globalization. A natural breakpoint was the 1970s when the international monetary and trading system changed substantially. Even for large industrial countries like the United States, there was a sharp acceleration in the import share in the 1970s. For developing and transitional economies, periods of rapid economic and trade liberalization (particularly in the late 1980s) are crucial factors. Compared to the earlier periods of inward orientation, changes in trade policy in the latter periods often led to structural breaks in the trade shares. We use a time trend to account for the shifts in trade shares or the ratios of factors (equations 7 and 8 below).

Moreover, trade ratios might not rise steadily; they may fluctuate erratically due to policy reversals, crises, or conflicts, particularly in developing countries. For example, Arbache et al. (2008) found that growth collapses in Sub-Saharan Africa were frequent before 1995. Weather conditions could also affect exports of developing countries when they are mainly agricultural products. In these cases, the trade shares in output are likely co-dependent variables with no exogenous trends.

# III. Methodology: The Model, Data, and Specification

# _The 1-2-3 Model_

The 1-2-3 model became a practical economic tool at the World Bank and for teaching more complex models due to its transparent algebraic and conceptual results and accessible numerical implementation using only national accounts and popular spreadsheet software (see Devarajan, Lewis, and Robinson 1990 and 1993; Devarajan, Go, Lewis, Robinson, and Sinko 1997). Since its inception, the 1-23 model has addressed various policy issues in developing countries. The most common application has been the real exchange rate effects (including Dutch disease effects) of commodity price shocks or changes in capital flows (such as foreign aid and transfers). The algebraic and numerical spreadsheet solutions anticipate the relationship between external shocks and policy responses of more complex models. For example, the model was used to determine the pre-1994 overvaluation of the CFA franc (Devarajan 1997, 1999), which informed the discussion about the magnitude of the 1994 devaluation. Since the new millennium, the authors have conducted similar exercises as part of World Bank operational work in CFA countries, the Arab Republic of Egypt, Zambia, and other African countries.

Another productive application has been the economic effects of trade reform, especially in the 1990s when the issue was crucial for many developing countries. Devarajan, Go, and Li (1999) quantify the fiscal effects of trade reform and show how the results depend on the substitution elasticity between foreign and domestic goods. Devarajan and Go (1998) incorporate rational-expectations dynamics to capture the intertemporal effects of trade reform and import price shocks. Relatedly, de Melo and Robinson (1992) use the framework to examine export externalities in developing countries. Taking advantage of the model’s simplicity and minimal data requirements, Auriol and Warlters (2012) use the 1-2-3 model to calculate the marginal welfare cost of public funds in 38 African countries.

Devarajan and Go (2003) link the framework to growth and poverty modules to examine the implications of growth and poverty reduction strategies, especially in those classified as Heavily Indebted Poor Countries (HIPCs) in Africa. The model has also been used to study the macroeconomic dynamics of scaling up foreign aid (Devarajan, Go, Page, Robinson, and Thierfelder, 2008). Extending the regional integration application in Devarajan, Go, Suthiwart-Narueput, and Voss (1997b), a global version called the R23 model exploits its parsimonious structure to link, through trade flows, over 200 1-2-3 models 6