Updated: Nov. 29.,2006
Lecture Notes
ECON 622: ECONOMIC COSTBENEFIT ANALYSIS
Lecture Seven
1
Cost of Foreign Exchange
(EOCFX) and Shadow Price of
Non-Tradable Outlays
(SPNTO)
2
Definition of EOCFX and SPNTO
• These variables (EOCFX and SPNTO) are estimated to measure
the value of the distortions created when funds are sourced in the
capital market and used to purchase either tradable goods
(EOCFX), or non-traded goods (SPNTO).
• These actions are repeated many times for each project and are
identical for such actions across projects.
• It is efficient and to estimate these variables once for a country and
use the same values repeatedly as needed.
• To make the estimates general we do not include the specific
distortions on the particular traded or non-traded good. These
effects are included when we estimate the economic cost of the
specific item.
3
Estimation of Economic Exchange Rate and
Premium of Foreign Exchange under two situation:
1.
2.
Project already has raised funds e.g. foreign aid and
spends them on traded goods.
Project raises funds in capital markets and spends
funds on
a. Traded goods (Premium of Foreign Exchange)
b. Non-traded goods (Shadow price of non-traded
outlays (SPNTO))
4
Economic Cost of Foreign Exchange
•
When the numeraire is the domestic currency at the domestic price level, the
foreign exchange effect of the change in the demand (or supply) of tradable
commodities must be converted into domestic currency.
•
Conversion should take place at the “shadow exchange rate,” or economic price
of foreign exchange (Ee).
Cases:
1. Market Exchange Rate
•
If there are no distortions on the demand or supply of tradable goods, and if the
exchange rate is determined by market forces, then the economic price of
foreign exchange is equal to the market exchange rate (Em).
5
Economic Cost of Foreign Exchange (Cont’d)
2.
Trade Distortions
–
Trade distortions will change the demand and/or supply of foreign
exchange such that the market exchange rate no longer measures
the economic price of foreign exchange. For example,
–
Tariffs- lower the market demand for foreign exchange and cause Em
to be less than Ee
–
Export Taxes - Decrease the market supply of foreign exchange and
cause the Em to be greater than Ee
–
Export Subsidies - Increase the market supply of foreign exchange
and cause the Em to be less than Ee
3.
Indirect taxes will impact the demand and supply of both traded and nontraded goods
-
Value added taxes
-
Excise taxes
6
• All goods are divided into three types:
1. Importable
2. Exportable
3. Non-traded goods
• Importable and Exportable goods are referred to as
TRADABLE GOODS.
• Prices of TRADABLE GOODS are determined by
international markets and expressed in units of a foreign
exchange currency.
• Domestic prices of such goods are determined by
multiplying the internationally given import price PIw or
the export price PEW by the market exchange rate EM i.e.
PDI =EMPIw, PDE=EMPEw
7
• As the world prices of these goods are fixed their
domestic prices, and the quality domestically demanded
or domestically supplied of these will depend on the real
exchange rate (inflation =0)
• Their quantities can be expressed in units of foreign
exchange.
• Importable and Exportable goods can be aggregate to
make market for tradable goods.
• This market is also the market for Foreign Exchange.
• This market will determine the country’s real exchange
rate.
8
Demand for Traded Goods
Equals Demand for Importable Goods plus Demand for Exportable Goods
Demand for Importable
Goods
EM
Demand for Exportable
Goods
EM
Demand for Traded
Goods
EM
DT=DI+DE
DI
Q (FX) Importable $FX
DE
Q (FX) Exportable $FX
Q (FX) Traded
Because the world price of importable and exportable goods are given to country the demand
for tradable goods is a function of the Real Exchange rate.
