Part 1 - AL-Tax

Chapter 15The tradable output went up, while the nontradable one decreased. Both GDPand CPI decreased. Real wages and real private income experienced an increase.We do not report these data here, but it is worth mentioning that the FTAA hasnegligible effects on the rest of the world. In particularly, k rn and k rt are roughlyconstant. Recall that in our artificial economy there is a fixed capital stock. Sincethere is almost no capital outflow or inflow to the rest of the world, the FTAAgenerated a reallocation of capital within Argentina, Brazil, and the USA.The Mercosur experiment showed that when a trade tariff τ ij is reduced, capitalflows from country j to country i. In the FTAA experiment, several τ ij valueswere simultaneously reduced. Thus, it is not possible to anticipate which countryshould receive or send capital abroad. It turned out that the USA receivedcapital, while Brazil and Argentina lost capital.These capital movements merit further discussion. Evidence from the formationof the European Union indicates that capital movement goes from richercountries to poorer ones. If the same were to happen with the FTAA, Brazilshould benefit from a capital inflow.Kehoe and Kehoe (1994b) discussed in detail the issue of capital flows in modelsof trade agreements. They showed that larger welfare gains take place whenthere is capital flow. However, any static model will hardly generate capital flowfrom a richer to a poorer country. What drives capital movement is the capitalrate of return. Hence, a possible way that a model can generate capital flow to apoorer country is by means of a productivity increase.Kim (2000) provided evidence that trade liberalization had a positive impacton the productivity of Korean manufactures. Tybout and Westbrook (1995)showed that a similar event took place in Mexico during the trade liberalizationof the 1990s. Holmes and Schmitz (1995, 2001) and Herrendorf and Teixeira(2001) showed, from a theoretical point of view, that trade liberalization mayhave a positive impact on a country’s productivity.Even without capturing the productivity surge and capital flow associated withtrade opening, the model still predicts welfare gains in both the Mercosur andFTAA experiments. We believe that these gains are lower bounds. We anticipatethat a more sophisticated model will display even larger welfare improvements.The observed GDP fall in the FTAA experiment also deserves attention (Table15.3). That fall was driven by a drop in y bn . Observe that when the Brazilian governmentreduces tariffs and tax rates, there is a fall in government fiscal revenue.This will lead to a decrease in g b and a consequent fall in y bn .The aforementioned fall in g b brings an important point to light. A reductionof the tax burden, as was done in the above experiments, has to be accompanied349