Cost and Benefit Analysis of Possible Philippine ... · Keywords: Philippines, Trans-Pacific...

Cost and Benefit Analysis of Possible Philippine Participation in the

Trans-Pacific Partnership Agreement‡

Caesar B. Cororaton and David Orden

July 2014

GII Working Paper No. 2014-1

Keywords: Philippines, Trans-Pacific Partnership, Global Trade, Global Computable General

Equilibrium

JEL Classification: C68, D58, F15

‡ Research funding provided by the Global Issues Initiative/ Institute for Society, Culture and Environment, Virginia

Polytechnic Institute and State University.

Caesar Cororaton ([email protected]) is Research Fellow and David Orden ([email protected]) is Director, at the Global

Issues Initiative (GII), Institute for Society, Culture and Environment (ISCE), Virginia Polytechnic Institute and State

University (Virginia Tech), Alexandria, Virginia, USA.

mailto:[email protected]

mailto:[email protected]

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Executive Summary

The goal of the twelve-nation Trans-Pacific Partnership (TPP) is to expand trade and investment

across the Pacific region through the elimination of tariffs and non-tariff barriers, the

harmonization of all trade regulations, and the elimination of investment barriers. The TPP group

includes Brunei, Chile, New Zealand, Singapore, United States, Japan, Canada, Mexico, Peru,

Australia, Malaysia, and Vietnam. Together, this group is a huge economic block representing 40

percent of the world’s GDP and 40 percent of world trade. In 2012, the TPP member countries

have a combined population of 783.6 million and GDP of US$27.5 trillion. A TPP agreement is

yet to be achieved with the members working to resolve many challenging issues, but given the

significance of this group as a major economic block, South Korea and Taiwan have already

signified interest in joining the group. The Philippines has yet to signify interest in joining the TPP

group, but the government is in the process of evaluating a possible participation. Currently, the

TPP member countries are markets for Philippine exports and sources of imports and foreign direct

investments (FDI). Participation or non-participation in the TPP can expand or contract these trade

and investment linkages.

The objective of the paper is to provide a quantitative analysis of the possible economic cost to the

Philippines of non-participation in the TPP. The paper uses a global computable general

equilibrium (CGE) model calibrated to the GTAP 8 database to simulate the possible effects in the

Philippines under the following scenarios: no Philippine TPP participation; Philippine TPP

participation with no foreign direct investment (FDI) inflow effects in the country; and Philippine

TPP participation with FDI inflow effects in the country. In the analysis, a TPP agreement is

modeled as a 10-year reduction (2015-2024) in tariffs and non-tariff barriers among the

participating parties. These three scenarios are compared with a baseline scenario where all trade

barriers are retained.

In the scenario where the Philippines does not participate, the ‘Original TPP’ scenario, a TPP

agreement will divert trade from the non-TPP, including the Philippines, to the TPP. The results

indicate that a 90 percent and a 20 percent reduction in tariffs and NTBs respectively within the

original TPP over a 10-year period will increase their combined exports annually starting by

US$8.3 billion in 2015 and increasing to US$71.7 billion in 2024. Furthermore, the results indicate

that the effects of the reduction in tariffs dominate the effects of the reduction in NTBs up to the

8th year in 2022. Thereafter, the NTB reduction effects dominate the tariff reduction effects.

However, a much higher reduction in NTBs of 40 percent will dominate the effects of the 90

percent drop in tariffs throughout the simulation period.

The reduction in the trade barriers within the TPP can expand the volume of trade within the group.

Exports within the group will increase annually starting by US$10.1 billion in 2015 and increasing

to US$87.4 billion in 2024. Exports of the non-TPP decline, largely due to the declining exports

to the TPP. As part of the non-TPP, the Philippines will also experience declining exports. The

country’s total exports will decline annually starting by US$0.01 billion in 2015 and decreasing to

US$0.4 billion in 2024. This is largely due to the country’s declining exports to the TPP.

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In the scenario where the Philippines joins the TPP, the ‘Original TPP + Philippines scenario, the

results indicate that the increase in exports of the expanded group is higher relative to the ‘Original

TPP’, largely due to the higher volume of exports within the expanded group. There is a larger

diversion of exports from the non-TPP, excluding the Philippines, to the expanded TPP. The

Philippines as well as the original TPP countries will experience increasing exports. Philippine

exports will improve starting by US$0.3 billion in 2015 and increasing to US$3.0 billion in 2024.

Thus, the reduction in the trade barriers within the TPP members (both under the ‘Original TPP’

and in ‘Original TPP + Philippines’) can create trade among the participating members and divert

trade from the non-TPP.

The increase in Philippine exports under TPP participation with higher FDI inflows is slightly

lower compared to the scenario involving no increase in FDI inflows. The slightly smaller export

effects are mainly due to the real exchange rate appreciation in the Philippines associated with

higher FDI inflows. The real exchange rate appreciates annually by 0.1 percent in 2015 and

increasing to 0.5 percent in 2024. This slightly reduces the country’s export price competitiveness

and lowers the full export effect in the Philippines of the reduction in the trade barriers among the

TPP group. The reduction in the country’s exports to the non-TPP is also relatively higher with

the real exchange rate appreciation.

Philippine non-participation in the TPP negatively affects some of its major sectors because of the

trade diversion effects. The negative effects are smaller initially, but they become larger over time.

The sectors which are negatively affected are the textile and wearing apparel sector, petroleum

products, construction, services, and equipment.

On the other hand, a Philippine TPP participation without additional FDI inflows affects the terms-

of-trade that favor the textile and wearing apparel sector. Its production is higher by 1 percent in

2015 relative to the baseline. The improvement of the sector is sustained to 14.3 percent in 2024.

The other sectors which are also favorably affected are services, petroleum products, utilities, and

chemicals. There is negative effect on the electronic equipment sector initially, but over time its

production improves. However, there are several sectors where the reduction in the trade barriers

will result in unfavorable terms-of-trade. Foremost of which is the construction sector, a non-

tradable sector. The other sectors with unfavorable terms-of-trade effects include agriculture,

mining, food manufacturing, metal products, and transport equipment and machinery. Their

negative output effects arise from the higher volume of imports as trade barriers are reduced.

Philippine non-participation in the TPP will result in lower factor returns. However, there is a

sustained improvement in wages and returns to capital under the Philippine TPP participation

scenario. But the returns to land decline. Philippine participation with additional FDI inflows will

result in higher factor returns, including the returns to land.

The welfare cost to Philippines of non-participation in the TPP increases from US$0.4 billion in

2015 (0.02 percent of GDP) to US$3.9 billion in 2024 (0.13 percent of GDP). The welfare effects

are relatively higher if Philippine TPP participation comes with higher inflows of FDI into country.

The feedback effects of higher FDI inflows on Philippine productivity was not included in the

analysis. The effects can be significant in sustaining the improvement in income and welfare in

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the Philippines. However, capturing this in the analysis may be complicated and could be an area

for further research.

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Contents

Executive Summary ........................................................................................................................ ii

1. Introduction ............................................................................................................................ 1

2. The Philippines with Trading Partners .................................................................................. 3

3. Framework of Analysis .......................................................................................................... 8

4. Definition of Simulations ..................................................................................................... 14

5. Simulation Results ............................................................................................................... 15

6. Summary and Conclusion .................................................................................................... 22

References ..................................................................................................................................... 26

Appendix A: Additional Simulation Results ................................................................................ 27

Appendix B: Mapping to GTAP 8 and Specification of a Global CGE Model ............................ 30

B.1. Mapping to GTAP 8 Database ..................................................................................... 30

B.2. Specification of a Global CGE Model ......................................................................... 35

Appendix C: The Effects of Capital Inflows on Tradables within a CGE Framework ................ 56

Appendix D: Welfare Measure ..................................................................................................... 61

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List of Tables

Table 1. Population and GDP of TPP Member and Interested Countries ...................................... 2

Table 2. Free Trade Agreements the Philippines is Involved ......................................................... 4

Table 3. Destination of Philippine Merchandise Exports ............................................................... 5

Table 4. Structure of Philippine Merchandise Exports ................................................................... 6

Table 5. Sources of Philippine Merchandise Imports ..................................................................... 7

Table 6. Net Foreign Direct Investments in the Philippines (US$ million) .................................... 8

Table 7. Estimates of Tariff and Non-Tariff Barriers ................................................................... 12

Table 8. Alternative Foreign Direct Investment Scenarios (US$ millions) .................................. 13

Table 9. Effects of 90 and 20% Reduction in Tariffs and NTBs (diff. from baseline, US$ billion

in 2007 prices) ............................................................................................................................... 16

Table 10. Sectoral Effects in the Philippines, 90 and 20% Reduction in Tariffs and NTBs (%

change from the baseline) ............................................................................................................. 19

Table 11. Effects on Factor Returns in the Philippines, 90 and 20% Reduction in Tariffs and

NTBs (% difference from the baseline) ........................................................................................ 21

Table 12. Welfare Effects in the Philippines, 90 and 20% Reduction in Tariffs and NTBs ........ 22

Table 13.Effects of 90 and 40% Reduction in Tariffs and NTBs (diff. from baseline, US$ billion

in 2007 prices) ............................................................................................................................... 27

Table 14. Sectoral Effects in the Philippines, 90 and 40% Reduction in Tariffs and NTBs (%

change from the baseline) ............................................................................................................. 28


NTBs (% difference from the baseline) ........................................................................................ 29

Table 16. Welfare Effects in the Philippines, 90 and 40% Reduction in Tariffs and NTBs ........ 29

Table 17. Mapping of Global CGE Sectors to GTAP 8 Database Sectors ................................... 30

Table 18. Mapping of Global CGE Countries/Regions to GTAP 8 Countries/Regions ............... 32

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1. Introduction

In 2005, four countries in the Asia-Pacific region, (Brunei, Chile, New Zealand and

Singapore) formed the Trans-Pacific Strategic Economic Partnership Agreement (TPSEP or P4)

to initiate the liberalization of trade across the Pacific. Since then, the initiative has expanded to

several countries across the Pacific with the United States taking the lead in 2009. At present, the

participating nations include the original P4 and eight more countries: United States, Japan,

Canada, Mexico, Peru, Australia, Malaysia, and Vietnam. This twelve-nation group is now called

the Trans-Pacific Partnership (TPP), and its goal is to expand trade through the elimination of

tariffs on goods and services, the dismantling of non-tariff barriers, and the harmonization of trade-

related regulations. In addition to trade liberalization objectives, the TPP also seeks to eliminate

investment barriers within the group to increase the flow of foreign investments across the

members.

Initially, the TPP members targeted the last quarter of 2013 to arrive at an agreement. At

present, the negotiations are still ongoing because of major challenging and contentious issues.

Krist (2013) has outlined some of these issues. One issue is how to define the product rules of

origins. Defining the rule may become complicated when a product incorporates components

imported from outside the TPP. Currently, all members of the TPP have trade agreements both

with countries within and outside the TPP group. Another critical issue pertains to agriculture,

particularly the development of sanitary and phyto-sanitary (SPS) disciplines that would minimize

the use of SPS measures for protectionist purposes. Market access for sensitive agricultural

products (rice, sugar, chicken and beef) and for non-agricultural goods (textile, garments, and

automotive products) is also a major issue in the negotiations. There are country-specific issues as

well that are sensitive such as improved market access in the United States and Canada of dairy

products from Australia and New Zealand; improved market access in the United States of textile

and apparel from Vietnam; intellectual property protection; limitations on the control of capital

flows; state-owned enterprises, etc. However, if the negotiations are successful, the agreement will

have significant impact on rules “protecting intellectual property, government procurement, labor

rights, protection of the environment, regulatory affairs, and leading edge issues such as state-

owned enterprises and digital commerce” (Krist, 2013).

2

In 2012, the TPP member countries had a combined population of 783.6 million and a total

gross domestic product (GDP) of US$27.5 trillion (Table 1). The group represents about 40 percent

of the world’s GDP and 40 percent of the world trade. Because of the significance of the TPP as a

major economic block, Taiwan and South Korea have announced interest in late 2013.These are

two dynamic economies in the region whose participation could further expand the economic base

of the block. The Philippines has yet to signify its interest in joining the TPP, but the government

is in the process of evaluating a possible participation.

Table 1. Population and GDP of TPP Member and Interested Countries

2012 Gross

2012 Population Domestic Product

Status Date million US$ billion

Brunei Original signatory 6/2005 0.4 17.0

Chile Original signatory 6/2005 17.5 268.2

New Zealand Original signatory 6/2005 4.4 167.3

Singapore Original signatory 6/2005 4.8 274.7

United States Negotiating 2/2008 313.0 15,684.8

Australia Negotiating 10/2008 21.9 1,520.6

Peru Negotiating 10/2008 30.3 197.0

Viet Nam Negotiating 10/2008 89.8 141.7

Malaysia Negotiating 10/2010 28.6 303.5

Mexico Negotiating 10/2012 112.7 1,178.0

Canada Negotiating 10/2012 33.7 1,821.4

Japan Negotiating 3/2013 126.6 5,959.7

Total - TPP 783.6 27,533.9

Taiwan Announced interest 9/2013 23.2 481.8

South Korea Announced interest 11/2013 49.7 1,129.6

Philippines Deciding 95.9 250.2

Source: United Nations and World Bank World Development Indicators

The objective of the paper is to provide a quantitative analysis of the possible economic

cost to the Philippines of non-participation in the TPP. In the analysis, the paper uses a global

computable general equilibrium (CGE) model calibrated to the GTAP 8 database to simulate the

possible effects in the Philippines under the following scenarios2: no Philippine TPP participation;

Philippine TPP participation with no foreign direct investment (FDI) inflow effects in the country;

2 GTAP refers to the Global Trade Analysis Project (https://www.gtap.agecon.purdue.edu/databases/).

https://www.gtap.agecon.purdue.edu/databases/

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and Philippine TPP participation with FDI inflow effects in the country. In the analysis, a TPP

agreement will involve a 10-year reduction in tariffs and non-tariff barriers among the participating

parties.

The rest of the paper is organized as follows. The second section presents a brief

background of the Philippines with its trading partners. The third section gives a brief discussion

of a global CGE model used in the analysis. The definition of the simulations conducted in the

paper is outlined in the fourth section. The fifth section discusses the results of the simulations.

The paper concludes in the sixth section with a summary and insights for policy.

In addition the paper includes four appendices. Appendix A presents additional set of

simulation results. Appendix B presents a mapping of the global CGE model to the GTAP 8

database and gives a full specification of the model. Appendix C presents some analytics on how

capital inflows may affect tradables and non-tradables through the appreciation of the real

exchange rate within a CGE framework. Appendix D presents a formula to measure welfare

changes.

2. The Philippines with Trading Partners

There has been a proliferation of trade agreements in Asia and the Pacific region. Currently,

the Philippines is involved in 17 trade agreements (Table 2). Some agreements have already been

signed and are put into effect, but some are still under negotiations while others are still being

proposed and under consultation. The agreements are either on a bilateral basis, or the Philippines

as a member of the Association of South East Asian Nations (ASEAN).

As a group of nations, the ASEAN has come a long way since its formation in 1967. In

1992, the member nations signed the ASEAN Free Trade Area (AFTA) where a region-wide tariff

reduction program was implemented. From the original members composed of six nations (Brunei,

Indonesia, Malaysia, the Philippines, Singapore and Thailand), the membership expanded to

include four additional nations (Viet Nam, Lao PDR, Cambodia, and Myanmar). In 2008, the

ASEAN drafted and signed the ASEAN Economic Community (AEC) Blueprint which requires

each member nation to abide and implement the plan towards the creation of a single market by

2015. Furthermore, to facilitate the integration of the region’s production base, the Association

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signed the ASEAN Trade in Goods Agreement (ATIGA) in 2009 where member countries which

were allowed to maintain a list of sensitive/highly sensitive products have to commit to reduce

tariffs on these product by 2015. The Philippines has committed to reduce tariffs on rice and sugar

imports. On sugar, Cororaton (2013) has shown using a global CGE model linked with a Philippine

CGE and poverty microsimulation model that while the reduction in sugar tariffs increases imports

into the Philippines, it has minimal impact on the local sugar production. It increases the country’s

sugar exports to the region and reduces the production cost in its sugar-using industries. Overall

real household income in the Philippines improves and poverty declines.

Table 2. Free Trade Agreements the Philippines is Involved

Free Trade Agreement Status

1 ASEAN Free Trade Area Signed and in effect

2 ASEAN- Australia and New Zealand Free Trade Agreement Signed and in effect

3 ASEAN-India Comprehensive Economic Cooperation Agreement Signed and in effect

4 ASEAN-Japan Comprehensive Economic Partnership Signed and in effect

5 ASEAN-Korea Comprehensive Economic Cooperation Agreement Signed and in effect

6 ASEAN-People's Republic of China Comprehensive

Economic Cooperation Agreement Signed and in effect

7 Japan-Philippines Economic Partnership Agreement Signed and in effect

8 ASEAN- EU Free Trade Agreement Negotiations launched

9 Regional Comprehensive Economic Partnership Negotiations launched

10 ASEAN-Hong Kong, China Free Trade Agreement Proposed/Under consultation and study

11 ASEAN-Pakistan Free Trade Agreement Proposed/Under consultation and study

12 Comprehensive Economic Partnership for East Asia (CEPEA/ASEAN+6) Proposed/Under consultation and study

13 East Asia Free Trade Area (ASEAN + 3) Proposed/Under consultation and study

14 Pakistan-Philippines Free Trade Agreement Proposed/Under consultation and study

15 Philippines-EU Free Trade Agreement Proposed/Under consultation and study

16 Philippines-Taipei, China Economic Cooperation Agreement Proposed/Under consultation and study

17 United States-Philippine Free Trade Agreement Proposed/Under consultation and study

Source: Asian Development Bank/Asia Regional Integration Center

The Philippines has a population of about 96 million. It has a per capital income of

US$2,800 (nominal in 2013) and US$4,700 (purchasing power parity, PPP in 2013). It is an open

economy with merchandise export-GDP and merchandise import-GDP ratios of more than 20

percent (Tables 3 and 5). In the period 2010-2013, the major markets for its merchandise exports

are Japan (18.5 percent), the United States (14.5 percent), the European Union (12.4 percent), and

China (12 percent). Singapore and Hong Kong are also major destination of Philippine exports.

