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Examining Trade Response of Armington-Krugman-Melitz Encompassing Module in a CGE Model

Author

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  • Ken Itakura
  • Kazuhiko Oyamada

Abstract

Computable General Equilibrium (CGE) models have been widely used for quantifying economic impacts of free trade agreements and economic partnership agreements. For the recent examples, it is estimated that Trans-Pacific Partnership (TPP) will increase Japanese real GDP by 0.66%, according to Cabinet Secretariat (2013) in Japan. Pacific Economic Cooperation Council (2012) also estimated that the impact of TPP on Japanese real GDP would be 2.0% higher by 2020. Both of the estimates are based on simulation results obtained from global CGE model; the former uses the GTAP model (Hertel, (1997), and McDougall (2003)), and the latter develops their own global CGE model (Zhai (2008), and Petri et al. (2012)). The difference in the estimated economic effects seems to be large, however, it is not surprising since the components taken into their estimates are different. Petri et al. (2012) considers exhaustive components of liberalization; such as removing tariffs, reducing non-tariff barriers, liberalizing trade in services and foreign direct investment. On the other hand, Cabinet Secretariat (2013) estimates the impact of removing tariffs, thereby resulted in the lower estimate. Beside the difference in the components of liberalization, it is more interesting for us to ponder the difference in trade specification used in their global CGE model. Petri et al. (2012) define their trade module by following Melitz (2003) based on product differentiation at the firm level. The GTAP model has been using the conventional Armington (1969) specification based on product differentiation at the country level. Thus, we are interested in comparing different trade specifications in global CGE model and its implications for resulting estimates of economic impacts of trade liberalization.This paper introduces the AKME module following the modeling strategy in Dixon and Rimmer (2012) and Oyamada (2013). We modify the GTAP model (Hertel, 1997), which is a global CGE model widely used by researchers for quantifying policy impact. We redefine trade flow information stored in the benchmark GTAP Data Base, and implement a calibration procedure established in Oyamada (2013) and Oyamada (2014b). We run simulation of trade liberalization to draw a comparison between different trade specifications, decomposing the trade response in detail. Since there exits only a handful of attempts to compare the trade effects by examining the AKME module, we provide another results for further insights. Impacts of liberalization on regional trade are amplified as we switch trade specification from the standard GTAP model to Armington, Krugman, and Melitz in turn. By introducing “sourcing-by-agent”, we can decompose the simulation results on regional imports into agent specific demands, which is not available in the standard GTAP model. Also with the sourcing-by-agent, we can identify the intra-manufactured trade flows as the largest share. Further decomposition reveals that intensive margin trade effects are more pronounced in Krugman specification, whereas extensive margin trade effects are significant in Melitz specification. These decompositions clearly enrich our interpretation of trade liberalization.

Suggested Citation

  • Ken Itakura & Kazuhiko Oyamada, 2015. "Examining Trade Response of Armington-Krugman-Melitz Encompassing Module in a CGE Model," EcoMod2015 8695, EcoMod.
  • Handle: RePEc:ekd:008007:8695
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    References listed on IDEAS

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    1. Peter Dixon & Michael Jerie & Maureen Rimmer, 2016. "Modern Trade Theory for CGE Modelling: The Armington, Krugman and Melitz Models," Journal of Global Economic Analysis, Center for Global Trade Analysis, Department of Agricultural Economics, Purdue University, vol. 1(1), pages 1-110, June.
    2. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-959, December.
    3. Hertel, Thomas, 1997. "Global Trade Analysis: Modeling and applications," GTAP Books, Center for Global Trade Analysis, Department of Agricultural Economics, Purdue University, number 7685, March.
    4. Zhai, Fan, 2008. "Armington Meets Melitz: Introducing Firm Heterogeneity in a Global CGE Model of Trade," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 23, pages 575-604.
    5. Peter A. Petri & Michael G. Plummer & Fan Zhai, 2012. "The Trans-Pacific Partnership and Asia-Pacific Integration: A Quantitative Assessment," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 6642, October.
    6. Petri, Peter A., 2012. "The Trans-Pacific Partnership and Asia-Pacific Integration," 2012: New Rules of Trade? December 2012, San Diego, California 143184, International Agricultural Trade Research Consortium.
    7. Oyamada, Kazuhiko, 2014. "Neutrality in the choice of number of firms or level of fixed costs in calibrating an Armington-Krugman-Melitz encompassing module for applied general equilibrium models," IDE Discussion Papers 465, Institute of Developing Economies, Japan External Trade Organization(JETRO).
    8. Oyamada, Kazuhiko, 2015. "Behavioral characteristics of applied general equilibrium models with an Armington-Krugman-Melitz encompassing module," IDE Discussion Papers 525, Institute of Developing Economies, Japan External Trade Organization(JETRO).
    9. Balistreri, Edward J. & Rutherford, Thomas F., 2013. "Computing General Equilibrium Theories of Monopolistic Competition and Heterogeneous Firms," Handbook of Computable General Equilibrium Modeling, in: Peter B. Dixon & Dale Jorgenson (ed.), Handbook of Computable General Equilibrium Modeling, edition 1, volume 1, chapter 0, pages 1513-1570, Elsevier.
    10. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    11. Oyamada, Kazuhiko, 2013. "Parameterization of applied general equilibrium models with flexible trade specifications based on the Armington, Krugman, and Melitz models," IDE Discussion Papers 380, Institute of Developing Economies, Japan External Trade Organization(JETRO).
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    Cited by:

    1. Kazuhiko Oyamada, 2017. "Behavioral Characteristics of Applied General Equilibrium Models with Variable Elasticity of Substitution between Varieties from Different Sources," EcoMod2017 10113, EcoMod.

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    Keywords

    Global; Trade and regional integration; General equilibrium modeling (CGE);
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