Modelling the Impact of Trade Liberalisation: A Critique of Computable General Equilibrium Models

Oxfam International Research Report

Authors: Lance Taylor and Rudiger von Arnim

The paper presents a review and critique of the most widely used trade models based on computable general equilibrium (or CGE) models. The emphasis throughout is on methodology. The paper provides concise analytical arguments explaining the fundamental weaknesses of CGE models, paying particular attention to the way that CGE models conceptualise and measure welfare. The authors also show that the manner in which the World Bank uses CGE modelling is highly problematic, making implausible assumptions about elasticities, the exchange rate, and macro causality.

Using a table-top two-region and three-sector CGE model which represents sub-Saharan Africa and the rest of the world, the authors illustrate that the results of modelling are radically different when alternative, and more plausible, assumptions are made. Although the authors’ model still incorporates a great deal of LINKAGE’s lack of realism, it provides unambiguous policy insights:

• If trade elasticities are lower than the World Bank stipulates, sub-Saharan Africa faces welfare losses even in an otherwise optimistic situation which rules out all macro-economic shocks.
• If the current account is allowed to respond to trade liberalisation, and imports to one region grow stronger than that region’s exports, it is Africa – and not the developed world – that faces a deteriorating trade balance.
• If the analysis includes government deficits, the African public balance often deteriorates, whereas the rest of the world’s fiscal position improves.
• If employment and income are variable, they might very well increase in sub-Saharan Africa, but do so in tandem with mounting trade deficits and foreign debt, which renders these advances temporary.

The paper concludes that developing countries would be ill-advised to follow the radical recommendations of the World Bank’s liberalisation strategy insofar as it rests on results drawn from the current trade models. The paper appeals for ‘honest’ simulation strategies showing the variety of outcomes that result from a range of plausible assumptions. These would enable policy makers to assess the different scenarios for themselves.

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Publication date: July 2006