Review of: Estimating the Impact on Mozambique of Different Trade Policy Regimes:
SADC, SACU or MFN?
This note has been prepared at the request of USAID’s Trade and Investment Program
(TIP), to provide an independent assessment of the recent paper on Estimating the Impact
on Mozambique of Different Trade Policy Regimes: SADC, SACU or MFN? by Andrea
Alfieri, Xavier Cirera and Alexis Rawlinson (hereafter AC&R). The review consists of
three sections: general comments, technical comments, and conclusions. My intention in
this review is to raise issues as I see them, focusing on constructive criticisms, as a input
for other readers, particularly those without a strong technical background in economics.
I trust that the authors will quickly point out any instances where my comments reflect a
misunderstanding of their analysis.
General comments

The paper is chock full of useful data and pertinent insights. Among other things, it
provides a valuable analysis of the SACU arrangements and the economic impact of
four different trade reform scenarios for Mozambique: joining SACU, with and
without the FTA with the EU; fully implementing the SADC Trade Protocol; and full
unilateral liberalization of MFN tariff rates.

Much to their credit, AC&R repeatedly emphasize that the results are limited by the
partial equilibrium and comparative static methodology. Despite the limitations, the
model yields new and valuable information on the direct, short-run impact of trade
reform for each of 5270 HS product codes (though the paper only reports the 2-digit
aggregations); results are also given for the impact on government revenue and
consumer welfare, based on 2004 import data. As the authors explain, the analysis
excludes indirect adjustments arising from market responses to the trade reforms, as
well as dynamic effects on investment, innovation, production techniques and labor
skills, in response to changing incentives and competitive pressures. The calculations
also exclude the impact on Mozambican exports and production for the domestic
market.

Even with all the caveats given in the paper, AC&R do not adequately convey to a
general reader the severity of the methodological limitations. For example, they say
nothing about the extent to which partial equilibrium results can differ from general
equilibrium effects, where the latter include upstream linkage effects, changes in the
cost of labor and capital, changes in household income and consumption, and changes
in the real exchange rate, among other indirect effects of trade reform. They don’t
even mention how the trade reforms might affect the exchange rate.
Because of the limitations of partial equilibrium methods, many analysts rely on CGE
models to assess the economic impact of trade reform. I am not saying, however, that
AC&R should have done a CGE paper. The estimation of partial equilibrium effects at
the 6-digit level is a major contribution to the debate.1 My point is simply that the
policy audience in Mozambique should have a better explanation of how much the
1
And CGE analysis has its own problems, including a much greater degree of aggregation, yielding impact
results that are much less product-specific.
limitations may matter. For generalist readers, it’s not enough to cite the caveats.
Moreover, ACR claim that the partial equilibrium analysis provides “a clear
orientation of the sign and magnitude of the changes expected…” (end of section 3.1,
with similar language in section 9.1). This may be seriously misleading.
xc: I guess we should put more emphasis on the limitations of the partial equilibrium
analysis.

The same comment applies to the static nature of the methodology, perhaps more
strongly. AC&R do explain very clearly that the results exclude dynamic effects. But
here, too, they do not adequately convey the severity of the problem. Indeed, the
prospective dynamic gains are the driving force behind efforts to liberalize trade,
across the globe. Estimates of the static effects routinely reveal very small net changes
in welfare from trade reform.
xc: Again, we should add a paragraph on potential dynamic gains, but the computation of
these gains was out of the scope of the paper and out of reach with this methodology

Some other important issues are more technical in nature. See next section.
Technical comments, in order of appearance. Asterisks (***) indicate importance.2

Intro, para 5 - impact on exports: AC&R suggest that not having estimates of the
impact on exports does not matter much because Moz already benefits from duty-free
access for most products to RSA and the EU. Later, they also (rightly) express doubt
that exports would rise significantly due to cost and capacity constraints. Nowhere do
they point out, however, that import taxes have adverse general equilibrium effects on
exports equivalent to a tax on the latter, through adjustments in the exchange rate and
incentives for resources to move away from export industries.
xc:We can add this general equilibrium effect as section 6. However, I believe that this
would depend on how export sectors are treated. The government may be assisting export
sectors via tax breaks and duty drawbacks. So the distortion may not be biased against
exporters. In any case this is an empirical issue and maybe we should mention it.

