Fiscal Impact of Trade Liberalization: The Case of Syria 1

Transcription

1 Fscal Impact of Trade Lberalzaton: The Case of Syra by Bernd Lucke Unversty of Hamburg von-melle-park 5 D-2046 Hamburg Germany emal: lucke@hermes.econ.un-hamburg.de March 200 Research Team: Prof. Dr. Bernd Lucke, Unversty of Hamburg, Germany, Prof. Dr. Mamdouh Alkhatb Alkswan, Kng Saud Unversty, Ryad, Saud Araba, Dr. Dorothea Lucke, Lucke Consult, Wnsen, Germany, Dpl.-Ing. agr. Ferdnand Pavel, Humboldt Unversty, Berln, Germany Anbara Abu-Ayyash, Unversty of Hamburg, Germany. Abstract: Scenaros of trade lberalzaton are studed n smulatons of a statc computable general equlbrum model of the Syran economy. The standard model s modfed to allow for government monopoles n selected sectors of the economy and for peculartes of the Syran multple exchange rate system. Structural features of the tarff system suggest low elastctes of substtuton for ndustral demands, so that the producton sde of the domestc economy receves lttle stmulus from reduced tarff rates. As a result, lost tarff revenue bascally benefts prvate consumpton. The government budget defct ncreases szably under radcal lberalzaton scenaro. However, revenue losses are stll manageable and compensatng measures,. e. the ntroducton of a general sales or value added tax, are suggestve. Keywords: Computable General Equlbrum Model, Trade Lberalzaton, Barcelona Process, Syra JEL: O53 Ths work has benefted from a fnancal grant from the Commsson of the European Communtes wthn the context of the FEMISE program. The vews expressed are those of the benefcary and therefore n no way reflect the offcal opnon of the Commsson. The paper s an abbrevated verson of the full report for ths proect to be submtted to the Insttut de la Médterranée and was prepared for the second FEMISE conference n marselle, March 2 March 30, 200.

2 I. Introducton Assocaton Agreements under the European Unon s Medterranean Intatve am at establshng a free trade area for most products n a 2 year transton perod, cf. Nsoul et al., 6. Removal of barrers to trade, both tarff and non-tarff, s hence a core ssue n the negotatons. But many Medterranean countres (henceforth MED) have underdeveloped tax systems both for value added and ncome taxes so that government revenue may rely heavly on taxng foregn trade. Syra has been partcularly reluctant to embrace the EU-Medterranean ntatve. The precse reasons for ths are unclear, snce the budgetary dependence on mport taxes (tarff revenues account for 5.6 percent of total government expendture n ) s much smaller than n many other MED countres, cf. Lebanon (28 percent), Algera ( percent), and Tunsa (6 percent), see e. g. Abed, 8. Moreover, despte a tradton of ant-western poltcal and economc orentaton, Syra has made efforts of market orented economc reforms n recent years and s tryng to end ts long-term poltcal solaton. Thus the EU ntatve mght be seen as a welcome chance to promote both developments. The Commsson of the European Unon (EU) has sponsored research on the fscal effects (n partcular the effect on the budget defct) of reduced Syran mport tarffs. Ths paper s an abbrevated verson of the fnal report on the sad research proect. Due to page lmtatons, only selected aspects of structural features, methodology and smulaton results are presented here. A detaled presentaton can be found n the fnal report (Lucke, 200). Specal attenton wll be devoted to scenaros of trade lberalzaton whch could be the outcome of an assocaton agreement between the EU and Syra under the Medterranean Intatve. The sequel of the paper s organzed as follows: Secton II summarzes some essental structural features of the Syran economy. The theoretcal framework and related questons are revewed n Secton III. Secton IV descrbes the Computable General Equlbrum (CGE) model used n the quanttatve analyss, and Secton V dscusses ssues related to calbraton. Selected results are presented n secton VI. Secton VII concludes. II. Structural features of the Syran economy Syra s a developng state wth a populaton of currently approxmately 6.3 mllon people 2, growng at the rapd pace of about 2.7 percent p. a. Its GDP per head (converted to US-dollar at the Berut free market exchange rate) was 88 $ n, sgnfcantly below comparable values of,565 $ for Jordan, 4,042 $ for Lebanon and 6,570 $ for Israel. Ths s so despte relatvely rch natural resources (cultvable lands, ol, and gas, cf. U.S. Energy Informaton Admnstraton, 2000) and an nfrastructure the qualty of whch meets the standards of other Arab countres. Snce the early 0 s, Syra has taken gradual steps to transform the country s then domnant economc system of central plannng to a more market orented economy. Strong fscal ncentves to prvate nvestors, both foregn and domestc, were provded by Investment Law No. 0 of, bascally exemptng nvestment proects from all relevant taxes and customs dutes for fve to seven years. In later years, the system of multple exchange rates was smplfed and offcal rates were moved closer to black market rates. Smultaneously, some 2 Excludng Palestnan refugees. 2

