Canada - Korea

Preliminary Assessment of the Economic Impacts of a Canada-Korea FTA

Simulation Results: Impact of Canada-Korea Merchandise Trade Liberalization

This section describes the impact of tariff elimination on Canada-Korea bilateral merchan-dise trade and the implications for GDP and economic welfare. The simulation involves full elimination of trade protection as captured in the GTAP database, updated as described above, for all industrial and agricultural sectors. Two interventions are made to take account of developments affecting the auto and dairy sectors:

1. Explicit account is taken of the impact on automotive shipments from Korea to Can-ada of the establishment of Korean brand auto production in the United States. These “transplants” are assumed to reduce automotive shipments from Korea to Canada by 57.2% compared to the level that otherwise would have been the case.

2. The dairy sector impacts are constrained to nil to reflect a WTO dispute settlement ruling that constrains Canadian exports of dairy products and the lack of Korean ex-port capacity.

Sectoral Aggregation, Armington Elasticities and Protection Levels

The simulations were run with a full sectoral disaggregation. The definitions of the GTAP merchandise trade sectors are given in Table 4a below, along with the values of the corre-sponding Armington elasticities of substitution.

Table 4a: GTAP sectors and Armington elasticities of substitution (Opens as new window)

The protection data in the GTAP 6.0 database are obtained from Market Access Map (MAcMap), which was produced and is maintained collaboratively by the Paris-based Centre d’Etudes Prospectives et d’Informations Internationales (CEPII) and the International Trade Centre (ITC) in Geneva. The tariff data are compiled at the Harmonized Tariff System 6-digit level and include the ad valorem equivalent of specific tariffs and the tariff equivalent of tariff rate quotas (TRQs). The GTAP 6.0 protection data are, however, current only as of 2001; accordingly, as previously noted, these data were updated to take into account the full implementation of the Uruguay Round tariff cuts, China’s accession commitments to the WTO, and the expiry of the WTO Agreement on Textiles and Clothing (ATC).

Table 4b presents the updated Canadian and Korean bilateral protection data for the GTAP ¹⁶ merchandise trade classification, along with the 2001 trade levels in the GTAP database on the basis of which the simulations were run. Generally speaking, the size of the trade impact is determined largely by the size of the elasticities and the size of the “wedge” between do-mestic prices and imports created by protection. As can be seen, Canada has high tariffs (9.9-113.9%) in few product categories, namely dairy, transport equipment, vegetable oils, and textiles and apparel. These products accounted for 13.3% of total Canadian imports from Ko-rea, with textile products accounting for more than half of this total (7.2%). The bulk of Ca-nadian imports from Korea faced duty rates that ranged between 0.1% and 8.6%. Electronic equipment was clearly the most significant sector in this group, representing 28.9% of total Canadian imports, followed by motor vehicles and parts with a trade-weighted tariff rate of 5.9%. Other major Canadian imports from Korea were machinery and equipment as well as chemical products. The duty rates for these products were low.

Korea has much higher levels of protection than Canada. About 0.3% of Canadian exports to Korea faced tariffs ranging between 206.8% and 1,000%. The main Canadian exports in this category were cereal grains (tariff rate of 321.7%) and beverages and tobacco (206.8%). About 7.8% of Canadian exports to Korea faced tariffs of 10.4% to 47.4%. Most products in this category were agricultural and food products, in which Canada has a clear comparative advantage. The majority (71.6%) of total Canadian exports to Korea faced duty rates of 0.1% to 8.1%. Sectors in this category included coal, chemical products, metals, electronic equip-ment, machinery and equipment, and mineral products. About 20.3% of Canadian exports (pulp and paper products) to Korea were duty-free.

Given the generally higher tariffs faced by Canadian exporters to Korea than Korean export-ers to Canada, the CKFTA would be expected to result in a larger percentage increase in Canadian exports than in Canadian imports. Given Korea’s high levels of protection, particu-larly in the agricultural sector, Canadian exports to Korea would also be expected to be boosted by market share captured from third-country exporters. Such a trade diversion would reduce Korea’s economic welfare gains derived from expanded trade with Canada.