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Table 3. Destination of Philippine Merchandise Exports

Average

Exports, US$ million 2010-2013

2010 2011 2012 2013 Share (%)

Japan 7,840 8,885 9,880 11,423 18.5

United States 7,559 7,102 7,417 7,819 14.5

European Union 7,401 5,949 5,929 6,172 12.4

China 5,724 6,237 6,169 6,583 12.0

Singapore 7,319 4,279 4,867 4,014 9.9

Hong Kong 4,336 3,701 4,776 4,418 8.4

South Korea 2,243 2,237 2,882 3,126 5.1

Thailand 1,783 1,906 2,446 1,936 3.9

Taiwan 1,752 1,993 1,943 1,801 3.6

Malaysia 1,396 1,099 1,018 1,297 2.3

Indonesia 449 627 840 803 1.3

Canada 334 416 508 545 0.9

Australia 350 394 387 807 0.9

New Zealand 33 45 49 47 0.1

Others 2,977 3,435 2,989 3,187 6.1

Total 51,496 48,305 52,100 53,978 100.0

% of GDP 25.8 22.5 22.3 21.1

Source: Bangko Sentral ng Pilipinas

The leading export items of the Philippines are electronics and related products, which

have an average share of 55 percent in 2010-2012. Manufactures capture about 86 percent of total

merchandise exports, while agriculture (including forestry) 7 percent and mining (including petro

products) 5 percent.

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Table 4. Structure of Philippine Merchandise Exports

Average

Exports, US$ million 2010-2012

2010 2011 2012 share, %

Total 51,496 48,305 52,100 100.0

Agriculture, including Forestry 2,950 4,069 3,612 7.0

Mining, including petro products 2,300 3,488 2,730 5.6

Manufactures 45,411 39,838 45,067 85.8

Electronics 32,553 25,243 24,990 54.5

Machinery & Transport Equipment 2,574 2,811 5,314 7.0

Wood manufactures, including furniture 1,181 1,848 2,339 3.5

Garments 1,722 1,912 1,594 3.4

Process food 1,098 1,191 1,447 2.5

Other manufactures 6,283 6,833 9,383 14.8

Others 835 910 691 1.6


Raw materials and intermediate goods account for 51 percent of Philippine merchandise

imports in 2010-2012. The other major import items are oil and fuel (19 percent), capital goods

(17 percent), and consumer goods (12 percent). Table 5 shows that the three leading suppliers of

Philippine imports in 2010-2013 are the United States (11 percent), China (10.6 percent), and

Japan (10.4 percent). Taiwan and South Korea are also key sources of Philippine imports.

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Table 5. Sources of Philippine Merchandise Imports

Average

Imports, US$ million 2010-2013

2010 2011 2012 2013 Share (%)

United States 5,887 6,536 7,124 6,686 11.0

European Union 7,401 5,949 5,929 6,172 10.6

China 4,628 6,085 6,680 8,033 10.6

Japan 6,744 6,516 6,470 5,184 10.4

Singapore 5,187 4,899 4,405 4,227 7.8

Taiwan 3,676 4,209 4,855 4,879 7.4

South Korea 3,833 4,420 4,526 4,800 7.3

Thailand 3,871 3,464 3,461 3,381 5.9

Indonesia 2,295 2,459 2,767 2,709 4.3

Malaysia 2,515 2,640 2,504 2,288 4.2

Hong Kong 1,470 1,510 1,466 1,297 2.4

Australia 839 1,071 1,347 975 1.8

Canada 334 416 508 545 0.8

New Zealand 409 524 459 470 0.8

Others 5,843 9,797 9,628 10,185 14.8

Total 54,932 60,495 62,129 61,831 100.0

% of GDP 27.5 28.1 26.5 24.2


In 2009-2013, FDI inflows into the Philippines was averaging US$900 million per year.

The major sources of FDI in the country are Japan (41 percent), Hong Kong (29 percent), and

United States (24 percent). While 2010 saw a sizeable net outflow of European FDI from the

Philippines, 2012 and 2013 showed net inflow of European FDI into the country.

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Table 6. Net Foreign Direct Investments in the Philippines (US$ million)

Total Percent

2009 2010 2011 2012 2013 2009-2013 Distribution, %

Total 1,731 -396 558 2,006 563 4,462 100.0

United States 719 229 225 554 -653 1,073 24.0

Japan 626 247 367 146 438 1,823 40.9

European Union -13 -1,411 -292 369 61 -1,286 -28.8

ASEAN 19 44 43 -62 -42 3 0.1

ANIEs /1/ 424 240 132 659 -80 1,375 30.8

South Korea 14 7 21 4 2 49 1.1

Hong Kong 408 216 100 655 -86 1,292 29.0

Taiwan 1 17 11 0 4 34 0.8

Others -43 254 83 339 840 1,473 33.0

/1/ Asian Newly Industrializing Economies


Thus, the TPP member countries are markets for Philippine exports and sources of imports

and FDI. Participation or non-participation in the TPP can expand or contract these trade and

investment linkages.

3. Framework of Analysis

The paper utilizes a global CGE model (Robichaud, et al, 2011). The model was calibrated

to the GTAP 8 database which consists of 57 sectors in 129 countries/regions. The database also

includes two types of labor (skilled and unskilled), capital, land, and natural resources. However,

to facilitate the computation of the model solution and the analysis of results, the database was

aggregated to 15 sectors in 20 countries/regions. Appendix B presents a mapping of the 15 sectors

and 20 countries/regions to the GTAP 8 database. Skilled and unskilled labor, and capital were

retained as separate categories of factors of production, while land and natural resources were

lumped into one category. The aggregated database was used to calibrate the global CGE model

whose complete specification is discussed in Appendix B.

Production. The production sector of the model has a three-level structure. At the first level,

sectoral output is produced using value added and aggregate intermediate consumption using a set

of fixed coefficients. At the second level, the aggregate intermediate consumption is broken down

into intermediate demand for goods and services using another set of fixed coefficients. Also at

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the second level, sectoral value added is specified as a constant elasticity of substitution (CES)

function of composite capital and composite labor. At the third level, composite labor is specified

as a CES function of two types of labor (skilled and unskilled). Also at the third level, composite

capital is specified as a CES function of two types of capital (physical capital and land, where land

includes natural resources). The aggregated land is used only in agriculture and mining.

Household. There is only one household in each country/region in the model. This

household earns income from earnings from the two types of labor and the two types of capital. It

pays income tax. Its household savings is a linear function of its disposable income. Its household

demand for goods and service is specified as a linear expenditure system (LES).

Government. In each country/region, the government earns its revenue from income taxes,

indirect taxes on commodities, taxes on the use of capital and labor in each sector, import tariffs,

export taxes, and production taxes. Government savings is determined as the difference between

total government revenue and total government expenditure. Total government expenditure is

distributed among commodities using a set of fixed shares. For a given amount of government

expenditure budget, the quantity demanded for each commodity varies inversely with the price of

the commodity.

Investment. In the model, investment expenditure (gross fixed capital formation, GFCF) is

constrained by the savings-investment equilibrium. GFCF is distributed among commodities using

a set of fixed shares. For a given amount of investment expenditure, the quantity demanded for

each commodity for investment purposes varies inversely with the price of the commodity.

Exports. In each sector, the producer allocates output to three market outlets so as to

maximize sales revenue for a given set of prices in these markets. These outlets are: domestic

market, export market, and international transport margin services. Imperfect substitutability is

assumed among products sold in these outlets by means of a constant elasticity of transformation

(CET) aggregator function. Sales revenue maximization by the producer given a set of prices will

result in a supply function in each of the outlets: supply to the domestic market, supply to the

export market, and supply to the international transport margin services.

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Export of each commodity is further disaggregated using another CET function to the

various export destinations, which also implies imperfect substitutability among exports to these

destinations. The producer maximizes its export revenue for a given set of export prices. This will

result in a supply function of each commodity in each export destination.

Domestic Demand. The goods and services available in the domestic market consist of

those which are domestically produced and imports. In the model, domestically produced and

imported goods are imperfect substitutes and are differentiated by prices. This product

differentiation is through a CES function. The prices of domestically produced goods include

indirect taxes. The prices of imported goods includes import tariffs, international transport

margins, and indirect taxes. The consumer minimizes the cost of buying these goods given a set

of prices. This will result in demand functions for domestically produced goods and imports.

Imports. Imports of each commodity are further disaggregated using another CES function

to the various sources of imports or import origin, which also implies product differentiation

among imports from the various origins. Cost minimization given a set of prices will result in

demand functions for imports in each of the import origins.

External Account. In the GTAP 8 database, information is available on the amount of trade

margin in each sector associated with each bilateral trade flows between countries/regions.

However, there is no information available matching the producers of the international transport

margin services to the individual bilateral trade flows. Therefore, disaggregating the international

transport margin services similar to the breaking down of exports of goods and services to the

various export destinations may not be possible as there is no information available in the GTAP

8 database needed to calibrate this part. Thus in the model, the supply of international transport

margin services in each country/region is pooled in ‘external account (EA)’, and its production is

shared among suppliers in each country/region through a competitive process. Furthermore, this

EA vis-à-vis each country/region includes payments for the value of the country’s/region’s

imports including international transport margins. The expenditure in the EA consists of the value

of exports, including international margins. The difference between revenue and expenditure in

the EA is foreign savings. The negative of foreign savings is the current account balance of each

country/region.

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Prices and Mark-Ups. The model has a system of prices which reflects the cost of

production plus a series of mark-ups which consists of layers of taxes and international transport

margins. The model has a unique price vector that clears the market for goods and services and

the market for factors of production.

Model Closure. The details of the model closure is given in Appendix A. Few of its features

include fixing the following variables: nominal exchange rate, real government expenditure,

government investment demand, supply of factors of production in each period, and current

account balance. The numeraire of the model is the GDP deflator of a reference country/region.

Model Dynamics. The model is dynamic-recursive. Sectoral capital stock is updated using

sectoral investment demand functions whose specifications are patterned after the Tobin’s q;

where sectoral investment demand is a function of the ratio of the rental rate of capital and the

user cost of capital in each sector. The user cost is the sum of interest rate and the sectoral

depreciation rate. Labor is updated using the population projections of the United Nations. The

other dynamic features of the model are discussed in Appendix B.

Trade Barriers. The tariff rates applied by each country/region on imports from each of the

import origins were calibrated from the GTAP 8 database. Over the past couple of decades the

series of tariff reduction programs implemented globally under the World Trade Organization

(WTO) and regionally under the various regional trading agreements have lowered quite

considerably the level of tariff rates across countries. However, despite the trade reform programs,

tariff rates in a few commodities remain high, especially those goods that fall under the special

product categories. Furthermore, there are several non-tariff barriers (NTBs) which continue to

affect the flow of commodities across borders. In the international market for food for example,

although most of the production, processing, and distribution of food is done by the private sector,

the market is affected by various forms of government intervention. “The economic justifications

for a government role in food markets stem from both the public goods aspects of disease and

pest control and the opportunities to reduce market transactions cost for firms and consumers”

(Josling, Roberts, and Orden, 2004). Thus, to factor in some of these features in international

trade in the analysis and in an effort to capture the overall level of protection imposed by countries

on imports, the calibrated import tariff rates were augmented to include estimates NTBs available

12

in the literature. However, modeling NTBs within a CGE framework is complex because NTBs

have both demand-shifting and supply-shifting effects which may affect both the demand and

supply elasticities which are difficult to implement in a CGE framework (Fugazza and Maur,

2008)3. Setting aside these challenging modeling issues on NTBs in the literature, the paper

simply adds the estimates of NTBs of Kee, Nicita, and Olarreaga (2006) to the calibrated tariff

rates to come up with the estimates of the overall level of protection. That is, following Kee,

Nicita, and Olarreaga (2006), the overall protection is 𝑇𝑖,𝑧 = 𝐴𝑉𝐸𝑖,𝑧 + 𝑡𝑖,𝑧 where 𝑇𝑖,𝑧 is the overall

protection that country z imposes on imports i; 𝐴𝑉𝐸𝑖,𝑧 is the ad-valorem equivalent (AVE) of

NTBs that country z imposes on imports i; and 𝑡𝑖,𝑧 is the applied tariff. The estimates of the overall

protection used in the analysis are given in Table 7.

Table 7. Estimates of Tariff and Non-Tariff Barriers

Simple Average Tariffs AVE of Non-Tariff Barriers /1/

Agriculture Mining Manufacturing Agriculture Manufacturing

Australia 0.003 0.013 0.031 0.210 0.052

New Zealand 0.001 0.016 0.023 0.254 0.084

Japan 0.050 0.003 0.031 0.345 0.043

Korea 0.540 0.028 0.065 0.262 0.040

Taiwan 0.097 0.026 0.048 0.262 0.040

Malaysia 0.069 0.037 0.052 0.423 0.181

Philippines 0.049 0.036 0.045 0.398 0.177

Singapore 0.000 0.000 0.000 0.262 0.040

Viet Nam 0.083 0.067 0.104 0.306 0.197

Indonesia 0.024 0.029 0.042 0.146 0.026

Thailand 0.124 0.037 0.096 0.087 0.017

Canada 0.008 0.007 0.033 0.127 0.021

United States 0.018 0.008 0.018 0.138 0.046

Mexico 0.068 0.091 0.090 0.266 0.126

Chile 0.027 0.030 0.035 0.113 0.038

Peru 0.052 0.073 0.079 0.146 0.055

European Union 0.029 0.008 0.026 0.345 0.057

Latin America 0.055 0.051 0.083 0.149 0.066

Africa 0.090 0.064 0.104 0.146 0.093

Rest of the World 0.084 0.053 0.096 0.430 0.040

Source: GTAP 8 database; Kee, Nicita, and Olarreaga (2006); and Fugazza and Maur (2008)

/1/ AVE refers to ad valorem equivalent

3 Requirements to provide information to consumers (e.g., labelling) may affect consumer behavior and therefore

consumer demand. Preventing the sale of products that have hazardous effects on health or creating standards to

increase compatibility can affect supply.

13

Foreign Investments. One of the benefits of participating in trade agreements is the

expected increase in the volume of trade flows among the participating parties as trade barriers are

minimized. Another benefit that normally goes with higher volume of trade is higher investment

flows and active transfer of technology among the participating parties. The Philippines is located

in a dynamic zone in Asia where a rapid increase in inflows of FDI has been observed in the past

couple of decades. Unfortunately, the inflows of FDI into the Philippines have been low; the

country has been underperforming in terms of attracting FDI. Using a concept called global FDI

frontier, Petri, Plummer, and Zhai (2012) have shown that FDI inflows into the Philippine are

significantly below the global FDI frontier by about US$30 billion (Table 8). This is also the case

of Indonesia where FDI inflows are considerably below the global frontier. The Philippines has a

large absorptive capacity for higher inflows of FDI given its large and young population base and

educated work force and its rich natural resources. Thus, the country may be able to improve its

FDI performance as it seeks deeper integration with its trading partners in the TPP, especially with

the United States and Japan, the two major sources of FDI in the Philippines. In the analysis, a

scenario is included which analyzes the economic effects of higher FDI inflows into the

Philippines. Higher FDI inflows is crucial in the country especially in its present stage of economic

development where the buildup of infrastructure is critical. However, higher FDI inflows may

affect both tradables and non-tradables via the real exchange rate effect. This general equilibrium

effect is also highlighted in the analysis.

Table 8. Alternative Foreign Direct Investment Scenarios (US$ millions)

Actual FDI Alternative estimated stocks (2006)

stock (2006) Top 3 years 75th percentile 1/2 to 90th

ASEAN 420,025 536,993 648,178 643,649

Brunei 9,861 19,057 15,312 15,312

Cambodia 2,954 3,245 3,481 3,969

Indonesia 19,056 77,545 178,794 134,655

Lao 856 1,209 1,686 1,599

Malaysia 53,575 90,704 73,067 78,074

Myanmar 5,005 7,165 6,378 7,280

Philippines 17,120 17,849 57,364 48,757

Singapore 210,089 211,070 210,521 210,521

Thailand 68,068 68,928 101,180 104,599

Vietnam 33,451 40,221 36,395 38,883

Source: Petri, Plummer, and Zhai (2011).

14

4. Definition of Simulations

To analyze the potential cost to the Philippines of non-participation, four simulations are

conducted using a global CGE model. The simulations are:

(4.a) Baseline. This is also called the business as usual (BaU) scenario. The global CGE

was simulated until 2024 using the actual real GDP and population growth from 2007 to 2013, and

the projected GDP growth of the World Bank and the population projection of the United Nations

until 2024. A calibrated (pre-solved) multifactor productivity in each country/region is used to

ensure that the model replicates exactly the real GDP used, both actual and projected, in the

baseline.

(4.b) No Philippine Participation in the Original TPP4. In this simulation, the trade

barriers in the original TPP members are reduced starting 2015 until 2024; a reduction over a 10-

year period. Since the negotiations among the original the TPP members are still ongoing and no

definite agreements have been reached yet at present, the reduction in trade barriers analyzed in

the paper is done in the following manner. The applied tariffs in the TPP member countries were

reduced in the simulation from the current level by 90 percent over the 10-year period. Tariffs

were reduced using a geometric growth formula. Issues related to NTBs are sometimes

contentious, and their negotiations are quiet involved and their resolutions are often times

protracted. Thus, the reduction in NTBs is expected to be much lower compared to the reduction

in tariff rates over the 10-year period. In the analysis, two sets of NTB reductions in the TPP

member countries were simulated and analyzed: 20 percent and 40 percent reduction. The NTBs

were reduced using a geometric growth formula over the 10-year period. Both tariffs and NTBs

in non-TPP countries/regions, including the Philippines, were retained during the simulation

period.

(4.c) TPP + Philippines without FDI Inflow Effects in the Philippines. In this simulation,

the trade barriers in the original TPP plus the Philippines were reduced using the same method

used in (4.b). In this simulation non-TPP countries/regions excludes the Philippines.

4 In the analysis, original TPP members refer to countries in Table 1, excluding Brunei because it is not in the GTAP

8 database.

