Chile’s Free Trade Agreements: How Big is The Deal?

Abstract

Chile put into place broad free trade agreements (FTAs) with its two major trading partners: the EU (effective 2003) and the US (effective 2004). This paper quantifies their economic effects for the Chilean economy, stemming from the conventional trade components (lower tariffs and higher market access) and other aspects of the latter broad FTAs, including improved intellectual property rights, factor productivity gains, and their fiscal consequences (tax compensation, larger customs expenditure). The paper also considers that the country risk premium may decline and aggregate investment may rise in response to the institutional stability and policy credibility enhanced by the FTAs. Simulation results are reported for steady states and dynamic transition paths, based on a three-sector dynamic general equilibrium model for an open economy inhabited by infinitely-lived representative agents. The model is calibrated to the Chilean economy and the actual features of both trade agreements. Due to Chile’s high initial trade openness, the reported effects of FTAs on resource allocations, relative prices, expenditure composition, welfare, output, and aggregate consumption do not exceed 1% in any given period. On impact, the largest gains come from a lower risk premium that leads to a temporary consumption and investment boom, which is reverted in the long run as a result of larger net foreign liabilities. In steady state, the gains from improved factor productivity dominate all other effects.