Dynamic Effects of Tariff Liberalization: An Intertemporal CGE Approach

Abstract: The paper presents an applied CGE trade model with overlapping generations facing life-time uncertainty. Investment and savings are derived from intertemporal optimization of agents under perfect foresight. We emphasize the features of a small open economy which takes prices for imports and the world interest rate as given. Downward sloping export demand functions make the terms- of-trade endogenous. The model intertemporally determines the current account and the accumulation of foreign assets. We calibrate the model to Austrian data and simulate the effects of trade liberalization as negotiated in the Tokyo-round as well as a complete tariff liberalization. Among the results, we find that unilateral tariff reductions are expansionary in the long-run, but are contractionary in the short-run if the commercial policy is anticipated. Foreign debt increases in the long-run forcing an improvement in the trade balance to service the additional debt. Welfare improves for some old generations at the expense of young and future generations. The utility loss of young generations is attributed partly to unfavorable terms-of-trade effects and partly to intergenerational redistribution from young to old. In the multilateral scenario, however, welfare improves for all generations. The terms-of-trade effect is reversed. The sensitivity analysis identifies the price elasticity of exports as a particularly important parameter. Furthermore, we find parameter configurations that produce non-monotonic adjustment of the current account.;