15

(4.d) TPP + Philippines with FDI Inflow Effects in the Philippines. This simulation is

similar to (4.c), except that FDI inflows into the Philippines increase by US$10 billion over the

10-year period. The increase in the inflows of FDI in the simulation was calculated using a

geometric growth formula. Given the relatively low level of FDI stock in the Philippines in the

estimates of Petri, Plummer, and Zhai (2012), the additional US$10 billion FDI in this simulation

may result in a stock of FDI stock that is still below the global FDI frontier. An improvement FDI

inflow increases foreign savings in the Philippines, which in turn increases total investments in the

country. In addition, this will have general equilibrium impacts on tradables and non-tradables

through the effects on the Philippine real exchange rate.

5. Simulation Results

To facilitate the analysis, the results for the TPP members and the non-TPP were

aggregated5. However, detailed results for the Philippines are presented. Table 9 presents the

possible trade effects of a TPP agreement based on the reduction in the trade barriers outlined in

the definition of simulations above. The results are calculated as the difference between the

individual simulations and the baseline, and are expressed in US$ billion in 2007 prices.

The first panel in the table shows that a 90 percent and a 20 percent reduction in tariffs and

NTBs respectively within the original TPP members over a 10-year period will increase their

combined exports annually starting by US$8.3 billion in 2015 and increasing to US$71.7 billion

in 2024. The results also indicate that the effect of the reduction in tariffs dominate the effects of

the reduction in NTBs. It is only in the 9th year in 2023 when the NTB reduction effects start to

dominate the tariff reduction effects. However, a much higher reduction in NTBs of 40 percent

will dominate the effects of a 90 percent drop in tariffs throughout the 10-year period (Appendix

A).

5 Country/region level results are available from the author upon request.

16

Table 9. Effects of 90 and 20% Reduction in Tariffs and NTBs (diff. from baseline, US$ billion in 2007 prices)

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

TPP members

Original TPP /1/

Combined export effects /2/ 8.32 16.26 23.87 31.16 38.19 45.06 51.78 58.43 65.05 71.71

Due to tariff change 5.25 9.96 14.15 17.87 21.16 24.06 26.64 28.92 30.98 32.84

Due to NTB change 3.05 6.22 9.53 12.98 16.58 20.37 24.35 28.53 32.91 37.51

Total Exports 8.32 16.26 23.87 31.16 38.19 45.06 51.78 58.43 65.05 71.71

Within TPP 10.13 19.78 29.01 37.87 46.43 54.80 63.01 71.13 79.23 87.38

Non-TPP -1.80 -3.52 -5.15 -6.72 -8.24 -9.74 -11.22 -12.70 -14.18 -15.67

Original TPP + Philippines

Total Exports 8.85 17.32 25.47 33.31 40.92 48.36 55.71 62.98 70.27 77.62

Within TPP + Philippines 10.82 21.17 31.11 40.69 49.99 59.10 68.09 77.01 85.94 94.96

Non-TPP excluding Philippines -1.97 -3.85 -5.64 -7.38 -9.07 -10.74 -12.39 -14.03 -15.67 -17.34

Non-TPP countries

Non-TPP (countries not in the original TPP)

Total Exports -1.56 -3.11 -4.64 -6.19 -7.77 -9.36 -10.99 -12.66 -14.37 -16.13

TPP -2.23 -4.36 -6.39 -8.36 -10.27 -12.15 -14.01 -15.86 -17.72 -19.59

Within Non-TPP 0.67 1.26 1.75 2.16 2.50 2.78 3.02 3.20 3.35 3.46

Non-TPP excluding the Philippines

Total Exports -1.78 -3.52 -5.25 -7.01 -8.79 -10.60 -12.44 -14.34 -16.28 -18.29

TPP + Philippines -2.44 -4.76 -6.99 -9.15 -11.26 -13.34 -15.40 -17.46 -19.52 -21.61

Non-TPP excluding Philippines 0.65 1.24 1.74 2.15 2.48 2.75 2.96 3.13 3.24 3.31

Philippines

No Philippine Participation

Total Exports -0.01 -0.03 -0.06 -0.08 -0.12 -0.16 -0.20 -0.25 -0.30 -0.35

TPP -0.03 -0.06 -0.09 -0.13 -0.16 -0.20 -0.24 -0.28 -0.33 -0.37

Non-TPP 0.02 0.03 0.04 0.04 0.05 0.05 0.04 0.04 0.03 0.02

With Philippine Participation without FDI Effects

Total Exports 0.25 0.51 0.78 1.05 1.34 1.64 1.96 2.29 2.64 3.00

TPP 0.29 0.58 0.87 1.17 1.48 1.79 2.11 2.44 2.78 3.14

Non-TPP -0.03 -0.07 -0.09 -0.12 -0.13 -0.15 -0.15 -0.15 -0.15 -0.14

With Philippine Participation and FDI Effects (US$ 10 billion increase in 10 years)

Total Exports 0.19 0.39 0.60 0.84 1.09 1.36 1.65 1.95 2.27 2.61

TPP 0.26 0.53 0.81 1.10 1.39 1.70 2.02 2.34 2.68 3.04

Non-TPP -0.08 -0.15 -0.21 -0.26 -0.30 -0.34 -0.37 -0.40 -0.41 -0.43

FOREX appreciation /3/ -0.11 -0.18 -0.24 -0.28 -0.33 -0.37 -0.41 -0.45 -0.50 -0.54

Source: Authors' calculations

/1/ TPP countries include: Australia, New Zealand, Japan, Malaysia, Singapore, Viet Nam, Canada, United States of America,

Mexico, Chile and Peru. It excludes Brunei because it is not in the GTAP 8 database

/2/ The effects of simulating changes in tariffs and NTBs separately may not be equal to the combined effects of simulating them

together because the global model is nonlinear because of CES and CET functions.

/3/ Appreciation in the real exchange rate in the Philippines

17

The increase in TPP’s exports is largely due to the higher volume of trade within the group.

Exports within the TPP will increase annually starting by US$10.1 billion in 2015 and increasing

to US$87.4 billion in 2024. However, the reduction in tariffs and NTBs within the TPP will divert

trade from the non-TPP. Exports of the TPP to the non-TPP decline.

The effects of a 40 percent reduction in NTB are much higher, with total TPP exports

improving annually starting by US$12.2 billion in 2015 and increasing to US$112.9 billion in 2024

(Table 13, Appendix A). The increase in the volume of exports within the TPP and the diversion

of trade from the non-TPP is also higher.

If the Philippines is included in the TPP group and also lowers its trade barriers to goods

from within the group, the increase in the total exports is slightly higher under ‘Original TPP +

Philippines’ relative to the case under ‘Original TPP’. With a 20 percent reduction in NTBs, the

total exports of the expanded group will increase annually starting by US$8.9 billion in 2015 and

increasing to US$77.6 billion in 2024.

The results for the non-TPP are presented in the second panel of Table 9. In the first set of

results, the Philippines is among the countries in the non-TPP. The total exports of the non-TPP

will decline annually starting by US$1.6 billion in 2015 and increasing to US$16.1 billion in 2024.

The drop in exports of the non-TPP is largely due to the drop in exports to the TPP, as the latter

reduce their within trade barriers. However, exports among the non-TPP will increase, but not

enough to offset the trade that has been diverted to the TPP.

If the Philippines participates in the TPP and reduces its trade barriers within the group,

the reduction in exports in the non-TPP (excluding the Philippines) is relatively higher, as larger

trade is being diverted to the expanded TPP.

Clearly, the reduction in the trade barriers within the TPP members (both under the

‘Original TPP’ and in ‘Original TPP + Philippines’) will create trade among the participating

members and will divert trade from the non-TPP.

The third panel of Table 9 presents the results for the Philippines. If the Philippines does

not participate in the TPP, its total exports will decline annually starting by US$0.01 billion in

2015 and increasing to almost US$0.35 billion in 2024. This decline is largely due to its declining

18

exports to the TPP group. Philippine exports to the non-TPP will increase, but only marginally and

not enough to offset the decline in its exports to the TPP.

In the case of Philippine TPP participation with no changes in the FDI inflows, Philippine

exports to the TPP will increase annually starting by U$0.25 billion in 2015 and increasing to

US$3 billion in 2024. The country’s exports to the non-TPP decline marginally.

Philippine exports to the TPP will also improve under the scenario involving TPP

participation with higher FDI inflows into the country, but the improvement is slightly lower

relative to the scenario with no changes in the FDI inflows. The slightly smaller export effects are

mainly due to the real exchange rate appreciation in the Philippines associated with higher FDI

inflows. The real exchange rate appreciates annually by 0.1 percent in 2015 and increasing to 0.5

percent in 2024. This slightly reduces the country’s export price competitiveness and lowers the

full export effect in the Philippines of the reduction in the trade barriers among the TPP group6.

The reduction in the country’s exports to the non-TPP is also relatively higher with the real

exchange rate appreciation.

Table 10 presents the sectoral effects in the Philippines. The first panel in the table indicates

that Philippine non-participation in the TPP will negatively affect some of the major sectors in the

economy. The negative effects are smaller initially in 2015, but they increase over the succeeding

periods. The sectors that are negatively affected are the textile and wearing apparel sector,

petroleum products, construction, services, and equipment.

6Appendix C shows the analytics of the effect of a real exchange rate appreciation on tradables within a CGE

framework.

19

Table 10. Sectoral Effects in the Philippines, 90 and 20% Reduction in Tariffs and NTBs (% change

from the baseline)

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024


Crops 0.01 0.01 0.01 0.02 0.02 0.02 0.02 0.02 0.02 0.02

All other agriculture 0.00 0.00 0.00 0.00 0.00 -0.01 -0.01 -0.02 -0.02 -0.02

Mining 0.00 0.01 0.02 0.03 0.04 0.04 0.05 0.05 0.06 0.06

Food 0.01 0.02 0.03 0.03 0.03 0.03 0.03 0.03 0.02 0.02

Textile and wearing apparel -0.02 -0.07 -0.12 -0.18 -0.24 -0.31 -0.37 -0.43 -0.49 -0.55

Petroleum products -0.02 -0.05 -0.07 -0.10 -0.13 -0.16 -0.19 -0.21 -0.24 -0.27

Chemical, rubber, plastic & others 0.00 0.00 -0.01 -0.02 -0.03 -0.05 -0.06 -0.08 -0.08 -0.10

Metal products 0.00 0.00 -0.01 -0.03 -0.04 -0.06 -0.08 -0.09 -0.11 -0.13

Transport & machinery equipment 0.01 0.00 -0.01 -0.02 -0.04 -0.06 -0.08 -0.10 -0.13 -0.15

Electronic equipment 0.01 0.01 0.01 0.00 -0.01 -0.03 -0.05 -0.07 -0.09 -0.12

All other manufacturing 0.02 0.03 0.05 0.06 0.06 0.07 0.08 0.08 0.08 0.08

Utilities -0.01 -0.02 -0.03 -0.05 -0.07 -0.08 -0.10 -0.12 -0.14 -0.15

Construction 0.00 -0.01 -0.02 -0.04 -0.06 -0.09 -0.11 -0.14 -0.17 -0.20

Services -0.01 -0.02 -0.03 -0.05 -0.07 -0.09 -0.11 -0.13 -0.14 -0.16


Crops -0.04 -0.07 -0.11 -0.14 -0.16 -0.18 -0.20 -0.21 -0.22 -0.23

All other agriculture -0.02 -0.06 -0.10 -0.13 -0.16 -0.19 -0.20 -0.22 -0.23 -0.24

Mining -0.03 -0.22 -0.47 -0.75 -1.03 -1.31 -1.58 -1.84 -2.07 -2.30

Food -0.06 -0.13 -0.21 -0.28 -0.34 -0.40 -0.44 -0.47 -0.50 -0.52

Textile and wearing apparel 0.97 2.31 3.87 5.49 7.16 8.75 10.31 11.73 13.09 14.28

Petroleum products 0.15 0.28 0.39 0.50 0.60 0.70 0.79 0.88 0.97 1.06

Chemical, rubber, plastic & others 0.02 0.11 0.13 0.23 0.26 0.37 0.40 0.50 0.55 0.62

Metal products -0.18 -0.44 -0.75 -1.07 -1.37 -1.66 -1.92 -2.16 -2.37 -2.56

Transport & machinery equipment -0.20 -0.49 -0.83 -1.18 -1.53 -1.86 -2.17 -2.47 -2.74 -3.00

Electronic equipment 0.04 0.10 0.18 0.29 0.41 0.54 0.68 0.83 1.00 1.15

All other manufacturing -0.07 -0.15 -0.23 -0.29 -0.36 -0.40 -0.43 -0.46 -0.48 -0.50

Utilities 0.08 0.16 0.23 0.29 0.35 0.41 0.47 0.53 0.59 0.65

Construction -0.52 -1.05 -1.56 -2.06 -2.53 -2.98 -3.39 -3.79 -4.16 -4.52

Services 0.08 0.16 0.24 0.32 0.40 0.48 0.56 0.64 0.73 0.80

With Philippine Participation and FDI effects (US$ 10 billion increase in 10 years)

Crops -0.04 -0.08 -0.12 -0.14 -0.16 -0.17 -0.18 -0.19 -0.19 -0.20

All other agriculture -0.01 -0.03 -0.04 -0.05 -0.04 -0.03 -0.02 0.00 0.02 0.04

Mining -0.04 -0.23 -0.45 -0.68 -0.89 -1.09 -1.25 -1.39 -1.51 -1.61

Food -0.08 -0.16 -0.23 -0.30 -0.35 -0.39 -0.42 -0.44 -0.45 -0.47




Metal products -0.21 -0.48 -0.75 -1.00 -1.22 -1.40 -1.54 -1.65 -1.73 -1.78


20

Electronic equipment -0.04 -0.06 -0.04 -0.01 0.06 0.13 0.22 0.31 0.42 0.53


Utilities 0.07 0.17 0.28 0.39 0.51 0.63 0.77 0.90 1.04 1.18

Construction -0.26 -0.48 -0.64 -0.75 -0.81 -0.83 -0.81 -0.76 -0.68 -0.58

Services 0.07 0.18 0.30 0.44 0.59 0.74 0.91 1.07 1.24 1.40


The second panel in the table shows that Philippine participation with no change in the FDI

inflows will affect the terms-of-trade that will favor the textile and wearing apparel sector. Relative

to the baseline, the sector’s production will improve annually starting by 1 percent in 2015 and

increasing to 14.3 percent in 2024. The other sectors that are favorably affected are services,

petroleum products, utilities, and chemicals. Initially, there is a negative effect on electronic

equipment, but its production improves over time. However, there are several sectors where the

reduction in the trade barriers will result in unfavorable terms-of-trade. Foremost of which is the

construction sector, a non-tradable sector whose production is negatively affected by the reduction

in the trade barriers. The other sectors which are negatively affected are agriculture, mining, food

manufacturing, metal products, and transport and machinery. Their negative output effects are

largely due to the higher inflows of competing imports as the trade barriers are reduced.

Higher FDI inflows favorably affect non-tradables. The results in the third panel of Table

10 indicate higher FDI inflows partially offset the negative terms-of-trade effects on the

construction sector. However, the sectors which were negatively affected by higher imports due to

the reduction in trade barriers within the TPP region have relatively smaller negative production

effects under the scenario with higher FDI inflows. This is largely due to the real exchange rate

appreciation that reduces the flows of competing imports into the country.

Table 11 presents the effects on factor returns. Wages of skilled and unskilled workers

decline if the Philippines does not participate in the TPP. Returns to capital and land also decline.

Philippine participation with no change in the FDI inflows will result in a sustained improvement

in wages and returns to capital. The returns to land however declines. But Philippine participation

with larger FDI inflows will result in higher improvement in factor returns, including the returns

to land.

21


NTBs (% difference from the baseline)

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024


Skilled wages -0.04 -0.08 -0.12 -0.16 -0.20 -0.24 -0.27 -0.31 -0.34 -0.38

Unskilled wages -0.04 -0.08 -0.11 -0.15 -0.19 -0.23 -0.26 -0.30 -0.33 -0.36

Returns to capital -0.04 -0.07 -0.09 -0.11 -0.13 -0.14 -0.15 -0.16 -0.17 -0.18

Returns to land 0.01 0.02 0.01 0.00 -0.02 -0.04 -0.06 -0.09 -0.11 -0.14


Skilled wages 0.34 0.63 0.88 1.13 1.36 1.59 1.80 2.01 2.22 2.41

Unskilled wages 0.28 0.53 0.74 0.96 1.16 1.36 1.55 1.73 1.92 2.10

Returns to capital 0.38 0.68 0.96 1.19 1.41 1.60 1.78 1.94 2.08 2.24

Returns to land -0.15 -0.29 -0.45 -0.61 -0.74 -0.87 -0.97 -1.06 -1.12 -1.20

With Philippine Participation and FDI effects (US$ 10 billion increase in 10 years)

Skilled wages 0.46 0.85 1.20 1.54 1.86 2.18 2.47 2.77 3.05 3.34

Unskilled wages 0.41 0.77 1.09 1.41 1.71 2.02 2.30 2.59 2.86 3.14


Returns to land -0.05 -0.06 -0.07 -0.05 0.00 0.07 0.16 0.27 0.40 0.53


The measure of welfare used in the analysis is equivalent variation (EV) whose formula is

given in Appendix D. EV is expressed in US$ billion. The combined welfare effects presented in

Table 12 are the sum of: (a) the cost of non-participation (due to the trade diversion effects from

the non-TPP, the Philippines included, to the TPP), and (b) the potential gain of participation

(considered as the economic opportunity foregone if the Philippines decides not to participate).

Measured in this manner, the welfare effect of Philippine non-participation in the TPP is US$0.4

billion in 2015 (0.02 percent of GDP). The welfare effect increases to US$3.9 billion in 2024 (0.13

percent of GDP). If the inflows of FDI into the Philippines improve with TPP participation, the

welfare effects are relatively higher.