Table 4b: Canadian and Korean bilateral tariffs & trade weights, GTAP classification (Opens in new window)

Merchandise Trade Impacts

Table 5 sets out the changes in Canada’s exports to Korea as a result of tariff elimination on bilateral trade in industrial and agricultural products based on the central scenario for closure.

Table 5: Changes in Canada’s merchandise exports (f.o.b) to Korea under a CKFTA (Opens in new window)

Based on the 2001 level and sectoral composition of Canada’s merchandise exports to Korea, the CKFTA induces an increase of 56% (these results are reported in columns 1 through 3). Applying the percentage changes by GTAP sector to the 2005 level and sectoral trade com-position (set out in columns 4 through 6) shows the implications for these results of the changes in Canada-Korea trade levels and composition between 2001, the base year for the GTAP model, and the most recent year for which we have complete sectoral merchandise trade data. Overall, the increase in Canadian exports is at the same at 56%. Based on the 2005 data, the value of Canadian exports to Korea would increase by $1,581 million.¹⁷

The major export gains are in the primary and processed food sectors, areas where Canada has been making inroads into the Korean market in recent years. Exports of other manufac-tured goods are boosted to a lesser degree, although the gains are still substantial.

Table 6 sets out the changes in Canada’s imports from Korea as a result of tariff elimination on bilateral trade in industrial and agricultural products. Based on the 2001 level and sectoral composition of Canada’s merchandise imports from Korea, the simulation results indicate a 29% increase. Based on the 2005 level and sectoral composition, the increase is smaller at 19%; this largely reflects the steep decline in Korean exports of textiles and clothing since 2001. This difference demonstrates the potential sensitivity of the results to the initial conditions reflected in the model database; by the same token, it shows the importance of taking into account significant structural changes that have occurred in the post-base-year period, such as in this case, the major reorganization of global trade in textiles and clothing due to China’s emergence and the expiry of the WTO’s Agreement on Textiles and Clothing, which resulted in the dismantling of the quota-based system of trade in this sector. Based on the 2005 data, the value of Canadian imports from Korea would increase by $1,006 million.

Table 6: Changes in Canada’s imports (c.i.f) from Korea as a result of a CKFTA (Opens in new window)

In contrast to Canada’s export gains, which are concentrated in the primary and food prod-ucts sectors, Canada’s import increases are primarily in the other manufactured goods sectors.

Trade Creation and Trade Diversion

The relative sizes of the trade creation/diversion effects of a CKFTA in respect of imports and exports are shown in Tables 7 and 8 below. All data in these tables are on the original GTAP 6.0 basis, based on 2001 trade levels and expressed in 2001 U.S. dollars.

Preferential access to a market created by a free trade agreement can lead to both trade creation and trade diversion. A concrete example serves to illustrate these effects. Consider, for example, the substantial increase in Canadian exports to Korea of primary and food products predicted by the model (as shown in Table 5). One such food product is boneless beef, which currently faces a 40% tariff in the Korean market. With the model’s assumption of price-sensitive consumer preferences, the elimination of this tariff on Canadian boneless beef imports would necessarily expand demand in Korea for beef, as lower-priced imports from Canada lead to a decline in boneless beef prices in Korea. However, much of the increase in Canadian exports would not reflect the expansion of final demand, but rather the capture of additional market share in Korea. In part, this additional market share would be captured from higher-priced domestic Korean producers; this is trade creation, which drives efficiency-enhancing structural adjustment in the Canadian and Korean economies. However, in part, the additional market share would be captured from third-party suppliers of beef (e.g. Australia), which would still face the 40% tariff. So while Korean imports of beef from Canada would increase, imports of beef from third parties would fall; this is trade diversion. As discussed below, whereas trade created by the CKFTA leverages economic welfare gains, diverted trade partly offsets these gains.

