Morocco's free trade agreement with the European community : a quantitative assessment

Policy Research WORKING PAPERS Trade Polloy Policy Research Department The World Bank September 1993 WPS 1173 Morocco's Free Trade Agreement with the European Community A Quantitative Assessment Thomas F. Rutherford E. E. Rutstr6m and David Tarr Welfare benefits to Morocco from a free trade agreement with the European Community would be about 1.5 percent of GDP. But welfare benefits would be 2.5 percent of GDP if Morocco liberalized trade with the whole world - and with only slightly higher adjustment costs. Policy RtcshWoiklngP md_natet effindings of woi in pogreca and encouage the exchange of ideu among Bank affand dlothe ioigWn davelopmnemintisewlpap, dimubutedbytheReserchAdvis(nyStaff, curythenames oftheauw,n clect ody thdrviw,andahouldbeuedandcitedaccordingly.Thefindin,gsbntertautions.andconclusionsareth1authweown.bysThCyould no be attiaed to th Wald Bank, its Board of Diracto, its managncnt, or any of its member countrieL  Policy Researchj Trade Policy WPS 1173 Thispaper-a productoftheTrade Policy Division, PolicyResearch Department-is part ofa largereffort in the department to investigate the consequences of regional integration. The study was funded by the Bank's Research Support Budget under the research project "Impact of EC '92 and Trade Integrationr on Selected Mediterranean Countries" (RPO 675-64). Copies of this paper are avaihble free from the Wor.d Bank, 1818 H Street NW, Washington, DC 20433. Please contact Nellie Artis, room NIO-013, extension 38010 (September 1993, 27 pages, plus 18 pages of appendices). Morocco is interested in developing a reciprocal the rest of the world - with only slightly higher free trade agreement with the European Commu- adjustment costs. Liberalizing trade with the nity (EC), although it already enjoys free access world would provide great.-r benefits because it to EC markets in industrial products and is not would eliminate the trade diversion costs associ- obligated to give EC exporters reciprocal access. ated with discriminatory trade liberalization. But Moroccan agricultural exports are impeded (Although the fact that significant benefits would by agricultural protecdon in the European accrue from discriminatory liberalization against Community. imports from either the European Community or the rest of the world indicates that trade diver- A free trade agreement would require that sion is not dominant.) Morocco lower . s moderately high tariffs against its most important trading partner. Tariff * As a result of improved access to the reductions against the European Community but European Community, employmcnt and output not against the rest of the world may provide in the vegetable and citrus fruit sectors would benefits provided the trade diversion costs of expand. But the phosphate sector stands to gain preferential tariff reduction do not dominate. most from the free trade agreement because liberalization would induce a depreciation in the Rutherford, Rutstr6m, and Tarr apply a 39 real exchange rate. sector general equilibrium model of the Moroc- can economy which includes the sectors most * Morocco's cereal, meat, dairy, and sugar likely to be affected by such an agreement. They sectors would lose most in terms of employment, investigate the economic effects of the prospec- because of significantly lower import prices from tive free trade agreement as well as five other the European Community. The nontraded goods trade liberalization scenarios for Morocco. sector would also contract slightly. Among their most important findings: *The value-added tax would have to be * The welfare benefits to Morocco from a free increased to compensate for the loss in tariff trade agreement with the European Community revenues, on which Morocco depends. would be about 1.5 percent of GDP. Such substantial welfare gains partly reflect the Estimates are provided as ranges, with benefits of reducing dispersion in the tariff probability assessments, because of the element regime. of uncertainty. * Welfare benefits of about 2.5 percent of GDP would accrue from liberalizing trade with The Policy Research Working Ppe Series disseminates the fuidings of work under way in theBank Anobjectiveof the series is to get these findings out quickly, even if presentz dons are less than fully polished. The findings, interpretatims, and conclusions in these papers do not necessarily represent official Bank policy. Produced by the Policy Research Dissemination Center .~~~~~~~~~~  MOROCCO'S FREE TRADE AGREEMENT ViTr THE EC: A QUANTITATIVE ASSESSMENT by Thomas F. Rutherford E.E. Rutstr&-m and David Tarr * University of Colorado, University of South Carolina, and Wodd Bank, respectively.  Table of Contents Page No. 1. Introduction 1 2. A Small Open Economy Model 3 2.1 Trade Protection in Morocco and the Free Trade Agreement Shocks 3 2.2 General Model Structure 7 2.3 Empirical Implementation of the Morocco Model 9 3. Results 12 3.1 Welfare, Revenue and Aggregate Primary Factor Movement 13 3.2 Employment Impact by Sector 16 4. Impact of Key Parameters and Sensitivity Analysis 19 4.1 Impact of Key Parameters 19 4.2 Sensitivity Analysi- 22 References 27 APPENDICES Appendix A. Elasticity Parameters A-2 A. 1 Choice of Point-Estimates A-2 A.2 Effects of Choice of Trade Elasticities A4 Appendix B. Adjustments to the Social Accounting Matrix A-6 Appendix C. The Relationship Between the Elasticity of Supply and the Sector-specific Capital Share A-9 Appendix D. Algebraic Formulation of the Model A-10  1. NRODUCTION Since 1986 Morocco has shown an interest in developing a closer trade association with the European Community (EC). Thli interest culminated in March 1992 with concretes discussions for a reciprocal Froa Trade Agreement with the EC. To some the Moroccan interest may be surprising, since Morocco already enjoys privileged relations with the EC. It has freo access to markets in industrial products (there are some minor exceptions such as trousers and canned sardLnes), and is not obligated to provide reciprocal access to Lts market to producers of the EC. However, EC agricultural protection impedes Moroccan exports (notably in the areas of vegetables and citrus fruits), so that improved access to EC markets is an important issue. Moreover, the reciprocal obligations of a Free Trade Agreement (FTA) with the SC will require that Morocco lower its moderately high tariffs