-
POLICY
~~~~~~~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~0
RESEARCH
WORKING
PAPER
Product Standards,
Imperfect Competition, and
s
1
Completion oft the Market
in the European Union
_M
'
*
Glenn Harrison
Thomas Rutherford
David Tarr
The World Bank
InternationalEconomicsDepartment
InternationalTrade Division
April 1994
*
F
1293
Modeling the staticand
steady-stateeffects on trade,
production, and market
~~~~~~~~~~~~structure
ofcompletion
ofthe
Mt,eo
opeino
h
European
Union'sinternal
market.
POLICYRESEA-.CHWORKINGPAPER1293
Summary findings
Harrison,Rutherford,and Tarr model the static and
steady-stateeffectson trade, production, and market
structureof completionof the EuropeanUnion's(EU's)
internal market.
The impetusfor changecomesfrom the removalof
border costsand the costsof producingto different
national standards.It alsocomesfrom consumers'
greater abilityto substituteamong the productsof
producers in differentEU countries,oncethe European
Union adopts its program on standards.
In the analysisof the static scenario,removingborder
costsand the costs of supply-sidestandardsimprovesthe
welfareof ElI countriesby only about 0.5 percent of
GDP. Resultsvary greatlyacross the countriesof the
EuropeanUnion,however,becausethe benefitsto a
country are roughlyproportional to its share of intra-EU
trade in its GDP.This is the first model to identifythese
country differencesbecauseof the greater countrv
disaggregation.
The additionaleffectof the programof standardsen
consumerdemandelasticitiesincreasesthe competition
and reducesmarkupsin imperfectlycompetitive
industries.Then there are additionalgainsfrom
rationalization,as wellas consumerefficiencygains in
imperfectlycompetitivesecto.s, that result in an increase
in the estimatedgainsto about 1.2 percent of GDP
(againwith wide differencesacrossEU countries).
The steady-stateresultslet the capital stock in eacn
country adjustto its new higherequilibriumvalue, which
acts as an additionalendowmentof capital,allowingthe
EuroveanUnionto producea higher levelof income.
The gainsto the EuropeanUnion then rise to about 2.6
percent of GDP.
Thispaper- a productof the InternationalTradeDivisionInternationalEconomicsDepartment- is part of a largerefforrin
the departmentto assessthe impactof changesin the globaltradingenvironment
on developingcountries.The studywasfunded
by the Bank'sResearchSupportBudgetunderthe researchproject"The Impac.of EC 1992and Trade Integrationin Selected
MediterraneanCountries"(RPO675-64).Copiesof this paper are availablefreefrom the World Bank,1818 H StreetNW,
Washington,DC 20433.PleasecontactNellieArtis,roomN10-037,extension38010 (42 pages,plus46 pagesof appendices).
April1994.
ThePolicyResearch
WorkingPaperSeries
disseminates
the findingsof workin progress
to encourage
the exchange
of ideasabout
development
issues.
Anobjective
of theseries
isto getthefindingsout quickly,evenif thepresentations
arelessthanfully polished.
The
papers
carrythenames
of theauthorsandshouldbeusedandcitedaccordingly.
Thefindings,interpretations,
andconclusions
arethe
authors'oun andshouldnot beattributedto the WorldBank,itsExecutive
Boardof Directors,
c any of its member
countries.
Producedby the PolicyResearchDissemination
Center
Product Standards, Imperfect Competitionand
Completionof the Market in the European Union
by
Glenn W. Harrison, ThomasF. Rutherfordand David G. Tarr'
Dewey H. Johnson Professor of Economics, Department of Economics, College of Business
Administration,Universityof SouthCarolina;AssistantProfessor, Departmentof Economics,University
of Colorado; and Principal Economist,The World Bank. The authors would like to thank acknowledge
he4iful comments from Alan Winters, John Whalley and participants ef seminars held at: the EC
Commission;,the U.S. InternationalTrade Commission;the World Bank; the 4th Annual Computable
General EquilibriumModelingConference,WaterlooOntario; and GeorgetownUniversity. This study
is part of the World Bank's research on "The Impact of EC 1992 and Trade Integration in Selected
MediterraneanCountries", supported under grant RPO #67564.
Table of Contents
1. Introduction
1
....................................................
2. A Multi-RegionalTrade Model ......................
S
General Model Features .........................................
Modellingthe Reductionin Border and StandardsCosts of Intra-EC Trade ....
Theory and EvidenceAgainst UniformPricing ...........................
Modellingthe Price Effectsof Integration .........
...................
Impact of Standardson Substitution .............................
Modellingthe Impact of IncreasedSubstitution.
.....
5
8
9
11
11
15
3. The Static Effects of Completionof the Market.20
Static Welfare Effects .21
CRTS Results and Comparisonwith IRTS.21
The Impact of IRTS .27
Intra-EC Trade.33
Comparing the Static Effects
..
4. The Steady-StatsEffects of Completionof the Market
Modellingthe SteadyState WelfareEffects .37
Steady-StateWelfare Effects ......................................
Explainingthe SteadyState Effects ...........
5. Conclusion ....
.......................
References .................................
34
37
..
................
39
39
40
40
1. Introduction
How large are the static welfare benefitsof completionof the internal market in the European
Community?Whatare the economicmechanismsunderlyingthese estimates?Are the long-runestimates
significantlydifferent from the short-run effects?The size of existingestimates,and their rationale,vary
a great deal.
First considerthe static welfareeffects. The officialforecastswere that the w:fare gains would
be between 4.3% and 6.4% of 1988GDP, albeitbased on heroic extrapolationsof partial equilibrium
2 tend to
calculationsfor a handful of industries.' Academicnumericalgeneral equilibriumcalculations
be much lower, ranging from 0.25% to 1.35% of GDP. These studies produce a range of estimates
varying, most importantly, with the nature of the assumedmarket structure and pricing policy. When
countrieswithinthe EC are assumedto havesegmentedmarkets,lower estimatesare derived (about0.25
to 0.50 percent of GDP). In this segmentedmarkets casethe benefits of EC integrationderive from the
removalof border costs and the reductionin costsfrom producingto a commonstandard. A commonly
held view, however, is that EC92 will have its strongest impact in imperfectlycompetitivemarkets by
increasing competition and inducing rationalization.The higher estimates derive from models which
assumethat completionof the market will inducea single integratedmarket in which internationalprice
discriminationis impossible, i.e., a uniform EC-wideprice is imposed.
These larger estimatesare sometimescharacterizedas hypotheticalbecause no clear rationaleis
articulatedfor how the integrationprocess will induce a common price. That is, if arbitrage fails to
eliminate price differences (net of transportation,border and standards costs) prior to 1993,' it is not
I Thisrangeis reportedin Cecchiniet al. [1988;p.8 3] andEmersonet al.
[1988;Table10.1.1,p.203],which
are extrapolations
of the workof Smithand Venables[1988]for a numberof sectorswhichexperienceincresing
returnsto scale.Winters[1992;p. 105]hasappropriately
characterized
theseextrapolations
as 'heroic'.
I Dueto Gasiorek,Smithand Venables[19921,HaalandandNorman[19921andMercenier[1992],allof which
are summarizedbelow.
I Weuse thedate"1993' to referto thenominalyearin whichcompletion
of themarketis to begin.Thedelys
in nationallegislativeeffortsto implementnecessarystatutes,as wellas otherdelaysin applicationof thoselaw,
makesthis date a matterof pedagogicconvenience
ratherthana predictionaboutwhenthe ECwillin facthave
completedthe single-market
program.
clear why it would eliminatepricedifferences(net of transportationcosts) after 1993.' We briefly review
the empirical work testing for price discriminationin the UnitedStates. It shows that even in the United
States, which is more fully integrated than the EC is likely to become in the near future, price
discrimination appears to exist in a wide variety of n,arkets. Moreover, a number of monopolistic
competition modelshave recentlybeen developedthat indicatethat price discriminatiknmay exist even
when market power arises only from monopolisticaliycompetitiveproduct differentiation.Thus, both
theory and empirical work orn the relatively integrated markets in the United States indicate the
implausibilityof the modellingexercises that assume that no price discriminationis possible after the
implementationof the EC92. In addition, we note thatthe impositionof uniform pricingresults(dueto
the eliminationof reciprocaldumpingimpliedby uniformpricing)in the counterintuitiveresult that intraEC trade declines subsequent to the EC92 program.5 Thus, we believe that it is necessary to model
market integration within the EC92 program with an approachthat captures the idea that EC92 will
increase competitionand rationalizationin imperfectlycompetitivemarkets without imposingcomplete
eliminationof firm level price discriminationacross the EC.
We model the effects of completionof the internalmarket in the EC on trade, production and
market structure. The impetusfor change in our frameworkcomes from two interrelatedeffects. One
effect is the, now standard, reductionof border and standardscosts (analogousto the segmentedmarkets
approach of previous studies, where the benefitsof reducedstandards costs is limited to the impacton
improvedeconomiesof scale). In addition, we maintainthatthe singlemarketprogram on standards will
have the impact of increasingthe ability and willingnessof buyers to substituteamong the products of
before1992,thenlowering
'Karp [1992;p.63]makesthesamepoint:'If it werepossibleto pricediscriminate
transportationcosts(broadlydefined)mighteither increaseor decreasethe incentivefor price discrimination.' Smith
and Venables[ 1988;p. 1523]note that '... it is not obviousthat there existfeasiblechanges in EC trade policy and
competition policy that could imposesuch a change. In practicepolicy may be expectedto be some combination
of our two experiments.'
5 See, for example, Smith and Venables[1988; pp. 1520-1523].
- 2-
producers in different countries. We reviewthe theory and evidenceregarding the impact of standards
which shows that the impactof standards, especiallyin the manner implementedin the EC92 program,
sould be to increase the substitutionpossibilitiesof EC buyers for the products of EC producers. In
many cases, such as common interconnectionin telephone equipment, it is because the products are
physically altered so that the productsof different producers become interchangeable.In other cases it
is because protectior'istbarriers are eliminated,as occurred with Germanbeer purity restrictions. For
other products a quality assurancestandardmay reduce the advantagesof product differentiation,such
as occurred in the United Statesas a result of SAE standardsfor motor oil and brake fluid.
These effects are appropriatelymodelledas a changein the elasticityof substitutionof consumers
in EC countries for the varietiesof outputof other EC firms. We simulatethis changealong a continuum
from an initial situation, characterizedby firm level productdifferentiationwhere consumersregard the
outputof other EC firms are equallysubstitutablewith other non-ECimports,to where consumersregard
the varieties of all other EC firms as equally substitutable with home varieties. A monopolistic
competitionmodel is developed in which each firm's post-1992markupis endogenouslydetermined as
a functionof the substitutabilityof the outputsof differentEC firms in the preferencestructure of national
consumers. We show, however, that even in the extreme case of no national preferences, pricing
differences and market segmentationare not eliminated. As long as arbitrage is imperfect, price
differences (net of transportationcosts) may persist, and firms determinetheir optimal markups in each
nationalmarket based on perceivedelasticitiesthat vary with (amongotherthings) the firm's marketshare
in each nationalmarket.6 Thus, an importantcontributionof this paper is that we provide a rationale for
haveshownthatif tradebarriersor nationalpreferencescontinueto existin the
HaalandandWootonL1992]
EC-widepricingthat resultsfromcompleteeliminationof segmentationcan,
the
uniform
post-1992environment,
contraryto the conventionalwisdom,reducewelfare.Thereasonis thatif firmsare forcedto chargea uniform
areretained,theywillraisepriceson theirintra-ECexportsand this
priceacrosstheEC, but nationalpreferences
maydominatetheeffectsof lowermarkupson theirdomesticsales.In otherwords,EC92couldreducewelfaredue
to thelossof thebeneficialaspectsof a typeof reciprocaldumpingdescribedby Branderand Krugman[19831.A
modeldoesnot,
TheHaaland-Wooton
by Maluegand Schwartz[forthcoming].
similarresultis shownanalytically
6
- 3-
the reduction of price discriminationoccasionedby the 1992 program that we numericallyimplement,
in which the extent of remainingprice discriminationis endogenouslydetermined.
Our estimates are that the reduction of border and standards costs associated with the EC92
program will result in welfare gains of about0.5% of EC welfare, a nontrivialwelfare increase,but not
overwhelminggiven that increasingreturns to scale sectorsare in the model. Allowingfor the additional
effectsof standardizationon consumersubstitutionelasticities(our versionof integration),however, more
than doubles the estimated welfaregains.
Turning to the estimatesof long-runwelfare effects, the benefits appearto be much greater. In
a widely cited study Baldwin11989;pp. 266, 2691employedestimatesfrom comparativestatics models
of the effects cf EC92 as an exogenousinputinto a singlesector Solow-typegrowth mcdel. He suggests
that the long run effects will be at least doublethe static effects and probably will be as much as four
times larger.
We also estimate the steady state growth effects of EC92. Our approach differs fro.n Baldwin
[1989; 19921in that we integrateour multisectorapproaclhand the steadystate effectsinto a single model.
Consequently,the interactionbetweenlong run growtheffectsand comparativestaticeffects at any initial
incomelevel is determinedendogenouslyin our model. We estimate that the benefits in the steadystate
more than quadruple the estimate of the welfare benefits (about 2.4% of EC GDP) compared to the
segmentedmarketscomparativestaticsestimate,explainingsome of the anticipatoryeuphoriasurrounding
the completionprogram even before it is fully enacted.
Our general equilibrium model is described in section 2, and the main policy simulations
discussedin section 3 (static welfare effects)and section4 (steadystate welfare effects).We compareour
model and simulations lb some detail with the previous literature, pointing out the differences in our
however,explainwhyEC92wouldforceuniformpricingin marketswhichwerepreviouslycharacterized
by price
discrimination.
Theproblemsthattheyidentify,however,haveledWinters[1992;p.20]to call for furtherresearch
to distinguishtradebarriersand consumerpreferences
as a rationalefor homemarketbias.
-4 -
approach. Comparedwith earlier estimatesour greater regionaldisaggregationreveals sharp differences
of expectedbenefitsfrom EC92 among EC countriesbasedon intra-ECtrade intensities.We emphasize:
the endogenousdeterminationof the extent of reductionin price discriminationderiving from the impact
of the EC92 productstandardizationprogramon consumerperceptionsof substitutability,the estimation
of steadystate growth effects in a unified endogenousframework,and the considerablygreater regional
and commoditydisaggregationin our model. In most other respectsour model is of the same genre as
earlier general equilibriumwork.
2. A Multi-Regional Tracle Model
Generai Model Features
In this subsectionwe focus on general modellingfeatures. Due to their importance in modelling
the process and effects of integrationin the EC, we discuss in some detail below how we model (i) the
reduction of border and standards costs as a result of the EC92 program, (ii) market integrationas an
endogenousconsequenceof other aspectsof the EC92 programand (iii) the extensionof static estimates
of welfare effectsto steady state estimates. AppendixA providesa det-i1edalgebraic formulationof the
model and the decompositionalgorithmemployedfor solution(see Rutherford [1992a,bI).
The model separatelyidentifiesnine regions of the EC: Belgium, Denmark, France, Germany,
Italy, the Netherlands,Portugal,Spain, and the UnitedKingdom.It also identifiesMorocco, Turkey,and
a residua!Rest of World (ROW), makingtwelveregionsin all. The presentversion identifiestwenty-six
sectors per region, listed in Table 1. Twelvesectorsin each regionare characterizedby increasingreturns
to scale (IRTS), as identifiedin Table I in the columnreportingthe Cost DisadvantageRatio (CDR).The
CDR, which is definedas the ratio of fixed to total costs, providesa measure of the importanceof scale
-5-
Table 1: Sectors of the Model
ID
s|
_m,~
It |.
AGR
A&kWftm
010
FOO
Feed
310,5
ewiee Md Tobacc
BET
EKE
&-V
Uill
Udus00
STE
dI
V.
Add"
CDR (1)
35
350
3
35. 390
I1
2
WO. 0%). 7... .2
MetFl Pn,ducow
NMM
Nw.MeI
|CHM
Cbb-thelmi
MET
Mei Prodw
1gW 1
5
IS0
1
6
2
e
190
2
S
210
2
6
_
1agh
meab1we'
&MA
130
OMA
Off le
htry
230
1
4
E3
Ebctical toodo
250
3
5
VEH
maw Vdiciw
20
2
It
01!
Oqb T,_oqt
TXC
Tiih
WOO
Wo
PAP
PaprmPvond
Pr50
RPL
Rubbw ad PFedi
CON
Ccmts¶d
TRA
Tr__e
SX
12
FIN
P
6M. 710, 73
15
TRN
TgAOgt ad Cmminkmi
610.6M, 00, 650
6
HEBA
Hed& S
ei.
750 M
4
EDU
HAaW
Swyie
M UM
4
SUR
Odbw
Su
PUB
OuMWe
Pubboc
Seo.i
E13410
ad C1hq
andRepair
_mce
Servi
290
14
410. 430
2
450
I
__
2
.
it
490. 510
4
53D.5S
_
SW.90,
?
6
Ito, P3D
to
6
economies.7 The market structure in IRTS sectors is monopolisticallycompetitive,with free entry and
exit. All other sectors exhibit constantreturns to scale (CRTS)and have a competitivemarket structure.
'The methodology
for estimationof the CDRis discussedin AppendixB.
-6 -
Table I also shows the original Eurostat sectors from which our aggregation was obtained, and the
aggregateEC share of each sector in value added.
We adopt a relatively detailedlevel of sectoral and regional disaggregationin our mcdel, since
disaggregationhas (as we show below) an important impact on the estimated effects of EC92. As
Gasiorek, Smith and Venables(19921(GSV)note, regional aggregationentails a nontrivial assumption
in these exercises since it is primarilythrough the reduction in border and standards costs of exporting
that the EC92 prograrn will have its impact.Regionalaggregationin effect converts exports, on which
a cost reduction would be achieved, into domesticproduction. Moreover, we show below that greater
regional disaggregationis fundamentalin revealingthe considerabledifferences in the welfare benefits
that will accrue to the EC countrieswith different intra-EC trade intensities.Table 2 lists the nine EC
countriesin our model and thei- intra-ECtrade intensities.
Regardingsectoralaggregation,previousstudieshaveemployedreasonableaggregationstructures
for IRTS sectors, but have employedone or at mosttwo large residualCRTSsectors representingat least
two-thirdsof the economy.Table 8 offersa summaryof the mainmodel featuresof previous studies. Our
26 sector model allows us to keep separate virtually all of the sectors which have significantIRTS as
estimatedat the 44-sectorlevel. It also allowsLs to maintainsome disaggregationof CRTS sectors, along
the linesthat might be expectedto influenceresults(viz., traded versusnon-traded,labor-intensiveversus
capital-intensive).By receivedstandards in the literaturethis makes for a "big model".
The rest of our static modelis relativelystandard.Wehave multipleprice-wedgedistortions,such
as factor taxes in production, value-addedtaxes, import tariffs, export subsidies, voluntary export
restraints(representedas ad valoremequivalents)and non-tariffbarriers (also representedas ad valorem
equivalents).Productiorwentailsthe use of intermediateinputs and primary factors. Primary factors are
mobile across sectors within a region, but are internationallyimmobile. Each region has a single
representativeconsumer, as well as a single governmentagent,
-7 -
Modelling the Reduction in Border and Standards Costs of Intr:A-ECTrade
The two types of real trade costs whichconstitutethe "sand in the gears" in our model are border
costs and standaraizationcosts on the supplyside. Border costs representthe costs of undertakingtrade,
such as administrativecostsof transactingand transportingover internationalboundaries.Standardization
costs on the supply side are due to differencesin technicalspecificationsand regulationsacross national
boundaries, being associated with the productioncosts of fulfillingtechnical regulations in foreign EC
markets. Standardizationcosts, which would include the costs on the demand side of fewer or less
adequatesubstitutesas discussedbelow, are viewedas being much more of a barrier to intra-LiCtrade
than explicit border costs (see Emersonet al. [1988; p.32ff.]), and their removal was one of the most
ambitious aspectsof the EC92 program. It is also the aspectof the programthat has naturallybeen the
hardestto enforce,given t' ; welterof nationallegislationand regulatorydirectivesinvolved.No observer
of intra-EC trade would doubt that substantialstandardizationcosts will continueto exist in the EC for
many years to come.