3 of the tght mport controls relevant for the prvate sector were relaxed. In response to these measures, the prvate sector expanded sgnfcantly and real GDP growth averaged 8 percent from to 5 and 5. percent from to. Accordng to estmates by the Internatonal Monetary Fund (IMF), the prvate sector accounted for 5 percent of GDP, 72 percent of total employment, 57 percent of gross captal formaton, 6 percent of non-ol exports, and 58 percent of mports over 2-7, cf. Internatonal Monetary Fund, a, Box. However, the state s producton actvtes reman substantal: Ol and natural gas actvtes, ncludng refnng, are predomnantly government-owned, wth mnorty shares of foregn companes only. Utltes (electrcty and water plants) are almost exclusvely operated by the government, and the same s true for the ar transport ndustry and all fnancal nsttutons. The telecommuncatons ndustry s also domnated by the state, but apparently openng up wth recent contracts by the Syran Telecommuncatons Establshment (STE) awarded to selected foregn frms. Strategc ndustres n manufacturng are domnated or monopolzed by the state. Roughly 50 percent of the constructon sector and much of trade and marketng actvtes s also n state hands. There has been no sgnfcant prvatzaton of publc enterprses so far. Investment expendtures (both publc and prvate) beneft from extremely low mport tarffs on captal goods. Smlarly, raw materals for ndustral use can be mported vrtually at world market prces. On the other hand, consumer goods often have rather hgh tarff rates n accord wth tradtonal mport substtuton polces. For detals of the foregn trade and multple exchange rate system, see Lucke, 200. Government absorpton of goods and servces (excludng the Prce Stablzaton Fund (PSF)) accounts for about 28 percent of GDP, where percent s classfed as government consumpton and 7 percent as development expendture,. e. government nvestment. The latter ncludes nvestment by state-owned companes. The largest part of government consumpton are wages and salares (of whch 57 percent s spent for mltary and securty). Nevertheless, wages n the publc sector are at a demotvatngly low level, gvng rse to wdespread corrupton. The low publc sector wages also depress wages n the prvate sector (US Department of State, 2000). Natonal Accounts Data do not contan nformaton on the dstrbuton of ncome, but noffcal estmates suggest that the captal share n natonal ncome s up to three tmes as hgh as the labor share, cf. Auger and Gasorek (2000). The basc sources of government revenues are ol-related proceeds, non-ol taxes and dutes, and non-ol publc enterprse surpluses. Ol-related revenues consttute a share of about 38 percent of total revenues (dependng on world market prces), whle the share of non-ol taxes ncludng dutes s around 48 percent. Non-ol publc enterprses contrbute approxmately 2 percent to total revenues, whch s only slghtly larger than the surplus of the Syran Petroleum Company (SPC) and assocated frms. The state budget defct (excludng PSF defct, but ncludng reduced reserves) amounts to 32 percent of total expendtures for the budget or. percent of GDP. The Prce Stablzaton Fund s not consoldated n the government budget. Under the PSF system, a general wheat subsdy s enforced, whch makes bread cheaply avalable. In addton, each Syran ctzen s enttled to purchase a lmted amount of basc foodstuffs lke sugar and rce at less than the market prce, cf. Internatonal Monetary Fund, b. Despte own revenues from prce surcharges and budgetary transfers, PSF operatons cause a large defct whch ncreases the consoldated government sector defct to 2.2 percent of GDP. 3

4 A partcularty of the Syran economy s the multple exchange rate system (MERS). A full account of ths system would be beyond the scope of ths paper, but for the purpose of quantfyng the fscal effects of trade lberalzaton, t suffces to note those regulatons that relate to prvate exports and mports. Permtted mports must be dstngushed by the applcable method of fnancng. For goods on the unrestrcted payments lst, foregn traders can, n prncple, use any prvately owned foregn exchange resources, but must obtan approprate regstraton, certfcaton and lcenses from varous authortes. For goods on the export proceeds payment lst the mporter has to prove that the requred foregn exchange orgnates from export proceeds. Snce these are short n supply, prvate exporters (who have to surrender parts of ther export proceeds to the government at the overvalued rate of Syran Pounds (LS) per US dollar) are able to sell the retaned part of ther export proceeds to mporters at a prvate market rate of currently about 56 LS/$ 34. It s mportant to note that these regulatons of the multple exchange rate system (MERS) have economc effects equvalent to a combnaton of mport taxes and export subsdes. To begn wth, prvate exporters of non-agrcultural products have to surrender 25 percent of ther export proceeds to the Commercal Bank of Syra (CoBS) at the rate of LS/$. Snce the Berut free market rate s approxmately 5 LS/$ and snce the CoBS s owned by the government, ths surrender requrement has equvalent effects to a tax on exports. Nevertheless, exporters beneft on average from the MERS, snce they are allowed to sell the retaned part of ther export proceeds to mporters of goods on the export proceeds lst. Snce the exchange rate on ths exports proceeds market s around 56 LS/$, the economc effects of the MERS on exporters of non-agrcultural goods are approxmately equal to a 0 percent tax on 25 percent of the export value n US dollars plus a 0 percent subsdy on 75 percent of the export value n US dollars. The net effect s hence a fve percent export subsdy 5. For mporters of goods on the export proceeds lst, the MERS s equvalent to an approxmately ten percent ad valorem customs duty. Ths customs duty equvalent, however, does not show up n the government budget plan - rather, t mmedately benefts the exporters, whose subsdy equvalent s also nvsble n the government budget. Note that the MERS duty equvalent not only drves a wedge between prvate mports from the exports proceeds lst and mports from the unrestrcted payments lst, t also drves a wedge between the former and publc sector mporters of smlar goods. Snce almost all publc sector transactons take place at the rate of 46.5 LS/$, publc sector mporters of goods that compete wth goods on the export proceeds lst have a 20 percent prce advantage from the MERS a maor mpedment to prvate sector economc actvty 6. 3 The exchange proceeds market operates freely for a gven export proceeds payments lst. Note, however, that t s probably napproprate to model ths as a free market for foregn exchange n Syra, snce the government ndrectly controls ths exchange rate by addng or deletng goods from the export proceeds payment lst. Such changes, n fact, occur frequently and ther systematc background s not easly understood. 4 Imports of a rather small thrd group of commodtes must be fnanced through worker s remttances. 5 For exporters of agrcultural products, who are exempted from the surrender requrement, the subsdy equvalent of the MERS s approxmately 0 percent of the true $-value. 6 The share of mports from the export proceeds lst s modest, but not nsgnfcant: Estmates range around 20 percent of total mport value. 4

