GEPPML: General equilibrium analysis with PPML

Abstract

GEPPML uses a theoretical property that only holds for PPML; however, GEPPML can be implemented with any given trade costs vector. GEPPML has some advantages over alternative methods of measuring gains from trade. Quantitative general equilibrium trade policy analysis imposes both estimation (of key parameters) and computation (of counterfactual equilibria) burdens on the analyst and his readers. A typical counterfactual comparative static exercise using gravity is to change some bilateral friction, for example, remove a tariff and then calculate the effects on trade flows and other variables of interest. The partial effect is based on the estimated bilateral friction, for example, the percentage reduction in buyers' price times the trade elasticity. The general equilibrium impact requires the new counterfactual multilateral resistances, typically solved from the equation system with a nonlinear solver. Our alternative GEPPML method is a more readily accessible way to generate the general equilibrium comparative statics of gravity models. Another benefit is the combination of statistical with economic theoretic intuition in interpreting results. The estimated fixed effects (and their changes) provide traditionally strong fit to the data (under the PPML structure) along with satisfying equilibrium market clearance and budget constraints.We derive our procedure of the comparative statics of gravity models in conditional general equilibrium, the modular trade impact of Head and Mayer (2014), as well as the full general equilibrium impact when endowments are fixed but sellers' prices change (Head & Mayer's, 2014 general equilibrium trade impact), such as in the Ricardian Eaton-Kortum model (Eaton & Kortum, 2002) and the Armington-CES model of Anderson and van Wincoop (2003). Multisector applications beyond the scope of this paper can similarly use GEPPML to calculate Modular Trade Impacts for each sector that nest in any compatibly separable intersectoral general equilibrium production model. This includes most applied general equilibrium models. 1 The second contribution is a hybrid combination of GEPPML and the "exact hat" algebra calibration methods of Dekle, Kortum (2007, 2008). 2 Our main analysis differs quantitatively from the usual applications of Dekle et al. (2007, 2008) in basing calculations on fitted (predicted) trade flows rather than observed trade flows, with the presumed advantage of controlling for measurement error in the trade flow data. We propose a hybrid "estibrating" procedure 3 that obtains estimates of some key trade cost components but also treats the gravity error term as a component of trade costs, thus calibrating the trade cost vector to fit the data. We demonstrate that our methods deliver results identical to those from Dekle et al. (2007Dekle et al. ( , 2008 when fitted trade values are replaced with observed values. An important difference between the two procedures is that GEPPML delivers trade cost response elasticities for specific variables/policies of interest and with the ...

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