22

Table 12. Welfare Effects in the Philippines, 90 and 20% Reduction in Tariffs and NTBs

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

US$ billion

No Participation -0.03 -0.07 -0.11 -0.15 -0.20 -0.24 -0.29 -0.34 -0.38 -0.44

Participation with no FDI 0.34 0.67 1.00 1.33 1.67 2.01 2.36 2.72 3.09 3.46

Combined welfare effects /1/ 0.37 0.74 1.12 1.49 1.87 2.25 2.65 3.05 3.47 3.90

Participation with FDI /2/ 0.38 0.78 1.20 1.63 2.08 2.54 3.02 3.52 4.04 4.58

% of GDP



Participation with FDI /2/ 0.019 0.038 0.055 0.071 0.086 0.101 0.114 0.127 0.140 0.151


/1/ The sum of the opportunity cost of non-participation and the estimated effects of participation

/2/ The sum of the opportunity cost of non-participation and the estimated effects of participation with FDI effects

6. Summary and Conclusion

The TPP members present a sizeable economic block in the Asia-Pacific region. It

represents about 40 percent of the world’s GDP and about 40 percent of world trade. The

Philippines is not part of the group and has not yet signified interest in joining the group. Currently,

the TPP member countries are markets for Philippine exports and sources of imports and foreign

direct investments (FDI). Participation or non-participation in the TPP can expand or contract these

trade and investment linkages. The paper provides a quantitative analysis of the possible economic

cost to the Philippines of non-participation. It uses a global CGE model calibrated to the GTAP 8

database. The analysis in the paper incorporates changes in tariffs and non-tariff barriers.

Four simulations were conducted using a global CGE model. The first simulation is a

baseline (business-as-usual) scenario where the existing tariffs and non-tariff barriers were

retained in both the TPP and non-TPP until 2024. The second simulation is a scenario where all

countries in the TPP (excluding Brunei because it is not in the GTAP 8 database) reduce their

tariffs and non-tariff barriers. The reduction in tariffs was implemented over a 10-year period from

2015 to 2024. Over this period tariffs were reduce by 90 percent from the current rates using a

geometric growth formula. The reduction in the NTBs within the TPP member countries is

expected to be smaller than the tariff change because of the complicated issues involved in NTB

negotiations. In the analysis, two sets of NTB reductions were simulated and analyzed: 20 percent

23

and 40 percent reduction. The NTBs were reduced using a geometric growth formula over the 10-

year period. Both tariffs and NTBs in the non-TPP, including the Philippines, were retained in the

second simulation during the period.

The third simulation is a scenario where the Philippines joins the TPP to form an expanded

group ‘Original TPP + Philippines’. Thus, similar to the TPP members, the Philippines reduces its

tariff and NTBs over the 10-year period within the expanded group and retains its current trade

protection with the non-TPP. Also, there is no additional FDI inflows into the Philippines in the

third scenario. The fourth simulation is similar to the third case, except that the Philippines benefits

from the higher inflows of FDI with TPP participation. The inflow of FDI increases geometrically

by US$10 billion over the 10-year period. The analysis compares the results of each of the

simulations with the baseline.

Under the second scenario, a TPP agreement will divert trade from the non-TPP, including

the Philippines, to the TPP. The results indicate that a 90 percent and a 20 percent reduction in

tariffs and NTBs respectively within the original TPP over a 10-year period will increase their

combined exports annually starting by US$8.3 billion in 2015 and increasing to US$71.7 billion

in 2024. The results also indicate that the effects of the reduction in tariffs dominate the effects of

the reduction in NTBs up to the 8th year in 2022. In the succeeding periods, the NTB reduction

effects dominate the tariff reduction effects. However, a much higher reduction in NTBs of 40

percent will dominate the effects of the 90 percent drop in tariffs throughout the 10-year period.

The improvement in TPP’s exports is largely due to the expansion in exports within the

group. Relative to the baseline, exports within the group will increase annually starting by US$10.1

billion in 2015 and increasing to US$87.4 billion in 2024. Exports of the non-TPP decline, largely

due to the declining exports to the TPP. As part of the non-TPP, the Philippines will also

experience declining exports. The country’s total exports will decline annually starting by US$0.01

billion in 2015 and decreasing to US$0.4 billion in 2024. This is largely due to the country’s

declining exports to the TPP.

Under the scenario ‘Original TPP + Philippines’, the increase in exports of the expanded

group is higher relative to ‘Original TPP’, largely due to the higher volume of exports within the

expanded group. There is a larger diversion of exports from the non-TPP, excluding the

24

Philippines, to the expanded TPP. The Philippines as well as the original TPP countries will

experience increasing exports. Philippine exports will increase annually starting by US$0.3 billion

in 2015 and increasing to US$3.0 billion in 2024.

Thus, the reduction in the trade barriers within the TPP (both under the ‘Original TPP’ and

in ‘Original TPP + Philippines’) creates trade among the participating members and diverts trade

from the non-TPP.

The improvement in Philippine exports under TPP participation with additional FDI

inflows is slightly lower relative to the case where there is no change in the FDI inflows. The

slightly smaller export effects are mainly due to the real exchange rate appreciation in the

Philippines associated with higher FDI inflows. The real exchange rate appreciates annually by

0.1 percent in 2015 and increasing to 0.5 percent in 2024. This slightly reduces the country’s export

price competitiveness and lowers the full export effect in the Philippines of the reduction in the

trade barriers among the TPP group. The reduction in the country’s exports to the non-TPP is also

relatively higher with the real exchange rate appreciation.

Because of the trade diversion effects, Philippine non-participation in the TPP negatively

affects some of its major sectors. Initially, the negative effects are smaller, but the effects become

larger over time. The sectors which are negatively affected are the textile and wearing apparel

sector, petroleum products, construction, services, and equipment.

On the other hand, a Philippine TPP participation without additional FDI inflows affects

the terms-of-trade that favor the textile and wearing apparel sector. The sector’s production

improves annually starting by 1 percent in 2015 relative to the baseline and increasing to 14.3

percent in 2024. The other sectors which are also favorably affected are services, petroleum

products, utilities, and chemicals. Initially, there is negative effect on electronic equipment, but

over time its production improves. However, there are several sectors where the reduction in the

trade barriers will result in unfavorable terms-of-trade. Foremost of which is the construction

sector, a non-tradable sector. The other sectors with unfavorable terms-of-trade effects include

agriculture, mining, food manufacturing, metal products, and transport equipment and machinery.

Their negative output effects arise from the higher volume of imports as trade barriers are reduced.

25

The results indicate that the higher inflows of FDI into the Philippines partially offset the

negative terms-of-trade effect on the construction sector. Thus, the negative effects of the reduction

in the trade barriers on the construction sector under Philippine TPP participation are reduced.

Also, the sectors which were previously negatively affected by the higher volume of imports

arising from the reduction in the trade barriers within the TPP now have relatively smaller negative

production effects with higher FDI inflows because of the real exchange rate appreciation.

Wages of skilled and unskilled workers decline if the Philippines does not participate in

the TPP. Returns to capital and land also decline. There is a sustained improvement in wages and

returns to capital under Philippine TPP participation. But the returns to land declines. However,

Philippine participation with additional FDI inflows will result higher improvement in factor

returns, including the returns to land.

The welfare cost to Philippines of non-participation in the TPP increases from US$0.4

billion in 2015 (0.02 percent of GDP) to US$3.9 billion in 2024 (0.13 percent of GDP). The welfare

effects are relatively higher if Philippine TPP participation improves the inflows of FDI into

country.

One factor that was not considered in the analysis was the feedback effect arising from the

impact of higher inflows of FDI on productivity in the Philippines. Capturing this feedback effect

may be complicated. In the literature, one way of factoring in this effect is to establish an equation

linking FDI inflows to total factor productivity7. This is may require some econometric estimation

of the linking equation, which is beyond the scope of the present paper and is an area for further

research.

7 This is similar approach applied by Lofgren and Robinson (2004) to analyze the effects of public expenditures on

total factor productivity.

26

References

Cororaton, C.B. 2013. “Economic Impact Analysis of the Reduction in Sugar Tariffs under the

ASEAN Trade in Goods Agreement: The Case of the Philippine Sugar Sector”. GII

Working Paper No. 2013-1.

Dervis, K., J. de Melo, and S. Robinson. 1982. General Equilibrium Models for Development

Policy. The International Bank for Reconstruction and Development/The World Bank.

World Bank: Washington D.C. pp. 185-197.

Fugazza, M., and J. Maur. 2008. “Non-Tariff Barriers in Computable General Equilibrium

Modeling”. Policy Issues in International Trade and Commodities Study Series N. 38.

United Nations Conference on Trade and Development.

Josling, T., D. Roberts, and D. Orden. 2004. Food Regulation and Trade: Toward a Safe and Open

Global System. Institute for International Economics: Washington, D.C.

Jung, H. S., and E. Thorbecke. 2003. “The Impact of Public Education Expenditure on Human

Capital, Growth, and Poverty in Tanzania and Zambia: A General Equilibrium Approach.”

Journal of Policy Modeling. 25:701-725.

Kee, H., A. Nicita, and M. Olarreaga. 2006. “Estimating Trade Restrictiveness Indices”. World

Bank Policy Research Working Paper 3840. World Bank: Washington, D.C.

Krist, W. 2013. “The Trans-Pacific Partnership Negotiations: Getting to an Agreement”. Program

on America and the Global Economy. Woodrow Wilson International Center for Scholars:

Washington, D.C. (www.wilsoncenter.org/page).

Lofgren, H., and S. Robinson. 2004. “Public Spending, Growth, and Poverty Alleviation in Sub-

Saharan Africa: A Dynamic General Equilibrium Analysis”. Paper prepared for

presentation at the conference “Growth, Poverty Reduction, and Human Development in

Africa, University of Oxford.

Petri, P., M. Plummer, and F. Zhai. 2012. “The ASEAN Economic Community: A General

Equilibrium Analysis”. Asian Economic Journal. Vol. 26. Issue 2. Pages 93-118.

Robichaud, V., A. Lemelin, H. Maisonnave and B. Decaluwe. 2011. “The PEP Standard Multi-

Region, Recursive Dynamic World Model, PEP Global Model (PEP-w-t_v1_4.gms)”.

(www.pep-net.org).

Robichaud, V. 2001. “Calculating Equivalent and Compensating Variations in CGE Models”.

(www.pep-net.org).

http://www.wilsoncenter.org/page

http://www.pep-net.org/

http://www.pep-net.org/

27

Appendix A: Additional Simulation Results

Table 13.Effects of 90 and 40% Reduction in Tariffs and NTBs (diff. from baseline, US$ billion in 2007 prices)

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

TPP members

Original TPP Members /1/

Combined export effects /2/ 12.21 24.10 35.71 47.06 58.18 69.21 80.14 91.02 101.93 112.91

Due to tariff change 5.25 9.96 14.15 17.87 21.16 24.06 26.64 28.92 30.98 32.84

Due to NTB change 6.90 13.95 21.15 28.50 36.02 43.81 51.81 60.04 68.52 77.26

Total Exports 12.21 24.10 35.71 47.06 58.18 69.21 80.14 91.02 101.93 112.91

Within TPP 14.94 29.48 43.66 57.51 71.09 84.57 97.93 111.25 124.59 138.03

Non-TPP -2.73 -5.38 -7.94 -10.45 -12.91 -15.36 -17.79 -20.22 -22.66 -25.12

Original TPP + Philippines

Total Exports 13.00 25.72 38.19 50.42 62.48 74.46 86.40 98.32 110.32 122.45

Within TPP + Philippines 15.97 31.58 46.86 61.85 76.61 91.29 105.92 120.53 135.22 150.07

Non-TPP excluding Philippines -2.97 -5.86 -8.67 -11.42 -14.13 -16.83 -19.52 -22.20 -24.90 -27.62

Non-TPP countries

Non-TPP (countries not in the original TPP)

Total Exports -2.54 -5.11 -7.71 -10.37 -13.09 -15.87 -18.72 -21.64 -24.64 -27.71

TPP -3.42 -6.74 -9.97 -13.14 -16.27 -19.37 -22.46 -25.55 -28.65 -31.77

Within Non-TPP 0.88 1.63 2.26 2.77 3.17 3.50 3.74 3.91 4.01 4.06

Non-TPP excluding the Philippines

Total Exports -2.87 -5.75 -8.67 -11.67 -14.73 -17.87 -21.08 -24.38 -27.78 -31.26

TPP + Philippines -3.71 -7.33 -10.86 -14.34 -17.77 -21.18 -24.59 -27.99 -31.42 -34.87

Non-TPP excluding Philippines 0.84 1.58 2.19 2.67 3.04 3.32 3.51 3.62 3.64 3.61

Philippines


Total Exports -0.02 -0.06 -0.10 -0.15 -0.21 -0.28 -0.36 -0.44 -0.53 -0.62

TPP -0.05 -0.10 -0.15 -0.21 -0.27 -0.34 -0.40 -0.47 -0.54 -0.62

Non-TPP 0.02 0.04 0.05 0.06 0.06 0.06 0.05 0.03 0.01 -0.01

With Philippine Participation No FDI Effects

Total Exports 0.37 0.75 1.16 1.59 2.04 2.51 3.01 3.54 4.09 4.67

TPP 0.41 0.84 1.28 1.72 2.19 2.67 3.16 3.67 4.21 4.76

Non-TPP -0.05 -0.08 -0.11 -0.14 -0.15 -0.15 -0.15 -0.14 -0.12 -0.09


/1/ TPP countries include: Australia, New Zealand, Japan, Malaysia, Singapore, Viet Nam, Canada, United States of America,

Mexico, Chile and Peru. Excludes Brunei because it is not in the GTAP 8 database

/2/ The effects of simulating changes in tariffs and NTBs separately may not be equal to the combined effects of simulating them

together because the global model is nonlinear due to the use of CES and CET functions.

/3/ Appreciation in the real exchange rate in the Philippines

28

Table 14. Sectoral Effects in the Philippines, 90 and 40% Reduction in Tariffs and NTBs (% change

from the baseline)

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024


Crops 0.01 0.01 0.02 0.02 0.03 0.03 0.03 0.03 0.03 0.03

All other agriculture 0.00 0.00 0.00 -0.01 -0.01 -0.02 -0.02 -0.03 -0.04 -0.04

Mining 0.00 0.02 0.03 0.05 0.06 0.07 0.08 0.09 0.09 0.10

Food 0.01 0.02 0.03 0.03 0.03 0.02 0.02 0.01 0.01 0.00

Textile and wearing apparel -0.02 -0.05 -0.09 -0.14 -0.19 -0.25 -0.31 -0.36 -0.41 -0.46

Petroleum products -0.04 -0.08 -0.13 -0.18 -0.22 -0.27 -0.32 -0.37 -0.41 -0.46

Chemical, rubber, plastic & others 0.00 0.00 -0.01 -0.02 -0.04 -0.06 -0.07 -0.09 -0.11 -0.13

Metal products 0.00 0.00 -0.01 -0.03 -0.05 -0.08 -0.10 -0.13 -0.16 -0.19

Transport & machinery equipment 0.01 0.01 0.00 -0.02 -0.04 -0.07 -0.10 -0.13 -0.16 -0.20

Electronic equipment 0.01 0.00 -0.01 -0.04 -0.07 -0.10 -0.15 -0.19 -0.24 -0.29

All other manufacturing 0.03 0.06 0.09 0.11 0.13 0.15 0.16 0.17 0.18 0.19

Utilities -0.01 -0.02 -0.04 -0.07 -0.09 -0.12 -0.14 -0.17 -0.20 -0.22

Construction 0.00 -0.01 -0.04 -0.07 -0.10 -0.14 -0.18 -0.23 -0.28 -0.33

Services -0.01 -0.02 -0.04 -0.06 -0.09 -0.12 -0.15 -0.18 -0.21 -0.24

With Philippine Participation, no FDI effects

Crops -0.05 -0.10 -0.15 -0.20 -0.24 -0.27 -0.30 -0.32 -0.34 -0.36

All other agriculture -0.02 -0.07 -0.11 -0.16 -0.20 -0.23 -0.26 -0.28 -0.30 -0.32

Mining -0.05 -0.33 -0.73 -1.17 -1.64 -2.11 -2.57 -3.02 -3.45 -3.86

Food -0.02 -0.06 -0.11 -0.16 -0.19 -0.23 -0.25 -0.28 -0.29 -0.30




Metal products -0.22 -0.58 -0.99 -1.43 -1.87 -2.28 -2.67 -3.03 -3.36 -3.66


Electronic equipment 0.11 0.28 0.50 0.75 1.03 1.32 1.63 1.95 2.28 2.60


Utilities 0.12 0.23 0.31 0.38 0.44 0.49 0.55 0.60 0.66 0.70

Construction -0.77 -1.57 -2.38 -3.18 -3.95 -4.71 -5.43 -6.12 -6.78 -7.42

Services 0.11 0.22 0.32 0.42 0.52 0.61 0.71 0.80 0.90 1.00


29

Table 15. Effects on Factor Returns in the Philippines, 90 and 40% Reduction in Tariffs and NTBs

(% difference from the baseline)

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024


Skilled wages -0.07 -0.14 -0.20 -0.27 -0.33 -0.39 -0.45 -0.51 -0.57 -0.63

Unskilled wages -0.07 -0.13 -0.19 -0.25 -0.31 -0.37 -0.43 -0.49 -0.55 -0.60

Returns to capital -0.07 -0.12 -0.16 -0.20 -0.23 -0.25 -0.28 -0.30 -0.31 -0.33

Returns to land 0.01 0.00 -0.02 -0.04 -0.08 -0.11 -0.15 -0.19 -0.23 -0.27

With Philippine Participation, no FDI effects

Skilled wages 0.51 0.95 1.35 1.72 2.09 2.43 2.78 3.09 3.43 3.72

Unskilled wages 0.42 0.79 1.13 1.45 1.76 2.06 2.36 2.63 2.93 3.18


Returns to land -0.11 -0.24 -0.42 -0.60 -0.77 -0.96 -1.10 -1.26 -1.36 -1.51


Table 16. Welfare Effects in the Philippines, 90 and 40% Reduction in Tariffs and NTBs

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

US$ billion


Participation with no FDI 0.48 0.96 1.43 1.91 2.39 2.87 3.38 3.88 4.41 4.95


% of GDP


Combined welfare effects 0.027 0.051 0.073 0.093 0.111 0.128 0.144 0.159 0.173 0.186


/1/ The sum of the opportunity cost of non-participation and the estimated effects of participation

30

Appendix B: Mapping to GTAP 8 and Specification of a Global CGE Model

B.1. Mapping to GTAP 8 Database

The GTAP 8 database contains information for 57 sectors in 129 countries/regions. To

facilitate the computation of the model solution and analysis of results, the database was

aggregated to 15 sectors in 20 countries/regions and used to calibrate the global CGE model. Table

17 presents the mapping of the 15 sectors in the model to 57 sectors the GTAP 8, while Table 18

the mapping of the 20 countries/regions to the 129 countries/regions in the database.