5 III. Theoretcal framework and questons The workhorse of the analyss below s a neoclasscal computable general equlbrum (CGE) model, (see, e. g. Gnsburgh und Keyzer, 7), wth some adustments necessary to capture essental features of the Syran economy. The model dstngushes eleven actvtes (specfed below), whch produce real value added from the prmary factors land, labor, and captal. In lne wth neoclasscal assumptons we assume that the real wage per qualty adusted labor unt s equal across actvtes. However, we allow for heterogenous rates of return to captal across sectors whch seems approprate gven the observed heterogenety of gross rates of return (estmates range between 2 percent for constructon to 66 percent for mnng, especally ol). The exstence of such large dfferences s, of course, due to tght government control and assocated monopolstc structures n some sectors of the Syran economy. Hence t seems reasonable to devate from the assumpton of free access and freely movng captal for the sake of a reasonably realstc model of the Syran economy. We defne nne commodty categores assocated wth the product groups of the one-dgt SITC classfcaton, wth constructon, and servces. Each actvty produces one or several commodtes. For each product category, a composte commodty, the so-called Armngton good, s produced from domestc supply and mports, assumng that these nputs are heterogenous. Mnmzng costs n the producton of Armngton goods mples that demand for mports depends negatvely on the relatve prce of mports. Other thngs beng equal, lower mport tarffs wll hence mply a trade creatng effect. Quantfyng ths effect n a general equlbrum framework s one of the obectves of ths study. Dsaggregatng tradng partners nto eght tradng blocks (specfed below), the composton of mports between tradng partners depends on the relatve customs tarff load per product category. Intatng preferental trade agreements (PTA) changes the relatve prce of mports from dfferent sources and therefore nduces trade dverson. In order to assess the total effect of trade lberalzaton under the Medterranean Intatve, ths study ams at calculatng the net effect of reduced Syran mport tarffs on each tradng partner under varous lberalzaton scenaros. Cheaper mports stmulate domestc consumpton, nvestment, and producton, nducng hgher tax revenues for the government, whch partally offset reduced customs revenue. It s therefore of prme nterest to calculate the net effect of trade lberalzaton on the government budget defct. In the case of Syra, ths exercse s not trval, due to two partculartes of the economy: Frst, the consoldated government budget does not consoldate expendtures and revenues of the Prce Stablzaton Fund. The PSF has ndrect tax revenues ot ts own, whch, however, are by far nsuffcent to cover subsdy expenses. Hence, a true measure of the government budget defct must nclude the PSF defct. The PSF budget s not dsclosed by the Syran authortes, but, fortunatley, we were able to obtan unpublshed data whch were used to consoldate the PSF defct. Second, as already ponted out, the multple exchange rate system (MERS) mplemented by the Syran government has dstrbutve consequences smlar to a system of taxes, customs dutes, and subsdes nvsble n the government budget. We therefore model the MERS as an nsttuton wth ndrect tax and subsdy equvalent nstruments. We assume that the government s nterested n keepng these nstruments at approxmately ther present level, 5

6 . e. at fxng the export proceeds market exchange rate at a level of 56 LS/$. Ths requres that the value of export-proceeds-market-mports adusts endogenously. Two nterpretatons of ths endogenous adustment are possble: Ether the government redefnes the export proceeds payment lst, or mporters substtute between mports on the export proceeds lst and other mportable goods 7. Snce the MERS s certanly a barrer to trade, the extensve report (Lucke, 200) also present smulatons whch quantfy the effects of tradtonal trade lberalzaton along wth abolton of the MERS. For reasons of space, these are suppressed n ths paper. The exstence of the MERS makes the nterpretablty of Syran statstcs generally dffcult, snce fgures for foregn transactons are often not compatble due to the usage of dfferent exchange rates 8. To derve a consstent data base for the quanttatve analyss below, all foregn transactons have been converted at the Berut free market rate of 5 LS/$. Ths s the rate most lkely to gve an approxmately accurate pcture of the value of mports and exports, but t s also the only mportant exchange rate dsregarded by government statstcans, cf. Central Bureau of Statstcs,, Thus, some of the data used are not dentcal to those gven n natonal statstcs. Snce the Berut market exchange rate s not endogenzed ts role n the model below s lmted to the descrpton of tax equvalent effects of the MERS. IV. Methodologcal Approach The followng model s used n the smulatons: The Syran economy s decomposed nto eleven actvtes: Agrculture, mnng, publc manufacturng, prvate manufacturng, utltes, constructon, wholesale and retal trade, transport and communcaton, fnance and nsurance, socal and personal servces, government servces. Real net value added at factor cost Q, =...,, s produced under constant elastcty of substtuton (CES) productons functons, where agrculture uses three nputs (land B, labor L, captal K ), whle all other actvtes use only labor L and captal K, β =0 for =2...,. (Note that, unless otherwse specfed, varables are n captal letters, wth bars denotng exogenous varables. Parameters are denoted n lowercase letters). ρ ρ ρ ( = α ρ + β + α β ) Q a K B L () Assumng compettve factor markets, proft maxmzaton mples the equalty between nomnal factor prces and margnal products. Hence factor demands are mplctly gven by B B Q ρ ( ) ρ ρ ρ α β α ρ = + + β β r P P a K B L B (2) 7 We also expermented wth the alternatve modelng strategy of havng the share of export-proceeds-mports fxed and lettng the export proceeds market exchange rate adust endogenously. However, by vrtue of the MERS equlbrum condton (45) below, ths would mply that the trade balance s essentally fxed across a wde varety of lberalzaton scenaros. As ths s not economcally plausble, we have not pursued ths approach any further. Endogenzng the export proceeds market exchange rate would requre a model whch dstngushes between mports from the export proceeds payment lst and other mports. The database for such a model s, however, not avalable. 8 The man exchange rates relevant for Syran statstcs are.2 LS/$, 23 LS/$ and 46.5 LS/$. Includng prvate non-proft servces. 6

7 Q ρ ρ ( ) ρ ρ α β α β ( α β ) ρ w = P a K + B + L L K Q ρ ρ ρ ( ρ ρ = α + β + α β ) α r P P a K B L K, (3) (4) B where r, r, and w denote the gross rates of return to captal, the rate of return to land and the nomnal wage, respectvely. In general, prces are denoted P wth super- and subscrpts ndcatng the goods to whch they refer. Note that ths specfcaton allows for heterogenous rates of return to captal across sectors whch seems approprate gven the observed heterogenety of gross rates of return, see above. From (3) to (6), the nomnal ncomes of the producton factors are gven by Y B = r B B P B, L K K Y = wl, and Y = r P K. The resource constrant for the producton factor labor s smply L = L, where L s the total supply of labor. I dstngush =..., commodty categores assocated wth the one-dgt SITC classfcaton, wth constructon, and servces. Due to lmtatons n the structure of the nput-output matrx t was not possble to treat SITC 0 (food and lve anmals) and SITC 4 (anmal and vegetable fats, ols and waxes) as dfferent goods, so that = s the aggregate of SITC 0 and SITC 4. Hence =2...,8 are SITC (beverages and tobacco), SITC 2 (raw materals), SITC 3(mneral fuels), SITC 5 (chemcals), SITC 6 (manufactures classfed chefly by materal), SITC 7 (machnes and transport equpment), and SITC 8 (mscellaneous manufactures), respectvely. Fnally, = collects SITC (commodtes not elsewhere specfed), constructon, and servces (trade, transport, fnance, socal and personal servces, and government servces). For each product category, the Armngton good X, =...,, s produced usng the nputs domestc supply D and mports M under a CES-producton technology: M M M M M ρ M ρ = ρ α + ( α ) X a D M (5) The cost mnmzng nput relaton s gven by M D M ( α ) P = D M M P α M + ρ, (6) and the zero proft condton s P X = P D + P M. X D M Equaton (3) descrbes trade creaton as a functon of the relatve prce between domestc and mported goods. To model trade dverson, assume that for a gven mport volume M Syra mnmzes the costs of mports over tradng partners k=...8, under a CES technology 7 m ρ 8 m m m ρ M = a α km k, (7) k =

