Improved market access for Russia or own liberalization as part of WTO accession: What will raise Russian income and red

1. Improved market access for Russia or own liberalization as part of WTO accession:What will raise Russian income and reduce poverty more? Thomas F. Rutherford, University of Colorado at Boulder David Tarr, The World Bank Oleksandr Shepotylo, University of Maryland Updated version available at: www.worldbank.org/trade/russia-wto June 6, 2005 The views are those of the authors and do not necessarily reflect those of the World Bank.

2. WTO is important to Russia for two reasons: • WTO accession. 2005 as the goal, 2006 as more realistic • The Doha Agenda—world price change implications for Russia. We compare the impact of these two potential events on Russia.

3. WTO accession—primarily a set of own commitments—especially in business services • Doha Agenda for Russia—subsidy and tariff reductions in the rest of the world Comparison devolves to: Can Russia gain more from trade and subsidy reform in the rest of the world or from its own liberalization?

4. Small open economy CGE model of Russia We depart from the standard CGE model in two ways: • Foreign direct investment in business services, with Dixit-Stiglitz endogenous productivity effects from FDI in business services and from trade liberalization in imperfectly competitive goods sectors. We build first on Jensen, Rutherford and Tarr (2004)  Two previous efforts to include endogenous productivity effects and FDI Brown and Stern (2001) — but results depend on capital outflow or inflow — e.g., Japan loses because it invests abroad. Productivity effects not mentioned in the results.  Dee et al.(2003) — Question of quota rents —countries that remove barriers gain due to capture of quota rents. Productivity effects not significant in the results.  However, in our model, endogenous productivity effects from FDI liberalization in services are fundamental to the results.

5. Services Z enter the production function as a CES aggregate of domestic and multinational services       1)         • Domestic and imported services are CES aggregates of domestic and multinational firm varieties, respectively. 2) This is pure firm level product differentiation.

6. Dual to the Dixit-Stiglitz quantity aggregates are Cost Functions that reflect the cost of purchasing service varieties at minimum cost:   3)            4)             5)           Thus, costs decline with the number of varieties—the Dixit-Stiglitz love of variety effect.

7. We assume that multinational service providers • Import some specialized inputs—either skilled labor • Or technology. • Thus, they use domestic labor less intensively • than domestic firms. • Although imported specialized inputs are partial • equilibrium substitutes for domestic labor, they • may be general equilibrium complements.

8. We build a “real household” model. All the 55,000 households of the Russian Household Budget Survey are agents in our general equilibrium model. We build on Rutherford, Tarr and Shepotylo (2004). A new algorithm was developed for models with a very large number of agents. Both the GAMS code and a graphical interpretation of the algorithm are available.

9. Counterfactuals: • Elements of the WTO accession counterfactual package • Tariffs reduced by 50% across the board. • Discriminatory tax on multinationals service providers removed or reduced. • Improved terms of trade due to improved market access of from 0.5%-1.5% for seven sectors. • We evaluate the impact of reduction in the barriers to FDI only. • We also evaluate WTO accession with a reduction in the barriers on FDI by 50% of the cuts in our WTO scenario.

10. Global Free Trade(without Russian participation); full removal of tariffs, export subsidies • and domestic support. Russia’s commitments will be dependent on its WTO accession agreement rather than Doha commitments of WTO incumbents. We assume Russia does not participate in these cuts. New price vectors of weighted average export and import prices facing Russia from the GTAP model are the shocks to our small open economy model.

11. 5. Doha Full removal of export subsidies; modest reductions in tariffs and domestic support.

12. Results: • WTO accession • Weighted average gains across households of 7.3% of consumption with a standard deviation across households of 2.2%. Virtually all households gain. • Liberalization of barriers against FDI is responsible for about 70% of these gains. • The poorest decile of the population gains (7.6%) slightly more than the richest (6.8%) since the return on capital rises less in real terms than the wage rate of unskilled labor. See table 7. • We plot the whole distribution and the poorest and richest deciles of the population in figure 2.

13. Rutherford, Tarr and Shepotylo have shown that: A constant returns to scale model without liberalization of barriers against FDI in services and endogenous productivity effects (inappropriate for Russian WTO accession) would produce much smaller average welfare gains (about 1.2 percent) and the wrong sign for the about seven percent of the Russian population.

14. Global free trade (elimination of export subsidies and domestic support) • Gains to Russia overall are 0.2% of consumption with a standard deviation of 0.2% of consumption. • Gains are evenly distributed across deciles. In figure 3 we plot the distributions of the entire population, the poorest and richest deciles. Despite gains on average, a significant share of the households are estimated to lose. • Russia is a significant net food importer. Elimination of subsidies to agriculture raises the import bill for food in Russia.

15. Doha .Modest tariff cuts; export subsidy elimination and modest reduction in domestic support Gains to Russia overall are -0.3% of consumption with a standard deviation of 0.2% of consumption. • The small tariff cuts do not provide enough gains to Russia to offset the negative impact of the subsidy reduction. • Impacts are evenly distributed across deciles. • We also simulate Doha with no export subsidy reduction and no domestic subsidy reduction. In that case, we estimate Russia will gain 0.2% of consumption. This shows again that subsidy reduction hurts Russia.

16. Conclusions: • Own liberalization is most important (especially services for Russia) Russia has by far the most to gain from its own liberalization, especially in business services, rather than from improvements in market access as a result in reforms in tariffs or subsidies in the rest of the world. Figure 5 shows the histogram of estimated welfare results for three scenarios: • Doha; • Global free trade • WTO accession The distributions of welfare impacts of Doha and global free trade are very close and overlap considerably. Global free trade is slightly more beneficial. But the distribution of gains from WTO accession shows dramatically larger gains.

17. A model with FDI liberalization in services with endogenous productivity effects is crucial to even assess the sign of the gains to the Russian poor from WTO accession. If a constant returns to scale model were employed, without liberalization of barriers against FDI in business services, the gains from Russian WTO accession would be only about 1.2 percent of consumption with about 7 percent of households expected to lose, i.e., for these seven percent of the households, the estimated sign of the effects would likely be wrong. • Transition costs must be considered by policy-makers, although they are outside of this model.

21. Figure 2:

22. a/ a/ Global free trade assumes full removal of export subsidies, no change in domestic support, and full removal of tariffs outside of Russia.

23. a/ a/ Doha 2 assumes full removal of export subsidies, some reduction in domestic support, and significant tariff cuts outside of Russia.