Table 17. Mapping of Global CGE Sectors to GTAP 8 Database Sectors

Global CGE Sectors GTAP 8 Database Sectors

Sector No. Code Description Code Description

1 1crops Crops pdr Paddy rice

wht Wheat

gro Cereal grains nec

v_f Vegetables-fruit-nuts

osd Oil seeds

c_b Sugar cane-sugar beet

pfb Plant-based fibers

ocr Crops nec

2 1oagri All other agriculture ctl Cattle-sheep-goats-horses

oap Animal products nec

rmk Raw milk

wol Wool-silk-worm cocoons

frs Forestry

fsh Fishing

3 1mng Mining coa Coal

oil Oil

gas Gas

omn Minerals nec

nmm Mineral products nec

4 1food Food cmt Meat-cattle-sheep-goats-horse

omt Meat products nec

vol Vegetable oils-fats

mil Dairy products

pcr Processed rice

sgr Sugar

ofd Food products nec

b_t Beverages-tobacco products

31

5 1texwap Textile and wearing apparel tex Textiles

wap Wearing apparel

6 1petro Petroleum products p_c Petroleum-coal products

7 1crp

Chemical, rubber, and plastic

prods crp Chemical-rubber-plastic prods

8 1metal Metal products i_s Ferrous metals

nfm Metals nec

fmp Metal products

9 1trnpmac

Transp_Machinery

equipment mvh Motor vehicles-parts

otn Transport equipment nec

ome Machinery-equipment nec

10 1ele Electronic equipment ele Electronic equipment

11 1omanf All other manufacturing lea Leather products

lum Wood products

ppp Paper products-publishing

omf Manufactures nec

12 1util Utilities ely Electricity

gdt Gas manufacture-distribution

wtr Water

13 1cns Construction cns Construction

14 1serv Services trd Trade

otp Transport nec

wtp Sea transport

atp Air transport

cmn Communication

ofi Financial services nec

isr Insurance

obs Business services nec

ros Recreation-other services

dwe Dwellings

15 1osg Public administration osg PubAdmin-Defense-Health-Education

32

Table 18. Mapping of Global CGE Countries/Regions to GTAP 8 Countries/Regions

Global CGE Countries/Regions GTAP 8 Database Countries/Regions

No. Code Description Code Description

1 1AUS Australia AUS Australia

2 1NZL New Zealand NZL New Zealand

3 1JPN Japan JPN Japan

4 1KOR Korea KOR Korea

5 1TWN Taiwan TWN Taiwan

6 1MYS Malaysia MYS Malaysia

7 1PHL Philippines PHL Philippines

8 1SGP Singapore SGP Singapore

9 1VNM Viet Nam VNM Viet Nam

10 1IDN Indonesia IDN Indonesia

11 1THA Thailand THA Thailand

12 1CAN Canada CAN Canada

13 1USA United States of America USA United States of America

14 1MEX Mexico MEX Mexico

15 1CHL Chile CHL Chile

16 1PER Peru PER Peru

17 1EU25 European Union 25 AUT Austria

BEL Belgium

CYP Cyprus

CZE Czech Republic

DNK Denmark

EST Estonia

FIN Finland

FRA France

DEU Germany

GRC Greece

HUN Hungary

IRL Ireland

ITA Italy

LVA Latvia

LTU Lithuania

LUX Luxembourg

MLT Malta

POL Poland

PRT Portugal

SVK Slovakia

SVN Slovenia

ESP Spain

SWE Sweden

33

GBR United Kingdom

18 1LTN Latin America ARG Argentina

BOL Bolivia

BRA Brazil

COL Colombia

ECU Ecuador

PRY Paraguay

URY Uruguay

VEN Venezuela

XSM Rest of South America

CRI Costa Rica

GTM Guatemala

HND Honduras

NIC Nicaragua

PAN Panama

SLV El Salvador

XCA Rest of Central America

XCB Caribbean

19 1AFR Africa EGY Egypt

MAR Morocco

TUN Tunisia

XNF Rest of North Africa

CMR Cameroon

CIV Cote d_Ivoire

GHA Ghana

NGA Nigeria

SEN Senegal

XWF Rest of Western Africa

XCF Central Africa

XAC South Central Africa

ETH Ethiopia

KEN Kenya

MDG Madagascar

MWI Malawi

MUS Mauritius

MOZ Mozambique

TZA Tanzania

UGA Uganda

ZMB Zambia

ZWE Zimbabwe

XEC Rest of Eastern Africa

BWA Botswana

NAM Namibia

34

ZAF South Africa

XSC Rest of South African Custom

20 1ROW Rest of the World XOC Rest of Oceania

CHN China

HKG Hong Kong

MNG Mongolia

XEA Rest of East Asia

KHM Cambodia

LAO Lao Peoples Democratic Rep

XSE Rest of Southeast Asia

BGD Bangladesh

IND India

NPL Nepal

PAK Pakistan

LKA Sri Lanka

XSA Rest of South Asia

XNA Rest of North America

CHE Switzerland

NOR Norway

XEF Rest of EFTA

ALB Albania

BGR Bulgaria

BLR Belarus

HRV Croatia

ROU Romania

RUS Russian Federation

UKR Ukraine

XEE Rest of Eastern Europe

XER Rest of Europe

KAZ Kazakhstan

KGZ Kyrgyzstan

XSU Rest of Former Soviet Union

ARM Armenia

AZE Azerbaijan

GEO Georgia

BHR Bahrain

IRN Iran Islamic Republic of

ISR Israel

KWT Kuwait

OMN Oman

QAT Qatar

SAU Saudi Arabia

TUR Turkey

35

ARE United Arab Emirates

XWS Rest of Western Asia

XTW Rest of the World

B.2. Specification of a Global CGE Model8

Indices

The following are the indices used in the variables of the model

(i, j, ij): sectors

(m): imported commodities

(nm): non-imported, domestically produced commodities

(x): exports

(nx): domestically produced sold to the domestic market only

(z, zj): countries or regions

(k): capital type

(l): labor type

(t): period

Production

Sectoral value added (𝑉𝐴𝑗,𝑧,𝑡) is a fixed proportion of sectoral output (𝑋𝑆𝑗,𝑧,𝑡)

(1) 𝑉𝐴𝑗,𝑧,𝑡 = 𝜐𝑗,𝑧𝑋𝑆𝑗,𝑧,𝑡

where (𝜐𝑗,𝑧) is a set of fixed value added coefficients.

Sectoral intermediate consumption is also a fixed proportion of sectoral output

(2) 𝐶𝐼𝑗,𝑧,𝑡 = 𝑖𝑜𝑗,𝑧𝑋𝑆𝑗,𝑧,𝑡

where (𝑖𝑜𝑗,𝑧) is a set of fixed intermediate consumption coefficients.

8 The structure of the model follows closely the PEP-w-t model (Robichaud, et al. 2011), but some equations were

modified to facilitate the coding of the model.

36

Sectoral value added is a CES function of composite labor and composite capital. The

breakdown of these composite factor inputs is discussed below. Cost minimization by firms yields

the following first order conditions (Rutherford, 2002): the demand functions for the composite

labor (𝐿𝐷𝐶𝑗,𝑧,𝑡) and the composite capital (𝐾𝐷𝐶𝑗,𝑧,𝑡), and a unit cost function of value added

(𝑃𝑉𝐴𝑗,𝑧,𝑡).

The demand for the composite labor is

(3) 𝐿𝐷𝐶𝑗,𝑧,𝑡 = 𝛽𝐿𝐷𝐶,𝑗,𝑧

𝜎𝑉𝐴,𝑗,𝑧 (𝛿𝐿𝐷𝐶,𝑗,𝑧𝛼𝑉𝐴,𝑗,𝑧)𝜎𝑉𝐴,𝑗,𝑧−1

(𝑃𝑉𝐴𝑗,𝑧,𝑡

𝑊𝐶𝑗,𝑧,𝑡)

𝜎𝑉𝐴,𝑗,𝑧

𝑉𝐴𝑗,𝑧,𝑡

where (𝛽𝐿𝐷𝐶,𝑗.𝑍) is the composite labor share parameter, (𝛼𝑉𝐴,𝑗,𝑧) the scale parameter in the CES

function, (𝛿𝐿𝐷𝐶,𝑗,𝑧) the composite labor productivity factor, (𝜎𝑉𝐴,𝑗,𝑧) the elasticity of substitution

between the composite labor and the composite capital, (𝑊𝐶𝑗,𝑧,𝑡) the composite wage, and (𝑉𝐴𝑗,𝑧,𝑡)

the value added.

The demand for the composite capital is

(4) 𝐾𝐷𝐶𝑗,𝑧,𝑡 = 𝛽𝐾𝐷𝐶,𝑗,𝑧

𝜎𝑉𝐴,𝑗,𝑧 (𝛿𝐾𝐷𝐶,𝑗,𝑧𝛼𝑉𝐴,𝑗,𝑧)𝜎𝑉𝐴,𝑗,𝑧−1

(𝑃𝑉𝐴𝑗,𝑧,𝑡

𝑅𝐶𝑗,𝑧,𝑡)

𝜎𝑉𝐴,𝑗,𝑧

𝑉𝐴𝑗,𝑧,𝑡

where (𝛽𝐾𝐷𝐶,𝑗.𝑍 ) is the composite capital share parameter, (𝛿𝐾𝐷𝐶,𝑗,𝑧) the composite capital

productivity factor, and (𝑅𝐶𝑗,𝑧,𝑡) the composite rental rate of capital.

The unit cost function of value added is

(5) 𝑃𝑉𝐴𝑗,𝑧,𝑡 = (1

𝛼𝑉𝐴,𝑗,𝑧) (𝛽𝐿𝐷𝐶,𝑗,𝑧 (

𝑊𝐶𝑗,𝑧,𝑡

𝛿𝐿𝐷𝐶,𝑗,𝑧)

1−𝜎𝑉𝐴,𝑗,𝑧

+ 𝛽𝐾𝐷𝐶,𝑗,𝑧 (𝑅𝐶𝑗,𝑧,𝑡

𝛿𝐾𝐷𝐶,𝑗,𝑧)


)

1


where (𝑃𝑉𝐴𝑗,𝑧,𝑡) is the CES dual price; it is the aggregate price of the CES components: the prices

of composite labor and composite capital.

The composite labor is a CES function of two types of labor: (l ) = skilled and unskilled

labor. Cost minimization by firms will yield the following first order conditions: the demand

functions for each type of labor, and a unit cost function of the composite labor.

37

The demand for type l labor is

(6) 𝐿𝐷𝑙,𝑗,𝑧,𝑡 = 𝛽𝑙,𝑗,𝑧

𝜎𝐿𝐷,𝑗,𝑧(𝛿𝑙,𝑗,𝑧𝛼𝐿𝐷,𝑗,𝑧)𝜎𝐿𝐷,𝑗,𝑧−1

(𝑊𝐶𝑗,𝑧,𝑡

𝑊𝑇𝐼𝑙,𝑗,𝑧,𝑡)

𝜎𝐿𝐷,𝑗,𝑧

𝐿𝐷𝐶𝑗,𝑧,𝑡

where (𝛽𝑙,𝑗.𝑍) is the share parameter of type l labor, (𝛿𝑙,𝑗,𝑧t) the productivity factor of type l labor,

(𝛼𝐿𝐷,𝑗,𝑧) the scale parameter in the CES function, (𝜎𝐿𝐷,𝑗,𝑧) the elasticity of substitution between the

two types of labor, and (𝑊𝑇𝐼𝑙,𝑗,𝑧,𝑡) the wage rate of type l labor including payroll tax.

The unit cost function of the composite labor is

(7) 𝑊𝐶𝑗,𝑧,𝑡 = (1

𝛼𝐿𝐷,𝑗,𝑧) ( ∑ 𝛽𝑙,𝑗,𝑧𝑙 (

𝑊𝑇𝐼𝑙,𝑗,𝑧,𝑡

𝛿𝑙,𝑗,𝑧)

1−𝜎𝐿𝐷,𝑗,𝑧

)

1

1−𝜎𝐿𝐷,𝑗,𝑧

This is a CES dual price.

The composite capital is a CES function of two types of capital: (k) = physical capital and

land (which includes natural resources). However, land is only used in agriculture and mining

while physical capital in all sectors.

The demand for type k capital is

(8) 𝐾𝐷𝑘,𝑗,𝑧,𝑡 = 𝛽𝑘,𝑗,𝑧

𝜎𝐾𝐷,𝑗,𝑧(𝛿𝑘,𝑗,𝑧𝛼𝐾𝐷,𝑗,𝑧)𝜎𝐾𝐷,𝑗,𝑧−1

(𝑅𝐶𝑗,𝑧,𝑡

𝑅𝑇𝐼𝑘,𝑗,𝑧,𝑡)

𝜎𝐾𝐷,𝑧

𝐾𝐷𝐶𝑗,𝑧,𝑡

where (𝛽𝑘,𝑗.𝑍) is the share parameter of type k capital, (𝛿𝑘,𝑗,𝑧t) the productivity factor of type k

capital, (𝛼𝐾𝐷,𝑗,𝑧) the scale parameter in the CES function, (𝜎𝐾𝐷,𝑗,𝑧) the elasticity of substitution

between the two types of capital, and (𝑅𝑇𝐼𝑘,𝑗,𝑧,𝑡) the rental rate of type k capital including factor

tax on capital.

The unit cost function of the composite capital is

(9) 𝑅𝐶𝑗,𝑧,𝑡 = (1

𝛼𝐾𝐷,𝑗,𝑧) ( ∑ 𝛽𝑘,𝑗,𝑧𝑘 (

𝑅𝑇𝐼𝑘,𝑗,𝑧,𝑡

𝛿𝑘,𝑗,𝑧)

1−𝜎𝐾𝐷,𝑗,𝑧

)

1

1−𝜎𝐾𝐷,𝑗,𝑧

This is a CES dual price.

38

Income and Savings

In each region there is a single household and a government. Household income (𝑌𝐻𝑧,𝑡) is

composed of labor (𝑌𝐻𝐿𝑧,𝑡) and capital income (𝑌𝐻𝐾𝑧,𝑡).

(10) 𝑌𝐻𝑧,𝑡 = 𝑌𝐻𝐿𝑧,𝑡 + 𝑌𝐻𝐾𝑧,𝑡

Labor income is the sum of labor earnings from the two types of labor, while capital income

is the sum of rentals paid for the two types of capital less depreciation. That is,

(11) 𝑌𝐻𝐿𝑧,𝑡 = ∑ 𝑊𝑙,𝑧,𝑡𝐿𝐷𝑙,𝑗,𝑧,𝑡𝑙,𝑗

(12) 𝑌𝐻𝐾𝑧,𝑡 = ∑ 𝑅𝑘,𝑗,𝑧,𝑡𝐾𝐷𝑘,𝑗,𝑧,𝑡𝑘,𝑗 − 𝐷𝑒𝑝𝑧,𝑡

where (𝑊𝑙,𝑧,𝑡) is the wage rate of type l labor before payroll tax, (𝑅𝑘,𝑗,𝑧,𝑡) the sectoral rental rate of

type k capital before rental tax, and (𝐷𝑒𝑝𝑧,𝑡) the amount of depreciation (capital consumption

allowance).

The household disposable income (𝑌𝐷𝐻𝑧,𝑡), the household consumption budget (𝐶𝑇𝐻𝑧,𝑡),

and the household savings (𝑆𝐻𝑧,𝑡 ) are

(13) 𝑌𝐷𝐻𝑧,𝑡 = 𝑌𝐻𝑧,𝑡 − 𝑇𝐷𝐻𝑧,𝑡

(14) 𝐶𝑇𝐻𝑧,𝑡 = 𝑌𝐷𝐻𝑧,𝑡 − 𝑆𝐻𝑧,𝑡

(15) 𝑆𝐻𝑧,𝑡 = 𝑃𝐼𝑋𝐶𝑂𝑁𝑧,𝑡𝜂

𝑠ℎ0𝑧,𝑡 + 𝑠ℎ1𝑧𝑌𝐷𝐻𝑧,𝑡

where (𝑇𝐷𝐻𝑧,𝑡) is the household income tax, (𝑃𝐼𝑋𝐶𝑂𝑁𝑧,𝑡) the consumer price index, (𝑠ℎ0𝑧,𝑡) the

intercept in the savings function in t, (𝑠ℎ1𝑧) the slope of the savings function, and (𝜂) the price-

elasticity of indexed transfers and parameters.

Government

The revenue of the government (𝑌𝐺𝑧,𝑡) comes from three sources: household income tax

(𝑇𝐷𝐻𝑧,𝑡), production-related taxes (𝑇𝑃𝑅𝑂𝐷𝑁𝑧,𝑡), and products and imports taxes (𝑇𝑃𝑅𝐶𝑇𝑧,𝑡).

39

(16) 𝑌𝐺𝑧,𝑡 = 𝑇𝐷𝐻𝑧,𝑡 + 𝑇𝑃𝑅𝑂𝐷𝑁𝑧,𝑡 + 𝑇𝑃𝑅𝐶𝑇𝑧,𝑡

Income taxes paid by households are a linear function of total income, i.e.,

(17) 𝑇𝐷𝐻𝑧,𝑡 = 𝑃𝐼𝑋𝐶𝑂𝑁𝑧,𝑡𝜂

𝑡𝑡𝑑ℎ0𝑧,𝑡 + 𝑡𝑡𝑑ℎ0𝑧,𝑡𝑌𝐻𝑧,𝑡

The production-related taxes are: the taxes on payroll (𝑇𝐼𝑊𝑇𝑧,𝑡), the taxes on the use capital

(𝑇𝐼𝐾𝑇𝑧,𝑡), and the taxes on production (𝑇𝐼𝑃𝑇𝑧,𝑡).

