EC 936 ECONOMIC POLICY MODELLING

LECTURE 5:

MODELS OF TRADE ANDTRADE POLICY:

CGE PERSPECTIVES ON TRADE LIBERALIZATION

TRADE ISSUES

• Exogenous shocks – Terms of trade– Changes in international capital flows

• Policy shocks– Tariffs and export subsidies– Non-tariff barriers (quotas, etc.)– Domestic taxes and subsidies

WHY CGE MODELS?

• Compensating equivalence strategy (partial equilibrium measures)

• Trade liberalization influences product prices, factor prices, tax rates, thus requiring general equilibrium analysis

• Counterfactual possibilities of CGE modelling

HOW TO MODEL TRADE

• SINGLE COUNTRY MODELS

VS.• WORLD TRADE MODELS

SINGLE COUNTRY MODELS

• Some lessons from Asia and Africa using micro-macro simulation approaches– Bangladesh– India– Nepal– Pakistan– Philippines– Benin– Senegal

Source: Cockburn, Decaluwe and Robichaud, 2007

TRADE AND OUTPUT EFFECTS

• Industrial production increases relative to agricultural output because:

(i) import price reductions have a relatively small effect on domestic demand for local products, given imperfect substitutability and low initial levels of import penetration;

(ii) industrial exports respond positively to tariff cuts;

(iii) input costs fall faster in industry than in agriculture.

FACTOR PRICE EFFECTS

• Relative wages increase while returns to capital fall

Assumes factor mobility elasticity as follows:

Capital: σf = 0

Labour: σf = -1

HOUSEHOLD INCOME EFFECTS

• Nominal income tends to fall in rural areas

• Nominal income tends to fall in urban areas, but by less than rural income

CONSUMER PRICE EFFECTS

• Nominal consumer prices fall more in industry than in agriculture or services

• Cost of living effects vary across regions and countries

WELFARE AND POVERTY IMPACTS

• Trade liberalization increases total welfare

• Trade liberalization reduces overall poverty but with different sectoral effects

• Trade liberalization tends to lower urban poverty

• Trade liberalization may increase rural poverty

CLOSURE MATTERS

• Modelling domestic savings: Senegal vs. Benin

• Factor mobility assumption: short-run vs. long-run (i.e. change σf for capital from 0 to -1)

• Government closure assumptions: revenue effects (sales tax vs. production/income tax)

MULTI-COUNTRY MODELS

• GTAP (GLOBAL TRADE ANALYSIS PROJECT)– Local closure vs. global closure rules– Product differentiation by country– International factor mobility– Political reaction functions

H. Explore Market Clearing Constraints

Run the GTAP model