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Quantifying the fiscal effects of trade reform

Author

Listed:
  • Devarajan, Shantayanan
  • Go, Delfin S.
  • Hongyi Li

Abstract

Using a tax model of an open economy, the authors provide a simple but rigorous method for estimating the fiscal impact of trade reform. Both the direction and the magnitude of the fiscal consequences of trade reform depend on the elasticities of substitution and transformation between foreign and domestic goods, so they provide empirical estimates of those elasticities. They also discuss the implications of their analysis for public revenue. In general, they find that it matters what the values of the two elasticities are relative to each other. If only one of the elasticities is low (close to zero), revenue will drop unequivocally as a result of tariff reform, reaching close to the maximum drop whether or not the other elasticity is high. For imports to grow and tariff collection to compensate for the tax cut, the import elasticity has to be high. Because of the balance of trade constraint, however, imports cannot substitute for domestic goods unless supply is able to switch toward exports. Hence, the export transformation elasticity has to be high as well. As substitution possibilities between foreign and domestic goods increase, a tariff reform can theoretically be self-financing. But if the elasticities are less than"large", tax revenue will fall with tariff reduction and further fiscal adjustments will be necessary. The authors provide empirical estimates of the possible range of values for the elasticities of about 60 countries, using various approaches. The elasticties range from 0 to only 3 in most cases - nowhere near the point at which tariff reform can be self-financing.

Suggested Citation

  • Devarajan, Shantayanan & Go, Delfin S. & Hongyi Li, 1999. "Quantifying the fiscal effects of trade reform," Policy Research Working Paper Series 2162, The World Bank.
  • Handle: RePEc:wbk:wbrwps:2162
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    References listed on IDEAS

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    2. Devarajan, Shantayanan & Lewis, Jeffrey D & Robinson, Sherman, 1993. "External Shocks, Purchasing Power Parity, and the Equilibrium Real Exchange Rate," World Bank Economic Review, World Bank Group, vol. 7(1), pages 45-63, January.
    3. Mohsin S. Khan, 1974. "Import and Export Demand in Developing Countries (Demande à l'importation et l'exportation dans les pays en développement) (La demanda de importación y de exportación en los países en desarrollo)," IMF Staff Papers, Palgrave Macmillan, vol. 21(3), pages 678-693, November.
    4. Carmen M. Reinhart, 1995. "Devaluation, Relative Prices, and International Trade: Evidence from Developing Countries," IMF Staff Papers, Palgrave Macmillan, vol. 42(2), pages 290-312, June.
    5. Ulrich R. Kohli, 1978. "A Gross National Product Function and the Derived Demand for Imports and Supply of Exports," Canadian Journal of Economics, Canadian Economics Association, vol. 11(2), pages 167-182, May.
    6. Shoven, John B & Whalley, John, 1984. "Applied General-Equilibrium Models of Taxation and International Trade: An Introduction and Survey," Journal of Economic Literature, American Economic Association, vol. 22(3), pages 1007-1051, September.
    7. Gonzalo, Jesus & Lee, Tae-Hwy, 1998. "Pitfalls in testing for long run relationships," Journal of Econometrics, Elsevier, vol. 86(1), pages 129-154, June.
    8. Rose, Andrew K., 1990. "Exchange rates and the trade balance : Some evidence from developing countries," Economics Letters, Elsevier, vol. 34(3), pages 271-275, November.
    9. Devarajan, Shantayanan, 1997. "Real Exchange Rate Misalignment in the CFA Zone," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 6(1), pages 35-53, March.
    10. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-1580, November.
    11. Devarajan, Shantayanan & Go, Delfin S., 1998. "The Simplest Dynamic General-Equilibrium Model of an Open Economy," Journal of Policy Modeling, Elsevier, vol. 20(6), pages 677-714, December.
    12. Marquez, Jaime, 1994. "The Econometrics of Elasticities or the Elasticity of Econometrics: An Empirical Analysis of the Behavior of U.S. Imports," The Review of Economics and Statistics, MIT Press, vol. 76(3), pages 471-481, August.
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    Citations

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    Cited by:

    1. Amos Peters, 2005. "The Fiscal Effects of Tariff Reduction in the Caribbean Community," Public Economics 0511018, University Library of Munich, Germany.
    2. Essama-Nssah, 2004. "Building and running general equilibrium models in EViews," Policy Research Working Paper Series 3197, The World Bank.
    3. Nabil Annabi & John Cockburn & Bernard Decaluwé, 2006. "Functional Forms and Parametrization of CGE Models," Working Papers MPIA 2006-04, PEP-MPIA.
    4. FERABOLI Omar, "undated". "A Dynamic Analysis of Jordan’s Trade Liberalisation," EcoMod2003 330700052, EcoMod.
    5. Devarajan, Shantayanan & Go, Delfin S. & Page, John & Robinson, Sherman & Thierfelder, Karen, 2008. "Aid, growth, and real exchange rate dynamics," Policy Research Working Paper Series 4480, The World Bank.
    6. M. Shahe Emran & Forhad Shilpi, 2008. "Estimating Import Demand Function in Developing Countries: A Structural Econometric Approach with Applications to India and Sri Lanka," Working Papers 2008-10, The George Washington University, Institute for International Economic Policy.

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