(18) 𝑇𝑃𝑅𝑂𝐷𝑁𝑧,𝑡 = 𝑇𝐼𝑊𝑇𝑧,𝑡 + 𝑇𝐼𝐾𝑇𝑧,𝑡 + 𝑇𝐼𝑃𝑇𝑧,𝑡

The tax on payroll is

(19) 𝑇𝐼𝑊𝑇𝑧,𝑡 = ∑ 𝑇𝐼𝑊𝑙,𝑗,𝑧,𝑡𝑙,𝑗 = ∑ 𝑡𝑡𝑖𝑤𝑙,𝑗,𝑧,𝑡𝑊𝑙,𝑧,𝑡𝐿𝐷𝑙,𝑗,𝑧,𝑡𝑙,𝑗

where (𝑇𝐼𝑊𝑙,𝑗,𝑧,𝑡) is the revenue from payroll tax on type l labor, and (𝑡𝑡𝑖𝑤𝑙,𝑗,𝑧,𝑡) the rate of payroll

tax.

Similarly, the tax on the use of capital is

(20) 𝑇𝐼𝐾𝑇𝑧,𝑡 = ∑ 𝑇𝐼𝐾𝑘,𝑗,𝑧,𝑡𝑘,𝑗 = ∑ 𝑡𝑡𝑖𝑘𝑘,𝑗,𝑧,𝑡𝑅𝑘,𝑗,𝑧,𝑡𝐾𝐷𝑘,𝑗,𝑧,𝑡𝑘,𝑗

where (𝑇𝐼𝐾𝑘,𝑗,𝑧,𝑡) is the revenue from the tax on the use of type k capital, and (𝑡𝑡𝑖𝑘𝑘,𝑗,𝑧,𝑡) the tax

rate on the use of capital.

The production tax is

(21) 𝑇𝐼𝑃𝑇𝑧,𝑡 = ∑ 𝑇𝐼𝑃𝑗,𝑧,𝑡𝑗 = ∑ 𝑡𝑡𝑖𝑝𝑗,𝑧,𝑡𝑃𝑃𝑗,𝑧,𝑡𝑋𝑆𝑗,𝑧,𝑡𝑗

where (𝑇𝐼𝑃𝑗,𝑧,𝑡) is the revenue from the tax on production, (𝑡𝑡𝑖𝑃𝑗,𝑧,𝑡) the tax rate on the use of

capital, and (𝑃𝑃𝑗,𝑧,𝑡) the unit cost of sector j.

The taxes on products and imports are: the indirect taxes on commodities (𝑇𝐼𝐶𝑇𝑧,𝑡), the

duties levied on imports (𝑇𝐼𝑀𝑇𝑧,𝑡), and the export taxes (𝑇𝐼𝑋𝑇𝑧,𝑡).

(22) 𝑇𝑃𝑅𝐶𝑇𝑆𝑧,𝑡 = 𝑇𝐼𝐶𝑇𝑧,𝑡 + 𝑇𝐼𝑀𝑇𝑧,𝑡 + 𝑇𝐼𝑋𝑇𝑧,𝑡

40

The indirect tax on commodities is

(23) 𝑇𝐼𝐶𝑇𝑧,𝑡 = ∑ 𝑇𝐼𝐶𝑖,𝑧,𝑡𝑖

where (𝑇𝐼𝐶𝑖,𝑧,𝑡) is the revenue from indirect tax. Since commodities available in the domestic

market are composed of domestically produced goods and imports, (𝑇𝐼𝐶𝑖,𝑧,𝑡) has two components:

(𝑇𝐼𝐶𝑛𝑚,𝑧,𝑡) the indirect tax on non-imported commodities, and (𝑇𝐼𝐶𝑚,𝑧,𝑡) the indirect tax on

imported commodities.

The indirect tax on non-imported commodities is

(24) 𝑇𝐼𝐶𝑛𝑚,𝑧,𝑡 = 𝑡𝑡𝑖𝑐𝑛𝑚,𝑧,𝑡𝑃𝐿𝑛𝑚,𝑧,𝑡𝐷𝐷𝑛𝑚,𝑧,𝑡

where (𝑡𝑡𝑖𝑐𝑛𝑚,𝑧,𝑡) is the indirect tax rate on non-imported commodities, (𝑃𝐿𝑛𝑚,𝑧,𝑡) the price of

locally produced commodities excluding taxes, and (𝐷𝐷𝑛𝑚,𝑧,𝑡) the domestic demand for

commodity nm.

Import duties are levied on commodities that enter the border. When these commodities

are moved beyond the border into the various domestic markets, similar to the domestically

produced goods, they are charged with indirect taxes as well. Moreover, the border price of imports

includes trade margins. Taking all these factors together, the indirect tax on imported commodities

(𝑇𝐼𝐶𝑚,𝑧,𝑡) is

(25) 𝑇𝐼𝐶𝑚,𝑧,𝑡 = 𝑡𝑡𝑖𝑐𝑚,𝑧,𝑡{𝑃𝐿𝑚,𝑧,𝑡𝐷𝐷𝑚,𝑧,𝑡 ∑ [(1 + 𝑡𝑡𝑖𝑚𝑚,𝑧𝑗,𝑧,𝑡)(𝑃𝑊𝑀𝑚,𝑧𝑗,𝑧,𝑡 +𝑧𝑗

∑ 𝑃𝑊𝑀𝐺𝑖𝑗,𝑡𝑡𝑚𝑟𝑔𝑖𝑗,𝑚,𝑧𝑗,𝑧,𝑡𝑖𝑗 )𝑒𝑧,𝑡𝐼𝑀𝑚,𝑧𝑗,𝑧,𝑡]}

where (𝑡𝑡𝑖𝑐𝑚,𝑧,𝑡) the indirect tax rate on imports, (𝑡𝑡𝑖𝑚𝑚,𝑧𝑗,𝑧,𝑡) the rate of import duties,

(𝑃𝑊𝑀𝑚,𝑧𝑗,𝑧,𝑡) the world price of m imported from country/region zj by country/region z in

international currency, (𝑃𝑊𝑀𝐺𝑖𝑗,𝑡) the world price of trade margins in international currency,

(𝑡𝑚𝑟𝑔𝑖𝑗,𝑚,𝑧𝑗,𝑧,𝑡) the rate of international transport margin services, (𝑒𝑧,𝑡) the exchange rate, and

(𝐼𝑀𝑚,𝑧𝑗,𝑧,𝑡) imports.

The total government revenue (𝑇𝐼𝑀𝑇𝑧,𝑡) from duties on imports is given as

41

(26) 𝑇𝐼𝑀𝑇𝑧,𝑡 = ∑ 𝑇𝐼𝑀𝑚,𝑧𝑗,𝑧,𝑡𝑚,𝑧𝑗 = ∑ 𝑡𝑡𝑖𝑚𝑚,𝑧𝑗,𝑧,𝑡(𝑃𝑊𝑀𝑚,𝑧𝑗,𝑧,𝑡 +𝑚,𝑧𝑗

𝑃𝑊𝑀𝑚,𝑧𝑗,𝑧,𝑡)𝑒𝑧,𝑡𝐼𝑀𝑚,𝑧𝑗,𝑧,𝑡

The total government revenue (𝑇𝐼𝑋𝑇𝑧,𝑡) from export taxes is defined as

(27) 𝑇𝐼𝑋𝑇𝑧,𝑡 = ∑ 𝑇𝐼𝑋𝑥,𝑧,𝑧𝑗,𝑡𝑥,𝑧𝑗 = ∑ 𝑡𝑡𝑖𝑥𝑥,𝑧,𝑧𝑗,𝑡𝑃𝐸𝑥,𝑧,𝑧𝑗,𝑡𝐸𝑋𝑥,𝑧,𝑧𝑗,𝑡𝑥,𝑧𝑗

where (𝑇𝐼𝑋𝑥,𝑧,𝑧𝑗,𝑡) is the revenue from taxes on export by country/region z to country/region zj,

(𝑡𝑡𝑖𝑥𝑥,𝑧,𝑧𝑗,𝑡) the rate of export taxes, (𝑃𝐸𝑥,𝑧,𝑧𝑗,𝑡) the price of exports excluding export taxes, and

(𝐸𝑋𝑥,𝑧,𝑧𝑗,𝑡) exports.

Government savings (𝑆𝐺𝑧,𝑡) is total government revenue net of total current government

expenditure (𝐺𝑧,𝑡).

(28) 𝑆𝐺𝑧,𝑡 = 𝑌𝐺𝑧,𝑡 − 𝐺𝑧,𝑡

Domestic Demand

Household demand (𝐶𝑖,𝑧,𝑡) is derived by utility maximization subject to a budget constraint.

This process will yield the following consumption function9

(29) 𝐶𝑖,𝑧,𝑡𝑃𝐶𝑖,𝑧,𝑡 = 𝐶𝑖,𝑧,𝑡𝑀𝐼𝑁𝑃𝐶𝑖,𝑧,𝑡 + 𝛾𝑖,𝑧

𝐿𝐸𝑆(𝐶𝑇𝐻𝑧,𝑡 − ∑ 𝐶𝑖𝑗,𝑧,𝑡𝑀𝐼𝑁

𝑖𝑗 )

where (𝐶𝑖,𝑧,𝑡𝑀𝐼𝑁) is the minimum consumption of commodity, (𝑃𝐶𝑖,𝑧,𝑡) the purchaser price of

commodity, and (𝛾𝑖,𝑧𝐿𝐸𝑆) the marginal share of commodity in the household consumption budget.

The volume of government expenditure on commodities (𝐶𝐺𝑖,𝑧,𝑡) is given by

(30) 𝐶𝐺𝑖,𝑧,𝑡𝑃𝐶𝑖,𝑧,𝑡 = 𝛾𝑖,𝑧𝐺𝑉𝑇𝐺𝑧,𝑡

9 This is a linear expenditure system (LES).

42

where (𝛾𝑖,𝑧𝐺𝑉𝑇) is the share of expenditure on commodities in the total current government

expenditure. The total current government expenditure is equal to the total real government

expenditure (𝑅𝐺𝑧,𝑡) multiplied by a public (government) expenditure price index (𝑃𝐼𝑋𝐺𝑉𝑇𝑧,𝑡), i.e.,

(31) 𝐺𝑧,𝑡 = 𝑅𝐺𝑧,𝑡𝑃𝐼𝑋𝐺𝑉𝑇𝑧,𝑡

The public expenditure price index is defined later. The equation (31) allows for alternative model

closures in the sense that government expenditure can either be fixed in real or in nominal terms.

The total investment in each country/region is determined by the savings-investment

equilibrium constraint which is be defined later. The total available investment (𝐼𝑇𝑧,𝑡) is distributed

across sectors using a set of fixed shares

(32) 𝐼𝑁𝑉𝑖,𝑧,𝑡𝑃𝐶𝑖,𝑧,𝑡 = 𝛾𝑖,𝑧𝐼𝑁𝑉𝐼𝑇𝑧,𝑡

where (𝐼𝑁𝑉𝑖,𝑧,𝑡) is the final demand for commodity for investment purposes (or the gross fixed

capital formation), and (𝛾𝑖,𝑧𝐼𝑁𝑉) the share of commodity in the total investment expenditures10.

The total intermediate demand (𝐷𝐼𝑇𝑖,𝑧,𝑡) for each commodity is the sum of the industry

demands for production inputs (𝐷𝐼𝑖,𝑗,𝑧,𝑡), i.e.,

(33) 𝐷𝐼𝑇𝑖,𝑧,𝑡 = ∑ 𝐷𝐼𝑖,𝑗,𝑧,𝑡𝑗

Supplies and International Trade

The supply of produced output in each country/region is represented by two-level nested

CET functions: (a) in the first nest, each sectoral output produced (𝑋𝑆𝑗,𝑧,𝑡) is allocated to three

outlets: domestic demand (𝐷𝑆𝑗,𝑧,𝑡), exports (𝐸𝑋𝑇𝑗,𝑧,𝑡), and international transport margin services

(𝑀𝑅𝐺𝑁𝑗,𝑧,𝑡); and (b) in the second nest, the total export of each country/region is distributed to the

various export market destinations. However, not all output produced are exportable. Some goods

are only sold in the domestic market. Thus, the commodities are grouped in two sets: (x) for output

10As pointed out in Robichaud, et al (2011), this specification implies that the production of new capital is Cobb-

Douglas. Thus, the quantity demanded for each commodity for investment purposes under a given amount of

investment expenditure is inversely related to its price.

43

sold in both exports and the domestic markets, and (nx) for output sold in the domestic market

only.

Producers allocate output to the three outlets in order to maximize revenue given product

prices in each of the outlets. Assuming imperfect substitutability among the three outlets, the

product is supplied to each outlet based on a CET function. The first order conditions yield supply

of exports, domestic demand, and international transport margin services.

The supply of exports is

(34) 𝐸𝑋𝑇𝑥,𝑧,𝑡 = 𝛽𝑥,𝑧𝐸𝑋𝑇𝛼1𝑥,𝑧

−(1+𝜎1𝑥,𝑧)(

𝑃𝑥,𝑧,𝑡

𝑃𝐸𝑇𝑥,𝑧,𝑡)

−𝜎1𝑥,𝑧

𝑋𝑆𝑥,𝑧,𝑡

where (𝛽𝑥,𝑧𝐸𝑋𝑇) is the share parameter in the CET function for exports, (𝛼1𝑥,𝑧) the scale parameter

in the CET function in the first nest, (𝜎1𝑥,𝑧) the elasticity of transformation in the first nest, (𝑃𝑥,𝑧,𝑡)

the basic price of commodities, and (𝑃𝐸𝑇𝑥,𝑧,𝑡) the border price of exports excluding export taxes.

The supply of goods sold in the domestic market is

(35) 𝐷𝑆𝑥,𝑧,𝑡 = 𝛽𝑥,𝑧𝐷𝑆𝛼1𝑥,𝑧

−(1+𝜎1𝑥,𝑧)(

𝑃𝑥,𝑧,𝑡

𝑃𝐿𝑥,𝑧,𝑡)

−𝜎1𝑥,𝑧


where (𝛽𝑥,𝑧𝐷𝑆) is the share parameter in the CET function for domestic demand, and (𝑃𝐿𝑥,𝑧,𝑡) the

price of locally produced commodities excluding indirect taxes.

The supply of international transport margin services is

(36) 𝑀𝑅𝐺𝑁𝑥,𝑧,𝑡 = 𝛽𝑥,𝑧𝑀𝑅𝐺𝑁𝛼1𝑥,𝑧

−(1+𝜎1𝑥,𝑧)(

𝑃𝑥,𝑧,𝑡

𝑒𝑧,𝑡𝑃𝑊𝑀𝐺𝑥,𝑧,𝑡)

−𝜎1𝑥,𝑧


where (𝛽𝑥,𝑧𝑀𝑅𝐺𝑁) is the share parameter in the CET function for domestic demand, and (𝑃𝑊𝑀𝐺𝑥,𝑧,𝑡)

the world price of imports of international transport margin services in international currency.

The basic price is the CET dual price which is an aggregate price of the CET components.

It is given by

44

(37) 𝑃𝑥,𝑧,𝑡 = (1

𝛼1𝑥,𝑧) (𝛽𝑥,𝑧

𝐸𝑋𝑇(𝑃𝐸𝑇𝑥,𝑧,𝑡)1+𝜎1𝑥,𝑧

+ 𝛽𝑥,𝑧𝐷𝑆(𝑃𝐿𝑥,𝑧,𝑡)

1+𝜎1𝑥,𝑧+

𝛽𝑥,𝑧𝑀𝑅𝐺𝑁(𝑒𝑧,𝑡𝑃𝑊𝑁𝐺𝑥,𝑧,𝑡)

1+𝜎1𝑥,𝑧)

1

1+𝜎1𝑥,𝑧

The total exports of each country/region is disaggregated to the various export destinations

using a second nest CET function. The first order conditions for revenue maximization yield the

supply of exports of country/region z in export destination zj

(38) 𝐸𝑋𝑥,𝑧,𝑧𝑗,𝑡 = 𝛽𝑥,𝑧,𝑧𝑗𝛼2𝑥,𝑧−(1+𝜎2𝑥,𝑧)

(𝑃𝐸𝑇𝑥,𝑧,𝑡

𝑃𝐸𝑥,𝑧,𝑧𝑗,𝑡)

−𝜎2𝑥,𝑧

𝐸𝑋𝑇𝑥,𝑧,𝑡

where (𝛽𝑥,𝑧,𝑧𝑗) is the share parameter in the CET function, (𝛼2𝑥,𝑧) the scale parameter in the CET

function in the second nest, (𝜎2𝑥,𝑧) the elasticity of transformation in the second nest, and (𝑃𝐸𝑥,𝑧,𝑡)

the price of exports excluding export taxes.

The dual CET price is

(39) 𝑃𝐸𝑇𝑥,𝑧,𝑡 = (1

𝛼2𝑥,𝑧) (∑ 𝛽𝑥,𝑧,𝑧𝑗𝑧𝑗 𝑃𝐸𝑥,𝑧,𝑧𝑗,𝑡

1+𝜎2𝑥,𝑧 )

1

1+𝜎2𝑥,𝑧

For commodities which are not exported their output prices are

(40) 𝑃𝑛𝑥,𝑧,𝑡 = 𝑃𝐿𝑛𝑥,𝑧,𝑡

The supply of each commodity in the domestic market of each country/region is

represented by two-level nested CES function: (a) in the first level is an Armington composite

good consisting of domestically produced commodities and composite imports; and (2) in the

second level is a disaggregation of imports from various countries/regions of origin. Also, since

not all commodities have competing imports, commodities are grouped in two sets: (m) for

commodities with competing imports, and (nm) for commodities supplied by domestically

produced goods only.

The first order conditions for cost minimization will yield the demand for domestically

produced goods, and the demand for the composite imports, and a composite import price. The

demand for domestically produced goods (𝐷𝐷𝑚,𝑧,𝑡) is

45

(41) 𝐷𝐷𝑚,𝑧,𝑡 = 𝛽𝐷𝐷,𝑚,𝑧

𝜎1𝑚,𝑧 (𝛼1𝑚,𝑧)𝜎1𝑚,𝑧−1

(𝑃𝐶𝑚,𝑧,𝑡

𝑃𝐷𝑚,𝑧,𝑡)

𝜎1𝑚,𝑧

𝑄𝑚,𝑧,𝑡

where (𝛽𝐷𝐷,𝑚,𝑧) is the share parameter for domestically produced goods, (𝛼1𝑚,𝑧) the scale

parameter in the CES function in the first nest, (𝜎1𝑚,𝑧) the elasticity of substitution in the first

nest, (𝑃𝐶𝑚,𝑧,𝑡) the purchaser price of commodity, (𝑃𝐷𝑚,𝑧,𝑡) the price of locally produced goods

sold in the domestic market including taxes, and (𝑄𝑚,𝑧,𝑡) the Armington composite good.

