Melitz in GTAP Made Easy: the A2M Conversion Method and Result Interpretation

Since the 1970s, Armington has been the workhorse specification of trade in computable general equilibrium (CGE) models. Under Armington, agents substitute between products from different countries. Conceptually, Melitz provides a more attractive approach in which substitution is between products from different firms rather than countries. Other attractive features of Melitz are monopolistic competition and economies of scale from fixed establishment costs for firms and fixed set-up costs on trade links. In this paper, we show how, with little change to existing code, an Armington model can be converted to Melitz by adding a few equations and introducing closure swaps. We apply our Armington-to-Melitz method to the Armington-based Global Trade Analysis Project (GTAP) model to derive GTAP-Armington-to-Melitz (GTAP-A2M). We show how results from a CGE model with Melitz industries can be interpreted via back-of-the-envelope calculations. In simulations of the effects of a tariff imposed by North America on imports of apparel, we find greater welfare losses for exporting regions under Melitz than under Armington principally because contraction of apparel output in these regions under Melitz generates an increase in the cost to their households of domestic apparel. Finally, we review two other Melitz-based versions of GTAP: GTAP-HET and a recently published model by Bekkers and Francois.