Virtually all studies of the welfare effects of EC92 use a joint ad valorem production cost for
these items of 2.5%. We follow this assumption,but decomposethis value into an amount attributable
to border costs and an amountattributableto productionstandardizationcosts. The reason for doing this
is that we model the effects of each in differentways. Bordercosts are modelledas additionalpurchases
of the domestic "transportation' good in each region. This good represents the activity of shipping,
handlingand warehousingfor customspurposes.Standardizationcosts on the supply side are more likely
to be reflected in extra costs of producingthe specificgood itself, rather than the purchaseof inputs of
any specific good. Thus we model supply side standardizationcosts as additionalvalue-addedin each
sector in which trade takes place. These costsare treatedas falling on importsto, and exports from, the
region. They do not fall on domesticsales, and hence should be interpretedas the differentialcosts of
transactingwith other EC countries.
-8 -
Estimatesof border costs for many EC regions and sectors can be extractedfrom Cawleyand
Davenport[1988;Tables B2, A31.The weightedaveragesof these border costs for trade with other EC
regions is shown in Table 2. The EC averageis about 1.7%, based on these estimates.If we assumethat
the real trade costs from border costs and supply side standardizationcosts amounts to 2.5% for each
region, the region-specificstandardizationcosts are derivedresidually and are shown in Table 2. These
estimated supply side standardizationcosts are then assumed to apply to all traded goods within the
indicatedregion.
Theory and Evidence Against Uniform Pridng
Previousstudies have modelledcompletionof the market in two stages, with the first stagebeing
the same as ours. In the second stage, previous studies have attemptedto capture the presumptionthat
EC integrationwill have its strongest impactby increasingcompetitionin IRTS sectors. Their second
stage involves a shift in the pricing behaviorof nationalfirms as the result of completion. Pricing is
originallyundertakenwith "segmentedmarkets", and with monopolisticcompetitionin IRTS sectorsthis
results in lower prices in foreignmarketsthan at home.' With completionof the market these segmented
marketsare replacedwith an integratedmarket in which price discriminationbetween home and foreign
markets is assumedto be impossible.
We claim that it is inappropriate either on theoretical or empirical grounds to model EC
integrationas a process that imposescompletepricitiguniformity. First considerthe theory. Although
the possibility of price discriminationby a monopolistselling in segmented markets has long been
accepted in economictheory, recent theoreticalwork has shown the existenceof price discrimination
equilibriain a variety of multi-firmsettings, even with free entry (e.g., Katz [19841,Borenstein[19851
' This resultawsumes,plausiblyenough,thatforeignmatet sharesfor a givenfirmaresmallerthandomoatic
marketshares.Hencethe perceiveddemandelasticityis differentin the two markts, resultingin diffences in
,.ark-ups.
-9-
Table 2: Border, standardcosts ar. intra-EC trade intensitiesfor EC regions (in percentage)
Country
Border costs
Standardizationcostsa
Intra-EC"
trade intensity
Belgium
1.692
0.808
35.6
Denmark
1.695
0.805
14.9
France
1.717
0.783
11.1
Germany
1.807
0.693
11.9
Italy
1.576
0.924
10.1
Netherlands
1.623
0.877
29.1
Portugal
1.540
0.960
12.0
Spain
1.663
0.837
08.8
United Kingdom
1.903
0.597
11.9
a. Border plus standard costs sum to 2.5 percent.
b. Definedas one-half intra-EC ex,portsplus importsdivided by GDP.
and Holmes [19891)9.These analyses suggest that price discriminationmay arise even when market
power over price arises only from monopolisticallycompetitiveproductdifferentiation.
On empirical grounds,considerthe UnitedStatesmarket, which is considerablymore integrated
than the EC is likely to become in the immediatefuture. Although there are generally alternative
0 there are a wide variety of observed pricing
theoreticalexplanationsfor the observed pricingpractices,"
practices in the United Statesthat are consistentwith price discrimination.These include: (1) two-part
tariffs, in which a lump sum fee is chargedand a usage charge per unit applies;" (2) discount coupons,
which allow those consumerswith lower opportunitycost of time to obtain a lower price; (3) sellingthe
I See Varian (1989]for a review of the theoryof price discriminationunder non-monopolyconditions.
10See Carlton and Perloff [19901for alternate explanations.The welfare economicsof these practices is a
separte matterwhich we do not address.
" Tie-in sales, wherethe purchaer of the product is requiredto purchaserelatedproducts, is one type of two
part tariff. For example,IBM, in requiring
purchasersof its computersto buy its tabulatingcards was able to obtain
a higher price for the machine from the more intensiveusers. Xerox, is charging a per unit rental fee for copies
that exceeded the marginal maintenan costs, price discriminatedagainst intensiveusers. See Scherer and Ross
(1990].
- 10
-
same product under different brand names and charging a premium for the label as occurs in
supermarkets;'2 (4) discountson productsthat face stiff competition,for examplein the shoe machinery
(Kaysen[19561)and computermarkets (Fisher, McGowanand Greenwood[1983]); and (5) geographic
price discriminationunder singleor multiplebasingpoints, with someabsorptionof transportationcharges
by the producer.13
A further highly counterintuitiveresultof the uniformpricing assumptionis that intra-EC trade
declines as a result of EC integration.This is becausefirms charge higher markups on their domestic
sales than on export sales prior to integration.Uniform pricing in the EC causes firms to raise export
markups and lower domestic markups, which reducesintra-EC trade.
Modelling the Price Effects of Integration
ImDactof Standardson Substitution.As a resultof the concernsraised above, reservationshave
been expressed regarding the manner in which integrationhas been modelled in previous studies of
EC92." Our approach is basedon a reviewof the theoreticaland empiricalliterature on standardswhich
is presentedin AppendixC. We concludethat the impactof the standardscomponentof the singlemarket
program (which is regarded by businessmenas the most important component of the single market
12 See Wolinsky [1987].
includingthesteel,cement,lead
'3 Someformof basingpointsystemhasbeenadoptedby manyU.S. industries
andwoodpulp industries.See Schererand Ross(19901for an elaboration.In addition,recentstudieshavefound
evidenceof price discriminationin monopolisticallycompetitivemarkets. Using data from retail gasoline markets,
Borenstein[19911used a model of spatialcompetitionin whichdifferencesin the willingnessof buyers to switch
stations results in price discriminationbetween leadedand unleadedgasoline. As gasoline stations which offered
leadedgasoline diminished,the relativeprice of leadedto unleadedgsoline rose. Shepard[1991] found the price
difference between full service and self-servicegasoline in stations that offered both services was consideably
greater than the price diffetenceacross differentstationsthat only offered one type of service. Based on a similar
in the U.S. airline industry.Pashigianand Bowen
model, Borensteinand Rose [1991] found price discrimin&tion
of
apparl in retail stores is consistentwith a price
in
the
pricing
use
of
sa:es
the
greater
found
that
[1991] have
in whichconsumerswho are more intered in
uncertainty),
as
greater
(as
well
of
pricing
discriminationtheory
being in fashionhave ISS elastic demandand pay higher prices early in the season.
"' For example,see Karp [1992;p.63], Smithand Venables[1988;p.1523], Merenier [1992;p.1] and Winters
[1992; p.20].
*11
-
program) will be to substantiallyincreasethe ability and willingnessof EC buyers to substituteamong
the products of EC suppliers. Thus, one of the key features of our modelling approach is that the
increasedcompetitivenessin IRTSsectors comes aboutthrough the greater abilityand willingnessof EC
buyersto substituteamongthe productsof EC producersdue to the singlemarket programon standards.
Standards arise from a variety of reasons. Taking the United States as an example, there are
literallythousandsof industrywideproductstandards.Mostof these are voluntary,arise from the demand
from buyers, and may be classified into uniformitystandards and quality standards.'5 There arc also
situations in which suppliers desire product standards, most notably for anticompetitivereasons.16We
explain why the single market program on standardsshould increase the ability of buyers to substitute
amongthe products of competingsuppliers in each of these cases.
First consider uniformity standards. The most important aspect of these is interchangeability
standards,which are designedfor the expresspurposeof allowingbuyersgreater subst .Ation
possibilities
amongdifferent suppliers. Well knowninterchangeabilitystandards are those in the auto industry which
were imposed on parts suppliers by the Society of Automotive Engineers (SAE) on behalf of auto
assemblers;these standards were designedso that assemblerswould be able to substituteamongdifferent
suppliers of parts such as wheelrims, spark plugs and screws and bolts. Other examplesare standardized
socket sizes in lamps that allow substitutionamong light bulbs. A photographermay interchangeably
choose amongvarious films, cameras, tripods, lens, filters and exposure meters due to standardization.
To facilitatereplacement,bricks sizes were standardizedunder governmentregulation.Operatingcontrols
for forklifttrucks are almostall standardizedso that trainingof drivers is interchangeableamongdifferent
manufacturersproducts. Despitethe enormousvarietyof paper towels, virtuallyall are eleven incheswide
Is See Hemenway[1975]for an excellentand more elaboratetreatmentof the theoryand evidenceon
voluntarystandards.
industrywide
16 Another
prominentreasonfor suppliersto desirestandardsis to gaineconomiesof scale.Thiswasdiscussed
aboveand includedin the model.
-
12 -
to fit the standardizeddispenser.
Regardingquality standards,thesealso increasethe substitutionpossibilitiesof consumersbecause
the reduce the productdifferentiationadvantagesof producers. In the spirit of the Akerlof [1970]model,
problemsof degradationof productquali.y oftenarise in marketswherebuyers have less informationthan
sellersand it is costlyto produce higher qualityproducts.Brand names will often developto resolvethe
degradationof product quality problem, but then consumersare reluctantto substituteamong competing
suppliers due to product differentiation. Grading of products then will allow greater substitutability
amongcompetingbrands. The auto industrysucceededin imposingquality standards on most of its raw
material suppliers such as steel, rubber, petroleum and machine products. Among these industries,
opposition from steel suppliers was strongest because steel suppliers were reluctant to lose product
differentiationadvantagesassociatedwith brand names. Similarlyoil viscositystandards for auto motor
oil were imposed on reluctant refineries. In general, products that are graded for quality have little
product differentiationadvantages."
Standardsare sometimesimposedby suppliersfor anticompetitivepurposes.For example,fearing
anticompetitive standards, the U.S. Federal CommunicationsCommission mandated standardized
interconnectionfor terminal equipment and open network architecture (ONA), which means that the
componentsof the telephonesystem are madeavailableon an unbundledbasis so that competingsupplier
services can be combined in any mannerdesired. Thesestandards have been highly successful, at least
judged by the wide variety of independentsupplierequipmentand servicesthat have developed."
As part of its single market program, EC policy is attemptingto implementsimilar reforms in
standards. The EC green paper on telecommunicationspolicy indicatesthat through the promotionof
Europe-wide standards-it shall provide equal access to all market participants (EC [1987; p.5]).
'
This includesmilk,eggs,meat,lumber,soybeans,diamondsand mushrooms.
SeeBesen and Saloner [1987]for furtherdetails.
- 13 -
Moreover, ONA has been mandatedby the Maastrichttreaty partly to insure the uniform interpretation
of essential requirementsacross the Communityin order to limit the possibilitiesfor the impositionof
restrictive licensingconditions."
Probablythe best knownexampleof supplier-basedanticompetitivestandardsis nationalstandards
that have the force of law for the purposeof protection,which the EC refers to as technical regulations.
For example, EC courts interpretedGerman beer purity laws as protectionistand required that beer
manufacturedin any member state could be importedinto Germany.This is an applicationof the mutual
recognitionprinciple in which products producedin one member state may be sold throughoutthe EC.
In the absence of specific EC legislationhowever, EC states may still block intra-EC imports if certain
nationalinterestsare involved.So the EC has attemptedto achieveharmonizationof technicalregulations
in which EC directives indicatemandatoryrequirementsfor nationalregulations.' In either event, the
European consumerwill be able to consumeproducts from other EC states that previously were illegal
to import.
It is likely that considerationssuch as these led businessmenwho were surveyed in the "Costs
of non-Europe"projectto concludethat they wouldhave greater accessto new regional marketsand there
would be increased price and non-price competitivenessas a result of the single market (Nerb [1988;
p.27]). Moreover, the survey led some observers to conclude that "there is a dynamic of dema I
associated with the learningprocess of consumersand enterpriseswhich is released or acceleratedwhen
barriers are removed" (Nerb (1988; p.26]). Thus, the theoryand empiricalwork on standards indicates
that the impactof the EC92 programof standardswill be to substantiallyincrease the ability of buyers
to substituteamongthe productsof EC suppliers,justifyingour modellingfocus.
"SeeXIII, September1993, p.12
(the magazineof DO XIIIof the EC)andEmersonet al. [1988; p.8 6 1.
manufacturer
may meet the technicalrequirements
eitherby producinga productthatmeets the defined
essentialrequirements(which allows manufacturer
varietysubject to the constraintof meeting the essential
requirementsof the product)or by producinga productin conformit)with Europeanstandardization
bodies
(Emersonet al., 1988, p.40).
DA
- 14 -
Modellingthe Impactof IncreasedSubstitution.We employa flexibledemandstructure in which
consumersmay have preferencesfor Eheproductsof firms dependingon regionof origin. As a result of
standardizationEt buyers may substitutemore readily amongproducts from different EC firms. Then
the perceivedelasticity of demandof EC firms on intra-ECexports increases,and intra-EC export price
margins are reduced endogenously.Consequtently,as markets become more integrated intra-EC trade
generallyexpands. Firms in CRTS sectors will not directlybe led to change their prices by this change
in EC consumerperceptions, but there will be indirecteffectsdue to the generalequilibriuminteractions
2" We discuss this aspect of the model in greater detail
inducedby changesin the prices of IRTS sectors.
below.
More formally, prior to the EC92 program we enviszge consumers as possessing weakly
separable utility functionsthat allow multiplestage budgetingof their choice decisions. First, based on
a Cobb-Douglasutility functionat the top level, they choose between the 26 different compositegoods
which are listed in Table 1, such as "motor vehicles" and "textiles and clothing". Having chosen how
much to spend on each aggregate commodity, they then choose between domestic and imported
compositesof this commodity:between"domesticautos" or "importedautos", for example.This decision
is based on a CES sub-utility function. Having decided how much to allocat; to imported autos,
consumersthen decide how muchto allocateto importsfrom different regionsin the model.This decision
is also based on a CES sub-utilityfunction.Finally, given the decisionon how muchto spend on autos
from each country, consumers allocateexpenditureson the different varietiesfrom each country based
on the lowest level CES sub-utilityfunction.22Figure 1 displaysthis structure of preferences (after the
21 A CRTS sectormight
useas an intermediate
inputtheoutputof an IRTSsectorwhosepricechanges,therby
changingthe costsof the CRTSsector.Altematively,
theCRTSsectormaybe a substitute
in demandfor theIRTS
sector,and thereforeexperiencea changein demanddueto thechangein relativepricesbetweenthe two.
I Giventhat the elasticitiesof substitution
for theselasttwo levelsof choicewith respectto foreigncountry
and foreignfirmvariety(withina country)arethesame,thestructureis equivalentto firmlevelcompetition
ammng
all imports.A specialcaseof thisstructure,withall elasticities
of substitution
equal,yieldsfirmlevelcompetition
amongall firmsthat is independent
of the countryof origin.
- 15 -
FRENCH
IMPORTS
JapaneseO
¢ormak Lm
autoamobilam from:
Germon fIrms
Jspnese
firms
Other Imports
firma from other region*
Figure 1: Structure of PreferencesBefore the EC92 Program
A
EC
Non-EC
DD
French
O
from
Sreack
rwme irma
~O ermea
U
1U
Other EC
Japanese
German
Japanese firma
Figure 2: Structure of PreferencesAfter the EC92 Program
- 16
-
U.
U.S firms
Other Non-EC
initial Cobb-Douglaschoice of how much to spend on the aggregatecommodity).
After the EC92 program is completed, we envisage consumers have a different preference
structure to reflectthe notion that, due to EC92 programs regardingstandards, EC-producedgoods are
now better substitutesthan before. They are better substitutesfor other EC-producedimports, and they
are better substitutesfor domesticvarieties.We simulatethis preferencechangealong a continuumwhere
in the limit consumersregard the productsof all EC firms as equallysubstitutable.The latter preft:ence
structure is shown in Figure 2.
Specifically, in the fully integratedscenario the preference structure of consumers is directly
analogousto the segmentedscenarioprior to EC92. Havingdecidedhow muchto spend on any aggregate
commodity,such as autos, consumersallocatethat incomeamongimportedand domesticvarietiesof the
commodity. However, now the notion of a "domestic variety" includes all other EC-produced varieties,
even if they are not produced in the EC country in which the consumerlives. That is, we shift from
treating other EC products as being "foreign varieties" and treat them as if they were 'domestic
varieties".3
Thesetwo preference structuresrepresentextremes,reflectingthe situationbefore EC92 and the
situation after the successfulcompletionof the EC92 program. It is then a simple matter to model the
path towards completionof the market as a weightedaverage of these two preference structures.Thus
a 25% weightingon the pre-EC92 preference structurecould be interpretedas saying that a quarter of
the (homogeneous)consumersin that countryperceiveno changein the substitutabilityof EC-produced
as changing'structure' just reflects presuned changes in the off-diagonal
of preferences
Thisrepresentation
matrixbetweendomesticandforeignvarieties.It is possibleto represent
implicit
Slutsky
substitution
elementsof an
CES structure
this changeexplicitlyin a CGEmodel,usingflexiblefunctionalformssuchas thenon-separable
developed by Perroni and Rutherford 11992],but we opt for the simpler more easily interpreted formulation
presentedhere. The crucial modellingfeature here is not the useof differentutilityfunctionstructures;ratherit is
n
the correct characterizationthat EC goodsare now better substitutesfor home goods.
- 17 -
goods.'
In most circumstances,economistsare reluctantto considerchanges in preferences as the basis
for a policy exerc'ise, in large part becausethe createddifficultiesin evaluatingwelfare measures, such
as Hicksianequivalentor compensatingvariation.In the presentmodel,however, we modify preferences
in such a way that indices of welfare change remain weli defined. This is because the changes in
preferences do not alter the optimalityof the initial allocation.In the absence of monopolisticpricing,
the change in preferencesalone do not disrupt the benchmarkequilibrium.
The key elasticitiesof substitutionare denotedODM.
ODD
and aOmM
and reflect the substitutability
between domestic (D) and imported (M) goods, alternativedomestic varieties, and alternativeforeign
countries (and varieties). These elasticitiesare crucial to the effects of EC92. Our priors are that
aDM
< a,M < oDD' Our priors derive from our above discussionand appendix on standards which
indicatesthat products producedin the same countrywill be more substitutableamong themselvesthan
products from different countries. This gives us the relationshipthat OK, <
aDD;
this inequalityplays
an importantrole in the analysisbelow.' Although it does not play an importantrole in the analysis,
we also posit that domesticconsumersare less willingto substituteforeignvarietiesfor domestic varieties
than they are among different varieties from foreign sources. In the absence of data-basedestimatesof
these elasticities we initially specify aDM= 5, aw
=
10,and ODD
=
15. Our priors for the three key
elasticitiesof substitutionremain the same when appliedto pre or post EC92 preference structure.
A formal derivationis providedin AppendixA, but intuitioninto how market integrationaffects
24 We assumethat this fractionis
constantacross all countries,reflectingthe overll proges twrds
completionof the EC92 program. It wouldbe a simplematterto let it varyacrossEC countries,perhapsreflecting
thedifferential
speedwith whichEC countriesareacceptingEC-widestandardsandare removingbordercosa on
EC imports.Thereis some anecdotalevidenceof such differentials,at leastas measuredby the speed of enacting
nationallegislationto implementthe EC92program(e.g., The Economrst,July3-9, 1993,Surveyon the European
Community).
U It alsogivesus cDMV
< aDD'
-
18-
markups and intra-EC trade can be obtained through exarninationof the markup equations. Definethe
markup for firms from one EC country(r) selling into another EC country (r') in the segmentedmarket
situation ;s m,,, and in the fully integratedequilibriumas m,,. It follows from equations(47) and (49)
of Appendix A that the markupunder segmentedmarkets is:
m,, -
I
aM
+
I
an
-
+
Il
I
1
aD,,N,
N,6,m
°w,V|
and the markup under fully integratedmarkups is:
OD
I
OD+D I I
N
E,
+ |w
I
N
(2)
where
rEEC
and 0,,, denotesthe market share of regionr firms in region r'.