against its most important trade partner. These tariff reductions against the EC may provide additional trade liberalization benefits to Morocco, provided the trade diversion costs of preferential tariff reduction do not dominate. This paper reports on an applied general equilibrium modelling exercise that investigates the economic eQ fects of the Moroccan proposal. Given the questions of improved market access of Moroccan fruits and vegetables and of trade diversion and trade creation (which arises in any preferential trade area), we decompose the effects on the Moroccan economy from this proposal into the following six policy scenarios: a) improved access for Moroccan fruits and vegetables in the EC ("ACCESS"); b) unilateral tariff reductions in Morocco against the EC alone ("ECLIB"), against imports from the rest of the world alone ("LIBROW"), and against all trading partners ("LIBALL"), without improved access to EC agricultural markets; c) cooperative tariff reductions with the EC, where on the EC side this implies extended market access for Moroccan fruit and vegetables ("FTA"); and d) full free trade agreement with the EC augmented by unilateral liberalization of tariffs against rest of world imports ("FTAALL"). Our analysis provides a quantitative indication of the income gain to Morocco of these strategies.  Among our most important results, we find that the welfare benefits to Morocco from the free trade agreement are about 1.5 of percent CDP, and are about 2.5 percent of GDP if Morocco adds trade liberalization with the rest of the world to the free trade agreement. These welfare gains are quite substantial ln the context of other model estimates with constant returns to scale such as ours, and partly reflect benefits from eliminating dispersion in the tariff regime, since dispersion is eliminated in the process of liberalization. The larger welfare gains from Morocco adding elimination of protection against the rest of the world to a free trade agreement with the EC, reflects the trade diversion costs associated with discriminatory trade liberalizaticon. On the other hand, the significant benefits that accrue from discriminatory liberalization agail.at either EC or rest of world imports indicates that trade diversion is not dominant. One interesting conclusion is that broader trade liberalization yields greater welfare gain than the PTA, but wlth only alightly hLgher adjustment Coste. Thls can be seen as an lmportant argument ln favor of the efforts towards lowering tariffs against non-EC sources subsequent to achieving a FTA. We evaluate the overall welfare sffects on the Moroccan economy from the above scenarios, as well as the sectoral impacts. The sectoral impacts are particularly Lmportant glven the emphasis that has been placed in Morocco on dLversLfication of production and exports, ..e well as concern over the costs of adjustment. The model provides a quantltative indication of the extent of output (not reported) and employment (report. 1 below) adjustment that will be required by industry. We find that although citrus frults and vegetables expand as expected from their improved access to the NC market from the PTA, by far the sector that gains the most from the trade liberalizatlon scenarios is the phosphate sector. Phosphate exports expand sLgniflcantly after the PTA or other trade liberalization scenarios due to the deprecLatlon of the real exchange rato induced by the liberalization. Conversaly, non-traded goods sectors slightly contract after the PTA or other liberalizing scenarios. The largest losers of employment, however, are the cereals, meat and dairy and sugar sectors. These 2  sectors face significantly lower import prices after trade liberalization. Estimates are provided within a range (wLth probability assessments over the range), as there is an element of uncertainty in the estimate. which we also quantify. Given the importance of the tariff au an instrumekt of revenue generation in Morocco, we exploit the ability of a "simulation laboratory" to zontrol for this effect by adopting the value added t&c (VAT) as an explicit replacement tax such that government revenue rem tns con'tant. The VAT induces distortion coats (marginal excess burden). We indicate the extent the VAT would have to be changed .in order to avoid a reduction in government revenue. The w'arginal excess burden of raising government revenue from the VAT is incorporated in the analysis. The model we uoe is a 39 sector computable general equilibrium model of the Moroccan economy. This level of disaggregation captures most of the important sectors of the Moroccan economy that would be affected by the Free Trade Agreement. In particular, citrus fruits, vegetables, cereals, sugar and meat and dairy products, textiles, apparel, fishing and phosphates are included as separate sectors. The model that we use in deliberately very simple, to facilitate the confrontation of policy-makers' intuition with easily interpreted simulations. The model assumea no terms-of-trade eofocts, a single household, no capital accumulation, and constant returns to scale production with competitLve pricing. In addition, the model is a "comparative statics" model which ignores the costs of adjustment of factors. Consequently, the benafits of the integration-liberalization scenarios will be les than our estimates to the extent of costs of adjustment. 2 * A SMULL OPEN ECONOMY MODEL 2.1 Trade Protection in Morocco and the Free Trade Agreement shocks Structure of Protection. Since 1983 Morocc has dramatically liberalized its foreign trade regime. In 1983 import licenses were required in all sectors, tariff rates were high and dispersed (some over 1CA% in a4- -cn to the special import tax of 15%), and 3  there were export licensing requirements and a state marketing board monopoly on exports of processed food products.' In 198S, the maximum rate for customs duties was lowered to 45%. Mout impressively, ? -A'occo 'as progressively reduced its import licensing requLrements so that by 1993 no imports will require a license (other than for health and safety reasons). On the export side only minor restraints remain since special customs regimes for exporters were extended and improved, export licensing was removed with only a few exceptions, and the monopoly of the state marketing board was abolished (see Mateus et al. (1988, p.ll)J. We therefore take as our point of departure, a trade regime that is free of