Estimation of the Value-Added/Intermediate Input Substitution Elasticities Consistent with the GTAP Data

Abstract

Elasticities are often a combination of expert decisions and literature estimates—many of which are outdated. Recent efforts focus on estimating new estimates for some of the most commonly used elasticities (e.g., the Armington elasticity in models of trade); however, several elasticities still have little empirical basis. The elasticity of substitution between intermediate inputs and value-added is one example, but this elasticity is quite important as it governs producers’ production regimes across sectors and regions reflecting their level of efficiency. We examine and estimate this elasticity for one of the most widely used CGE models (parameter ESUBT in the Global Trade Analysis Project model), using the latest four datasets available (2007, 2011, 2014, and 2017). Our work finds that the default value of zero in GTAP does not reflect the true behavior implied by the data. Using our estimates, we propose a set of new values—for the short run (1-year), medium runs (3-4 years and 6-7 years) and long run (infinite horizon). We demonstrate the importance of our new estimates using a scenario from the EU Farm to Fork policy. We find that using the estimated elasticities leads to much milder market and welfare impacts; these effects are further dampened with the long-run elasticity estimates.