8 where tradng partners k=...,8 are gven by the followng countres or tradng blocks: Arabc states (Arab) (Algera, Bahren, Egypt, Iraq, Jordan, Kuwat, Lebanon, Lbya, Morocco, Mourtana, Saud Araba, Somala, Sudan, Tunsa, Unted Arab Emrates, Yemen), European Unon (EU 5) (Austra, Belgum, Denmark, Fnland, France, Germany, Greece, Ireland, Italy, Luxemburg, Netherlands, Portugal, Span, Sweden, Unted Kngdom), Formerly socalst countres (Ex-Soc.) (Bulgara, Byelorussa, Chna, Cuba, Czech Republc, Hungary, Poland, Rumana, Russa, Serba, Ukrane), Unted States of Amerca (USA), Argentna, Brasl, Chle (ABC), Turkey, Japan, and the rest of the world (ROW). Mnmzaton requres M M α P = m m k k m m α Pk m + ρ (8) and total costs of mports are gven by 8 M m = Pk M k k = P M () Havng defned the supply sde of the domestc commodty market by Armngton aggregates, ntermedate demand for commodty of sector s assumed to depend lnearly on gross output G of sector : V = a G. Total (nomnal) ntermedate demand of sector s therefore V X = P V = P V (0) Deprecaton per sector depends lnearly on the captal stock, O = δ K. Hence gross output at factor costs s gven by P G = P Q + P V + P O, () G Q V K Equaton (2) descrbes the value of the total supply of actvty at producers cost. To specfy the demand sde, let us start wth exports, whose treatment s completely analogous to mports. Assume that for a gven level of real gross output G producers maxmze ts value 8

9 P G = P D + P E (2) G D E subect to a constant elastcty of transformaton (CET) choce between sales on the domestc market and exports: It s then necessary to have E E E E E E = α ρ ρ ρ + ( α ) G a D E (3) E D P α = E ( α ) E E D P E ρ (4) Further, for a gven aggregate export volume E and equal world market prces for all countres export revenue 8 E E = P Ek k = P E (5) s maxmzed over sales to tradng partners k=...8, under a CET-transformaton functon It s then necessary to have e ρ 8 e e e ρ E = a αk E (6) k k = E E k e ρ e α = e αk (7) such that the export shares of ndvdual tradng blocks are nvarant. Dsposable land ncome s gven by YD ( τ ) = Y, where effectve drect tax rates are B B B denoted τ wth approprate superscrpt. Analogously, dsposable labor ncome s gven by L L L F Y = τ Y + Y, where Y s labor ncome from foregn countres. Dsposable captal F D ( )( L ) L ncome s defned as YD ( τ π π π ) = Y, where K K SS LS F K F π s the net share of captal SS LS ncome flowng to foregn countres. To understand π and π, note that the Syran government budget dstngushes between supply surplus (SS) and lqudty surplus (LS) of publc entreprses. The lqudty surplus comprses temporary surplusses due to deprecaton or provsons, whereas the the supply surplus s smlar to after tax economc SS LS profts. Hence, π and π denote the share of these surplusses n total captal ncome. Nomnal household ncome conssts of dsposable factor ncomes plus exogenous transfers from the government and abroad:

10 Y = Y + Y + Y + TR + TR H B L K D D D G F (8) Nomnal household savngs are assumed to be a constant fracton of household ncome, H H H S = s Y, whle (real) household consumpton s derved from maxmzng the utlty functon of a Stone-Geary lnear expendture system (LES) max ( C H γ ) H α, = 3 = 3 α H = () subect to the budget constrant = 3 P C + S = Y T X H H H H (20) H where the γ are mnmum consumpton levels and T s a catchall for other government taxes on hourseholds. Note that households do not consume raw materals (SITC 3), whch s why =3 s excluded n (32). Maxmzaton yelds the followng demand functons: C H 0 = 3 H H H H X = α ( s ) Y T P γ (2) = 3 γ + 3 X P The captal market s modeled as an nsttuton wth revenues (supply) and expendtures (demand). Captal market revenues are defned as K H D F G F = = R O S DS DS DE DEF (22) D F where DS and DS denote domestc and foregn debt servce, respectvely, DEF are G foregn loans, and the endogenous varable DE denotes government outlays for nvestment purposes, labelled development expendtures n the government budget. Captal market expendtures are gven by nvestment demand (both publc and prvate), defcts of the government (excludng PSF) fnanced by domestc or by foregn F D loans( DEF and DEF, respectvely), PSF-defct W T : PSF DEF, and exogenous taxes on wealth F K X D F = PSF + W = E P I DEF DEF DEF T (23) 0

