TWN Info Service on WTO and Trade Issues (Nov14/08)
24 November 2014
Third World Network  

TTIP may lead to EU disintegration, unemployment, instability - Part II
Published in SUNS #7919 dated 19 November 2014
 
Medford, MA, USA, 18 Nov (Jeronim Capaldo*) -- The Trans-Atlantic Trade and Investment Partnership (TTIP), a major trade agreement currently being negotiated by the United States and the European Union, is projected in econometric studies used by proponents as resulting in net economic gains for all countries involved, and with some projecting as benefiting the global economy too.
 
Most assessments in these studies, using Computable General Equilibrium (CGE) models, predict gains in terms of trade and GDP for both the EU and US, with some also predicting gains for non-TTIP countries and creating no losers in the global economy.
 
Unfortunately (as discussed in detail in Part I), these desirable results rely on multiple unrealistic assumptions and on methods that have proven inadequate to assess the effects of trade reform, and furthermore, several of these studies share the same questionable economic model and database.
 
To obtain a more realistic TTIP scenario, we need to move beyond CGE models. A convenient alternative is provided by the United Nations Global Policy Model (GPM), which informs influential publications such as the UNCTAD Trade and Development Report.
 
The GPM is a demand-driven, global econometric model that relies on a dataset of consistent macroeconomic data for every country. Two features make the GPM particularly useful in the analysis of a large trade agreement.
 
Firstly, the model assumes a more realistic mechanism leading to macroeconomic equilibrium. All models that make these types of projections necessarily make assumptions on the way economies will stabilize after a policy change, which in this case is the introduction of TTIP.
 
The most important difference between the GPM and the CGE models described is that, in the GPM, the full- employment assumption is replaced by the Keynesian principle of "effective demand" (Keynes 1936, Chapter 3). This means that the level of economic activity is driven by aggregate demand rather than productive efficiency.
 
Consequently, a cost-cutting trade reform may have adverse effects on the economy if the "costs" that it "cuts" are the labour incomes that support aggregate demand.
 
Unlike in CGE models, changes in income distribution contribute to determining the level of economic activity. The absence of this mechanism in many commonly used models has often led to major errors in assessing the impact of trade reforms.
 
Secondly, the GPM provides an explicit analysis of the macroeconomic workings of every world region. This, in turn, has two important benefits. It means that the model can provide well-founded information on the economic interactions among all regions, rather than just assuming that a given proportion of a country's income will be spent on imports from other countries.
 
It also means that the GPM allows us to assess whether a given policy strategy is globally sustainable. For example, the GPM shows that, when sought by every country, a strategy of export-driven growth may lead to adverse consequences such as a net loss of trade.
 
A third valuable feature of the GPM is its estimation of employment. Using International Labour Organization data, the GPM specifies how a given change in GDP growth affects employment growth, and vice versa.
 
A critical advantage of the specification used is that these growth-and-employment relationships (which economists call "Okun's relationships") are not constant over time.
 
In this way, the GPM recognizes that different factors might affect the relationship between output and employment at different moments in history. Thus, the model is able to account for recent puzzles such as "jobless growth."
 
Given the large amount of data that must be processed to estimate and simulate the GPM, we keep the analysis tractable by aggregating some countries into blocs. With this, we lose specific analysis for these countries.
 
Despite its limitations, the GPM offers a useful perspective on the consequences of agreements such as TTIP.
 
Indeed, it offers a "big picture" and insights into several important adjustment mechanisms that are often overlooked by other models.
 
SIMULATION STRATEGY: GLOBAL IMPLICATIONS OF EXISTING TRADE PROJECTIONS
 
Our country aggregation leaves the world's largest economies as independent units. In the TTIP area, the United States, the United Kingdom, Germany, France and Italy appear as stand-alone economies.
 
The remaining countries are aggregated into two blocs: "Other Northern and Western Europe" (including Finland, the Netherlands and Belgium) and "Other Southern and Eastern Europe" (including Greece, Spain, Portugal and eastern European economies).
 
