Putting Services and Foreign Direct Investment with Endogenous Productivity Effects in Computable General Equilibrium Models

In this chapter I explain an innovative modeling approach that incorporates services, foreign direct investment (FDI) and endogenous productivity effects from services. I begin with a small stylized model to help understand the fundamental economics. The model shows that services liberalization yields welfare gains several multiples of the welfare gains obtained from a constant to returns to scale model. Further, the welfare gains are supported by the econometric estimates of the gains from trade or FDI liberalization. I then describe computable general equilibrium studies by my colleagues and I conducted for the Russian government on the potential effects of Russian accession to the World Trade Organization (WTO). We find that the projected welfare gains generated from liberalization of barriers against foreign direct investment are about 5% of consumption, with the total benefits of all aspects of WTO accession being about 7% of consumption. We find that almost every household in Russia would be expected to gain from WTO accession. We show, however, that a model of Russian WTO accession that fails to incorporate FDI in services and endogenous productivity effects from additional services would yield an estimated gain of less than 1% of consumption with about 7% of the households losing. Reviews of the work have indicated that the work has had a significant influence on the public debate and helped the Russian government to steer public opinion in favor of WTO accession. In the process of doing this work, T. Rutherford and I developed a technique for incorporating tens of thousands of households as agents of the model. All of the major results in the chapter are shown to be robust under sensitivity analysis.