11 Captal market equlbrum requres that the current account (CA) s equal to the gap between K K revenues and expendtures: CA = R E. Assumng that total nvestment s a constant fracton of captal market revenues = P I = s R X K K I (24) makes t possble to treat the current account defct CA as an endogenous varable. Usng CES demand functons, gross nvestment s gven by I 0 4 I K K α si R = I > 4 ρ X I I I X ( P + ρ ) α ( P + ρ ) = 5 I ( ) I α +ρ =, = 5 (25) where I s zero for SITC 0 SITC 4, snce these do not nclude (sgnfcant) amounts of captal goods. The PSF budget constrant s modeled as PSF Q PSF PSF PSF Q PSF m t P Q + TR + DEF = s P Q + f p M = = =, (26) where PSF PSF t and s denote PSF-specfc ndrect tax and subsdy rates on domestc producton and f s a subsdy rate on mports. government budget. Revenues consoldated n the government budget are gven by PSF TR s the transfer the PSF receves from the ( ) 8 G Q m B B L L K SS LS K = + k k + τ + τ + τ + π + π = = k = R t P Q c p M Y Y Y 2 H W F D MERS e = + T + T + DEF + DEF + t p E. (27) Here t s the effectve ndrect tax rate per sector earmarked for the government budget, t MERS s the effectve ndrect tax rate equvalent of the multple exchange rate system and c k s the effectve customs rate for good mported from country k. Government expendture s gven by G e X G G D F G PSF = = =, E s p E P C TR DS DS DE TR (28) where s s the effectve subsdy rate on exports and C G s government consumpton of good. Development expendtures DE G and total government consumpton are assumed to be constant fractons of government revenues, such that

12 DE = s R G G G I (2) = P C = s R X G G G C (30) and demand functons for government consumpton are specfed as CES functons fulfllng budget dentty and homogenety of degree zero: C G 0 = 3 G G G α sc R = G 3 ρ X G G G X ( P + ρ ) α ( P + ρ ) = 5 G ( α ) G + ρ = = 3 (3) The budget restrcton s, of course, smply R G G = E. The multple exchange rate system s another nsttuton wth revenues gven by MERS MERS e MERS m = + = =. R t p E c p M (32) Whle MERS e t p E s the MERS export tax due to the surrender requrement for 25 percent = of prvate non-agrcultural exports, MERS m c p M s the MERS customs tarff equvalent = caused by forcng mporters of goods on the export proceeds payments lst to purchase foregn exchange at an exchange rate hgher than the Berut free market rate. Ths customs tarff equvalent s hence equal to the MERS effectve export subsdy due to the sale of retaned export proceeds. Total expendtures of the MERS are therefore gven by 2 ( ) E = t + s p E MERS MERS MERS e = (33) and budget balance requres R MERS MERS = E. In order to acheve budget balance, the share of mports wth mandatory payments n export proceeds λ s requred to adust accordng to excess demand or excess supply on the PEP export proceeds market 0 FM EPM. For exogenously gven exchange rates e and e (free market Berut and export proceeds market, respectvely) and exogenously gven shares of retaned REP exports λ the MERS subsdy rate s also exogenous and gven by export proceeds market exchange rate 0 As ponted out above, ths adustment s ether to be nterpreted as governmental control of the export proceeds market exchange rate or as the result of substtuton on the sde of prvate mporters. 2

13 s EPM REP e = λ. (34) e MERS FM The MERS customs tarff equvalent rate, however, s endogenous and gven by c EPM PEP e = λ, (35) e FM so that changes n the payment n export proceeds lst not only affect the export proceeds market balance but also the effectve domestc prce of mports. Prce denttes complete the model: The domestc prces of exports are derved from world market prces p, adusted for export taxes and subsdes. Smlarly, domestc prces for e mports are derved from world market prces equvalent) and mport subsdes. ( ) P = + s + s t p e MERS MERS e k m p adusted for customs tarffs (and (36) ( ) P = + c + c f p m MERS PSF m k k (37) Fnally, the current account dentty s redundant by Walras law. V. Calbraton Calbraton of the relevant parameters s mostly acheved usng the Socal Accountng Matrx documented n the full report (Lucke, 200). Ths matrx uses natonal accounts, foregn trade and government budget data provded by varous Syran authortes (Central Bureau of Statstcs,, 2000) and the IMF (a, b). A maor lmtaton of the analyss s the fact that the Syran government was unable to provde an nput-output matrx for Syra. Instead, usage of materal nputs was approxmated usng proportons borrowed from Jordan s 87 nput-output matrx. However, approprate adustments were made to some sectors of the economy, n partcular the ol producng sector, to make the mpled nput usage compatble wth exstent data on total ntermedate consumpton per sector from the Syran natonal accounts. Also, data on labor nput and captal stocks, partally constructed from avalable net nvestment seres, were used to calbrate rates of return to captal. The remanng parameters to be specfed are varous elastctes of substtuton and transformaton. Fortunately, key parameters for Syra are avalable from tme seres estmates usng modern unt root and contegraton technques, see Devaraan et al.,. From ths we set the elastcty of transformaton between domestc and exported goods equal to 0.0 and the elastcty of substtuton between mports and domestc goods equal to 0.. In calbratng the elastctes of substtuton or transformaton between tradng blocks I follow Martn, 2000, who argues that benchmark values of 3.0 (for both elastctes) are approprate for Lebanon s foregn trade. Ths s a rather hgh value, whch must be cautously receved gven Syra s They acknowledged the exstence of an nput-output matrx constructed n the 80s, but, unfortunately, the staff n the Mnstry of Plannng dd not fnd t any more. 3

