Welfare Gains from the Variety Growth
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A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Kancs, d'Artis; Persyn, Damiaan Working Paper Welfare Gains from the Variety Growth JRC Working Papers in Economics and Finance, No. 2019/1 Provided in Cooperation with: Joint Research Centre (JRC), European Commission Suggested Citation: Kancs, d'Artis; Persyn, Damiaan (2019) : Welfare Gains from the Variety Growth, JRC Working Papers in Economics and Finance, No. 2019/1, ISBN 978-92-79-99245-2, Publications Office of the European Union, Luxembourg, http://dx.doi.org/10.2760/028399 This Version is available at: http://hdl.handle.net/10419/202307 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Neither the European Commission nor any person acting on behalf of the Commission is responsible for the use that might be made of this publication. Contact information Name: d'Artis Kancs Address: European Commission, DG Joint Research Centre, Via E. Fermi 2749, 21027 Ispra, Italy. Email: d'[email protected] Tel.: +32 229-59203 JRC Science Hub https://ec.europa.eu/jrc JRC114590 PDF ISBN 978-92-79-99245-2 ISSN 2467-2203 doi:10.2760/ 028399 Luxembourg: Publications Office of the European Union, 2019 © European Union, 2019 The reuse policy of the European Commission is implemented by Commission Decision 2011/833/EU of 12 December 2011 on the reuse of Commission documents (OJ L 330, 14.12.2011, p. 39). Reuse is authorised, provided the source of the document is acknowledged and its original meaning or message is not distorted. The European Commission shall not be liable for any consequence stemming from the reuse. For any use or reproduction of photos or other material that is not owned by the EU, permission must be sought directly from the copyright holders. All content © European Union 2019. How to cite this report: d'Artis Kancs and Damiaan Persyn; Welfare Gains from the Variety Growth; Publications Office of the European Union, Luxembourg, 2019, ISBN 978-92-79-99245-2, doi:10.2760/028399, JRC114590. Welfare Gains from the Variety GrowthI d’Artis Kancsa,c,∗, Damiaan Persynb,c,d aEuropean Commission Joint Research Centre, I-21027 Ispra Italy bEuropean Commission Joint Research Centre, E-41092 Seville, Spain cLICOS, University of Leuven, B-3000 Leuven, Belgium dVIVES, University of Leuven, B-3000 Leuven, Belgium Abstract We estimate the variety gains of trade in Estonia, Latvia and Lithuania following the fall of the iron curtain more than a quarter of a century ago. We apply the methodology of Feenstra (1994); Broda and Weinstein (2006); Ardelean and Lugovskyy (2010) and Soderbery (2015) to domestic and international trade data for the period 1988-1997. Although, there was a decline in the number of local varieties during this period, an increase in the number of import varieties from the EU more than outweighed this decline. The increasing variety of imported goods from EU countries substantially lowered the cost of living, resulting in welfare gains to consumers that range from 0.73% in Latvia to 1.28% of GDP per year in Estonia. Keywords: Variety growth, welfare gains, trade integration, iron curtain. JEL code: C68, F12, F14, F17, R12, R23. IThe authors acknowledge helpful comments from Lucian Cernat, Marton Csillag, Dmitry Kulikov, Aleksandra Parteka, Giulia Santangelo, Jan Van Hove and participants of GTAP, EEA and BEA conferences in Dakar, Mannheim and Vilnius, as well as workshop participants at the University of Leuven and European Commission. We are grateful to Anson Soderbery for providing the hybrid LILM elasticity code, Smirnov Sergey Olegovich for granting access to data and Laila Ekharde for providing the necessary concordances. The authors are solely responsible for the content of the paper. The views expressed are purely those of the authors and may not in any circumstances be regarded as stating an official position of the European Commission. ∗Corresponding author, Competence Centre on Modelling, European Commission. Email address: d'[email protected] (d’Artis Kancs) 1. Introduction The fall of the iron curtain more than a quarter of a century ago has led to one of the largest and most abrupt trade policy liberalisations in the postwar European history. Virtually overnight, around a dozen of former centrally planned economies in Central and Eastern Europe (CEE) opened up their markets to the world trading system. The trade liberalisation coincided with several other radical changes and policies in CEE countries, such as structural reforms (price liberalisation and privatisation) and macroeconomic stabilisation policies, which have attracted plenty of attention from economists (Shleifer and Vishny, 1991; Svejnar, 2002). Attempts towards assessing the impact of the trade liberalisation on CEE economies have been limited to classical gains from trade (Baldwin et al., 1997; Levchenko and Zhang, 2012). However, entirely new goods and varieties that became available in formerly centrally planned economies through the rapidly growing foreign trade with the West created additional welfare effects, which are not captured by these neoclassical models. To the best of our knowledge, the present paper is the first to estimate the welfare effects operating through changes in the choice set of consumers following the fall of the iron curtain in the CEE. The neoclassical trade theory predicts large gains from the trade integration of countries with large differences in endowments in terms of labour, capital, skills and natural resources or technological differences between countries and sectors; such as eastern and western European countries. Using a neoclassical framework, welfare impacts of the CEE’s trade liberalisation following the fall of the iron curtain have been assessed e.g. by Baldwin et al. (1997); Levchenko and Zhang(2012). The majority of these studies simulate the trade integration between the East and West using CGE models, and subsequently evaluate welfare gains relative to a hypothetical scenario, where the foreign trade remains highly restricted. These studies find substantial welfare gains from the CEE’s trade liberalisation with the West (cumulative gains up to 15% of the GDP), stemming mostly from countries specialising in sectors where they have a comparative advantage, and reaping the gains through trade. More recent theories of the international trade rather emphasise the importance of trade-induced changes in the variety of goods, quality, scope, markups, firm productivity and cost structure, which act as important channels of welfare gains (Hottman et al., 2016). These effects are not captured by neoclassical models with homogeneous goods used in above studies.1 Krugman(1980) was among the first to derive a model illustrating 1Models of international trade with imperfect competition often offer three additional sources of gains 1 how trade can increase the welfare of consumers through the availability of new goods or an enhanced set of differentiated varieties of the same good. Since then, both the methodology (Romer, 1994; Feenstra, 1994; Feenstra and Kee, 2004; Feenstra, 2004; Broda and Weinstein, 2006; Arkolakis et al., 2008; Ardelean and Lugovskyy, 2010; Soderbery, 2015; Feenstra, 2018), and the empirical framework (Broda and Weinstein, 2004; Hummels and Klenow, 2005; Broda and Weinstein, 2010; Kancs, 2010; Blonigen and Soderbery, 2010; Hottman et al., 2016; Lewrick et al., 2016; Amiti et al., 2017) have improved significantly. These empirical studies mostly estimate variety gains from globalisation for OECD economies and typically find substantial welfare gains ranging between 0.1 and 0.5 percent of GDP per year.2 These variety gains from trade are in addition to classical gains from trade (exploiting comparative advantages), suggesting that the actual gains from the trade integration are considerably larger than typically estimated in neoclassical trade models. The existing empirical work on the variety growth from globalisation and trade integration has been focussed on developed countries, and marginal/gradual