Thirteenth Annual Conference on Global Economic Analysis
Bangkok, 9 – 11 June 2010
A quantitative economic assessment of a Canada-EU
Comprehensive Economic Trade Agreement
Elisavet Kitou▲ and George Philippidis♠
▲ Department for the Environment Food and Rural Affairs (DEFRA), Area D, 4th Floor, 9 Millbank, c/o
Nobel House, 17 Smith Square, London, SW1P 3JR, UK, email: firstname.lastname@example.org
♠ Aragón Research and Development (ARAID), Centre for Agro-Food Research and Technology (CITA),
Government of Aragón, Avda. Montañana 930, 50059 Zaragoza, Spain, email: email@example.com
The first round of negotiations held in Ottawa on the 19th October, 2009, heralded
the opening of bilateral trade talks intent on reaching a Canadian-European Union
(EU27) free trade area (FTA) agreement. A second round of negotiations were staged in
Brussels in January, whilst further rounds are scheduled for 2010, with the longer term
aim of ratifying an agreement within 24-30 months. Although stumbling blocs will be
encountered, the divergent political interests of each region are compatible. In Canada, a
FTA with its second largest trading partner offers a viable alternative to its current
overdependence on the US. Similarly, the EU27 sees an opportunity to regain a
competitive foothold in the North American market.
This paper re-examines the long run trade led gains from a Canada-EU27 FTA.
Unlike previous studies, our assessment also accounts for the HS6 level sensitive
product declarations submitted by both parties in the first round. We examine the extent
to which these proposals afford protection to key strategic sectors and impact on trade
led growth and real incomes. All estimates are compared with a realistic contemporary
baseline scenario. The results suggest that non tariff barrier (NTB) reductions dominate
real income gains, whilst sensitive product exceptions, principally affecting wheat,
dairy, wearing apparel and leather sectors, reduce Canadian and EU27 real income gains
by 20% and 24%, respectively. Trade diversion impacts are relatively marked for the
US and EFTA, whilst China escapes largely unscathed due to the pattern of its trade
Keywords: EU27 · Canada · Economic integration · Sensitive products
JEL classification: C68 · F11 · F15 · F17
Since its inception, the European Union (EU) has traditionally enjoyed warm
relations with Canada. Notwithstanding, progress on economic integration has been
sporadic, focusing on isolated sectors (e.g., science and technology, education,
competition, wine and spirits, aviation etc.) and between specific geographical regions
(e.g., Canada-UK, Canada-France, Quebec-France). Consequently, the annual Canada-
EU27 summit in Berlin in July 2007 took on additional significance when the idea was
first mooted to examine the potential for closer economic ties. At that time, the Doha
Development Round (DDR) was still in full sway and neither side wished to undermine
multilateral negotiations which promised „first-best‟ economic gains to all parties
concerned. Unfortunately, in the ensuing period multilateral talks have lingered, whilst
the trade reform agenda has been engulfed by a proliferation of „second-best‟ bilateral
free trade areas (FTAs). Indeed, over the last two years, Canada has signed accords with
Columbia, the European Free Trade Association (EFTA), Jordan and Peru, whilst the
EU27 has ratified an FTA with Korea and is looking to finalise an agreement with
Against this background, the politically strategic importance of a Canada-EU27
FTA should not be underestimated. Canada has enjoyed significant growth as a member
of the North American Free Trade Agreement (NAFTA) with Mexico and the United
States (US), although as the recent economic crisis has shown, it has arguably become
over-reliant on the US economy, subsequently lacking resistance to US business cycles.
Moreover, recent calls from Capitol Hill to re-negotiate NAFTA as well as clauses in
the fiscal stimulus package to „buy US‟, have not gone unnoticed by Canada. From the
EU‟s perspective, an FTA with Canada presents a unique opportunity to restore a
degree of competitive parity with the US, which was lost under the NAFTA agreement.
Table 1 presents the top ten merchandise trade partners for Canada and the EU27
and highlights two main observations. Firstly, as postulated by the gravity model
(Anderson and van Wincoop 2003), bilateral trade is positively related to mass (i.e.,
GDP) and negatively correlated with distance. Under these simple criteria, EU27
imports from Canada are perhaps under-represented. For example, due to its GDP the
EU27 ranks second for Canada, whilst Canada, which has a considerably larger
economy than either of Switzerland, Turkey or South Korea, lies tenth.1 Furthermore,
time series data (Eurostat 2009) demonstrate that Canada‟s share of EU27 trade has
fallen from 2.3% in 1999 to 1.7% in 2008. Secondly, the data show that the US and to a
lesser extent China, play a key role for both regions, whilst specific EFTA members
(i.e., Switzerland and Norway), have significant trade relations with the EU27.