As can be seen in Table 7, the choice of closure impacts significantly on the extent of trade diversion in import markets. The extent of trade diversion is greatest under the most restrictive closure, in which both capital and labour supply are fixed and the gains from trade in the factor markets take the form of increases in wages and returns to capital. The amount of trade diversion is least in the closure scenario, in which both labour and capital supply are fully flexible and gains from trade in factor markets are reflected in increases in jobs and capital. The expanded economic activity due to the increased supply of labour and capital generates additional demand for imports from all parties, offsetting the diversion effect of the CKFTA with the third parties. In the case of Korea, the demand for imports—when both supplies of labour and capital are allowed to change—more than offsets the trade diversion effect, resulting in a net increase in imports from third parties.

Table 7: CKFTA Impact on Source of Canadian and Korean Merchandise Imports Under Alternative Closures, in 2001 US$ millions (Opens in new window)

Table 8 below provides a similar comparison of the trade creation and trade diversion effects on the export side.

Table 8: CKFTA Impact on Destination of Canadian and Korean Merchandise Exports Under Alternative Closures, in 2001 US$ millions (Opens in new window)

As can be seen, the impact of alternative closures on export trade diversion is even greater than on the import side. For both Canada and Korea, the expansion of productive capacity under the least restrictive closure (iv) is sufficient to support not only the expansion of bilateral trade under the CKFTA but also additional exports to third parties. Conversely, under the most restrictive closure rule with fixed supply of labour and capital, a larger part of the bilateral trade stimulated by the CKFTA in fact requires a reduction in Canadian and Korean exports to third parties. This largely reflects the resource constraints that are assumed in this simulation. Productive resources are assumed to be fixed in supply and fully used in the both the pre-FTA context and the post-FTA context. Accordingly, the additional production to support increased exports to the FTA partner must come from increased efficiency of production; insofar as the efficiency gains induced by the FTA are insufficient, the implication is diversion of shipments from domestic or third-country markets to the FTA partner.

The empirical literature does not offer a consensus opinion on the extent of trade diversion caused by FTAs. The “conventional wisdom” has been that the trade-creation effect has dominated the trade-diversion effects. Direct attempts to measure whether FTAs reduce the amount of trade with third parties using gravity models have generally failed to show significant negative affects, although different studies have reached opposite conclusions on this point¹⁸. Our central scenario, which has only comparatively modest amounts of trade diversion, is thus not out of line with the empirical literature.

Impact on GDP

Table 9 compares the changes in GDP as a result of the CKFTA for Canada, Korea and other trading partners, under the alternative closure assumptions; all data in this table are on the original GTAP 6.0 basis, based on 2001 data and expressed in 2001 U.S. dollars.

Table 9: Changes in GDP as a result of the CKFTA under Alternative Closures, Selected Regions, in 2001 US$ millions (Opens in new window)

For Canada, the simulations suggest the CKFTA would result in an increase in the value of GDP of between 0.064% in the standard closure scenario (labour and capital supply both fixed) to 0.268% in scenario (vi) where both capital and labour supply are flexible. In the central scenario (labour supply elasticity = 1, capital supply flexible), the GDP gain for Canada is 0.114%.

Applying these percentage changes to the size of Canada’s GDP as it was in 2005 ($1,369 billion), the corresponding range is from $876 million to $3.7 billion, with the central scenario estimate at $1.6 billion¹⁹.

The value of Korean GDP would increase by between 0.024% and 0.691% across the five scenarios, with the central scenario estimate at 0.059%. Scaled to the size of Korea’s economy in 2005 ($955 billion), this amounts to a range of between $229 million and $6.6 billion, with a central scenario estimate of $659 million.