9
Supply of Traded Goods
Equals Domestic Supply of Importable Goods plus Domestic Supply of Exportable Goods
Domestic Supply Importable
Goods
EM
EM0
Domestic Supply Exportable
Goods
SI
EM
SE
EM0
DT
QSI
Q(FX) Importable
Domestic Supply Traded
Goods
EM
ST=SI+SE
EM0
QSE
Q (FX) Exportable
QT
Q (FX) Tradable
Exchange rate determined by the demand and supply of tradable Goods
QDT=QST
10
Demand for Foreign Exchange
An equivalent way to see how the exchange rate is determined as to draw the
demand for imports and supply of exports
Importable Market
P
Demand for Imports
SImportable
EM
_
EM0
EM0
EM1
DImportable
QIS
Import
Q ID
E1
Q Importable(QFx)
DM
QFXD
The demand for imports=Demand for importable goods-Supply of importable goods
Demand for Foreign Exchange=Demand for Imports
QFxD=QID-QIS
11
Supply of Foreign Exchange
Exportable Market
Imports and Exports
P
SExportable
SX
_
EM0
_
EM
E1
1
DM
DExportable
QED
Export
QES Q Exportable(QFx)
QFXD/S
QFxS=QES-QED=Supply of Foreign Exchange =Supply of Exports=SX
12
Total Economy=Market for Tradable Goods plus
Market for Non-Tradable Goods
Tradable Goods
Non-Tradable Goods
EM
ST
SNT
E0
PNT
DT
QT0
•
•
•
•
•
Q(FX)
DNT
QNT0
Because there is a given amount of capital and labor in country, GDP=Quantity
Supplied of Tradable goods + Quantity Supplied of Non-tradable goods.
Price of non-traded goods is fixed as the numeraire price in the economy (market
equilibrium determined by relative prices).
Real Exchange rate determined in traded goods market.
Real Exchange rate is the relative price of Traded to Non-Traded Goods.
Changes in exchange rate will cause the demand and supply of Non-Traded goods to
shift. This is the relative price effect on demand for a good.
13
Full Employment and Equilibrium in Tradable
and non-Tradable Goods Markets
Tradable Goods
EM
Non-Tradable Goods
ST0
E0
SNT
PNT
QT 0
DT0
Q(FX)
DNT
QNT0
GDP=QT0+QNT0 Full Employment
Should think of tradable Goods and Non-Tradable Goods as two large
composite goods
QST=QDT
QSNT=QDNT
14
Economic Equilibrium
Importable
EM
Exportable
Market for Foreign Exchange
SI
SX
SE
E0
DI
DE
QSI
QDI
Import
QDE
QSE
Export
DX
QFX0
Equilibrium in Traded goods market also means that there is equilibrium in foreign
exchange market.
QDI +QDE =QDT
QSI+QSE=QST
In equilibrium QDT=QST
15
Hence QDI+QDE=QSI+QSE
QDI-QSI=QSE-QDE
Imports=Exports
Determination of Market Exchange Rate
No Distortions
Exchange Rate: # of units
of domestic currency per
unit of Foreign Exchange
S0fex
Ee=Em
D0fex
Q0
Em = Market Exchange Rate
Quantity of foreign exchange US$
Ee = Economic Exchange Rate
S0fex= Supply of foreign exchange as derived from supply of exports
D0fex=Demand for foreign exchange as derived from demand for imports
Ee = Ws * Em +Wd * Em
as
Ws +Wd = 1
then
Ee=Em
16
Determination of Exchange Rate with Distortions
Case One: Project already has
funds from Foreign aid
Exchange
Rate
• Import Tariff = Tm
S0
E0m(1+Tm)
m
E1
Em
0
Dt+ project
Dt
Q
d
1
Q0
Q
s
1
(net of tax)
D0
Quantity of Foreign
exchange Traded
Ee = Ws * Em +Wd * Em(1+Tm)
17
Determination of Exchange Rate with Distortions
Exchange
Rate
Case Two:
• Export Subsidy = kx
S0
S0+export subsidy
E1m(1+kx)
E0m(1+kx)
m
E1
Em
0
D0 + Project
D0
d
Q 1 Q0
s
Q1
Quantity of Foreign
exchange Traded
Ee = Ws * Em * (1+kx) + Wd*Em
18
Determination of Exchange Rate with Distortions
Exchange
Rate
Case Three:
• Export Tax = tx
S0+export tax
S0
m
E1
Em
0
E1m(1-tx)
E0m(1-tx)
D0 + Project
D0
d
Q1
Q0
s
Q1
Quantity of Foreign
exchange Traded
Ee = Ws * Em * (1-tx) + Wd*Em
19
Determination of Exchange Rate with Distortions
Case Four
• Market Determined Exchange rate