The structure of trade protection in both trading partners is presented in Table 2.
The underlying statistic for both regions is the relatively low average MFN applied
tariff rates (4.7% and 5.6% in Canada and the EU27, respectively). In both regions,
tariff protection is concentrated in the agricultural sectors, recorded at 11.5% (Canada)
and 16.0% (EU27). The maximum applied tariff line in Canada is found within animal
products (718%), although on average Canadian dairy produce is the most sensitive,
with an applied protection rate of 126%.2 By the same token, EU27 dairy (64.1%) and
„sugars and confectionary‟ (33.3%) regimes are the most trade prohibiting. In non-
agricultural and fishing sectors, both Canadian and EU27 average applied tariffs are
highest on clothing imports (16.9% and 11.5% respectively).
Reviewing the data above, it is expected that Canada would benefit considerably
more than the EU27 from a hypothetical FTA, whilst trade diversion impacts are mainly
expected in the US. Average applied tariffs on merchandise trade are relatively low
which is likely to moderate Canada-EU27 trade gains, although Guerin and Napoli
(2008) suggest that the EU27 exhibits a similar tariff structure to the US when it signed
the CUSFTA (Canada-US FTA) in 1989, which resulted in notable trade gains to
Canada. Further, it is anticipated that higher than average protection on agro-food
imports would imply important resource shifts in these sectors under full liberalisation;
a factor which underlies the debate on „sensitive product‟ exceptions within the
negotiations. Finally, the potential economic gains from the liberalisation of non-tariff
barriers (NTB) relating to trade-inhibiting practices on merchandise (i.e., licensing, pre-
shipment inspection, rules of origin, etc.) and services trade (i.e., application delays for
visas; restrictions on ownership by, or participation of foreign firms, etc.) and the
concomitant positive spill-over effects on investment are likely to be considerable.3
1 Furthermore, other positive factors on trade postulated within the gravity model, such as cultural
similarities and common language, suggest that Canada-EU trade ties should be even stronger.
2 Note, that in Table 2, zero per cent of dairy tariff lines are duty free.
3 EU-Canada services trade amounted to €20.5 billion in 2007 (Eurostat 2009), dominated by „transport‟
and „travel‟ services. The EU also offers notable exports to Canada of (€877 million) and insurance (€621
A review of the relevant literature reveals only two studies which enumerate the
economic gains from a Canada-EU27 FTA. One example by Cameron and Loukine
(2001) employs the standard Global Trade Analysis Project (GTAP) computable
general equilibrium (CGE) model and accompanying version 4 database, aggregated to
6 regions and 10 sectors (including aggregate „primary agriculture‟ and „food sectors‟).
The study develops two policy scenarios: tariff elimination on all merchandise trade
except food and agriculture; and complete tariff elimination. As the study pre-dates EU-
enlargement, the authors represent an „enlarged‟ common agricultural policy (CAP) via
trade preferences to accession members. The study estimates that trade creation exceeds
trade diversion yielding real income or equivalent variation (EV) gains to Canada and
the EU15 of up to $236 million (0.04% of GDP) and $772 million (0.01% of GDP),
respectively. Interestingly, the US suffers a trade diversion loss of $562 million.
In a second study, commissioned by the European Union and Government of
Canada (EU and GC, 2008), a 35 sector aggregation of the GTAP data (version 7) is
employed.4 The CGE model code is modified to capture imperfectly competitive „scale
effects‟, efficiency gains in manufacturing and services sectors from reductions in trade
costs (i.e., NTB), and a long run closure to characterise capital accumulation from real
income induced investment increases. Consequently, EV estimates from a Canadian-
EU27 FTA scenario are significantly magnified compared with Cameron and Loukine
(2001). Canada and the EU27 gain €8,161 billion (0.77% of GDP) and €11,594 billion
(0.08% of GDP) respectively, whilst 66% and 75% of the total gains stem from NTB
removal in Canada and the EU27, respectively.