Whereas the trade impacts generated by the model are relatively stable across the alternative scenarios (with the bilateral trade impacts showing almost no sensitivity), the estimated GDP gains vary greatly across the scenarios and thus depend heavily on the assumptions made by the modeller concerning the supply response of the economy to the incentives created by liberalized trade.

Empirical estimates of the relationship between expanded trade and economic activity suggest a strong impetus to GDP growth but overall smaller gains in GDP than in trade: “Research reported elsewhere … using a variety of alternative techniques, suggests that annual GDP gains to each partner would amount to 20% of the expanded [bilateral] trade… These gains reflect the adoption of improved production methods in response to competitive pressures, the exit of less efficient firms, scale and network economics, reduced mark-up margins, more intensive use of imported inputs, and greater variety in the menu of available goods and services.”²⁰

Applying this rule of thumb to the estimated increase in the trade share of GDP for Canada and Korea generated in the central scenario closure scenario, the implied GDP gain would equal about $276 million for Canada and $504 million for Korea. The estimated GDP gain for Korea in the central scenario matches up well with this simple rule of thumb; the gain for Canada is, however, substantially higher.

In considering the plausibility of the size of the estimated GDP gain for Canada, we take note of the following two considerations:

• Given the structural features of the Canadian and Korean economies that would be affected by an FTA, the GTAP simulations show higher gains for GDP for Canada than for Korea under all the alternative closures, save for that where the constraints on both labour and capital are fully relaxed (iv)²¹.

• The estimated GDP gain for Canada is estimated to be substantially larger ($876 million) in the most restrictive closure scenario in which trade diversion effects are very large. The estimated GDP gain inferred from the rule of thumb would therefore require an implausibly larger trade diversion effect.

On these grounds, we conclude that the estimated GDP impact for Canada, which is larger than Korea’s gain, and is consistent with only modest degrees of overall trade diversion, is in the right ballpark.

For most third parties, the proposed CKFTA is estimated to have a negative impact on GDP under the restrictive standard closure (i). However, the size of the negative impacts diminish as the constraints on the production capacity in both Canada and Korea are relaxed under less restrictive closure rules (ii)-(iii) and (v), and turn into positive gains for many regions under the least restrictive scenario (iv). For instance, the United States is shown to have a reduction of GDP by US$564 million under the standard closure rule; however, in the least restrictive scenario (iv), it has a positive GDP gain of US$130 million. Under the central scenario, the GDP impacts on third parties are, for the most part, negative but negligible; and global GDP impacts are overall modestly positive, dominated by the gains experienced by Canada and Korea. This latter outcome is consistent with the positive association between trade liberalization and global growth.

Impact on Household Economic Welfare

The most widely reported measure of the economic benefits or costs of a policy change in computable general equilibrium model simulations is known as “equivalent variation”; this is the amount of money that would make the household sector as well off in the pre-policy shock scenario as in the policy shock scenario²².

Table 10 reports the economic welfare gains generated in the simulation for Canada, Korea and other countries/regions, broken down into three main components:

1. Changes in allocative efficiency that arise from the reallocation of production inputs (labour and capital) to their most effective applications induced by the reduction in the level of tariff distortions in the FTA partner economies.

2. Changes in the terms of trade (the ratio of export to import prices) induced by the impact of the FTA on prices of goods and services in each country.

3. Changes in the availability of factor endowments such as labour and capital induced by the FTA under alternative scenarios. This applies to Canada and Korea only; in other regions, the supply of labour and capital in other countries remains fixed.

For purposes of this international comparison, the data are presented in terms of the original GTAP data – i.e., in 2001 US$ scaled to the size of the various economies in 2001.

Table 10: Regional Household Economic Welfare Impacts, in 2001 US$ millions (Opens in new window)

As in the case of the GDP impacts, the estimated economic welfare gains vary considerably across the alternative closure scenarios. The simulations suggest that Canadian households would derive an economic welfare benefit of between US$143 million and US$1.9 billion, with our central scenario estimate at US$586 million. Scaled to the size of Canada’s economy in 2005, the corresponding range is between $266 million under the most restrictive assumptions and $3.5 billion under the least restrictive assumptions; the central scenario estimate is $1.1 billion²³.

