Quantitative Trade Models: Developments and Challenges

Abstract

Applied general equilibrium (AGE) models, which feature multiple countries, multiple industries, and input-output linkages across industries, have been the dominant tool for evaluating the impact of trade reforms since the 1980s. We review how these models are used to perform policy analysis and document their shortcomings in predicting the industry-level effects of past trade reforms.We argue that, to improve their performance, AGE models need to incorporate product-level data on bilateral trade relations by industry and better model how trade reforms lower bilateral trade costs. We use the least traded products methodology of Kehoe et al. (2015) to provide guidance on how improvements can be made. We provide further suggestions on how AGE models can incorporate recent advances in quantitative trade theory to improve their predictive ability and better quantify the gains from trade liberalization.

The Role of the New Goods Margin for New EU Countries Trade

“…Kehoe et al . () point out the inability of multisector‐applied general equilibrium models to predict the effects of trade reforms such as NAFTA. These models rely on the constant elasticity of substitution utility functions, which led to predicting large increases in trade in those sectors in which significant trade already exists.…”

“…In general, these results highlight the importance of the new goods margin in trade liberalization episodes, especially when other structural transformations are involved. Kehoe et al (2017) point out the inability of multisector-applied general equilibrium models to predict the effects of trade reforms such as NAFTA. These models rely on the constant elasticity of substitution utility functions, which led to predicting large increases in trade in those sectors in which significant trade already exists.…”

Comparative Advantage and Biased Gravity

“…My paper is also related to a fast-growing literature developing and exploring the properties of gravity models with sectoral heterogeneity. Costinot and Rodríguez-Clare (2014) and Kehoe et al (2016) review recent advances in this area. These models have been used to study, for example, the effect of sectoral specialization on the incidence of trade costs (Anderson and Yotov, 2010), the degree heterogeneity in trade costs across sectors (Chen and Novy, 2011), the effect of sectoral productivity differences on inter-sectoral trade flows , and the welfare implications of sectoral heterogeneity and changes in sectoral comparative advantage over time (Ossa, 2015, andLevchenko andZhang, 2016).…”

Reflections on the Economic Modelling of Free Trade Agreements

“…Fourthly, Kehoe et al (2017) review how CGE models are used to perform trade policy analysis and highlight some shortcomings these models should address if they are to continue to be used to evaluate the impact of trade reforms. One main such shortcoming (as in all trade models) relates to the need to deal with cases where initial levels of trade are low.…”