A CEPR conference on "Dynamic Issues in Applied Commercial Policy Analysis" was held on 26-28 January in Geneva. The workshop formed part of CEPR's research programme on `Market Integration, Regionalism and the Global Economy', funded by a grant from the Ford Foundation. It was organized by Richard Baldwin (Graduate Institute of International Studies, Geneva and CEPR) and Joseph Francois (World Trade Organization and CEPR).
In `Getting There is Half the Fun: Trade Policy Reform and Transitional Growth' by Joseph Francois, Håkan Nordström (World Trade Organization and CEPR) and Clint Shiells (International Monetary Fund) emphasize the relevance of classical transitional dynamics for trade policy, particularly for developing countries. The empirical evidence from cross-country growth regressions points to important transitory growth effects related to trade policy reforms. They examined those effects using a Solow model, formally developing the transitional dynamics and contrasting policy reforms in countries in steady state (developed countries) and countries out of steady state (developing). They show that policy reforms that appear identical in a static or steady state framework can have substantial greater impact on developing countries, once accounting for accumulation effects during transition.
The paper `Putting Growth Effects in Computable Equilibrium Trade Models' by Richard Baldwin and Rikard Forslid (University of Lund) considers the systemic problems involved in incorporating growth effects in Computable General Equilibrium (CGE) models. It first covers the inclusion of medium-run growth models. However, since the inclusion of an endogenous capital stock is common in the most advanced CGE models, the authors focused on the paper's main contribution namely how endogenous growth effects can be included. The authors show that marrying common CGE approaches to the common product-innovation-type of endogenous growth model will typically produce the result that trade liberalization has no impact on the steady state growth rate. The authors suggest a number of trade-and-growth links that can be captured by modifying the product-innovation-type of endogenous growth model.
Christian Keuschnigg (Institut für Höhere Studien and CEPR) and Wilhelm Kohler (University of Essen) presented a paper on `Economic Transition, Endogenous Innovation and Capital Accumulation'.
James Markusen (University of Colorado) and Anthony J. Venables (London School of Economics and CEPR) use a model of multinationals to address policy issues involving wages and labour skill in their paper on `Multinational Production, Skilled Labour, and Real Wages". Multinational firms may arise endogenously, exporting their firm-specific knowledge capital to foreign production facilities, and geographically fragmenting production into skilled and unskilled labour intensive activities. Multinationals thus alter the nature of trade; from trade in goods (produced with both skilled and unskilled labour) to trade in skilled labour intensive producer services. Results shed light on several policy questions. They found that multinationals increase the skilled/unskilled wage gap in high income countries while the effect on wage gap in low income countries is ambiguous. Multinationals export less skilled jobs to lower income countries and create a tendency towards factor price equalization. They also address questions like: do trade barriers protect unskilled labour in the high income countries and do multinational exports of skilled labour services substitute or complement skilled labour in host countries?
In `Economic Policy and the Manufacturing Base: Hysteresis in Location' Anthony Venables analysed the incentives for agglomeration caused by the combination of imperfect competition and intersectoral linkages. Firms are monopolistically competitive in all industries. Using a simulation based on chemical industry data that considers two locations and one industry, Venables suggested that the industry in the taxed location may collapse with all firms locating in the other country. Hysteresis in location may arise, which has implications for removal of the tax, highlighting the importance of a country's industrial base and suggesting that the effects of economic policies are not always as intended.
The standard approach to numerical assessment of trade policy changes is considered in `Scenarios as Reference Points for Trade Policy Analysis' by Jan Haaland (Norwegian School of Economics & Business Administration and CEPR), Victor Norman (Norwegian School of Economics & Business Administration and CEPR). The authors calibrate a simulation model, use it to produce a reference case, and simulate the effects of changes in policy relative to the reference case. They point out two weaknesses of this approach. First, the calculated effects may be rather different from those actually realized simply because the economy undergoes other changes as the trade policies are implemented. Second, the counterfactual approach may miss the very objective of the policies one tries to evaluate, because the policy aim may be not to improve on the status quo, but to prevent something worst. The establishment of the GATT is a case in point. One of its purposes was to promote freer trade; but an equally important objective was to prevent trade wars. To assess the effects of policies in such circumstances, the relevant reference case is not the actual equilibrium observed in some base year, but the equilibrium that would evolve over time in the absence of the policies. In fact, no one but several reference equilibria should be employed, as the purpose of the policies may be to prevent adverse events which may occur only in some possible states. They show for example that the effect that European integration can have by preventing protection is large relative to the direct gain from freer trade.
In `Capital Flows and North American Economic Integration' Timothy Kehoe (University of Minnesota) analyzes capital flows into and out of Mexico in light of the steps that have been taken towards North American Economic Integration and the 1994-95 financial crisis. The paper quantifies the magnitude of capital flows that are likely to result from economic integration. It also provides a brief history of the crisis and analyzes its causes. There are two significant conclusions: First, opening Mexico to foreign capital should result in large capital inflows over the next couples of decades. Second, the 1994-95 financial crisis was not the fault of Mexico's economic openness policy, but rather of a combination of an unprecedented sequence of shocks to the Mexican economic and political system together with a sequence of risky financial policies taken by the government in 1994.