• Current Account in Equilibrium
• Import Tariff = Tm
• Export Tax = tx
Exchange
Rate
A
B
Tariff
St
m
E1
Em
0
S
Export Tax
L
J
D
H
G
F
Dt
Q d1 Q0
Dp
Quantity of Foreign
exchange Traded
s
Q1
Ee = Ws *Em * (1-tx) + Wd * Em * (1+Tm)
20
Determination of Exchange Rate
with Distortions and Capital Flows
Exchange
Rate
St
Case Five:
S
• Market determined Exchange Rate
• Balance of Payments Deficit
Sustained through Capital Inflows
A
• Import Tariff = Tm
B
• Export Tax = tx
m
m
E0
J
L
E1
N
H
F
K
D
M
G
DP
Dt
s
Q0
s
Q1
d
Q1
d
Q0
Quantity of Foreign
Exchange Traded
Ee = Ws * Em * (1-tx) + Wd * Em * (1+Tm)
Conclusion: No change in basic estimation procedure.21
Economic Price of Foreign Exchange
Trade Distortions
• An increase in demand for imported inputs will cause a (slight)
depreciation in the domestic currency, which in turn will cause a
reduction in imports and an increase in exports
• The economic value of the foreign exchange required by a project is
determined by the economic values of the forgone imports and
increased exports
Example: The main trade distortions are tariffs on imported goods and
taxes on exports. The economic price per unit of foreign exchange is
Ee = Ws * Em * (1-tx) + Wd * Em (1 + Tm)
Where Ws = The proportion of an extra unit of foreign exchange that is
met by an increased supply of exports:
Ws =
s
s - d * (Qd/Qs)
Wd = The proportion of an extra unit of foreign exchange that is met by a
reduction in other imports:
Wd
- d * (Qd/Qs)
=
s - d * (Qd/Qs)
22
Calculation of Foreign Exchange Premium
If the elasticity of foreign exchange supply (s) is equal to the
elasticity of foreign exchange demand (d): s = - d
Then, a simple way to calculate the foreign exchange premium is:
FEP =
Tariff Revenues + Export Subsidies - Export Taxes
Value of Imports + Value of Exports
23
Example for Indonesia (1991)
The Economic Cost of Foreign Exchange is calculated as follows:
Ee = Ws * Em* (1 - t xadj) + Wd * Em * (1 + Tadj)
Where:
Ee = Economic exchange rate
Em = Market exchange rate = 1,950.3 Rp/$1.0
Ws = Weight on supply = 0.33
Wd = Weight on demand = 0.67
t xadj = Weighted average rate of tax on price-responsive exports
= 0.00157
Tadj = Weighted average rate of tariff on price-responsive, non-reexported imports = 0.0919
Therefore,
Ee = 0.33 * 1,950.3 * (1-0.00157) + 0.67 * 1,950.3 * (1+0.0919) = 2,069.38
Foreign Exchange Premium (FEP) = Ee/Em - 1 = 0.061
Note: The market exchange rate is obtained from International Financial Statistics, October
1992. Data for oil and non-oil imports and exports, and for re-exported imports, are from
the Central Bureau of Statistics. Data for government imports are from the Quarterly
Report of Balance of Payment, April 1992, Central Bank of Indonesia. Data for import
duty and export tax are obtained from Ministry of Finance, Nota Keuangan 1992/93.24
Application of
Foreign Exchange Premium
• To value tradable goods at economic prices, the CIF
prices of importable goods, or the FOB prices of
exportable goods should be converted into domestic
prices using the economic exchange rate (Ee).
• Alternatively, this valuation at economic prices can be
achieved by adding a foreign exchange premium
[(Ee/Em) - 1] per unit of foreign exchange demanded (or
supplied) by a project.
25
Economic Cost of Foreign Exchange
Step1: Project Borrow 600 from Domestic Capital Market
Tradable Goods
EM
Non-Tradable Goods
ST0
SNT
400
200
E0
PNT
DT1
QT 0
DT0
Q(FX)
DNT1
DNT0
QNT0
Assume: Demand for tradable goods is reduced by 400 and demand for Nontraded by 200. Total borrowing funds =Total reducing in demand for goods
and services.