* After Table 2 – the higher duty rates are mainly for revenue collection: It’s almost
tautologically true that goods facing higher duty rates are the main source of customs
revenue. But the revenue objective could just as well be achieved with lower and more
uniform rates. Thus, revenue objectives cannot explain for the observed dispersion in
duty rates, which create very high rates of effective protection and costly incentives
for inefficient resource allocation.
2
I avoid using page numbers for reference because some readers may be printing on A4 rather than lettersize paper, which affects the pagination.
2
xc: The intention of the paragraph was to differentiate between two objectives of trade
policy, revenue vs protection, and to say that is not protection that explains the tariff
structure. High tariffs may not bring much revenue because protect a sector with few
imports or price elasticity of demand is very high. The point we want to make is that
revnue objective dominates protection objective. About: “the revenue objective could just
as well be achieved with lower and more uniform rates”. I think that it may be also
maximized with higher dispersion in few tariffs, while others are duty free. This depends
eventually on the trade policy objectives, but I think that at some point we (or someone
else) should do an exercise of simulation for achieving an “optimal” tariff structure.

* Section 3.1 - price elasticities: The analysis would be improved by (a) more
justification for using unitary export elasticity for RSA, rather than a higher or lower
elasticity, and (b) sensitivity analysis reporting the effects of alternative
parameterization. The reader is given no clue about the extent to which this
assumption affects the results.
xc: See final note

** Section 3-2 – Definition of scenarios: The MFN scenario is a curiosity. It’s not
clear that this is a very informative option, because no one is advocating zero duties
across the board. A better option would have been to examine the effects of moving to
a low, uniform tariff at (say) 5% while eliminating all exemptions.
xc: The idea was to get a higher bound of the estimations. This scenario has been
incorporated in the revised version

*** Same place: I don’t see why the reduction to 20% in top duty rate is incorporated
in the post-reform scenarios but not the baseline. Using 25% for the baseline
overstates the revenue loss from the indicated reforms. Worse, Table 6 shows the 20%
rate being used for only the FTA scenario. If other scenarios do not incorporate the
top-rate reduction, then the revenue impacts are all skewed against FTA.
xc: But the level of imports in 2004 was with the rate at 25% not 20%. Of course this
implies that part of the tariff reduction would happen anyway because MFN
commitments. We should specify this rather than changing our pre-reform to 20%. FTA
is the only scenario that includes this reduction, because the others imply adopting a
different tariff structure, SACU or 5%

*** Below Table 6, SACU scenarios: It’s hard to see how Mozambique could avoid
the de facto effect of the TDCA under SACU. Thus, the SACU 1 scenario (without
TDCA) is largely irrelevant. There also seems to be a serious problem with the SACU
2 (with TDCA) scenario. The calculations include the effect of reducing duties on
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imports from the EU to zero, but exclude the impact of TDCA the price of imports
from RSA. Consequently, it’s not clear that either SACU scenario makes sense.
xc: There is uncertainty about the final outcome TDCA-EPA. That is why we opted for
using the two scenarios that we know in practice. I agree that the TDCA is the most
likely, but it is still uncertain. Not sure I understand your second point “but exclude the
impact of TDCA the price of imports from RSA”

