III-A
III. AGE analysis of trade, policy
reform and environment
A. Core concepts and structura l features of AGE models
B. Coun try c ase studies
Sour ces:
* Shoven and Wha ll ey 1984
* OEE Chap ter 5
Lee and Rola nd- Holst 1997 & other CGE studies
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Concepts and structural features
1.
2.
3.
4.
5.
Overview and a simple AGE structure
Solution procedures for ‘Johansen’ models
Incorporating environmental analysis
Dealing with institutional issues
Dealing with political economy
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Overview of AGE models
• Describe Walrasian equilibria in fairly
detailed manner--sufficient to support
policy claims
– Too large to be solved analytically; must use
numerical solutions instead
– But structure and results depend on same
theoretical foundations
• Advantages and disadvantages of size.
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Pros and cons of AGE modeling
• √ Capture economy-wide mechanisms and
implications
• X limitations
– ‘Time’ is not explicitly taken into account: major limitations
for analysing impact of exchange rate changes
– ignores risk/uncertainty issues; credit market imperfections
ignored
– aggregations can mask important differences; AGE models
must be used in conjunction with in-depth, ‘micro’ research
and analyses
– resource intensive: only worthwhile when economy-wide
effects are deemed sufficiently important!
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An N-good, F-factor economy
• General structure
• Equilibrium conditions
• Closure rules and decisions
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Variables in the basic model
P
commodit y p rices (N)
W
mobil e factor prices (F)
R
sector-specific f actor prices (N)
Y
dom. commodit y supplies (N)
X
mobil e factor demands (NF)
D
dom. final demand s (N)
S
net imports (N)
V
factor endow ments (F)
U
agg rega te utilit y (1).

Foreign cu rrency exch. r ate (1)
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-- Suppose V and P are giv en, and let  = 1 be the numéraire price.
-- Agg rega te revenue is given by G(P,V) = max{PY | V}. From F ONC:
Yj = Yj (P, V)
(j = 1, ..., N),
(5.1)
Wi = Wi(P, V)
(i = 1, ..., F),
(5.2)
Rj = Rj (P, V).
(j = 1, ..., N),
(5.3)
and the p rices of mobil e and specifi c factors:
-- Each sector is a price-taker in factor markets. Th erefore, the outpu t leve l that
maximi zes revenue is also the co st-mi nimi zing level, and from FONC
of the sectoral co st mi nim ization p roblem Cj (W, Yj) = mi n{WX | Yj),
we obtain de ma nds for intersectorall y mobil e factors:
Xij = Xij (W, Yj)
(i = 1, ..., F; j = 1, ..., N). ,
(5.4)
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Domestic fi nal dema nds for each commodit y are found from the
expend it ure minimi zation problem E(P,U) = mi n{PD | U}:
Dj = Dj (P, U)
(j = 1, ..., N). ,
(5.5)
Net trade vo lumes are determined by ma rket-clearing conditions:
Sj = Dj – Yj
(j = 1, ..., N), ,
(5.6)
whe re Sj > (<) 0 indicates a ne t impo rt (expo rt) good . Import prices are set
in world markets, whil e for M expo rtables (M Š N), prices are set by
inve rse foreign demand func tions:
Pk = Pk (Sk)
(k = 1, ..., M).
(5.7)
Finall y, the model i s closed by an agg rega te budge t cons traint:
E(P,U) = G(P,V)
(5.8)
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Closure
•
•
•
•
No. of equations must match endog. vars.
In (5.1)-(5.8): 4N + F + FN + M + 1 eqns.
But we have 5N + 2F + FN + 2 variables.
Must choose N - M + F + 1 exog. vars
– Declare V exog; (N - M) elements of P, and .
• Now (5.1)-(5.8) solve for Y, W, R, X, D, S
and U as endogenous variables.
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Closure rules and decisions
• Other closures are possible
– ‘Neoclassical’ closure has all domestic prices
flexible
– Alternatives: e.g. fix wages, allow
unemployment in labor market.
• These choices reflect our beliefs or
observations about the real world.
