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GTAP Resources: Frequently Asked Question Details

Subject: Decomposing trade effects of an FTA simulation

Question: Is it possible to decompose the trade effects of an FTA simulation into trade diversion and trade expansion effects?

Answer: There is no official way of decomposing the trade diversion and trade creation effects of an FTA in GTAP.

An extensive discussion of trade creation and diversion is available in GTAP Working Paper #26.

There are two things you can examine to help you get at trade diversion and trade creation type effects, however.

1) You can decompose the IMPORTDEMAND equation into the expansion and substitution terms.

# regional demand for disaggregated imported commodities by source (HT 29) #
= -ams(i,r,s) + qim(i,s)
- ESUBM(i) * [pms(i,r,s) - ams(i,r,s) - pim(i,s)];

Ignoring ams, the expansion term is (qim(i,s) ). This term shows you the overall expansion effect on trade of the FTA (a trade-creation-like effect). The substitution term (- ESUBM(i) * [pms(i,r,s) - pim(i,s)]) shows how we substitute between imports from different sources (a trade-diversion-like effect).

Note that the overall impact of FTA on trade, is qim(i,r). If you sum the trade-diversion-like effects (qxs(i,s,r) - qim(i,r)) you will get zero (since the weighted sum of qxs should = qim). So trade is greater than qim in some regions and less in others but overall trade increases by qim.

2) The second approach is to use the allocative efficiency effects in the welfare decomposition to show trade creation and diversion. These are volume changes combined with the tariff revenues - so are dollar amounts and therefore can be aggregated. As they are efficiency effects, you are getting the welfare gain/loss from the trade creation/diversion. To get trade creation and diversion one might aggregate the allocative efficiency gains (particularly those related to MTAX) over sources within the FTA and outside of the FTA. The increase in trade/allocative efficiency gains within the FTA and the decrease in allocative efficiency with countries outside of the FTA, respectively, are again trade-creation and trade-diversion-like effects that give an indication of the extent of trade diversion and creation.

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Date Added: 12/7/2011