** Figure 3: For generalist readers, it would be useful to use this figure to make a few
additional pedagogical points:
o In this case eliminating duties on SADC imports has no effect on the price or the
consumer surplus in Moz. There is still a negative revenue effect, equal to the
shaded area shown in my Figure 1 below. (This point is presently buried in the
Methodological Appendix.)
o In this case, the shaded area also represents a real resource cost to Mozambique
from trade diversion. Moz will now be paying South African suppliers a price of
(1+τ)p*. In the initial (tariff-ridden) situation, suppliers in RSA were only paid
p*, with the difference being a transfer from consumers in Moz to the Treasury in
Moz – not a real welfare cost to the nation. (More on that below).
aa: It seems to me that Bolnick’s is sometimes confusing welfare effects computed
using standard Harberger triangles with trade diversion and trade creation effects.
They are different concepts and maybe we should make it clearer in the text by
interpreting the welfare change along the following lines. For instance, in the figure
below I think there’s no doubt that by defining Mozambique’s welfare as Rev + CS,
the country is having a net loss equal to the shaded area due to revenue loss. This loss
can be “interpreted” as a transfer to SADC exporters (A) plus a resource loss due to
trade diversion (B) which is actually a deadweight loss for the all FTA. This is clearly
explained by Panagariya in the case referring to figure 2 in his paper.
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Figure 1: Imports from SADC and ROW
SADC1
Price
(1+τ)p*
SADC0
E1
ROW1
A
B
E0
p*
ROW0
Demand
Imports
Msadc1

Msadc2
M1
M0
*** Para after Eq (12) – Import demand elasticity assumptions: These parameters are
critical to the empirical results, and should not be dished up with a simple reference to
Stern et. al (1976). Please elaborate! Are the Stern estimates pertinent to a country
like Mozambique? What are some representative parameter values for key sectors?
Are these short-run or long-run elasticities? How sensitive are the results to reasonable
parameter changes? Am I making a mountain out of a molehill?
xc: Well the issue here is that we do not have any information on import demand
elasticities and its computation with the data available in Mozambique is very difficult.
Of course the results are very sensitive to the import demand coefficients, but we could
not find any other source. In future work we will do some sensitive analysis. In any case
the ordering of the scenarios in terms of welfare will not change

Section 4.1, first bullet (and section 4.4) – SACU w/o TDCA involves “greater
protection than existed in 2004”: The numbers here don’t support this statement. They
show that under SACU 1 the average price of imports drops by 3.55%, and (in Table
7) the value of imports falls less than this, indicating a rise in import volume. A drop
in import prices and rise in volume do not suggest greater protection.
aa: we deleted the above statement from the text already

**** Before Table 7 – revenue losses exceed consumer gains, implying overall
national welfare loss: This is the first of many places in the paper where the algebraic
sum of the change in revenue and the change in consumer surplus is used to tally the
change in national welfare. Either I’m not thinking clearly (always possible!) or this
computation introduces a major problem with the quantitative results. Let me use a
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simple example, shown in my Figure 2 (below), to make my point. The example is the
MFN case, with a tariff of τ applied to all imports of a particular good.
Figure 2: Simple tariff case
Price
E1
(1+τ)p*
A
ROW1
B
E0
p*
ROW0
Demand
Imports
M0
M1
Suppose we remove the tariff. Consumer surplus improves by A+B, while revenue
declines by A. The foregone revenue, however, is a transfer from the Treasury to the
consumers. It is not a national welfare loss. aa: Do we say it is a national welfare loss?
It seems to me that in the text we simply say that the net welfare change defined as
Tariff revenue + consumer surplus is (in this case) positive by B (A is a transfer and B
is a gain from trade) This is clearly explained in the JEL paper by Panagariya (2000,
p. 290-291), which the present study cites as the main source of the model being used.
aa: Actually this is not correct. Panagariya in a similar case in the quoted paper (fig 1a
– p291) states clearly that B is a net (welfare) gain for A (in the text the example refers
to the opposite case so the author defines “the area e as a net loss” to the home
country).
Furthermore, in the MFN case, area A cannot possibly exceed area (A+B). The
difference (triangle B) is often called the “deadweight loss,” because this part (and
only this part) of the tax-induced loss to consumers is not offset by a corresponding
gain to the Treasury. When the tax is removed, triangle B represents the net gain in
national welfare, which must be positive in the partial equilibrium model. aa: Agreed.
The case shown in my Figure 1, above, is quite different. There is no change in the
equilibrium price or quantity, and therefore no change in consumer surplus. And in
that example the loss of revenue does correspond to a national welfare loss – but the
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welfare effect derives from paying a higher price to suppliers in RSA, not from the
loss of revenue to the Treasury.
Thus, the change in national welfare is not equal to the change in revenue plus the
change in consumer surplus. The correct formula is to tally the net welfare effect as
the change in the deadweight loss triangle plus the change in the real cost of imports
due to trade diversion.
xc: Not sure I understand your point. Should not be trade diversion incorporated in the
loss of revenue not being transferred to consumers? We have revised our figures,
because there was a scaling problem, that underestimated consumer surplus, and
maybe now the figures are more in line with your comment. In any case, we prefer to
use changes in consumption surplus and revenue because are more relevant for the
policy makers. Trade creation and trade diversion are what explain changes in
consumer surplus and revenue.