But European nations and the US are not the only countries in the world. One benefit to macroeconomic models is that we can estimate the effect of a policy change like TTIP on countries outside of the potential trade bloc.
 
Accordingly, we are able to estimate how TTIP will affect individual countries like Argentina, Brazil, Canada, China, the Commonwealth of Independent States (CIS), India, Indonesia, Japan, South Africa and Turkey (which we count as independent units, much as we did with the US). All other countries are grouped into two blocs per continent.
 
As in other simulation exercises, we first project a baseline path for the economy of every country or country bloc from 2015 to 2025 in order to match previous studies. We then determine counterfactual values that are implied by the adoption of the TTIP.
 
To determine the baseline, we use all information available on countries' past and present policies and spending patterns. We use the same baseline assumptions as UNCTAD (2014).
 
For example, we assume that governments in TTIP countries and in some non-TTIP countries will not reverse their commitments to fiscal austerity. Therefore, even in the baseline scenario, we do not expect fiscal spending to expand aggregate demand even though historically this has been an important channel.
 
This confirms a major advantage to GPM-type models that we noted above: they allow for greater realism about the likely path of policy in the foreseeable future. (For more information about how these assumptions on the path of different countries' policies were constructed, see UNCTAD, 2014).
 
In order to implement the TTIP scenario, we assume that the volume of trade among TTIP countries will initially expand at the pace indicated by the existing studies. However, we do not rely on these studies for changes in net exports, which ultimately determine any changes in GDP.
 
Instead, we calculate net exports changes taking into account the global feedbacks built into the GPM. Therefore, our simulation clarifies the implications of the "consensus" pattern of trade in terms of GDP, income distribution and non-TTIP trade.
 
In the GPM, the impact of a given increase in trade is different from other models. As indicated above, such change affects the distribution of income ultimately feeding back into total demand and income.
 
Finally, we consider two specific mechanisms through which the European economy could adjust to these TTIP-induced changes in net exports.
 
First, we assume that increased international competition will exert pressure on the real exchange rate. This might occur as firms in every country try to preserve their international competitiveness and increase efforts to reduce labour costs. It might also be the result of unemployment pressures and legislation that would reduce total labour compensation.
 
As a result, the labour share of GDP would further decrease in Europe in a downward trend toward the lower US share, weakening aggregate demand. Finally, this adjustment mechanism might also play out through a nominal devaluation. This might indeed help an economy gain higher market shares abroad, but it may also generate a race to the bottom at the end of which no country will have gained higher exports.
 
The second mechanism recognizes a policy strategy that has become central in recent decades assuming that, in order to stimulate flagging domestic demand, policy authorities may increase lending. As a result, asset prices (including some financial assets) might increase, setting off the unstable dynamics that have become apparent after the 2009 financial crisis.
 
NET EXPORTS AND GDP
 
Our simulations show that the assumed trade expansion among TTIP countries will cause a net export loss for all EU economies. Losses would be a drag on aggregate demand for all EU economies. Northern European Economies would suffer the largest decreases (2.07% of GDP by 2025) followed by France (1.9%), Germany (1.14%) and the UK (0.95%).
 
On the other hand, US net exports would be higher by slightly more than one percent.
 
A likely explanation for how EU-US trade could expand while EU net exports to the world could decline is that, in the EU's stagnating economy, domestic demand for lower-value-added manufactures - in which the EU is relatively uncompetitive - will crowd out higher-value-added ones.
 
Indeed, our figures show an increase of net exports in almost every other region of the world except Europe, suggesting that higher demand for low-value-added products will lead to higher net imports from Asian and African economies and from the US.
 
Alternatively or additionally, TTIP could facilitate EU imports of manufactures assembled in the US with parts made in China and other regions.
 
Net exports are a key component of GDP. As such, the net loss of trade will directly lower EU countries' national income. Our simulations indicate small but widespread GDP losses for the EU, in a clear contrast with existing assessments.
 
