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CONSEQUENCES OF THE WTO ACCESSION: THE ROLE OF ECONOMIC DISTANCE Sergey Afontsev Institute for World Economy and International Relations XIIth Annual Leontief Readings Conference Saint Petersburg, February 15-16, 2013 Paper Objectives Dynamics of Russian imports in 2013–2015 will be affected by two major factors, i.e., global economic recovery and trade cost reduction following Russia’s WTO accession. Economic history provides only one comparable example when post-crisis growth in Russian and world economy coincided with a period of trade liberalization in Russia (2001–2003). The paper estimates the impact of import tariffs, economic distance, and GDP growth in Russia and abroad on Russian imports of goods differentiated by industries and countries of origin. Research is based on the gravity model of bilateral trade with monopolistic competition using panel data on Russian trade with 150 countries in 2001–2003. The Model: Consumers Representative consumer in country j maximizes utility function Uj by consuming differentiated good g given Dixit-Stiglitz preferences reflecting his/her taste for diversity: Uj = ( N i 1 1/ n i k 1 xijk ) , (1) where N is a number of countries, ni is a number of varieties of good produced in country i, xijk is household consumption of a variety k of good g produced in country i, is elasticity of substitution between goods in consumption. The Model: Consumers Assume each firm produces only one good variety, with all firms and all individuals within each country being symmetric. Then budget constraint for a representative consumer with income yj is yj = n p (1+tij)xij, N i 1 i ij (2) where pij is the c.i.f. price in country j of the good produced in country i and tij is the ad valorem tariff rate in country j for the good from country i. The Model: Consumers Assume there are ‘iceberg-form’ costs of transporting goods from country i to country j, with fraction ij of goods sent being lost during the transportation. Denoting good price in producer country as pi and defining cijij/(1-ij), we have pij = pi/(1+cij). (3) The Model: Consumers Then maximization of (1) given (2) and (3) gives us the following expression for equilibrium demand in country j for good from country i: xij = (yj/Pj)(pi (1+cij)(1+tij)/Pj)-, (4) where Pj = (ni (pi (1+cij)(1+tij))1-)1/(1-), and = 1/(1-). (5) The Model: Consumers Summation of (4) over all consumers produces the following result: xij qij = (Yj/Pj)(pi (1+cij)(1+tij)/Pj)-, (6) where Yj is gross domestic product of country j. The Model: Producers Each firm in each country produces output qi according to the following technology: qi = zikili1- - , (7) where zi is an exogenous productivity term, ki (li) is the amount of capital (labor) used by the firm, and represents fixed costs which are assumed to be identical across countries. The Model: Producers Profit maximization with (7) ensures mark-up pricing rule, as is characteristic of this class of models: pi = (/(-1))((C/zi)riwi1-), (8) where ri is the rental rate on capital, wi is the wage rate, and C=-(1-)-(1-). Further, zero-profit condition under monopolistic competition implies qi = (-1), (9) i.e., each firm’s output is determined parametrically, which is one more characteristic of the model class under consideration. The Model: Producers The number of firms in country i equals ni = ()-1ziKiLi1-, (10) while the factor endowment constraints under full employment of both capital and labor give us ni = Ki/ki = Li/li. (11) The Model: Equilibrium Trade Flows To solve for equilibrium trade flows in value terms (Mij), we multiply (6) by pij and use (8) to obtain Mii = (/(-1))Yj((C/zi)riwi1-)(pi (1+cij)(1+tij)/Pi)1-. (12) Using (10) and noting that C(riKi)(wiLi)1- equals country i’s GDP (Yi), we have Mij = (1/(-1)ni)YiYj (pi (1+cij)(1+tij)/Pi)1-. (13) The Model: Equilibrium Trade Flows Assume that (1+cij) is given by the non-tariff-barrier-totrade function of the following form (cf. Carrere, 2006): (1+cij) = G De ij (14) where Dij is distance between countries, Gs are ‘geography’ dummy variables for each country, and s are coefficients on these variables. Given (14), we can rewrite (13) as G Mij = (1/[(-1)ni])YiYj(pi Dij e (1+tij)/Pj)1-. (15) Empirical Exercise To test (15), we constructed the database on Russian imports from 150 countries disaggregated by 16 industries. Countries included in the sample accounted for 93.3 to 100 per cent of total Russian industry imports in 2001–2003. The total number of observations in the database equals 7200, of which 3340 observations correspond to nonzero imports. Two methods are used: ‘Traditional’ loglinear estimation; Poisson maximum likelihood as recommended by Westerlund and Wilhelmsson (2006) and Santos Silva and Tenreyro (2006). Empirical Exercise Some variables in (15) are nonobservables. We propose to use the following control variables/approximations for these nonobservables. The level of internal prices pi is controlled for by GDP per capita (higher domestic demand exercises upward pressure on prices) and PPP to current exchange rate ratio (PPP-spread). Large PPP spread can reflect low engagement of a country in foreign trade (large nontradable sector) and/or undervaluation of a national currency, both circumstances contributing to the fact that foreign consumers face lower prices for country’s products. The number of firms is approximated by the population size Li. Empirical Exercise: Loglinear Estimation Equation (15) can be rewritten in logs as lnMij = -lnni + lnYi + lnYj + (1-)lnpi + (1-)lnDij + + (1-)lnG + (1-)ln(1+tij) - (1-)Pj. (16) Making special assumptions about the form of non-tariffbarrier-to-trade function (14), we propose to estimate the following empirical model: lnMijk = 0 + ui + uk + 1lnYi + 2lnYj + 3ln(1+tijk) + 4ln(Yi/Li) + 5ln(PPPi) + + 6lnDij + 7Glli + 8GFSUi + 8GFCBi + 8lnPj + ijk, (17) Empirical Exercise: Loglinear Estimation Oil Intensity: Share of Oil and Oil Products in Intermediate Consumption Empirical Exercise: Poisson Maximum Likelihood Empirical Results: Summary The impact of partner country’s GDP on Russian imports is strongly positive. In models for differentiated goods and goods of ‘low oil intensity’, as well as in the general sample, coefficients on partner country GDP are statistically higher than 1, pointing to the scale economies in exporting countries. At the same time, we failed to find any statistically significant impact of Russia’s own GDP on country/industry import volumes. Empirical Results: Summary Import tariffs do not affect import volumes in any model specification. Though we can not rule out the hypothesis that coefficients on the tariff variable and the distance variable are the same in most specifications, the former are never statistically significant. This means that the present level of Russia’s MFN tariffs does not influence decisions on import volumes. Coefficient on the distance variable appeared to be strongly negative in all specifications, as predicted by the basic logic of the gravity model. Empirical Results: Summary Coefficients on the GDP per capita show that Russia imports more differentiated goods from developed countries. This can reflect a ‘taste for quality’ in respect of differentiated goods (as developed countries are likely to export higher-quality varieties of differentiated goods AND/OR advantages of developed countries in production of capital-intensive manufacturing goods. Higher foreign prices (lower PPP spread) quite logically correspond to lower Russian imports (except for the case of homogenous goods). Empirical Results: Summary Soviet heritage in trade captured by dummy variables for the former USSR and the former Communist block is still quite remarkable as far as its impact on Russian imports is concerned. Extremely low coefficients generated by Poisson maximum likelihood estimation suggest that zero industry imports from specific countries result from particular patterns of trade specialization rather than prohibitive impact of import duties and/or distance-related costs. Implications for Russia’s WTO Accession Russia’s WTO accession is likely to affect imports by reducing distance-related trade costs rather than import tariffs that were found to be not statistically significant in all model specifications. Implications for Russia’s WTO Accession Change in Export Structure Seems to Shift EC for Total