30
Technical Discussion on CGE Modelling Set Up
23
In the CGE model, there is a single representative or composite household in each
region. Household income is allocated to government, personal consumption, and
savings. In each region the composite household owns endowments of the factors
of production and receives income by selling the services of these factors to firms.
It also receives income from tariff revenue and rents accruing from import/export
quota licenses. Part of the income is distributed as subsidy payments to some sectors,
primarily in agriculture.
Taxes are included at several levels in the model. Production taxes are placed on
intermediate or primary inputs, or on output. Tariffs are levied at the border. Additional
internal taxes are placed on domestic or imported intermediate inputs, and may be
applied at differential rates that discriminate against imports. Where relevant, taxes
are also placed on exports, and on primary factor income. Finally, where relevant (as
indicated by social accounting data) taxes are placed on final consumption, and can be
applied differentially to consumption of domestic and imported goods.
On the production side, in all sectors, firms employ domestic production factors (capital,
labour and land) and intermediate inputs from domestic and foreign sources to produce
outputs in the most cost-efficient way that technology allow. In most sectors, perfect
competition is assumed, with products from different regions modelled as imperfect
substitutes.
Heavy manufacturing sectors are modelled with imperfect or monopolistic competition.
Monopolistic competition involves scale economies that are internal to each firm,
depending on its own production level. An important property of the monopolistic
competition model is that increased specialisation at intermediate stages of production
yields returns due to specialisation, where the sector as a whole becomes more
productive the broader the range of specialised inputs. In models of this type, part of
the impact of policy changes in final consumption follows from changes in available
choices (the variety of goods they can choose from). Similarly firms are affected by
changes in available choices (varieties) of intermediate inputs. Changes in available
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Reducing Transatlantic Barriers to Trade and Investment – An Economic Assessment
24
varieties also involve changes in available foreign varieties, in addition to domestic
one. As a result, changes in consumer and firm input choices will “spill-over” between
countries as they trade with each other.
Tariffs and tariff revenues are explicit in the standard GTAP database, and therefore can
be directly incorporated into the model used here directly from the standard database.
However, NTBs affecting goods and services trade, as well as cost savings linked to
trade facilitation are not explicit in the database and we need to take steps to capture
these effects. Where NTBs leads to higher costs, we follow the standard approach
to modelling iceberg or dead-weight trade costs in the GTAP framework, originally
developed by Francois (1999, 2001) with support from the EC to study the Millennium
Round (now known as the Doha Round).
10
It has featured in the joint EC-Canadian
government study on an EU-Canada FTA, as well as the 2009 Ecorys study on EU-US
non-tariff barriers. In formal terms, we model changes in the efficiency of production
for sale in specific markets. In this sense, we can capture the impact that NTBs can
have in raising costs when serving foreign markets. Where NTBs instead involve higher
prices because of rents, we model this as additional mark-ups (higher prices) accruing
to firms. As highlighted already in the discussion in Chapter 2, there is an approximate
60:40 split between cost generating NTBs and rent generating NBTs, in terms of impact.
3.2. Sectors and regions in the model
While in the GTAP data about 60 sectors and 130 different regions are available, for the
purpose of this study we have aggregated sectors and regions to allow us to concentrate
on the key results. The sector and regional aggregations are presented in Table 3.
10 The original Francois approach has grown from a specialized extension in early applications to a now standard feature of
the GTAP model, following its incorporation by Hertel, Walmsley and Itakura (2001).
36
Technical Discussion on CGE Modelling Set Up
25
Table 3 Sectors and regions used in the CGE model
Sectors
Regions
Agr forestry fisheries
European Union
Other primary sectors
United States
Processed foods
Other OECD, high income
Chemicals
East Europe
Electrical machinery
Mediterranean
Motor vehicles
China
Other transport equipment
India
Other machinery
ASEAN
Metals and metal products
MERCOSUR
Wood and paper products
Low Income
Other manufactures
Rest of World
Water transport
Air transport
Finance
Insurance
Business services
Communications
Construction
Personal services
Other services
22
27
In this chapter we summarize the policy scenarios used in the CGE assessment that
follows in Chapter 5. This includes some explanation of concepts, such as “policy spill-
overs,” that are included in the scenarios.
4.1. Scenarios
As discussed in Chapter 2, while it is conceivable for all tariffs to be removed, it is
not realistic to assume that all NTBs and costs from regulatory divergence can be
removed. This is because of the underlying differences in the nature of these measures.
