Measuring the Benefits of Unilateral Trade Liberalization Part 2: Dynamic Models

  • Carlos E. J. M. Zarazaga
  • Published 1999


ECONOMIC AND FINANCIAL REVIEW FIRST QUARTER 2000 The drive for a multilateral trade agreement encompassing the Americas gained momentum about two years ago, with the U.S. Congress poised to grant the president fast-track authority to negotiate Chile’s inclusion in the North American Free Trade Agreement (NAFTA). But the series of severe financial crises that rattled the world almost immediately upon NAFTA’s inception frustrated the fast-lane approach and slowed progress toward the agreement. Perhaps this delay reflected that policymakers, businesspeople, and even the general public were reconsidering the benefits of trade agreements with crisis-prone partners. With the prospect of agreement postponed indefinitely, would countries in the area benefit from lowering, even if unilaterally, their trade barriers? This is the issue addressed in this series of two articles begun in the third quarter 1999 Economic and Financial Review. Part 1 concluded that static applied general equilibrium models could make a mild case for unilateral trade liberalization. However, the article raised the possibility that dynamic models, which incorporate the dimension of time, might do substantially better. That conjecture was partially inspired by numerical experiments with models in which the level of capital after the tariff reduction is changed exogenously (from outside the model). For example, a static applied general equilibrium model by KPMG Peat Marwick (1991) delivers larger welfare gains when the level of capital in Mexico is increased exogenously to make the rate of return to capital the same both before and after NAFTA. The study starts by assuming that the level of capital is the same before and after the inception of NAFTA. Mexico’s gains from NAFTA are negligible in this exercise, the equivalent variation of 0.32 percent of GNP. But the assumption of a constant level of capital implies a higher real rate of return to capital after NAFTA. Because this is an unrealistic outcome under free capital mobility, the study lets capital rise to the level needed to ensure that the rate of return is the same before and after NAFTA. Under this assumption, the welfare gain is equal to 4.6 percent in GNP. Two qualifying comments are in order. First, the capital increase necessary to make the rate of return the same before and after NAFTA is about 8 percent, which is substantial and, for all we know, has not yet materialized, even six years after NAFTA’s inception. Second, this expansion in capital is introduced from outside the model. It is impossible to determine, therefore, whether this new capital level is consistent Measuring the Benefits of Unilateral Trade Liberalization Part 2: Dynamic Models

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Cite this paper

@inproceedings{Zarazaga1999MeasuringTB, title={Measuring the Benefits of Unilateral Trade Liberalization Part 2: Dynamic Models}, author={Carlos E. J. M. Zarazaga}, year={1999} }