Working Paper: NBER ID: w9169
Authors: Huiwen Lai; Daniel Trefler
Abstract: The difficulty of incorporating general equilibrium price effects into econometric estimating equations has deterred most researchers from econometrically estimating the welfare gains from trade liberalization. Using a paired-down CES monopolistic competition example, we show that this difficulty has been greatly exaggerated. Along the way, we estimate indeed precisely estimate large welfare gains from trade liberalization as measured by compensating variation. Unlike calibration methods, econometric methods allow researchers to isolate the violence done by the model to the data. We find that the CES monopolistic competition model horribly mis-specifies behavioural price elasticities and general equilibrium price feedbacks. The model as conceived is therefore of limited value for analysing the effects of trade liberalization. We report a number of specification issues that should point the way to better theoretical modeling.
Keywords: No keywords provided
JEL Codes: F12; F13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CES monopolistic competition model mis-specifies behavioral price elasticities (D43) | inaccurate welfare gain estimates (D69) |
| CES monopolistic competition model mis-specifies general equilibrium price feedbacks (D58) | inaccurate welfare gain estimates (D69) |
| properly specified price responses (D41) | accurate welfare gain estimation (D69) |
| inadequacy of CES model (C50) | welfare estimates driven by the model rather than data (C51) |
| CES model mis-specification (C50) | welfare conclusions not robust (D69) |
| trade liberalization (F13) | consumption decisions (D12) |
| elasticity of substitution between varieties (D11) | sensitivity of welfare gains (D69) |