Trade and the External Wealth of Nations

Abstract

Most CGE trade models fix current account balances exogenously, in accordance with the widely accepted view that trade policy may influence trade flows, but that current accounts are constrained by symmetric capital account balances, on which trade policy has little effect. The MIRAGE-D model was developed to make explicit the international capital flows which must take place to balance the current account implications of the simulated trade flows, and to compute the cumulative consequences of such capital flows on the international investment positions (IIP) of countries. In MIRAGE-D, current account balances and their capital account counterparts are endogenous, following a three-tier portfolio management model, adapted from Decaluwé and Souissi (1994; Souissi, 1994; Souissi and Decaluwé, 1997), which represents country-agent wealth allocation behavior. The allocation of capital among countries and industries is determined by an investment supply and demand equilibrating mechanism. Investment supply is the demand for new physical capital ownership titles resulting from the wealth allocation process, while investment demand is a constant elasticity function of Tobin’s q in the Jung-Thorbecke (2001) style. An illustrative simulation scenario was run with both MIRAGE-D and the standard version of MIRAGE. Apart from the IIP of countries, which the standard version does not produce, other simulation results, although not identical, show moderate differences, which are fully explained by the financial aspects, and arise from the consistency required between such financial aspects and the rest of the model.