Calibrating a CGE model with NTBs that Incorporates Standard Models of Modern Trade Theory
Deliverable No. 2.3, Working paper by Eddy Bekkers, WTI and wiiw (Vienna), and Joseph Francois, WTI
Abstract We propose a way to incorporate NTBs for the four workhorse models of the modern trade literature in computable general equilibrium models (CGEs). CGE models feature intermediate linkages and thus allow us to study global value chains (GVCs). We show that the Ethier-Krugman monopolistic competition model, the Melitz ﬁrm heterogeneity model and the Eaton and Kortum model can be deﬁned as an Armington model with generalized marginal costs, generalized trade costs and a demand externality. As already known in the literature in both the Ethier-Krugman model and the Melitz model generalized marginal costs are a function of the amount of factor input bundles. In the Melitz model generalized marginal costs are also a function of the price of the factor input bundles. Lower factor prices raise the number of ﬁrms that can enter the market proﬁtably (extensive margin), reducing generalized marginal costs of a representative ﬁrm. For the same reason the Melitz model features a demand externality: in a larger market more ﬁrms can enter. We implement the different models in a CGE setting with multiple sectors, intermediate linkages, non-homothetic preferences and detailed data on trade costs. We ﬁnd the largest welfare effects from trade cost reductions in the Melitz model. We also employ the Melitz model to mimic changes in Non tariff Barriers (NTBs) with a ﬁxed cost-character by analysing the effect of changes in ﬁxed trade costs. While we work here with a model calibrated to the GTAP database, the methods developed can also be applied to CGE models based on the WIOD database.