The Effects of the EU-Ukraine FTA: An Inequality Analysis using a CGE-Microsimulation Model for Ukraine

This paper analyzes the effects of the planned free trade agreement (FTA) between the European Union (EU) and Ukraine on inequality and poverty in the latter using a CGE-microsimulation model for Ukraine. Special attention is thereby given to the in-house production of agricultural and processed food goods generated by the Ukrainian households. Due to a lack of information on these activities in the national accounts data, this type of household production is neglected in an already existing CGE analysis of the welfare effects resulting from the EU-Ukraine FTA. However, in-house production of food products for own consumption plays a crucial role in Ukraine. According to a household expenditure survey for Ukraine 60.5% of the households are engaged in the production of agricultural goods like potatoes, eggs and cabbage and an even slightly higher percentage (61.6%) of them reported to produce processed food goods like dairy products and preserves. The CGE-microsimulation model used in this paper follows the top-down approach, meaning that variables, such as prices and factor returns which change as a result of the simulation of the trade integration in the CGE model are then transferred to the microsimulation model where they are treated as exogenous variables. The CGE model used here is a rather standard, small open economy, single-country model for Ukraine exhibiting perfect competition and constant returns to scale. It incorporates 38 sectors of production and a representative household which is disaggregated into four types according to the domestic poverty line and the place of residence (rural or urban). Labor is differentiated based on the level of education in skilled and unskilled labor and is assumed to be fully employed. The microsimulation model consists of a log-income and a discrete choice labor supply equation as well as of accounting identity and arithmetical computation equations. In-house production of agricultural and processed food products is not treated as being part of the – in most of the literature existing – labor market alternative “being self-employed”, but is modeled explicitly and analogous to the labor status as a discrete choice. This is mainly done for the following two reasons. Labor market status is assumed to be a choice made on the individual level, whereas the decision whether or not to participate in household production of agricultural and processed food goods for own consumption is made on the household level. The second reason is that the explanatory variables which influence the choice of the labor market alternative do not necessarily have to coincide with the ones that determine the decision on in-house production of food products. The data needed for the CGE model include the Ukrainian national accounts and input-output tables for 2007, additional statistics from national sources like information on indirect taxes, labor remuneration and tariffs, international trade statistics and a household expenditure survey for 2007 covering more than 10,000 Ukrainian households and more than 20,000 household members. The latter is also the basis for the microsimulation model. Concerning the household level, information on expenditures, place of residence, characteristics of the household head and land ownership are the most important variables. With respect to the household members, information on sex, age, education, labor market status and income are crucial.