The aim of this study is to reassess the economic impacts of a Canada-EU27 FTA
employing the GTAP data and a modified long run variant of the accompanying CGE
model. Unlike previous studies, more attention is given to the trade impacts in the agro-
food sectors where a majority of tariff peaks occur, whilst we also shed more light on
the trade diversion (and consequently global) impacts. A unique feature of the paper is
to focus on the HS6 sensitive product declarations submitted by both parties in the first
round of trade talks in October 2009. We examine the extent to which these proposals
afford protection to the relevant sectors and affect trade led growth and real incomes.
All results are compared with a realistic contemporary baseline scenario.
4 The sector aggregation treats agricultural and food processing activities as single aggregate sectors. The
regional aggregation employed is not stated and it is not clear if the authors refer to the EU25 or EU27.
Moreover, the remit of the study does not contemplate the impacts of trade diversion on third countries.
The rest of this paper is structured as follows: Section 2 details the data,
methodology and the scenario designs employed. In section 3, the results are discussed,
whilst section 4 concludes.
2.1 Modelling and Data
There is a burgeoning of CGE trade literature quantitatively analysing (inter alia)
the impacts of multilateral (e.g., Francois et al. 2005), regional (e.g., De Bruijn et al.
2008) and bilateral trade agreements (e.g., Gouranga and Andriamananjara 2006).
Underpinning these studies is the widely respected Global Trade Analysis Project
(GTAP) database (Narayanan and Walmsley 2008), which in its latest incarnation
(version 7), is benchmarked to 2004 and covers production and trade flows for 113
regions and 57 commodity groupings.
Accompanying the data, is a „standard‟ comparative static GTAP model
framework based on a system of neoclassical final, intermediate and primary demand
functions. Assuming weak homothetic separability, optimisation is sub-divided into
„nests‟ to allow greater „behavioural‟ flexibility through the incorporation of differing
elasticities of substitution, whilst accounting identities and market clearing equations
ensure a general equilibrium solution. Once the model is calibrated to the data and an
appropriate endogenous/exogenous variable split is chosen (i.e., „closure‟),
macroeconomic or trade policy „shocks‟ can be imposed on key exogenous policy
variables (i.e., tariff/subsidy rates, technical change variables etc.). Through the
interaction of economic agents within each market, a „solution‟ is characterised by a
„counterfactual‟ set of equilibrium conditions. The standard framework is modified in a
number of ways, with additional discussion in the technical appendix.
As the analysis of Canada-EU27 protectionism reveals, sectoral impacts in
agricultural sectors are likely to be larger due to the prevalence of tariff peaks.
Consequently, to improve the analysis, significant additional model code is inserted to
capture the rigidities inherent within agricultural factor and product markets. Firstly,
following Keeney and Hertel (2005), constant elasticity of substitution (CES)
substitution possibilities are modelled between intermediate inputs and primary factor
demands, whilst in livestock sectors, intermediate feed inputs are also now CES
substitutable.5 A constant elasticity of transformation (CET) controls the transfer of
labour and capital factors between agricultural/non-agricultural sectors to capture
observed differentials in wages and rents in each sub-sector.
Secondly, a three-stage weakly separable CET nest to capture land-use
heterogeneity across different agricultural activities is employed. Thirdly, following the
procedure of van Meijl et al. (2006), an econometric nonlinear land supply function is
estimated for the 113 regions in version 7 database, complete with an aggregation
program for the relevant land supply parameters. Fourthly, the study incorporates
explicit modelling of the EU27 common agricultural policy (CAP) (e.g., set aside, CAP
budget, intervention prices, quotas etc.), whilst raw milk quotas are modelled in
Canada.6 Finally, Canadian and EU27 tariff-rate quotas (TRQs) are modelled (Elbehri
and Pearson 2005), although the broad GTAP sectoral classification restricts TRQ
representation to Canadian dairy imports and EU27 wheat and beef imports (see
To keep the model within computational limits and focus on those issues of
interest the data is aggregated to 13 regions/countries and 32 sectors (Table 3). Owing
to the addition of model coding for the agricultural sectors, it is necessary to
disaggregate the EU27 into four separate regions, although results are only reported for
the EU27. In addition to Canada, the choice of remaining regions is based on the trade
data in Table 1, whilst a „rest of the world‟ region captures residual production and trade
flows. The detailed disaggregation of agro-food sectors permits a more detailed
examination of the main gainers/losers at the sectoral level. Remaining non-food sectors
are grouped into four manufacturing sectors and ten services sectors.
