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

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Great Expectations Ex Ante Assessment of the
Effects of Trade Reform

• Joe Francois and Will Martin
• 15 June 2006

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Weve 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
• 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

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Are we there yet?

• Paul Krugmans 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 months growth in China or India

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But perhaps its OK?

• 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

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Key questions

• What needs to be measured?
• What should we do better?
• How might we do it?

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What needs to be measured?

• 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

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Efficiency and Productivity
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A disturbing disconnect

• 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

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What should we do better?

• Welfare measures
• Measures of distortions
• Aggregation of distortions
• Revenue replacement
• Process productivity
• Changes in product variety quality
• Investment, factor markets growth

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Welfare measures

• 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 zpep rp p is world price
• 2nd order approximation with fixed of products
  yields Harberger triangles

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Can augment B to capture

• Process productivity gains
• Increases in product variety
• Improvements in product quality
• Declines in price-cost margins output increases
  at firm level
• Investment and growth

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The ubiquitous EVs

• The compensated measure of EV
• ?Bc 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

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Measuring distortions

• 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

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Measuring distortions (2)

• 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

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Better data on distortions

• Detailed price comparisons and surveys of
  exporters potentially very important
• Kym Andersons 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?

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Services trade barriers

• 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

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Aggregating distortions

• 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

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Estimated costs of protection
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Aggregation

• 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?

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Revenue replacement

• 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

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Process productivity

• 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

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Process productivity exports

• Exporting firms have higher productivity
• Traditional explanations --Arrows
  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

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Process productivity 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

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Variety quality of exports

• 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

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Export variety and quality

• 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

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Factor Markets Labor

• 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

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Investment climate

• 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

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To conclude Some 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

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Implementation

• 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