The demand for the composite imports (𝐼𝑀𝑇𝑚,𝑧,𝑡) is given by

(42) 𝐼𝑀𝑇𝑚,𝑧,𝑡 = 𝛽𝐼𝑀𝑇,𝑚,𝑧


(𝑃𝐶𝑚,𝑧,𝑡

𝑃𝑀𝑇𝑚,𝑧,𝑡)

𝜎1𝑚,𝑧

𝑄𝑚,𝑧,𝑡

where (𝛽𝐼𝑀𝑇,𝑚,𝑧) is the share parameter for the composite imports, and (𝑃𝑀𝑇𝑚,𝑧,𝑡) the price of the

composite imports.

The CES dual price is the composite price of (𝑃𝐷𝑚,𝑧,𝑡) and (𝑃𝑀𝑇𝑚,𝑧,𝑡), i.e.,

(43) 𝑃𝐶𝑚,𝑧,𝑡 = (1

𝛼1𝑚,𝑧) (𝛽𝐷𝐷,𝑚,𝑧(𝑃𝐷𝑚,𝑧,𝑡)

1−𝜎1𝑚,𝑧+ 𝛽𝐼𝑀𝑇,𝑚,𝑧(𝑃𝑀𝑇𝑚,𝑧,𝑡)

1−𝜎1𝑚,𝑧)

1

1−𝜎1𝑚,𝑧

The total imports of each commodity in each country/region is disaggregated into imports

from various countries/regions of origin using a second CES nest. The first order conditions for

cost minimization yields the import demand for imports by z from zj

(44) 𝐼𝑀𝑚,𝑧𝑗,𝑧,𝑡 = 𝛽𝑚,𝑧𝑗,𝑧


(𝑃𝑀𝑇𝑚,𝑧,𝑡

𝑃𝑀𝑚,𝑧𝑗,𝑧,𝑡)

𝜎2𝑚,𝑧

𝐼𝑀𝑇𝑚,𝑧,𝑡

where (𝛽𝑚,𝑧𝑗,𝑧) is the share parameter for imports from origin zj, (𝜎2𝑚,𝑧) the elasticity of

substitution in the second nest, (𝛼2𝑚,𝑧) the scale parameter in the CES function in the second nest,

and (𝑃𝑀𝑚,𝑧𝑗,𝑧,𝑡) the price of imports inclusive of taxes, duties and trade margins.

The CES dual price is

(45) 𝑃𝑀𝑇𝑚,𝑧,𝑡 = (1

𝛼2𝑚,𝑧) (∑ 𝛽𝑚,𝑧𝑗,𝑧𝑧𝑗 (𝑃𝑀𝑚,𝑧𝑗,𝑧,𝑡)

1−𝜎2𝑚,𝑧)

1

1−𝜎2𝑚,𝑧

46

For commodities without competing imports their purchasing prices are given by

(46) 𝑃𝐶𝑛𝑚,𝑧,𝑡 = 𝑃𝐷𝑛𝑚,𝑧,𝑡

External Account

In the GTAP 8 database, information is available on the amount of trade margin in each

sector i associated with each bilateral trade flows between countries/regions z and zj. However,

there is no information available matching the producers of the international transport margin

services (𝑀𝑅𝐺𝑁𝑗,𝑧,𝑡) to the individual bilateral trade flows. Therefore, the disaggregating

international transport margin services similar to the breaking down of exports of goods and

services to the various export destination cannot be done because there are no information available

in the GTAP 8 database needed to calibrate this nest. Thus similar to the PEP-w-t- model, the

present model has the supply of 𝑀𝑅𝐺𝑁𝑥,𝑧,𝑡 in each country/region pooled in a sector called

‘external account’ (EA)’ and its production is shared among suppliers in each country/region

through a competitive process.

The EA receives payments (𝑌𝐸𝐴𝑧,𝑡) for the value imports of the country/region including

international transport margin services, i.e.,

(47) 𝑌𝐸𝐴𝑧,𝑡 = 𝑒𝑧,𝑡 ∑ {𝐼𝑀𝑚,𝑧𝑗,𝑡(𝑃𝑊𝑀𝑚,𝑧𝑗,𝑧,𝑡 + ∑ 𝑃𝑊𝑀𝐺𝑖,𝑡𝑡𝑚𝑟𝑔𝑖,𝑚,𝑧𝑗,𝑧𝑖 )}𝑚,𝑧𝑗

The saving in the EA (𝑆𝐸𝐴𝑧,𝑡) is the difference between total receipts and spending which

is given by

(48) 𝑆𝐸𝐴𝑧,𝑡 = 𝑌𝐸𝐴𝑧,𝑡 − 𝑒𝑧,𝑡 ∑ 𝑃𝑊𝑋𝑥,𝑧,𝑧𝑗,𝑡𝑥,𝑧𝑗 𝐸𝑋𝑥,𝑧,𝑧𝑗,𝑡 − 𝑒𝑧,𝑡 ∑ 𝑃𝑊𝑀𝐺𝑚,𝑡𝑚 𝑀𝑅𝐺𝑁𝑚,𝑧,𝑡

where (𝑃𝑊𝑋𝑥,𝑧,𝑧𝑗,𝑡) is the world price of x exported by country/region z to zj in international

currency.

The current account balance (𝐶𝐴𝐵𝑧,𝑡) of each country/region is the negative of (𝑆𝐸𝐴𝑧,𝑡),

i.e.,

(49) 𝐶𝐴𝐵𝑧,𝑡 = −𝑆𝐸𝐴𝑧,𝑡

47

Prices

The unit cost of a sector’s output (including taxes related to the use of capital and labor,

but excluding other production taxes) is given by

(50) 𝑃𝑃𝑗,𝑧,𝑡 =𝑃𝑉𝐴𝑗,𝑧,𝑡𝑉𝐴𝑗,𝑧,𝑡+𝑃𝐶𝐼𝑗,𝑧,𝑡𝐶𝐼𝑗,𝑧,𝑡

𝑋𝑆𝑗,𝑧,𝑡

where (𝑃𝐶𝐼𝑗,𝑧,𝑡) is the price of intermediate consumption which is given as

(51) 𝑃𝐶𝐼𝑗,𝑧,𝑡 =∑ 𝑃𝐶𝑖,𝑧,𝑡𝐷𝐼𝑖,𝑗,𝑧,𝑡𝑖

𝐶𝐼𝑗,𝑧,𝑡

There are various forms of taxes that appear in the model. The relationship between prices

before and after taxes are defined below. The basic price of production in (37) is the unit cost in

(50) plus production taxes, excluding taxes on the use of labor and capital which have already been

included in the unit cost. That is,

(52) 𝑃𝑗,𝑧,𝑡 = (1 + 𝑡𝑡𝑖𝑝𝑗,𝑧,𝑡)𝑃𝑃𝑗,𝑧,𝑡

where (𝑡𝑡𝑖𝑝𝑗,𝑧,𝑡) is the production tax rate.

The wage rate of type l labor including payroll tax in (6) and (7) is

(53) 𝑊𝑇𝐼𝑙,𝑗,𝑧,𝑡 = (1 + 𝑡𝑡𝑖𝑤𝑙,𝑗,𝑧,𝑡)𝑊𝑙,𝑧,𝑡

where (𝑡𝑡𝑖𝑤𝑙,𝑗,𝑧,𝑡) is the payroll tax rate, and (𝑊𝑙,𝑧,𝑡) is the wage rate of type l labor.

Similarly, the rental rate of type k capital including the rental tax rate on the use of capital

in (8) and (9) is

(54) 𝑅𝑇𝐼𝑘,𝑗,𝑧,𝑡 = (1 + 𝑡𝑡𝑖𝑘𝑘,𝑗,𝑧,𝑡)𝑅𝑘,𝑗,𝑧,𝑡

where (𝑡𝑡𝑖𝑘𝑘,𝑗,𝑧,𝑡) is the rental tax rate, and (𝑅𝑘,𝑗,𝑧,𝑡) is the rental rate of type k capital in sector j.

The price of locally produced commodities in (41) and (46) is

48

(55) 𝑃𝐷𝑖,𝑧,𝑡 = (1 + 𝑡𝑡𝑖𝑐𝑖,𝑧,𝑡)𝑃𝐿𝑖,𝑧,𝑡

where (𝑡𝑡𝑖𝑐𝑖,𝑧,𝑡) is the indirect tax rate.

The relationship between the export price and the world price of exports is

(56) 𝑃𝐸𝑥,𝑧,𝑧𝑗,𝑡(1 + 𝑡𝑡𝑖𝑥𝑥,𝑧,𝑧𝑗,𝑡) = 𝑒𝑧,𝑡𝑃𝑊𝑋𝑥,𝑧,𝑧𝑗,𝑡

where (𝑡𝑡𝑖𝑥𝑥,𝑧,𝑧𝑗,𝑡) is the export tax rate, and (𝑃𝑊𝑋𝑥,𝑧,𝑧𝑗,𝑡) is the world price of exports in

international currency.

The local price of imports is

(57) 𝑃𝑀𝑚,𝑧𝑗,𝑧,𝑡 = 𝑒𝑧,𝑡(1 + 𝑡𝑡𝑖𝑐𝑚,𝑧,𝑡)(𝑃𝑊𝑀𝑚,𝑧𝑗,𝑡 + ∑ 𝑃𝑊𝑀𝐺𝑖,𝑟𝑡𝑚𝑟𝑔𝑖,𝑚,𝑧𝑗,𝑧𝑖 )(1 +

𝑡𝑡𝑖𝑚𝑚,𝑧𝑗,𝑧,𝑡)

where (𝑃𝑊𝑀𝑚,𝑧𝑗,𝑡) is the world price of imports, and (𝑡𝑡𝑖𝑚𝑚,𝑧𝑗,𝑧,𝑡) is the import tariff rate.

The world price of exports and imports are the same

(58) 𝑃𝑊𝑋𝑥,𝑧,𝑧𝑗,𝑡 = 𝑃𝑊𝑀𝑚,𝑧,𝑧𝑗,𝑡 ∀ 𝑥 = 𝑚

The consumer price index is a Laspeyres index defined as

(59) 𝑃𝐼𝑋𝐶𝑂𝑁𝑧,𝑡 =∑ 𝑃𝐶𝑖,𝑧,𝑡𝐶𝑖,𝑧

0𝑖

∑ 𝑃𝐶𝑖𝑗,𝑧0 𝐶𝑖𝑗,𝑧

0𝑖𝑗

where (𝐶𝑖,𝑧0 ) is household demand at the base value, and (𝑃𝐶𝑖𝑗,𝑧

0 ) is consumer price at the base

value.

The investment price index is

(60) 𝑃𝐼𝑋𝐼𝑁𝑉𝑧,𝑡 = ∏ (𝑃𝐶𝑖,𝑧,𝑡

𝑃𝐶𝑖𝑗,𝑧0 )

𝛾𝑖,𝑧𝐼𝑁𝑉

𝑖

This price index is the dual price of a Cobb-Douglas function which describes the commodity

demand for investment purposes in (32).

49

Similarly, the public expenditure price index is

(61) 𝑃𝐼𝑋𝐺𝑉𝑇𝑧,𝑡 = ∏ (𝑃𝐶𝑖,𝑧,𝑡

𝑃𝐶𝑖𝑗,𝑧0 )

𝛾𝑖,𝑧𝐺𝑉𝑇

𝑖

which is also a dual price of a Cobb-Douglas function which describes the commodity demand for

public consumption in (31).

The GDP price deflator is a Fisher index defined as

(62) 𝑃𝐼𝑋𝐺𝐷𝑃𝑧,𝑡 = √∑ (𝑃𝑉𝐴𝑗,𝑧,𝑡)𝑗 (𝑉𝐴𝑗,𝑧

0 ) ∑ (𝑃𝑉𝐴𝑗,𝑧,𝑡)𝑗 (𝑉𝐴𝑗,𝑧,𝑡)

∑ (𝑃𝑉𝐴𝑗,𝑧0 )𝑗 (𝑉𝐴𝑗,𝑧

0 ) ∑ (𝑃𝑉𝐴𝑗,𝑧0 )𝑗 (𝑉𝐴𝑗,𝑧,𝑡)

Equilibrium

The equilibrium in the labor market is

(63) 𝐿𝑆𝑙,𝑧,𝑡 = ∑ 𝐿𝐷𝑙,𝑗,𝑧,𝑡𝑗

where (𝐿𝑆𝑙,𝑧,𝑡) is the supply of type l labor. This will determine the value of the wage rate (𝑊𝑙,𝑧,𝑡)

in (53).

The equilibrium in the capital market is

(64) 𝐾𝑆𝑘,𝑗,𝑧,𝑡 = ∑ 𝐾𝐷𝑘,𝑗,𝑧,𝑡𝑗

where (𝐾𝑆𝑙,𝑗,𝑧,𝑡) is the supply of type k capital in sector j. This will determine the value of the

sectoral rental rate of type k capital (𝑅𝑘,𝑗,𝑧,𝑡) in (54).

Total investment expenditure is equal total savings plus the amount of depreciation. Total

savings is the sum of household savings, government savings, and foreign savings (which is the

negative of the current account balance in (49)).

(65) 𝐼𝑇𝑧,𝑡 = 𝑆𝐻𝑧,𝑡 + 𝑆𝐺𝑧,𝑡 − 𝐶𝐴𝐵𝑧,𝑡 + 𝐷𝐸𝑃𝑧,𝑡

50

The amount of depreciation is the sum of capital consumption allowances for all types of

capital in all sectors, and the capital consumption allowance is a constant fraction of the

replacement value of capital, i.e.,

(66) 𝐷𝐸𝑃𝑧,𝑡 = 𝑃𝐾𝑧,𝑡 ∑ 𝛿𝑘,𝑗,𝑧𝐾𝑆𝑘,𝑗,𝑧,𝑡𝑘,𝑗

where (𝛿𝑘,𝑗,𝑧) is the depreciation rate of capital k in sector j, (𝐾𝑆𝑘,𝑗,𝑧,𝑡) is the sectoral supply of

type k capital, and (𝑃𝐾𝑧,𝑡) is the price of new capital which is defined later in the section on

dynamics.

The supply of commodity by local producers is equal to the domestic demand for that

commodity produced locally, i.e.,

(67) 𝐷𝑆𝑖,𝑧,𝑡 = 𝐷𝐷𝑖,𝑧,𝑡

The quantity of each commodity exported from z to zj is equal to the quantity imported

from z by zj, i.e.,

(68) 𝐸𝑋𝑥,𝑧,𝑧𝑗,𝑡 = 𝐼𝑀𝑚,𝑧,𝑧𝑗,𝑡 ∀ 𝑥 = 𝑚

The supply of international transport margin services is equal to the sum of the demand

associated with all bilateral (z,zj) trade flows in all ij commodities, i.e.,

(69) ∑ 𝑀𝑅𝐺𝑁𝑖,𝑧,𝑡 = ∑ 𝑡𝑚𝑟𝑔𝑖,𝑖𝑗,𝑧𝑗,𝑧𝐼𝑀𝑖𝑗,𝑧𝑗,𝑧,𝑡𝑧,𝑧𝑗,𝑖𝑗𝑧

Note that because of (47), (48), (58), (68) and (69), the sum of 𝑆𝑅𝑂𝑊𝑧,𝑡 expressed in

common international currency across countries/regions is zero.

The product market equilibrium where supply is equal to demand for each commodity in

the domestic market of each country/region is defined as

(70) 𝑄𝑖−1,𝑧,𝑡 = 𝐶𝑖−1,𝑧,𝑡 + 𝐶𝐺𝑖−1,𝑧,𝑡 + 𝐼𝑁𝑉𝑖−1,𝑧,𝑡 + 𝐷𝐼𝑇𝑖−1,𝑧,𝑡

Note that because of Walras Law, one of the demand-supply product equilibrium

conditions is redundant. Thus, (70) is over (i-1) only.

51

Gross Domestic Product

The gross domestic product at basic prices (𝐺𝐷𝑃𝑧,𝑡𝐵𝑃) of each country/region is defined as

the payments to factors plus taxes on production but excluding taxes on factors, i.e.,

(71) 𝐺𝐷𝑃𝑧,𝑡𝐵𝑃 = ∑ 𝑃𝑉𝐴𝑗,𝑧,𝑡𝑉𝐴𝑗,𝑧,𝑡 + 𝑇𝐼𝑃𝑇𝑧,𝑡𝑗

GDP at market price (𝐺𝐷𝑃𝑧,𝑡𝑀𝑃) is GDP at basic prices plus taxes on products and imports,

i.e.,

(72) 𝐺𝐷𝑃𝑧,𝑡𝑀𝑃 = 𝐺𝐷𝑃𝑧,𝑡

𝐵𝑃 + 𝑇𝑃𝑅𝐶𝑇𝑆𝑧,𝑡

Model Closure

The present global CGE model adopts the PEP-w-t model closure with the following

features:

(a) The numeraire is the GDP deflator of the reference country/region (𝑃𝐼𝑋𝐺𝐷𝑃𝑧𝑟,𝑡), where zr

is the reference country/region. In the present case, zr = Europe Union 25. In the PEP-w-t

model zr = United States.

(b) Government expenditure in real terms (𝑅𝐺𝑧,𝑡) in (31) is fixed in each period t in each

country/region.

(c) Public investment demand (𝐼𝑁𝐷𝑘=𝑐𝑎𝑝𝑖𝑡𝑎𝑙,𝑗=𝑔𝑜𝑣𝑟𝑛𝑚𝑒𝑛𝑡,𝑧,𝑡) is fixed in each period t in each

country/region.

(d) The supply of type l labor (𝐿𝑆𝑙,𝑧,𝑡) in (63) is fixed in each period t in each country/region.

This is however updated in the succeeding periods using the growth projections of the labor

force.

(e) The supply of type k capital in each sector (𝐾𝑆𝑘,𝑗,𝑧,𝑡) in (64) is fixed in each period t in each

country/region. This is however updated in the succeeding periods using a dynamic

equation discussed in the next section.