As a result when modelling the liberalisation of NTBs we must take into account the
degree to which NTB-related costs can realistically be reduced (via various means
and techniques). On the basis of the Ecorys (2009) survey, a reasonable underlying
rule of thumb is that approximately 50 per cent of the cost/price impact of NTBs can
be removed – i.e. they are “actionable.” While there is some variation by sector, the
mapping from overall price/cost differences to those that can be negotiated on reflects
this finding, which is based on expert opinions, cross-checks with regulators, legislators
and businesses supported by the business survey from the Ecorys (2009) study. Against
this background, the study is set up around scenarios differing with respect to levels of
ambition and scope of coverage. The scenarios are summarized in Table 4 below.
The scenarios summarized in the table are relatively modest. Starting from the level of
barriers reported in Table 2, only about half of the barriers are considered as negotiable
or actionable. Of these, half are reduced in the most ambitious scenario (or 25 percent
4. The Policy Options Considered
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Reducing Transatlantic Barriers to Trade and Investment – An Economic Assessment
28
of total NTBs in Table 2). This is the most ambitious scenario. The modest scenarios
assume even less reduction in NTBs. Under both the ambitious and modest scenarios, it
is assumed that more aggressive liberalization is applied to procurement. The scenarios
reported here are therefore far less ambitious than under the original Ecorys study,
where full elimination of actionable NTBs was assumed.
Table 4 Scenario Summaries
Narrow (limited) FTA Scenarios
Tariffs only
98 per cent of tariffs eliminated
Services only
10 per cent of services NTBs eliminated
Procurement only
25 per cent of procurement NTBs eliminated
Comprehensive Scenarios
Less ambitious
98 per cent of tariffs eliminated
10 per cent of NTBs eliminated on both goods
and services (20 per cent of actionable)
25 per cent of procurement NTBs eliminated
Ambitious
100 per cent of tariffs eliminated
25 per cent of NTBs eliminated on both goods
and services (50 per cent of actionable)
50 per cent of procurement NTBs eliminated
4.2. Spill-overs
The simulations that are carried out also take into account concepts of both regulatory
convergence and regulatory spill-overs. More specifically, in setting up the experiments,
we have included two sets of possible effects beyond bilateral liberalization. These are
defined as follows. First, we have included direct spill-overs. These are based on the
assumption that improved regulatory conditions negotiated between the EU and the US
will also result in a limited fall in related trade costs for third countries exporting to the
EU and US. In other words, this captures the extent to which the bilateral streamlining
of regulations and standards, and reduction in regulatory burdens, also benefit other
exporters to the EU and US. This positive market access effect for third countries is
modelled as being around 20 per cent of the bilateral fall in trade cost related to NTBs
for the core scenarios. (We have also examined 10 per cent spill-overs as a robustness
27
The Policy Options Considered
29
check.) This concept was introduced in the EU-Japan study by Copenhagen Economics
(2009). In practice, it means that if there is 5 per cent NTB-related trade cost reduction
between the EU and US, there will also be a 1 per cent trade cost reduction for third
countries exporting to the EU and US. The logic is that firms in third countries may find
it easier to meet either EU or US regulatory requirements if bilateral negotiations lead
to simplifications that are not inherently discriminatory. Kox and Lejour (2006), for
example, provide evidence that differences in regulations can increase operating costs
in different markets, reducing bilateral trade.
A second indirect effect involving third countries is considered as well: the indirect spill-
overs. These are meant to gauge the economic implications if third countries adopt some
of the common standards agreed between the EU and the US. Given that, collectively,
the EU and the US would stand as the world’s biggest trading block, there is a very
real possibility that mutual agreement on regulations and standards would be adopted,
partially, also by third countries. Thus, where the EU and the US act as a regulatory
hegemon, there is scope for setting de facto common, global standards. This implies
that the bilateral agreement will give EU and the US improved market access in third
markets from reduced NTBs. In addition, there will be scope for reductions in NTBs
amongst third countries, as they converge further on common standards. Therefore,
indirect spill-overs will lead to lower costs and greater trade between third countries as
well. We have modelled indirect spill-overs as 50 per cent of the direct spill-over rate.
This means that for example for a 5 per cent trade cost reduction between the EU and
US, and with 20 per cent corresponding direct spill-overs, we will have a 1 per cent
(direct spill-over) reduction for third countries exporting to the US or EU, and a 0.5 per
cent (indirect spill-over) reduction for EU and US export costs to third countries, and
for trade between third countries.
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Reducing Transatlantic Barriers to Trade and Investment – An Economic Assessment
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4.3. Sectoral effects: Preliminary ranking
At this stage, we have spelled out trade flows, tariff barriers, and non-tariff barriers.
