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GTAP Resource #1283

"How Confident Can We Be in CGE-Based Assessments of Free Trade Agreements?"
by Hertel, Thomas, David Hummels, Maros Ivanic and Roman Keeney

With the proliferation of Free Trade Agreements (FTAs) over the past decade, demand for quantitative analysis of their likely impacts has surged. The main quantitative tool for performing such analysis is Computable General Equilibrium (CGE) modeling. Yet these models have been widely criticized for performing poorly (Kehoe) and having weak econometric foundations (McKitrick; Jorgenson). FTA results have been shown to be particularly sensitive to the trade elasticities, with small trade elasticities generating large terms of trade effects and relatively modest efficiency gains, whereas large trade elasticities lead to the opposite result.

Robust econometric estimation of trade elasticities ¨C or more specifically, the elasticity of substitution among varieties of goods supplied from different countries -- has proven to be quite difficult historically. This is because of the high degree of multicolinearity in import prices. By their very nature, Most Favored Nation tariffs are non-discriminatory in nature, affecting all suppliers in the same way (Hummels). Tariff preferences, where they exist, are often difficult to measure ¨C sometimes being confounded by quantitative barriers and other restrictions. Thus, the history of estimating these key substitution elasticities is checkered at best.

This paper capitalizes on a unique data set containing not only tariffs, but also bilateral transportation costs for goods traded internationally (Hummels). The latter vary much more widely than do tariffs, and use of these data permit much more precise estimation of the trade elasticities that are central to CGE analysis of FTAs. We estimate the trade elasticities, as well as the associated standard errors, at the same level of commodity aggregation employed in the subsequent CGE model. We follow the GTAP 5.0 aggregation scheme which includes 42 merchandise trade commodities covering food products, natural resources and manufactured goods. These estimates are all statistically significant at the 5% level.

Our CGE analysis focuses on the prospective Free Trade Agreement of the Americas (FTAA) currently under negotiation. The assessment is done in comparative static mode in order to emphasize the role of the trade elasticities in determining the conventional gains/losses from such an FTA. Rather than producing point estimates of the resulting welfare, production and employment effects, we report confidence intervals instead. These are based on repeated solution of the model, drawing from the econometrically estimated distribution of trade elasticities. Specifically, we use the Gaussian Quadrature approach, which has proven to be the most efficient and unbiased approach to systematically assessing the sensitivity of model results to parametric uncertainty (DeVuyst and Preckel; Arndt). We find that, while many of the individual sector results are not robust to variation of the trade elasticities, the aggregate welfare results are robust in most cases.

Resource Details (Export Citation) GTAP Keywords
Category: 2003 Conference Paper
Status: Published
By/In: Presented at the 6th Annual Conference on Global Economic Analysis, The Hague, The Netherlands
Date: 2003
Created: Hertel, T. (4/30/2003)
Updated: Conner, J. (5/22/2003)
Visits: 5,015
- Calibration and parameter estimation

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