# **3 General equilibrium gravity and counterfactuals**

We can now quantify the trade and welfare impacts of counterfactual PTAs. Thanks to the analysis of the impact of different clusters of signed PTAs in the previous section, we not only assess the economic consequences of signing new agreements but also of deepening existing ones. To illustrate our approach, we firstly shift all PTAs worldwide to the highest ambition and then focus on two regions: (i) Latin America and the Caribbean countries (hereafter “LAC countries”) and (ii) the East Asia and Pacific region (hereafter “EAP countries”). Indeed the method can be applied to any other region. Concerning the latter counterfactuals, we simulate in GE a deepening of existing PTAs within the two regions, meaning switching existing PTAs from cluster #2 and #3 to cluster #1, or between countries in the two regions and the Rest of the World. Second, we simulate a scenario where LAC (or EAP) countries sign unsigned agreements with each other, with different level of ambition. The first consequence of deepening agreements and signing new ones, as evidenced above by our gravity estimation, is to modify the overall structure of trade costs.

## **3.1 Quantification strategy**

To proceed we rely on a GE gravity model, we change the vector of agreements between country pairs (deepening existing agreements or signing new agreements of one of the three types). Bilateral trade between each country pair will react to the simulated policy change through two channels: (i) a direct effect driven by the estimated parameters _βz, z_ = (1 _, ..._ 3) in Equation 1; (ii) an indirect effect induced by third countries adjustments. In our case, the typical example is the impact on trade between the United States and Brazil of a simulated deepening of MERCOSUR. The usual trade diversion effect will show up, which here depends on the content of the agreements. Here, the multilateral resistance terms (MRT thereafter) _`a la_ Anderson & Van Wincoop (2003) act as GE trade cost indices transmitting local policy shocks to the overall matrix of trade frictions. The inward MRT _Pj_ on the importer side accounts for the impact on consumers and the outward MRT Π _i_ for the impact on producers in the exporter country. Ultimately, the effects spill also on the price of the variety exported by the representative producer and expenditure in the exporting country. This corresponds to the _general-equilibrium effects_ for an endowment economy (Head & Mayer 2014).

Two types of counterfactuals can be contemplated. At the extensive margin, we impose the ratification of new agreements at different depth within a region of the world economy. In this scenario, we impose that non-positive entries in _PTAz_ # are switched to 1 separately for each depth class _z_ = 1 _,_ 2 _,_ 3. At the intensive margin, we deepen the existing agreements involving countries in a given region of the world economy, both with other countries in the region and with countries outside the region. In this simulation, positive entries in either _PTAz_ =3 or _PTAz_ =2 are switched to zero while the corresponding entries in _PTAz_ =1 are set to 1. Alternatively, we can deepen all the existing agreements in the world economy.

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