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

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? 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? 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 What needs to be measured?

What should we do better?

How might we do it?

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

Efficiency and Productivity

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U1

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A disturbing disconnect

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

Welfare measures The balance-of-trade function captures

production, expenditure & tariff revenues generalizes measures based on expenditure fnB = 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 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 compensated measure of EV

ΔBc = B(p1,u0) - B(p0,u0) In applied work, usually use

uncompensatedEV = 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 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) 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 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 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 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

Estimated costs of protection

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Trade weighted

Opt

imal

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?

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%

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

Process productivity: exports

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

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

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

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

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 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 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 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