it’s going to have negative consequences on the third country that gets left out.”
The findings in “A Comparison of the Effects of NAFTA and Mercosur” hold a few key implications for managers, suggests Lyle. If your company’s well-being is correlated with the GDP of your country, then free-trade agreements are a good idea and you should lobby for them, all else being equal. “The other lesson is that all else is never equal,” observes Lyle. “All of those other exogenous and qualitative factors mean that whether it’s a good thing for you or not depends on the laws, infrastructure and institutional set-up of your nation. You almost might deduce that because of the numbers, free trade will expand. It might be wise to identify those areas where America does enjoy a competitive advantage over other nations and try to focus your business development efforts in that direction.”
The team’s study could stimulate exploration in a few areas, says Lyle. “If NAFTA does improve trade between the U.S and Mexico, what does it do for trade between Mexico and Germany, which is Mexico’s next biggest trade partner?” questions Lyle. “It probably had a negative effect. Somebody would have to look at that before coming to any firmer conclusions. The other question would be, OK, we’ve increased total trade, but to whose benefit? In economic theory, we’ve grown the pie. There are more resources to go around and things are more efficient, but who benefits? Is it the workers, the citizens, the governments, the multinational corporations?”
Rosensweig confirms that academics debate the costs and benefits of regional trade pacts. “What is clear is the need for executives to analyze how current and prospective agreements can influence competition in their industry. Companies that develop insights into the nature of trading relationships, and the impacts of the various trade agreements that are in place or are under negotiation, will always fare better in the global economy,” suggests Rosensweig. “You have to dig deeper than what you read in the newspapers to fully incorporate the impacts into your strategies.”