Then the change in markup (defined as the fully integrated minus the segmented markup)
simplifiesto
-
in,,, =
LODD
aUMM
Nr L
EC
OrDM
J
aDD
(3)
5'4
aAMM
ODM
When this expressionis negative,markupson intra-ECtrade will fall and trade will tend, cetens
paribus, to increase. As we have arguedabove,there is likelyto be greater similarityand substiutabiity
amongthe products of domestic producersthan amongthe products of foreign producers, and still less
-
5, ,aA - 10,
ODD > aw4
, and for our
betweendomestic and foreign, and we have chosen elasticitiesaccordingly,i.e.,
and
aDD
a
15. The first term in this simplifiedexpression is negative when
aDg
specific values equals -0.033; but there is some ambiguitywith respect to the second term. Given the
- 19
-
ranking of the elasticitiesof substitution,the secondterm will be positive the smaller is 0c in relation
to O., i.e., the smaller the share domesticfirms have of the domestic market relativeto non-EC imports
in the domestic market.' Given our specificvalues, the change in the markupequals
-0.033 + 6,, [(.133)(l)1
N, [ @,
9C,,
]
Numerically,we find that the sign of the secondterm is positivein most cases, but considerablysmaller
than the first term bec c,
it is multipliedby the ratio of a share (0,,,) divided by the numberof firms,
where for example for Belgium's markup in Germanywe have the share of Belgian exports in the
German market divided by the numberof Belgianfirms. Thus, we find that the change in the markup
is uniformly negative,where in most casesthe decline in the markup is between2 and 3.3 percent.
We discuss how we model the steadystate effects of completionof the market in section4.
3. The Static Effectsof Completionof the Market
Static Welfare Effects
Table 3 displays the results of completionof the market on aggregateEC welfare. In effect, this
measureof the welfare effectsadopts a utilitariansocialwelfarefunctionfor the EC, such that we simply
add up the welfare effects for individualEC countries.In Table 3 we displaya matrix of results where
we simulatepartial and full removal of border and supply side standards costs and well as partial and
completechange in the elasticitiesof substitution(referred to in the table as percent of integration).
Althoughthe steady state results are presentedin Table 3, we defer discussionof them to section 4.
,,, + E
the secondtermwillbe positiveif and onlyif 4
2 Specifically,
rRtEC
-
20 -
rfe5C
O,,,> 30,,,,.
Table 3: Welfareeffects of EC92 on the EC
Percent
Removal
of BorderandStandards
Costs
0%
25%
Static
(1)
Steady
saxw
(2)
Statk
(3)
Steady
sate
(4)
IRTS
CRTS
0.00
0.00
0.00
0.00
0.12
0.11
25%
IRTS
CRTS
0.11
0.00
0.30
0.00
50%
IRTS
CRTS
0.23
0.00
75%
IRTS
CRTS
100%
IRTS
CRTS
Percent
ntegration
75%
50%
Stfea;
Statk stati
(5)
(6)
Static
(7)
0.38
0.34
0.25
0.22
0.85
0.74
0.38
0.34
0.24
0.11
0.72
0.33
0.37
0.23
1.14
0.70
0.59
0.00
0.36
0.11
0.98
0.30
0.50
0.23
0.36
0.00
0.83
0.00
0.50
0.11
1.20
0.27
0.50
0.00
1.04
0.00
0.65
0.11
1.38
0.23
Steady
state
8)
1I0%
Static
/9)
Stea4
swe
(10)
1.33
1.15
0.52
0.46
1.79
1.56
0.51
0.35
1.57
1.08
0.66
0.47
2.03
1.48
1.38
0.64
0.65
0.35
1.80
0.99
0.81
0.49
2.25
1.37
0.65
0.23
1.59
0.57
0.81
0.36
2.00
0.90
0.98
0.50
2.44
1.24
0.82
0.23
1.76
0.49
0.99
0.36
2.16
0.79
1.18
0.30
2.60
1.10
0%
a. Welfareeffcts arein eachcasethe aggregatcequivalent
vaiationas a percentof aggregateECGDP.
Source:Model esimta.
First, considerthe static welfareeffectswith IRTS in Table 3. Theseestimatesimplythat removal
of internaltrade barriers and market integrationare complementaryto each other, which is consistent
with the receivedwisdomfrom previousstudies. Full integrationwith completeremoval of internaltrade
barriers results in an aggregatewelfare gain of 1.139%of GDP per annum.
The relatve contribution of market integrationand removal of trade barriers appears to be
roughly additive and, as it turns out, somewhatsymmetric.That is, x% integrationand y% removal of
sand achieves about the same welfare increase as y% integrationand x% removal of sand, provided
neither x nor y are zero.
- 21 -
CRTS Resultsand Comparisonwith IR[S. Despitethe fact that we have argued strongly that it
is appropriateto model 12 of the 26 sectors (about21 percentof value-added)as being subjectto IRTS,
it is helpful in urnderstandingthe results to considerthe results in the counterfactualcase in which all
sectors are subject to CRTS. We implementthis by settingthe CDR equal to zero for all sectors. Given
that there are no rationalizationgains to be realizedfrom improvedscale efficiency in a CRTS model,
we would expectthat the welfare effectsof EC92 would be much smaller, and indeedthey are. In Table
3 the effect of assumingIRTS and monopolisticallycompetitivepricing in our model is seen to increase
the welfare gains by almost nothing(if we assumezero price integration)or by as much as 100% (if we
assume full price integration).
In Table 4 we preserL results showing the distributionaleffects across countries. We find
considerabledisparityin the welfareeffectsacross EC countries,eventhough all gain. Table 4 showsthe
effect on welfare in percentageand in absoluteterms (equivalentvariation as a percent of GDP and in
billionsof 1985 U.S. dollars, respectively),the percentagechangein the real wage and the real price of
capital, and finallythe percentagechangein the real cost of living. The numberswithoutparenthesesare
for the IRTS fully integratedscenario in which all border and standardscosts "sand" are removed.The
CRTS results are in parentheses.
ExaminingTable 4 for the distributionof welfare gains across the countries of the EC in the
CRTS case, one sees that Belgium and the Netherlandsare the countries which experience the largest
increase in welfare as a percent of (iDP. The key to understandingthis is to recognize that we have
modelledthe impactof the EC92 programon standardsand borders costs as costs which will be reduced
on intra-ECexports onlly,i.e., there are no cost reductionson productionfor the domesticmarket. Border
costs require resourcesof the domestictransportationsectorin our modeland supplyside standards costs
are a componentof value-addedto the extent that the good is exported. Sincethe single market program
is assumedto reduce the border and standardscosts of intra-EC exportingby 2.5 percent, the first order
- 22 -
Table 4: Country compositionof the welfareeffectsof EC92a:100% integrationand removal of border
and standards costs
Per-ca chmge in:
e
Regi-n
We(fare
STa
Steady
I
Welfa,r in dbuare
3,37
6.39
Static
Germny (DE)
1.10
2.03
(0.44)
Dmamrk (DK)
1.82
3.78
France(FR)
0.80
(0.36)
1.13
Toe Netherlas
(NL)
Portugal (C
2.47
Rest of Woid
(ROW)
1.05
(0.46)
2.03
2.48
(1.20)
7.73
1.04
1.72
s
b
el
d.
13.39
1.21
2.51
2.19
5.36
7.07
IS.44
1.49
-0.00
0.05
Steady
sA
5.2
(2.6)
6.7
1.0
(0.4)
1.6
2.4
(1.2)
3.0
0.8
(0.4)
1.4
__
1.
4.62
(2.03)
8.8
3.41
(1.65)
10.63
0.53
0.7
1.0
(0.4)
1.5
3.0
(1.3)
4.9
0.5
0.6
(0.3)
4.31
(1.57)
797
01
(-0 2)
0.4
-0.35
4.06
-0.00
(0.1)
0.0
1 (-0.42)
aw.r
Real co
prces
S&tac
Swuiy
1.4
(0.7)
1.0
0.9
0.1
0.1
(0.3)
(0.1)
3.3
(1.3)
(0.5)
(0.21)
0.80
(0.29)
I-0.005)
7.27
(3.14)
(0.42)
Uuited Iingdom
(UK)
6.31
(0 93)
(0-30)
taly (T)
3.32
(0.54)
1.96
Szauic
5*41
(2.90)
(C.81)
Spain (ES)
Steady
(1.51)
(1.53)
Real prVce'
qfcapita .
state
Belgium (BE)
Real wages
1.7
0.7
(0.3)
(0.4)
1.2
0.4
(0.5)
(0.2)
1.4
(0.7)
(0.2)
03
0.4
0.0
0.1
40.1
0.8
(0.3)
0.0
4.0
(2.5)
1.2
(0.7)
1.1
1.3
-0.2
0
.0.6
(0.3)
1.0
(0.4)
-0.3
(-0.3)
.0.3
0.3
0
0
O.0
(01)
0
bNumibenwithout paentheses are for IRTS in fully integrated scenario with *11border and standards
costs rmoved. Results for experiment with all sectors sbject to constant retums to scale are in parentheses.
Equivalnt variation as a percent of GDP.
Equivak.t variation in billions of 1985 U.S. dollarm
Rea price of capita is fixed in the stady mate scenario.
effect on welfare (as a percent of GDP) will be approximatelyequal to the share of intra-EC trade in
GDP times 2.5 percent. But there will be additionalgains from removingdistortioncosts.
In Figure 3 we depict the welfare economics of a 2.5% reduction in the costs of intra-EC
exporting under CRTS (in partial equilibrium).We take the example of Belgian exports of steel to
Germany. There is a rectangleof benefits from the reduction of the costs of exporting Belgiansteel to
-
23 -
FIGURE3: Distribution of EC 92 Benefts under CRTS:
Case of Belgian Steel In Germany
J
EX
~~~~~~~~~1.026
\
~~~~~~~~~~~~EX
sPo
IPi
'8
j
/
~~~~~~~~~~~D
I
o,
I
,
Quantityof BelgiansteelIn Gewrany
NOTE: The Ina equilibrium for Belgian stee" in Gemarn Is at (Po,Qa), determined
by the Intersecton of the export supply curve of Belgian steel producers to Gerrany
(1.025 E9. and tie demand by German consurners for Belgian steel (0). Followin
the changes of EC92, the export supply curve shifts down by 2.6 percent to EX.
resulting a new equilibuum (abstracting from general equuilbriumeffects) at (Pi, Q,).
There are rectwnles of benefits A (to Germany) pius a (to Belgium), the sum of
whbichIs 2.6 percent of the Initial exports; plus trangls of benefits from reduced
distorion Costs equal to C (to Gerrnany) and D (to Belgium).
-
24 -
Germany, equalto 2.5% of the initialcosts of exporting.Providedneither Germandemandfor steel, nor
Belgian supply of steel, are limiting elasticity cases, the initial rectangle of benefits will be shared
betweenthe exportingand importingcountry(Ato Germanconsumersand B to Belgian producersin the
figure). In addition, the border and standards costs are analogousto distortionsto trade, which when
removedallowa reallocationof resourceswith an increasein intra-ECtrade. That is, there are 'triangles'
of benefits that augment the benefits from the reducedcosts of exporting. In Figure 3 triangle C is a
benefit to Germanconsumers and triangleD is a gain to Belgianexporters. These realiocationbenefits
will be increasedor decreasedto the extent that the countryis responsiveto changes in relative prices
of imports and exports. Figure 3 also revealsan importantfeature which impactson the sharing of the
benefits of EC92 across the EC countries. The more elastic is a country's demand or supply curves in
relationto the other countriesof the EC, the smaller will be its share of the benefitsof EC92.
In T2b!le2 we list the intra-EC trade intensitiesof the EC countries in our model. The three
countriesthat trade most intenselywithinthe EC are Belgium,Netherlandsand Denmark, and these are
the three countries that gain the most from the EC92 program in the CRTS case. For the remaining
countries there is little difference in their intra-EC trade intensities(rangingfrom 12% to 8.8%), and
there is also not a large difference in their welfare gain as a percent of GDP (ranging from 0.5% to
0.29%).
The benefitsfor all countriesunder CRTSexceedthe first order effect of the loweringof the cost
of production.In particular, 2.5% times the trade intensityratio yields the followingfirst order welfare
effect in percentof GDP: Belgium0.89, Netherlands0.37, Denmark0.37, Germany0.30, Portugal0.30,
U.K. 0.30, France 0.28, Italy 0.25, and Spain0.22. Other than for the U.K. and Denmark, the welfare
benefitsare between 1.4 and 2.2 times this "first order' effect, suggestingthat the triangles in Figure 3
- 25 -
are quite large.' By the standards of CRTS models, we have assumed rather large trade elasticitiesin
2'
our benchmark equilibrium, so the triangles in figure 3 are almost as large as the rectangles.
ExaminingFigure 3 reveals that the benefitswould be closer to the rectanglesthe more inelasticare the
demand elasticities." When we counterfactuallyreduce all three import demand elasticities for all
countries in our model to one-fourthof their original values, the benefits for most EC countries are
reduced to between 1.17 and 1.28 of the rectangleeffect.30
Thus, the intensivenesswith which a country engages in trade is of first order importancein
explainingthe benefitsthat are likely to be achievedfrom CRTSsectors. More aggregatedmodelshave
aggregated small countries such as Belgium with larger countries. In so doing they have produced a
region which is closer to average with respect to trade intensities, which will mask important
distributionaleffects across the EC countries.
In column9 of Table 3 the CRTS welfaregain to the aggregateEC from complete removal of
border and standards costs barriers to intra-ECtrade variesfrom 0.46% to 0.5% with CRTS, depending
on the degree of market integration. Market integration,which in our model is greater substitutability
amongEC products, has only a very smalleffect on welfarein a CRTSmodel (by inducingslightlymore
resource movement)becauseit does not affect markupsor entry and exit.
27For the U.K. the benefitsare close to the first order effect;this indicatesthat the U.K. is obtaininga
relativelysmallshareof thebenefitsof integration.As discussedabove,thissuggeststhatU.K. importdemandor
export supply is more elastic than that of the other EC countries.
23Similar to the approach of Gasiorek, Smithand Venables[1992], we choose to calibrate with elasticitiesto
be consistentwith price-costmarginsgivenby estimatesof theCDRsubjectto a zero profitmodelassumption.
Nonetheless,the trade elasticitiesare small in relationto those used in their models.
29We show below, however, that the higher elasticitiesreducethe additionalwelfare gainfrom rationaliution
and consumption
efficiencygainsin IRTSsectors.Thus,thehighelasticitieshaveoffsettingeffectsregardingtheir
welfare impact.
w Exceptionsare Denmark, whichremainsan outlier, obtainingbenefitsequalto 1.78 timesthe rectangleeffect,
and Germanyand the U.K. whichobtain less than the rectangleeffect. Note also that the large demandelasticities
that we have employed,however, result in somewhathigher estimatesof the welfareeffects and of the adjustment
across industriesin both the CRTS and I1P S cases.
-
26 -
The Impact of IRTS. Examinationof Tables 3 and 4 reveals that the welfare benefits of the
completeremovalof border and standardscostsroughlydouble. both for the aggregateEC as well as for
individualEC regions, when the impact of IRTS with full market integrationis incorporated.The key
to explainingthe impactof IRTS is the role of market integrationon elasticities,markups and entry and
exit. To clarify this point first comparethe CRTS and IRTS results with 0% integration(row I of Table
3). Then the static effects of removingborder or standardscosts are virtuallyidenticalbetweenIRTS and
CRTS. That is, without additional effects from market integration, the beneficial effects of removing
border and standards costs can be attributedto "traditional' efficiencygains found in a standard CRTS
framework.
The key to understandingthe impact of IRTS in our model is that integration increases the
elasticityof demandon intra-ECexports, therebyinducingmarkupdeclines. The equationfor the markup
wasdiscussedearlier. A decline in the equilibriummarkupcan only be achievedthrough an improvement
in the realizationof scale efficiency.
Despitethe fact that we employ equivalentvariationin general equilibrium,to isolatethe crucial
variables in IRTS sectors, in Figure 4 we presenta partialequilibrium,consumerssurplus interpretation
of a symmetric monopolisticallycompetitiveindustry with a given level of fixed costs per firm and
constantmarginalcosts (MC). An additionalsimplificationin Figure 4 is that it presumesa homogeneous
output, so the elasticity increase is represented simply as a rotation of the market demand curve.'
Originally there are nOfirms charging price POand producing q0. We assume zero profits, so rectangles
A+ C equal fixed costs per firm. As a result of an increase in the market elasticity of demand, the
perceivedmarginalrevenue of the firm will equal marginalcosts at a larger output level. In the absence
of general equilibrium effects which chan-e actor costs, the marginaland average cost curves for the
"'The analysisof Figure4 extendsnaturallyto our firmlevel productdifferentiationcase by definingthe market
outputas the CES aggregateof the outputof the individualfirms, and the marketprice as the price dual to the CES
quantityaggregate.
- 27 -
FIGURE4: RatlonszaUonmad Corhumpton EMoloy
Gabm*hm Inlnmr d Ematm
REPRESINTATNE
FIRM
AMRKET
De
p~~~~~~~~~~~~~~p
Pt
D
~~~~~~~~~~~~~Pt
'>~~~~~~~~~
MC~~~~~~~~~~~~~M.
'
1
q.
Mm
NOTE:bIer_as mnwcut
danwndebalty kv*jd rpmrtlvs
fms to br prim
andsomato edtb,kyaInhit rwwzeropr equdun. 1V*weat gainequasXt
aresurKde
tie
dernwdmtrdnabve MC,Lo.,Xi omrxnpion tfiknry gakiB
pkusto m1lnJon gannoD,whem
neD- ri
-
28 -
M
representativefirm remain unchanged.Then, due to the zero profit constraint, exit must occur such that
the new perceiveddemand curveof the representativefirm, d,, is tangentto the average cost curve at the
new lower markup. It followsthat P, < P. and industryoutput increases.
Welfare effects are shown in the panel of Figure 4 labelled Market, where D. and D, are the
initial and new market demand curves. Since price exceedsmarginalcosts in the initial equilibrium,the
expansionof output increaseswelfare; but the welfare gain is decomposedinfo two parts. First there is
the typical consumptionefficiency triangle B (as would occur for example with removal of a tax).'
Unlike a tax, however, there is an additionalgain of consumers' surplus equal to the rectanglen, that
has no offsetting cost or lost tax revenue. The additionalconsumers' surplus gain derives from the
rationalizationgain of spreadingfixed costs. That is, the expansionof output costs society resources at
the rate of MC per unit but is valued as the area under the demand curve.33 These consumption
efficiencyand rationalizationgains from increasedelasticitiesin IRTS sectors are gains from the single
market program over and above the gains from the reduction of the costs of exporting that were
characterizedin Figure 3.3
A similar interpretationwill apply even when general equilibriumeffects are incorporatedthat
will induceshifts in the marketdemandcurves. For IRTSindustriesthat experienceoutput declineor only
small output increase, exit occurs. For those that experienceoutput increases, entry can occur with a
markup decline only with a significantoutput expansion.All of these scenariosresult in rationalization
32 Following the procedureof Burns [1973], the efficiencytriangle is obtainedby connectingthe pre and post
equilibriaby a straight line.
33Since fixed costs per firm are unchangedA+C = C+D, i.e., A=D and n,4 = nj). Then the welfare
increaseequals the area under the demandcurve betweennq0 and n,q, that lies above industry marginalcosts.
34The greater the absolute value of the declinein the markup, the larger will be the welfare benefits from
rationalizationand consumptionefficiency.A proportionalreductionin the elasticitiesof substitutionin the model,
however, will increase the absolute value of the decline in the markup. That is, given benchmark elasticities,
OD
= 15, or'.
= 10, the dominant first term in equation 3 is (1115)-(1I10)= -1/30. If the elasticitiesof
substitutionwerescaleddown, for exampleby 1/5,thenthe firstterminequation3 would equal (1/3)-(1/2)= -5/30.
This would result in a larger drop in the new equilibriumprice in Figure 4 and greater welfare gains.
-
29 -
in the use of fixed costs and, since price-marginalcosts markups decline, a decrease in consumption
deadweightloss. These are benefitsabove what would occur in a CRTS sector.
In Table 5 we present someof the key data for the IRTSsectors in three representativecountries:
Belgium, France and Spain. We focus on these countriesbecause: Belgiumis the country that gains the
most from the EC92 program; France is a representativelarge country; and Spain is a country with
relatively small trade shares in Germany. The table presents results for the scenario of 100 percent
integration and 100 percent removalof border and standardscosts.
In the first three columnswe presentthe rprcent declinein the 'Lerner" markup ([price-marginal
costs]/price). The equationfor the changein the Lerner markup is presentedin equation3. Note that for
the industriesin all three countries,their markupson their exportsales in Germanychange between-1.0
and -3.3 percent. For some products there are no exportsto Germanyin the benchmarkdata, hence the
markup equation is not applicable. Since the Spanishshare of the German market is small, when the
markupequationapplies, the declinein the markupis closeto -3.3 percent, which is the value of the first
term in the change in the markupequation.
