FTAA and Service Liberalization in Colombia

In a previous study we found that accession to the FTAA could be welfareworsening for Colombia because exports to the USA will be diverted away from Colombia in favor of other Latin countries. In this paper we show that there remain potentially large gains from an FTAA-style agreement. These gains come from increased factor productivity and product variety as a result of service liberalization and foreign direct investment (FDI). These benefits are likely to be large enough to overcome the loss of competitiveness in US goods markets. We use a computable general equilibrium model of the Colombian economy that includes imperfect competition in order to highlight the pro-competitive effects from entry as well as productivity effects from increased product variety. In contrast to perfect competition models, such as the GTAP model, this analysis incorporates productivity effects in both goods and services markets endogenously, through a Dixit-Stiglitz framework. The numerical model is innovative as it recognizes that foreign direct investment or the availability of foreign expertise is necessary to have foreign firms compete in key business services; and it endogenously captures increases in total factor productivity from foreign direct investment liberalization.