non-tariff barriers. Tariff rates as of 1991 by sector are presented in column 10 of table 1. The structure of the rates is taken from legal applicable rates at the tariff line level that are aggregated, based on an unweighited average, to the 39 sectors of our model. Legal tariff rates, however, are not Indicative of actual tariff collections, because there are exemptions to the tariff (as well as exemptions to the fiscal import tax and the value-added tax) for a number of purposes, most importantly for inputs into products that will be exported. In view of the importance of the revenue implications of the proposed tariff changes, we therefore proportionally adjusted all the legal rates. The rates that appear in table 10 have been proportionately adjusted for all sectors, such that the total tariff collections in the economy, based on 1991 imports, equals actual aggregate tariff collections from budget data for 1991.2 The average import tariff based on collections is 19%, which includes tariff surcharge (fiscal import duty).3 The most important sectors regarding import revenues are Industrial Machinery, and Coal and Crude Oil, which together account for over 30% of revenues from trade taxes. Among the most important non-tariff barriers scheduled to be removed in early 1993 are those in several agriculture sectors: sugar, cereals, meat, dairy 't8. Mateus at al. 19881 and UNDP-Wordd Bank (19921 for detols. 'Appendix B dicus thds adjument 'As memben of the Msghreb pmferential tmding ae, inoas fiom Algea an Tunisa are exempted frnm the fial import duty. 4  Table 1: Morocco - Basic Data for the Socild Accounting Matrix 8ECTOR (Abbrov.) SECTOR SHARB OP TOTAL: TRADE BY SECTOR: TARWPRA (In percent) (In percent) (1) (2) (3% (4) (5) '6) (7) (8) (9) (10) Output Labor Capital Imports % fromEC El. wur: %to eC lmoogir Er ______________________________ .________________ ___________ _ Consumption Output kORICULTURB 1. Cereals (CER) R 5.44 3.04 10.32 7.16 53.8 0.85 54.2 13.20 150 45* 2. Sugar (SUG) R 0.26 0.12 0.41 0.00 0.0 0.00 0.0 0.00 0.00 45* 3. Citrus FruIts (Cfl) R 2.18 1.50 2.84 0.03 64.8 9.26 69.8 0.40 40.20 31.56 4, Vegetables (VEO) R 1.84 1.14 2.15 0.26 100,0 2.75 dP.6 2.40 14.00 1135 5. Meat and Dairy (MAD) R 4.90 1.62 9.88 0.23 50.2 0.02 100.0 0.70 0.00 45S* 6. Eshln (FSN) R 0.38 0.08 0.25 0.00 64.8 0.66 53.6 0.00 16.30 7. Forestry and Other Agri- cultue (FOR) 1.02 0.51 1.74 2.44 59.4 0.17 86.6 32.80 7.00 29.54 MINIG AND RELATED _ 8. Phosphates (PHS) 2.52 2.5 4.04 0.00 0.0 22.45 51.1 0.00 89.20 9. Other Non-Metallic Mining (NDM) R 0.40 0.46 0.30 1.99 7.7 0.73 41.2 41.10 15.40 16.48 10. Metals Mining (MIN) R 0.59 0.58 0.91 0.14 86.4 4.57 80.6 18.30 81.40 14.74 11. Coal and Crude Oil (CAO) R 0.16 0.47 0.08 18.82 1.6 0.14 84.2 96.20 22.90 11.35 12. Refined Oil (OIL) 4.14 031 0.20 1.89 51.6 2.19 73.9 19.50 7.50 23.80 13. Electricity and Water J(ELB) 1.80 1.54 1.77 0.00 0.0 0.00 0.0 0.00 0.00 piANUAClU RJINO_ 14. Food Products (POO) 4.10 5.38 0.95 3.38 53.6 0.44 95.7 10.90 1.00 35.23 15. Other Food Products (OFP) 5.40 4.24 2.16 3.98 47.7 7.40 633 12.90 13.30 27.91 16. Bverages and Tobaeco (DEV) 1.01 1.84 0.51 0.34 76.8 153 94.2 5.30 15.00 30.02 17. Texties (T) 4.10 6.07 2.28 5.3C 71.0 625 61.0 21.10 14.40 25.30 18 Clothing (CLO) 2.31 2.27 1.81 0.02 86.7 4.02 94.1 0.20 1550 34.13 19. Leather and Shoes (LEA) 1.24 1.88 0.68 0.15 89.5 4.78 71.5 2.40 3850 24.01 20. Wooden ProducU (WDS) 1.9S 2.93 0.64 2.36 31.4 C.26 83.7 17.60 3.00 19.98 21. Pper and Printing (PAP) 1.11 1.92 029 2.27 47.1 0.92 69.4 28.20 8.20 27.65 22. Cement (CEM) 1.66 358 0.41 0.95 38.1 0.11 682 11.00 0.70 21.86 23. Iron and Steel (LAS) 0.46 0.44 0.12 657 63.3 1.87 79.2 75.60 31.90 16.84 24. Electro-Mchncal Ind. ustry (E ai) 1.79 3.93 1.12 2.29 88.9 0.11 87.3 22.60 0.60 21.45 25. Industrial Machinery (IND) 0.98 0.74 0.62 17.83 45.3 0.06 68.2 74.10 0.60 20.44 26. Transport Equipment (TEQ) 1.14 153 0.46 4S6 62.4 0.25 66.1 46.90 2.10 15.04 27. Electrical Equipment (E!O) 0.78 1.40 0.17 3.84 57.4 0.13 99.4 49.80 1.60 2.I1 28. Offlce Machinery (MAC) 0.07 0.04 0.02 1.06 73.9 0.02 9c2 73.70 1.90 30.54 29. Chenicals (CUM) 3.41 3.80 2.45 .15 67.1 7.41 29.4 34.90 21.20 19.40 30. Rubber and Plastics (RBR) 0.75 1.22 0.24 L03 74.5 0.15 20.5 21.50 0.80 23.16 31. Other Industries (OTH 0.33 0.44 0.18 0.19 77.2 .05 44.7 11.00 1.50 26.26 ERVICES 32. Construction (CON) 9.51 3.83 6.44 0.00 0.0 0.00 0.0 0.00 0.00 33. Trade (TRD) 12.57 2.99 21.61 0.00 0.0 0.00 0.0 0.00 0.00 34. Transport (TRN) 5.49 3.87 4.19 1.41 100.0 9.39 57.2 4.80 20.90 10.00 35. Cormunicatons (COM) 0.50 0.46 0.70 0.01 100.0 0.02 57.2 0.40 0.60 10.00 36. Banking (BNK) 1.63 1.73 2.10 0.00 100.0 0.02 57.2 3.00 9.30 37. Insurmce (INS) 0.34 038 0.00 0.00 100.0 1.24 57.2 3.20 10.70 10.00 38. Other Services (SRV) 11.82 6.99 14.87 0.86 100.0 7.70 57.2 1.20 7.60 10.00 39. Administration (ADM) 12.86 2.85 0.00 0.00 0.0 0.00 . 0.00 0.00 _ = * Sectors marked R (for resource) have sector-sopccfic capital. 4Nontariff barrier estimated at 45 pmecnt legal tariff rates after adjustment for collections are 10 percent. 16 percent and 28 perent in cereals. sugar and meat and dairy respectively.  and edible oils. These non-tariff barriers are believed to be quite binding, and Morocco intends to increase tariffs in the meat ana dairy industries, and impose variable levies in the others to cushion the adjustment costs. We therefore assume in our benchmark that the tariff levels in the meat and dairy, sugar and cereals sectors are 45 p6rcent. Shockg of the Free Trdad AqSegmet An a reault of the decade long liberalization of trade, some dlversificatlon in exports has been achieved, mainly in textiles and phosphate derivatives, but the development of export markets in agriculture has been inhibited by protectionist policies in the EC. Given the generally free access to EC markets by Moroccan producers, SC restrictions of importance on imports from Morocco only remain in fruit and vegetables, trousers, and canned sardines. At the level of aggregation of our model, increased access to the EC markets for Moroccan products will primarily Lnfluence the export price of the fruit and vegetable sectors.4 The Moroccan Free Trade Agreement proposal would involve a lor aring and eventual elLmination of all remaining trade barriers on all imports from the EC (i.e., lowering of the tariff), with correspondingly increased market access for Moroccan products into the EC, most notably in agriculture. We