For Korea, the results range from a negligible loss under the most restrictive closure scenario to a gain of almost US$3 billion in the least restrictive scenario²⁴. Most other regions, and the global economy as a whole, would incur losses due to trade diversion under the most restrictive scenario; however, the outcomes for third parties improve sharply under less restrictive scenarios; for the global economy as a whole, economic welfare improves as resource constraints in Canada and Korea are relaxed.

With regard to the sources of gains/losses, this is influenced heavily by the closure assumption. If capital and labour are fixed, as they are in scenario (i), increased demand largely results in increases in wages and in returns to capital; these higher factor costs are passed on in the form of higher prices which are reflected in the model’s accounting as terms of trade gains. In scenarios in which higher factor prices induce greater labour and capital supply, the smaller become the net increases in wages and returns to capital; in welfare accounting, the gains attributed to terms of trade decline while the gains attributed to increases in allocative efficiency and endowments increase. Under the least restrictive scenario (iv), the endowment effect overwhelms all other gains, accounting for roughly 60% and 80% of the total welfare gains for Canada and Korea, respectively.

How Canada and Korea derive benefits from the CKFTA (i.e. whether largely in the form of improved terms of trade or in the form of improved allocative efficiency and/or increased endowments) determines whether the impact on the rest of the world is positive or negative. This can be understood intuitively on the following basis: since one region’s export prices are another region’s import prices, global terms of trade impacts must net out to zero. Accordingly, improved terms of trade for Canada and Korea necessarily translate into terms of trade deterioration in the rest of the world combined²⁵. Scenarios in which Canada and Korea extract gains in the form of terms of trade improvement thus are necessarily worse for the rest of the world than scenarios in which the gains come in the form of improved allocative efficiency and/or increased supply capacity.

The estimated economic welfare gains for Canada in the central scenario ($1.1 billion) are broadly consistent with the size of the gain in GDP ($1.5 billion) and the size of the incremental bilateral trade flows ($2.6 billion). The gains for Canada are greater than for Korea; this is to be expected since the negative welfare impacts of trade diversion for Korea should be greater given the overall higher level of tariffs.

TRADE IN SERVICES

A specific estimate of the impact of services trade liberalization under the CKFTA is not provided in this study. This reflects the following considerations.

First, the General Agreement on Trade in Services (GATS), which provides the framework for the liberalization of international trade in services, classifies trade in services into 155 service types and four modes of supply:

1. Cross-border supply: a service is supplied from a supplier’s country of residence to a consumer’s country of residence.

2. Consumption abroad: a service is supplied through the movement of a consumer to a supplier’s country of residence.

3. Commercial presence: a service is supplied through the movement of a commercial organization to a consumer’s country of residence.

4. Presence of natural person: a service is supplied through the movement of a natural person to a consumer’s country of residence.

Barriers to trade in services can be put in place in each of the four modes of supply. The measurement of barriers to services trade thus involves quantifying the trade restrictive effect of a wide variety of domestic regulatory measures, which indirectly affect trade in all four modes. Unlike the case of merchandise trade, for which there exists a comprehensive and reasonably reliable data set describing the height of border barriers, a comprehensive database on the barriers to Canada-Korea services trade does not exist²⁶. By the same token, it is not possible to obtain an estimate of the complete elimination of trade barriers, as was done above for goods trade. An estimate of the services component of the CKFTA would require before-the-fact knowledge of the specific measures that would be subject to liberalization, and this is not available.

