Foreign Competition and Income Distribution in Canada: A Dynamic Microsimulation CGE Model Analysis

Abstract

In this study we assess the impact of increased foreign competition on labour markets and income distribution in Canada, using a newly developed dynamic microsimulation computable general equilibrium (CGE) model. The main findings of the simulations conducted are that the decline in world prices of imports and exports of the manufacturing products during the 2000s induces small increases in low-income rates and inequality in the short run as well as contractions in the export-oriented manufacturing sectors. In the long run, however, it enhances capital accumulation, particularly in the primary and service sectors, increases real GDP and reduces low-income rates, especially among families with two persons or more.

KEY WORDS:

• Computable general equilibrium
• microsimulation
• trade
• low-income
• distribution
• Canada

JEL CLASSIFICATIONS:

• D33
• D58
• F17
• I32
• O51

Acknowledgements

The authors wish to thank, without implicating, Gilles Bérubé, James Davies and Anne-Sophie Robilliard for their valuable comments, and Lyming Huang for his help with data preparation. All remaining errors are ours. The views expressed in this paper are solely those of the authors and do not necessarily reflect the views of the organizations they are affiliated with, nor those of the Government of Canada.

Notes

¹For a detailed literature review on the impacts of Canada–US free trade agreement and NAFTA (North American Free Trade Agreement) on the Canadian economy, see Harris (2006).

²According to Baldwin & Macdonald (2009), while the volume of manufacturing output relative to the total economy fell by only 1% annually between 2000 and 2005, the relative price of all manufacturing products fell by 3% annually.

³See the study by Dissou (2007) which examines the impact of energy price hikes on the economic activity in Canada using a multi-sectoral dynamic general equilibrium model.

⁴For a survey on applied microsimulation techniques see Davies (2009).

⁵An appendix with a complete list of equations is available from the authors.

⁶Note that with the closure rule discussed above, the scale parameter is endogenously adjusted to ensure that savings-investment identity is respected.

⁷As in Annabi et al. (2008), the current version of the model does not include a reweighting procedure reflecting future changes in household composition. This would increase considerably the complexity of the model and its numerical solution, and hence has been left for future research. See Davies (2009) for a detailed discussion on dynamic microsimulation.

⁸The model is formulated as a system of non-linear equations solved recursively as a constrained non-linear system (CNS) with GAMS/Conopt3 solver and a 64bits operating system.

⁹Output is equal to the sum of GDP at factor cost (value-added) and intermediate consumption.

¹⁰Matching may be used in the opposite situation. In implementing their microsimulation CGE model to Russia, Rutherford & Tarr (2008) used this approach to estimate income sources for 55,098 households.

¹¹Aggregating households may be a useful strategy in explaining simulation results. However, one should keep in mind that each group may be very heterogeneous, which prevents the link between the base run characteristics and the aggregated results from being straightforward.