estimate the price distortion in agriculture due to border barriers in the EC to be about 8%, following the EC model developed by Harrison, Rutherford, and Wooton [1989). An upperbound" scenario would assume that the EC demand schedule for Moroccan fruits and vegetables is infinitely elastic, so that a removal of tariffs and other barriers will be entirely passed on to Moroccan producers as an increase in the export price. If the EC demand schedule were less than infinitely elastic, the price increase passed on to Moroccan exporters would be less than 8. Moreover, if Moroccan exporters are currently capturing some of the rents from the EC trade barriers, then the export price increase would result in less than the full 8% of benefits to Moroccan exporters. Since Moroccan 4Mormco's exporu in fruit and vegetables are dominated by oaga aed aother ciua fruits, which are both the major conomponts of our citma fruits, and by tomatoer, poatoes, and presetred vegeables, which ae the major conmontas of our vegetables sector.  production is small relative to EC demand (suggesting highly elastic demand in the EC), and since the variable levy is assumed to capture rents in the EC, we take as our base case scenario the full 0% increaue in the price of fruits and vegetables from improved access to the SC market. Domestic taxee consist of the value added tax (VAT), employment and corporation taxes, and production taxes and subsidies. Sinco we do not have good updated data on collections by sector7 all of these rate-i have been set uniformly. The most important '-ax in eur model is the value-added tax, and import taxation is the next most important. The legal VAT rate is 19%, applied to both importe and domestic production. As witl tmport taxation, however, there are exemptions to the VAT. In order to be consistent with aggregate VAT revenues collected on domestic production and imports, the domestic VAT rate hao been set to 3% and the rate applied to imports to 11%.5 The VAT taxation on imports introduces further distortion in the trade regime.6 The other tax rates are calibrated based on aggregate tax collections as recorded in the SAK. They ares 1% production tax (net of subsidieo), an 8% labor tax (net of subsidies), and a St corporation tax (net of subsidies). 'In the appwdix we provide a detailed documentationof he x rae Wpled In our mol. Bely, however, tal Moroccan valadded in 1991 was 189.4 billion di;a2, wile total impots wer 59.7 bilion dirhm. Valusimdded tax an domesti snler foport) was 5359 (7853) mDllion dirhams, which represent. 3 percent of value-dded uad 11 pereeot of iports. We applied tim rat to dte uctue of value-added and impots in our 1980 SAM, which yields an amount of value-added Sovernme rev-'10 equal to 32 percat of total govenme evne. Import tae (cluding the P.F.I.) equal 11,465 million didbms In 1991, or 19 perce of the valuo of lmpots. We cale all cual taiff rates in 1991 so that the weighted aveage lat equals ths 19 percent. i yields that 30 perct of governmt revenue I our mDode Is from taiff collections. Actu valuedded ad tadff collectios i 1991 were 24 and 21 pec of ovem n rewve, repetivey, but these ae Many xes employed in Morocco that ar not presnt in our model (ach n a pesnal w , exci taxes, liceng feew and a corpora tax. With our mapping we have asured that the atmacure of the VAT and iipost ta fomn 199& gs impimed in our model. Moteove, rogarding what is importat for the revenue implcatiorn of the model, the relative in_on of toh VAT to impot te u a percet of toWl govemet revenu is presved approximately (3230 verms 24121). 'Given that the VAT is appUied on al production and in our model it i soo rebated on expor, iie entire VAT appled on impot im a diseriminatory tax on imponrs. TeMr are two methods of value-added taxatio that do ot dcdminate agalt imports: (1) apply the VAT on all domestic production, including that destined for exports, but do not apply the VAT on Lmpors (the origin principle); or (2) apply the VAT on imporls and domestic production for the domestic market only (the destination pdrciple). If all don_stc production is subject to the VAT and imports re abo taxed the VAT on import Is a discrminatorq teaiff. In Morcco, an effort is made to rebate the VAT on exports. Then, in principlo, Morocco implements the VAT according to the desinadon principle, and provided the rebte of VAT on eoRt is complete, the VAT is not dIsrmbItory against Imports. 6  2.2 general Model Structure Our Small Open Economy (8OE) model is doslgnad for trade policy analjuiL with a large number of sectors. The model io a "generic" general equilibrium - model of a alngle economy along the llnes of de Molo and Tarr (19921 and HarrLson, Rutherford and Tarr '19931. Goods are produced using primary factors and intermediate Lnputs. Prlmary factors Lnclude labor and capital. Land is not included expllcitly, but we nonetheless have a sector-opecLfLi factor by varylng the share of capital that lo sector-specific in "resource" sectors ('he nine ,esource sectors are denoted by an R following their names in table 1). Labor is assumed fully mobile acroso sectors. Production exhibLts constant returns to scale, and producers behave competitively, selecting output levels such that marginal cost at th.-% output levels equals the glven market price. In export sectors, output is differentiated between goods destined for the domestLc, EC and all other export markets. This relatLonship is characterized by a two-level constant elastLcity of transformation frontier. ComposLt* output is an aggregate of domestic output and composite exportel composite exports are an aggregate of exports for the SC and non-EC markets. Final demand by prlvate households arlses from nested constant elasticity of iubstitution utility functlons. Thioa allows consumer decLison-making to occur in multi-stage budgeting. At the top level, goods from dLfferent sectors compete subject to the budget constraint of the consumer, where all income elasticities are unity. In tbh second stage, the consumer decides how much to spend on domestic versus aggregate imports, subject to income allocated to spending in the sector from the first stage, with possibly different elasticities of substitution by commodity. Finally, having decided how much to spend on imports, the consumer allocates this expendlture on SC versus non-EC imports. In two sectors, meat and dairy, and sugar, we depart from the "Armington" assumption and