Consistently with our figures for net exports, Northern European Economies would suffer the largest GDP reduction (0.50%) followed by France (0.48%) and Germany (0.29%). GDP would increase slightly in the US (0.36%) while GDP increases in non-TTIP countries would be positive but negligible (approximately 0.1%).
 
EMPLOYMENT AND INCOMES
 
Following the reduction of net exports and overall economic activity, we project clear losses in EU employment and labour incomes. Recall that our model allows us to make employment projections, because it estimates the relationship between GDP growth and employment growth over several decades based on ILO data.
 
This is compatible with a tendency toward specialization in higher-value-added, lower-employment-intensity products, which would lead to export and output gains in a few sectors while adversely affecting many others.
 
As a result, we calculate that the EU as a whole would lose approximately 600,000 jobs by 2025, most of which are in Northern Europe, France and Germany. By comparison, this is more jobs than the EU lost in the crisis years of
2010 and 2011 - clearly Europe must avoid another job loss of this magnitude even if gradual and spread over many years.
 
The loss of employment would further accelerate the reduction of incomes that has contributed to the EU's current stagnation. Indeed, labour income will continue its steady decrease as a share of total income, weakening consumption and residential investment while likely exacerbating social tensions.
 
The flip-side of this decrease is an increase in the share of profits and rents in total income, indicating that proportionally there would be a transfer of income from labour to capital. The largest reductions will take place in the UK (with 7% of GDP transferred from labour to profit income), France (8%), Germany and Northern Europe (4%), reinforcing a negative trend that has continued at least since the early 2000s (Figure 1).
 
To emphasize the difference between our results and existing estimates of employment impact, we calculated the projected reduction of per capita employment income implied by the fall of employment and the labour share.
 
As mentioned in Part I, CEPR estimates that the annual income of the average household would increase in the long term by 545 Euros, while Ecorys projects an increase in working life income, again for the average household, of 12,300 Euros. Given the ongoing deterioration of income distribution, we chose to focus on working households, calculating the change in per capita employment income.
 
Our results are clearly incompatible with both CEPR and Ecorys. Indeed, we project losses of working incomes per capita ranging from 165 to more than 5,000 Euros. France would be the worst hit with a loss of 5,500 Euros per worker, followed by Northern European Countries (4,800 Euros), the United Kingdom (4,200 Euros) and Germany (3,400 Euros).
 
For a household with two working persons, the loss ranges from 330 to more than 10,000 Euros. By contrast, in the US there would be an increase of employment income.
 
The loss of economic activity and the weakening of consumption in the EU means that tax revenue will be less than it would have been in the absence of the TTIP. We estimate that the surplus of indirect taxes (such as sales taxes or value-added taxes) over subsidies will decrease in all EU countries, with France suffering the largest loss (0.64% of GDP or slightly more than 1% of total government budget).
 
Government deficits would also increase as a percentage of GDP in every EU country, pushing public finances closer or beyond the Maastricht limits.
 
The loss of employment and labour income will increase pressure on social security systems. Using GPM employment projections and UN population data, we can calculate the economic dependency ratio, that is the ratio of total population to employed population. This indicates how many people are supported by each job, either through family relationships or social security contributions.
 
According to our calculations, the ratio would increase throughout the EU announcing more troubled times for European social security systems. By contrast in the US, indirect taxes would not be affected while the economic dependency ratio would slightly improve.
 
ASSET PRICE INFLATION AND REAL DEVALUATION
 
Policymakers will have a few options to adjust to the shortfall in national incomes projected by our study. With wage shares and government revenues decreasing, other incomes must sustain demand if the economy is to adjust. These adjustments have to be profits or rents but, with flagging consumption growth, profits cannot be expected to come from growing sales.
 
A more realistic assumption is that profits and investment (mostly in financial assets) will be sustained by growing asset prices. The potential for macroeconomic instability of this growth strategy is well known.
 
