Trade liberalization is expected to act positively on development and poverty alleviation, both of which have become a high priority of international community. This explains why numerous studies have focused on assessing the expected benefits of trade liberalization on poverty. The main empirical tool for these assessments has been the use of multi-country Computable General Equilibrium Models (CGEM). These models, however, have produced divergent results. As demonstrated by recent studies, the associated increase in world welfare from full trade liberalization ranges from 0.2% to 3.1% — results that differ by a factor of 15 to 1! The impact on poverty headcount is also very divergent as the number of people lifted out from poverty ranges from 72 million to 446 million —a ratio of 5.5 to 1! This is a rather contrasting picture of the effects of trade liberalization on poverty. It gives the impression that with global trade modeling, divergent results are the rule. Moreover, as a sophisticated and complex tool of analysis, CGEM often appears as a “Black Box”, the results of which are difficult to understand.
The objective of this study is to examine the efficiency of trade modeling in capturing the benefits from trade liberalization. It will provide a survey of methodologies utilized to assess the impact of trade liberalization on poverty and will examine the extent to which such assessments diverge. The survey also demonstrates the benefits of “complementary analysis”, which utilizes different methodologies to study a specific topic.
First, the paper examines the advantages and drawbacks of each method, with a particular focus on multi-country general equilibrium models. Second, the paper undertakes a global modeling under general equilibrium — MIRAGE model— the results of which are compared to those obtained in recent studies.
Using the MIRAGE model (The MIRAGE model was developed at the Centre d’Etudes Prospectives et d’Informations Internationales (CEPII) in Paris. Full description of the model is available at the CEPII Web site (www.cepii.fr)) full trade liberalization is estimated to increase world real income by $100bln (+0.33%) after ten years of implementation. This trade reform would be development-friendly, as it entails a larger growth rate for developing countries, and especially for Least Developed Countries (LDC). It would also contribute to poverty alleviation, as unskilled labor would gain in numerous developing zones, especially in Latin America and most of Sub – Saharan Africa. Finally, full trade liberalization would reduce world income inequality as the Gini coefficient of world income distribution (taking into account population distribution) would be reduced marginally. Nevertheless, certain developing countries might lose by this world trade reform, such as Argentina, Mexico, and South Africa.
Trade liberalization implies allocative efficiency gains, which are positive in any case. But liberalizing trade may cause deterioration of terms of trade either because rising world prices of agricultural commodities have adverse effects on net food importing countries (Middle East North Africa countries, Mexico, Tunisia, Bangladesh, China) or because preferential access is eroded (SubSaharan Africa – SACU (South Africa Custom Union) not included – Mexico, Tunisia, Bangladesh.) Furthermore, assuming imperfect competition and product differentiation in industry and services, agricultural specialization has a cost; trade reform gives agricultural countries incentives to reallocate productive factors in the primary sector. In so doing, economies of such countries benefit less from economies of scale and varieties. This mechanism mainly explains why in the simulation presented here Argentina loses from full trade liberalization. Other countries, such as Australia, New Zealand, and Brazil, are negatively affected by this mechanism, but to a lesser extent.
Finally, conclusions that have been unanimously adopted by the literature are confirmed:
- Agriculture liberalization plays a major role in the benefits that can be drawn from liberalization.
- Tariffs are by far the main source of distortions.
- Liberalization in developing countries is a key element of the trade reform.
- The paper also offers four explanations on divergent results of multi-country general equilibrium models, including the MIRAGE model undertaken here:
- Experiments are not the same
- Data are not the same
- Behavioral parameters are not the same
- Theoretical features are not the same
Each explanation is examined in detail. The simulation in this paper is also utilized to check explanations of divergent results in the literature. In order to quantify the importance of the four factors, a sensitivity analysis is carried out. This method provides a quantitative assessment of expected benefits from liberalization when one hypothesis is modified and it confirms that:
- Direct trade barriers like tariffs, tariff quotas, and anti-dumping duties are smaller than previously expected. Furthermore, the worldwide structure of protection is less penalizing for developing countries than it was frequently stated few years ago. This is due to the multiplication of preferential schemes, which were not taken into account previously. Consequently, the expected benefits from full trade liberalization are not as large as they were assessed in recent literature.
- In multi-country trade models the size of the expected benefits depends crucially on the value of Armington trade elasticities. The simulation that has been carried out in this study is founded on GTAP elasticities which are small compared to others used in the literature. These values have been validated by a recent econometric research carried out by Hertel, Ivanic, Preckel, and Cranfield (2000.)
- The size of expected benefits from trade liberalization also depends crucially on the potential positive impact of trade openness on factor productivity. Several multi – country trade models utilize ad hoc methodologies to capture this element, like an equation relating positively total factor productivity to trade openness. This relation makes sense; openness may accelerate transmission of technologies. This is broadly confirmed by empirical works, but this kind of econometric study meets a significant number of conceptual and empirical difficulties. Furthermore, the previous direct relation between total factor productivity and trade openness is not founded on microeconomic basis and the parameters of the relationship are not measured with sufficient precision. As a result, integrating this relation automatically amplifies expected benefits, but the size of benefits has to be gauged with extreme care; this, however, does not highlight the channels through which trade integration raises factor productivity.
While this work is primarily focused on the issue of poverty, it does not provide an estimation of the extent to which full trade liberalization could alleviate poverty. Such an assessment would require utilization of numerous household surveys in developing countries, which goes beyond the technical feasibilities of this survey.
Another method of assessment would be possible: using poverty elasticities as in the Global Economic Prospects (2002 and 2004) or as in Cline (2004). An examination of this method, however, reveals that it is founded on weak assumptions. Furthermore, it presents the relation between trade liberalization and poverty alleviation as a mechanical one. According to this method, it would be sufficient to liberalize trade for increasing remuneration of unskilled labor in developing countries and reducing automatically (and proportionally) the stock of poor people in the world. This presentation is not realistic. Trade liberalization has frequently contrasting effects on poverty (poor people engaged in agricultural activities vs. poor working in industry or services, urban poor vs. rural poor, level of education, etc.) Studies on poverty alleviation have to focus on these contrasting effects and on (international and domestic) policies that have to be simultaneously put in place in order to accompany liberalization. Finally, poverty alleviation is a concept with a high qualitative content while in these studies people can be lifted out from poverty simply because they earn few cents more.
Benefits from eliminating tariff barriers, domestic support, and export subsidies have been recently revised downwards, first, because liberalization has progressed in recent years (end of implementation of the Uruguay Round, China’ accession to WTO, etc.), and second, because regional agreements and preferential schemes were not taken into account in previous works. When these elements are accounted for, two points explain divergent results across studies: trade elasticities and dynamic relations. Thus, it remains that trade liberalization is beneficial and contributes to poverty alleviation. It is all the more plausible for two reasons: first, trade reform could also concern non tariff barriers, trade facilitation, and obstacles to trade in services, and second, appropriate domestic reform accompanies trade reform. These two areas have not been enough investigated by economic research. They could constitute priorities in research agenda in order to understand fully the potential benefits that developing countries could draw from trade liberalization.
Full Discussion Paper
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