assume that imports and domestic production are perfect substitutes. This is becauso there are no (or negligible) imports in the initial 7  equilibrium due to the non-tariff barriers discussed above- the Armington assumption, without very high elasticitLes of substitution, will imply (contrary to expectations) that trade liberalization yields very little increase in imports. In principle, the appropriate model is the one that is bencnmarked to an econometrically estimated elasticity of supply in the sugar, and meat and dairy Lndustries. Absent explicit estimates, we use the model that in closest to o-r assessment of the supply elasticity. In our sensitivity analysis, we adjust che share of sector-specific capital and thereby the supply elasticity, yielding alternate estimates of import penetration after liberalization. As discussed above, the only Moroccan trade distortions currently included in the model are ad valorem tariffs (or subsidies) on imports and a value added tax that is applied at different rates on imports and domestLc products. The model allows tariff rates on imports to differ depending on whether the import is from the EC or the rest of the world (ROW); and we allow exports to have different prices dependtng on whether they are sold in the SC or ROW. These distinctions allow us to study policies such as accession to a free trade area. The Free Trade Association with the SC also involves changes in Morocco's access to EC markets. The main effect of increased access would be an increase in the Moroccan export price, and these are therefore included as policy instruments that can be varied in counterfactual simulations. Government expenditures and Investment demand are exogenous. Funding of government expenditures is provided by net tax revenues. There are three other components of government income in addition to import tariffs. These are (i) value-added taxes on factor inputs to production and on imports, (Li) employment and corporation taxes on factor employment, and (iLi) ad valorem production subsidies net of excise taxes on production output. In a counter-factual scenario the value-added tax adjusts endogenously to balance government (net) tax revenues with expenditures. Thus the welfare effects of changes in trade policy explicitly incorporate the appropriate marginal excess burden of raising government revenue from other sources. 8  Since private consumption equals the income from primary factors plus net transfere to the consumer by the government (from domestic and foreign trade taxes), Walras law is satisfied. Public consumption is balanced with the value of public endowmeato and tax revenue. World market impurt and export prices are fixed, so there are no endogenous changes In the terms of trade. In other words, import supplies and export demands are infinitely elastic. The current account balances the value of exports and imports taking into account exogenously-fixed capital inflows. This guarantees no "free-lunch" either taken from or given to foreigners.7 2.3 Eupirical implementation of the Morocco model We employ a 1980 Social Accounting Matrix (SAM) for Morocco which distinguishes 39 production sectors. This provides a consistent set of input- output relationships showing intermediate, final demand and value added transactions. Table 1 summarizes some of the most important industry data employed in our model, and displays the names of each of our sectors along with a 3-letter acronym for later reference.$ Columns 1-3 show the share of Moroccan output, employment and capital by sector, derived from the 1980 8AM. Although a full update of the 1980 SAM is unavailable, appendix B shows that, at the 9 sector level of aggregation, output shares did not significantly change between 1980 and 1991. Over 40% of both output and factor employment originates in the service sectors, about 30% of the economy is in manufacturing (food and textiles and apparel comprise about half the manufacturing sector) and the remaining 30% is in the agricultural and mining sectors. Columns 4 and 6 display the sectoral decomposition of imports and exports, where the share accounted for by EC imports and exports is displayed in columns 5 and 7. These shares are updated 1991 data, aggregated from tariff line data provided by the government of Morocco. Phosphates are the most important export 7A morm formal decription of the model is given ia Appendix D. 7bis SAM was constmoted by Mstm et Ai. (1988). 9  sector, and they encounter no trade barriers in the ZC. Fruit and vegetables exports together make up 14% of all exports to the PC. Columns 8 and 9 show the importance of trade for each sector. Clearly the mining sectors are very dependent on exports, as is the citrus fruit sector to a lesser degree. We therefore expect some benefits to this latter sector from increased access to EC markets. The benchmark values of all elasticities in the model are reported in Appendix A. Estimates of elasticitie must be assembled for primary factor .substitution, import demand, import source, domestic demand, and the transformation of domestic supply into domestic and exported products.9 Despite our literature search, there are many elasticities about which there is considerable uncertainty. our "remedy" for this problem, which is endemic to any large-scale model of this kind, is to undertake systematic sensitivity analyses of our major results with respect to plausible bounds on these elasticities. Even if we are unable to specify a point estimate with any precision, our priors over the likely bounds that these elasticities could take are quite strong. To the extent that our major conclusions are robust to perturbations over these bounds, we do not see our uncertainty over specific values of these elasticities as a weakness of the model.10 We report the results of these sensitivity analyses, which involve a minimum of 1000 simulations for each counter-factual policy in Section 4. They will allow us to conclude whether or not our main results are robust, at least with respect to plausible uncertainty over elasticities. We numerically elaborate in appendix C, the model parameters that define the gross substitute-complement relationship between domestic and export production. Although this relationship is important for sectors such as citrus '11in detail, thene elasticities refer to the elasticy of ubstitution betwen primay fuctor of production in each ector; the elasticity of substitution between domestic production ad an impoes composite in each ector, the ebaicity of ubstitution between imports dinguished by source, also by sector, the elasticity of substitution between domestic consmption of each good (the compones of which are, in uns, compositus of domestic and imporled production); and the elsicity of transformadon of domoesic production into does tic uss and export. 