Second, given the various alternative modes for trade in services, companies will tend to choose the path of least resistance—e.g., opting for commercial presence (mode 3) over cross-border provision (mode 1), or vice versa, depending on which approach is less costly in terms of regulatory compliance. It follows that liberalizing one mode (e.g. cross-border trade) in a context in which another mode is relatively unimpeded (e.g. commercial presence through inward FDI) may yield little in the way of impacts since firms will have already committed resources to the path of least resistance. In other words, there is as much uncertainty about the market response to a change in a restrictive measure as there is about the quantification of the measure’s restrictive force.

Third, there are equivalent difficulties to evaluating the liberalizing effect of specific negotiated changes to domestic regulations to the difficulties involved in estimating the overall trade-impeding effect of the regulatory framework.

Several elements of the negotiation agenda address services trade in one mode or another: financial services, cross-border trade in services, investment and temporary movement of persons. Other elements of the negotiations that facilitate international commerce could also be expected to impact to some extent on the ease of conducting services trade between Canada and Korea. Absent specific estimates, it can be inferred that the results for merchandise trade understate the total trade impact, the impact on GDP and the impact on consumer welfare.

Investment Liberalization

The GTAP scenarios elaborated above do not take into account measures that might be included in a CKFTA to liberalize or facilitate direct investment. To take into account the impact of investment liberalization, a dynamic CGE model that includes FDI is required. Such a model is being developed for Canada but is not yet available. At present, it should be noted that the potential to expand two-way direct investment between Canada and Korea appears to be reasonably strong, particularly with regard to Canadian direct investment into Korea. This can be inferred from an index measuring the overall level of investment restrictiveness in the two countries in terms of tax equivalents. For Canada, restrictions on inward FDI from the FTAP model database²⁷ are evaluated to be equivalent to a 6.11% tax on foreign affiliates’ capital; the equivalent figure for Korea is 22.01%.

Absent specific estimates, it can be inferred that the GDP and consumer welfare impacts reported above deriving from merchandise trade liberalization likely understate the extent of gains in these areas from such investment liberalization as might be forthcoming pursuant to the CKFTA.

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16. Trade statistics collected by one country frequently differ from statistics measuring the same trade flow collected by its trading partners. In the case of Canada-Korea trade, a trade data reconciliation exercise conducted on the 2001 and 2002 bilateral trade data indicated that Canada’s bilateral deficit and Korea’s bilateral surplus were both overstated. The main source of errors in the data was underreporting of exports due to non-filing of ex-port documents and indirect trade (e.g. Canadian shipments to the U.S., which then are sent onwards to Korea might be reported as exports to the U.S. in Canadian statistics, overstating Canada-U.S. trade and understating Canada-Korea trade). As Statistics Canada notes in its comment on the reconciliation exercise “Customs offices are generally more attentive to goods entering the country rather than leaving because of the requirement for tariff assessment and the application of trade agreements. Consequently, import data are usually more reliable than ex-port data.” Accordingly, for unreconciled data such as the 2005 figures, the most accurate measure of the balance is on the basis of import-import data. For a fuller discussion see Sandra Bohatyretz, “Tiger by the Tail? Canada’s Trade with South Korea,” in Canadian Trade Review, Statistics Canada Catalogue No. 65-507-MIE, (2004).

In the simulation, tariffs for sectors with zero trade (e.g. Canadian exports of rice) are set to zero in or-der to avoid a spurious surge in exports/imports upon tariff elimination. This is consistent with standard practice in GTAP-model simulations.

17. Note: the bilateral trade figures are not significantly influenced by the choice of closure. Accordingly, we report only the results for the central scenario for closure. As shown below, the main impact of alternative closures is on the extent of trade diversion experienced by third countries.

18. A 2003 study for the Australian Productivity Commission contradicted this conventional wisdom, find-ing that most FTAs reported to the WTO were trade diverting. See Adams, R., P. Dee, J. Gali, and G. McGuire. 2003. “The Trade and Investment Effects of Preferential Trading Arrangements—Old and New Evidence.” Staff Working Paper. Australia Productivity Commission. Canberra. However, a more recent review of this same evidence using updated trade data reached the opposite conclusion, namely that most FTAs were net trade creating. See Dean A. DeRosa. 2007. “The Trade Effects of Preferential Arrangements: New Evidence from the Australia Productivity Commission.” Working Paper 07-1, Peter G. Peterson Institute for International Econom-ics, Washington, D.C., January 2003.