52

(f) The minimum consumption (𝐶𝑖,𝑧,𝑡𝑀𝐼𝑁) in (29) is fixed in each period t in each country/region.

(g) The exchange rate (𝑒𝑧,𝑡) is fixed in each in each period t in each country/region.

The model has been tested for homogeneity wherein changing the value of the numeraire

changes all price variables and the nominal values of the variables by the same proportion as the

change in the numeraire, but retains the volume of the variables as they are not affected.

Dynamics

The supply of sectoral capital (k=capital) in each country/region in period t+1 is equal to

the stock in the preceding period, minus depreciation, and plus the volume of new capital

investment in the preceding period. That is,

(73) 𝐾𝑆𝑘,𝑗,𝑧,𝑡+1 = 𝐾𝑆𝑘,𝑗,𝑧,𝑡(1 − 𝛿𝑘,𝑗,𝑧) + 𝐼𝑁𝐷𝑘,𝑗,𝑧,𝑡

where (𝐼𝑁𝐷𝑘,𝑗,𝑧,𝑡) is investment demand of the private sector. The investment demand of the

government (for j=government) is fixed in model closure (c) above. There is no change in the

supply of land (k=land) over time.

The total investment demand is constrained by the total investment in (65), i.e.,

(74) 𝐼𝑇𝑧,𝑡 = 𝑃𝐾𝑧,𝑡 ∑ 𝐼𝑁𝐷𝑘,𝑗,𝑧,𝑡𝑘,𝑗

where the price of new capital (𝑃𝐾𝑧,𝑡) which is given by

(75) 𝑃𝐾𝑧,𝑡 = (1

𝐴𝑧𝐾) ∏ (

𝑃𝐶𝑖,𝑧,𝑡

𝛾𝑖,𝑧𝐼𝑁𝑉 )

𝛾𝑖,𝑧𝐼𝑁𝑉

𝑖

where (𝐴𝑧𝐾) is a scale parameter.

Following Jung and Thorbecke (2001) the sectoral investment demand of the private sector

(j=private) is patterned after the specification of the Tobin’s q. That is,

(76) 𝐼𝑁𝐷𝑘,𝑗,𝑧,𝑡 = ∅𝑘,𝑗,𝑧 (𝑅𝑘,𝑗,𝑧,𝑡

𝑈𝑘,𝑗,𝑧,𝑡)

𝜎𝑘,𝑗,𝑧𝐼𝑁𝐶

𝐾𝑆𝑘,𝑗,𝑧,𝑡

53

where (𝑈𝑘,𝑗,𝑧,𝑡) is user cost of type k capital in sector j, (𝜎𝑘,𝑗,𝑧𝐼𝑁𝐶 ) is the elasticity of investment

demand relative to Tobin’s q. The user cost of capita is given as

(77) 𝑈𝑘,𝑗,𝑧,𝑡 = 𝑃𝐾𝑧,𝑡(𝛿𝑘,𝑗,𝑧 + 𝐼𝑅𝑗,𝑧,𝑡)

where (𝐼𝑅𝑗,𝑧,𝑡) is the interest rate in z in period t. This interest rate is a rationing device that adjusts

so as to satisfy the investment constraint in (74).

Baseline Scenario

The standard reference scenario is called the ‘business as usual (BaU)’ scenario. This

scenario is generated using the individual countries/regions projections on population (from the

population projections of the United Nations) and on GDP per capita (from the GDP growth

projections of the World Bank). The growth of the per capita GDP (𝑔𝑟𝑧,𝑡

𝐺𝐷𝑃𝑝𝑐) is

(78) 𝑔𝑟𝑧,𝑡

𝐺𝐷𝑃𝑝𝑐 =𝑔𝑟𝑧,𝑡

𝐺𝐷𝑃+1

𝑔𝑟𝑧,𝑡𝑝𝑜𝑝

+1− 1

where (𝑔𝑟𝑧,𝑡𝐺𝐷𝑃) is the growth rate of GDP, and (𝑔𝑟𝑧,𝑡

𝑝𝑜𝑝) is the growth rate of the population.

Following the PEP-w-t model, some variables and parameters are updated using an index

that incorporates the growth projections of the population and GDP. This index is

(79) 𝑔𝑑𝑝𝑖𝑛𝑑𝑒𝑥𝑧,𝑡 = (1 + 𝑔𝑟𝑧,𝑡𝑝𝑜𝑝

)(1 + 𝑔𝑟𝑧𝐺𝐷𝑃 )𝑔𝑑𝑝𝑖𝑛𝑑𝑒𝑥𝑧,𝑡−1, 𝑤𝑖𝑡ℎ 𝑔𝑑𝑝𝑖𝑛𝑑𝑒𝑥𝑧,𝑡=1 = 1

where ( 𝑔𝑟𝑧𝐺𝐷𝑃 ) is defined as

(80) 𝑔𝑟𝑧𝐺𝐷𝑃 = (

1

𝑇𝑇−𝑡=1) (∑ 𝑔𝑟𝑧,𝑡

𝐺𝐷𝑃𝑝𝑐𝑇𝑇−1𝑡=1 )

where t=1 is the first period and TT the last period. This index (𝑔𝑑𝑝𝑖𝑛𝑑𝑒𝑥𝑧,𝑡) is used to update the

following variables: 𝐶𝑖,𝑧,𝑡𝑀𝐼𝑁 in (29), 𝐿𝑆𝑙,𝑧,𝑡 in (63), 𝐼𝑁𝐷𝑘=𝑐𝑎𝑝𝑖𝑡𝑎𝑙,𝑗=𝑔𝑜𝑣𝑟𝑛𝑚𝑒𝑛𝑡,𝑧,𝑡 in item (c) of the

model closure, 𝑠ℎ0𝑧,𝑡 in (15), 𝑡𝑡𝑑ℎ0𝑧,𝑡 in (17), and 𝑅𝐺𝑧,𝑡 in (31).

Similar to PEP-w-t, the model can be solved so the value of the GDP of each country/region

align with the GDP projections of the World Bank. This is done by setting (𝑔𝑟𝑧,𝑡𝐺𝐷𝑃) equal to the

54

World Bank projections and solving for a multifactor productivity factor (𝐴𝑧,𝑡𝑉𝐴) for each

country/region over the simulation period (from t=1 to TT). The solution of the model using these

values of (𝐴𝑧,𝑡𝑉𝐴) will generate the GDP growth projections of the World Bank.

Elasticity of Substitution

(a) Between Domestic Products and Imports, and Among Imports of Origin

The elasticity of substitution between domestically produced commodities and imports (in

the first nest in the CES structure in (41), (42), and (43)) is

(81) 𝜎1𝑚,𝑧 = ∑ 𝑠ℎ𝑖,𝑚,𝑧𝑄

𝑖 𝐸𝑆𝑈𝐵𝐷𝑖

where (𝐸𝑆𝑈𝐵𝐷𝑖) is the elasticity parameter in the GTAP model, and (𝑠ℎ𝑖,𝑚,𝑧𝑄

) is share of sector i

in the base aggregate composite commodities (∑ 𝑄𝑚,𝑧0

𝑚 ) in each country/region. The value of the

elasticity of substitution among imports from the different trading partners (in the second nest in

the CES structure in (44) and (45)) is 𝜎2𝑚,𝑧 = 2 ∗ 𝜎1𝑚,𝑧.

(b) Between Factors of Production

The elasticity of substitution between the composite labor and composite capital (the first

nest in the CES structure in (3), (4), and (5)) is

(82) 𝜎𝑉𝐴,𝑗,𝑧 = ∑ 𝑠ℎ𝑗,𝑧𝑉𝐴

𝑗 𝐸𝑆𝑈𝐵𝑉𝐴𝑗

where (𝐸𝑆𝑈𝐵𝑉𝐴𝑖) is the elasticity parameter in the GTAP model, and (𝑠ℎ𝑗,𝑧𝑉𝐴) is share of sector j

in the base aggregate value added (∑ 𝑉𝐴𝑗,𝑧0

𝑗 ) in each country/region. The value of the elasticity of

substitution between the two types of labor (the second nest in the CES structure in (6) and (7)) is

𝜎𝐿𝐷,𝑗,𝑧 = 2 ∗ 𝜎𝑉𝐴,𝑗,𝑧. Similarly, the value of the elasticity of substitution between the two types of

capital (the second nest in the CES structure in (8) and (9)) is 𝜎𝐾𝐷,𝑗,𝑧 = 2 ∗ 𝜎𝑉𝐴,𝑗,𝑧.

(c) Between Domestic Market and Exports, and Among Export Destination

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The elasticity of transformation in the first nest of the CET structure in (34), (35), and (36)

is 𝜎1𝑥,𝑧 = 2, while in the second nest in (38), and (39) is 𝜎2𝑥,𝑧 = 3.

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Appendix C: The Effects of Capital Inflows on Tradables within a CGE Framework

This appendix is largely based on Dervis, de Melo, and Robinsion (1982). Let the goods

produced in an open economy be Xi where i = {T (tradable), H (nontradable)}. If there are no

transportation costs and trade restrictions, the domestic price of tradable is

(83) 𝑃𝑇 = 𝑃𝑊 ∙ 𝐸𝑅

where 𝑃𝑊 is the world price of tradable and 𝐸𝑅 is the exchange rate.

Assume labor, 𝐿𝑖 be mobile across sectors and capital, 𝐾��, be fixed in all sectors. Under

perfect competition, the sectoral demand for labor is

(84) 𝐿𝑖 = 𝐿𝑖 (𝑊

𝑃𝑖, 𝐾��)

where W is the nominal wage, 𝑃𝑖 sectoral output price, and 𝑊

𝑃𝑖 the real wage.

Using (83) the demand for labor in the tradable sector is

(85) 𝐿𝑇 = 𝐿𝑇(𝑊, 𝐸𝑅, 𝐾𝑇 )

with 𝜕𝐿𝑇

𝜕𝑊< 0 and

𝜕𝐿𝑇

𝜕𝐸𝑅> 0.

For nontradable, the demand for labor is

(86) 𝐿𝐻 = 𝐿𝐻(𝑊, 𝑃𝐻 , 𝐾𝐻 )

with 𝜕𝐿𝐻

𝜕𝑊< 0 and

𝜕𝐿𝐻

𝜕𝑃𝐻> 0.

Using (85), the supply of tradable can be written as

(87) 𝑋𝑇 = 𝑋𝑇(𝐿𝑇 , 𝐾𝑇 ) = 𝑋𝑇(𝑊, 𝐸𝑅, 𝐾𝑇

)

with 𝜕𝑋𝑇

𝜕𝑊< 0 and

𝜕𝑋𝑇

𝜕𝐸𝑅> 0.

Using (86), the supply of nontradable can be written as

57

(88) 𝑋𝐻 = 𝑋𝐻(𝐿𝐻 , 𝐾𝐻 ) = 𝑋𝐻(𝑊, 𝑃𝐻 , 𝐾𝐻

)

with 𝜕𝑋𝐻

𝜕𝑊< 0 and

𝜕𝑋𝐻

𝜕𝑃𝐻> 0.

The effective demand for tradable is

(89) 𝐶𝑇 = 𝐶𝑇(𝑊, 𝑃𝐻 , 𝐸𝑅 )

with 𝜕𝐶𝑇

𝜕𝑊< 0,

𝜕𝐶𝑇

𝜕𝐸𝑅< 0,

𝜕𝐶𝑇

𝜕𝑃𝐻> 0

The effective demand for nontraditional is

(90) 𝐶𝐻 = 𝐶𝐻(𝑊, 𝑃𝐻 , 𝐸𝑅 )

with 𝜕𝐶𝐻

𝜕𝑊< 0,

𝜕𝐶𝐻

𝜕𝐸𝑅> 0 and

𝜕𝐶𝐻

𝜕𝑃𝐻< 0.

All goods are gross substitute in demand. The supply in (87) and (88) and the demand in

(89) and (90) are homogenous of degree zero in ER, 𝑃𝐻,and W. From (89) and (90), an increase in

W will increase real wage, decrease employment and output, and will reduce the effective income

and demand.

The overall budget constraint is

(91) 𝑃𝑇𝑋𝑇 + 𝑃𝐻𝑋𝐻 = 𝑃𝑇𝐶𝑇 + 𝑃𝐻𝐶𝐻

Given the expressions above, (91) can be written as

(92) 𝑃𝑊 ∙ (𝐶𝑇(𝑃𝐻 , 𝐸𝑅) − 𝑋𝑇(𝐸𝑅)) + (𝐶𝐻(𝑃𝐻 , 𝐸𝑅 ) − 𝑋𝐻(𝑃𝐻)) = 0

The budget constraint implies that the excess demand or supply of tradable is offset by

excess supply or demand for nontradable.

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Normalize the model around the wage rate11. The requirement for equilibrium in the

market for tradable is

(93) 𝐸𝑇 = 𝑃𝑊 ∙ [𝐶𝑇(𝑃𝐻 , 𝐸𝑅) − 𝑋𝑇(𝐸𝑅)] = 0

where ET is the excess demand for tradable.

Equilibrium in the market for nontradable requires

(94) 𝐸𝐻 = 𝐶𝐻(𝑃𝐻 , 𝐸𝑅 ) − 𝑋𝐻(𝑃𝐻) = 0

where EH is the excess demand for nontradable.

Totally differentiating (94) will result in the following expression

(95) 𝑑𝐸𝐻 =𝜕𝐶𝐻

𝜕𝐸𝑅𝑑𝐸𝑅 + (

𝜕𝐶𝐻

𝜕𝑃𝐻−

𝜕𝑋𝐻

𝜕𝑃𝐻) 𝑑𝑃𝐻

The expression in (95) can be drawn in an (𝐸𝑅, 𝑃𝐻) space with the following slope

(96) 𝑑𝑃𝐻

𝑑𝐸𝑅|

𝑑𝐸𝐻=0=

−(𝜕𝐶𝐻

𝜕𝐸𝑅⁄ )

(𝜕𝐶𝐻

𝜕𝑃𝐻⁄ )−(

𝜕𝑋𝐻𝜕𝑃𝐻

⁄ )> 0

Since both the numerator and the denominator are both negative given the conditions in

(88) and (90), the expression in (96) is positive.

Equilibrium in the labor market requires

(97) 𝐸𝐿 = 𝐿𝑇(𝐸𝑅) + 𝐿𝐻(𝑃𝐻) − �� = 0

where EL is the excess demand for labor and ��the fixed supply of labor.

Totally differentiating (97) will lead to the following expression

(98) 𝑑𝐸𝐿 = (𝜕𝐿𝑇

𝜕𝐸𝑅) 𝑑𝐸𝑅 + (

𝜕𝐿𝐻

𝜕𝑃𝐻) 𝑑𝑃𝐻

11 The solution of the model is not affected by the choice of the normalization rule, which is equivalent to the choice

of the numeriare. With this normalization rule, W can be omitted because it is equal to 1.

59

The expression in (98) can be drawn in the (𝐸𝑅, 𝑃𝐻) space as

(99) 𝑑𝑃𝐻

𝑑𝐸𝑅|

𝑑𝐸𝐿=0=

−(𝜕𝐿𝑇𝜕𝐸𝑅

)

(𝜕𝐿𝐻𝜕𝑃𝐻

)< 0

The term in (99) is negative because the numerator is negative and the denominator is

positive given the conditions in (85) and (86).

An exogenous capital inflow, ��, can be introduced into the model through (93), that is

(100) 𝐸𝑇 = 𝑃𝑊 ∙ [𝐶𝑇(𝑃𝐻 , 𝐸𝑅) − 𝑋𝑇(𝐸𝑅)] − �� = 0

Changes in �� in (100) shift the (𝐸𝐻 = 𝐸𝑇 = 0) line. An increase in �� shifts the line to the

left, which increases the increase price of nontradable and decreases (appreciates) the exchange

rate.

Since the equilibrium of the model is not affected by the choice of the numeriare, we

normalize around a composite price index given by

(101) 𝑃𝑇 ∙ Ω𝑇 + 𝑃𝐻 ∙ Ω𝐻 = ��

where Ω𝑖are weights (Ω𝑇 + Ω𝐻 = 1) that define the aggregate price index �� whose value is fixed.

Using (83) , the expression in (101) can be written as

(102) 𝑃𝑊 ∙ 𝐸𝑅 ∙ Ω𝑇 + 𝑃𝐻 ∙ Ω𝐻 = ��

From (102), the price of the home good can be expressed as

(103) 𝑃𝐻 =��

Ω𝐻−

𝑃𝑊 ∙𝐸𝑅∙Ω𝑇

Ω𝐻∙ 𝐸𝑅

The slope of this curve is

(104) 𝑑𝑃𝐻

𝑑𝐸𝑅= −

𝑃𝑊 ∙Ω𝑇

Ω𝐻

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The expression in (104) is linear and is negative because prices and weights are positive.

Thus, an appreciation of the exchange rate (decline in ER) increases the price of nontradable. Since

the value of �� is fixed because it is predetermined, it is clear in (101) that an increase in the price

of nontradable following a capital inflow-induced exchange rate appreciation reduces the price of

tradable. Thus, from (88) the supply of nontradable increases, while from (87) the supply of

tradable decreases following a capital inflow-induced exchange rate appreciation.

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Appendix D: Welfare Measure

The welfare measure used in the analysis is equivalent variation (EV). The global model

used in the analysis utilizes a LES system whose demand functions are given in (29). Robichaud

(2001) has shown that the EV corresponding to a demand system which is LES may be written as

(105) 𝐸𝑉𝑧,𝑡 = ∏ (𝑃𝐶𝑖,𝑧,𝑡

𝐵

𝑃𝐶𝑖,𝑧,𝑡𝑆 )

𝑔𝑎𝑚𝑚𝑎_𝐿𝐸𝑆𝑖,𝑧

(𝐶𝑇𝐻𝑧,𝑡𝑆 − ∑ 𝐶𝑀𝐼𝑁𝑖,𝑧,𝑡

𝐵𝑖 𝑃𝐶𝑖,𝑧,𝑡

𝑆 )𝑖 − (𝐶𝑇𝐻𝑧,𝑡𝐵 −

∑ 𝐶𝑀𝐼𝑁𝑖,𝑧,𝑡𝐵

𝑖 𝑃𝐶𝑖,𝑧,𝑡𝐵 )

where the superscript B refers to the baseline solution, while S to the simulation solution.

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