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Other features
• Can add in
–
–
–
–
–
–
Intermediate inputs
Products distinguished by source
Different kinds of labor
Many sources of final demand
Trade and transport ‘margins’
Tariffs, taxes, and other policies … etc.
• Again, real-world conditions should motivate
these.
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Solving the model: the
‘Johansen’ AGE structure
• First-order approximations to changes in variable
values
• Models solved in proportional (percentage)
changes of variables, or ‘hat calculus’.
• Advantages:
– Models are linear in variables
– Parameter values are intuitive and accessible (shares,
elasticities)
– Simulation results are additive in separate shocks
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Features of Johansen models
• Parameter values are shares and elasticities
• Quick checks:
– Homogeneity & ‘balance’ of underlying data base.
• Solution is by matrix inversion
– Entire model is a system of linear equations
• Examples of Johansen-style models:
– ORANI (Australian economy)
– GTAP (international agricultural trade)
– Model OEE, Ch.6
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The AGE model
1.
2.
3.
4.
5.
6.
7.
Output supplies and factor demands (N+FN)
Zero pure profits in production (N)
Factor market clearing conditions (F)
Consumer demands for goods (N)
Net trade in commodities (N)
Export prices (M)
Aggregate budget constraint (1)
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Variables solved within model
1.
2.
3.
4.
5.
6.
7.
Output supplies and factor demands (N+FN)
Returns to sector-specific factors (N)
Mobile factor prices (F)
Consumer demands for goods (N)
Net imports (N)
Export prices (M)
Aggregate real income (1)
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Data base
• The model in proportional change form uses
data on production, consumption, trade,…
all in the form of
– Shares (e.g. employment shares by sector)
– Elasticities (e.g. parameters of demand and
supply functions).
• Easy to check ‘balance’ of data base
• Easy to interpret results.
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Environmental analysis in GE
• Most AGE models constructed for more
general analytical purposes: environmental
structure is added later
• Given uncertainty about env. variables and
valuations this may be appropriate!
• Industrial emissions
• Natural resource degradation
• Questions about institutions.
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Industrial emissions: AHTI
Fertilizer
Rubber/Plas tic/Chem Prod.
Paper Products
Non-Ferr. Basic Metals
Garments
Wood Products
Cement & Non-Metallic
Other Textiles
Mis c. Manufacturing
Coal & Petroleum Prod.
Metal Products
Textile & Knitting
Oils and Fats
Electrical Machinery
Milk and Dairy
Transport Equipment
Other Foods
Sugar Milling/Refining
Animal Feeds
Beverages and Tobacco
Meat & Meat Prod.
Feed Milling
0
20
40
60
Linear AHTI value .
80
100
120
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Deforestation & land degradation
• Commercial and non-comm’l deforestation:
does timber have market value?
– Non-comm’l deforestation is driven by search
for land, and responds to changes in the
marginal valuation of land in agricultural
production...
– … although institutional setting also matters
(more later)
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Land degradation
• Hard to measure, and problems of
aggregation.
• Can use information on erosion rates by
crop, together with land use data, to build
‘baseline’ data set.
– Then erosion changes can be inferred from
changes in land use
• Production externalities: technical ‘regress’.
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Institutional issues
1. Trees may be cut (or planted) to establish
property rights over land.
2. In open access forests (non-commercial),
opportunity cost of forest is set by ag. land
values and clearing costs.
3. In commercial forestry, timber
harvesting/replanting also depends on property
rights.
•
Will an increase in timber prices promote or retard
tree-felling in aggregate? Depends on prop. rts.
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Institutions in AGE models
• Can incorporate open access (quantity vs.
price adjustment in market clearing)
• Distinguish between commercial forestry
and land colonization by farmers
• In latter case, implied land values indicate
pressures for deforestation.
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Dealing with political economy
• Economists’ welfare weights seldom
coincide with those of policy-makers!
– This extends to valuations of environmenteconomy tradeoffs.
• AGE results can be re-cast to reflect
alternative sets of priorities…
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