In columns4-6 we present the percent change in entry and exit, and in columns 7-9 we present
the percent change in output per firm. The key differencesappear in the output per firm columns. We
see that rationalizationis much greater in Belgiumthan in the other two countries. Again the reason is
that the intra-EC trade intensityof Belgiumis much greater than the other two countries in the table.
Sinceexport sales constitutea muchlarger percentageof outputfor Belgium,the same percentagedecline
in markup on exports to the various EC markets inducesa much larger reallocation of resources in
Belgium's IRTS sectors.
Columns 10-12-how the percent change in output in the IRTS sectors, and the numbers in
parentheses show the percent change in productionwhen these sectors are presumed to operate under
CRTS. One can see that different IRTS scenariosexpand and contract in the different countries (a full
- 30 -
Table 5: Changes in IRTS sectors in Belgium, France and Spain: 100% integration and removal of
border and s.:andardscosts
Percentagechangein:
prod**on'
OPSutperfnrm
Number ffirnw
Mark up in Germany
SP
FR
(2)
SP
(3)
BE
(4)
PR
(5)
SP
(6)
BE
(2)
FR
(1)
(8)
SP
(9)
BE
(10)
Fa
(i1)
(12)
Food
-3.3
-3.2
-3.3
-19.6
-7.7
-1.0
30
11
6
4.7
(.5.2)
2.9
(1.8)
5.1
(1.6)
Steel
-1.6
-2.9
-3.3
4.5
0
-6.2
54
12
4
60.9
(32.1)
12.3
(6.0)
-2.7
(.7.3)
Nonmetallic
minerals
NAb
NA
NA
-33.1
-11.0
2.4
17
5
9
-21.6
(-11.3)
-6.6
(01.1)
i.1
(0.5)
Chemicals
-2.8
-3.1
NA
-4.1
-4.6
-8.6
28
7
-1
22.8
(4.3)
1.8
(1.0)
-9.8
(4.5)
Metal
products
NA
-3.3
-3,2
-27.2
1.4
1.4
5
3
5
-23.9
(-11.8)
4.9
(1.7)
6.9
(-1.5)
industrial
nachinery
-2.8
-3.1
-3.3
-10.9
-5.3
-11.2
33
-1
0
18.5
(11.3)
-5.9
(.4.4)
-11A1
(-12.4)
Office
macbinery
NA
-2.6
-3.1
-29.6
-8.8
-0.1
13
15
1
-20.7
(-12.1)
5.3
(2.6)
0.6
(0.0)
Electrical
goods
-1.0
-3.2
-3.3
-22.9
-8.3
-12.5
44
1
2
11.1
(9.7)
-7.4
(-3.0)
-10.7
(-0.4)
Motor
vehicles
-3.1
-3.2
-3.3
49.5
-16.3
-12.1
60
27
20
139.4
(45.5)
6.7
(2.7)
5.4
(-6.1)
Otder
transport
equrpment
NA
-3.0
NA
-29.1
-6.7
-12.6
20
12
8
-14.8
(-12.3)
4.8
(0.4)
-5.3
(0.0)
Paper
-3.3
-3.3
-3.3
-17.0
-11.2
-7.8
51
8
11
25.2
(.0.5)
-4.5
(-2.0)
2.8
(3.8)
NA
-3.3
-10.2
-2.7
-2.8
46
0
0
BE
Rubberand
plastics
_
_
-3.3
_
I_
I
30.8
-2.8
-2.3
(25.0)
(-2.7)
(-8.7)
a, Value in parenthesesis percentchange in productionunder CRTS.
b. NA = Not applicablesince thereare no exports to Gcermanyfrom this countryof this productin the benchmark.
presentationof the output changesby industryand regionare presentedin the Appendix).The interesting
pattem is that the sign of the outputchange in the IRTS scenariois generallythe same as the sign of the
output change in the CRTS scenario. The magnitude of the change in absolute value, however, is
generally larger with IRTS. Thus, traditionaldeterminantsof resource allocation, factor intensitiesand
remainingtax wedges,play a key role in influencingindustrialstructure. Shiftsin relativecosts that occur
- 31 -
in a CRTS world provide an impetusfor outputdeclineor expansion.If relativecosts declineand output
expands due to a change in factor intensities,in an IRTS world the output expansioninduces a further
decline in average costs and price, which magnifiesthe output increase.
35
Returning to Table 4, note that despite the fact that markups decline, and real incomes
increase, with integration, real prices also increase. For a sharp example, in Belgium real incomes
increase while real prices also increase by 1.4% despite some significant declines in specific IRTS
sectors.36 The key is that the relative price of labor increasesby 5.2%, and the relative price of capital
by 3.3%, so factor earnings increase at a faster pace than commodityprices." Factor earnings increase
so much in Belgium because resources are being allocated more efficiently, hence the value of the
marginalproduct of each factor is greater than with the previous allocation of resources. In addition to
the benefits that occur under CRTS as discussedabove, there are significantgains from rationalization
and markup declines. All of these gains are dependenton the intra-EC trade intensityof the country.
Intra-EC Trade. In the Appendixwe presentthe percentagechange in exports and importsto EC
countriesand non-ECcountries, respectively.Wehave arguedthat a counterintuitivefeature of modelling
EC integrationas uniform pricing is that intra-EC trade declines as a consequence.With our approach
to integration,however, there is a strong increasein trade amongthe EC countries,and a modestdecline
in trade between EC countries and the rest of the world. We also note, withoutshowingin a table, that
35Our numeraireis a basketof finalconsumption
in theRestof the World.
36Forexample,the followingIRTSsectorsexperiencepricedeclines:Foodby 3.3%, Iron & Steelby 4.7%,
Chemicalsby 3.2%, Industrialand OfficeMachineryby about4.5%,and Vehiclesby 5.5%. MostCRTSsectors
in Belgiumexperiencean increasein relativeprices(e.g., Beverages& Tobaccoby 2.4%, Utilitiesby 2.6%, and
virtuallyallservicesectorsby about3%). In theCRTSversionof the modelthe Belgianincreasein thepricelevel
is onlyabout0.7%.Thestructuralpatternof priceincreasesanddecreasesis approximately
thesameas in theIRTS
version,eventhoughno sectorhas IRTSin thiscase.
37Thesamequalitativeeffectoccursin the CRTSmodel,withthe relativepriceof laborincreasingby 2.6%
and the relativepriceof capitalby 1.3%.
- 32 -
domestic sales of EC firms typically decline. Althoughdomestic markups increase for EC firms, the
largest declines in domestic sales are not explainedby differencesin markupchanges; rather the largest
declines in domestic sales occur in those countriesthat have the highest intra-EC trade intensities.
Thus, overall we have a pictureof EC countriestrading muchmore with each other, relying less
on their domesticmarkets for sales, and, sincetheir economiesbecomemore trade intensive,there is only
a slightdecline in trade with countriesoutsideof the EC.
Regardingthe decline in EC trade with the rest of the world, we have modelledEC92 as a shift
in relative costs for EC countriestoward trading with EC countriesrather than non-EC countries. That
is, the 2.5 % cost decrease on exportsto EC countriesaccruesonly to firms in EC countries. It is possible
that some, .f not all, of the border and standardscosts reductionsthat accrue to EC firms will also benefit
non-EC firms.' To the extent that this occurs then there would be an increase in non-EC exports and
importsto and from the EC for ROW relativeto what we have reported.This would also allowa welfare
increasefor the rest of the world in the static model since then a picture similar to figure 3 would also
applyto the rest of the world exports to EC countries.
Comparing the Static Effects
All four of the previous studies summarizedin Table 6 followedSmithand Venables[1988] by
first simulating a ^.5% reduction in border and standards costs, and then by simulating the same
reduction in costs along with uniform pricing across EC markets (what they call "market integration").
The different results are partly explained by the different structural features of their models. We
emphasizethat there were good reasons for these featuresand aggregationschemesto be chosen for the
purposesof the original studies; we caution, however, that this can affect the economicsof the analysis
31For .xample,a Moroccantruck deliveringvegetablesto Belgiumshouldhave reducedbordercostas it
pausesbetweenSpainand Franceand betweenFranceandBelgium.
-
33 -
Table 6: Key modellingassumptionsand results of GE studies
Harrison,
Rutherford
& Tarr
(presentstudy)
Gasiorek,
Smith
& Venablts
(1992)
Haaland&
Norman
(1992)
Mercenier
(1992)
Modellingassumptions
6
21
34
23
1.6%
2.4%
1.9%
1.1%
(8%)
(7%)
(8%)
(19%)
Numberof EC (non-ECregions)
9 (3)
7 (1)
1 (4)'
5 (1)
Numberof IRTS(CRTS)sectors
12(14)
14 (1)
11(2)
5 (4)
Percentof economysubjectto
IRTS'
Weightedaverage CDRb
Welfareeffects,static model
Removeborder& standardcosts
('sand in the gears')2
0.52
0.44
0.25
n.a.
Marketintegration
1.18
1.35
0.48
0.87j
. We calculatesector res based on value-add estimae for EUR12fron EmersoneSal. 11988;table C2, pp. 271-2751
b. Weightedavenge CDRc are CDR valuesweightedby the shae of total valueaddedof the ector. Weightedaverge CDR vulu
in parenthesesare CDR valuesweightedby the sector's share of value-addedwithinIRTS ectors.
each of the EC and EFA into6 identicalregion.
c. l4siand ad Nonran (19921decomnpoae
of realtradecost of 2.5%
d SC-widewelfareeffectsarea GDP-weightedaverageof theindividualcountrywelfareeffects A reduction
is simulated.
c. Hasaandand Norman[1992; Table 3.41report welfaregSainss a percentof expenditureson tradeablegoods,wbich are 25% of their
total expenditures.We sceletheir estimates(by 1/4) to plac. themon a comparablebasis.
f. Mercenier's (19921Counot competition,free entry ad interrstionslfactor nobilitycase (Table6d).
Source:Authors' calculations.
dramatically.
All of the models in Table 6 includedat least one sector with IRTS. Although for different
reasons in our model versus the others, in general the singlemarket program results in a rationalization
of resources in the IRTS sectors across the EC, which increaseswelfaredue to the greater realizationof
scale efficiency. Then the larger the share of the IRTS sectors and the greater the extent of unrealized
larger the benefits.
scale economiesin those sectors, Lhe
The first row of Table 6 shows the combinedshare of value-addedof the IRTS sectors in the
- 34 -
respective models. Ceterisparibus, we would therefore expect GSV to find the largest gains from the
single market program. The extent of unrealizedscale economiesin the IRTS sectors is measuredhere
by the CDR applied in the initialequilibrium.As shown in row 2 of Table 6, Mercenier [19921assumed
higher values for the CDR in his IRTS sectors than the others, and thus there were considerablegains
9 Thus, despitethe fact that the Mercenier [19921model
from scale to be realized in his IRTS sectors."
has a smaller share of the economysubject to IRTS than the Haaland and Norman [1992] model, it
generates larger welfare estimates.
In aggregate, our static results would appear to be most closely comparableto those of GSV.
However, closer examinationwill show that the way in which EC92 has it's effects on the economy is
quite different. In addition to the fundamentallydifferent way in which integration in IRTS sectors is
approached, which we have emphasizedabove, our aggregationschemesare quite different.
First consider the regional aggregationquestions. Table 6 shows that GSV offer the most
regionallydisaggregatedmodelwithinthe EC. GSV correctlynotethat the choiceof regional aggregation
can be relevant to estimatesof welfareeffects. They emphasizethat since it is the eliminationof barriers
between regions within the EC that one gets the benefits of the single market program, the fewer the
number of EC regions identifiedin the model structure, the smaller is the opportunity for sand in the
gears to be present and to play a role in the simulations.We have shown above, however, that the role
of trade intensities is crucial in explaining the different impacts across countries. The relatively
homogen ous distributionof benefits found in GSV is a natural consequenceof a regional aggregation
schemethat aggregates over regions with diverse trade intensities.
Haaland and Norman [19921 refer to their model as the "twin" to GSV, with greater
disaggregationof the non-ECregions, but they treat the EC and EFTA as six identicalregions. Obviously
"'Me weightedaverageCDRsarecalculatedtwoways.In thefirst,thesectorweightis its shareof value-added
in thetotal economy;in the second,the sectorweightis its shareof value-added
withinthe sectorswithIRTS.
- 35 -
their approach will not allow an analysisof the distributionof benefits within the EC.
We now turn to sectoral aggregationquestions. The reason that previous studies choose their
aggregationschemes is that lumpingtogethertwo IRTS sectors with differentCDRs (or an IRTS sector
and a CRTS sector) will result in a weightedaverage CDR for the aggregatesector betweenthe CDRs
of the separate sectors, the exact value depending on the relative size of the aggregated sectors.
Examinationof the database on CDR estimatesassembledin AppendixB, employingthe original 44sector Eurostat classification,reveals considerablevariance in the CDR estimatesacross sectors. Given
that returns to scale are presumedto be the driving force behind the larger welfare gains of EC92,
previous studies have chosen correctly to keep as many IRTS sectors separate as computational
considerationspermitted,and to lumpthe remainingsectors intoone residualCRTSsector. This way the
resulting model reflects well the "returns to scale relief" of the original 44-sectordatabase.
Theoretically,however, it is possiblethat one can cause similar biases by excessiveaggregation
of the CRTS sectors. For example,these biases may originatefrom the differencesin factor intensities
that are being "lost" as one aggregates.Assumefor the sake of argumentthat IRTS sectors expanddue
to EC92 and that they are relativelycapital-intensive.The ability of these IRTS sectors to expand will
dependon the factor intensitiesof other sectors, sincethey are the ones that will have to release resources
to allow the IRTS sectors to expand. Aggregationover two CRTS sectors, one of which is capital
intensiveand the other of which is labor intensive,will result in an aggregatedsectorwhich is a weighted
averageof the two regardingfactor intensities.Sincedifferent regionswill specializein different sectors,
the results at the regional level could be very different.' These welfare effects will also depend on
whether or not the CRTS sectors are the beneficiariesof reducedtrade barriers. Whether or not sectoral
A similarpointapplieswith respectto aggregations
over sectorswithdisparatetradepolicieswhenone is
studyingtheeffectsof movements
towardsuniformpolicies;thegreateris the modelaggregation,thelesswelfae
benefitswouldsuchuniformitypoliciesbe expectedto generate,as emphasizedin Harrison,Rutherfordand Tar
[1993;p. 195]in thecontextof a single-open
economymodel.
-
36 -
aggregationof CRTS sectors makes muchof a differenceto the estimatedimpactof EC92, however, is
an open issue.
To investigatethis we have aggregatedall 14 of our CRTS sectors into a single large sector, and
considera version of our model with 12 IRTSsectors and one CRTS sector. At the aggregateEC level,
the welfare improvementis equal to 1.17% of GDP in the case of 100 percent removal of border and
standardscosts and 100 percent integration.This amountsto little difference comparedto analogous26
sector experimentwhere 1.18 percent welfareincreasewas obtained. For individualcountries,however,
there are significantdifferences with the followingwelfare increases(as a percent of GDP) by country
in the 13 sector model: BE 2.93, DE 1.13, DK 1.29, ES 0.44, FR 1.11, IT 1.33, NL 2.88, PT 0.52,
and UK 0.81. For the Netherlands, this constitutesan increase of 0.8% of GDP compared with the
analogousscenario in which the CRTS sectorsare disaggregated,placing it almost equal to Belgiumas
the country with the largest percentagegain in welfare. The gain for Portugalis reducedby a significant
0.5%. We concludethat at the level of specificregionsthere are significantlydifferent results introduced
by the aggregationbias.
4. The Steady-State Effects of Completion of the Market
Modelling the Steady State Welfare Effects
It is apparent that the political rhetoric surroundingmajor policy initiativessuch as the EC92
program,as well as other regionaltrade liberalizationsin process, revolvesaroundthe steadystate effects
rather than the static effects. This rhetoric has fed on argumentsand calculationsbased on static effects,
but has not been checked by the extensionof those argumentsand calculationsto properly quantifythe
possible extent of steady state effects. We propose doing so for EC92 with a simple extensionof our
model. The present goal is not to describe the path of the EC after EC92, nor even to quantifythe net
long-run welfare effects of that path taking into accountthe costs of transition to a higher steady state
- 37 -
growth rate. Rather, we attempt to show how one can extend a relatively rich, detailed static model to
address the upper bound welfare effects of EC92 in the long run."
Our steady state calculations build on our static calculations in a simple way. In the static
calculationwe allowthe price of capitalto vary withineachcountry,whileholdingconstantthe aggregate
stockof capital in each country.The steadystate calculationessentiallyreverses this: we allowthe capital
stock in each country to be endogenouslydeterminedwhileholding constantthe price of capital in each
country. This approach is in the spirit of the equilibriumconcept proposed by Hansen and Koopmans
11972]and Dantzigand Manne119741for multisectoralplanningmodels:solvefor a time-invariantcapital
stock. An invariantcapitalstock equilibriumis a set of prices,productionand investmentlevels for which
the economy is able to grow at a steady rate with constantrelative prices. In our model the optimal
capital stock is defined as the stock such that the cost of investment,includingdepreciationand interest,
is exactly equal to the capital rental rate. This can be viewedas a multisectoralversion of the 'golden
rule" equilibriumfrom older growth theories.
The most importantdifferencebetweenour steadystate calculationand the Hansenand Koopmans
[1972] approach is that we do not explicitlymeasurethe commodity-composition
of investment.Hence
there is some uncertaintyregardingthe determinationof the steady-statecapital price. We simplyassume
that the price of capital, within each region, is identicalto the price of a basket of consumptiongoods.
When we further assume that the benchmarkcapital stock is optimal, then the steady-statecalculation
reducesto fixingthe capital price and permittingthe capital stock to find an endogenouslevel.
Weemphasizethat this calculationmeasuresan upperboundon potentialwelfaregains in the long
run. In the public finance literaturethere are manyexamplesin which steady state gains are large but in
the correspondingintertemporalmodel the gains are virtuallyoffset by adjustmentcosts. After all, the
" We wouldalso arguethat sucha calculation,while beingof interest in its own right, is also an important
(numerical)input into any calculationof the longer run growthpath that took account of transitionaldynamics.
- 38 -
capital stock can only be producedthrough investment,and that requiresreduced consumptionalong the
transition path. For sufficientlyhigh discountrates, the cost of the foregoneconsumptioncould easily
outweigh the longer-run benefitsof the capitalaccumulationit allows.
We believethat our approachis defensiblebecause it provides a meaningfulupper bound on the
potential gains from classical(Solow-type)growth effects. Of course, the values calculated in this way
could fail to capture growth effects arisingfrom inducedimprovementsin productivityor innovation(so
called "learning by doing").
Steady-State Welfare Effects
Table 3 shows the baseline steady-statewelfare effects of the EC92 program. The gains are
slightly more than doublethose from the comparablestatic model. Completionof the program results in
an aggregatesteady-statewelfare gain of 2.38% of GDP for the EC. The distribution of these welfare
gains, and related economiceffects, is shown in Table 4.
Explaining the Steady State Effects
In large measure the steady state effects are a reflection of the static effects. Examinationof
detailedproduction,trade, and pricingpatternsrevealsthe samestory as describedearlier. The exception,
of course, is that the capital stock is free to grow or contractto that level that keeps the price of capital
at its benchmark value. Since we generatedan increase in the relative price of capital in all regions in
our static model, this impliesthat there must be an expansionof the capital stock in each region in the
steady state. This expansionof the capital stock then works through in the model like an "endowment
effect", generatinglarger welfare gains sincethere are more resourcesto be employed.
- 39 -
5. Conclusion
We model the static and steady state effectsof completionof the internalmarket in the European
Communityon trade, productionand market structure. The impetus for changecomes from the removal
of border costs and standardcosts, as well as an increase in the perceivedsimilarityof nationalproducts
due to increasedacceptanceof commontechnicalstandards. Removingthe border and standardscosts of
intra-Communitytrade results in relativelysmall welfare gains. The additionaleffect of standardization
of consumerperceptions on market structure more than doubles the estimatedbenefits; and the steady
state growth effect more than quadruplesthe welfaregains, explainingsome t f the anticipatoryeuphoria
surroundingthe completionprograrr even before it is fully enacted.