19. These figures are not significantly impacted by the change in the expenditure composition of Canada’s GDP between 2001 and 2005. A rough check on this can be made by applying the percentage changes gener-ated in the model simulation for individual components of GDP (i.e. consumer expenditure, investment, gov-ernment spending, exports and imports) to the levels of these GDP components in 2005 and recalculating the total GDP change. Taking this into account marginally reduces the gain in scenario (i) from $880.8 million to $872.9 million.

20. Dean DeRosa and John Gilbert, “Estimates from Gravity and CGE Models,” Chapter 8 in Gary Clyde Hufbauer and Richard E. Baldwin, “The Shape of a Swiss-U.S. Free Trade Agreement,” op cit.; at p. 238.

21. For both Canada and Korea, the GDP gains under the least restrictive closure rules (iv) are much bigger than those under the scenarios (ii)-(iii) and (v). This may be understood intuitively on the following basis. When a constraint is imposed on one of primary production factors (labour or capital), economic growth is subject to diminishing returns. When the constraints on all primary factors are removed under the scenario (iv), however, the economy expands under constant returns to scale, which generates a greater GDP impact.

22. This measure is technically Hicksian equivalent variation calculated using pre-shock prices.

23. The scaling up from 2001 US$ figures to 2005 C$ figures is done as follows: the GTAP figure for equivalent variation for Canada of $143.1 million in 2001 US$ is 0.035% of 2001 consumer expenditure. Ap-plying this percentage to consumer expenditure of $760,380 million in 2005 yields the above estimate of equivalent variation in 2005, expressed in C$. The other figures are calculated in like fashion.

24. The small decline in household economic welfare for Korea in the most restrictive scenario contrasts with the gain in GDP reported earlier for the same scenario. This result reflects the fact that GDP gains are re-ported taking into account the relative price changes induced by the FTA while equivalent variation, the meas-ure of household economic welfare, does not take these price changes into account. Since Korea experiences terms of trade gains but allocative efficiency losses the choice of post-shock versus pre-shock prices in doing such a calculation can result in one measure being positive and the other negative if both are relatively close to zero.

25. The widespread losses in terms of trade in the most restrictive closure scenario reflect the loss of exports to Canada and Korea due to preference erosion. Since most countries have exports to Canada and Korea, they all tend to be affected in this manner. Mechanically, the loss of exports to Canada and Korea results a price de-cline of production in other countries to restore equilibrium; this is only partially offset by the extent to which Canadian and Korean imports are reduced (since these imports are also higher priced in the shock scenario) and replaced by domestic production abroad or from third-party imports. The Armington assumption is an essential factor here: the imperfect substitutability of goods according to location of production allows relative increases in prices of Canadian and Korean products—if there were perfect substitutability, competitive forces would negate these terms of trade effects.

26. For a detailed review of the issues facing the quantification of services trade barriers and estimating the impact of services trade liberalization, with specific reference to the Canadian context, see the trio of articles in Part II of John M. Curtis and Dan Ciuriak (eds.) Trade Policy Research 2002 (Ottawa: Department of Foreign Affairs and International Trade, 2003): Brian R. Copeland, “Benefits and costs of trade and investment liberali-zation in services: Implications from trade theory”; Zhiqi Chen and Lawrence Schembri, “Measuring the Barri-ers to Trade in Services: Literature and Methodologies”; and Shenjie Chen, “Trade and Investment in Canada’s Services Sector: Performance and Prospects.”

27. For background on the FTAP model and data see, Australian Productivity Commission “The Structure of the FTAP Model”.