Chapter 18. Trade Elasticity Parameters for a Computable General Equilibrium Model

Computable general equilibrium (CGE) models of international trade typically rely on econometrically estimated trade elasticities as model inputs. These elasticities vary by as much as an order of magnitude and there is no consensus on which elasticities to use. We review the literature estimating trade elasticities, focusing on several key considerations. What are the identifying assumptions used to separate supply and demand parameters? What is the nature of the shock to prices employed in the econometrics? And what is the time horizon over which trade responds to this shock? This discussion ranges from older reduced form approaches that use time-series variation in prices, to more recent work that identifies demand elasticities from trade costs or by using instruments in cross-section or panel data, and finally to prominent applications that separately identify supply and demand parameters in the absence of instruments. We also discuss recent theoretical developments from the literature on heterogeneous firms that complicate the interpretation of all these parameter estimates. Finally, we briefly survey a literature on structural estimation and link this to recent attempts to incorporate such theories in CGE applications. By elucidating the differences and similarities in these approaches we hope to guide the CGE practitioner in choosing elasticity estimates. We favor elasticities taken from econometric exercises that employ identifying assumptions and exploit shocks that are similar in nature to those imposed in the model experiment.