A Dynamic Analysis of Jordan's Trade Liberalisation

This paper aims at providing a qualitative and quantitative assessment of the effects of establishing a free trade area between the European Union (EU) and Jordan within the framework set up by the Euro-Jordanian Association Agreement. The Agreement was signed in November 1997, and entered into force on May 1st, 2002. The main purposes of the Association Agreement are the progressive elimination of tariffs on industrial goods, the gradual but limited trade openness for agricultural products, and eventually the establishment of a free trade area between the EU and Jordan within 12 years by its entry into force. Trade liberalisation in the form of a preferential trade agreement (PTA) is expected to provide benefits for Jordan in terms of trade creation and lower consumer prices, that bring about a rise in welfare. The increased competition in the domestic economy due to trade openness implies also higher factor productivity and higher long-term growth. A key role in such a process is played by investment demand, that is potentially important to the dynamic behaviour of output over the long-run. On the other hand, trade liberalisation has also some unpleasant effects on Jordan?s domestic economy. There is clearly a loss in government revenue, due to foregone tariff duties. Such an impact is likely to be particularly strong in Jordan, where government revenue relies heavily on custom duties. The magnitude of the adverse effect of import duties reduction will be influenced by the counteracting fiscal measures taken by the Jordanian government. Moreover, preferential trade liberalisation is likely to cause trade diversion, that is some diversion of Jordanian imports from more efficient non-EU countries to more costly EU producers. A multilateral liberalisation process would avoid the costs of trade diversion, although it would clearly further reduce government revenue and would hence require additional compensatory fiscal measures. Therefore, a trade policy issue playing a role in Jordan?s trade liberalisation is the debate about global versus regional integration. Whereas there is wide empirical evidence that economic growth and trade liberalisation are related, there is further evidence supporting the view that non-discriminatory trade openness leads to higher growth than preferential trade liberalisation does. Hence, the policy implications for Jordan suggest that broad and non-discriminatory trade openness would be more beneficial than regional integration. The main purpose of the paper is to analyse the dynamic impact on the Jordanian economy of simulating different scenarios of trade liberalisation, i.e. preferential trade area with the EU, non-discriminatory liberalisation and fiscal measures adopted to counteract the decrease in government revenue with particular emphasis on welfare effects. The impacts of free-trade scenarios on the Jordanian economy are initially studied by means of a static computable general equilibrium (CGE) model. However, a dynamic CGE model is more useful and appropriate than a static one to depict the long-term effects of trade liberalisation and to provide a clearer picture of the global impact of the trade agreement on Jordan. The dynamic model implemented in the paper is a single-country multi-sectoral CGE model. On the demand side, the representative consumer chooses a consumption stream so as to maximise her expected discounted lifetime utility subject to a dynamic budget constraint. On the supply side, constant returns to scale and perfect competition are initially assumed. Output is determined by a nested production function. At the top tier, the production technology uses intermediate goods according to a fixed input-output coefficients specification. A value added production function which allows for substitution between two primary inputs, capital and labour, characterises the second tier?s technology. The domestic economy is assumed to be a price-taker in the international markets. The Armington assumption of constant elasticity of substitution (CES) between domestically-produced goods and imports is used in modelling international trade flows, and allows for some degree of independence of domestic prices. Exports and domestic sales are modelled according to a constant elasticity of transformation (CET) specification. The initial neo-classical model is then extended to include non-competitive behaviour of firms. Whereas in the class of static CGE models consumers and firms are assumed to take savings and investment decisions which are not forward-looking, the dynamic CGE models address this issue by solving for savings and investment paths that result from dynamic optimisation based on future expectations, and they lead therefore to values of the variables and prices that are both intra- and inter-temporally consistent. The model is calibrated to Jordanian data of 1998, based on the Social Accounting Matrix (SAM) for Jordan, and makes the distinction among Arab countries, EU and Rest of the World (ROW) in terms of commercial relations with the home country, i.e. Jordan. The model is then implemented by means of the mathematical software GAMS.