Market size and the evaluation of future trade agreements: The role of population and TFP growth

In the coming decades, Europe’s and China’s population will shrink, whereas other world regions will experience continuing population growth. Similarly, productivity growth will differ across developing and developed economies, leading to changes in future market sizes across countries. These changes will reshape countries’ attractiveness as partners in free trade agreements (FTAs), impacting the geopolitical influence of economies like the European Union (EU) and China. Standard methods for evaluating FTAs abstract from these changes in market sizes. We use population and productivity projections to evaluate the welfare effects of future trade agreements as a function of market size. We apply our method to a potential EU-China FTA. For the EU, we find that as the EU’s market size grows by 7.46% between 2025 and 2050, the welfare effect of a potential EU-China FTA increases by 23.8%. For China, a projected market size increase of 32.53% leads to a 13.3% decrease in the welfare effects of the FTA. We show that total factor productivity growth is a more relevant driver of welfare changes than population dynamics, suggesting that policy makers should prioritize future productivity growth when evaluating future trade agreements.