2.2 Experimental Design
Under the auspices of the Comprehensive Economic Trade Agreement (CETA), the
first round of Canada-EU27 negotiations began on the 19th October, 2009, in Ottawa,
whilst a full ratification of an agreement is unlikely before 2012. Under article
XXIV:5(c) GATT, a FTA should be completed within, “a reasonable length of time”,
5 The standard GTAP employs a Leontief specification. This implies that, for example, the intensiveness
of fertiliser application on land cannot alter, or competing feeds are not substitutable in livestock sectors.
Substitution elasticities are calibrated to OECD central values of Allen partial elasticities (Keeney and
6 Owing to the short term transitional nature of many of Canada‟s agricultural policies and the medium to
long run time horizon considered, no attempt was made to further model its agricultural sector.
defined as ten years, although it is further stated that, “In cases where member
parties…believe that 10 years would be insufficient they shall provide a full
explanation…of the need for a longer period”. As Bartels (2009) notes, “Practice
indicates that it is relatively common for the implementation period to stretch to 12
years” (pp346). Accordingly, a long-run „baseline‟ is carefully designed up to 2024
(Table 4), against which two Canada-EU27 FTA scenarios are compared.
The baseline incorporates trade protection shocks to accommodate European
enlargement. Further Canada/EU27 tariff elimination shocks are implemented to
characterise recently ratified FTA deals (post 2004), or FTAs which are scheduled to
conclude post 2004. In this way, our reported trade creation and diversion effects from
the EU-Canada FTA are more accurately isolated. Thirdly, the baseline employs the
latest DDR modalities for agriculture (WTO 2008a) and non-agriculture (WTO, 2008b),
differentiated between developed and developing countries, small vulnerable economies
(SVEs), recently acceded members (RAMs) and less developed countries.
To enumerate the Doha tariff shocks, specialist software developed by Horridge and
Laborde (2008) is employed; with data on 5113 disaggregated HS6 applied and bound
tariff lines across 227 countries in 2004. By entering the relevant tariff reduction
formulae, this facility calculates necessary applied tariff reductions (accounting for
tariff binding overhangs) and aggregates to a GTAP concordance consistent with the
user‟s chosen aggregation. Doha tariff reductions also include „sensitive‟ concessions
on four per cent (five and one third per cent) of HS6 product lines for developed
(developing; small vulnerable economies (SVEs); recently acceding member (RAMs))
countries,7 based on the criterion of tariff revenue forgone (Jean et al. 2005).8 Fourthly,
in accordance with the „provisional‟ agreement reached at the Hong Kong summit in
December 2005, all export subsidies are eliminated.
In addition to the above trade shocks, a „likely‟ EU27 CAP reform scenario is
inserted. Following Oskam et al. (2004), a digression rate of 2 per cent per annum in
7 Owing to complexity of the model code, TRQs are only modelled between Canada and the EU27. It is
therefore assumed that 68% (instead of 66% - see WTO 2008) of the corresponding Doha tariff reduction
is applied to sensitive product lines to account for the absence of additional market access from TRQ
8 This criterion has become an accepted hypothesis for identifying sensitive products, although it is
hampered by assuming invariant tariff quantities, whilst cases of prohibitive tariff barriers have a zero
weighting. Nevertheless, it still „largely‟ accounts for the (political) importance of the commodity (i.e.,
size of the tariff revenue), the height of the applied tariff compared with the c.i.f. import price, and the
distance between the binding and applied tariff rates (i.e. the revenue fall under each formula is a function
of this „distance‟).
nominal euros is applied to the EU27 single farm payment (SFP) (pillar I) from the
2013 ceiling limits9 and modulation rates are raised to 20 per cent from the current 5 per
cent limit. With complete decoupling, all price support and quantitative constraints are
eliminated, whilst the Canadian milk quota is maintained.10 A final feature of the
baseline is the model closure. Given the importance of investment flows on potential
trade led gains, a long run closure swap permits an endogenous treatment of the
interaction between changes in investment and the capital stock. Thus, it is assumed that
investment moves in tandem with fixed savings rates, respecting the long run empirical
observation that domestic saving finances domestic investment (Francois et al. 1996).
