How confident can we be of CGE-based assessments of Free Trade Agreements?

Computable General Equilibrium models, widely used for the analysis of Free Trade Agreements, are often criticized for having poor econometric foundations. This paper improves the linkage between econometric estimates of key parameters and their usage in CGE analysis in order to better evaluate the likely outcome of a Free Trade Area of the Americas (FTAA). Our econometric work focuses on estimation of a particular parameter, the elasticity of substitution among imports from different countries, which we show to be central to our evaluation of the normative impacts of the FTAA. We match the data in the econometric exercise to the policy experiment at hand, and employ both point estimates and the associated standard errors in our FTAA analysis which takes explicit account of the degree of uncertainty in the underlying parameters. In particular, we sample from the distribution of parameter values given by our econometric estimates in order to generate a distribution of model results, from which we can construct confidence intervals. We find that imports increase in all regions of the world as a result of the FTAA, and this outcome is robust to variation in the trade elasticities. Nine of the thirteen FTAA regions experience a welfare gain in which we are more than 95% confident. We conclude that there is great potential for combining econometric work with CGE-based policy analysis in order to produce a richer set of results that are likely to prove more satisfying to the sophisticated policy maker. (C) 2007 Elsevier B.V. All rights reserved.