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- 42 -
Table of Contents
Appendices
Table Al Effectsof EC92 on Output: IRTScomparedwith CRTS
Table A2 Change in the Valueof Exports to and Imports from EC Countries,
by Regionand Product
Table A3 Change in the Valueof Exports to and Imports from non-EC Countries,
by Country and Product
AppendixA: Algebraic Formulationof the Model
A-1
I Model Structure - An Overview
A-1
1.I Key Features
1.2 Markets and Prices
1.3 EquilibriumSurmnary
2 Equationsfor the Central Model
2.1 Markets - Primal Form Equations
2.2 Profit conditions
3 Pricing Equationsfor MonopolisticIndustries
3.1 CES Aggregators(primal form)
3.2 Associatedprice indices(CES cost functions)
3.3 Associateddemand functions
3.4 Firm behavior
3.5 The perceivedelasticityof demand
3.6 Applicationto the EC model
4 Formulationand Solutionusing Dual Joint Maximization
4.1 Integrabilitywith homotheticpreferences
4.2 Joint maximizationwith primal variables
4.3 Joint maximizationin price space
4.4 Dual joint maximizationwith price distortions
4.5 Dual joint maximizationformulationfor MRT
A-2
A-2
A-3
A-4
A-7
A-9
A-11
A-11
A-11
A-12
A-12
A-14
A-15
A-16
A-17
A-18
A-19
A-20
5 Singlecommoditysubmodelfor monopolisticsectors
A-20
AppendixB: Calibrating the Cost DisadvantageRatio
AppendixC: Standards and Buyers' IncreasedSubstitutionPossibilities
The Auto Case
UniformityStandards
Quality Standards
Other Motivationfor Standards
Small Firm Quality Assurance
AnticompetitiveMotivation
Conclusion
AppendixD: Data and Benchmarking
1 Assemblyand Reconciliationof 10 and Trade Data
2 Calibrationof the MonopolisticSubmodel
3 The BenchmarkEquilibrium
A-4
B-1
C-5
C-6
C-8
C-8
C-9
C-9
C-10
C-11
D-1
D-1
D-4
D-8
Table A1 Effw.tu of EC92 on output. IRTS compared with CRTS'
(percentagechange)
tor
AGR
FR
IT
AL
PT
UK
ROW
2.3
(O0n7_
3.3
(2.6)
-4.3
(-2.6)
11.9
(2.5)
2.1
(I.-1)
0.1
(404)
0.50
(0.2)
-7.2
27.8
,, ., t-5(-2.5) (8.9)
5.1
(2 0)
2.9
(1.8)
-6.2
32.7
4.4
(1.6)
-2.1
(-1.5)
0.0
(0.L0)
-6.2
10.5
0.0
5) (-3.S
)
(S.0(.6)
BE
DE
2.2
(-2.0)
-5.0
(-3.0)
..,,'4.7
DK
ES
18.2
t7.2)
3ET
-6.6
(-1.0)
1.8
(1.4)
1.3
(O.S8)
-0.5
(40T?
3.6
(3 6)_
-2.3
O
(-3.
NE
2.4
(5.4)
-5.3
(_5.6)
0.8
(3.6)
2.7
(1.7)
-0.3
(_1.7)
-0.2
(-0.4)
7.6
(4.2)
0.6
(0.1)
1.7
(1.1)
0.5
(0.4)
1.5
(1 2)
-2.0
_,(-1.8)
2.1)
(0.2)
(1.2)
(-0.8)
(6.0)
-3.0
(4 .2)
-13.8
(-5.0!
11.1
(3.7)
w~r '" Z2.8
1.7
-17.2
N
23.9
-0.7
1..211
18S
I
'
11 3)
8.6
)
4.4
(3.6)
0.2
(40.2)
4.1
(1.4)
-1.2
(-2.2)
0.3
(0.0)
-0.1
(0.0)
(-6.2)
(21.6)
(-7.3)
(-2.8)
(-1.6)
-6.6
(-I .I )
-2.1
(0.0)
-14.5
(-S.S)
-2.3
(0.S)
17.7
(4.6)
0.1
(0.I )
-9.8
1.8
-4.8
23.8
-13.0
4.2
-0.6
18.5
6.9
4.9
4.9
2.7
-0.8
-4.3
-0.3
-0.6
( )
-4.2
(-4.1)
-11.1
-5.9
(4.
-4.4)
5.1
(2.9)
10.3
(3.2)
-28.9
(-12.4)
-9.2
(-4,4)-
-0.4
(4024)
3.8
(2.3)
-12.7
(-7.4)
-0.6
(-1.7)
5.3
(2.6)
-3.5
2
-6.0
(-4.8)
0.0
(0.0)
2.6
(2.0)
-0.3
(4
. 12
)
- W 11.1 7.2
,4 '9.7)
(3,1)
-11.1
(-1.7)
-10.7
(4.7?
-7.4
0-0oL
3.8
(0.7
31.3
(20.1)
8.2
(4.4)
-3.9
(-2.7?
-0.4
(4.1)
-0.2
(-O.1)
TI
F
~
w4
g
>21.6
.f....f3'
.11.3)
. 20.7
, '.12. 1)_
..'
i
.
C
A/00
Wz,,
.
_6._
39.4
45.5)
.
4.4
(2.7)
-40.0
(-15.9)
5.4
(1.4)
(2.7)
6.7
0.6
(-2.4)
19.6
(-0.6)
(-6.1)
-6.6
-11.3
(-6.3)
M4143
'12.3)
6.6
(2.3)
-1.4
(-8,1)
-5.3
(-2.3)
4.8
0.1
(0.4) (2.0)
16.4
(0.2)
0.0
(0.0)
4.9
(2.4)
-0.5
(9.2)
1.1
(0.6)
-1.9
(2.0)
0.6
(-0.5)
-1.5
(-1.2)
3.9
(3.4)
7.0
(9.4)
1.5
(0.8)
-'.5
(-2.0)
0.1
(0.0)
8.8
_16.7)
0.5
(-0.1)
34.8
(37.0)
0.2
(0.2)
-6.3
(-7.4)
4.3
(3.1)
-17.5
(-14.3)
14.8
(13.6)
-0.4.
(-2.4)
0.1
(0.0)
<
.0z.2S.2
9.4
¢ ."Z,S4.S) (3.7)
3.5
(-0.2)
2.8
(0.7
4.5
4.5
(-2.0)
(-O.1)
-1.6
(-4.3)
10.7
(3.8)
-4.6
(-1.2)
-0.1
(0.0)
7!.,
.
5.9
(10.3)
0.0
(0.0)
(
-0.9
4.2
)
.
,',',. ,p0.8
..
.0)
-7.0
(-2.7)
-9.4
(-4.8)
-2.3
(-1.3)
-2.8
(-2.7)
25.5
(10.5)
-16.9
(-10.5)
-15.0
(-8.7)
(0.2)
(0.0)
1.7
(0.5)
1.0
(0.4)
1.1
(0.3)
0.6
(0.3)
0.8
(0.4)
0.3
(0.1)
1.9
(0.7)
0.7
(0.2)
1.2
(0.6)
0.0
(0.0)
-5.4
(-3.2)
0.4
(0.2)
0.0
(-O.1)
0.4
(0.2)
1.2
(0.8)
0.1
(-O.1) _
-1.3
-I.2)
0.4
(0.2)
0.0
(-O.1)
0.1
(.1
FINl
-3.7
(-1.6)
0.7
(0.3)
-1.6
(-I1.7)
0.8
(0.3)
0.0
(40.2)
0.9
(O.S)
0.7
_(40.3)
-1.0
(-1.0)
1.0
(0.6)
-0.1
(0.0)
TRN
-6.4
(-11.2)
-2.3
(-2.S)
-3.'
(-2.2)
-0.4
(40.6)
-1.1
(-1.6)
-0.8
(40.9)
-18.7
(13.4)
0.5
(40.9)
2.1
(I.0)
0.4
(0.2)
HEA
1.7
(0.8)
0.7
(0.2)
0.9
(0.4)
0.4
(0.2)
0.5
(0.2)
0.4
(0.2)
0.9
(0.4)
0.3
(0.1)
0.0
(0.0)(0)
DDU
0.2
(0.0)
0.5
(0.2)
0.6
(0.2)
0.1
(0. 1)
0.4
(0.2)
0.2
(0.1)
0.2
(0.1)
0.3
(0. 1)
0.0
(0.0)
ER
0.4
(0.2)
1.0
(O.)
0.6
(. (0(01)
0.3
0.5
(0.2)
0.4
(0.2)
-4.6
(-.)
0.0
0.4
(-O.1)(03(.)
0.0
UB
0.9
(0.3)
0.8
(0.3)
0.8
(0.4)
0.6
(0.3)
0.7
(0.3)
0.6
(0.3)
(
0.6
(03)
0.2
(0.1)
ON'
a. CRTS reault are in panthc.
_
-0.9
Shaded seconuLethose subject to IRTS.
-0.8
_
0.6
(0.2)
-0.2
0.0
0.2
(0.0)
Table A2 Chane im the value of exporb tod
hlmporbfromnEC oousbries, by regiomand product
(in percentage)
|
Elr
IM~~L
AGR 49
~~52
~135
FOO 132
BET
2
ee
S
17
13
0
_35
EXb
Dl
EX
lM
EX
im
EX
IM
EX
IM
EX
lM
EXI
IM
EX
54
93
38
26
35
156
41
Bs
42
148
18
52
0
0
35
Ila
792
11II
35
117
32
IJH
309
97
14
140
38
8
27
51
46
45
62
48
34
65
5
0
0
35
39
40
36
49
63
50
51
20
18
66
105
O
126
O
O
84
EX
Mf
17
3
-1
102
168
Q
-1
32
40
5
-9
53
14
7
1
o
-1
IIM
_6
.56
45
51
69
32
41
13
80
569
41
66
63
88
24
180
9
41
66
70
6
47
St
97
81
64
87
261
64
40
107
214
38
45
-10
2
121
44
64
47
159
104
3
61
160
63
84
Sl
124
81
102
K3
39
-5
-5
CM 66
35
68
62
MEb 89
2161
76
30
67
STE
74
NM I
IMA
SO
O
O
O
O
76
71
89
206
62
31
o
o
68
57
-4
o
100
60
III
5S
I IS
47
116
63
110
126
144
169
104
285
-3
2
56
89
91
78
107
74
77
89
53
so
57
96
434
34
107
-8
2
0
0
72
84
41
37
53
96
0
0
0
o
0
o
-1
o-
-4
0
OMA
0
0
36
24
ELG
34
28
71
49
27
57
92
203
86
159
103
93
52
24
119
95
69
116
VEH
132
69
S8
53
-17
552
71
65
63
60
79
96
73
64
10S
262
39
143
15
I 103
56
43
165
61
75
60
34
45
48
48
-6
2
7
12
24
25
13
21 121
30 12S_
12
22
23
2R
IS
21
41
1
-2
42
22
23
28
76
21
31
34
23
87
52
35
25
1120
36
2
41
47
3
O
PP
78
So
94
SS
99
10
10S
92
94
140
109
124
83
I1IS
41
8S
210
-2
O
RL
37
17
O
O
O
O
113
167
96 .133
103
23
O
O
62
313
O
O
-2
O
-4
113
22
17_ _16
20
42
2
2
46
2
7
-899
7
4
-4
1
-27
TX
WCOo
CON
70
8S
S
O
_
0
,37
16
12
9
O
O
O
O
FI
19
TN
-2S
28
9
iS
4
_3_
ED
O
O
O
O
O
O
slER~~
_~~
UB
O-
_~~~~~_
_
O
-17
a. See tble I for sedor nae.
52
709
24 121
O
_ O
35
12
24
17
-7
21
22
5
14
9
O
_
O
_
37-
_°
.130
O
871
49
O
o8
65
7
19
30
312
to
23
19
23
9
-6
6
O
O
36
17
3
-11
64
23
10
35
-7
O
-2
O
O
_-17
-
10
O
O
56
O
42-O-O
10-
- 10
40
14
O
SO
1
S5
4
O
O
O
O
6
-26
5
7
4-8
4
_
_
0
O
O
O
8a
4
Table A3 Change In the valueof expoeb to mnd Imports fronm on-EC oountries, by oountry end product
CaM
percege)
DE
BE
E.
l
AGR
FOO
O
BFL
Ull
LV
EX
_13
i
O
O
33_
A
19
57
2
-I
-4
-23
ELG-7
VEH
01E
~25
178
14
-1Q
W
0
O
WOO
O
0
.0
TRA
|
I
|LTRN
1
~ ~2
-1
_
O
°
1
-I
_
1
I
O
O
I
f1
5
W -2
-24
-2
2
O
191
-22
£EL
W
°
FM
0
PUB
0
-I
0
0
0
-
-321
p
O
AL
AL
AL
0
0
0
-I
0
6
0
-°
-
-5
20
-1_
_
_33
0
0
-
ALO
O
Q
0
-
2
1
-
6
-
-2
2
1
-3
-4
-I
-5
-6
0
0
3
3
-2-
-5
-S
-1
12
B2
-27
_
1
2
-5-4
-2
-30
4
0
-
2
5
-4
-
5
4
0
9
=
W
0
-
-9
0
=
-3
0
0
0
-3
-2
O
O
W
=
-2
2L
0
0
3
-2
2
-7
2
-25
0
O
2
-8
10
-8
5
-2
2
-
W
W
0
2
0
O
3
14
O
I
O
O
6
_
0
0
0
2
O
0
1
3
6
5
O
0
OO
-16
0
0
-10
0
4
0
-14
O
1
0
3
15
4
-
5
6
2
O
O
I
== 11
-3 _
4 -
O
0
A
O
A
-6
Q
0
O
O
O
0
O
2
0
O
-2
1
O
-9
-13
.
9
-7
0
6
1
2
A
5
-2
-4
A
-1
_L
3 O
_
O
560
O
O
O
7
0
AL
3
5
0
07
Q
O
1
0
-
-7
O
I
-3
O
Q
-8
2
-2
I
W
-I
-S
0O
°
0
-1
I
_
-2
°
O
2 =4 =2- 0 =2 4 2
4
11
-4
O
O
-2
5
_3
O
0
2158
O
3
EX 0W
EX
-
0
4
O
0
-8
O
0
-10
46
3
I
-9
-I
-2
-I
4
0
8
0
O
O
11
-2
-08
°
Q
°
5
4
1
-
-2
===
-6
_
3
O
_4
O
0
0
O
1
O
0
O
_
4
=1
-3
_2
15
-W -
_
0
O4
-1
-4
4-2
EX
EX
RW
R
UK
r
|PlT
-
6
4
O
-I
L1
01MA
_
1
Q
tT
ir
Er
2
0
O_
0
IA-2
-3
_3W4
-160
-7
22
-3
0
N-2
|
lL
26
-I
FR
DKES
1m| L.
D
1
0
9
42
O
-
O
0
0
AL
AL
0
0
0
0
0
0
0
A
0
Appendix A: Algebraic Formulation of the Model
This appendixpresentsthe mathematicalstructureof a multi-regionalgeneral equilibriummodel
which has been developedfor trade policyanalysis.We refer to the model as MRT. These notes provide
a detailedreference which complementsthe model's GAMSsource code. Detailsof data preparationand
calibrationare provided separatelyin AppendixD.
Section 1 presents a general overviewof the equilibriumstructure. Section 2 presents a more
detailedalgebraicrepresentationof equilibriumconditionsfor the central model. Section3 developsthe
pricing equationsfor monopolisticsectors. Section4 describeshow the central equilibriumstructure is
representedusingdual joint maximization.Section5 summarizesthe partialequilibriumsubmodelswhich
determineprice-cost marginsand the numberof firms in monopolisticsectors.
1 Model Structure - An Overview
1.1 Key Features
The main features of the modelare describedin the text. They are:
* 12 regions: Belgium, Denmark, Spain, France, Italy, Netherlands, Portugal, United Kingdom,
Morocco, Turkey and Rest-of-World.
* 26 traded commodities.
* Monopolisticcompetitionwith increasingreturns to scale in a subset of 12 industries.
* A flexible Armingtonstructure in which commoditiesare distinguishedby country and/or region of
origin. Market integrationis representedby a changein the preferencesof consumerswithinthe
EC so that intra-EC goods becomecloser substitutes.This induceschangesin producerpricing
for sectors subject to monopolisticcompetition.
A-1
* Two types of resource-consumingnon-tariffbarriers: "borders costs" and "standards costs", both of
which are affectedby the EC92 program.
* Multipleprice-wedgedistortions:factor taxes in production,tariffs, export subsidies, voluntary-export
restraints (representedby ad valoremequivalents),non-tariffimport restrictions(also represented
by ad valoremequivalents).
* Full general equilibriumstructurewith input-outputtablesand fully endogenousprimary factor markets
in all regions.
1.2 Markets and prices
The followingnotationalconventionsare adopted:
ij
are used to index goods.
r,r'
are used to index countries/regions.
f
is used to indexprimary factors (laborand capital)
P,
refers to a market price index. Unlessotherwise noted, the benchmark value for any
market price is unity.
X'
refers to the benchmarkvalue of a quantityvariableX. When reference prices are unity,
all quantitiesare measuredin billionsof 1985U.S. dollars.
The equilibriumstructure of the model is based on the followingmarket prices:
PUr
Price index for final consumptionin region r.
PSj,
Consumer price for the Armingtonaggregate of good i in region r, inclusive of all
applicabletariffs, border costs and monopolisticmarkups.
PY;,
Supply price (marginalcost) of good i from region r, excluding fixed costs associated
with the productionof goods in industriessubjectto increasingreturns.
A-2
PVi,
Price indexfor factor inputs(value-added)in sector i, region r. This price is gross of all
applicablefactor use taxes.
PM,
Aggregateprice indexfor importsof goodi into region r - applicablewhen regionr has
not been integrated.
PEi,
Aggregateprice indexfor importsand domesticsuppliesof good i from all EC countries
in an EC regionr - applicableonly when EC marketsare integrated.
PNi,
Aggregateprice index for importsof good i from non-EC countrieswithin an EC region
r - applicableonly when EC marketsare integrated.
PFf,
Price for factorf in region r.
1.3 EquilibriumSummary
Finaldemandin each regionarises from a singlerepresentativeagentmaximizinga Cobb-Douglas
utility function subject to a budgetconstraint. Income consistsof returns to primary factors (labor and
capital) and tax revenue rebated to the consumerin a lumpsum.
Within each region, final and intermediatedemand are expressed for the same Armington
compositeof domesticand importedvarietiesof individualgoods. In the non-EC regions (and in the EC
regions prior to market integration),the composite "supply"is a nested CES aggregate in which at the
first level domestic varieties trade off with imported varieties while at the second level there is
substitutionbetween importsfrom different regions. After integration,within EC regions, the structure
of this Armingtonaggregationchangesto reflect improvedsubstitutabilitybetween commoditiesfrom
different EC memberstates.
Productionhas iastandard structure with fixed coefficientsfor intermediateinputs and a CES
aggregateof individualprimary factors comprisingvalue-added.
A-3
Two types of costs are associatedwith inter-regionaltrade. First, we introduce "standardscosts"
through which a product variety producedin one country requiresadditionalvalue-addedin order to be
sold in a second country. Second,we accountfor "borderscosts"representingcostsof transportinggoods
betweendifferent regions. Both of the costs are zero for domestic sales.
Some of the commoditiesare produced subject to increasing returns to scale with free entry
drivingprofits to zero. In this frameworkprice-costmarginsare determinedby Cournotcompetition(with
fixed conjectural variations). In equilibriumfirms enter the market to the point that revenues from
markups on marginal cost exactly balancethe fixed costs of production. Changes in market share or
elasticitiesof substitutionin demandaffectthe optimalCournot markup,so our modificationof intra-EC
elasticities(whichwouldhavenot effect in a modelof perfectcompetition)here causessignificantchanges
in supply prices and market share.
2 Equations for the Central Model
2.1 Markets - Primal Form Equations
(i)
Regional output:
Xi,,,
Y-,
(1)
I,,
where
(ii)
Yi,
is output of good I in regionr,
X,,,.
is exports of good i from region r to r'.
Regionaldemand:
Si, =
where
aYj, + T,
is total supply (productionplus imports),
Si,
C1,
+
-
is total final consumption,
a,,
is intermediatedemand coefficient,and
T,l
is demandfor good i in transportcosts.
A4
a2)
(iii)
Value-added:
Vj, - aj,',, +
jA,,
+fi, N.,
(3)
,:S,~~~~~~~~~I
where
<,
is total sector i value-added,
ay,,
is value-addeddemandcoefficient,
a',rr'
is the standards cost coefficient for shipments of good i from region r to
region r.,
(iv)
f,
is the fixed cost per firm, and
Ni,
is the numberof firms (for IRTS sectors).
Primary factor markets:
Ff
where
F,
(4)
the rrice-i-esponsivedemandcoefficientfor factor in sector i.
Armingtonsupply for non-integratedregions r:
~
S,F
~
where
a&
is the endowmentof factorf in region r, and
aF fiis
(v)
E
~
'i
HI,
Sj,
is the benchmarksupply,
r?,r
is the value-shareof domesticsupply
X,,,,
is benchmarkexports of good . from regionr to region r',
OM,'
is the benchmark value share of region r exports in region r' imports,
and
PDMI,PMZM
are determinedby the Armington elasticitiesof substitution, aDM and
mm pm. a
v-
1
A-5
(vi)
Armingtonsupply for integratedregionsr:
f
Si,
o.