'sMes remarks should not bo interprcted as denying the value of any new empirical work on gnerting such elasdcities. On the contrary, any effort that could generate better boundson the e point estimats i eful in generating policy concluson that carry greater credibility, even if those conclusions will sill be probabilistic i nature. 10  fruits and vegetables, whlch are expected to experience export price lncreasoe, lt is typleally not transparent in models of thli type for the followlng reason. Let a denote the supply elasticity of the composite output ln a sector and j denote the elastlclty of transformatlon between domestlc and exported output ln a sector. Abstractlng from general equlilbrlum effects from other markets, de Halo and Tarr 119921 show that lf and only if a > ja, an lncrease ln the export prlce wlll lncrease output of the domestic variety and ralse the domentlc prlce, l.e., the lmport and domestlc varletles are gross complements 3.n production." Although a slmilar condition exlits in consumption, all elasticlties in consumption are entered parametrically, and lt li straightforward to examlne whether the import and domestlc varletles are gross substltutes.12 Although jo li entered parametrically, a (the industrywlde elasticity of supply) is only defined lmplicitly and, ln a model with constant returns to scale such as ours, could potentially assume extremely large values, especially for small sectors where output expansion will not significantly alter the relative costs of its inputs. we report our basic results for the cases of low, medium and high industrywide elasticities of supply. We implement a change in the elasticity of supply, by assumlng three different shares of sector speciflc capital ln all the resource (R) sectors: 50, 75 and 90 percent. Cotarua parlbus, the larger the share of capital that is sector specific, the lower the industrywide elasticity of supply. Appendix C numerically elaborates the relationship between the assumed share of sector-specific capltal ln the cltrus anO vegetable sectors, and the Itibe intuion for ths result as foliow. When th export pric increa_s, fim tovouer wil incae if output levels a held con Frms will therfor puhase more Iu In order to produce mom. DEigarding th relativo pice chag betwen domec and export makt for a moment, this wald res In an inoae In conpoolt pducton, I.e., of goods desind for both tbe domesic and expost murke. li increae In comoste uput we label the output effect. The extent of ths effet depend on e. It i equivalt to the Income effect in consumer theory. Thero is also a tansformaton effect, however, my from produciWg domestie goods in favor of export production, due to the change in the relative price of exports to domesi vadeties. The extet of this trnsfomat effect depends on , the tansformation elastiity, and it is equivalent to the subsiution effect in consumer theory. When e > p, the output effect domin tho trformtion effect, and the goods are gros complements. '2da Melo and Tarr (1992 show that a necess ad sufficient codition for the price of the dometic import competing good in a sectr to be a gross substitute with the import good is that the price elstieity of demand for the composite Armin good is less than the Anmington substitution elatieity. This condition euns thtth ubtitutio effect wil dominate the icom effect in demand. A similar rsult is dscued in Rutmt6m (9M2. 11  supply elasticity of the composite output for domestic firm. in these sectors. In the case of citrus fruits, the Industrywide elasticity of supply varies from about unity to 3.5, but takes slightly lower values in the vegetable sector. Given that the elasticity of transformation (go) is S in our benchmark, this implies that exports and domestic outputs in these sectors are gross substitutes. In the present version of the model we only have one private household in Morocco. It is important to note, however, that there are several powerful theorems in international trade theory to show that one can effect Pareto- efficient reforms for multiple households providing there are aggregate (real) income gains and one accepts some weak conditions on patterns of demand and ownership.13 These results do nct rely on the availability of lump-sum redistributive taxes, nor do they address the issue of an optimal reform package. What they do show is that one can focus initially on aggregate gains in income and welfare, knowing that the redistributive aspects of the problem do have a solution that leaves each household at least as well off as before the reform. This is not a complete substitute for actually solvlng for the equity effects of a reform package, but it is a partial substitute. The SOB model is generated with the GAMS software developed by Brooke, Kendrick and Meeraus [19881 and solved with the MPS/GE software developed by Rutherford (19891. The systematic sensitivity analyses are undertaken with the ZPSS software developed by Harrison (19901 and using the procedures developed by Harrison and Vinod 119923. 3. RBSULTS The policy simulations that we consider and the aggregate results on welfare and taxes are summarized in table 2, and the employment effects by sector are summarized in table 3. In the following section, we present the results of systematic sensitivity analysis to determine the robustness of the results to a Sc Dixit and Norman (1980; pp.79/801119861. The conditons on demad d factor ownerahip pa a pdmaily to nde opure exchange' economies. 7Tea conditios are tivialy met in our model. 12  parameter specificption. One parameter which stands out in importance regarding some of the results in the industry-wide elasticity of supply assumed in the resource sectors. Consequently, ln this section, we present our "best guess" estimates under three different assumptions regarding the lndustry-wlde elasticity of supply in resource sectors. 