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  • ERASMUS UNIVERSITY ROTTERDAM

    Dutch trade and welfare implications of tariff reform

    A General Equilibrium Analysis

    Rowan Winkels

    9/17/2016

    We study the role of import tariffs on the trade flows and welfare levels of the

    Netherlands, surrounded by eight of its biggest trading partners. We extend the general

    equilibrium Heckscher-Ohlin model and run various numerical simulations. With the

    Netherlands modeled as a relatively capital abundant country, our cases see Dutch

    trade flows commonly divert according to Heckscher-Ohlin theorems. Complete

    elimination of Dutch import tariffs shows welfare and net exports to increase by 0.56%

    and 54.98% respectively. Prices converge as trade intensifies in all cases. Factor price

    equalization does not completely materialize as insufficient implicit factor trade takes

    place.

  • 1

    Contents

    1. Introduction and relevant literature ........................................................................... 3

    1.1. The Heckscher-Ohlin model ..................................................................................... 4

    1.2. Implied effects of import tariffs ................................................................................. 6

    1.3. Quantifying trade reform ........................................................................................... 7

    2. Theoretical framework .............................................................................................. 8

    2.1. General equilibrium analysis .................................................................................... 9

    2.2. Establishing micro-economic foundations .............................................................. 10

    2.2.1. Modeling firm behavior ..................................................................................... 10

    2.2.2. Modeling household behavior .......................................................................... 12

    2.3. Formal structure ..................................................................................................... 14

    2.3.1. Algebraic simplification ..................................................................................... 15

    2.3.2. Final equilibrium conditions .............................................................................. 16

    3. Methodology ........................................................................................................... 17

    3.1. Extending the 2x2x2 model .................................................................................... 17

    3.2. Introducing GAMS .................................................................................................. 20

    3.2.1. Endogenous variables ...................................................................................... 21

    3.2.2. Parameter values ............................................................................................. 22

    3.2.3. Model equations ............................................................................................... 24

    3.3. Establishing GAMS model strength ........................................................................ 29

    3.4. GAMS simulations and expectations ...................................................................... 31

    3.4.1. Case 1: Unilateral tariff drop of a single good .................................................. 31

    3.4.2. Case 2: Unilateral tariff drop of all a country’s goods ....................................... 32

    3.4.3. Case 3: Multilateral tariff drop .......................................................................... 34

    3.4.4. Case 4: Nexit .................................................................................................... 35

    4. Results .................................................................................................................... 36

    4.1. Benchmark results .................................................................................................. 37

    4.2. Case 1: Unilateral tariff drop of a single good ........................................................ 38

    4.3. Case 2: Unilateral tariff drop of all a country’s goods ............................................. 39

    4.4. Case 3: Multilateral tariff drop ................................................................................ 41

    4.5. Case 4: Nexit .......................................................................................................... 42

  • 2

    5. Discussion .............................................................................................................. 43

    5.1. Unilateral tariff implications .................................................................................... 44

    5.2. Multilateral tariff implications .................................................................................. 45

    5.3. Nexit implications ................................................................................................... 45

    5.4. GAMS Model improvements .................................................................................. 46

    6. Conclusion .............................................................................................................. 47

    7. Reference list .......................................................................................................... 48

    8. Appendix ................................................................................................................. 51

    8.1. Additional calculations and data sourcing .............................................................. 51

    8.1.1. Working population and capital stock ............................................................... 51

    8.2. NL input-output matrices ........................................................................................ 52

    8.2.1. Real input output matrix, year 2010. ................................................................ 52

    8.2.2. Simulated input output matrix. .......................................................................... 53

    8.3. Benchmark model strength comparison ................................................................. 54

    8.4. GAMS model code ................................................................................................. 55

  • 3

    1. Introduction and relevant literature

    Free trade is, without a doubt, one of the most debated topics in modern economics.

    Throughout history, economic protectionism and political incentives have caused many

    countries from all around the world to impose trade barriers. More specific, Irwin (2012)

    attributes the imposition of higher import tariffs to the Great Depression of the 1930s.

    Thereafter, countries started to rethink their international trading positions and the

    inherent effects of trade barriers. Increasingly, groups of countries have created

    reduced tariff trade environments through multilateral trade agreements. It wasn’t until

    1968 that the European Union (EU) managed to create its tariff free internal market.

    Today, the United States of America and the European Union are in advanced talks

    concerning the so-called Transatlantic Trade and Investment Partnership (TTIP). This

    comprehensive multilateral trade and investment agreement is meant to further

    integrate EU and US markets. Supporters of TTIP are enthusiastic about the economic

    growth that free trade will bring between the two trading blocs. European critics of the

    agreement fear that strict regulations in the EU, especially concerning the food industry,

    will be relaxed in order to compete with lower US standards. Although similar fears were

    expressed concerning the EU’s internal market, no widespread deregulation has

    occurred since.

    International trade agreements and the EU’s internal market seem to have greatly

    benefitted the Netherlands, one of its founding countries. The graphs in figure 1 display

    an indisputable increase in Dutch production output, wealth and international trade from

    1968 until now. Although it would be too blunt to attribute all this growth to the absence

    of import tariffs, economic theory does support the assumption that free trade benefits

    welfare. Nevertheless, the comprehensive effects of import tariff reductions remain

    unknown.

    In this paper, we aim to determine the effects of tariff reform on Dutch production

    output, national welfare and trade levels. In an extended Heckscher-Ohlin (H-O) setting,

    we formulate a large scale general equilibrium model which centers on the Dutch

    economy. Through various simulations, we are able to ascertain the effects of both

  • 4

    unilateral and multilateral tariff drops. Additionally, a so-called ‘Nexit’ is simulated,

    where the

    Netherlands steps out of the European Union. The resulting simulated levels of

    production and directions of trade are found to mostly follow the theorems embodied in

    the H-O model. In general, we find the Dutch economy obtains higher levels of national

    welfare as import tariffs are dropped.

    In the remainder of this section we highlight the H-O model and its inhe

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