July 4, 2005 Presentation at the School of Oriental and African Studies Estimating GDP Effects of Trade Liberalisation on Developing Countries A Study by the Centre for Development Policy and Research, commissioned by Christian Aid

Introduction This study estimates GDP losses caused by trade deficits due to trade liberalisation. Recent econometric studies suggest that while trade liberalisation in poor countries led to an increased growth of both exports and imports, it has caused import growth to systematically outpace export growth  In a sample of 17 least developed countries, yearly import growth outpaced yearly export growth by 1.4 percentage points The effect is not transient, but rather worsens with time, as the difference in export and import growth rates accumulates.

Introduction (continued) Import growth outpacing export growth will cause trade balance problems; an often neglected result is that it will also lead to lower national income as net demand for domestic goods is reduced The allocation of impacts between GDP and the balance of payments in each country and year would depend on private demand and government policy, as well as on the respective country’s ability to raise additional external finance for the increase in trade deficit The problem cannot be fixed by a one-time financing inflow, but only by either an ever-increasing stream of external finance (unrealistic), or by an ongoing depreciation of the real exchange rate.

The Main Question of Our Study Had trade liberalisation not happened, what GDP level could have been sustained, given the same level of external financing?

Methods Computable General Equilibrium (CGE) models are the accepted method for studying macro effects Most CGEs postulate full employment and full capacity utilization, so that no recessionary impacts of deficient demand are even possible We build the simplest possible CGE model that has variable capacity utilization We use regression results of existing cross-country studies for behavioral coefficients, national accounts and government statistics for calibration We solve the model for every country where sufficient data is available ( a sample of 32 LDCs and low income countries), for every post-liberalization year

Basic Causal Chain of the Model

Specific Modeling Choices High aggregation level All accounting is done in dollars Total external finance is constant across scenarios Compare history in a year to a counterfactual in the same year No explicit model of exchange rate behavior

Role of the Real Exchange Rate In Walrasian/neoclassical models, the real exchange rate adjusts to clear the balance of payments After trade liberalisation, real exchange rate does in fact depreciate – but is that sufficient to offset the increase in import demand?

Testing the Role of the Real Exchange Rate To assess the importance of real exchange rate depreciation in the adjustment to the trade balance deficit, we conducted sensitivity analysis with respect to real exchange rate changes The mitigating effect of real exchange rate adjustment never exceeded 25% of the overall impact, and was typically around 10% of the overall impact. That suggests that exchange rate changes alone are not a sufficient adjustment instrument to address trade liberalization-caused balance of payments problems.

Results The results suggest that over the countries in the sample, the negative GDP impact of trade liberalisation was typically between 7% and 18% of GDP Converting to constant 2000 US dollars, this sums up to 896bn US$ over a 20-year period for all countries in the sample

Discussion The sectors likely to have been most strongly affected by this GDP loss are manufacturing and the service sector The manufacturing sector has the highest value-added potential The short-term damage to demand for local manufacturing products is further likely to have led to decreased investment in manufacturing capacity, undermining prospects for future growth The service sector in LDCs is largely informal and typically contains a large share of the poor