3.1 Welfare, Revenue and Aggregate Primary Factor Movement The first three columns of table 2 show the welfare gain measured as the Equivalent Variation as a percent of benchmark GDP. Columns 7-9 show the percentage labor adjustment measured by the necessary reallocation of labor across sectors as a percentage of total labor supply. Columns 10-12 likewise measure the necessary reallocation of capital across sectors as a percentage of total capital supply. The results depend on the industrywide elasticity of supply assumed in the resource sectors. The greater the elastlcity of supply, the more resource movement across sectors (more labor has to change jobs), but the more welfare gain as well. For example, under ACCESS, the cLtrus fruits and vegetables sectors obtain higher EC prices. With larger elasticity of supply, they expand output more. ThLs results in greater welfare gain to the economy, but also more movement of capital and labor between sectors. Conversely, the meat and dairy, sugar, and cereal producers will suffer a decline in demand as a result of lowerlng tariffs under all scenarios except ACCESS. The greater the elasticlty of supply, the more output, labor and capital reduction there will be in these sectors, but the larger the welfare gain as a result of shlftlng these resources into more efficient sectors.4 All the results of columns 1-3, .7-9 and 10-12 follow thls pattern. '"Th different elsticities of supply re implemented through varying the are of ector specific capiwl. Given ector ecific capital, in reponse to a change in demand, the rent on capital in the sector will cbanp which implies there will be less movement of tsource in or out of the sctor. For example, specific capital owners in citrus fruits and vegetables ear greater ren under ACCESS, but the increase in their rens increaes their pnces and dininishe the expansionofoutput. Convesey, in contmcting ectors, ector pecific capital rsults in a eduction of ren, coss and prices, and a diminished reductioa in output. 13  Table 2: Free Trade Agreement with the EC and Related Trade LLberalizations Welfare, Tax and Factor Adjustment Effects on Morocco' ________ % Chango in Welfare %Cbango in VAT e X of bbor that hange jobs * of capital t adjua H M L H M L H M L M MN H FrA 2.2S 1.52 1.20 54.0 583 60.3 3.2 2.S 2.2 5.1 3.3 2.7 EC81 2.05 1.29 0.97 54.6 5dS9 60.9 33 2.6 2.3 5.4 3.6 3.0 ACCESS 0.31 0.27 0.25 -1.8 -1.2 -1.0 0.4 03 0.3 0.6 0.4 0.3 LIBROW 1.86 1.10 0.78 55.7 60.1 62.0 3.2 2.5 2.2 5.3 3.5 2.9 LIBALL 3.12 2.37 2.06 80.7 8S.5 87.7 3.7 3.0 2.8 6.0 4.3 3.6 FIAALL 336 2.60 2.29 80.0 84.9 87.1 3.6 3.0 2.7 5.6 3.9 3.3 a. All aslmlations use tho Value-Added Tax as replcement tx. Reult amt for high (H), medium @4), and low (L) elatcity of supply in rceource ecton. DESCRTION OF POLICIES: FrA ... FuU free trade agreement with the EC. Inmreaed expost price for chtra fmuit ad vegtables for SC deintion by 8 percent, dimination of inpost proetion from EC sources. ECLIB ... Eimination of impont protection againt C import. ACCESS ... Incraed expont pries for citms fiuits nd vegetable to EC deations by 8 porco. LIBROW ... Emiation of impost protection against non-BC impots. LIALL ... Eliminaon of impost protcwtion against all imports, BC and n-BC. FTIAALL ... Ful free trade agreemt with the BC, augmened by elImiation of impost proteon from non-SC su. as weU. Flrst conelder the pollcy scenario ACCESS. Improved access to the EC for citrus fruits and vegetables will lmprove Moroccan welfare by slightly more than one-fourth of a percent of GDP, due to improved resource allocation and better terms-of-trade in cltrus fruits and vegetables. Since columns seven through nine show that factor movement is small under ACCESS, It is primarily the terms-of- trade improvement that is provldlng the benefits from improved access. Removing tariffs against EC imports (ECLIB) results ln an improvement in Moroccan welfare of between one and two percent, which is about 4 to 7 times the benefits of lmproved access alone. The free trade agreement (FTA), which combines the polLcies of ACCESS and ECLIB, results in galns ln Moroccan welfare that are 14  roughly additive in the separate policies. Removing tariffs against the non-EC rest of the world (LIBROW) results in !jains of about 80 percent of those from liberalizing trade with the EC alone, reflective of the fact that the EC is the larger trade partner. If tariffs are lowered against all imports (LIBJLL) another substantial increase in Moroccan welfare (of about one percent of GDP) is obtained (compared with ECLIB), interestingly, without significantly additional shifting of labor and capital among sectors. The reason that the additional welfare is obtained with little additional resource movement is that lowering tariffs against only the EC induces resource movement, but that resource moveme"t is not necessarily toward the most efficient sectors by world standards, i.e., there is trade diversion from the Morocco-EC Free Trade Agreement.0 Resource movement that is induced by trade diversion will not occur when tariffs are lowered to all supplying countries. The significant benefits that accrue from discrim&.natory liberalization against either EC or rest of world imports indicates, however, that trade diversion is not dominant. Liberalizing tariffs to the rest of the world in combination with a free trade agreement (FTAALL) with the BC results in benefits that are roughly additive in the separate poll3ies that make up FTAALL, i.e., LIBALL plus ACCESS. All simulations are performed assuming that the rate of VAT taxation would be altered so that revenue to the government is unchanged. For scenarios involving reduced tariffs against the EC, columns 4-6 of table 2 show that the VAT would have to be increased by about 55-60 percent. This means that the VAT collection rate on imports would rise to about 16-17 percent (from the collected 11 percent) and on domestic products to about 4-5 percent (from the collected 3 percent). For scenarios involving full tariff liberalization against all imports, the VAT rate would have to rise by about 80-90 percent. "Trade diverson would occur In a Moroccan Fre Trade Ageentni with the BC, when a cupper outside the SC would spply the product to Morocco at a cheaper price than the EC suppier, but the baff incluJvN price of the DC supplier is chae. Ttade diversion coss ae more likely to be high relative to trade ceation benefits: (1) the higher the tariff rcte ginst and M) the lager the are of trde with the countries that are excluded from the integation agreement. We alo show in ection 4.1 tt (3) the lower elascticity of mbution of composite impott ad (4) the higher the elsicity of substitution for imports fron differeot counties of origin, the grea the relte cost of trade diversion. 