Trade and CGE Models

By Paul

The Economist a couple of weeks back had a good article on economic models;

“Economic models fall into two broad genres. Macroeconomic models, the distant descendants of Phillips's machine, belong mostly in central banks. They capture the economy's ups and downs, providing a compass for the folks with their hands on the monetary tiller. The second species, known as computable general equilibrium (CGE) models, largely ignore the vagaries of the business cycle. They concentrate instead on the underlying structure of production, shedding light on the long-term repercussions of such things as the Doha trade round, a big tax reform or climate change…

Trade's virtuous effects are of two distinct kinds. First, trade helps countries make the most of what they already have. It frees countries to allocate their resources—whether they be cheap labour, fertile land or educated minds—as efficiently as possible. But, secondly, trade can also allow countries to accumulate resources more quickly. Indeed, the biggest prizes lie in faster growth, not heightened efficiency; in accumulation and innovation, not allocation.

By their nature, CGE models are better suited to capturing the first effect than the second. They provide “before and after” snapshots of the economy at two points in time. They are therefore good at capturing the one-off gains that might arrive from a redeployment of the economy's resources. They are much less good at capturing the continuing gains that result from a faster accumulation of capital, or a quickened pace of productivity growth. Most trade models, indeed, hold productivity fixed…”

Oxfam recently had a new paper up critiquing the CGE modelling in trade- Modelling the Impact of Trade Liberalisation; A Critique of Computable General Equilibrium Models, by Lance Taylor and Rudiger von Arnim, New School for Social Research;

The paper presents a review and critique of the most widely used trade models based on computable general equilibrium (or CGE) models. The emphasis throughout is on methodology. The paper provides concise analytical arguments explaining the fundamental weaknesses of CGE models, paying particular attention to the way that CGE models conceptualise and measure welfare. The authors also show that the manner in which the World Bank uses CGE modelling is highly problematic, making implausible assumptions about elasticities, the exchange rate, and macro causality. World Bank models assume that the most central macro-economic indicators do not change in response to any liberalisation scenario. The authors argue that this is negligent, especially in developing countries with historically large trade deficits, significant debt problems, and a large informal economy with underemployment in modern sectors. The authors also identify a particular inconsistency inherent in the use of ‘Armington’ specifications of elasticities in CGE models. They show that, even if the Bank’s welfare measures and macro causal scheme are accepted, the welfare gains that liberalisation is supposed to induce are estimated incorrectly in LINKAGE, GTAP, and other trade models that adopt the popular Armington specification of imperfect competition between trading partners…

CGE models can be useful quantitative supplements to experimental thinking about the importance of different potential causal linkages among economic variables at the country or world level. However, mechanically churning out ‘projections’ of welfare gains or any other indicator subject to one single set of causal assumptions and parameter values is a fundamental misuse of a sometimes helpful tool.”


Economic modeling and trade negotiations

World trade; In the twilight of Doha

Weighed in the balance; The Doha round of world trade negotiations was supposed to lift many millions out of poverty. It looks unlikely to do so

F&D edition focusesd on Trade

Demystifying Modelling Methods for Trade Policy

Assessing World Bank Support for Trade 1987-2004: An IEG Evaluation

The Future of Trade after Doha: What’s in It for Developing Countries?- video presentation

EcoMod has short training courses on CGE

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