I
where
Ir'C
E
1
+ (1~aC
X~
IC
,
':
6
fAfI,
aec
is the benchmarkvalue-shareof EC imports,
PC,.
is the value share of imports from region r in all imports from EC
countries,and
96/x.
is the value share of importsfrom region r in all imports from non-EC
countries.
(vii)
Value-addedsupply:
F
vi, = VP,x E iflr
where
V.,
aSi,
4|
is benchmarkvalue-added,
is the benchmarkvalue share of factorf,
a,
is the benchmarkinput coefficient,and
p,
is determinedby the elasticityof substitution.
(viii) Border/transportcost:
O
where
r
i-if
is the indexof the single commodityemployed, for transportservices,
and
is the transportation cost coefficient.
A-6
(ix)
Welfare index:
w, '.
(9)
[ cl
is benchmarkfinal demandfor good i, region r.
where
2.2 Profit conditions
(i)
Value-added:
is the ad-valoremfactor tax rate
where
is the benchmark(tax-inclusive)price
PVs,
(ii)
(10)
l
PVv, l J
Marginal cost:
PYa,- aPVL.
+
(11)
EafPSj,
(iii) Armingtoncompositesupplyprice for non-integratedregions:
PS,,
j
a
|
PDI;;I' PM,,J
( -
,')[-
(12)
in which:
(13)
PDD- (O+A,,)PY,,
and
PM,,- [
G[, (1 +lA)(
+ i)(PYw,+A,,PT,i+astPV i)]
,
|
(14)
and
PT,, - PSI,
where
(15)
is the markupon marginalcost on sales of good i from a firm in region
r in region r..
A-7
is the ad-valorem tax rate which incorporates import tariffs, export
subsidiesand various non-tariffbarriers,
(iv)
PDj,
is the benchmarksupplyprice for goods rrom domesticproducers,
PM;,
is the benchmarksupply price for imports.
{
Armingtoncompositesupply price for integratedregions:
E
PS,, =
~"rPN
PE
1.,1
+
PEi,
(I-cg,,) |
1"
|
PN
(16)
J
|
in which:
[(I+Ai
1,,)(1+ ,)(PY,+#,,.PT,+asPVJ] |
,E
, 1 4 ,EC
(17)
and
PNM, |1.
where
9,,
+(l")(,1+!,)(Pi+,,,PT,+apJPVir,))
(18)
PEj,
is the benchmarksupplyprice for importsfrom EC countries, and
PN,
is the benchmarksupply price for importsfrom non-EC countries.
A-8
(v) Regional income, includingfactor income, tax revenueand profits from monopolisticsectors:
1,-
FfrPFf, +
income from primary factors
E 9,,,
ii,,,(pY,,,+#,,,PT,+ai,,1PVi,,)X.,, +
net tax revenue and NTB rents on imports
S(1-6
,)
, (Prf,+f ,,PT,+as,,Pv,) X,., +
(19)
i'd
net tax revenue and NTB rents on exports
4, PFf, aœr,V, +
factor tax revenue
£E
[ Al, (I +117) (Pi? +
,PT+ajPV.;
X,,
-
PK. ji, Nj,
monopoly markup revenue less fixed costs
where 0!., is the share of trade taxes accruingto the importingcountry,r. In most calculations,free entry
assures that monopolyprofits are zero.
(vi) Final demand:
ci, -L,
l,
(20)
(vii) Free entry zero profit conditionfor monopolisticfirms:
N
Nj,s
[ F;,0(I+t;,,,)(PAj,+#j,,fPTf
+as V,) Xj
(21)
~~~~~PV,l
f,l
3 Pricing Equations for Monopolistic Industries
The followingfeatures characterizethe modelrepresentationof industriesproducingunder IRTS:
A-9
* Goods are distinguishedby firm, by regionand by area of origin. An area may contain one or more
regions. Within a given country, for example, an area of origin may be "imported" or
1 '. The first of these containsall regions other than the importing country itself. The
"domestic
second contains only a single region.
* Demands arise from a nested Constant-Elasticity-of-Substitution
(CES) structure. At the lowest level
is a CES aggregateof supply from tirms in a singleregion r. At the next level, region r supply
trades off with other regions from the samearea, and at the top level, consumerschoosebetween
aggregate commodities from different areas. For example, in the EC following integration,
consumers distinguishbetween EC and non-EC commodities.In all other countries as well as
within the EC prior to integration,consumersonly distinguishdomestic and imported varieties.
Demand for the final compositearises from consumermaximizationof a Cobb-Douglasutility
function, so that the Marshalliandemandfunctionexhibitsa unitary price elasticity of demand.
* Producerscompete in quantitiesbased on a Cournotmodelwith fixed conjecturalvariations. Markups
on over marginalcost are based on maximizationof profit. Profits fall to zero, however, due to
free entry. Fixed costs at the firm level are exogenous,and as markup revenues change, so too
does the number of firms producingwithina givenregion.
Algebraicrelationsfor supplyof a singlecommodityto a singlemarket will now be outlined. One
such set of equationsapplies to each market for commoditiesproduced subject to increasingreturns to
scale. The followingnotation applies:
X
Aggregatedemand;
Yk
Supply from area k;
S,
Supply from regionr;
qf.
Supply from firmf in region r;
P
Price index for aggregatedemand;
A-10
Pk
Price index for supply from area k;
w,
Price index for supply from regionr; and
7rf,
Sales price for supplyfrom firmf in region r.
3.1 CES Aggregators (primal form)
X
[
Ciira^";
x.s
[
,s1/ S-]
&'=
[Eg'
(22)
j:T(23)
(24)
]
3.2 Associated price indices (CES cost functions)
(27)
w,= (Fah p<)T
3.3 Associated demand functions
(28)
~~~~
(29)
[Pk
SI=F IP
|Yk for
A-1l
k-k,.
(29)
)
3.4 Flrm behavior
Consider the optimizationproblemfacing firmf in region r selling into a given market. Profit
is given by:
flr(q) - wlrq - Cf>(q)
(31)
First order conditionsfor profit maximizationare:
ar=,- air q
+ xft - c>,(q)
(32)
wu~q
aq~
aq
in which cf, representsthe marginalcost of supplywhich is treated as exogenousin this derivation. The
first order conditionsmay be written:
(K-r,A,)
in which mr, is the markupover marginalcost (expressedon a gross basis):
cf,=
1I
,r,,
(33)
(34)
_ at,, qf,
8awf,.ef,tr
-
In this equation e,, is the "perceivedelasticityof demand".
The pricing equationspresentedhere are easy to interpret,but they are somewhatmore difficult
to derive. The expressionfor e,, arises from the nested CES structureof demandtaken together with the
Couraot assumptionsconcerningthe responseof other producers.
3.5 The perceived elasticity of demand
Begin with the inversedemandfunction:
(35)
S I= w
We then compute the derivative:
aw,,
q,,
lw,, + 5" as, + ,aW,
f
qM
e S, qf,
(36)
w, aqf,
Under Cournot conjectures'
I For simplicity,the equationspresentedhere are based on unitary conjecturalvariations. Conjectures
departing from one are a simple extension.
A-12
as, s
(37)
S,r
aQft
lJqf'
J
dw,
and the term aw' is computed by applying the chain rule a second time:
aqfr
dw,
aq',
as,
as, aq,,
-w,
(38)
Combining, we have:
-If
I-I
+ --
--
+
e5 q,
aqf,pfr, f
qfq S,]
aw,
w, qf,
as,
(39)
Make the substitution:
Iqf-1/,
(40)
to obtain:
1
e
ef,
dw, S, 7rfrqf,
1 r qft
w,S,
(41)
oS, w, w,S,
Apply similar steps at the next level to obtain:
Ow,5,
I
as,W,r
nt1
w,S, +aPk Y W,S,
OYkPkPY
7 kYk
(42)
Apply the operations again, taking into account the fact that demand elasticity for aggregate X is unity:
aPk Yk
-
ay, Pk
I
I PAY,
aPXPX
m --
a
PkYA
-~
PX
(43)
We then may assemble all of these equations to obtain an expression for the optimal Cournot markup.
To simplify notation, we introduce:
= Wp,S
for k-k,
-t
(44)
and
'
=X
pk
Px
We then have:
A-13
(45)
ah
.
-_
(46)
_-_
+
3.6 Applicationto the EC model
In our modellingwe begin with two distinguishedsupply areas in each market: domestic and
imports. There are three associatedelasticitiesof substitution:
is the elasticityof substitutionbetweengoods supplyby different domestic firms
ODD
mm
jis
the elasticityof substitutionbetweenany two foreign supplies, whetheror not they are
firms within the same region, and
is the elasticity of substitutionbetween goods from any pairs of domestic and foreign
ODM
firms.
Let
r,,,
denote the market share of region r firms in region r'.
In the benchmarkwe haveonly domesticand importedfirms distinguished.Applyingthe formulae
above we thereforehave two different markupequations(one for sales into the domestic market and the
other for export sales):
~~+fiiJ+[.iJzrr
=
I
ODD | aDM
I
+
laMM
ODD |
N,
umJ
NO
ODM|
+ ItODM
[,
N,
(47)
1r
ODM]
N,
where
6,9
eM
(48)
F,,#
In the counterfactualexperiment which we interpretas "market integration," we modifythe
structure of demandfor consumerswithin EC countries. In the modifiedfunctions,firms withinthe EC
area are distinguishedfrom non-EC firms. The elasticityaDD determinesthe trade-off betweenany pairs
A-14
of EC firms (whetheror not they are in the same country),whileaDM
determinessubstitutionpossibilities
betweenEC and non-EC supplies.The elasticityof substitutionbetweentwo non-EC firms remain equal
to OMM-
The mark-upequationstor firms selling into the EC market become:
I
+
aDD
5
Ut
OUM
+
I
I aDU
I
+
-r
DD
N,oEC
I -
I |
OMD
0;."]N~'c
+ [i-
Dm a.<MIN(10
rE EC
N,
(49)
..ODM~.rOEC
N
Markup equationsfor sales into non-EC countriesare unaffected.
4 Formulation and Solution using Dual Joint Maximization
It is well known that an undistortedcompetitiveequilibriumcan be represented as the solution
to an appropriatelyformulatedrepresentativeagent problem. In a model with multiple consumers with
heterogenouspreferences and endowments,the main difficulty with the optimizationapproach lies in
detcrmininga consistentset of Negishiweights on individualagents' welfare. Further difficultiesarise
when market imperfectionssuch as taxes, tariffs or monopolisticmarkupson marginalcost are present.
Despite these difficulties, the optimizationformulationremains attractivebecauseof the efficiency and
robustnessof commercialsolversfor large-scalenonlinearoptimization,such as MINOS(Saunders)and
CONOPT(Drud) - both of which are availableas GAMSsubsystems(see Brooke, Kendrickand Meeraus
[1986]).
We solveour MRT model usinga representativeagent approach.The noveltyof this work is that
we formulate our subproblems in prices rather than quantities, and we employ the SequentialJoint
Maximization(SJM) algorithmof Rutherford[1992], in which the Negishi weights are calculatedwith
A-15
a simple Jacobi iterations. MRT represents the first large-scale aipplicationof the dual-form SJM
algorithm.
This section begins with an introductionto the SJM in a general framework. It concludeswith
an overviewof the SJM procedureas it is appliedto the MRT model, incorporatingmonopolymarkups
and tax distortions.
4.1 Integrabilitywith homo.hetic preferences
Consider a simple economicequilibriummodel in which consumerpreferences are homothetic
(i.e., all income elasticitiesare unity). Definethe expenditurefunctionfor householdh as:
ej(7r) = min irT d
Ub(d) = I
s.t.
in which Uhois the utilityfunctionfor consumerh, ir is a vector of commodityprices, and d is a vector
of commoditydemands. Without loss of generality,we may assume that Uhois linearly homogeneous,
so UMb
=
X Uh(d). For this case, the expenditure function provides an index of the "price of a unit
of utility".
If consumerh has commodityendowmen:sub, the maximumattainableutility at market prices
ir is then given by the indirectutilityfunction Vh(r) = 1rTWh/ eh(7r).
Let n =
ohstand for aggregateendowmentvector and initiallyassume that W. = OhD. The
Wh
excess demand function representingthese preferences and endowmentsis "integrable". To see this,
considerthe joint maximizationproblem:
max W(U1(d1),. . .,UH(dK);0)
dh
s.t.
r Et d5
-
IIh Ub(db)h
7r n
where W(.) is a Cobb-Douglaswelfarefunctionintowhich are nestedthe utilityfunctionsof the different
households. Due to homogeneity,we can reducethis problemto:
A-16
maxIf
t
Ub
s. t.
Eh e,(7r)
Uh
-
where expenditure functions eh(wr)are evaluated at prices defined by Lagrange multipliers at the
maximum.
A Cobb-Douglasfunction impliesdemandfunctionsbased on fixed expenditureshares for each
2
household. Here, this implies the followingrelations:
irT dh
e,(7r)
Ub
oh9
-
(ir' ()
~=
XrT(oh
~~3
4
7rTWh
U
In other words, the value of consumerh expendituresequalsthe value of consumerh endowments.This
is true because the Cobb-Douglasvalue shares in W(U;O)correspond exactly to shares of aggregate
endowments. It follows that for any price vector 7r, the demand vector arising from the jointmaximizationproblem is the same as would result from summingH independentdemand vectors. This
result corresponds to Theorem 4 in Eisenberg [1961]; for a rigorous economic interpretation, see
Chipman (1974].
4.2 Joint maximization with primal variables
Assumethat the demand side of the economyis characterizedby linearly homogeneousutility
functions Uh(d) and endowment vectors w, not necessarily proportional. Let the supply side be
representedby a set of J constant returns to scale technologies.A unit netput vector for sectorj, x, is
selectedfrom a convex productionset T. Constantreturns to scale prevail in all sectors, so that Xx v
X > O is feasible for anyxx E T
2
Justification:
1:
2
3
4
Implied by the definitionof e()
Follows from the Cobb-Douglasstructureof the aggregationfunction.
Follows from linear algebra.
From the definitionof u^.
A-17
A competitiveequilibriumin this economyis characterizedby a vector of market prices, w, and
a vector of activity levels, y, which satisfy the followingconditions:
Market clearance:
w; 2
Ey xf +
j
Zero profit:
h
d,
A
vJ
_rTXi 2 0,
Budget balax.ce:
7rT78
irTdh,
vh
In addition,the choicesby consumersand producersmust be independentlyrational. Hence, dl maximizes
Uh(d)
subject to budget balance, and x. maximizesunit profit (wTx)subject to technology constraints(x
E7).
The equilibriumis supported as a solutionof the joint maximizationproblem:
max W(U) = f
UA(dA)&
h
S.t.
(50)
xi +
wŽ 2 sd',
vi
A competitiveequilibriumis representedwhen the Negishiweightsare chosen so that 0b is proportional
to irTwA.The SJM algorithm searches for 0b values by successive approximations in which th;eLagrange
multipliersfor the previous iteration are used to form an estimatefor the welfare functionbudgetshares
in the subsequent iteration.
4.3 Joint maximizationin price space
Let eb(r), the unit expenditurefunctionfor consumerh, be defined as above. Let oj(ir) be the
analogous"unit revenue function"for sectorj, definedas:
oj(r) a max 7rTxs.t. x E Ti
Sheppard's lemmacharacterizesconsumerdemand and producernetputs:
T
dA(lr) = Ve,(7r)e )
eA(-r)
A-18
and
xj(7r) - Vj(Ir)
Using these relations and identifyingthe Lagrange multipliers as the activity vector y, it is
straightforwardto show that the Karush-Kuhn-Tuckerconditionsfor the followingnonlinear program
correspondto a competitiveequilibriumfor the underlyingeconomy:
max
s.t.
1'A log(e,(ir)) - irrw,
.(wr)s 0
vj
The SJM iterations follow a sequence of maximizationproblems in which, for iteration k,
C,
=
(-,,
4.4 Dualjoint maximizationwith pricedistortions
In the general equilibriumstructure price distortionscan, without loss of generality, be applied
only to the supply side of the economy. Supposethat xi is chosen to solve
max *Tx
s.t. x E TJ
in which * is a vector of tax-distortedprices (users costs), for example: *.i = iri(l+t~,). When ta"
distortions are present, the tax revenuereturned per unit operationof sectorj is given by (7r-*)Tx.
In order to accommodateprice distortions in the dual joint maximizationprocedure, the tax
distortionsare introducedinto the constraints,and the tax revenueeffects are treatedsymmetricallywith
factor endowments- using laggedvalues for productionactivities. The generic dual-form optimnization
problem is:
max E
1. log(e,(w))
4(
- irT w,
-
s.t. X,(*) 5 0
A-19
e9j Vx (7- r)
O
in which qh is the fraction of sectorj tax revenuewhich accrues to householdh and where Y and £are
lagged values for the sectorj activitylevel and netputvector, respectively.
4.5 Dual joint maximization formulation for MRT
The MRT model is formulatedas a joint maximizationproblem in the spaceof prices. In every
major iteration,the followingnonlinearprogrammingproblemto refineestimatesof prices and quantities
(activitylevels and trade flows are determinedby the value of Lagrangemultiplierson the corresponding
zero profit constraints):
maxE
1, log |lPS:'
J
-
(10)-(18)
In this calculationIr(X,V) standsfor whatappearson the right-hand-sideof equation(19), evaluatedusing
s.t.
the current estimatesfor trade flows and value-added,JZ,,, and t,.
For purposesof determiningsectoralprices and incomes,monopolymarkup rates (i,,,.) areheld
fixed. A consistent equilibrium's obtainedthrough a recursive procedure in which calculationsof an
equilibrium for the central model alternate with single sector simulationsfor individualmarkets to
determineoptimal markups and numbersof activefirms.
5 Single commoditysubmodel for monopolisticsectors
The equi ibriumconditionsfor marketswheretechnologiesexhibit increasingreturns to scale and
firms price above marginal cost do not fit into a Negishi-typecomputationalframework. We have
therefore adopted a decompositionprocedureto overcome this problem. In our computations,separate
systems of nonlinear equationsgenerateconsistentapproximationsof market shares, numbers of firms
and markupsover marginalcost for each commodity.Demandsand suppliesfor all regions are included
A-20
in these systems of equations, although factor markets, income effects and intersectoral linkages are
ignored. In every iteration, regional demand functions are calibrated to the most recently calculated
general equilibriumsolution.
The singlecommoditymodelsare formulatedwith marginalcosts assumedconstant. This seems
appropriategiven the degree of disaggregation(no monopolisticsector commands more than 2% of
aggregateexpenditureor value-added).Givenconstantmarginalcosts, the sellingprice is thendetermined
solely through the markupequations.
The single commoditymodelsincludefour classesof equations:
* Inverse demand functionswhich translatemarkupsand exogenousmarginalcosts into sales prices.
* Equationsrelatingthe numberof firms to sales volumes,trade flows and (exogenouslyspecified)fixed
costs. These equationsembodythe assumptionthat free entry drives profits to zero.
* Markup equations, as derived in section3, which definemarkups over marginalcost as a functionof
market share and iumbers of firms.
* Ordinary demand functionswhich translatesales prices into trade flows.
A-21
AppendixB: Calibrating the Cost DisadvantageRatio
We assume that total costs at the level of the representativefirm may be specified as:
c = f + mq
wheref is fixed costs, m is constantmarginalcosts, and q is firm level output. Averagecosts are then:
ac
f +m
q
Assumingzero profits, data in the initialequilibriumprovide informationon the industry total costs (C)
and industryoutput(Q). If there are n representativefirms initially,then nc, - C, and nq, = Ql, where
the subscript I refers to the data of the initial equilibrium.Since
c'
ncfl
C,
q,
nq,
Q'
the initialdata provides one point on the firm's average cost curve:
c,,
f
+ m.
q,
q,
Given the specified functionalform of the average cost curve, it may be calibrated if a second
point is known. Supposewe have an estimatethat if output declinesto aq, then average costs increase
to ( I) where 0 < a < 1, , > I and where ia < I is required for marginal costs to be non-
negative. This provides a second point on the industryaverage cost curve:
C
q,
f + m.
atq,
Multiplyingnumerator and denominatorin the last two equations by n, we obtain equations
involvingindustry output and costs, on whichdata is available.Thus we have:
C,
Q,
F
Q,
and
B-l
Q,
r
where F is industr-yfixed costs. Solvingtheseequationsfor industryfixedcost and industry marginalcost
yields:
F =Cl
1
- I)
t
and
Since the cost disadvantageratio (CDR) is definedas
c
which by symmetry equals F we
C
know that at the initial equilibrium:
CDR = ($-1)cr
i -'i
We obtain the values of a and a primarily from engineeringstudies summarizedby Pratten
[1987], a synposisof which is availablein Emersonet al. [1988].We enterdata for these two parameters
at the 44-sector level correspondingto the sectors in the EC input-outputtables, and then aggregateto
the sectorsof our model. The mappingand sourcesof our CDR estimatesare provided in Table B-i. The
final, aggregated,CDR estimatesused in the model are listed in Table I in the text.