26
Step 2: Borrowed funds used to purchase 600 of traded goods
Tradable Goods
Non-Tradable Goods
600
ST0
SNT0
Eu
200
400
200
E0M
PNT
DT2
DT
QT1
QT0
DT0
QT2 Q(Fx)
DNT1
DNT0
QNT1 QNT0
Suppose all 600 is spent on Traded goods hence demand for Traded good shift from DT1
to DT2 .At the exchange rate of E0 there is now an excess demand of traded goods of
QT2-QT0 or 200 and in the Non-traded goods market there is an excess supply of
Non-traded goods of QNT0-QNT1 or 200
27
Step 3: Exchange rate rises to E1 to reduce excess demand in Tradable goods
market and excess supply in Non-Tradable goods market.
Tradable Goods
Non-Tradable Goods
EM
SNT1
SNT0
ST0
E1
E0
200
400
PNT
80 120
DT1
QT 0
DT2
120 80
DT0
QT1 Q(FX)
DNT1 DNT2 DNT0
QNT1QNT2QNT0
Final Impact: Reduction in Tradable goods demand 400+120=520
Reduction in Non-Tradable goods demand 200-120=80
Assumption is that |TD| = 1.5 TS
28
Step 1:Equilibrium in Market for Foreign Exchange
Importable
EM
Exportable
Market for Foreign Exchange
SX0
SI
SX1
300
100
300
100
E0
DI0
DI1
QSIQDI1 QDI0
Imports
DE0
DE1
QDE1QDE0
QSE
DM0
DM1
QFX0
Exports
Reducing in demand for Traded goods of 400 is assumed to reduce demand
for importable goods of 300 and a reduction in demand for exportable goods
by 100. Hence, reduction in demand for traded goods of 400 gets translated
into a reduction of demand by imports of 300 and an increase in supply
exports of 100.
29
Step 2: Equilibrium in Market for Foreign Exchange
E
S 0X
S1X
600
E1
E0
300
100 100100
D1M
D0M
D2M
Q0FX QSFX Q1FX QDFX
With the purchase of 600 of Traded goods (importable) there is an excess
demand for foreign exchange of QFxD-QFxS or 200. Hence exchange rate must rise
to E1. This will cause the supply of export to increase by 100 and the demand for
import to decrease by 100.
Assumption that |ID| = xS
30
Financing of a Project by Borrowing from Abroad and Using Funds to Buy Traded
Goods
Step 1: No impact on consumer demand due to borrowing from Abroad
Step 2: More Foreign Exchange to purchase traded goods for Project
Traded Goods
Non-Traded Goods
S 0T
E
Step 2
S
S0NT
T
0 B
Step 1
600
PNT
E0
D0T
Q0T
Q1T
D0T P
Q
Change in supply of traded goods (foreign exchange) increased
by 600 and Change in demand for foreign exchange increased by
600 with the Project
D0NT
Q0NT
No Impact on Non-Traded
31
Market for Foreign Exchange
S0FX
E
Step 2
S1FX
Step 1
No change in exchange rate
as change in demand for FX
of 600 is offsetted by
additional supply of FX of 600
600
E0
DMFX
Q0
Q1
DMFX  P
Q FX
32
TABLE 1
CALCULATION OF ECONOMIC OPPORTUNITY COST OF FOREIGN EXCHANGE
600 of Project Funds Sourced in Capital Market And Spent on Tradables
m
vt
m
vh
Applicable
m
vt
eis
Distortion
Alone
vh
eia
Change Due To
(exclusion for
Capital Market
investment
Sourcing
eis = 0.75)
Tradables Demand
-400
vt = .20
n.a.
-80
-20
Import Demand
-300
m = .12
-36
-36
-36
Export Supply
+100
n.a.
n.a.
n.a.
Nontradables Demand
-200
vh = .05
n.a.
-10
-2.5
Change Due To Real
Exchange Rate
Adjustment
Tradables Demand
Tradables Supply
-120
+80
Import Demand
Export Supply
-100
+100
Nontradables Demand
Nontradables Supply
+120
-80
Total Distortion Costs (-),
Benefit (+)
Distortion Cost/ Project Expend.
= Premium on Tradables Outlays
EOCFX/
Market Exchange Rate
(exclusion for
investment
eia = 0.33)
vt = .20
-
n.a.
n.a.
