Revisiting Armington and AIDS: How Sensitive Simulated Pattern of Trade is to Functional Form Choices?

Abstract

Most applied general equilibrium (AGE) and partial equilibrium (PE) models use the Armington approach to represent the trade specification of their models. In the context of analyzing the impact of economic changes in trade policies, it is important what type of specification is used in the trade structure of such models. It may be plausible to use functional forms such as the Constant Elasticity of Substitution (CES) based Armington specification for relatively homogeneous aggregated goods like cereals (or other agricultural goods), but its restrictiveness makes it less satisfactory when examining the trade relationships for more complex and heterogenous aggregated goods such as electronics (or other manufacturing goods). Almost Ideal Demand System (AIDS) is a flexible functional form, and incorporating such a demand system into a trade specification makes more sense for electronic goods where complementary trading relationships could be more prevalent. This paper compares the Armington specification with the AIDS specification for electronic goods using comparatives tatic analysis. The effect of change in price and income over global patterns of trade are examined. The results show that using different specifications of the trade structure in economic models can significantly alter the simulated patterns of trade, both in terms of magnitude and direction of changes in trade flows.