The importance of deep integration in preferential trade agreements: the case of a successfully implemented Ukraine-Turkey free trade agreement

We construct a 45-sector model of Ukraine with Turkey and seven other regions to estimate the impacts on Ukraine of effectively implementing the deep Free Trade Agreement (FTA) it concluded with Turkey on February 3, 2022. Econometric evidence shows that the impacts of Preferential Trade Agreements (PTAs) are much greater than can be explained by tariffs alone. Consequently, we include deep integration in our model, which includes reduction of: (i) Barriers against suppliers of business services including by FDI; (ii) Non-tariff barriers in goods; and (iii) Time-in-trade costs. We innovatively estimate the ad valorem equivalents of the three types of deep integration instruments; and we construct an updated and disaggregated input-output table of Ukraine. Our central model contains foreign direct investment (FDI) in business services with endogenous productivity effects from additional varieties of goods or services in imperfectly competitive sectors. We estimate that a successfully implemented FTA will increase welfare in Ukraine by 2.72 percent, with the deep integration aspects responsible for about 56 percent of the gains; but preferential tariff reduction alone by Ukraine contributes almost nothing. The deep integration and imperfect competition features produce estimated gains 3.5 times larger than a model of perfect competition limited to tariff elimination. Permanent exclusion or very limited access in sensitive sectors, however, reduce the estimated welfare gains to 1.51 percent. Reduction of non-discriminatory barriers against both FDI and Ukrainian investment in business services would add an additional 2.0 percent of real household income to the estimated gains.