The paper `Trade Liberalization, Investment and the Capital Stock' by Joseph Francois, Brad McDonald (World Trade Organization) and Håkan Nordström explores trade policy and investment linkages in a multi-country framework under alternative steady state closure rules, linking trade to consumption, production and investment. The authors emphasize the general equilibrium nature of capital accumulation mechanisms. They offer a numerical assessment of the Uruguay Round, highlighting such linkages. They find that when policy shocks are capital friendly, induced investment may be greater than suggested by current savings rates. As a result, multiplier type analysis can be very misleading. The importance and direction of this magnification hinges critically on the sensitivity of savings rates with respect to real returns.
In `Investment Creation and Investment Diversion: Simulation Analysis of the Single Market Programme', Richard Baldwin, Rikard Forslid and Jan Haaland find suggestive but not conclusive evidence that the programme may have led to investment diversion in the EFTA countries and investment creation in the EU economies. The authors argue that a simple mechanism, based on the derived demand for capital can account for this. Discriminatory liberalization shifts production from non included countries to the integrating region. Since EU92 focused on tradable sectors and these are capital intensive, the production shifting raises the rental rate in the integrating regions, lowering it elsewhere. This leads to investment creation and diversion. Results from simulation show that investment diversion does occur for the EFTA6 (their steady state capital stock drops by two thirds of a percent) when the EU s liberation involves market integration in addition to real trade cost reduction. When EU92 is extended to include the EFTA6, EFTA6 capital stocks rise by almost 5%. In terms of real income, the difference between the EFTA6 included and excluded cases is quite large amounting to 5.5% of GDP for the EFTAns. In all cases, the EU experience investment creation and real income gains. The effects on the US and Japan are trivially small, but mostly negative in terms of capital stocks and real income.
A numerical model based on the endogenous growth literature is developed in `Dynamic Gains from Trade Liberalization in a Small Open Economy' by Thomas Rutherford (University of Colorado) and David Tarr (World Bank). The authors trace out the dynamic adjustment path of all the variables in the model and evaluate the welfare consequences of a change in policies, ie, two policies that achieve the same steady state growth path could have very different welfare consequences due to the dynamic adjustment path. They use a two sector model; one sector, Y, produces only final goods under constant returns to scale and uses as inputs labour, capital and an intermediate good X. The good X is produced by both foreign and domestic firm under the large group monopolistic competition assumption and increasing returns. The sole distortion in the economy is a 10% tariff on imports in the X sector. They establish a benchmark steady state growth path and after removing the tariff compare all variables to their benchmark value. One of their most important results is that welfare increases by 5.7% of the present value of consumption, a rather large increase for a tariff rate of only 10% in an economy with less than 15% of its GDP coming from imports. As a result of increased competition from foreign varieties the domestic industries declines sharply in the first 4 years, but due to spillovers it begins to recover subsequently. They do not need spillovers to generate the large welfare gains. What is crucial to the large welfare gains is the availability of increased varieties.
Differences in the rate of population growth between North and South have important implications for patterns of trade, migration, and the distribution of the gains from economic activity, both within and between nations. In a paper on `Population Growth, Trade Policy and Migration Incentives' Joseph Francois and Doug Nelson (Tulane University) focus on migration related effects. They provide a theoretical discussion of explicit linkages between population growth, trade policy and migration. This is supplemented by CGE based numerical examples. The numerical analysis highlights issues such as the importance of income distributional effects.
David Roland-Holst (OECD Development Centre and Mills College) presented his paper on `Labour Markets and Dynamic Comparative Advantage'. Historically, domestic migration has been one of the main animating forces of economic modernization and one of contributors to or companions of economic stagnation, particularly in the context of rural urban population shifts. Although migration has largely run its course in the industrialized countries, it will still exert a dramatic influence on the course of growth in large and populous developing countries such as China, India and Indonesia. The paper presents a framework for incorporating migration into a dynamic general equilibrium model. The model is then used to appraise the role migration might play in the Chinese development over the next two decades.
The paper `Long-Term Modelling of Resource and Environmental linkages' by David Roland-Holst and Dominique van der Mensbrugghe (OECD Development Centre) reports on results of research on coordinated approaches to trade and environmental policy. In particular, they set out an explicit theoretical framework for evaluating the two types of policies and show how trade and environment linkages give rise to a complex array of second best issues. They derive optimal interventions and sufficient conditions for welfare improving piecemeal trade and environmental policy reforms in a small economy. These results are then applied to a dynamic simulation model of Indonesia to indicate the magnitude of the interactions, second best effects and prospective efficiency gains which can result.
Sweder van Wijnbergen (University of Amsterdam and CEPR) closed the conference with a paper on `Political Bargaining and the Design of Adjustment Policies'.