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Don't be in the dark when making trade deals

Free trade is meant to be a wealth-creating policy, with net positive effect for participating macro-economies. But there are winners and losers at micro level, and the UAE needs to study those effects ahead of signing agreements

Don't be in the dark when making trade deals
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UAE manufacturing willbe one of the leadingbeneficiaries of freetrade agreements.
Gulf News Quarterly Financial Review

While the domestic implications of free trade agreements (FTAs) in other regions of the world have been extensively studied, the potential implications of FTAs for the UAE economy have not, and, as a result, the needed dialogue to address such implications is very limited.

Yet the UAE continues with its quest of negotiating FTAs with several countries and economic blocs - the EU, US, Australia and New Zealand, to name just a few.

With such a small domestic economy, UAE policy makers believe that in order for UAE businesses - and the economy - to grow, new markets beyond the GCC must be explored and consolidated. However, given its labour market structure, the potential implications of FTAs on the UAE could differ considerably from those observed in other parts of the world. Hence, we cannot take what we have learned from research conducted elsewhere as given, or use that information to formulate domestic policy.

The need for research

There is a real need for more research and dialogue to study these potential effects as the UAE moves forward towards consolidating foreign markets, so that policy making can be developed to accommodate effectively a greater degree of openness and economic liberalization.

An FTA means that UAE goods and services will receive preferential treatment when entering the market of trading partners, but also that goods and services produced by trading partners will receive preferential treatment when entering the UAE market.

This situation will cause income to be redistributed among factors such as labour and capital, and output to adjust upward in industries expecting to benefit from FTAs as they target new markets (‘winner industries'), and to adjust downward in industries expected to lose, owing to the extra competition exerted by companies from trading partners (‘loser industries').

Winners and losers

It is well documented in the economic literature that wages and returns to capital will increase in winning industries and fall in losing industries. That raises important questions for the UAE: (i) which industries will win; (ii) which will lose; (iii) have these industries been identified; (iv) will the benefits exceed the costs; (v) should the economy open by sector-by-sector? These five questions will be difficult to answer in light of the limited amount of research conducted in the area.

For the sake of argument, let's assume that FTAs will in general produce net benefits for the UAE, and as a result of an expanding export sector the economy will continue to grow.

Because of the particular characteristics of the UAE labour market, the economic implications of such economic growth could have spillover effects (both negative and positive) among the UAE population. This is true even if the UAE begins to export capital-intensive goods, although there is no evidence that the country is in a position to compete with other and more advanced capital-abundant countries.

Preliminary research shows that what is likely to happen in order to support the export market is greater reliance on labour that can be easily imported. This research shows a large and positive effect of labour on output, especially in the manufacturing sector.

For example, a 1 per cent increase in the number of machine operators could increase output by as much as 3.9 per cent. New FTAs could increase the wages of professional and technical workers and machine operators, while wages in other labour categories could fall.

In addition, the UAE manufacturing sector will be one of the leading beneficiaries of FTAs, and an increase in labour immigration will have minimal effect on wages.

All these findings are important for policy purposes, but they are yet to be addressed.

For example, the manufacturing sector is mostly located in Sharjah, an emirate that still faces energy generation problems, and energy demand could easily increase with FTAs. An increase in labour immigration to support the expanding manufacturing sector could also put additional pressure on energy demand.

If wages are not going to be severely impacted upward by an expanding manufacturing sector because labour immigration will keep those wages relatively stable, we need to define in time the policies that are necessary to support both the manufacturing sector and an increasing number of manufacturing workers.

The domestic consequences of FTAs are not going to be marginal. If, as stated above, wages drop in loser industries, how much labour will leave the UAE and, that being the case, will other sectors of the economy be at risk? We have been able to observe this phenomenon after the collapse of the real estate sector in Dubai. Given that 80 per cent of the labour force in the UAE is migrant in source, a large outflow of workers could dampen some of the benefits from the FTAs.

With no clear policy on how to deal with potential wage losses and decrease in output in loser industries, and with a relatively high cost of living in the UAE, it would not be implausible to see the business community seeking higher government transfers to stay in business.

Frictions in the labour market where migrant workers are not allowed to change jobs freely will only make things worse. If workers are not allowed free movement across different industries in the economy, they could face even larger wage losses.

Possible increase in demand for housing

Finally, if the net flow of workers is positive (more come in to work in winner industries that leave from loser industries), some emirates like Ajman and Um Al Quwain, where the cost of living is relatively lower, could experience an increase in demand for housing.

While this may be good news for the real estate sector, the downside is that most of these workers work in Sharjah and Dubai. Incomes generated in Sharjah and Dubai are counted as part of Sharjah's and Dubai's GDP.

We could go back to the years 2003-2004, when, according to the IMF, both Ajman and Um Al Quwain had negative growth rates in real GDP per capita due to populations growing faster than GDP in each emirate. Will compensatory packages be necessary to support Ajman and Um Al Quwain? This is just another unanswered question that needs to be addressed.

The bottom line is that the UAE appear to be addressing FTAs in some sense blindfolded. It is imperative to study the implications of FTAs for the UAE before such FTAs are implemented.

The writer is Associate Professor at the American University of Sharjah