** Section 5.2 – fraud adjustment: I haven’t read Van Dunem’s (2005) paper to see
how he arrives at the fraud elasticity of 1.4. But the explanation given here suggests
that Van Dunem assumes that the entire bilateral discrepancy between the reported
CIF value of imports to Moz and exports from RSA is due to fraud on the Moz side.
That sounds plausible. Except that (a) footnote 4 in section 2.1 suggests that the
discrepancy is very small, which belies such a large elasticity; and (b) there is a
history on the RSA side of claims for fictional exports or back-and forth exports for
purposes of defrauding the government on duty drawbacks, VAT refunds, and other
export incentives. Also, (c), it’s unlikely that a single elasticity applies to a reduction
from 20% to 5% versus a reduction from 5% to 0%. This adjustment turns out to have
a large effect on the results. Thus, it merits more careful discussion, and possibly more
careful application of Van Dunem’s estimate.
xc: Without discussing van Dunem’s paper. Our footnote refers to totals and the problem
of unclassified imports in 2004. Before this year there were more discrepancies, and at
the product level discrepancies still persist. By using this elasticity we wanted to make
the point that if it is positive then trade reform may trigger larger registered trade flows.
We use 1.4 because that is the reference that we have for Mozambique. But as you
mention, quite likely there should be some threshold effect on the elasticity, a tax level at
wich smuggle happens.

Several tables (e.g., Tables 22 and 28) lack mention of units. Are the numbers in rand,
dollars, millions, billions? Billion dollars

* Just below Table 24 – Kirk and Stern (2004) results: There is such a large difference
between the present results and those of Kirk and Stern – even a reversal in the sign of
the net welfare effect – that one would appreciate a more thorough discussion of the
reasons.
xc: It is difficult to discuss when their approach is quite different, since they applied
percentages on aggregate numbers, while we aggregate from impacts at the product level
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
* Section 7.1 – price transmission: This excellent passage neglects an important point.
The net welfare effect from trade liberalization should include the net benefit to
consumers from lower prices on goods produced domestically that face more intense
foreign competition due to the reform. To be sure, there is a corresponding loss of
income to domestic producers, but as resources are reallocated to alternative uses, a
simple partial equilibrium model shows that the benefit to consumers exceeds the loss
to producers. Calculations in this paper show only the welfare change associated with
net imports (because that’s where we have data). This focus is likely to understate the
change in national welfare, possibly to the point of reversing some results. This is just
another way of underscoring the limitation of the partial equilibrium analysis.
xc: Agree, but again we cannot quantify that. In any case its is important to point out at
the importance of price transmission

* Section 8, trade deficit – The analysis in this section is weak. Changes in the overall
trade balance are inherently driven by a variety of macroeconomic and microeconomic
factors that fall well outside the scope of the partial equilibrium analysis in this paper.
Among other things, the trade balance varies with the availability of international
financial flows (including grants and remittances); the trade balance also depends
heavily on the balance between domestic saving and investment; changes in trade
patterns due to economic reforms may produce offsetting exchange rate effects. In
addition, the rapidly growing trade deficit indicated in Table 28 is a figment of the
dates chosen. Using 2002 as the starting point rather than 2001, the deficit has
narrowed, not widened. In essence, this section reads like an afterthought and adds
nothing useful to the findings.

