Do-it-yourself partial equilibrium modelling David Vanzetti Division on International Trade in Goods and Services, and Commodities UNCTAD, Geneva United Nations Conference on Trade and Development Much of the material for this presentation was compiled by Joseph Francois of the Tinbergen Institute. Several of the models can be downloaded from his website,

Typical questions Who gains from removing export subsidies? Is domestic support important? Do special/sensitive product exemptions weaken the outcome?

Country-specific questions Will we gain or lose from further liberalisation? Export enhancement? Or flooded with imports? Tax revenues?

The need for quantitative analysis Policy changes have negative and positive effects. Price changes generate winners and losers. Quantitative analysis needed to aggregate effects. Numbers are needed to support arguments.

Overview The policy issue Model choices Some simple spreadsheet models Use and abuse of model results

Incidence of a tax D P Q S S’  Domestic production tax. Taxes collected are area The welfare cost is area 546. This is the sum of the producer loss 2467 and consumer loss 1542, less taxes collected. © Joe Francois

Large country import tariff D P M S Import taxes collected are area Consumer cost is area Taxes collected amount to area The welfare gain equals the difference between consumer losses and taxes. As some taxes (area 7456) come from terms of trade gains, the welfare effects depends on the relative size of 243 and © Joe Francois

Welfare effects of tariff change D P Q S When import tax t is removed, domestic price fall to P. Taxes formerly collected, area 2356, are lost. Consumers gain area Producers lose area The welfare gain equals the dead weight losses (DWL), 267 plus 345. These may be offset by a terms of trade effect, a rise in P, not shown hear. P+t TR 3 DWL 1 P

Terms of trade effect DmDm P Q SmSm With removal of import tax, Pw must rise to equate imports and exports. Some of te gains of liberalisation are captured by the exporter. Pw+t Pw m0 SxSx DxDx x0

Choices Homogeneous or heterogeneous product (imperfect substitutes) Preferential or multilateral tariff changes Spatial (bilateral) or non-spatial Net trade or two way trade Linear or non-linear Static or dynamic Deterministic or stochastic

Spreadsheet models Simple Transparent Focused on specific issue Use ‘Solver’ to provide numerical solution

The Toolbox Perfect (single market) Imperfect substitutes (Armington) Multi-region perfect Global Armington (GSIM) Global perfect (ATPSM)

© Joe Francois

Use ‘Solver’ in Excel to obtain numerical solution. Specified one cell as objective to be solved given constraints. © Joe Francois

q x1x1 x2x2 Armington preferences To accomodate two-way trade, we can use the Armington assumption. Under this assumption, imports x 2 and domestic goods x 1 are used to produce a composite utility good q. See discussion in Hertel, Ianchovichina, and McDonald With more import sources, we simple boost the indexing of n to cover all import sources. ©JFF © Joe Francois

Inputs Tariffs Elasticities World price Production Consumption Exports Imports

Output Consumer surplus Producer surplus Tariff revenue Quota rents Welfare Prices Production Consumption Exports Imports

Set up models Determine policy issue Choose model Choose country aggregation Specify commodity/ies

Data Get bilateral trade and tariffs data from WITS Other policy variables, domestic support, tariff rate quotas, production quotas Production data, from FAOSTAT for agricultural products, GTAP, national accounts Elasticities, (and cross-elasticities, Armington), from ATPSM, GTAP, other Check P+M=C+X, ΣM=0.

Shocks Common source of differences in results Compare bound vs applied rates Negotiate bound, but shock applied Exemptions

Why Results Differ Shocks - reducing tariffs on all imports rather than bilateral Price transmission from imported to domestic Greater specialisation with homogeneous product Net trade ignores some tariff revenues Linearisation errors

Interpreting Results Did simulation solve? Check ΣM=0, ΣToT=0 Check shocks are correct Any variables below 0, i.e. <-100%? Small trade shares problem – no change from zero trade Explain counter-intuitive results Usually composition effects Confabulation

Sensitivity analysis Which variables or parameters drive the results? (Armington elasticities?) Is there uncertainty about these variables? Run model with different values to check results are robust

Selling your results Don’t oversell (others will do this for you) Use results to provide insights, not answers But are results driven by assumptions – elasticities, closures, market structure, short vs long run?

Are the negotiators correct? UNCTAD modelling shows some counter- intuitive results: –EU export subsidies benefit developing countries –Tariff revenues may rise from tariff reductions, and generally fall by less than the tariff cut –More countries lose than gain from multilateral agricultural liberalisation –Market expansion offsets preference erosion

Summary Build you own for useful insights Consider would additional complexity (dynamics, IRTS) reverse policy implications Keep it simple

The End

Algebra: from first order conditions For CES demands (see solution sheet) P is a composite price P j is the price of good j E is total expenditure k si is a supply function constant term k a is a composite demand constant term  is the elasticity of substitution  =(  -1)/ 

GSIM In the GSIM model, linearized Armington demand is added up across all markets, yielding one market clearing condition for each exporter. Hence, with 10 regions and 100 potential trade flows, the model is reduced to 10 equations. See Francois and Hall © Joe Francois