14 complex qualty standard and rules of orgn regulatons, cf. Lucke, 200. On the other hand, the fact that Syra s n a phase of economc transton mples that tradtonal trade relatons may undergo vvd changes, whch would ustfy the choce of hgh elastcty values for tradng partners. Moreover, trade dverson n favor of tradng partners wth reduced mport tarffs leads to revenue losses for the customs authortes. If the specfed elastctes were too low, then the mpact of trade lberalzaton on the budget defct would be underestmated. Conversely, hgh elastctes gve an upper lmt for possble revenue losses, and ths s what polcy makers mght be nterested n. Further, we explot the fact that tarff rates for many products are dfferent for dfferent usages, see Mnstry of Fnance, 8. For nstance, nomnal tarff rates for ndustral usage are often merely percent (or free of charge for proects under Investment Law No. 0). Snce the model s farly aggregated on the commodty sde t s n partcular ncapable of dstngushng dfferent usages of commodtes. Hence the average calbrated tarff rates n the model wll tend to be too hgh for ndustral demands. I capture ths bas by compensatng through the specfcaton of a low elastcty of substtuton of 0.0 for nvestment demand, reasonng that tarff reductons are not lkely to yeld notable ncreases n captal goods and raw materal mports, snce these do not carry much of a tarff load anyway. Note that ths s not to say that nvestment demand s not prce elastc, the assumpton merely states that nvestment demand s hardly prce elastc along the partcular varaton of prces used n the smulatons below. A smlar reasonng apples to the elastcty of substtuton of government consumpton. Government consumpton s overwhelmngly consumpton of servces, most of whch are probably domestcally produced. As far as the government consumes mported servces, t s essental to note that taxes on foregn trade n servces are constant n most of the smulatons. Hence government consumpton s not lkely to respond much to trade lberalzaton, whch s why I assume an elastcty of substtuton for government demand equal to 0.0 as well 2. The man aggregate to respond to reduced mport tarffs s thus prvate consumpton. Here, the LES specfcaton (3) requres the calbraton of mnmum consumpton quanttes, whch then mply the demand elastctes. Usng data from the 85/86 ncome and expendture survey, I assume that mnmum consumpton levels n are equal to nomnal consumpton levels n 85/86. On average, ths s precsely 25 percent of today s consumpton expendture, whch seems a reasonable specfcaton of mnmum consumpton 3. Elastctes of substtuton for the producton functons () are not readly avalable. In the publc sector, factor substtuton seems to be extremely low, snce, e. g. employees ntendng to resgn from ther posts must seek offcal permsson, whch s dffcult to obtan (US Department of State, 2000). Therefore, I assume an elastcty of substtuton of zero (fxed proportons) for pure publc sector actvtes. For pure prvate sector actvtes I use the Cobb- Douglas benchmark (elastcty of substtuton equal to one), so that for sectors wth mxed publc/prvate actvtes I calbrate the elastcty of substtuton wth the share of prvate actvty. 2 Ths may not be approprate for non-servce component of government consumpton. However, ths component s very tny (2.6 percent of total government consumpton). 3 Mnmum consumpton quanttes vary wth product categores. They are partcularly hgh (54 percent of todays consumpton) for SITC 5, whch ncludes medcnes. 4

15 VI. Smulaton results Varous lberalzaton scenaros are smulated. Denotng the status quo (benchmark) by L0, let us focus on the followng removal of tarff barrers: Scenaro L: 50 percent decrease n dutes on agrcultural products mported from the EU. Scenaro L2: Zero dutes on agrcultural products mported from the EU. Scenaro L3: Zero dutes on non-agrcultural products mported from the EU. Scenaro L4: Scenaro L and Scenaro L3. Scenaro L5: Zero dutes on products mported from the EU. Scenaro L6: Zero dutes on products mported from the EU, Arab, and Turkey. Scenaro L7: Zero dutes on all mports 4. A frst selecton of results s gven n Table, whch dsplays real varables only. Gross domestc product at factor cost (GDPF) s hardly changed n any of the scenaros. There are slght reductons n GDP at market prces (GDPM), but comparson wth GDPF shows that these are solely due to the reduced ndrect tax,. e. tarff load. Prvate consumpton (CPRIV) s almost constant when tarffs on EU agrcultural products are reduced, but ncreases more mpressvely when manufactures are lberalzed. Varablty n publc consumpton (CPUB) s tny, there are small ncreases when lberalzaton s confned to agrcultural products, and small decreases when manufactures are (also) nvolved. Gross nvestment (INVEST) grows a lttle, but only for the radcal scenaro L7 s the growth rate larger than one percent. Imports respond to trade lberalzaton much more than exports: Changes n mports are three to four tmes the changes n exports, so that the trade balance deterorates. Table Effects of Trade Lberalzaton on Man Aggregates, Real Varables n Bllon LS L0 L L2 L3 L4 L5 L6 L7 GDPF (0.00%) (0.00%) (0.00%) (0.00%) (0.00%) (0.0%) (0.02%) GDPM (-0.0%) (-0.04%) (-0.05%)) (-0.07%) (-0.0%) (-0.07%) (-0.0%) CPRIV (0.05%) (0.0%) (0.6%) (0.74%) (0.7%) (.0%) (2.2%) CPUB (0.0%) (0.2%) (-0.50%) (-0.40%) (-0.2%) (-0.22%) (-0.5%) INVEST (0.07%) (0.4%) (0.2%) (0.28%) (0.36%) (0.48%) (.08%) Imports (0.34%) (0.74%) (.74%) (2.08%) (2.48%) (3.4%) (7.4%) Exports (0.4%) (0.2%) (0.3%) (0.52%) (0.68%) (.03%) (2.56%) Trade Balance (33,4%) (74,%) (223%) (257%) (28%) (34%) (802%) 4 Unlke L-L6, ths scenaro also ncludes abolton of taxes on the mport and export of servces. 5