In addition to the baseline shocks, the first „policy‟ scenario implements a full
Canada-EU27 FTA characterised by bilateral tariff eliminations.11 Whilst the standard
GTAP database lacks bilateral estimates of NTBs, EU and GC (2008) provide
econometric estimates of NTB costs between Canada and the EU27 for the ten
aggregate service sectors included in this study. Following EU and GC (2008), Canada-
EU27 NTB liberalisation is only partial, although as suggested by the trade data and
literature, even small NTB cost reductions will bestow important trade creation gains to
both parties.12 In non-commodity goods sectors (i.e., food processing and
manufacturing), the assumption in EU and GC (2008) of a two percent NTB cost saving
is implemented. In the model code, the (partial) removal of trade restraining NTB
measures is imposed by shocking a bilateral hicks-neutral technical change variable in
the import (Armington) demand function (Hertel et al. 2001). This has the effect of
increasing the „effective quantity‟ imported at a lower „effective price‟.
The second scenario examines the impact of „sensitive‟ product exemptions on trade
creation and diversion. Unfortunately, GATT article XXIV employs a nebulous
definition of a preferential trading agreement (e.g., FTA), as the removal of restrictions
„on substantially all the trade‟, which grants a degree of flexibility at the negotiating
9 Since a full FTA is assumed by 2024, the 2% per annum reductions on the SFP ceiling limits in 2013 to
EU27 members are calculated over 11 years.
10 Referring to the Canada-EU talks, Canadian Trade Minister Stockwell Day maintained that “..supply
side sectors are not things we negotiate...We have established many bilateral and multilateral agreements
with that understanding, and that is how we are proceeding with this one.”
11 Although this scenario is politically overambitious, it still serves as an upper limit estimate on the gain
to both parties.
12 EU and GC (2008) estimate additional NTB services trade costs into Canada ranging between 24-52%,
whilst those for the EU are between 18-42%. The authors have extrapolated from the increase in services
trade under EU‟s single market in order to estimate the magnitude of NTB services trade cost reductions
from Canada-EU bilateral liberalisation. Consequently, NTB cost reductions in the order of between 2%-
10% (depending on the service sector) are derived, which in turn, are employed in this study.
table. Examining Canada‟s initial tariff offer from the October 2009 negotiations (EC,
2009), exceptions are proposed on 8.1% of tariff lines, divided between agrifood (3.7%)
and non-agrifood (4.4%) commodities respectively. The EU27 proposes exceptions on
10% of tariff lines apportioned as 3.9% and 6.1% between agrifood and non-agrifood
tariff lines respectively. These tariff reduction exemptions are implemented at the HS6
level and aggregated to the GTAP sector concordance employing the TASTE program.
The size and complexity of the model framework makes a discussion of all the
results unwieldy. Instead, the focus is on Canada and the EU27 aggregate region, whilst
some commentary is reserved for the trade diversion impacts on third countries.
3.1 Scenario 1 vs. Baseline
3.1.1 Macro Welfare
Macroeconomic (welfare) impacts are presented in Table 5 compared with the
baseline and calculated as money metric changes in real income (equivalent variation)
measured in millions of euro at 2004 prices. Table 5 also provides a decomposition of
equivalent variation (EV) between allocative efficiency (AE), terms of trade (ToT)
impacts, endowment effects (EE) and efficiency gains from partial removal of non tariff
barriers (NTBs). Compared with the baseline, both the EU27 and Canada realise trade
led gains of €4,336 million and €3,157 million respectively, which equates to a
corresponding per capita real income gain of 0.05% and 0.45%. Not surprisingly,
Canada‟s trade led gains are larger given the EU27‟s trade weighting.
Interestingly, the proportion of EV gains owing to trade facilitation from NTB
eliminations is 67% (Canada) and 57% (EU27) (not shown). Indeed, despite the fact
that NTB removal is only partial, it still dominates since it applies to the majority of
trade flows (except primary agriculture), whilst in many sectors (i.e., non-food
manufacturing) tariff barriers are typically low, or zero (i.e., services) in these sectors.
AE measures the change in resource or product usage from policy shocks imposed
on a given market distortion (i.e., tax/tariff or subsidy). For example, a tax discourages
resource usage compared with free (undistorted) markets, whilst a subsidy has the
opposite effect. Consequently, taxed (subsidised) activities have a positive (negative)
marginal social value, whilst an increase (decrease) in the level of a relatively highly
taxed (subsidized) activity results in an AE gain (loss) (Huff and Hertel, 2000). Tariff
abolition implies increases in imports for both regions, whilst there is a contraction in
subsidised agricultural activity in the EU27 (-0.05% (not shown)). Accordingly, Canada
and the EU27 realise AE gains of €889 million and €973 million, respectively.