Methodological Appendix: I went through only a few sub-sections, and found a few
issues of note:
o Section 10.2.1.2 Case 2: As I understand this case, Trade Creation (TC) is not
zero. This can be seen in the difference between M* and M0 in the graph, and the
fact that both variables enter the CS equation. xc: Panagaryia in an identical
example in his paper (fig.3 – case 2, p. 296) defines Trade Creation as greater
than zero. However, this seems to contradict previous definitions of trade creation
that should imply bothh generation of new trade and switch towards more
efficient producers (with respect to either domestic or other external producers).
In our case we say that there is no trade creation since SA is not more efficient
than the ROW and we define this increase in trade as something else: a so-called
“consumption effect” following Morrisey, Milner and McKay. In Panagariya
there’s no mention to such consumption effect.
o Same section and case: the equation for ΔE seems to include only the quantity
effect on VAT revenue and neglect the price impact from having a smaller tariff
rate (=P0 - Psa in Figure 10.2.1). xc: corrected
o *** Same section and case: This section has the first appearance of the equation
for the net national Welfare Effect (WE) in the Appendix. It is given as: WE = ΔR
+ CS. In line with my earlier comments, and my Figure 2 above, CS is defined to
include the revenue loss rectangle plus the deadweight loss triangle. If my
comments are on target, then this is not the correct equation for WE. The problem
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applies throughout the paper. aa: See comments made above. It is possible to
distinguish standard welfare effects from trade creation and diversion effects. The
result, however, should not change.
o *** Section 10.2.4, MFN scenario: The equation for CS in this section appears to
be incorrect. Elimination of the tariff (τ) yields a gain in consumer surplus equal
to ΔP*M0 (the rectangle) plus (1/2)*ΔP*ΔM (the triangle). Also, the labels for P
and M in Figure 10.2.4 are incomplete. xc: I think is correct as it is
xc: We solved the model in GAMS as a system of equations, so in reality there is only
one case for every scenario and the algebra is irrelevant. It is in the paper as an
illustration of the methodology
Conclusion
The authors deserve great credit for producing these important results, and also for
calling attention to shortcomings of the static partial equilibrium analysis used in the
paper. Their computations provide very interesting and useful information on the direct
impact of trade reform on particular sectors, but their overall conclusion should be much
more attenuated. Despite the caveats, the authors lean too heavily on the empirical results
to make the case for joining the SACU customs union. This is particularly problematic
considering that the results for the SACU case are estimated using the current revenue
sharing formulae. As the authors acknowledge, the consequent changes affecting the
revenue shares for BLNS raise serious doubts that SACU would admit Mozambique
using this formula.
xc: I think maybe we should lower the tone in the conclusions, but the objective was not
to propose joining the SACU. It was only to acknowledge that with the methodology
used SACU implies larger welfare than SADC because of revenue transfer. Also, we
acknowledge that SACU is also full of problems and difficulties, and more important that
domestic reform is crucial.
In addition, my technical comments raise several questions about the calculations,
especially the net national welfare effect, and the sensitivity of the findings to variations
in key parameter assumptions.
After reading the paper, I conclude that moving ahead with discussions on joining SACU
is warranted. But this conclusion is driven by impacts that are outside the static partial
equilibrium model, such as unhindered trade with the dominant regional economy in
South Africa, the likely impact on investment, and simpler rules of origin. The revenue
effect is a possible bonus for entering SACU, but it should not be regarded as a motive.
This is because the estimates are soft, and the revenue sharing arrangement is likely to
change anyway if Mozambique were to be admitted.
xc: Agree, but the paper was an attempt to provide a framework for discussion
However, the potential negative effects of SACU membership must be kept clearly in
mind. These include the loss of control over tariff and excise policies; accession to a
more complex tariff structure; and exposure to trade policy decisions made by South
9
Africa in response to domestic political pressures. xc: I think we try to mention these
problems in the paper
The policy decision therefore involves judgments on the trade off between benefits and
costs. The answer cannot be determined by technical analysis alone.
-----------------Bruce Bolnick
Nathan Associates
October 23, 2006
xc: we would like to thank you for your extensive and thorough comments. Just to add
that that the idea is to work on improving the estimates with a methodology that uses the
CES function at HS-6 and do some more sensitivity analysis. We hope that this can
provide valuable information for decision making in trade policy, and it can also provide
more robustness at the results of this paper. In addition, just to add that we will be replace
the version on the web with an updated version that includes some of the comments here.
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