-24
n.a.
-16
m = .12
-
-12
n.a.
-12
n.a.
-12
vh = .05
-
n.a.
n.a.
+6
n.a.
+4
-48
-156
-82.5
.08
.26
.1375
1.08
1.26
1.1375
33
Estimation of Shadow Price of Non-Tradable Outlays (SPNTO)
Financing of Project by Borrowing from Domestic Capital Market and
Used to Purchase Non-Traded Goods
Step 1: Projects Borrows 600 from Domestic Capital Market
Traded Goods
Non-Traded Goods
S0NT
S 0T
E
200
400
E0
PNT
D1T
Q0T
D0T
QFX
D1NT
D0NT
Q0NT
Assume: Demand for tradable goods is reduced by 400 and demand for Nontraded by 200. Total borrowing funds =Total reducing in demand for goods
and services.
34
Step 2: Borrowed Funds from Domestic Capital Market Used to
Purchase 600 of Non-Traded Goods
Traded Goods
Non-Traded Goods
S0NT
S 0T
E
200
400
E0
400
PNT
D2NT
600
D1T
T
1
Q
T
0
Q
D0T
QFX
D1NT
Q1NT
Q0NT
D0NT
Q2NT
Suppose all 600 is spent on Non-Traded goods. Hence demand for NonTraded goods shifts from D1NT to D2NT. At an exchange rate of E0M there is an
excess supply of Traded goods of 400 (Q0T-Q1T) and an excess demand for
Non-Traded goods of 400 (Q2NT-Q0NT) .
35
Step 3: Exchange Rate Falls to Increase Demand for Traded Goods
and Reduce Supply of Traded Goods Tradable Goods
Traded Goods
Non-Traded Goods
S
E
S0NTS NT
T
0
1
200
400
E0
400
PNT
D2NT
E2
240
T
1
Q
D1T
160
T
0
Q
D0T
QFX
160 240
Q1NT
D1NT
NT
0
D
D3NT
NT
NT
Q0NT Q3 Q2
Final Equilibrium
Demand for traded goods has decreased by - 400 + 240 = -160
Demand for non-traded goods has decreased by -200 - 240 = -440
Total= -600
Assumption is that |TD| = 1.5 TS
36
Step 1:Equilibrium in Market for Foreign Exchange Markets
Importable
EM
Exportable
Market for Foreign Exchange
SX0
SI
SX1
300
100
300
100
E0
DI0
DI1
QSIQDI1 QDI0
Imports
DE0
DE1
QDE1QDE0
QSE
DM0
DM1
QFX0
Exports
Reducing in demand for Traded goods of 400 from 600 of raising funds in
capital market is assumed to reduce demand for importable goods of 300 and
a reduction in demand for exportable goods by 100. Hence, reduction in
demand for traded goods of 400 gets translated into a reduction of demand by
imports of 300 and an increase in supply exports of 100.
37
Step 2:Equilibrium in Market for Foreign Exchange Markets
Market for Foreign Exchange
E
S 0X
S1X
300
100
E0
E2
D0M
200
200
Q0FX
D1M
Q FX
With the purchase of 600 of non-traded goods there is an excess supply of 200 of foreign exchange. Hence
exchange rate must fall to E2M . This will cause the supply of exports to fall by 200 and the demand for
imports to increase by 200.
Foreign Exchange Market Equilibrium
Step 1: Reduction in demand for imports 300
Increase in Supply for exports 100
Step 2: Increase in demand for imports 200
Assumption that |ID| = xS
Reduction in Supply for exports 300
Net Impact: Demand for Imports reduced by 100
Supply of Export reduced by 100
38
Total =
200
TABLE 2
CALCULATION OF SHADOW PRICE OF NONTRADABLES OUTLAYS
600 of Project Funds Sourced in Capital Market And Spent on Nontradables
Applicable
Distortion
Change Due To
Capital Market
Sourcing
Tradables Demand
Import Demand
Export Supply
Nontradables Demand
m
Alone
m
vt
vh
m
vt
vh
eis
eia
(exclusion for
investment
eis = 0.75)
-400
-300
+100
-200
Change Due To Real
Exchange Rate
Adjustment
vt = .2
m = .12
vh = .05
n.a.
