Armington Elasticities and Terms of Trade Effects in Global CGE Models

A Productivity Commission Staff Working Paper, Armington Elasticities and Terms of Trade Effects in Global CGE Models by Xiao-guang Zhang was released on 8 February 2006, in conjunction with the staff working paper, The Armington Model. Armington elasticities specify the degrees of substitution in demand between similar products produced in different countries. They are critical parameters which, along with model structure, data and other parameters, determine the results of policy experiments. Especially when many tariffs are small, trade liberalisation simulations can produce positive or negative welfare outcomes depending on the values assumed for Armington elasticities. The Commission developed a research program on the role of Armington elasticities in quantitative models that are commonly used to analyse trade issues. The research program was designed to improve the effectiveness of models used in analysing various options for unilateral, bilateral and multilateral liberalisation. The purpose of this paper is to illustrate the effects of the Armington assumption on one of the main factors that affects welfare outcomes, namely, the terms of trade. In publishing its research in this area, the Commission hopes to clarify issues that arise as single-country and global trade models are increasingly used to assess the potential impacts of various types of trade liberalisation