The “Gains” from Preferential Trade Liberalization in the CGE Models: Where do they Come From?

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(Published in Sajal Lahiri, Regionalism and Globalization, London and New York: Routledge, chapter 3) (with Rupa Duttagupta).  In a series of papers, Bhagwati and Panagariya (1996), Bhagwati, Greenaway and Panagariya (1998) and Panagariya (1996, 1997a, 1998) have argued forcefully that a tariff preference by a country is likely to hurt itself and benefit its union partner. On the other hand, Robinson and Thierfelder (1999) argue, “The results from a large number of model-based empirical studies strongly support a few robust conclusions about RTAs [Regional Trade Agreements]: (1) they increase welfare of participating countries; (2) aggregate trade creation is much larger than aggregate trade diversion…”  In this paper, we subject the CGE models, based on conventional theory, to a critical examination.  We argue that when these models generate benefits to a country from its own preferential liberalization, they do so by recourse to models characterized by internally inconsistent assumptions.  And even within the wrong model structure, the gains are generated by choosing questionable values of some key parameters.