Report

7 Revenue and Welfare Implications
of SAFTA: Partial Equilibrium Analysis
INTRODUCTION
The trade theory argues that trade liberalisation
enhances economic efficiency, promotes growth and
helps correct domestic market failures in imperfectly
competitive markets. However, these benefits have
associated costs, one of which is the loss of trade tax
revenue. Trade taxes constitute an important part of
government revenue in developing countries. In general,
it is found that countries’ reliance on revenues from
taxes on international trade is inversely related to their
income levels (Baunsgaard and Keen 2005). Given this,
tariff loss due to trade liberalisation may be substantial
for SAFTA member countries, therefore welfare
implications of trade liberalisation become an
important issue.
Recent research suggests that for developing
countries with binding government budget constraints,
it is a priority to implement comprehensive reform
packages of the domestic tax system to accompany
trade liberalisation. Baunsgaard and Keen (2005) use
panel data of over 25 years for 111 countries and show
that high-income countries in fact recovered the
revenues they have lost from other sources from past
episodes of trade liberalisation. For middle-income
countries, recovery has been in the order of 45–60 cents
for each dollar of lost trade tax revenue, with signs of
close to full recovery when separately identifying
episodes in which trade tax revenues fell. Troublingly,
however, revenue recovery has been extremely weak in
low-income countries (most of which depend on trade
tax revenues): they have recovered, at best, no more
than about 30% of each lost dollar. The view that loss
of tariff revenue may have adverse implications for
tariff-dependent developing countries, as it may lead
to lower government expenditure as the entire loss is
not recovered by taxes, has been supported by many
1
SMART rests on the Armington assumptions.
studies in the literature (Emran and Stiglitz 2005, Munk
2005, Atolia 2006).
It is although argued about the loss of revenue to
the government may not be fully recovered through
alternative source, very few studies have actually
estimated the extent of revenue loss to countries under
SAFTA. In this chapter, we use the partial equilibrium
model to estimate the impact of zero tariff regime
on the revenue and welfare of SAFTA member
countries.
REVENUE, WELFARE AND TRADE EFFECTS:
METHODOLOGY
Revenue, Welfare and Trade Effects have been
estimated using UNCTAD/World Bank SMART model.
SMART is a partial equilibrium model simulating the
impact of a tariff change on trade flows, tariff revenue
and consumer welfare for a single market. 1 It focuses
on one importing market and its exporting partners
and assesses the impact of a tariff change scenario by
estimating new values for a set of variables.
The theoretical framework of SMART on the
export side assumes that, for a given good, different
countries compete to supply a given home market. The
focus of the simulation exercise is on the composition
and volume of imports into that market. Export supply
of a given good by a given country supplier is assumed
to be related to the price that it fetches in the export
market. The degree of responsiveness of the supply of
export to changes in the export price is given by the
export supply elasticity. SMART assumes infinite export
supply elasticity – that is, the export supply curves are
flat and the world prices of each variety are exogenously
given. This is often called the price-taker assumption.
SMART can also operate with finite elasticity – upward
sloping export supply functions – which entails a price
effect in addition to the quantity effect.