-36
n.a.
n.a.
-80
-36
n.a.
-10
-20
-36
n.a.
-2.5
(exclusion for
investment
eia = 0.33)
Tradables Demand
Tradables Supply
+240
-160
vt = .2
-
n.a.
n.a.
+48
n.a.
+32
n.a.
Import Demand
Export Supply
+200
-200
m = .12
-
+24
n.a.
+24
n.a.
+24
n.a.
Nontradables Demand
Nontradables Supply
-240
+160
vh = .05
-
n.a.
n.a.
-12
n.a.
-8
n.a.
Total Distortion Costs (-),
Benefit (+)
-12
-66
-10.5
Distortion Cost/Project Expend.
= Premium in Nontradables Outlays
.02
.11
.0175
Shadow Price of Nontradables Outlays
39
1.02
1.11
1.0175
Financing the Project by Borrowing from Abroad and Using Funds
to Buy Non-Traded Goods
•
•
Step 1: No impact on consumer demand due to borrowing from abroad.
Step 2: More foreign exchange available to purchase traded goods by
others.
Traded
Non-Traded
E
S0T
E
S0T+BF
S0NT
S1NT
600
600
E0
E1
PNT
D0I
360 240
Q0T
Q
240 360
D1NT
D0NT
D2NT
Q
Change in demand for traded goods is increased by 360, change in
demand for non-traded goods is decreased by 360.
Assumption is that |TD| = 1.5 TS
40
Market for Foreign Exchange
E
SXFX
SXFX
600
PNT
E0
E1
DMFX
300
300
Q0T
QFX
600 excess supply of FX from foreign borrowing results in falling
real exchange rate to E1. This will cause the demand for imports
to rise by 300 and the supply of export to fall by 300.
Assumption that |ID| = xS
41
TABLE 3
CALCULATION OF SHADOW PRICE OF NONTRADABLES OUTLAYS
600 of Project Funds Sourced Abroad And Spent on Non-Tradables
Applicable
Distortion
(exclusion for
investment
eis = 0.75)
Change Due To
Capital Market
Sourcing
n.a.
n.a.
n.a.
n.a.
n.a.
+72
n.a.
+48
Change Due To Real
Exchange Rate
Adjustment
Tradables Demand
Tradables Supply
+360
-240
Import Demand
Export Supply
+300
+300
m = .12
-
+36
n.a.
+36
n.a.
+36
Nontradables Demand
Nontradables Supply
-360
+240
vh = .05
-
n.a.
n.a.
-18
n.a.
-12
+36
+90
+72
-.06
-.15
-.12
0.94
0.85
0.88
Total Distortion Costs ( -),
Benefit (+)
Distortion Cost/ Project Expend.
= Premium on Nontradables Outlays
Shadow Price of Nontradable Outlays
(exclusion for
investment
eia = 0.33)
vt = .2
-
m
Alone
m
vt
v h
m
vt
vh
eis
eia
42
General expressions for premia on foreign exchange and
shadow price of non-tradable outlays
Definitions:
•
s1
= share of project funds sourced by displacing the demand for importables,
•
s2
= share of project funds sourced by displacing the demand for exportables,
•
s3
= share of project funds sourced by displacing the demand for nontradables,
•
f1
= fraction of a gap between the demand for imports and the supply of exports
that is closed by a movement along the demand function for imports as the real
exchange rate adjusts to bring about equilibrium,
•
1
= fraction of a gap between the demand and the supply of tradables that is
closed by a movement along the demand function for tradables as the real
exchange rate adjusts to bring about equilibrium,
•
gd
= fraction of project funds effectively sourced in the domestic capital market
•
gf
= (1-gd) = fraction of project funds effectively sourced in the foreign capital
market
43
•
M
= the uniform tariff rate on imports,
•
vt
= the rate of value added tax on domestic consumption of tradables,
•
vh
= the rate of value added tax on the domestic consumption of non-tradables,
•
Cs
= share of reduced expenditure from the capital market sourcing of funds that
are taxed by VAT, i.e. consumption. Cs = (1-eis)
•
Ca
= share of reduced expenditure from the adjustment of the exchange rate that
are taxed by VAT, i.e. consumption Ca = (1-eia)
•
eis
= share of reduced expenditure due to funds sourced through the capital
market that is excluded from the VAT base (i.e. investment)
•
eis
= share of reduced expenditure due to exchange rate adjustment that are
