CoPS/IMPACT Working Paper Number G-148

Title: The Effects of a Free Trade Agreement Between Australia and the USA with Special Reference to the Victorian Economy: Main Report

Author: Philip D. Adams


This paper documents analysis of the economic effects of the proposed free trade agreement between Australia and the USA using a specially-built dynamic version of the GTAP world general equilibrium model. At the core of the new model is the standard GTAP Version 6.0 framework, released in April 2001. Onto this basis we add the following.

* A series of new variables representing useful aggregates of primary agricultural and agriculture-related sectoral outputs, exports and imports. These do not alter the basic theory of GTAP in any way and are merely defined for convenience.

* New variables and equations which furnish GTAP with simple dynamic behaviour. These allow us to run linked annual GTAP simulations for each year between 1997 and 2023. For each region, the new equations: (a) link net investment in each year to the change in the capital stock for that year; (b) allow employment to respond temporarily to changes in real wage rates; and (c) allow rates of return to capital to respond temporarily to changes in demands for capital. In the long run, all 3 dynamic equations reduce to simpler forms: investment moves in proportion to capital stock; and employment and rates of return converge to baseline trend levels.

* A tops-down regional disaggregation facility which allows results at the national level for output and employment to be disaggregated first to the state/territory level and then to the level of 56 sub-state regions.

In reporting our results we concentrate on findings for the Victorian economy and for its eleven sub-state regions. Our main findings are:

* Cuts in protection associated with the FTA lead to increased employment, increased capital and higher real wage rates in Australia and the USA;

* The effects of the agreement vary across industries. The mechanisms, however, are fairly straightforward, depending primarily on the extent to which the protection cuts exposes sectors to additional import competition and on each sector's export orientation.

* The states that gain most from the FTA are Queensland, Western Australia and Tasmania. The states that gain least are Victoria and South Australia. However, it should be noted that all states gain, and that the difference between the increase in real GSP for the state that gains most (Western Australia) and the state that gains least (Victoria) is only 0.09 percentage points.

* An implication of our regional methodology is that regions with an over-representation of favourably affected "national" industries gain at the expense of regions with an under-representation of such industries. Victoria gains least because it is over-represented in industries least favourably affected by the FTA. Prominent among these is Motor vehicles.

* In the long-run year, the Victorian sub-state regions that gain most from the FTA are the Western District (real GRP up 0.47 per cent c.f. an increase in Victoria's real GSP of 0.13 per cent), Wimmera (real GRP up 0.39 per cent), Goulbourn (0.38 per cent) and the Mallee (0.37 per cent). All regions are projected to experience increased real GSP as a result of the FTA, but Melbourne and Barwon are expected to expand least. In terms of employment, the FTA results in net job loss in Melbourne and Barwon.

JEL classification: C68 , F15 , R13

Keywords: Multiregional, CGE, trade, liberalisation, dynamics.

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