In what follows in Chapter 5, we will focus on effects. Before doing so, it is useful to
benchmark expectations. What we mean is that, before we turn to modelling results,
we want to provide a non-model based ranking of some important sources of likely
effects. This involves the data summarized in Table 5 below. In the Table, column
A summarizes the total value of tariffs and actionable NTBs (as defined by Ecorys)
applied by the US against EU exports. The next two columns summarize the importance
of each sector to total EU exports to the US. Column B is based on gross values, while
column C is based instead on the value added contained in exports.
11
In column C, we
see that while chemicals are 12.38 percent of exports on a gross value basis, they are
somewhat less important on a value added basis, accounting for 11.21 percent of EU
value added contained in exports to the EU. As a crude first pass at possible effects,
column E provides an impact-ranking index. This is based on the value added contained
in exports by sector (C), the scope for liberalization (A), and the price elasticity of
demand for imports (D). Together, these provide a rough estimate of increased exports,
on a value added basis, following from improved market access to the US for EU firms.
For example, of the total value added contained in EU exports to the US, column E says
that full liberalization in chemicals could yield an 8.39 percent increase in total exports
to the US on a value added basis. As it is value added that translates into GDP, the index
also provides a crude ranking of overall GDP impacts of sector-specific liberalization.
11 See Francois, Manchin, and Tomberger (2012) for explanation of the value added calculations, which are based on our
CGE model database
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The Policy Options Considered
31
Table 5 Impact ranking indexes
A
B
C
D
E=.01*A*C*D
actionable
NTBs + tariffs
gross export
share
export value
added share
price elasticity
index
Agr forestry
fisheries
3.70
1.73
2.09
4.77
0.37
Other primary
sectors
0.00
1.36
1.70
12.13
0.00
Processed foods
48.93
4.42
4.71
2.46
5.67
Chemicals
14.69
12.38
11.21
5.09
8.39
Electrical
machinery
9.91
1.09
0.94
9.65
0.89
Motor vehicles
22.49
8.81
7.11
10.00
15.99
Other transport
equipment
8.63
5.31
4.94
7.14
3.04
Other machinery
0.80
16.92
16.25
9.71
1.26
Metals and metal
products
6.69
2.75
2.53
13.91
2.36
Wood and paper
products
5.76
2.42
2.61
7.99
1.20
Other
manufactures
3.20
7.32
4.90
6.56
1.03
Water transport
0.65
0.05
0.04
3.80
0.00
Air transport
2.35
3.12
2.41
3.80
0.22
Finance
6.46
6.20
7.45
2.04
0.98
Insurance
3.84
6.02
7.10
3.18
0.87
Business services
1.58
10.07
12.28
3.18
0.62
Communications
0.65
0.85
1.01
3.18
0.02
Construction
0.90
0.35
0.36
4.21
0.01
Personal services
0.66
1.49
1.76
8.71
0.10
Other (public)
services
0.00
7.36
8.59
3.92
0.00
Source: CGE calculations.
The estimates in column E of Table 5 are of course partial equilibrium. They miss cross-
sector effects, including labour market interaction and intermediate linkages. They also
miss consumer benefits from access to more goods and services. Even so, they provide
a clear ranking of likely effects. This ranking carries through the estimates in the next
chapter, and so it is worth discussing the pattern for the impact indexes briefly, as
shown in Figure 10. From the figure, we can see that for some sectors, especially motor
vehicles, though they are not dominant on a value added basis, the combination of
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Reducing Transatlantic Barriers to Trade and Investment – An Economic Assessment
32
high elasticities and high trade barriers means that, overall, these sectors are likely to
dominate in terms of impact. By the same logic, despite the fact that “other machinery”
is a major sector on a value added basis, the low level of barriers means it does not
rank highly in terms of expected benefits from improved market access. From Figure
10, the manufacturing sectors are likely to have the greatest impact by far overall. This
includes motor vehicles, chemicals, processed foods, and other transport equipment.
In contrast, while value added shares are comparable for the services sectors (business
services is more important on a value added basis than either chemicals or motor
vehicles), the combination of low elasticities and relatively low barriers means that,
overall, we expect the greatest impact of market access on exports and GDP to be from
liberalization on good sectors, and especially chemicals, machinery (vehicles and other
transport equipment), and processed foods. The pattern in Figure 10 reveals itself again
when report results in Chapter 5. Manufacturing liberalization is the primary driver of
benefits from improved trade-related market access.
Figure 10 Value added and impact rankings
Source: own calculations. See Table 5.
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