Followingothers such as Gasoriek, Smithand Venables[19921,we assumethat the initialoutput
level is at the minimumefficientscale (MES).This is not an unreasonableassumption,since firms should
have difficulty competingat less than MES. However, given our assumed functional form, at MF.S
further cost savingscan be obtainedby expandingoutput.To the extentthat output is less than MES, we
have indeedunderestimatedthe CDR, sincethe slopeof the averagecost curve increasesin absolutevalue
for decreases in output.
B-2
Table B-i: Source of Data on CDR Values
Sh of M3
Sec¶r
0W4" (a)
*
Level()
AOR
.
BEV
BUS
CHM
COA
0.33
.
Perceg
Coti
lecrima at OuVut
5
lfpbli
_
_
_
CDR
_
_
0.0D0
0.025
S<une ol Daet'
_
_
_
_
_
_
_
_
_
_
_
_
_
_
_
_
_
_
_
427, Table 5.5
.000
0.33
.
4-19
0.057
0.000
.
o.oo
0.33
.0.0
5-10
0.037
cor.
COM
CON
.
ELE
ELO.
0.33
0.33
5
5-15
FIN
HEA
LEA
MAC
MEA
MET
0.5
S
0.33
0.5
0.67
0.33
I.5
3-8
5
10
MLK
0.67
0
OFP
OIL
OMP
ORE
OTR
PAP
P8D
PH8E
PSB
PUB
RE8N
344 (-Teeco
No imfza,ub
auniinlm
Equimeal
in Pmuni)
0.000
EDU
has
NMM
NUC
OFM
25
0.33
0.5
0.33
10-26
10
5-10
0.67
0.33
0.5
0.33
0.5
0.5
.
4-9
4
3.5
10-11
8-2D
9.13
.
.
.
0.025
0.049
Table 5.36. S3cr
342. 346
16. intrpohbiu
0.050
0O.0D0
0.007
0.055
0.102
0.049
Table 10.1 Pnfl
No ilfem.
451
321, 322, 326
412
221
0.
lwaeOm
0.000
0.09
0.100
0.7
Tabbe 10.1 ProaMu(-AarcbhW
241-247
5sTbhs 53 -aprximeon
33
0.132
0.020
0.040
0.452
0.140
0.110
0.0C0
0.000
0.000
0.000
0.000
411-412, 42D, 422, 423 (iym
14, Table 5.5
322
22
36
471. 472 (p
in4 pril
in. ionm
and
aipatk)
lou1r)
0.000
REP
0.000
RE5
RPL
TOB
TRA
TRN
TRS
FIX
TXC
VEH
0.33
0.33
0.33
.
0.33
.
0.5
0.5
5-10
2.5
WOO
.
.
.
.
2
0-2
11
0.037
0.017
0.000
0.00D
0.010
0.000
0.010
0.110
0.000
4.I
429
Table 10.1 Pratag dika smael RTS
Ta
10.1 Psulo
Table 10.1 Pa
Itrpolo6aa
Table 10.1 PaBe
amly ii 2-10, Cl1doig i cledrty 0
Tex1
Fredwr'
Wmtin, end Wagg.
Table S.3
Data correspondto the paramnetera in the CDR calibrationequation.
b
(8-1) *
100 corresponds to the data in the column where 1$is from the CDR
calibrationequation.
¢ Numbers indicatedare sectors from Table S. 1 of Pratten [1987] unless otherwise
indicated. Where other tables are listed, these are also from Pratten [1987).
B-3
For our preferred point estimatesof the CDR we use the midpointof the range of the estimates
shown in Table B-i. We take the upper and lower boundsof the range of these estimatesfor our high
the CDR.
and low estimates%of
B4
AppendixC: Standards and Buyers' Increased Substitution Possibilities
This appendixbriefly reviewsthe theoryand empiricalwork on standards.We concludefrom this
review that the impactof the EC92 single market program regardingstandards will be to substantially
increasethe abilityof EC buyers to substituteamongthe products of EC suppliers, therebyjustifyingour
modellingfocus.
There are literallythousandsof industrywideproductstandardsin existencein the U.S. Following
the survey by Hemenway119751,we broadlydecomposethese into standardson product uniformityand
standardsori productquality. Uniformitystandardsrefer to matterssuch as the dimensionsor architecture
of the product (e.g., electric lamp sockets,telecommunicationinterconnections,bed sheets, record sizes)
that typically allow consumersto interchangeproductsof different suppliers. Product quality standards
distinguish products by better or worse. Examplesinclude USDA standards on orange drink, peanut
butter and meat.3
Most industrywidestandards in the U.S. are voluntary,' and there are a number of important
factualobservationsregardingthem. First, and most importantfor our purposes,the vast majorityof both
types of standards serve to significantlyincreasethe abilityof buyers to substituteamong the products
of competing sellers. This is most evident with uniforrmitystandards which are primarily designedto
allowbuyersto use different sellersproductsinterchangeably,if not as perfect substitutes.But an increase
in the elasticity of substitution also occurs due to quality standards when, as is typical, they reduce
product differentiation advantages of brand names.
3 Sometimesdimensionalstandards mayhavequality aspectsas in the case of lumber yard standardson the
two by four to prevent adulterationor degradation.
'Only abuut3 percent of the 14,000 formalindustrywidestandards in effect in 1964were written under
governmentauspices. See Hemenway11975;p.81 1.
C-5
Second, notwithstandinga numberof considerationsthat have inducedsellers to seek and obtain
standards, the principalbeneficiariesof standardsare buyers, not sellers, and not surprisingly therefore
the principal impetus for standardshas come from buyers. Third, standardsare most likely to occur in
markets where buyers are concentrated.This is becausethe benefitsof standardsare like a public good
which falls on all buyers, who can free-rideon the lobbyingcostsof those who incur costs to obtain the
standards. The single most telling piece of evidencein support of these latter two points is that the vast
majorityof industry-widevoluntarystandardsare in producersgoods.
Fourth, since standard setting is so widespreadthe subject is vast and there are other many
considerations that lead the establishmentof standards, including supplier driven concerns such as
economiesof scale benefits, anticompetitiveand protectionistmotivations,and the desire to avoid freerider problems on product quality that coulddestroy the market.5 These considerations,especiallylegal
prohibitions against intra-EC importsthat do not meet nationaltechnical requirements,are specifically
addressed by the single market program. The single market program will serve to increase buyer
elasticities, since the European consumerwill be able to consumeproducts from other EC states that
previouslywere illegal to import.
The Auto Case
Beforediscussingthe subjectgenerally,we discussthe caseof the U.S. automobileindustry since
it serves to illustrateand clarify these and other points. During the fitst decade of the 20th century, the
auto industry was composedof a large numberof small firms, a.semblers and parts suppliers. Products
such as wheelrims, sparkplugs and nuts and bolts were not standardized;rather partsweremanufactured
according to the peculiar specificationsof each assembler,who often relied on only one parts supplier
I For a fascinatingsurvey see Hemenway[19751,which is the sourceof the informationin this appendix
unless otherwisecited.
C-6
for a particular part. In 1910, a crisis hit the industry in which 18 assemblers and numerous parts
suppliers exited the industry. The crisis made clear the advantagesto the buyers of standardizedparts,
becausewhena parts supplierexited, problemswere createdfor assemblerswho couldoften not substitute
among parts suppliers without significantdelays. The Society of AutomotiveEngineers (SAE) was
formed about that time, and given that its presidentbelievedthat the lack of interchangeabilityamong
parts of different companieswas responsiblefor the vast majorityof assemblerproductionproblems, it
earnestly set upon the task of defining auto parts standards. In the early years SAE committees were
dominatedby small auto makers,who were mostinterestedin uniformparts specification.SAE succeeded
in defining224 sets of standards by 1921; as early as 1915SAE foundover 90 percent compliancewith
its standards among parts suppliers in products such as screws and bolts, wheels and rims, and spark
plugs. By the 1920s, the SAE standards committeescame to be dominatedby large auto assemblers
(notablyGeneral Motors and Ford), and the emphasisshifted from standardparts specifications(which
was of less interest to G.M. and Ford since they could define these independentlyand obtain some
competitionamongsuppliers)to more basicraw materialpurchaserequirements(like steel standards)and
standardspromotingefficiencyof the automobile(like oil viscositystandards).Nownerewas the attempt
to establishraw materialpurchasestandardsmore vigorouslyopposedthan in the steel industry; the steel
industrywas reluctantto lose productdifferentiationadvantagesassociatedwith brand names.But the auto
industry wrote standards as was able to imposethem on the steel industry, as well as in the rubber,
petroleum and machine products industries.
Becauseconsumersof autos are atomisticand becauseauto makersregard it as importantto have
a cheap high quality complementaryproducts available, SAE extended its standard setting into some
products that are complementarywith autopurchases,such as brake fluidand oil viscosity.Oil refineries
opposed SAE standards in auto oil, which had been classifiedonly as light, medium and heavy because,
C-7
like the steel industry, they did not want to lose productdifferentiationadvantagesof brand names.
Uniformity Standards
The objectiveof uniformity standardsis to insure that the products of different sellers may be
used interchangeablyby buyers. Of course, quality differences among suppliers remain, so that the
products that are interchangeableare not necessarilyperfect substitutes; but without the standard for
interchangeabilityno substitutionwould be possible. Thus, there is generally a strong increase in the
ability of buyers to substitute amongthe productsof sellers as a result of uniformity standards.
Well knownexamplesof uniformitystandardsthat increasebuyers substitutionpossibilitiesanong
suppliers abound. Standard socket sizes in lampsallow substitutionamong light bulbs. A photographer
may interchangeablychoose amongvariousfilms, cameras,tripods, lens, filters and exposure metersdue
to standardization.To facilitatereplacement,brickssizes were standardizedunder governmentregulation.
Operating controls for forklift trucks are almost all standardized so that training of drivers is
interchangeableamong different manufacturersproducts. Despitethe enormousvariety of paper towels,
virtuallyall are eleven inches wide to fit the standardizeddispenser.
Quality Standards
One of the most importanttheoreticalcontributionson this subjectis the modelof Akerlof[ 1970].
He posits a situation characterizedby asymmetricinformation,in which suppliers know the quality of
their product and incur a cost for producinghigher quality products. Buyers, however, only know the
average quality of all products in the market prior to purchase.Then, suppliers of low quality products
will free-ride on those who supply high qualityproducts. Akerlof shows that a less than optimalquality
product will be produced, and in some cases the market will collapse.
C-8
The Akerlof model is typically interpreted(Link (19801)as showing that both producers and
consumers will benefit from grading standards in these markets, i.e., standards which differentiate
products accordingto better or worse qualities.What will often occur, however, withoutpressure from
buyers, is that firms will invest in brand identification.Brand names solves the quality degradation
problem since other brands cannot free ride on the higher quality. Buyers will then be reluctant to
substituteamong suppliers if the brand is of unknownquality, and the quality level of some brands of
high quality maybe unknownto the buyer. Qualitystandardsthen allowgreater buyer substitutionamong
competingbrands because buyers are assured of quality; at the same time, quality standards reduce
productdifferentiationadvantageso1 sellers.
Typicallyproducts that are graded accordingto quality lack product differentiationadvantages.
This includesmeat, lumber, wool, milk, eggs, soybeans,diamondsand mushrooms. SAE standardson
productssuch as brake fluidand oil are other examples.On the other hand, tire and major paper makers
have resisted gradingso they could maintainproductdifferentiationadvantages.
Other Motivationfor Standards
Small Firm QualityAssurance.Japaneseexports in the 1950sare an exampleof where it was in
the suppliers interestto e tablish standards.As canbe explainedby the Akerlof model, small and medium
sized Japanese companieshad a reputationfor poor quality (it was relatively costly for them to create
brand identification).But in 1949Japan enacted, with manufacturerssupport, its exports standardsand
inspection law. The law covered 40 percent of Japaneseexports and those that passed inspectionfor
quality were entitledto affix the JIS (JapaneseIndustrialStandard)seal. Part of the increase in Japanese
exports is attributed to this guarantor of product quality, which increased the willingnessof buyers to
substitutewith Japanese products.
C-9
AnticompetitiveMotivation. Suppliers will sometimes impose standards for anticompetitive
purposes. Fearing anticompetitivestandards,whenthe FederalCommunicationsCommissionintroduced
competition into the supply of equipmentto telephonecustomersin the 1960s, it required standardized
interconnectionfor terminal equipmen Jo that independentsuppliers could effectively compete with
AT&T.This policywas extendedto the Bellcompaniesafter the antitrustsuit against AT&T. In addition,
the FCC in its Computer III decisionof 1986requiredopen network architecture(ONA), which means
that the componentsof the telephonesystem are made availableto competingsuppliers on an unbundled
basis so that competingsupplierservicescan be combinedin any desiredmanner. The FCC standardized
interconnectionand ONA policieshave been enormouslysuccessfulwhenjudged by the wide variety of
equipment available and greatly increased range of services that independentsuppliers can offer to
telecommunicationscustomers.(See Besen and Saloner[19891for further details).
As part of its single market program, EC policy is attemptingto implement similar reforms in
standards. The EC green paper on telecommunicationspolicy indicatesthat through the promotion of
Europe-wide standards it shall provide equal access to all market participants (EC [1987; p.5]).
Moreover, ONA has been mandatedby the Maastrichttreaty for among other reasons to insure the
uniform interpretationof essentialrequirementsacross the Communityin order to limit the possibilities
6
for the impositionof restrictivelicensingconditions.
Probablythe best knownexampleof supplierbasedanticompetitivestandardsis nationalstandards
that have the force of law for the purposeof protection,what the EC refers to as technical regulations.
For example, EC courts interpretedGermanpurity laws for beer as protectionistand required that beer
manufacturedin any memberstate could be imported intoGermany.This is an applicationof the mutual
recognitionprinciple in -whichproductsproduced in one member state may be sold throughoutthe EC.
In the absenceof specific EC legislationhowever, EC states may still block intra-EC imports if certain
See XVl!,September1993, p.12 (the magazineof DG XIII) and Emersonet al. [1988; p.86].
C-10
nationalinterestsare involved.Sothe EC has attemptedto achieveharmonizationof technicalregulations
in which EC directives indicatemandatoryrequirementsfor national regulations. A manufacturermay
meet the technical requirements either by producing a product that meets the defined essential
requirements (which allows manufacturervariety subject to the consEraintof meeting the essential
requirementsof the product) or by producinga product in conformitywith European standardization
bodies (Emersonet al. [1988; p.4 0]). In either event, the Europeanconsumerwill be able to consume
products from other EC statesthat previouslywere illegalto import.
Conclusion
The theoryand empiricalwork on standardsindicatesthat the impactEC92 program of standards
will be to substantiallyincreasethe ability of buyers to substituteamongthe products of EC suppliers.
Giventhe exclusivefocusof modelerson the cost savingseffectsof standardsthrough economiesof scale
effects, there is a need to modelthe anticipatedstrong impacton consumerdemand of standardization.
References
Akerlof, G., "The Market for 'Lemons:' Quality Uncertaintyand the Market Mechanism," Quarterly
Journal of Economics,84, 1970, 489-500.
Besen, Stanleyand Garth Saloner, "The Ecoromics of TelecommunicationsStandards," in R. Crandall
and K. Flamm (eds.), ChangingtheRules: TechnologicalChange,InternationalCompetitionand
Regulationin Communications(WashingtonD.C.: The BrookingsInstitution, 1989).
Emerson, Michael et al., The Economicsof 1992 (Oxford: Oxford UniversityPress. 1988).
EuropeanCommunity, Towardsa DynamicEuropeanEconomy:GreenPaper on the Developmentof the
CommonMarketfor Telecommunications
Equipment(Brussels:EC Commission, 1987).
European Community, DG XIII, "CommunicationsPolicy on Telecommunications,"XIII magazine,
September 1993.
C-1 I
Farrell, Joseph and Garth Saloner, "Stardardization,Compat:bilityand Innovation," Rand Joarnal of
Economics, 16, 1985, 70-83.
Hemenway,David, IndusrrywideVoluntaryProductStandards(Cambridge, MA: Ballinger, 1975).
Kindleberger,Charles, "Standardsas Public,Collectiveand Private Goods," Kyklos, 36, 1983, 377-396.
Link, Albert, "Market Structureand VoluntaryProductStandards,"Applied E^onomics, 15, 1983, 393401.
Tassey, Gregory, Technology,Infrastructureand CompetitivePosition(Norwell, MA.: KluwerAcademic
Publishers, 1992).
C-12
Appendix D: Data and Benchmarking
This appendix outlines the steps involved in assemblyof the raw data and calibration of the
monopolisticsubmodel.Manydetails are omitted,since completedocumentationfor the interestedreader
is provided in the form of GAMSsource code.
1. Assemblyand Reconciliationof 10 and Trade Data
Two primary data sources for the MRT model are a set of Eurostat input-output tables for
1980/85, and the CHELEM harmonizedaccountson trade and world economyfor 1985. In addition, we
use selecteddata from a variety of other sources, includingthe Pern GDP comparisonsand Emerson's
1988study. Detailedreferencesare provided in the GAMSsource code.
The GAMSprograms involvedin generatingthe model's input data are displayedin Table D-1.
We began with a set of input-outputtables in worksheetform obtain from the European Community.
Separate region-specificGAMS programs (not shown in Table D-1) cross-check and reconcile the
individual
input-output
tables,
and thev then generate a single aggregate file (io.dat) with data for all
regions, aggregatedto 44 sectors.
The CHELEM bilateralbilateral trade data is also obtainedin spreadsheetfiles (for 1985), and
written into GAMS-readablelormat in their most disaggregateform in file trade.dat.
The ECDAT.GMSprogramreads the Eurostatdata and providesa few simple statisticalreports
for diagnosing errors. This program is used to restart MRTMAP.GMSwhich reads the commodity
aggregationmapping (MAPPING.GMS)and the CHELEM trade data. The MRTMAP program first
aggregatesthe input-outputand trade data to a consistent26-sectoraggregation. Although the 10 and
bilateral trade data are provided at a 44-sector level, 26 was the largest number of sectors for which
consistentdomesticand trade statistics can be compiled.Fol!owingaggregation,the program 'sifts" the
D-1
Table D)-: Overviewof Programs
|io.dat
n-isSCda t|
EUROSTATinput-output
GOPdeftators
Border costs
Elasticities
d non-tariff
Tariff
Raw MP
tabtes
(1980/85)
ecclat.gn
CllELElt BILATERAL
l
DATA (U.N. )
~~~~TRADE
l|tradest.dat
t.e
input.dat
trade data by setting to zero any bilateral trade flow which is less than 1I%of the value of commodity
exports and imports. In order to maintain consistencyin productionaccounts, the adjustmentof trade
flows is accompanied by a corresponding adjustment of domestic consumption.
MRTMAPgeneratestwo reports relatedto the siftingof trade data. ParameterDENSITY(Table
D-2) reports the aggregatedensityof bilateraltrade flow matricesbeforeand after adjustment.Parameter
CHANGE (Table D-3) reports percentageadjustmentin consumptionlevels incurred by the trade data
adjustment.
The second task performed by MRTMAP.GMSis to extractsummary statistics comparingthe
trade flows reported in the Eurostat input-outputtables withthe aggregatetrade flows from the Chelem
data set. The results of this comparison are provided in parameters TRDVOL (Table D-4) and
COMPARE (Table D-5 which presents results for Germany).
