Behavioral Characteristics of Applied General Equilibrium Models with Flexible Trade Specifications Based on the Armington, Krugman, and Melitz Models

Comparing simulation results obtained by applied general equilibrium (AGE) models using intra-industry trade specifications based on the theoretical models presented by Armington (1969), Krugman (1980), and Melitz (2003) may be important in evaluating trade-related economic policies today. The purpose of this paper is to reveal some of the behavioral characteristics of AGE models that include the Armington-Krugman-Melitz encompassing (AKME) module developed by Dixon and Rimmer (2012).To fully verify the significance to include the AKME module, both static and forward-looking dynamic types of three-region, three-sector AGE model are prepared mainly based on the GTAP 8.1 database for 2007. The original 129 countries/regions and 57 commodities/activities are respectively aggregated to three. The regions consist of the Asia-Pacific (r01), the North and South Americas (r02), and the European Union and the Rest of the World (r03). The three sectors are the primary industries (i01), manufacturing (i02), and services (i03). As noted previously, the manufacturing sector (i02) is assumed to be imperfectly competitive with increasing returns to scale (IRTS), while the other two are characterized by constant returns to scale (CRTS). The primary industries sector (i01) uses a sector specific factor, such as land and natural resources, in addition to capital, labor, and intermediate goods in its production process. The services sector (i03) provides a fraction of its output as the inter-regional shipping supply. Some of the parameters and exogenous variables are determined by the author based on the empirical studies such as done by Ardelean (2006), Balistreli et al. (2011), and Hummels and Klenow (2005). The forward-looking dynamic model is calibrated assuming that the global economy captured by the benchmark data set is in a steady state.Simulations with a special focus on the strength of the importer’s love of variety (LoV), the key findings can be summarized as follows: (A) the introduction of imperfect competition into the manufacturing sector largely inflates the effects of trade liberalization. A higher level of LoV may contribute to further expansions of the effects; (B) the Melitz-type trade specification does not always enhance effectiveness of a certain policy change more than the one obtained with the Krugman-type, especially when the importer’s LoV is not so strong. There are likely to be points where the volumes of effects obtained with the Melitz-type exceed the ones with the Krugman-type; (C) with the Melitz-type trade specification, combinations of the number of registered firms and the proportion of active firms, which often change in opposite direction from each other, make the behaviors of the total variety non-monotonic so that effects of an exogenous shock become more complicated than the ones observed in a model with the Krugman-type specification; (D) in the case of intra- and inter-regional trade liveralization, a stronger LoV may have effects to invigorate inter- rather than intra-regional trade with the Melitz-type specification, making the inter-regional markets more accessible; and (E) when a multi-lateral trade liberalization takes place sequentially, the regions/countries that liberalizing trade faster may have the leader’s advantage such that firms in the leader regions/countries can operate with relatively lower productivity.