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Great Expectations: Ex Ante Assessment of the Effects of Trade Reform. Joe Francois and Will Martin 15 June 2006. We’ve made enormous progress. GTAP has given easy access to the data needed for global trade analysis MAcMap 6-digit data for policy analysis With preferences included

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Great expectations ex ante assessment of the effects of trade reform

Great Expectations: Ex Ante Assessment of the Effects of Trade Reform

Joe Francois and Will Martin

15 June 2006

We ve made enormous progress
We’ve made enormous progress Trade Reform

  • GTAP has given easy access to the data needed for global trade analysis

  • MAcMap 6-digit data for policy analysis

    • With preferences included

  • Able to gain key insights into policy reforms

    • Help highlight problems, identify opportunities

  • Contrast with the Uruguay Round

    • Hard to get data even after the Round concluded

Are we there yet
Are we there yet? Trade Reform

  • Paul Krugman’s “dirty little secret” remains: the welfare measures from trade reform are very small

    • 0.7% of GDP in recent World Bank analysis

  • What sensible policy maker would stake her career on gains of 0.7% of GDP?

    • A month’s growth in China or India

But perhaps it s ok
But perhaps it’s OK? Trade Reform

  • Our standard measures are based on a rigorous theoretical framework

  • And perhaps the unmeasured gains scale up these measures proportionately?

    • So we might rank policies, without providing a “number”?

  • Alas, this is not always the case

Key questions
Key questions Trade Reform

  • What needs to be measured?

  • What should we do better?

  • How might we do it?

What needs to be measured
What needs to be measured? Trade Reform

  • Some indicator of the potential for the gainers to compensate the losers?

  • Where might these gains come from?

    • Allocative efficiency changes

    • Process productivity changes

    • Product variety & quality effects

    • Factor market & investment effects

A disturbing disconnect
A disturbing disconnect Trade Reform

  • Traditional trade theory, and most empirical modeling, focuses on allocative efficiency

    • The difference between b and e in the figure

    • With the PPF unchanged, except via input price

    • Generally small

  • Macro-growth literature focuses mainly on shifts in the Production Possibility Frontier

    • Mainly due to process productivity

    • Price distortions, variety & quality effects on inputs included, but no consumer gain

    • Sometimes large

What should we do better
What should we do better? Trade Reform

  • Welfare measures

  • Measures of distortions

  • Aggregation of distortions

  • Revenue replacement

  • Process productivity

  • Changes in product variety & quality

  • Investment, factor markets & growth

Welfare measures
Welfare measures Trade Reform

  • The balance-of-trade function captures production, expenditure & tariff revenues

    • generalizes measures based on expenditure fn

      B = e(p,u) – r(p,v) – zp(p,u,v)´(p-p*)

  • Where e(p,u) is the expenditure fn; r(p,v) is GDP; zp=ep – rp; p* is world price

  • 2nd order approximation with fixed # of products yields Harberger triangles

Can augment b to capture
Can augment B to capture Trade Reform

  • Process productivity gains

  • Increases in product variety

  • Improvements in product quality

  • Declines in price-cost margins & output increases at firm level

  • Investment and growth

The ubiquitous ev s
The ubiquitous EV’s Trade Reform

  • The compensated measure of EV

    ΔBc = B(p1,u0) - B(p0,u0)

  • In applied work, usually use uncompensated

    EV = e(p0, u1) – e(p0, u0)

    • Includes income effects on distorted goods

      • Can differ a lot if revenues used for public goods

    • But quite close to a potential real GDP measure

  • Compensated measures internationally comparable & additive

Measuring distortions
Measuring distortions Trade Reform

  • Doing much better with tariff measures

    • Ad valorem equivalents, preferences included

  • Key issue now is non-tariff measures (NTMs)

    • Kee, Nicita and Olarreaga infer these measures from a finely disaggregated trade model

      • Suggest NTMs are twice tariffs in industrial-country agriculture, four times as high in non-agriculture

      • Would scale up the costs of protection by a factor of 9 in agriculture, 25 in non-agriculture

Measuring distortions 2
Measuring distortions (2) Trade Reform

  • Francois and Woerz find ATC quotas were far higher than we thought when rents captured by importers are included

  • From price comparisons, Bradford finds NTMs may be 10 times tariff barriers in the OECD

  • Not likely that the unmeasured benefits proportional to our measured gains from tariff cuts

Better data on distortions
Better data on distortions Trade Reform

  • Detailed price comparisons and surveys of exporters potentially very important

    • Kym Anderson’s project on agric distortions

    • Will provide better information on NTMs

    • May reduce measured protection– water in tariffs

  • Also some insights into the counterfactual

    • Is protection stochastic?