excluding from the VAT base (i.e. investment)
44
TABLE 4
GENERAL EXPRESSIONS FOR PREMIA ON TRADABLES AND NONTRADABLES
(Project Funds Sourced 100% in Domestic Capital Market)
With Uniform Import Tariff ( m) Alone:
Premium on Tradables
= (s1 + f1s3) m
Numerical Check:
.08 = [0.5 + 0.5(.33)](0.12)
Premium on Nontradables = [s1 - f1(s1+s2)] m
Numerical Check:
.02 = [0.5 - 0.5(.67)](0.12)
With Uniform Import Tariff ( m ) Plus Value Added Taxes (v t and vh)
(No Credit For Investment Goods)
Premium on Tradables
= (s1 + f1s3) m + (s1+s2)vt + s3vh + 1s3(vt-vh)
Numerical Check:
= .08 + (.67)(0.2) + .33(0.05) + 0.6(.33)(0.15)
.26 = .08 + .1333 + .0167 + .03
Premium on Nontradables = [s1-f1(s1+s2) m] + (s1+s2)vt + s3vh - 1(s1+s2)(vt-vh)
Numerical Check
= .02 + .1333 + .0167 - (.6)(.67)(0.15)
.11 = .02 + .133 + .0167 - .06
With Uniform Import Tariff ( m ) Plus Value Added Taxes (v t and vh)
With Credit for Investment Goods
Premium on Tradables:
= [(s1+f1s3) m] + c s [(s1+s2)vt+s3vh] + ca [ 1s3(vt-vh)]
Numerical Check:
= .08 + (.25)[.1333+.0167)] + (.67)(.03)
.1375 = .08 + .0375 + .02
Premium on Nontradables: = [s1f1(s1+s2)] m + c s [(s1+s2)vt+s3vh]
- ca [ 1(s1+s2)(vt-vh)]
Numerical Check:
= .02 + (.25)(.1333+.0167) -.67[.6(.67)(.15)]
.0175 = .02 + .0375 - .04
Note: cs = (1-eis)
ca = (1-eia)
45
TABLE 5
GENERAL EXPRESSIONS FOR PREMIA ON
TRADABLES AND NONTRADABLES
(Project Funds Sourced 100% Abroad)
With Uniform Import Tariff (m) Alone
Premium on Tradables
= zero
Premium on Nontradables = -f1 m
Numerical check
-.06 = -(.5)(.12)
With Uniform Import Tariff ( (m ) Plus Value Added Taxes (vt and vh)
(No Credit For Investment)
Premium on Tradables
= zero
Premium on Nontradables = -f1 m - 1(vt-vh)
Numerical Check
-.15 = -(.5)(.12) - (.6)(.15)
With Uniform Import Tariff ( m ) Plus Value-Added Taxes (vt and vh)
With Credit For Investment
Premium on Tradables
= zero
Premium on Nontradables = -f1 m - ca 1(vt-vh)
Numerical Check
-.12 = -(.5)(.12) - (.67)(.6)(.15)
Note: cs = (1-eis)
ca = (1-eia)
46
WEIGHTED AVERAGE PREMIA WITH “STANDARD”
CAPITAL MARKET
TABLE 6SOURCING
gd
gf
gd
gf
WEIGHTED AVERAGE PREMIA WITH “STANDARD”
= fraction of project funds
effectively
sourced
in the domestic capital market
CAPITAL
MARKET
SOURCING
= (1-gd) = fraction of project funds effectively sourced in the foreign capital market
= fraction of project funds effectively sourced in the domestic capital market
TRADABLES
AND NONTRADABALES
= (1-gd) = PREMIA
fraction ofON
project
funds effectively
sourced in the foreign capital market
Project Funds Sourced From:
Both
PREMIA ON TRADABLES AND NONTRADABALES
Markets
Project Funds Sourced From:
gd = .7
Both
Markets
Applicable Distortions Domestic Capital Market
Foreign Capital Market
gf = .3
gd = .7
m = .12 Distortions Domestic Capital Market
Applicable
Foreign Capital Market
gf = .3
Project
m = .12Funds Spent
On Tradables
ProjectNontradables
Funds Spent
.08
.02
-0-.06
.056
-.004
On Tradables
m = .12,
vt = .20, vh = .05
Nontradables
.08
.02
-0-.06
.056
-.004
Project
Funds
m = .12,
vt = Spent
.20, vh = .05
On Tradables
ProjectNontradables
Funds Spent
.26
.11
-0-.15
.182
.032
On Tradables
.26
m = .12,
v
=
.20,
v
=
.05,
e
=
.75,
t
h
ih
Nontradables
.11eia = .33
-0-.15
.182
.032
Funds
Project
vt = Spent
.20, vh = .05, eih = .75, eia = .33
m = .12,
On Tradables
.1375
.0175
ProjectNontradables
Funds Spent
-0-.12
.09625
-.02375
-0-.12
.09625
-.02375
On
Tradables
Nontradables
.1375
.0175
47
A Case of South Africa
• A General Equilibrium Analysis
• Take into account:
- project funds sourced from the capital
market (62.5% from displaced investment,
11.5% from household saving and 26.0%
from foreign savings).
