Vietnam.<sup>3 2</sup> These export processing arrangements are important for the analysis since they imply that the economies of China and Vietnam are much more open then suggested by statutory tariff rates. This in turn implies a much smaller impact of WTO accession on the Chinese and other economies than found by studies that ignore duty drawbacks.

The dynamic GTAP model has a sophisticated representation of consumer demands via a constant difference of elasticities (CDE) functional form and a supply side that emphasizes the role of intersectoral factor mobility in the determination of industry output. Product differentiation between imports and domestic goods, and imports by region of origin allows for two-way trade in each product category, depending on the ease of substitution between products from different regions. In each region, a single regional household allocates income from land, skilled and unskilled labor, financial assets, and a natural resource endowment across private and government consumption, and saving according to a Cobb Douglas utility function. Firms supply commodities to both the domestic and export markets, while minimizing production costs.

The investment theory in the model allows us to link economic activity over time while keeping track of endogenous regional capital stocks and financial wealth,<sup>3 3</sup> international investment and income flows. The theory respects the empirical regularity that regions tend to invest primarily in assets located in their domestic economy. A smaller portion of investment comes from abroad and the theory offers a disequilibrium approach for allocating this investment across regions. Investors respond to expected rates of return and act so as to eliminate errors in their expectations gradually over time. In the process of adjustment, investors gradually eliminate any differences in the rates of return across regions that might exist in the short run by reallocating capital from regions with lower rates of return to regions with higher rates of return.<sup>34</sup> This leads to equalization of rates of return across regions only in the long run.3 Financial assets represent claims on earnings from regional physical capital, which is owned by both domestic and foreign households via a global trust.<sup>36</sup> In the model, the

> 32 The GTAP model with duty drawbacks is presented in lanchovichina (2003).

3 Unlike capital, land, labor and the natural resource endowment are exogenous. All factor inputs are fully employed, immobile across regions, and with the exception of land and the natural resource input, are perfectly mobile across sectors. The model captures how differences in relative rates of factor accumulation interact with differential sector intensities giving rise to the so-called 'Rybczynski' effect.

> 34 This way of determining changes in FDI flows captures only the substitution effect of allocating FDI, i.e. the relocation of incremental FDI from regions with falling rates of return to regions with rising rates of return.

35 The disequilibrium approach is also necessary to reconcile the theory of investment with observed reality. In many cases actual investment, as reported in the national statistics, does not correspond to that predicted by theory. For example, observed rates of return may be very low while observed investment is high. Such discrepancies can be rectified in one of two ways: the data can be altered so that theory and data are consistent; or alternatively, the theory can be modified to more accurately reflect the world. In GTAPDyn the latter method is used.

36 The global trust collects all the regional saving allocated to foreign investment, then allocates it across regions to investment. It is a fictitious agent invented to simnplify the need for data in the global model. Without the global trust a region's saving would need to be allocated directly to foreign investment by region. As a result bilateral data on foreign investment would be required (nxn data values, where n equals 9