In this adjustment scenario, there would be a strong increase in asset prices where financial markets are more developed, especially in the United Kingdom, Germany, Other Western and Northern European Countries and France (Figure 2). Aggregate demand in these economies would be sustained by a recovery of the financial sector, stimulated by domestic lending and growing profits.
 
However, it is critical to note that such growth would last only as long as asset prices keep growing, requiring ever-rising levels of lending. In the current context of weak commercial lending, this might require intentional policy interventions, such as further deregulation. This road to growth has been taken before and its risks have proven extremely high.
 
During the most recent economic crisis, individuals and businesses quickly ran up unsustainable debts until generalized insolvency suddenly stopped economic activity. Moreover, the extent to which deregulation is successful in increasing lending, rather than just reducing accountability in the financial sector, is not clear.
 
Of course, a run-up in asset prices is not the only policy and economic response to the drop in aggregate demand.
 
But it appears to be slightly more viable than alternative adjustment mechanisms. For example, it is often suggested that an opportunity might come from real devaluation. Countries might be tempted to seek this alternative by way of a nominal depreciation, a reduction of real labour costs or both.
 
In light of the discussion in section 3, the latter channel does not appear viable. This is because it would prove counter-productive when applied by many countries.
 
In other words, if the incomes of workers in every country are reduced, the demand hole is dug even deeper.
 
Moreover, the magnitude of the cuts required could be socially unsustainable after decades of falling labour shares.
 
On the other hand, a substantial nominal depreciation of the Euro would probably trigger defensive depreciation in other currencies before any improvement in competitiveness is achieved.
 
According to our projections, a real devaluation would have some effect in Germany and France but nothing that might strongly stimulate aggregate demand (Figure 3). Furthermore, attempts at strong devaluations are often followed by a race to the bottom in which the trading partners of the country that devalues try to regain the lost ground by devaluing as well. But even when a race to the bottom does not happen, lasting periods of real devaluation might lead to the accumulation of external debts as Europe's deficit countries have experienced after 1999.
 
To reiterate, our model requires some form of adjustment to compensate for the drop in aggregate demand. The precise path that future policymakers will choose (if any) is of course unknowable at present. But our model sheds light on the likely macroeconomic consequences of a TTIP-induced change in trade volumes, and also on the policy responses that are more or less likely to fill the demand gap.
 
DISCUSSION AND CONCLUSION
 
Existing studies on TTIP have focused on the impact the agreement would have on aggregate economic activity in member countries. They have done so based on detailed sectoral analyses of TTIP economies, but have neglected the impact of income distribution and other important dimensions of macroeconomic adjustment.
 
Our assessment of TTIP is based on the United Nations Global Policy Model, which has proven a convenient tool to estimate the impact of policy changes involving large areas of the world economy. Our simulation does not question the impact of TTIP on total trade flows estimated by existing studies. Rather we analyse their implications in terms of net exports, GDP, government finance, and income distribution.
 
Our analysis points to several major results. First, TTIP would have a negative net effect on the EU. We find that a large expansion of the volume of trade in TTIP countries is compatible with a net reduction of trade-related revenues for the EU. This would lead to net losses in terms of GDP and employment. We estimate that almost 600,000 jobs would be lost as a result of TTIP.
 
Secondly, TTIP would reinforce the downward trend of the labour share of GDP, leading to a transfer of income from wages to profits with adverse social and economic consequences. Policymakers would face a few options to deal with this demand gap. Our model suggests that asset price inflation or devaluation could result, leading to higher economic instability.
 
In this paper, we have focused on trade and its consequences, leaving the investment component of TTIP on the sidelines. Going forward, valuable insights could be drawn by further extending the analysis of TTIP's financial effects.
 
[* Jeronim Capaldo, Research Fellow at the Global Development and Environment Institute (GDAE) of Tufts University, contributed this two-part series article based on his GDAE Working Paper 14-03, October 2014. The first part was published in SUNS #7918 dated 18 November 2014. The full paper, with tables, graphs, footnotes and references can be accessed at: http://www.ase.tufts.edu/gdae/policy_research/TTIP_simulations.html] +