supplied, the preference for variety exerts a counteracting force—helping to increase the demand for exports. In simulations introducing the Hummels-Klenow preference for variety in exports from China and India, Dimaranan, Ianchovichina and Martin (2007) found that the terms of trade for these exporters need not deteriorate significantly, despite very high projected rates of export growth.

Some traditional treatments of new varieties, such as those based on monopolistic competition and a love-of-variety inspired by Krugman (1980), are typically implemented with agriculture and services as perfectly competitive sectors and the rest of the economy characterized as monopolistically competitive. However, as Rodrik (2004) notes, the process of discovering efficient new exports is just as important and difficult in agriculture and services as in manufacturing. Models developed by Melitz (2003), with a fixed cost of entry into export markets, provide a basis for modeling the endogenous emergence of new products. Again this is an area for future data and CGE model development.

# **_Distortions in markets for services_**

The potential gains from trade liberalization in services are rarely considered in CGE models, or at best are included only in rather rudimentary ways. This is because of a lack of good data on bilateral services trade, and methodological difficulties in modelling distortions in services markets. This is a serious omission, since there are indications that the costs of barriers to trade in services may be much larger than the barriers presented by conventional trade measures such as tariffs and subsidies (Dee, Hanslow and Pham 2003).

Konan and Maskus (2006) point out that the costs of services distortions are likely to be larger than those on merchandize trade because they typically involve restrictions not only on cross-border trade (Mode 1 of GATS), but also on supply by establishing enterprises in the country or by the movement of service suppliers (Modes 3 and 4 of GATS). Jensen, Rutherford and Tarr (2006) find that the benefits of reform in services trade, when allowing for productivity growth in trading a wider range of qualities of goods as the quality of business services rise (following Markusen, Rutherford and Tarr 2006), completely dominate as a source of benefits from likely reforms following Russia’s accession to the WTO. These methodological developments have begun to find their way into global CGE models, as reflected in the BKS study cited in Table 1, but much scope remains to improve services trade data and the measurement and modelling representation of services market distortions.

CGE models typically ignore the dynamics of financial capital markets. Trade expands the demand for international financial services to transfer the required payments and often to provide temporary credit. Trade reform thereby ‘thickens’ international markets by raising not only the share of global goods production that passes through them which reduces the variation across time in prices for traded products) but also markets for international financial services to transfer the required payments and to provide temporary credit. Together these forces contribute to the long-term stability of financial markets. Openness also tends to reduce inflation. It can do so by increasing competition in domestic markets, which drives down prices and reduces political pressure on the central bank to inflate, and by providing more options for people to hold savings in foreign currencies, which reduces the ability of governments to inflate savings away (Rogoff 2003).

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