The European Community's `1992' programme will take effect mainly through changes to international trade flows, but existing estimates of elasticities tend to be highly aggregate, rather old, and obtained using a variety of methods. In Discussion Paper No. 717, Research Affiliate Paul Brenton and Programme Director L Alan Winters estimate price elasticities for France, West Germany, Italy and the UK, using the Almost Ideal Demand System on 1970-87 trade and production data at a detailed industry level. Their model distinguishes products by location of production, and consumers choose symmetrically among domestic and various import suppliers.

Their initial results for 70 West German manufacturing industries indicate very low price elasticities, while expenditure elasticities are higher for domestic supplies (mainly luxuries) than for imports (mainly necessities). They then run two simulations of the `1992' programme. First, only import prices decline (intra-EC imports by 2.5% and extra-EC imports by 1%). With low price elasticities and no change in the principal (domestic) supplier's price, changes in trade volumes and welfare are small, with the latter averaging some 0.7% of base-year sales. The income effect on domestic supplies is strong enough for domestic sales to increase even in face of an adverse relative price change. Second, with an additional 2.5% fall in costs for all EC suppliers, the welfare gain averages 2.7% and there is trade diversion as imports from the rest of the world decline.

Brenton and Winters assess the robustness of their results by applying the same model to data on 15 Italian manufacturing industries and also using the more restrictive CES model. Both exercises confirm their low price elasticities. This insensitivity of demand to price changes implies that the `1992' programme's effects on certain industries may be quite small. Low price elasticities imply large price and rent effects from relaxation of quantitative restrictions, however, while the effects on the rest of the world realized through changes in volumes will be small. Identifying who appropriates the rents from quantitative constraints may therefore be critical to the distribution of the `1992' programme's welfare effects.

Estimates of Bilateral Trade Elasticities and Their Implications for the Modelling of `1992'
Paul A Brenton and L Alan Winters

Discussion Paper No. 717, September 1992 (IT)