The ToT effects for both regions are also positive, estimated at €434 million
(Canada) and €1,040 million (EU27). Owing to tariff eliminations, trade induced
increases in economic activity bid up factor prices (i.e., real exchange rate) in both
regions. Consequently, domestic (and consequently export) prices are increased.
Examining the EE, the endowment of land falls (rises) slightly in the EU27 (Canada)
owing to a contraction (expansion) in the primary agricultural sector.13 The single
largest source of EV gain is the EE for net capital investment. Owing to trade induced
economic growth, EE is estimated at €928 million and €1,504 million in Canada and the
The employment of NTBs represent an additional usage of resources to (inter
alia) meet regulatory stipulations, modify products for different markets and comply
with import procedures. Liberalisation of NTBs therefore represents an unambiguous
efficiency gain to both regions, which is a function of the size of the trade flow and the
trade elasticity in each region. Given Canada‟s greater trade relative dependency on
EU27 markets, efficiency gains in Canada (€897 million) exceed those of the EU27
(€820 million), both in relative and absolute terms.
Examining third countries, the trade diversionary impacts of the Canada-EU27
FTA are mostly felt in the US and EFTA regions, which show per capita real income
losses of 0.02% (€1,626m) and 0.05% (€212 million) respectively. As a result of the
relative contraction in economic output in both regions, the majority of EV losses stem
from relative contractions in net capital investment and ToT losses due to real exchange
rate deteriorations. Despite its importance in EU27 and Canadian trade (Table 1), the
loss to China is mitigated owing to the fact that unlike Canada and the EU27, it
specialises in lower value added goods (vis-à-vis services trade).
13 In the GTAP model data, the land factor is specific to the agricultural sectors only.
3.1.2 Sectoral Output, market prices and trade balances
Table 6 presents changes in sectoral output, market prices and trade balances
compared with the baseline. Output changes are a function of the relative trade
competitiveness between the EU27 and Canada, the associated arming ton (trade)
elasticities, the magnitude of the bilateral trade flows, as well as the pattern of each
region‟s trade with third countries (trade diversion). The majority of agro-food trade is
through processed food sectors, which impacts on upstream sectors through purchases
of intermediate inputs. With the exception of „vegetables, fruits and nuts‟, dairy and the
„other food‟ processing,14 Canada is more trade competitive in these sectors.
Examining the results for scenario 1 (Table 6), Canada witnesses large percentage
increases in rice (185.1% - calculated from a small base) and wheat (14.8%).15 From the
EU27 perspective, the elimination of its wheat TRQ results in a production fall of 1.9%.
Canadian „oilseeds‟ and „other grains‟ production falls due to the reallocation of land
into the wheat activity, whilst the contraction in Canadian oilseeds impacts on the
downstream „vegetable oils and fats‟ sector.16 Furthermore, Canada‟s „vegetables, fruits
and nuts‟ sector (14% of total agricultural output) contracts 0.5%, whilst the removal of
its dairy TRQs leads to 7.9% and 9.3% reductions in Canadian raw milk and dairy
sectors respectively.17 The EU27 makes concurrent gains of 0.3% and 0.8% in raw milk
and dairy, respectively. Examining meat production, the Canadian meat and livestock
industry benefits at the (slight) expense of EU27‟s corresponding sectors.
Overall, aggregate agro-food production18 in Canada falls by 0.3%, with a 0.6%
gain in primary agriculture partially mitigated by contractions in food processing (-
0.7%) due to large contractions in dairy activities. In the EU27, agricultural production
falls 0.1% due to output losses in the wheat sector, whilst overall agro-food production
improves (0.1%), due to trade led gains in dairy.
In manufacturing sectors, where the majority of bilateral intra-industry trade
occurs, partial removal of bilateral NTBs in both regions has (ceteris paribus) an
unambiguous positive impact on sectoral output. The exception is „light‟ manufacturing
14 This is typically a large sector covering (inter alia) processed fish, vegetable, fruit and cereal products.
15 Wheat constitutes approximately 10% of primary agricultural production in Canada.
16 In this paper, land usage is modelled as heterogeneous between competing agricultural sectors – see
appendix. Moreover, „other grains‟ is not traded in significant quantities between the two regions, whilst
the GTAP protection data records near negligible tariffs on bilateral oilseeds trade.
