EC 936 ECONOMIC POLICY MODELLING LECTURE 5: MODELS OF TRADE AND TRADE 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: σ f = 0 Labour: σ f = -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 σ f 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