INSIDE GLOBAL ISSUES
Working Paper No. 201409 , March 11st , 2014
China’s Potential Future Growth and Gains from Trade Policy Bargaining
Li Chunding, John Whalley
Abstract
Numerical simulation analysis of bargaining solutions is little developed in existing literature. In this paper, we use a numerical general equilibrium model which captures China and her major trading partners and examine the outcomes of trade policy bargaining solutions (bargaining over tariffs and financial transfers) over time, and then measure both absolute and relative gains to China from trade bargaining. These measurements are important for policy making. Our simulation results indicate that China’s welfare gain from trade bargaining will increase over time if countries keep their present higher GDP growth rates for several decades, but there are major difference when using different bargaining solution concepts. These differences have not been noted in existing literature but have an intuitive explanation. Our results also indicate that if China jointly bargains along with India, Brazil and other developing countries with the OECD, and when we use PPP to adjust China’s relative GDP size China’s gain will further increase.
Keywords: Bargaining Solutions; Welfare Gain; General Equilibrium; Numerical Simulations
JEL Classification: D60; C78; C68
1. Introduction
China’s trade has grown rapidly in recent decades and has generated large trade surpluses, which have financed an accumulation of foreign reserves. Exports have become one of its main engines of economic growth which in turn have generated adjustment resistance in importing countries. Increasingly over time this will take China to more and more trade policy bargaining to try to use access for foreign suppliers to the growing Chinese market as the bargaining chip to keep protection abroad as low as possible given China’s export lead growth strategy. Given this situation, an interesting question to ask is how China’s welfare gains from trade bargaining might change over time if countries keep their present GDP growth rates and China’s relative size in the global economy progressively grows further. Our focus is the impact of growth on bargaining power over several decades. Our aim is not only to capture China’s welfare gains from bargaining over time, and to investigate China’s future shifting bargaining power, but also assess how calculated gains from bargaining behave over time. Do they increase more or less rapidly than relative GDP growth? Do they increase at an accelerating rate?
Existing literature on bargaining is theoretical and analytical rather than numerical (Nash, 1950; Johnson, 1965; Kalai and Smorodinsky, 1975; Rubinstein, 1982; Roth et al, 1991; Trejos and Wright, 1995; Johnson et al, 2002; Cahuc et al, 2006; Kennan, 2010). The focus is on bargaining solution concepts and bargaining theory, and only a few papers have used numerical techniques to compute bargaining solutions (Trifon and Landau, 1974; Calmfors et al, 1988; Coles and Muthoo, 1998; Carpenter, 2002). With the exception of Abrego et al (2001) and Bouet & Laborde (2009) this numerical literature on bargaining does not use general equilibrium structures to numerically solve for bargaining outcomes. They are instead mostly based on partial equilibrium models and few of them have been used for simulation analyses related to concrete policy issues. Our focus and methods, however, differ sharply from Abrego et al (2001) and Bouet & Laborde (2009) in examining the links between bargaining power and growth rather than the links between environmental policies and trade bargaining that they explore.
Our global general equilibrium model captures five countries, each of which is endowed with two factors and produces two goods which are heterogeneous across countries. Countries are linked through trade and they bargain on their own import tariffs which, for simplicity, we assume are at uniform rates across goods imported from a country, but can vary across country sources. Since, for now, China’s trade partners are more heavily developed countries, we assume China bargains bilaterally with the whole of the OECD. Using this model structure, we then explore bargaining solution outcomes and simulate welfare gains for each bargaining partner under various scenarios which reflect changes in country size as growth proceeds.
We adopt 2008 as our base year and build a benchmark data set which we use to calibrate model parameters. We then analyze China’s welfare gains over time at ten yearly intervals from 2010 to 2100 as China’s endowments grow at different rates from those of other countries. These gains are computed as a sequence of single period comparisons of numerical bargaining solutions using different solution concepts (Nash (NBS), Kalai-Smorodinsky (KS)) relative to non-cooperative Nash outcomes to yield measures of country gains from bargaining in both absolute size of utility gain and each country’s relative gain. We evaluate China’s welfare gain over time using both Nash bargaining and KS bargaining with the OECD, thus yielding the change in China’s welfare gain over time from bargaining. We evaluate China’s welfare gain with using different economic growth rates for each country. We also evaluate China’s welfare gain when bargaining jointly with the OECD with India and Brazil. We finally compute China’s bargaining welfare gains over time using a purchasing power parity (PPP) adjustment for China’s relative size in the 2008 base year data. We additionally conduct sensitivity analysis of China’s bargaining welfare gains to elasticity parameters.
Our simulation results show that China’s welfare gains from bargaining with the OECD increase over time if all countries keep their present GDP growth rates. Using the NB solution concept, China’s share of global bargaining gains grows to 41% in 2010; 67.7% in 2050 and 88.7% in 2100. This shows growth in bargaining gains at roughly the rate of increase in relative GDP. China’s annual average growth rate in its trade bargaining welfare gain using Nash bargaining is about 11%, just a little higher than its GDP growth rate and the OECD’s is about 6%, higher than its GDP growth rate. When we use different economic growth rates for China, the results have some changes. Lower growth rates will generate less bargaining gain and lower bargaining power. But using the KS-solution concept, things are different. China’s share of global gains is only 10.6% in 2010, but grows much more rapidly to 70.9% in 2050 and to 99.1% in 2100; initially proportionally smaller but growing much faster, with the opposite result for the OECD. This implies important numerical differences when using Nash and KS bargaining solution concepts for numerical policy based work. With asymmetric shifts in the utility possibility frontier due to growth, Nash bargaining using tangencies between an implicit Cobb Douglas function and the frontier, and the KS use of a utopia point proportional to intersections with axes which behaves differently.
Additionally, when China joins with India and Brazil to jointly bargain with the OECD or when we use a PPP adjustment for the GDP measure in 2008 for China’s base case economic size, China’s welfare gain from bargaining increases by 40% and 37% compared to the Nash China-OECD bargaining case. Thus, if we take account of China’s relative size via purchasing power parity, China’s welfare gain would be even larger. It also emerges as a good strategy for China to join with other developing countries to jointly bargain with the OECD exerting its bargaining power.
For computational reasons we use strong assumptions to conduct our analysis and these affect results. One key issue is that we use a balanced trade structure in our general equilibrium model which neglects China’s trade surplus position and likely over estimates China’s bargaining power since imports are smaller in reality due to the surplus. However, this may not be as severe a problem as it may seem because although we adjust trade data for each country’s trade to be balanced; for China we only change ROW’s (the rest of the world) exports and imports to yield this result. Trade between China, OECD, India and Brazil does not change and are the same as actual data in our analysis. The balanced trade structure thus does not fundamentally change China’s trade position with OECD, India and Brazil, and may not impact China’s trade bargaining power. We do not, however, capture the potential bargaining component for China from the strategic use of reserves to drive down exchange rates unless market access for exports is preserved.
This paper is organized as follows. In section 2 we discuss China’s current trade situation with other countries, and briefly discuss how future growth may change this. Section 3 describes the model structure and the bargaining solution concepts we use. Section 4 sets out our data used in calibration and reports calibrated parameters. Section 5 reports simulation results and computes China’s trade bargaining welfare gains for the growth scenarios discussed above. Section 6 offers conclusions, implications and final remarks.
2. Background to China’s Trade Policy Bargaining
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3. Model Structure and Bargaining Solutions
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4. Data and Calibration of Model Parameters
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5. Simulation Results
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6. Concluding Remarks
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