International Trade and CGE Models: Theory, Practice, Problems, Improvements

This paper will review the specification of international trade in CGE models, focusing on how the modelers have drawn on trade theory to build empirical models to analyze issues of: trade liberalization, regional integration, trade-wage links, structural adjustment to macro shocks, choice of development strategy, and long-run issues such as the adaptation to climate change. The paper will review the theoretical implications and empirical properties of the widely-used Armington specification, focusing on its strengths and weaknesses in CGE models, both theoretical and empirical, and on potential improvements. In particular, we will consider the implications of the Armington specification for the major trade theorems (Stolper-Samuelson, Rybczinski), the links between trade and wages, and the links between changes in the current account balance and the labor market, focusing on how the CGE models have been used in policy debates on trade liberalization and regional integration. The paper will review attempts to add elements of “new trade theory” and “new, new trade theory” in CGE models in order to analyze various issues (e.g., regional integration, long-run growth), and consider how successful they have been in addressing the limitations of “standard” trade theory as embodied in trade-focused CGE models. Given the recent active literature on micro-focused models (e.g., the Melitz model, agent-based models, and microsimulation models), the paper will also consider ongoing and potential work incorporating ideas from this literature in CGE models.CGE modeling of international tradeReview past treatment of trade in CGE models and suggest improvements, given new challenges