Measuring the Impacts of Global Trade Reform with Optimal Aggregators of Distortions

• Author: Will Martin,Dominique van der Mensbrugghe,David Laborde
• DOI: http://doi.org/10.1111/roie.12271
• Published date: 01 May 2017
• Date: 01 May 2017

Measuring the Impacts of Global Trade Reform

with Optimal Aggregators of Distortions

David Laborde, Will Martin, and Dominique van der Mensbrugghe*

Abstract

Aggregation of tradedistortion measures is essential in appliedwork, but traditional trade-weightedaverage

measures are egregiously flawed. This paper shows how appropriate tariff aggregation can overcome under-

estimation of both efficiency and terms-of-trade gains from reform. The improvement is shown to result

from better measurement of a distortion effect that is most important in the early stages of reform and a

weighting effect that becomes more important as protection is reduced. Applications confirm that the tech-

nique can be applied relatively easily, and—with elasticity estimates suggestedby the available econometric

evidence—point to close to a doubling of the global welfare gains from global trade reform, and dramatic

changes in the measured welfare impacts in many individual cases. Sensitivity analysis suggests that, for

global trade reform, the ease of substitution between tariff lines is much more important than that between

varieties from different countries.We provide an online aggregation tool to allow replication of our analysis

or investigation of alternative scenarios for global reform. We hope that this paper will contribute both to

wider use of optimal aggregators and improved estimates of the key elasticityparameters.

1. Introduction

Economists have long been aware that the standard approaches used to assess the

implications of large-scale reforms, such as WTO agreements, may seriously under-

state their benefits because of excessive aggregation of trade distortions. The problem

is potentially very important because border protection rates applied to finely differen-

tiated products frequently differ greatly.

1

It has proved difficult to resolve because the

needed information on production and demand structures is typically available only at

a much higher level of aggregation than the information on tariffs and trade flows and

theoretically consistent approaches to aggregation have not been available.

Historically, measures such as simple or trade-weighted average tariffs have been

employed to summarize trade policy distortions up to a level consistent with that used

for analysis of production and consumption. As emphasized by Anderson and Neary

(1996), these measures are without theoretical foundation and may introduce signifi-

cant biases. The most obvious problem with the trade-weighted average is that the

weight on any tariff declines as it rises, with very high tariffs having vanishingly small

weights even when their trade-distorting impacts are large. As we show in this paper,

these standard tariff aggregators have another fundamental problem in failing to take

into account the tariff-revenue-enhancing effects of within-group increases in imports

resulting from tariff cuts on highly protected goods. The first problem is clearly serious

* Laborde and Martin: MTID, International Food Policy Research Institue (IFPRI), 2033 K St NW,

Washington, DC, 20006-1002, USA. E-mails: d.laborde@cgiar.org and w.martin@cgiar.org. van der

Mensbrugghe: Department of Agricultural Economics, Purdue University, West Lafayette, IN47907,

USA. E-mail: vandermd@purdue.edu. This paper reflects the views of the authors only and not those of

any of the institutions with which they are, or have been, affiliated. This research was partially funded

by the Multi-Donor Trust Fund for Trade at the World Bank and by the CGIAR Research Program on

Policies, Institutions and Markets, led by IFPRI.

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C2016 The Authors. Review of International Economics Published by John Wiley & Sons Ltd

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

Review of International Economics, 25(2), 403–425, 2017

DOI:10.1111/roie.12271

when liberalization reduces tariffs substantially from their initial level. The second

problem is most serious in the initial stages of liberalization, when tariffs are at their

highest.

New and theoretically consistent approaches to the aggregation problem have now

emerged. Anderson and Neary (1994) proposed a uniform tariff that yields the same

welfare as the original differentiated tariff structure. In a subsequent work (Anderson

and Neary, 2003), they developed uniform tariff measures that are equivalent to using

the full vector of tariffs in measuring effects on trade volumes. In this paper we seek

aggregators that are optimal in yielding correct estimates of the key variables in open-

economy modeling: economic welfare, tariff revenues, economic welfare and the terms

of trade.

Building on the Anderson–Neary approach, Bach et al. (1996) and Bach and Martin

(2001) proposed an approach to aggregation in the context of structural economic

models that mitigates many of the problems resulting from use of atheoretic aggrega-

tors—and showed that the implications of aggregation could be large for specific coun-

tries. However, they were only able to apply their approach to individual countries or

regions. Anderson (2009) made an important step forward in identifying an approach

that enables optimal aggregators to be used in multi-country models. He showed that

an optimal approach to aggregation dramatically increased the measured welfare ben-

efits of trade reform relative to results obtained with a two-sector model in a highly

protected country (pre-reform India).

While suggestive, the available results leave open many important questions, includ-

ing: (1) How large might this aggregation bias be in other economies, and in models of

the type usually used to analyze global trade reforms, where perhaps 20 or 25 sectors

are separately identified, or in econometrically estimated models which are typically

more aggregated? (2) For which types of policy reform and in which ways does this

approach make the most difference; are, for instance, its impacts greatest for partial

reform or for full liberalization; and are its impacts on welfare most pronounced

through domestic efficiency impacts or changes in the terms of trade? (3) What param-

eter estimates are needed to implement it on a larger scale and to which of these

parameters are the results most likely to be sensitive? (4) How important is the

intensive-margin adjustment considered in this paper relative to extensive-margin

changes (see Debaere and Mostashari, 2010), and finally, (5) Can this approach now

be implemented on a routine basis?

A number of studies have used tariff-line level data in combination with economy-

wide models to address questions about specific products and markets. Grant et al.

(2009), for example, drill down to focus on individual tariff lines in the US market.

Gouel et al. (2011) focus on product-level exceptions from reform in the Japanese and

European markets. A related strand of the literature (see Anderson and Croser, 2011;

Kee et al., 2009) focuses on estimation of summary statistics such as the Anderson–

Neary Trade Restrictiveness Index for efficiency in a single country, or on Mercantilist

Trade Restrictiveness indexes for overall market access opportunities. Kehoe et al.

(2013) show that products with small initial trade shares sharply increase their trade

weights following liberalization—a result that highlights the importance of allowing

for changes in trade shares when aggregating measures of protection.

This paper uses a two-stage modeling approach that brings together in a theoreti-

cally consistent manner detailed data trade and trade distortions with information on

the structure of the economy that is available only at a higher level of aggregation.

The approach is potentially relevant to many types of study, such as GNP functions of

the type estimated by Kohli (2004); disaggregated models of import demand of the

404 David Laborde, Will Martin and Dominique van der Mensbrugghe

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C2016 The Authors. Review of International Economics Published by John Wiley & Sons Ltd