16 The effects of trade lberalzaton on the government budget and on captal accumulaton are shown n Table 2. To nterpret the effects on the government budget, t may be useful to express tarff revenue as a percentage of the government revenues (excludng loans and the PSF). Ths benchmark value s 78 bllon LS. Thus, the tarff revenue loss mpled by, say, scenaro L2 s less than half a percent of today s government revenue. For L3, however, 3 percent of government revenue are affected and for L6 and L7 (complete lberalzaton) we fnd 4.4 percent and percent, respectvely. Whle these reductons n tarff revenue are not neglgble, they appear consderably smaller than those reported for other MENA-countres under smlar scenaros. Note that the loss of tarff revenues n absolute terms s mrrored by smlar ncreases n prvate consumpton, cf. Table. Changes n domestc ndrect taxes are small, and changes n drect taxes are not much larger. Thus, total tax revenues (excludng PSF and MERS revenues) decrease by almost the same amount as does tarff revenue. Consoldatng the PSF, we see that the total government defct ncreases almost one-to-one wth the loss of tarff revenue. Snce household savngs are hardly changed and nvestment expendtures even ncrease, cf. Table, the government defct must be fnanced from abroad, whch explans the current account deteroraton n the last row of Table 2. Ths perspectve s hardly promsng for the Syran government, whch s already plagued by a szable external debt 5 whch requres complcated negotatons wth the Pars Club, see Internatonal Monetary Fund, a. Table 2 Effects of Trade Lberalzaton on Government Budget and Captal Accumulaton, Nomnal Varables n Bllon LS L0 L L2 L3 L4 L5 L6 L7 Tarff revenue (-.87%) (-4.3%) (-34.6%) (-36.5%) (-3.0%) (-4.%) (-00%) Domest nd. tax (0.06%) (0.3%) (0.82%) (0.8%) (0.5%) (0.7%) (0.3%) Drect taxes (0.0%) (0.20%) (0.65%) (0.74%) (0.85%) (.0%) (2.37%) All taxes (-0.23%) (-0.54%) (-4.2%) (-5.6%) (-5.48%) (-7.0%) (-4.6%) Govern defct (0.63%) (.3%) (4.56%) (5.%) (5.7%) (7.83%) (6.4%) Househ savngs (0.08%) (0.8%) (0.85%) (0.3%) (.03%) (.33%) (2.%) Current account (3.6%) (30.3%) (7.0%) (%) (28%) (6%) (34%) Table 3 llustrates trade dverson effects for scenaro L,. e. a 50 percent reducton of mport dutes on EU agrcultural products. The table shows percentage changes n real mports vs-àvs the benchmark equlbrum and s confned to agrcultural commodty groups (ncludng beverages and tobacco), the effects of other commodty groups beng neglgble (changes of less than 0.25 percent n absolute value). Clearly, the EU benefts at the expense of all other tradng partners. However, t should be noted that the magntude of ths effect s determned 5 Ths debt s partally denomnated n hard currency, partally n Russan rubles. 6

17 by the rather hgh elastcty of substtuton specfed for the choce of tradng partners. If a lower value were approprate, trade dverson effects would generally be reduced. Table 3 Trade Dverson of Syran Imports, Percentage Changes of Scenaro L ABC Arab EU5 Ex-Soc. Japan ROW Turkey USA SITC % -2.60% 4.05% -2.60% -2.60% -2.60% -2.60% -2.60% SITC % -0.4% -0.4% -0.4% -0.4% % The same caveat apples to smulatons whch reduce tarff rates on non-agrcultural products. Table 4 gves the respectve percentage changes for a 00 percent reducton of mports from the EU (scenaro L3). Ths scenaro may be partcularly relevant as st may be close to the tarff reducton fnally agreed upon n an Assocaton Agreement. Wth hgh elastcty of substtuton, the EU wll make large nroads nto the domans of other Syran tradng partners. Ths holds for all product categores except agrcultural products (SITC 0 and SITC 4) and Servces. Table 4 Trade Dverson of Syran Imports, Percentage Changes of Scenaro L3 ABC Arab EU5 Ex-Soc. Japan ROW Turkey USA SITC % 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% SITC % 82.7% -26.0% -26.0% -26.0% % SITC2 -.2% -.2% 3.36% -.2% -.2% -.2% -.2% -.2% SITC % 26.02% -6.34% -6.34% -6.34% -6.34% -6.34% SITC5-0.7% -0.7% 3.85% -0.7% -0.7% -0.7% -0.7% -0.7% SITC6-7.35% -7.35% 35.24% -7.35% -7.35% -7.35% -7.35% -7.35% SITC7-28.4% -28.4% 5.40% -28.4% -28.4% -28.4% -28.4% -28.4% SITC8 -.87% -.87% 48.6% -.87% -.87% -.87% -.87% -.87% Servces -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% Fnally, Table 5 depcts trade dverson effects n scenaro L6, where dutes on all products from Arab countres, Turkey, and the EU are completely abolshed. For the EU, gans n trade are then almost as large as f tarff reductons only n favor of the EU had been enacted a result whch s probably due to large dfferences n the product structure of exported goods between the EU on the one hand and Arab states and Turkey on the other hand. 7

18 Table 5 Trade Dverson of Syran Imports, Percentage Changes of Scenaro L6 ABC Arab EU5 Ex-Soc. Japan ROW Turkey USA SITC0+4-7,23% 8,83% 27,6% -7,23% -7,23% -7,23% 25,0% -7,23% SITC - 0,6% 6,00% -30,3% -30,3% -30,3% - -30,3% SITC2-3,0% 8,3%,30% -3,0% -3,0% -3,0%,30% -3,0% SITC3-6,33% 23,30% -8,36% -8,36% -8,36% 23,30% -8,36% SITC5-4,3% 4,7%,27% -4,3% -4,3% -4,3%,27% -4,3% SITC6-0,5% 2,23% 30,5% -0,5% -0,5% -0,5% 30,5% -0,5% SITC7-30,82% 33,7% 55,20% -30,82% -30,82% -30,82% 55,20% -30,82% SITC8 -,8% 3,80% 45,20% -,8% -,8% -,8% 45,20% -,8% Servces -,0% 8,78% -,0% -,0% -,0% -,0% 8,78% -,0% VII. Conclusons and poltcal recommendatons The two most mportant results from the CGE-analyss of Syran trade lberalzaton are the followng: Frst, revenue losses due to lower mport dutes can be szable, but reman manageable. Second, there s lttle stmulus for the producton sector of the domestc economy,. e. effcency gans are low. The frst result s due to the fact that Syran customs tarff revenues are rather fable. For, tarff revenues were percent of government revenues (excludng PSF revenues), and merely 5.6 percent of total government outlays (ncludng the PSF). By comparson, the average annual growth rate of the government budget n the last fve years was 2. percent, wth a maxmum rate of 6. percent n 6 and a mnmum rate of 7.6 percent n. Hence, even the total loss of tarff revenues would only be slghtly larger than other fluctuatons n government revenues experenced n recent years. The comparably weak role of tarff proceeds s related to the fact that the tarff system s certanly not desgned as revenue maxmzng, see MEDA-Team, Rather, t seeks to ensure relatvely cheap mports for ndustral and publc sector purposes, whle protectng domestc ndustres through hgh tarff rates on non-basc consumpton goods. Yet Syran customs tarffs have a reputaton of beng extremely hgh (U.S. Department of State, 6). However, an analyss of effectve tarff rates whch corrects for overvalued customs exchange rates fnds rather low average effectve tarff rates for maor product categores. Only few selected tems carry prohbtve tarff loads. See the extensve research report on ths proect (Lucke, 200) for a detaled analyss of the effectve tarff structure. Low effectve mport dutes for almost all essental ndustral nputs explan the second mportant smulaton result. Trade lberalzaton hardly affects the costs of nput usage, snce ntal tarff rates are already low. Hence the producton sde of the economy s largely nsulated from the effects of tarff reforms. Snce government consumpton of traded goods s small (and a smlar effect of low ntal tarffs apples) prvate consumpton s the man benefcary of trade lberalzaton. Real dsposable ncome of prvate households rses by approxmately the amount of lost tarff revenue. Ths addtonal ncome s partally spent on mports and partally spent on domestc goods. Domestc ndustres, whch suffer from ncreased competton of mported output goods, beneft from ncreased prvate household 8

