Drinking Your Own CGE Bath Water

Trade Minister Peter van Loan goes after Maude Barlow with a letter in yesterday’s Globe and Mail, responding to her fine recent op-ed on the Canada-EU free trade talks.

Among other cheap shots, van Loan once again cited as “proof” the findings of a computable general equilibrium model that was commissioned by the EU and the Canadian government to support the ngotiations they had already decided to undertake:

“A study concluded that a free trade agreement with the European Union would boost Canada’s economy by $12-billion a year. The same agreement could also increase our bilateral trade by 20 per cent. That means jobs and growth for Canadians.”

[Never mind that van Loan is the one who gets his facts wrong in public (and never deigns to correct them): see my recent blog post on his false statistics regarding automotive trade.]

Let’s add a little bit more colour regarding that model.  Its prediction of a 20% increase in bilateral trade, actually consists of a predicted 17.1 billion euro increase (24%) in Canada’s goods and services imports from the EU, but only an 8.6 billion euro increase (21%) in Canada’s exports to the EU.  This study itself therefore predicts a widening of Canada’s already large trade deficit with Europe, by 8.5 billion euros.  The generic “expansion of trade” delivers more stimulus (in both absolute and proportional terms) to EU sales in Canada, than the other way around.  How does that create “jobs and growth” in Canada?  Answer: it doesn’t.  In a demand-constrained world, a bigger trade deficit means lower employment.  (See current international evidence to that effect in my recent blog post, “Mercantilism Works?”,  for Real World Economics.)  Only if we assume costless instantaneous sector adjustments (including of fixed capital), constrant full employment, and internationally immobile capital (the last is most laughable at all), can the CGE model convert a sow’s ear of wider trade deficit into a silk purse of higher GDP.

[Interestingly, van Loan’s claim that the EU deal would produce jobs in Canada is not only far-fetched — it is fully contradictory to the methodology of the study on which the $12 billion result is based.  Since the model assumes constant full employment throughout, no jobs are created by an FTA; this is explicitly stated in the report.  All the “gains” from trade are generated solely by an improved allocation of resources.  In claiming both $12 billion in GDP and new jobs, van Loan is nonsensically double-dipping at the well of wishful thinking.)

These repeated, generic invocations of that EU-Canada Joint Study are beginning to piss me off.  Nobody bothers to go through the model to see how it works, or what its assumptions are.  They cut straight to the $12 billion claim, and invoke it as fact.  And no-one is questioning why Canada’s government (which is supposed to be arm-wrestling the Europeans for the best deal possible) relies uncritically on a second-hand EU-financed model to inform its own negotiating tactics.  (The model was built solely by Europeans, and was used previously to estimate the effects of other EU trade initiatives, like the proposed FTA with Korea.)

If a big guy comes to me in a dark alley and proposes a “deal” that looks bad on the surface (“You give me 17 billion euros, and I will give you 8 bilion euros”), but he tells me it will be “good for me,” I might want to conduct some analysis of my own to see if it really will be good for me!

Here is what the people who actualy built that EU CGE model have to say about how to interpret its results:

“Given the necessarily speculative nature of the scenarios we evaluate, and the simplifications that are obviously necessary in modeling the entire world economy, our results should not be taken as precise predictions.” (Francois, van Meijl, and van Tongeren, “Trade Liberalization in the Doha Development Round,” Economic Policy 42(4), pp. 349-391., 2005)

Here is how Peter van Loan interprets those results — as rather precise predictions, indeed!

“A Canada-EU agreement will … grow Canada’s economy by at least $12 billion.” (International Trade Minister Peter van Loan, October 18, 2010)

The repeated and unexplained invocation of that purely hypothetical $12 billion estimate relies on the assumption that no-one will bother reading the fine print of the actual report, to see what nonsensical assumptions it is based on.  The $12 billion claim is propoganda and should be ignored.