The third task performedby MRTMAP.GMSis to adjustbilateraltrade flows data and infer trade
flows wici rest-of-world.This is done by solvinga sequenceof weightedleast-squaresproblems,cne for
D-2
Table D-2: Effects of SiftingTrade Flows
11806PARANETER
DENSITY COMPARISON
OF TRADEFLOWSWITH SIFTING
AGR
FOO
BET
ENE
UTI
STE
amN
CHN
MET
IRA
OKA
ELC
VEN
OTE
TXC
wOo
PAP
RPL
CON
TRA
FIN
TRN
HEA
EOU
SER
PUB
onIo
84.028
63.889
50.694
41.667
33.333
59.722
51.389
79.167
75.000
79.167
31.250
70.139
68.750
52.083
81.944
51.389
68.750
47.917
51.389
38.889
61.111
76.389
6.944
10.417
52.083
13.889
SIFTED
63.194
54.167
46.528
33.333
31.944
54.167
40.972
61.111
63.889
67.361
29.167
56.250
59.722
42.361
72.917
41.667
57.639
38.194
45.139
37.500
52.7m
70.833
6.944
9.722
47.917
13.889
SIFTED:DROPALL ALL FLOWSWNtCHARELESS
THAN 1X OF MINCSUPPLY,
DEMAND)
each traded comr 'ity. The input to these problemsare CHELEM bilateral trade statistics (X,,.) and
EUROSTATaggregate import and export statistics (E, and M,.). The weights (wf.)
assign a value of
unity to intra-EC trade data and zero to trade flows with ROW:
minE
s.t.
EX,,, - E,
r*ROW
EX,,, - Ai,
rROW
PI
Following the calibrationof trade flows and reconciliationwith input-outputstatistics, the data
constitutesa balancedequilibriumdata set at a 12-region,26-sectorlevel. We write this data in GAMSreadableto a text file, input.dat, which is thenused for subsequentmodelling.The text file is used instead
D-3
Table D-3: ConsumptionAdjustmentRequiredby Trade Data Sifting
11814 PARAMETER
CHANGE CONSUMPTION
ADJUSTMENT
DUETO SIFTING(X)
-BE
AGR
ENE
CH"
I1A
OKA
ELG
OTE
TXC
DE
-1.000
-1.000
4.000
-1.000
5.000
-1.000
RPL
1.000
-1.000
4
AU
fOO
ENE
STE
ML
ES
FR
IT
1.000
2.000
1.000
PAP
7.000
1.000
1.000
1.000
1.000
1.000
PT
2.000
4.000
5.000
UK
*1.000
-1.000
MR
3.000
-1.000
-1.000
-1.000
7.000
2.000
1.000
2.000
2.000
7.000
17.000
2.000
9.000
1.000
1.000
1.000
1.000
VEM
1.000
TXC
woo
PAP
RPL
FIN
TRN
5.000
3.000
6.000
1.000
5.000
7.000
2.000
1.000
TY
S.000
7.000
mmI
CH"
MET
1IA
aMA
ELG
DK
1.000
3.000
8.000
1.000
1.000
1.000
1.000
4.000
of a GAMS "restart" in order to provide a separationbetween names used in benchmarkingand those
used in the specificationof model and reports. We also anticipatethat users of the model will rarely need
to go "below" this level, makingit efficientto have code and data files that are self-containedfrom this
point on (GAMS "restart" files are naturallyvery sensitiveto the precise version of GAMS used to
generatethem, and this could causeproblemsif users employdifferent versions of GAMS).
2. Calibration of the Monopolistic Submodel
The final stage tn data manipulationis to infer values for conjecturalvariations and numbers of
firms which are consistentwith specifiedscale elasticitiesand industryequilibria. These calculationsare
performedin programMRTCAL.GMS.This programreads the balancedequilibriumdata set (input.dat),
D4
Table D-4: Comparisonof AggregateTrade Volumes
19578 PARAMETER
TROVOL COMPARISON
OF AGGREGATE
TRADEVOLUMES
(INCLUDINGALL REGIONSBUT ROW)
AGR
CHN
CON
MTOT EC
51
75
5
MTOTCH
22
48
XTOT EC
28
S9
8
EDU
XTOTCH
IS
63
1
ELG
50
FIN
MET
N"q
PAP
PUS
RPL
TtA
TRN
TXC
VEN
woo
FOO
BET
ENE
UTI
STE
INA
OKA
OTE
SER
24
20
la8
23
1
28
8
28
52
47
14
50
7
175
2
60
49
29
18
9
33
17
7
19
54
44
43
8
63
7
131
1
48
39
45
11
52
26
28
21
17
4
32
33
63
56
68
11
48
10
69
2
54
74
24
29
6
35
26
12
15
71
49
62
9
54
11
60
1
50
62
43
15
the sectoral aggregation (mapping.gms) and the assumed values for elasticities of substitution in
productionand final demand (esub.gms).This programalso installs our estimatesof border costs, nontariff barriers, Armingtonelasticitiesand cost-disadvantageratios (CDRs).
We have specified the value of productionat consumerprices in the benchmark data. These
numberstogetherwith engineeringestimatesof cost disadvantageratiosdeterminethe value of fixedcosts
by sector and region:FC,, - CDR,, YqC,
The calibrationof parametersspecificto the monopolisticsubmodelbegins from the fre-entry
assumptionwhich assuresthat there are no excessprofits. Subjectto the zero-profitassumption,mark-ups
over marginal cost generate revenue which exactly equals fixed cost. The monopolisticpricing rule is
based on elasticitiesof substitutionin demand, the numberof firms operating in a given market, and an
adjustmcntparameter, the "conjecturalvariation", which is equal to unity in markets characterizedby
D-5
Table D-5: Comparisonof Trade Volumesfor Germany
-.-
19591 PARAMETER
COMPARE
INDEX 1
COMPARISON
OF EUROSTAT
ANDCHELENTRADEVOLUMES
DL. (GERMANY)
10
10OX
Cm
N
CH_X
YOTPtT
2CONSUM
AGR
t4
2
4
1
CNN
18
29
10
19
COw
ELG
FIN
14
S
3
20
3
8
13
MET
1"m
4
3
9
4
4
2
9
3
PAP
6
6
4
5
-6
-2
PUB
I
RPL
TRA
TRN
TXC
VEN
wOo
FOO
BET
ENE
UTI
STE
INA
OKA
OTE
SER
6
1
6
16
8
3
10
1
36
1
15
8
8
6
13
10
33
2
8
1
4
11
20
73
-118
14
8
2
1S
1
29
9
30
3
8
1
5
*6
-26
-3
-11
1
9
47
-T
17
-16
12
2
2
-1
-43
14
30
8
4
1
12
7
10
2
14
26
13
2
-16
57
-41
-2
-2251
1507
-137
172
-3
8
3
2
-3
-24
-4
-25
.2
-108
1
-28
-32
39
41
36
-2
-15
"pure' Cournot-Nash players.
We would prefer to work with a model in whichall marketsare characterizedby Cournot-Nash
equilibria, but this assumptionmay not be consistentwith the assumptionof free-entry and zero profits
in the benchmark,givenvaluesfor elasticitiesof substitution.Weevaluatethe consistencyof the CourmotNash model by solving a sequenceof least-squaresproblems,one for each commodityproduced subject
to increasing returns to scale. These problems look implicit numbers of firms (Nr) which result in
calibrated conjectural variations (CVf,.)which are as close as possible to unity:
The constraintsin these least-squaresproblemsimposezero-profit- fixedcosts equalthe valueof markup
revenue with markups calculatedon the basis of benchmarkvalue shares (0) and exogenously-specified
elasticities(a). Table D-6 reports valuesof calibratedconjecturalvariationsfor the commoditySTE (iron
and steel). These results are roughly consistentwith those obtainedfor CHM, MET, IMA, OMA, ELG
and RPL -- all calibrate to conjecturalvariations which are considerablyless than unity on domestic
D-6
min E (CV+-1)2
CVy,,
, r.
s.t.
Xm MGC(a,Nj;os'
FCi,=
0 S Ni, S 100, CV,,
0
markets, indicatingmore competititvepricing behaviorthan is predictedby the Cournot model, subject
to our assumedvalue shares and demandelasticities.
The markets can be calibratedto "pure Cournot" pricing includeFOO, NMM, VEH, OTE, and
PAP. For these markets, we performa secondcalculationin which we try to find numbers of firms which
are as small as possible, subjectto benchmarkconsistencywith Cournot conjectures:
Table D-6: CalibratedNon-CournotConjecturalVariations
-.-.
CONJECTURAL
VARIATIONS
CALIBRATEDNON-COJRNOT
358 PARMETEROMEGA
ROW
STE.SE
STE.DE
STE.DK
STE.ES
STE.FR
STE.IT
STE.NL
BE
0.509
DK
DE
0.487
0.501
ES
0.738
FR
0.551
0.830
0.526
0.868
0.286
0.663
STEMUr
STE.MR
0.814
0.471
0.735
+
STE.8E
IT
0.645
NL
0.887
0.350
0.442
0.805
STE.PT
PT
UK
0.512
"R
TY
STEM.D
0.490
STE.DK
STE.ES6
STE.R
STEIT
STE.ML
STE.PT
STE.UK
STEM.R
STE.TY
0.854
0.573
0.849
0.883
0.680
0.721
0.661
0.381
0.854
0.697
D17
max min(N,)
N,
r
s.t.
FC, =
O
E
X'
N, 5 100,
MG(CV,,, N)
CV= 1
3. The Benchmark Equilibrium
The followingpages providea summaryof aggregateand sectoral statisticsfrom the constructed
benchmarkdataset.
D-8
----
12223 PARAMETER
INCOME
INCOMESOURCES
ANDCHECKSUMS
ROW
8287.689
BE
DE
DK
ES
FR
96.338
688.384
65.174
266.373
623.490
0.024
0.576
0.160
0.191
1.190
0.910
2.756
0.395
0.320
1.537
0.526
1.347
0.334
0.469
1.249
10.308
0.366
1.158
0.149
0.199
0.996
18.395
0.526
-34.422
0.220
6.146
-2.687
8316.392
98.689
659.798
M.433
273.698
625.776
1.78787E-106.783353E-91.0160bE-111.425462E-9-1.96758E-9
FACTOR
VA TAX
TARIFF
NTB-M
NTB-X
TRDBAL
TOTAL
CHKSUM
+
IT
NL
PT
UK
MR
TY
FACTOR
428.378
136.767
41.741
541.456
24.957
150.695
VA TAX
0.220
0.043
0.048
0.809
TARIFF
1.064
1.010
0.121
3.195
0.010
0.057
NTB-M
0.675
0.582
0.252
1.334
NTB-X
0.715
0.344
0.007
0.564
0.006
0.013
TRDBAL
7.555
-1.156
8.277
-10.457
2.390
5.213
TOTAL
438.606
137.589
50.447
536.900
27.363
155.979
CHKSUM -8.41726E-91.73941E-11-7.2582E-112.49884E-102.91358E-115.29496E-11
SET
S
/
R
Sectoral identifiersfor the 26-sectormodel
AGR
Agriculture,
FOO
Food,
BET
Beverages and Tobacco,
ENE
Energy,
UTI
Utilities,
STE
Iron and Steel,
NMM
Non-MetallicMineral Products,
CHM
Chemicals,
MET
Metal Products,
IMA
IndustrialMachinery,
OMA
Office Machinery,
ELG
ElectricalGoods,
VEH
Motor Vehicles,
OTE
Other TransportEquipment,
TXC
Textiles and Clothing,
wOO
Wood,
PAP
Paper and Printing,
RPL
Rubber and Plastics,
CON
Constructionand Repair,
TRA
Trade,
FIN
FinancialServices,
TRN
Transport and Courunication,
HEA
Health,
EDU
Education,
SER
Other Market Services,
PUB
General Public Services/;
Regions in the model /
BE
Belgium,
DE
West Germany,
DK
Dermark,
ES
Spain,
FR
France,
IT
Italy,
NL
Netherlands,
PT
Portugal,
UK
United Kingdom,
MR
Morocco,
TY
Turkey,
ROW
Rest of world/;
D-9
----
12302PARAMETER
PRDSHR
(M)
SHARESOF GLOBALPRODUCTION
AGR
FOO
BET
ENE
UTI
STE
NMM
CHM
MET
IMA
OMA
ELG
VEH
OTE
TXC
wOO
PAP
RPL
CON
TRA
FIN
TRN
HEA
EDU
SER
PUB
VA
ROW
44.64
68.28
66.19
52.87
50.58
30.46
28.3a
49.40
27.31
46.23
58.07
46.23
59.78
60.98
63.87
53.21
39.88
48.48
37.56
64.72
54.11
49.76
68.94
73.47
68.58
74.32
73.01
BE
1.32
1.05
1.01
1.60
1.48
4.62
2.31
1.81
1.46
1.12
0.31
1.29
1.37
0.75
1.03
1.72
1.40
1.43
2.55
0.99
1.44
1.57
1.15
1.53
0.47
0.60
0.85
DE
6.80
6.15
7.62
7.73
14.90
24.29
15.97
15.36
19.53
19.07
15.11
17.43
15.66
5.94
5.50
10.34
17.48
12.87
11.57
7.29
13.49
9.56
9.80
7.28
4.84
7.12
6.06
DK
1.47
0.94
0.96
0.56
0.87
0.14
0.99
0.60
1.13
1.14
0.57
0.60
0.34
1.23
0.40
1.06
1.37
0.71
1.47
0.78
0.95
1.39
0.91
0.88
0.43
0.56
0.57
ES
6.89
3.40
3.54
3.97
4.66
8.55
6.93
3.80
5.00
2.52
3.00
3.12
3.46
2.76
3.19
3.21
3.56
4.57
5.94
2.69
3.86
3.94
2.77
2.06
4.36
1.42
2.35
FR
11.91
5.90
3.65
8.36
8.86
9.17
10.55
8.46
13.73
6.15
9.20
9.73
7.67
10.82
5.66
7.12
11.37
9.00
12.63
6.61
10.66
8.64
8.75
8.54
5.39
4.25
5.49
+
AGR
FOO
BET
ENE
UTI
STE
NMM
CHM
MET
IMA
OMA
ELG
VEH
OTE
TXC
wOO
PAP
RPL
CON
TRA
FIN
TRN
HEA
EDU
SER
PUB
VA
IT
7.40
3.90
2.70
4.96
5.47
9.75
13.27
7.21
11.07
8.68
6.07
7.08
3.64
4.32
9.70
9.89
6.99
8.25
9.77
5.80
5.96
6.45
5.05
5.04
4.71
2.32
3.77
NL
2.62
1.93
1.42
3.64
1.64
1.59
2.20
2.58
2.32
1.24
0.68
2.50
0.63
2.12
0.73
1.41
3.16
1.58
3.59
1.64
1.65
2.15
2.28
0.85
0.92
1.57
1.20
PT
1.52
0.76
0.56
0.55
0.72
0.62
1.57
0.65
0.88
0.25
UK
6.61
5.07
10.36
12.17
8.53
10.37
11.97
7.99
11.79
12.00
6.96
9.86
5.63
11.08
4.99
6.88
12.35
9.36
11.10
6.65
6.60
10.45
MR
0.14
0.93
0.16
0.29
0.24
0.10
1.39
0.32
0.44
0.19
0.04
0.12
0.12
TY
8.68
1.71
1.82
3.31
2.05
0.34
4.48
1.83
5.34
1.42
0.60
0.52
0.21
0.23
0.40
0.26
0.04
0.28
2.81
3.36
1.43
2.74
2.21
1.88
0.91
5.16
8.54
6.92
4.77
0.38
0.22
0.22
1.00
0.48
1.33
0.49
0.63
1.52
1.30
0.80
0.78
1.21
0.70
0.34
0.65
0.36
0.34
0.38
0.22
0.37
D-10
1.55
1.07
---- 12302 PARAMETER EXPFRC
AGR
FOO
BET
ENE
UTI
STE
NMM
CHN
MET
IMA
OMA
ELG
VEH
OTE
TXC
woo
PAP
RPL
CON
TRA
FIN
TRN
EDU
SER
+
AGR
FOO
BET
ENE
UTI
STE
NMM
CHM
MET
IMA
OMA
ELG
VEH
OTE
TXC
woo
PAP
RPL
CON
TRA
FIN
TRN
EDU
SER
PUB
ROW
17
4
31
31
4
20
8
9
31
13
4
14
4
3
9
16
2
IT
6
7
6
1D
17
16
18
14
38
42
25
30
36
29
13
9
26
7
4
17
EXPORTS AS FRACTIONOF DOMESTIC PRODUCTION(X)
BE
23
34
17
48
6
74
40
90
36
80
80
72
90
57
77
32
44
88
3
18
9
44
DE
7
12
5
8
2
2
NL
30
39
27
57
1
83
24
77
25
60
90
69
49
63
60
16
18
61
4
21
3
40
8
PT
24
17
39
19
46
49
37
51
46
34
14
14
30
4
6
2
20
3
17
10
7
12
16
13
6
23
25
29
37
22
17
DK
17
45
7
22
3
67
21
49
33
49
82
39
7
54
46
45
12
42
ES
7
8
7
16
16
5
2
20
31
22
14
18
1S
23
30
12
32
24
21
12
13
14
1
UK
13
11
10
38
MR
4
7
13
41
38
37
10
25
72
21
21
65
18
10
8
40
2
73
45
3
10
8
15
19
3
7
14
5
TY
5
9
20
4
12
7
18
15
4
6
12
2
28
FR
15
13
22
11
3
39
18
37
14
36
41
29
41
53
24
9
11
27
1
4
6
12
2
34
7
3
8
13
12
D-1I
-...
12302 PARAMETER IMPFRC
IMPORTSAS FRACTIONOF DOMESTIC CONSUMPTION(X)
ROW
BE
DE
DK
ES
FR
10
4
3
33
15
5
44
1
26
16
30
11
16
21
8
57
3
88
28
60
41
11
6
6
46
13
13
13
39
25
13
25
19
45
32
17
68
5
71
40
87
44
IMA
18
9
24
8
40
17
34
11
25
83
21
56
35
41
OMA
ELG
VEH
OTE
TXC
25
15
12
25
6
93
74
91
65
77
50
30
21
41
45
78
55
50
50
57
58
24
20
19
9
54
29
33
27
29
AGR
FOO
BET
ENE
UTI
STE
NMM
CHM
MET
woo
39
17
41
8
17
4
48
14
24
12
22
2
3
1
11
15
RPL
CON
TRA
FIN
TRN
SER
90
4
9
6
9
4
24
47
12
28
1
2
10
4
9
1
2
4
6
4
7
+
AGR
FOO
BET
ENE
IT
19
15
11
47
NL
37
28
24
61
PT
24
8
2
55
UK
21
17
6
28
MR
18
8
5
37
TY
2
6
5
34
PAP
UTI
4
STE
NMM
31
9
85
40
45
12
46
36
11
13
22
14
CHM
27
69
44
27
23
MET
34
5
32
15
10
33
24
IMA
21
72
72
23
OMA
61
49
52
93
70
56
ELG
VEN
OTE
TXC
woo
PAP
RPL
CoN
26
35
28
12
8
12
17
I
68
71
57
77
52
25
71
1
25
31
52
27
25
15
36
2
36
34
29
25
9
13
20
13
7
2
9
16
TRA
4
4
FIN
TRN
4
4
40
3
10
4
4
6
3
1
8
SER
PUB
5
25
2
42
42
10
4
12
40
4
13
6
D-12
AGR
FOO
BET
ENE
UTI
STE
NMM
CHM
MET
INA
OMA
ELG
VEH
OTE
TXC
wOO
PAP
RPL
CON
.KA
FIN
TRN
EDU
SER
+
AGR
FOO
BET
ENE
UTI
STE
NMM
CNN
MET
IMA
OMA
ELG
VEH
OTE
TXC
Woo
PAP
RPL
CON
TRA
FIN
TRN
EDU
SER
PUB
EXPFRC
12302PARAMETER
ROW
17
4
31
31
4
20
8
9
31
13
4
14
4
3
9
16
2
IT
6
7
6
10
17
16
18
14
38
42
25
30
36
29
13
9
26
7
4
17
CX)
OF DOMESTICPRODUCTION
EXPORTSAS FRACTION
BE
23
34
17
48
6
74
40
90
36
80
80
72
90
57
77
32
44
88
3
18
9
44
DE
7
12
5
8
2
2
NL
30
39
27
57
1
83
24
77
25
60
9C
69
49
63
60
16
18
61
4
21
3
40
8
PT
24
17
39
19
46
49
37
51
46
34
14
14
30
4
6
2
20
3
17
10
7
12
16
13
6
23
25
29
37
22
17
OK
17
45
7
22
3
67
21
49
33
49
82
39
7
54
46
45
12
42
ES
7
8
7
16
16
5
2
20
22
14
18
15
23
30
12
32
24
21
12
13
14
31
1
TY
5
9
20
4
UK
13
11
10
38
MR
4
7
13
41
38
37
10
25
72
21
21
65
18
10
8
40
2
73
45
3
10
8
15
19
3
7
14
5
12
7
18
15
4
6
12
34
7
3
8
13
2
28
FR
15
13
22
11
3
39
18
37
14
36
41
29
41
53
24
9
11
27
1
4
6
12
2
12
D-13
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