17 In the GTAP database, raw milk is non-tradable and almost entirely purchased by the downstream dairy
18 In the interests of saving space, aggregate agro-food statistics are not reported in Table 6.
in Canada, which suffers due to its relatively higher tariff protection. In the absence of
tariff protection for services trade, the partial NTB elimination results in output
increases in both regions, where the smaller percentage rises in the EU27 reflect
changes on a larger base and the reduced relative importance of Canadian trade in the
EU27. With sectoral rises in manufacturing and services, Canadian and EU27 real GDP
grows 0.4% and 0.04% compared with the baseline (Table 6). Macro growth is
accompanied by rises in net capital investment (Table 7), although with the decline in
EU27 primary agriculture, land usage falls slightly accompanied by corresponding land
use increases in Canada (Table 7).
Turning to the changes in factor prices (Table 7), economic growth in both
regions bids up relative labour, capital and natural resource returns. Aggregate
agricultural land rents fall slightly in the EU27 owing to minor land idling, whilst in
Canada land rents increase 2.1% from the expansion in primary agricultural output.
With increases in factor costs, there are general rises in domestic sectoral market prices
(Table 6) in both regions, with the notable exception of Canadian dairy prices, which
fall owing to an influx of cheaper EU27 imports. The retail price index rises 0.2% and
0.1% in Canada and the EU27, respectively.
Turning to the trade balances (Table 6), the Canadian (EU27) „agricultural and
fishing‟ trade balance improves €363 million (deteriorates €440 million) largely due to
the reported impacts in the wheat sector. On the other hand, the Canadian (EU27)
processed food balance deteriorates €377 million (improves €1,126 million) as a result
of FTA induced changes in the dairy sector. Indeed, with reduced Canadian dairy
production, EFTA and the US switch to EU27 dairy exports resulting in dairy trade
balance deteriorations of €200 million and €426 million, respectively.19
In the non-food sectors, Canadian protection on light manufacturing trade
(including textiles and wearing apparel) is more prohibitive resulting in sectoral trade
balance deteriorations (to the EU27‟s concurrent trade balance gains). In the remaining
cases, Canadian sectoral trade balances generally improve at the expense of the EU27,
since the trade weight of the EU27 grants Canada with greater scope for trade creation.
Aggregating over all sectors, the trade balances in both regions deteriorate €50 million
and €215 million in Canada and the EU27, respectively.
19 Trade balance statistics for the remaining regions are not reported in the tables.
3.2 Scenario 2 vs. Baseline
3.2.1 Macro Welfare
In scenario 2, a number of sensitive product exceptions have been introduced into
the FTA based on the initial tariff offers from both Canada and the EU27. Accordingly,
this reduction in market access results in smaller EV gains (see Table 5) for both
Canada and the EU27 of €2,519 million (0.36% per capita utility) and €3,295 million
(0.04% per capita utility), respectively. Since the NTB percentage reductions remain
unchanged compared with scenario 1, the proportion of the EV gains due to NTB trade
facilitation increases to 81% and 74% for Canada and the EU27 respectively. A cursory
glance at third countries‟ welfare shows that EV impacts are mitigated (except for
Mexico) due to reduced trade diversion effects. Comparing between scenarios 1 and 2,
the largest per capita utility improvement occurs in the EFTA region (0.02%), whilst in
euro terms, the US‟s EV loss is reduced by €536 million.
3.2.2 Sectoral Output, market prices and trade balances
As expected, estimates in Table 6 quantify the extent to which stifling market
access impacts on macro growth, particularly in Canada which has greater trade
dependence on the EU27. Accordingly, as a general rule, output falls compared with
scenario 1, although more noticeable impacts are apparent in sectors containing
sensitive tariff line exceptions on commodities trade. Examining scenario 2 model
shocks on trade protection, reductions in Canadian tariff cuts are strongest in
„vegetables, fruits and nuts‟, „pigs and poultry‟, white meat, dairy products, processed
sugar, textiles and clothing. For the EU27, similarly affected sectors are wheat, „other
grains‟, red and white meats, „other processed food‟, textiles, clothing and heavy
manufacturing.20 Furthermore, TRQs on Canadian dairy and EU27 wheat and red meat
imports, are maintained.
In Canada, processed sugar, „vegetables, fruits and nuts‟, and in particular, dairy
activities expand compared with the baseline, due to reductions in market access, but
also from reallocations in primary resources from other contracting sectors. Canadian
TRQs on dairy remain over quota despite small falls in imports from the EU27 (not
20 Due to confidentiality reasons, the authors are not at liberty to specify specific HS6 tariff line
exceptions, given that we are still at an initial stage in the negotiations.
shown), whilst EU27 raw milk and dairy production remains static compared with the
baseline. Despite reduced market access in Canadian „pigs and poultry‟ and white meat
sectors, output in both cases contract compared with the baseline. This is due to a
greater abundance of EU27 sensitive product declarations for (red and) white meat,
which impacts negatively on Canadian producers.
