Trade policy analysis: choosing Trade policy analysis: choosing the appropriate methodologythe appropriate methodology

Marc BacchettaERSD/WTO

OutlineOutline

Research based policy makingCriteria for choosing a methodologyKey methodologies

– Modelling assumptions– Required resources

Research based policy makingResearch based policy making

Research based information on policies is needed at different stages of the policy making process– Proposal – Policy dialogue with stakeholders– Implementation

DialogueDialogue

Dialogue between researchers and policy stakeholders is crucial

Researchers may help policy makers specify questions

Researchers should guide the choice of appropriate methodologies

Methodology: the questionMethodology: the question

Which approach is best suited to answer the question at stake given existing constraints ?

Choice of methodology is not Choice of methodology is not necessarily straightforwardnecessarily straightforwardThe question should dictate the choice of a

methodology ... But there are various constraints:

– Time and resources– Sunk costs (incl. familiarity with certain

methodologies, institutional constraints)– Fashion

Key approachesKey approaches

Descriptive statisticsModelling approaches:

– Ex ante vs ex post approaches– Econometric vs simulation models– Partial vs general equilibrium

Ex ante vs ex post approachesEx ante vs ex post approaches

Ex ante simulation involves projecting the effects of a policy change on a set of economic variables of interest – Can answer “what if” questions

Ex post approaches use historical data to conduct an analysis of the effects of past trade policy– Can answer “what if” questions if estimated

parameters are used for simulation (which assumes that past relations continue to be relevant)

Econometric vs simulation modelsEconometric vs simulation models

In econometric models, parameter values are estimated using statistical techniques– Parameter values come with confidence intervals

– Parameter estimation is resource intensive

– Results are specific to one country or group of countries

In simulation models, parameters are typically drawn from a variety of sources and some are calibrated

Descriptive statistics (1)Descriptive statistics (1)

Trade flows analysisExample: assessment of trade patterns

and/or trade performanceConceptual tools

– Revealed comparative advantage, intra-industry trade, export diversification, etc.

Empirical tools– Entropy indices, revealed comparative adv.

Trade performance and Trade performance and competitiveness assessmentcompetitiveness assessment Trade in services Merchandise trade

– Trade performance Growth and pattern in the direction of trade Composition of trade Export concentration and principal products

– Competitiveness, specialization and complementarity International competitiveness of exports Export specialization Trade complementarity and intensity ...

IndicesIndices

Export specialization index

Trade complementarity index– with

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Descriptive statistics (2)Descriptive statistics (2)

Trade policy analysisExample: trade policy assessment Conceptual tools

– Effective protection, non tariff barriers, bound and applied tariffs, tariff escalation, etc.

Empirical tools– Averages, dispersion indices, coverage ratios,

etc.

Trade policy assessmentsTrade policy assessments

Trade policy reviews– Trade and investment regime– Trade policies by measure and by sector

Tariff profiles

NAMA tariff simulations

Econometric estimation of gravity Econometric estimation of gravity equationsequationsCan be used to study the impact of trade

policy variables on trade flowsExample: effect of regional trade

agreementEx post: not well suited for making

predictionsNo welfare effects

Econometric estimation of gravity Econometric estimation of gravity equationsequationsReasonable data requirementsReasonable entry costsCost of econometric software package ?Importance of integrating theory with

estimation

Econometric estimation of economic Econometric estimation of economic consequences of tradeconsequences of trade

Example: assessment of the distributional effects of trade policy

Ex postVariable level of econometric

sophisticationVariable data requirements

Partial equilibrium simulationsPartial equilibrium simulations

Focuses on a specific market or product and ignores interactions with other markets

Best suited for the analysis of sectoral policies, or when interactions with other markets are expected to be limited

Allows to include more market relevant details than GE models

Ex: assessing the welfare effect of a reduction of the tariff on wheat

Partial equilibrium simulationsPartial equilibrium simulations

A number of partial equilibrium models have been developed to simulate international trade policy changes– Those include SMART, ATPSM, SWOPSIM

Data requirements are manageable– Elasticities are crucial

General equilibrium simulationsGeneral equilibrium simulations

GE explicitly accounts for all the links between sectors of an economy – households, firms, governments and the rest of the world

Imposes constraints s.t. income equals expenditure

Trade off between detail and breadth of coverage Assesses effects of policy changes on aggregate

and sectoral variables, including:– Income, production, employment, relative factor and

product prices, etc.

General equilibrium simulationsGeneral equilibrium simulations

Single or multiple country models Highly intensive in data and parameters

– SAM, behavioural parameters, elasticities– GTAP provides data and a simple model

Entry cost is significantHigh risk of misinterpretation

Paper on Turkey Paper on Turkey

Glenn Harrison, Thomas Rutherford and David Tarr (2003) “Trade Liberalization, poverty and Efficient Equity,” Journal of Development Economics, Vol. 71 (1), June 2003, 97-128.

 Policy application—joining a Customs Union with the European Union (not membership).

 Small Open Economy model with 40 households, 20 rural and 20 urban.

 Economic Theory suggests that for developing countries trade liberalization should shift production toward labor intensive products. That should be pro-poor.

In Turkey the authors did not find this. They estimated that the poor lost. Why?

They show that estimation of factor intensities is crucial to a sensible link between trade policy and poverty analysis.

Input-Output tables notoriously fail to accurately report factor intensities. Capital’s share is a residual. In Agriculture, labor’s earnings are underreported, so it is the most capital intensive sector in IO tables. Services sectors are also problematical.

 In Turkey locomotives are reported as 100% labor; textiles are capital intensive.

Perverse results may be obtained if estimates are based Perverse results may be obtained if estimates are based on IO table factor intensities. The lesson learned for on IO table factor intensities. The lesson learned for future applications is that factor intensities should be future applications is that factor intensities should be estimated outside of the input-output model.estimated outside of the input-output model.

The authors caution consumers of these models to ask producers how they have obtained the values of their factor intensities.

The study identifies sectors where an increase in the tariff rates will increase the welfare of the poor. The authors caution, however, that political economy reasons suggest that these models should not be used for industrial policy to help the poor. Likely to be abused like the many other arguments to depart from tariff uniformity.

Partial vs general equilibrium modelsPartial vs general equilibrium models

CGE PE

Capturing economy wide linkages X

Consistency wrt budget constraints X

Capturing disaggregated effects X

Capturing complicated policy mechanisms X

Use of timely data X

Capturing short and med. term effects X

Capturing long term effects X

Past performance in projecting impacts

Conflicting resultsConflicting results

Policy makers don’t like conflicting resultsIn most cases different results reflect

different assumptionsSuch differences are difficult to avoidWhat matters is the presentation of the

results

ReferencesReferences

Piermartini, R. and R. Teh (2005) Demystifying modelling methods for trade policy, WTO Discussion Paper No. 10

Bowen, H.P., A. Hollander and J.-M. Viaene (1998) Applied international trade analysis, University of Michigan Press

Abler, D. (2006) Approaches to measuring the effects of trade agreements, CATPRN Paper 2006-1