Question

"Costa Rica Trade Liberalization, Fiscal Imbalances, and Macroeconomic Policy: A Computable General Equilibrium ModeL" (Cattaneo, Hinojosa-Ojeda, and Robinson, 1999). Explain the findings in detail, review academically

Answer 1

In the 1980s, Costa Rica signed structural adjustment agreements with the World Bank that included trade liberalization, elimination of producer and consumer subsidies, and other policy reforms. How might the broader reform program that Costa Rica must carry out temper the gains from the trade liberalization component.

The authors developed a multihousehold SAM for Costa Rica for 1991. Using the IFPRI standard CGE model, they vary macro closure rules to describe alternative ways to implement structural adjustment commitments.

A single trade liberalization experiment, that removes all import tariffs and export taxes, is carried out under two alternative foreign savings closures: fixed foreign savings and an endogenous exchange rate versus a fixed exchange rate and endogenous foreign savings. Both scenarios are also conducted with three alternative closures for government savings: loss of trade tax revenue causes the government to run a deficit, and the government budget balance is fixed with trade tax revenue replaced by a corporate income tax or by a retail sales tax.

Trade liberalization generates efficiency gains for the economy as a whole, and changes in the distribution of income across households are small. However, there are trade-offs that the government must face to maximize these potential gains. The scenarios offer a blueprint for government policy, recommending reduced government expenditures and higher retail sales taxes to offset the significant loss of trade tax revenues.