A further key area is EU27 wheat production which remains protected (TRQ
remains in-quota), whilst also drawing in land from other EU27 cereals and oilseeds
sectors. Accordingly, an important source of competitive trade gain to Canada in
scenario 1 is now curtailed. Indeed, these trends in the wheat sector largely explain why
Canadian (EU27) „agriculture and fishing‟ production worsens (improves) compared
with scenario 1. In addition, the increase (reduction) in aggregate land usage in Canada
(EU27) is duly moderated (Table 7). Similarly, Canadian (EU27) food production now
benefits (suffers) compared with scenario 1, since Canadian dairy market access
remains restrictive. In „light‟ manufacturing, both regions issued numerous tariff
exceptions, principally on textiles and wearing apparel trade, which impacts negatively
on sectoral output in both regions, compared with scenario 1. In „heavy‟ manufacturing,
tariff line exceptions issued by the EU27 significantly reduce Canadian output gains
compared with the baseline, whilst concurrently benefiting the EU27.
Examining the price trends, reduced economic activity reduces inflationary
pressure on factor returns, although relative output increases in EU27 agricultural
output bid up land rents compared with the baseline (and scenario 1). On the other hand,
smaller tariff cuts by both regions, imply higher import prices. Overall, the former
exerts more influence on market prices (when compared with scenario 1), although
notable exceptions are dairy, processed sugar and light manufacturing in Canada, as
well as wheat prices in the EU27. Compared with scenario 1, the retail price index falls
in the EU27, whilst dairy, processed sugar and light manufacturing price rises
contribute to a slight retail price index rise in Canada.
Turning to the trade balances, the main differences from scenario 1 occur in the
wheat sector where the EU27 trade balance improves (€345 million) at the expense of
Canada (-€404 million). In dairy trade, the opposite is the case, whilst notable trade
balance improvements occur in the US (€438 million) and EFTA €204 million) dairy
sectors from eliminated trade diversion effects. Similarly, in heavy manufacturing, the
incorporation of sensitive product exceptions on EU27 import protection improves the
trade balance €1,188 million compared with scenario 1, where most of the formerly
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diverted trade is taken from the US (-€708 million (not shown)). Finally, in „light
manufacturing‟ sectors a number of sensitive product exceptions where issued on both
sides in the initial tariff offers data, where trade balance improvements compared with
scenario 1 reflect relatively greater restrictions on market access by one partner.
Accordingly, in Canada trade balances improve for „wearing apparel and leather‟ and
other light manufacturing, whilst in the EU27, the „textiles‟ trade balance improves.
In October 2009, Canada and the European Union (EU) held the first of five
rounds of trade talks with a view to establishing a Comprehensive Economic Trade
Agreement (CETA). From an economic perspective, the promise of unfettered access
for Canadian producers to its second largest trading partner presents an attractive
proposition, whilst simultaneously offering the EU27 a foothold in the North American
market. This paper quantitatively assesses the trade led impacts from a Canada-EU27
free trade area (FTA) agreement. In particular, the paper focuses on the role of the
sensitive product declarations submitted by both partners at the first round of talks, with
special attention on how such exemptions protect „key‟ sectors and consequently, affect
real income gains. As a final aim, the study attempts to shed light on the likely third
country effects from the deal.21
Importantly, the results are consistent with two previous studies on Canada-EU27
free trade showing that trade creation exceeds trade diversion and that Canadian gains
are relatively larger given the importance of the EU27 in its trade portfolio. A deeper
comparison of the results reveals that our real income estimates exceed Cameron and
Loukine (2001), but are below those of EU and GC (2008). In the former case, this is
because Cameron and Loukine (2001) do not incorporate non tariff barrier (NTB)
liberalisation or capital accumulation effects; which in this study are found to be two
significant sources of welfare gain.
In the latter case, there are several explanatory factors. Firstly, this study
incorporates numerous rigidities in factor, input and output markets, both between
primary agricultural sectors and agricultural/non-agricultural sectors. This inhibits the
21 One important caveat of this study is that the comparative static framework and assumption of market
clearing does not adequately account for the structural adjustment costs required between equilibria,
particularly frictional unemployment costs.