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posted on 17 October 2016

How Preferential Trade Agreements Affect The U.S. Economy

from the Congressional Budget Office

The United States has 14 preferential trade agreements with 20 of its trading partners. In CBO's view, the consensus among economic studies is that, all told, such agreements have had small positive effects on the U.S. economy.

Preferential trade agreements (PTAs) are treaties that remove barriers to trade and set rules for international commerce between two countries or among a small group of countries. PTAs directly affect a country's economy by altering its flows of trade and investment. Primarily through trade, PTAs indirectly affect other aspects of a country's economy-such as productivity, output, and employment. As of August 2016, the United States had established 14 PTAs with 20 of its trading partners. This report surveys the economic literature on trade and PTAs and summarizes that literature's findings on how trade and PTAs have affected the U.S. economy.

How Does Trade Affect the U.S. Economy?

International trade yields several benefits for the U.S. economy. Trade increases competition between foreign and domestic producers. That increase in competition causes the least productive U.S. businesses and industries to shrink; it also enables the most productive businesses and industries in the United States to expand to take advantage of profitable new opportunities to sell abroad and obtain cost savings from greater economies of scale. As a result, trade encourages a more efficient allocation of resources in the economy and raises the average productivity of businesses and industries in the United States. Through that increase in productivity, trade can boost economic output and workers' average real (inflation-adjusted) wage. In addition, U.S. consumers and businesses benefit because trade lowers prices for some goods and services and increases the variety of products available for purchase.

Not everyone benefits from trade expansion, however. Although increases in trade probably do not significantly affect total employment, trade can affect different workers in different ways. Workers in occupations, businesses, and industries that expand because of trade may make more money, whereas workers in occupations, businesses, and industries that shrink may make less money or experience longer-than-average unemployment. Such losses can be temporary or permanent. Nevertheless, economic theory and historical evidence suggest that the diffuse and long-term benefits of international trade have outweighed the concentrated short-term costs. That conclusion has consistently received strong support from the economics profession.

Why Does the United States Establish Preferential Trade Agreements?

The United States establishes preferential trade agreements for economic and noneconomic reasons. Those agreements enable the United States and its partner countries to realize the economic benefits of increased trade and investment. In addition, the agreements sometimes harmonize laws and regulations which, among other effects, make the costs of operating businesses in other countries more similar to those costs in the United States. An important noneconomic reason for establishing PTAs is to achieve foreign policy goals. Those goals include supporting the economies of U.S. allies and promoting the adoption of preferred domestic policies, such as environmental conservation or stronger workers' rights.

How Do Preferential Trade Agreements Work?

Preferential trade agreements facilitate trade and investment among member countries. To encourage member countries to trade, PTAs reduce or eliminate barriers to trade, such as import tariffs (taxes that countries impose on foreign-made goods), restrictions on trade in services, and other commercial rules that impede the flow of trade. In addition, PTAs facilitate investment among member countries by easing regulations on foreign investment and providing improved legal protections for foreign investors.

Preferential trade agreements also set commercial rules that, among other effects, narrow differences in the costs of operations among member countries. For example, some PTAs establish minimum labor and environmental standards and protections for intellectual property. If the costs of compliance are high, those types of rule-based reforms can impede trade and investment flows, making some businesses less competitive in foreign markets.

To ensure that member countries comply with the provisions of an agreement, PTAs establish dispute resolution mechanisms. Those mechanisms can take two forms: One provides a legal platform for countries to make claims against other member countries; the other enables investors in member countries to make claims against the governments of other member countries.

How Much Have Preferential Trade Agreements Affected the U.S. Economy and the Federal Budget?

In CBO's view, the consensus among economic studies is that PTAs have had relatively small positive effects on total U.S. trade (exports plus imports) and, primarily through that channel, on the U.S. economy. The effects have been small because the agreements were mostly between the United States and countries with much smaller economies and because tariffs and other trade barriers were generally low when the agreements took effect (see table below). PTAs have had little effect on the U.S. trade balance (exports minus imports) and have slightly increased flows of foreign direct investment, mostly by encouraging additional U.S. investment in the economies of member countries. As a result, the indirect effects of PTAs on productivity, output, and employment in the United States have also been small and positive. Empirical estimates support that view. But those estimates are uncertain and may be understated, because the effects of nontariff provisions are hard to measure and because issues with data keep researchers from identifying how PTAs affect the service sector.

Characteristics of Partner Countries of U.S. Trade Agreements Before the Year of Implementation

The effect of PTAs on the federal budget is unclear. In assessing the budgetary impact of previous preferential trade agreements, CBO's cost estimates have indicated that they would slightly lower the amount of federal revenues received from tariffs. However, those results did not consider how the macroeconomic effects of PTAs might alter the federal budget. Nevertheless, the small size of the effects on output suggests that the overall budgetary effects have also been small.

[click here to read the entire study]


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