Assessing the gains and vulnerability of free trade: A counterfactual analysis of Macau

Free trade can generate macroeconomic gains but also vulnerability to external shocks for a highly-specialized economy. To test this hypothesis, we evaluate the effects of Mainland-Macau Closer Economic Partnership Arrangement (CEPA) on Macau's real GDP growth rate and its volatility, as well as the costs of exposure to the anti-corruption campaign from mainland China using a counterfactual analysis. Counterfactuals of Macau are constructed by exploiting the inter-dependence among different economic entities and the optimal control group is selected with a leave-nv-out cross-validation method. Our results support the hypothesis. CEPA raised the annual real GDP growth rate of Macau by 20.76% from 2004 to 2007, meanwhile it increased the volatility of real GDP growth rate by 35%, and the anti-corruption campaign reduced the annual real GDP growth rate by 17.54% from 2013 to 2016. Our findings imply that free trade could be a double-edged sword for a small and highly-specialized economy and the gains of free trade can be enlarged by reducing its vulnerability.