15  To sum up the aggregate effects, there are significant trade diversion costs when only partially liberalizing import protection, implying that a complete elimination of the protective system would result in higher welfare gains than a free-trade agreement with the EC. horeover, tnmere is a clear correlation between the welfare effects and the necessary factor adjustments. The higher the welfare gain, the higher is generally the adjustment needed. One interesting conclusion is that broader trade liberalization yields greater welfare gain than the FTA, but with only slightly higher adjustment costs. This can be seen as an important argument in favor of the efforts towards lowering tariffs against non-EC sources subsequent to achieving a PTA. Finally, welfare benefits of 1.5 to 2.5 of GDP, from the free trade agreement or broader liberalization, is quite substantial for models with constant returns to scale. We have shown, however, that a considerable portion of the benefits derives from eliminating dispersion in the tariff regime, since dispersion is eliminated in the process of liberallsation.16 3.3 Employment Impact by Sector The sectoral employment adjustments occasioned by the policies are depicted in table 3. By far the sector that gains the most from the trade liberalization scenarios is the phosphate sector, where employment increases by over 60 percent. Despite the fact that phosphate exporters do not obtain improved terms of trade on world markets from the free trade agreement, the reduction of tariffs depreciates the real exchange rate in Morocco, and allows them to obtain more in domestic currency for their exports even if the price of their exports in foreign currency is unchanged. 17 Citrus fruits, vegetables and leather goods (all significant exporters) are the other industries that expand the most. 'lia hct, when we fis humonied aiffs for al uen to dir weightd avenge evel in the bmmnuk C1IJ pero) ad basquweny simuted dh vaious poliies of shown in tble 2 (in the maum ldticty sco) we obtined considerably maer benfits. m potular, tse welfae benefits a a peecenge of GDP ae as follows: FA, 0549; BCLE, 0325; ACCESS, 0.243; UBROW, 0290; U3BALI, 1.233; FrAALL, 1.456. Thi shows that about two4-id of the benofits in many of the sdos deives from ha_monzation of the tuaf regime. "Formlly speaking (since there is no money in the model, the price of expots buys more in terms of domest nontraded goods. 16  Conversely, since the cost of the imported goods rises in tnrms of non- traded goods, sectors which are primarily non-traded generally lose employment after the PTA or other liberalizing scenarios. The largest losers of employment, however, are the agricultural sectors that lower tariffs significantly (cereals, meat and dairy and sugar). For reasons mentioned above, we treat two sectors in the model as homogeneoust meat and dairy, and sugar. In these sectors the industry-wide elasticity of supply play. an especially important role in determining the decline in employment. The elasticity of supply in these sectors is controlled by the share of sector specific capital. More precise estimates for these sectors could be obtained if econometrically estimated supply elasticities were available. The estimates for these sectors are illustrative, given our best guess of the supply elasticities. 17  Table 3, Percent Employment Change by Sector and Scenario * I FTA EI.3 A5SU 3.331W LIALL fIALL SEOR 1(A_v.) N U L H 3d L H 3 L H U L a U L N t L 1. C.mh (CE) lw .13 94 46 4la .9.5 .9 . .i -e1.1 -9.1 .6.3 .13A -333 .30.9 -333 -llf .101 2. &w OM f -32 4.4 41.5 23 41.1 4.2 -2.4 43 -1.0 42. -.5 1.6 -,p.5 o41. -56. -7L7 - 4" 3. Cb FDm (CU) a 2A4 I73 15.9 23 I .J IA 17I2 I" 333 2.2 W . I3 2. 2.2 2. 23. 182 3S4 aL V _,IabI(e0) a 9.1 6.4 Li -3.1 .34 43 89 .7 a.7 -33 .20 .2. 4.4 -..7 -3.9 93 ae . 7.1 5. %di a Wq (MA 1 47.3 4.e 43 47.1 .53.1 453 - IJ 4.3 4.6 67.7 42 .4.7 64 4.2 413 43-as 4" . IL Fhb, MO f .2* -2*, 43 .22 .33 42 .3 e02 62 0.1 0.2 .1 3 0.4 3J 13 es 7. )'muuy*ceuAviv. (FOR) -.4.7 9 s e 0 43 .4.5 .4.7 -43 43 .03 3.3 -3.3 .. -1.3 -724 -7. -73 -73 AD .ATED a ftmobm(MM5 924m .5 53.I 3.7 7P9 67.3 46 -7.1 -62 102 733 1.1 333 n3.5 719 3t. 3)* *10.7 9. Ost Nmua MhftS 6 .7 sA 6.1 53 .3 47 43 21 -245 44 133 -3J .3 -J.1 -IA 43 3 mm" au (We a 3J 2.7 2A 4* 2.9 2. 4.7 4A 4.3 29 2.1 33 4.2 3* 2.7 3 2* 2.5 It.cu3ad Ca& on CA) 1 93 3.5 8.1 9gJ OA a 40 4.7 47 4- 43 41 2A 23 2.7 21 2.3 22 t. oboO -2*w -3A -3 *I 33 0.3 0.1 0J e 50 42 4A 2.3 2.a 4.2 7 2 13.32sdaidumd watow.D) -L.l 4A 4 -*1.0 42 0.3 4L 43 43 -*I 4.2 6. 4 0.31 OA -ID 43 03 MANUFAC IUDO 14. Food P (/FM) 4.0 452 J9 4 4 43 0.1 0.1 0.31 - 2 4.* A 43 4J5 -1A 47 -4A I5. Od Food to06w (OF3? -3.9 -3I .2.3 4* .3.3 .2 43 46 4.3 .1 -3J .4.3 43 4* 41 7 4 14L $moqsw d T_o OM" -2.2 .23 .23 .13 .23 -4 43 42 43 4* 14J9 .13 .3* -3. .3.1 -J -3 17. T. MMXT -44 .7 .3 4* 39 -33 43 42 4 -2.7 -2.7 4 43 4 3 4.2 IL ae () -* 4.1 4.1. -,1 *.1,1 43 42 4.2 43 -3.7 -IJ -13 -IJ -J -41 -3. .*I -1.9 it. Laiie Sad e (IA 33.2 30.9 9.7 14.3 31. 303 .I3 433 .3.1 3a 5.7 4.5 l.7 Ms5 9 I 9.9 I 23 Wood bII (WDH) 03 Os 0.5 0 4 0O5 4L 40 0* -. 7 a * - -2 -2 -2* .2A .13 -IJ 21. r_red tar (PAIP) 2.a -27 2.7 .2A -2.7 -2 43 4.2 42 -3.3 -3.2 -32 -5* 4. .4* .-5 .4 As 2. C E) .13 .3.1 13* -33 -3.1 49 4.3 43 43 1. 4 .33 .33 -22 -2* -1 -2.2 -2* -s 21kmadS Sala) 2.5 Is 1.5 3a 23 2w -43 - * 4 332 2.7 2A4 [A. 4A 0. ID 4. 43 24. lJ.a&Ueim3 _Oy .42 .37 34A 43 -.3 -. Qa O D 0 0 e9 33 42 1 1 4J 4* 25. b9W Ma y OMND -3.7 4J 4 S -24 4J22 44 44 4OA .7D 4. 1 4 - 42 .33.3 -9.9 -13 -1. -33. 2L T _mu Eq _ (m) .1. 43 4.1 -1. -1.2 49 43 43 0.2 0.7 Is -2 -2a -3. - -2. 4- 21. EB IE01 4.m1 4. 43 -. 4* 4 4J AA 43 43 .7 .4.5 -4A .300 43 .932 *10A 4J .03 21. oUbf ! y AOUX) -72 -171* -36. -363 -3" -165 43 47 4A .32 .-n 439.2 -49.1 -190 -B3. -9A 2. bt7db 3O 03 43 IJ 0.7 03 49 47 7 5.1 4J 4A Si 22 Is 2.5 La I 30.3d6o1.a.r.(d31O 47 .13 -I3 4A4 -2 -IJ 43 402 42 2A 1. 3.3 4.1 49 43 4A -. -43 31. O&w &"M 61n) -33 4J .13 42 41 -I3 3.1 0.3 0 -IA -3j 4S -32 -J3 .3 -1S -3 -43 m. . 3.C4MmbU (CON) 3 03 -345 0.2 ID0 0 4.1 42 4J 032 IJ -3A 03 w -1A 0 33. Tl (1`D) 4. 4S 4.9 4.7 -a .3J 13 0. 7 0A 43 -2.5 -1. 43 -33 -2 45 -24A 4A 3L T _mp. (ntN) 23 22 2l 23 Li7 2 40 43 45 53 52 S 5 5A 5.A 5. 4.9 49 35. CoMmIlw (00U) -1.0 4L 03 -3 6 O 3O 4. 1 4. 43 4S e 5 09 450 4.5 IL 0.1 36X '.