EPA Review Annex Documents - DFID

Fontagne et al (2008) argue that the ‘correct’ approach to be taken for this type of analysis
should follow the CGE route however, the severe data limitations can make the PE approach
more attractive. CGE models have strong data requirements which are often unavailable for
individual ACP countries hence these models tend to group countries into regional
aggregates and draw conclusions at a regional level (see ECA (2005) and Keck and
Piermartini (2008) for a discussion). Further to this, the sectoral aggregation in CGE models
using the GTAP database (version 6) is limited to 57 sectors. In contrast, PE models can be
readily used for individual countries where disaggregated trade data is available and allows
analysis at the highest levels of disaggregation (over 5000 products). Here however, the
analysis is limited to the familiar Vinerian trade creation and diversion effects and also
analysis of possible fiscal implications of liberalisation on a standalone basis. The main
weakness of this type of model is that, unlike its CGE cousin, PE models do not take into
account sectoral spillover effects and operate under a ceteris paribus assumption for each
sector. A mitigating factor for using PE models, as argued by Fontagne et al (2008), is that
the highly specialised nature of ACP economies in products differentiable only at high levels
of disaggregation suggests that the CGE approach may miss important product specific
effects. Another drawback of using the CGE approach is that results are likely to vary
significantly depending on the closure used for the model. It is common to assume that
labour markets clear, or that the balance of trade of developing countries stays constant;
however whichever is chosen will impact the final results.
Several key assumptions in simulation models are important to note. Firstly, it is often
assumed that countries supply capacity is infinite and that changes in demand as a result of
changes in preferences will be immediately met by countries. In the case of ACP countries, it
is likely that this assumption does not hold, hence the effects of liberalisation, on the export
side, might provide an upper bound potential rather than a true effect. Secondly, there tends
to be an implicit assumption that changes in tariffs are directly transmitted to consumer. This
is not always the case as it is possible that the rent created by the tariff reduction is kept on
the exporter side rather than passed on to consumers. Another assumption that is commonly
used is the Armington assumption of imperfect substitution, firstly across domestic and
international sources and secondly across the different international origins. This assumption
is a crucial one so as to avoid corner solutions and generally assumes that the elasticity of
substitution between domestic and imported goods is lower than the elasticity of substitution
across different origins for the imported goods. This assumption is very useful in that it
allows one to move away from the homogeneous good assumption of past but it does not
explicitly consider quality differentiation in goods trade.
Regardless of the type of simulation model chosen to assess the impact of the EPAs, the
crucial step in carrying out a good analysis is that of choosing an appropriate counterfactual
scenario. The counterfactual scenario gives us a yardstick with which to compare the
possible benefits of a change in preferences. A common mistake in the literature (ECA 2005)
is that of choosing Cotonou preferences as the counterfactual scenario. 81 This is
conceptually incorrect as the waiver received from the WTO for Cotonou preferences ended
in January 2008 hence the more likely counterfactual would be reverting trade back to
enabling clause preferences be these GSP or EBA. 82 Whilst for LDCs the changes from
Cotonou to EBA are likely to have little to no impact in market access, the difference
between Cotonou and GSP preferences is relatively large. Fontagne et al (2008) estimate
that the loss of Cotonou preferences could reduce ACP exports by 4% where the impact is
greatest for the COMESA region that could suffer a fall in exports to the EU of 12%. It is then
probable that the impact of the EPA depends on the eligibility of ACP countries to EU
unilateral preferences. GSP countries are likely to suffer most from the loss of Cotonou
81 At the time the ECA (2005) study was carried out, there was great uncertainty as to the possible
counterfactual solutions that would replace the EPAs if these were not signed.
82 Perez (2005) uses a possible counterfactual of extending GSP+ concessions to all ACP countries.
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