19 demand for ther products, so that the net effect on gross domestc product at producers cost s approxmately zero across all scenaros 6. These results mply that the Syran government may not fnd tarff lberalzaton partcularly attractve. Tarff barrers to foregn trade are probably a mnor problem of the Syran economy. Non-tarff barrers may be much more mportant, but wth the excepton of the MERS t was mpossble to model these barrers due to the navalablty of relable data. The scarce nformaton that s avalable suggests that the ntransparency of the foregn trade system, along wth regulatons on lcences, techncal and qualty standards, along wth rules of orgn and foregn currency holdngs, along wth tardness and corrupton n the admnstraton s a maor mpedment to foregn trade, cf. Royal Dutch Embassy, undated. Reducng non-tarff barrers mght well nduce stmul to the Syran economy from whch not only households, but also prvate sector ndustres beneft greatly. In ths case, postve effects on GDP and tarff revenues are lkely. Thus, whle the removal of tarff barrers may be essentally a zero-sum game for the Syran economy, the removal of non-tarff barrers mght pay a double dvdend. The smple message s that t s not n the frst place the formal tarff structure whch s to be blamed for neffcences n the Syran economy. Effcency gans requre deep structural reforms elsewhere n the Syran economy before trade lberalzaton can prove frutful. Clearly, among structural economc reforms whch are lkely to promote growth of the Syran economy and ncreased prospects for trade lberalzaton n partcular, the followng wll be of prme mportance: Exchange rate unfcaton and full convertblty of the Syran pound suggests tself, gven the success of recent deprecatons n the offcal exchange rate and the stablty of the Berut free market rate. Impedments to prvate sector actvty should be lfted by encouragng nvestment and renforcng property rghts. Also, publc sector monopoles should be reduced and publc enterprses prvatzed. Margnal and average tax rates of drect taxes should be reduced to nternatonal standards. In compensatng for the revenue loss, a general sales tax could replace varous specfc excses whch are almost exclusvely borne by government enterprses. Ths would extend the ndrect tax system to the prvate sector, whch presently carres lttle such load. (Lateron, the transmsson to a full value added tax would be desrable, along wth a general straghtenng of the tax system, cf. Corm, 7a, 7b). It s mportant to note that a general sales tax would also be the most suggestve measure the Syran government could take f t agreed to trade lberalzaton n an Assocaton Agreement: Snce lost tarff revenue bascally accrues to prvate households and stmulates prvate consumpton, the ntroducton of a general sales tax could compensate the government s revenue loss whle leavng prvate households at approxmately the status quo ante. VIII. References: Auger, Patrca and Mchael Gasorek, 2000: Trade Lberalzaton Between the Southern Medterranean and the EU: An Analyss of the Sectoral Impact. FEMISE Conference Paper, Marselle. Central Bureau of Statstcs,. Foregn Trade Statstcs. Syran Arab Republc, Offce of the Prme Mnster. 6 Note that ths reasonng assumes that government consumpton remans constant despte the revenue loss,. e. at the cost of ncreased (foregn) government debt.

20 Central Bureau of Statstcs, Statstcal Abstract. Syran Arab Republc, Offce of the Prme Mnster. Corm, C. G., 7a: Etude de Modernsaton du Mnstère des Fnances de la Républque Arabe Syrenne, Rapport d Ensemble, Commsson Européenne. Corm, C. G., 7b: Etude des Besons du Mnstère des Fnances en Syre, Rapport de Pré- Dagnostc, Commsson Européenne. Devaraan, Shantayanan, Delfn S. Go, and Hongy L, : Quantfyng the Fscal Effects of Trade Reform: A General Equlbrum Model Estmated for 60 Countres, Dscusson Paper, World Bank, Washngton, D. C. Gnsburgh, Vctor, and Mchel Keyzer, 7: The Structure of Appled General Equlbrum Models, MIT Press, Cambrdge. Internatonal Monetary Fund, a. Syran Arab Republc Staff Report for the Artcle IV Consultaton, SM//37, Washngton D. C. Internatonal Monetary Fund, b. Syran Arab Republc Statstcal Appendx, SM//40, Washngton D. C. Lucke, Bernd, 200: The Fscal Impact of Trade Lberalzaton: A CGE Analyss for Syra, FEMISE Research Report to be submtted to the Insttut de la Médterranée, Marselle. Martn, Wll, 2000: Assessng the Implcatons for Lebanon of Free Trade wth the European Unon, World Bank Dscusson Paper, Washngton, D. C. MEDA-Team, Report on Syra s Internatonal Trade, Techncal Assstance Unt to the Delegaton of the European Commsson, Damascus. Mnstry of Fnance, 8. Decret No. 25, Tableau des Tarfs des Douanes, Syran Arab Republc, Damaskus. Royal Dutch Embassy, undated. Trade Barrers and Constrants to Access Resultng from Syran Commercal Polcy, Damaskus. Syran Arab Republc, 80. Lo No. du , Relatve à l Insttuton de la Taxe Unque sur les Importatons, Damaskus. U.S. Department of State, Fscal Year 2000 Country Commercal Gude: Syra, Washngton D. C. U.S. Department of State, 6. Country Reports on Economc Polcy and Trade Practces: Syra, (8 Aprl 2000) U.S. Energy Informaton Admnstraton, Syra. March (2 August 2000). 20