      • If so, benefits even if bound rate exceeds applied

    • Is mean protection stable, or increasing?

Services trade barriers
Services trade barriers Trade Reform

  • Current measures are extremely poor

  • Widely suspected that average barriers to services trade are larger than in goods

  • And many of these barriers likely create higher costs per unit than tariffs

    • Through rent seeking; reduction in competition; or x-inefficiency

  • A priority, albeit a difficult one

Aggregating distortions
Aggregating distortions Trade Reform

  • The ubiquitous weighted-average has major problems

    • Averaging problem– understates costs

    • Weighting problem-- low weights on highly protected goods

  • The differences can be huge

    • Manole and Martin found costs with optimal aggregators 15 times those with weighted average

    • Some with higher average tariffs had lower costs

Aggregation Trade Reform

  • We have all the information we need to do better

    • Currently, we just throw much of it away

  • There are papers at this conference looking at different approaches

  • This is surely one area where we can do better?

Revenue replacement
Revenue replacement Trade Reform

  • Most trade liberalization studies assume that tariff revenues are redistributed costlessly to consumers

    • Alas, such lump-sum transfers rarely exist

  • Tariff revenues must be replaced via an alternative tax, or expenditure changes

    • Harrison, Rutherford & Tarr found that tariff replacement via a VAT cut the benefits of liberalization by 40%

Process productivity
Process productivity Trade Reform

  • Evidence from the firm level that liberalization increases productivity by expanding the availability and quality of intermediate inputs

  • Also an extensive literature on transmission of knowledge through trade

  • Pavcnik found productivity gains in import-competing firms through competition, exit and reallocation

    • The adjustment that governments often fear is a major source of gain

Process productivity exports
Process productivity: exports Trade Reform

Exporting firms have higher productivity

  • Traditional explanations --Arrow’s learning-by-doing

  • But Clerides, Lach & Tybout, & Bernard & Jensen, cast doubt on this explanation

    • Seemed to be little increase in productivity post-export

    • More efficient firms self-selected into exporting

  • Also highlighted the fact that firms are very heterogeneous in their productivity

  • And that price-cost margins decline with liberalization

  • Process productivity heterogeneous firms
    Process productivity: Trade Reform Heterogeneous firms

    Melitz (2003) provided a framework where trade liberalization with heterogeneous firms yields productivity gains

    • High productivity firms self-select into exports

    • Competitive pressure following liberalization causes exit of less-productive firms, reallocation of resources to more efficient

  • Some recent studies question the rejection of gains from learning-by-doing

  • Variety quality of exports
    Variety & quality of exports Trade Reform

    • Our traditional models assume that all export growth is at the intensive margin

      • Expanded exports involve more of the same products going to the same markets

      • Hummels & Klenow (HK 2005) find that 2/3 of export expansion is in new products

      • Evenett & Venables find that 1/3 of export growth in developing countries is from new markets

    • HK find quality upgrading on intensive margin

    Export variety and quality
    Export variety and quality Trade Reform

    • Assuming preference for variety, increases in export variety augment export demand

      • Shift out the export demand curve

      • Offset terms of trade fall implied by usual models

      • May help resolve old puzzles on elasticities

    • Quality upgrading augments these gains

      • Hummels-Klenow find rising intensive-margin prices in growing economies

    • These gains are additional to the gains from process productivity

    Factor markets labor
    Factor Markets: Labor Trade Reform

    • Desirable to include labor supply

      • Relevant supply elasticities are compensated, so even response by prime-working-age males nontrivial

    • Labor market performance is important

      • Simple closures like fixed consumer real wage increase the gains from libn, but are they realistic?

      • Doing better seems to require knowledge of countries’ institutions

    Investment climate
    Investment climate Trade Reform

    • Investment climate always important

      • In Melitz-type models, firms “die” and need to be replaced

    • Recent work suggests that the full gains from trade are much greater if the investment climate is supportive

      • Rutherford and Tarr (2002) find an 11% gain from 10% point tariff cut, with variety effects on intermediates and with domestic reinvestment

      • But 37% with foreign investment allowed

    To conclude some key potential improvements
    To conclude: Trade ReformSome key potential improvements

    • Improved estimates of distortions

    • Better aggregation of distortions

    • Better representation of process productivity

      • Heterogeneous firms & reallocation

      • Learning-by-doing?

    • Capturing changes in product variety & quality

    • Capturing gains associated with investment

    Implementation Trade Reform

    • New data needs are difficult but important

      • Aggregation looks more straightforward

    • Many of the new approaches involve distributions of firm productivity, costs of exporting, elasticities of substitution

      • Might we be able to obtain adequate, agreed measures of these parameters

      • To get agreed consequences of liberalization?

    • An ambitious agenda, and we can surely learn a lot trying