- all distortions in import tariff, subsidy,
value-added tax, and other indirect taxes.
48
Table 1
Impact of Capital Extraction and Spending on Project Inputs in South Africa
Capital Sourcing and Spending
Domestic Funds
a) Project Demands for Importables
Displacement (K-Market)
Effect of Real Exch Rate on Demand
Effect of Real Exch Rate on Supply
Excess Demand for Goods
Domestic Funds
b) Project Demands for Exportables
Displacement (K-Market)
Effect of Real Exch Rate on Demand
Effect of Real Exch Rate on Supply
Excess Demand for Goods
Domestic Funds
c) Project Demands for Non-Tradables
Displacement (K-Market)
Effect of Real Exch Rate on Demand
Effect of Real Exch Rate on Supply
Excess Demand for Goods
Funds Borrowed from Abroad
d) Project Demands for Non-Tradeables
Displacement (K-Market)
Effect of Real Exch Rate on Demand
Effect of Real Exch Rate on Supply
Excess Demand for Goods
Importables Exportables Non-Traded
+100.0
-39.0
-8.4
+7.6
+45.0
-24.0
-6.9
+14.1
-45.0
-37.0
+15.3
-21.7
0
-39.0
-8.4
+7.6
-55.0
+100.0
-24.0
-6.9
+14.1
+55.0
-37.0
+15.3
-21.7
0
-24.0
+11.8
-24.0
+11.8
+100.0
-37.0
-26.1
+36.9
0
+18.8
-38.1
+56.0
+100.0
-41.5
+58.5
0
-39.0
+14.3
- 12.9
-11.8
+22.7
-20.4
+43.1
49
Table 2
ExternalitiesGenerated from Project Funds Sourcedfrom Domestic Markets and
Spent on Importables
Capital Sourcing and Spending
Domestic funds
a) Project Demands for Importables
Displacement (K-Market)
Effect of Real Exch Rate on Demand
Effect of Real Exch Rate on Supply
Excess Demand for Goods
Importables Exportables Non
-Traded
+100.0
-39.0
-8.4
+7.6
+45.0
-24.0
-6.9
+14.1
-45.0
-37.0
+15.3
-21.7
0
Externalities:8.21%
Import Tariffs
=(45-100)*3.6% = -1.98%
Production Subsidies
= -(-45)*0.6% = + 0.27%
VAT
= [(-39-24)*0.156 + (-8.4-6.9)*0.804]*11.36%
+[(
-37)*0.156 + (15.3)*0.804]*6.54%
= - 2.09%
Other Indirect Taxes
= (-39-24-8.4-6.9)*5.63% = - 4.41%
50
Table 3
Summary of Externality
(Percentage)
Funds Drawn from
Domestic Capital Source
Foreign Capital Source
Capital Market Weights
(Domestic: 74%, Foreign: 26%)
Funds Spent on
Tradables
-8.21
0
-6.08
Funds Spent on
Non-Traded
-3.06
+5.15
-0.93
51