Transcript Macroeconomic Analysis within a General Equilibrium

Evaluating the Social Impact
of Economy-Wide Policies
B. Essama-Nssah
World Bank Poverty Reduction Group
(PRMPR)
April 2007
Introduction

Impact Analysis


An assessment of variations in individual
and social welfare attributable to an
exogenous shock or implementation of a
policy.
Attribution based on a comparison of the
policy state and the counterfactual, ceteris
paribus.
2
Introduction

Economy-Wide Shocks and Policies




Affect potentially the whole population
Are bound to have both macroeconomic,
structural and distributional effects that work
through a number of flow-of-fund variables
and individual good or factor markets.
Need for an analytical framework that
accounts for interdependence between
stabilization, structural and distributional
issues.
General equilibrium analysis offers such a
framework.
3
Introduction

Approaches


Standard Representative Household (RH)

Impact on functional distribution of income, mean
welfare within a few representative socioeconomic
groups, and between-group inequality, but not on
poverty.
Extended Representative Household

Extends the RH approach by modeling the size
distribution within group, hence allowing poverty
analysis in addition to what RH allows.

e.g. Lognormal (Dervis, de Melo and Robinson 1982) or Beta
(Decaluwé, Savard and Thorbecke 2005) or Parameterized
Lorenz (Essama-Nssah 2005)
4
Introduction

Approaches, continued


CGE-Micro-Simulation
 Use unit record data from household survey to build a
household model of expenditure, or income generation
to allow a rich analysis of poverty and inequality.
Focus of Presentation

A Stylized ERH Framework

Positive component: a two-sector model of an open
economy


Structure
Specification
5
Introduction

Stylized ERH, continued

Normative component: the Lorenz model of
income distribution





Structure
Parameterization
Recovering Inequality and Poverty Measures
Numerical Implementation
Impact of Budgetary Policy


Policy Options
Outcomes
6
A Two-Sector Model of an
Open Economy

Structure
 A logical representation of a
socioeconomic system wherein the
behavior of all participants is
compatible.

Organized around the standard
Walrasian template.
7

Structure,




continued
Two categories of agents: producers and consumers,
or firms and households.
Supply and demand behavior: an observable
consequence of the optimization assumption.
Market interaction: method of social coordination by
mutual adjustment among participants based on
“quid pro quo” (Lindblom 2001).
Behavioral compatibility entails equilibrium on all
markets.
8

Structure, continued


Comparative statics entails comparison of
equilibrium states associated with changes in the
socioeconomic environment.
Social desirability depends on chosen criterion


Pareto efficiency focuses on how well the system
promotes individual objectives: efficiency implies no
other situation is unanimously preferred by all
participants.
Poverty-focused criterion: less poverty is preferred to
more.
9

Structure,

continued
Incentives configuration such that
amount of effective demand equals
amount supplied.

Alternatively:


No feasible change in individual behavior is
worthwhile.
No desirable change in individual behavior is
feasible.
10
Circular Flow Chart for an Open Economy
Factor services
Producers
Factor markets
markets
Factor
Intermediate goods
Product markets
Exports
Households
Final goods
Imports
Rest of
the world
11
Structure of a SAM for a Basic Model of an Open Economy
Activity
Activity
Commodity
Household
Household
Domestic Sales
Intermediate
Consumption
Payments to
Factors of
Production
Rest of World
Total
Commodity
Rest of
World
Exports
Household
Consumption
Balance of
Trade
Total Supply of
Consumption
Goods
Total Sales
Total Absorption
Total Household
Income
Total Earnings
of Rest of the
World
Imports
Total Factor
Payments
Total
Total
Household
Expenditure
Total
Expenditure
by Rest of
World
12

Structure, continued

Social Accounting Matrix (SAM)





An accounting framework that reflects the circular
flow of economic activity.
A square matrix: dimension based on the number of
sectors and agents considered.
Each entry represents a payment to a row-account by
a column-account.
Consistency implies that row total must equal
corresponding column total.
Also, if all but one accounts balance, the last one must
balance as well (Walras’ law).
13
Specification

Based on Devarajan, Lewis and Robinson
(1990)

Two sectors of production:




Export good not sold domestically.
Home good used for both intermediate and final
consumption
Imported and domestic intermediate goods
enter the production process.
Production process in each sector represented
by a Cobb-Douglas function
 ki
li
X i  Ai Ki Li ;  ki  li  1; i  e, d .
14

Specification, continued

The demand for labor is derived from first
order conditions for profit maximization
 li ( PVAi X i )
Li 
; i  e, d .
w

Similarly for capital [capital is mobile in the
long run]
Ki 
 ki ( PVAi X i )
r
; i  e, d .
15

Specification, continued

The net price in sector i is given by
PVAi  PX i  a2i PQ2 , i  e, d .

a2i is the amount of aggregate intermediate
good (Q2) per unit of output in sector i.
16

Specification, continued


Producer price of exports
PX e  R(1  te ) e
Two aggregate commodities for final (j=1) and
intermediate consumption (j=2)

Qj  Bj  jM
 j
j
 (1   j ) D

1

 j 
j
j
; j  1, 2
17

Specification, continued

Import demand functions derived from cost
minimization.

j
j
M j  B  PM
1
j

(1 j )
j
j
j
 (1   ) PD

1
(1 j ) (1 )
j
j
j
j
 j
j
 PM Q sj ; j  1, 2
Demand for domestic components of aggregate
goods (implication off cost minimization).


(1 j )
D j  B j 1  j j PM j

 (1   j j ) PD

1
(1 j ) (1 )
j
j


 j j PD j j Q sj ; j  1, 2
18

Specification, continued

Domestic price of imports inclusive of tariffs
PM j  R(1  tm j ) mj ; j  1, 2

Price of domestic sales includes a sales tax
PD j  PX d (1  txd ); j  1, 2
19

Specification, continued

Producer price of the domestic good
2
PX e 

 PD D
j 1
j
j
;
j  1, 2
X 2 (1  txd )
Price of composite goods
PQ j  ( PD j D j  PM j M j ); j  1, 2
20

Specification, continued


Rural household represents 60 percent
of the population, and owns a fraction RL
of labor and a fraction RK of capital (to
be determined by data in SAM).
Urban household represents 40 percent
of the population, and owns a fraction (1RK ) of capital and a fraction (1- RL) of
labor.
21

Specification, continued

Household income
Yh   hl ( wLS )   hk (rKS )   hg YG   hf RS f ; h  r , u


Household demand for final good (no savings)
Yh
d
Q1h 
; h  r , u; Q1d   Q1dh
PQ1
h
Government fiscal revenue
2
YG   tm j ( R mj M j )  txd X d
j 1
22

Specification,

continued
Total demand for intermediate good
Q2d   a2i X i ; i  e, d .
i

Equilibrium in the home good market
Xd 

2
D
j 1
j
; j  1, 2
Material balance for composite goods
Q sj  Q dj ; j  1, 2
23

Specification, continued

Equilibrium condition for each factor market
under full employment of given amounts of
capital and labor.
LS   Li ; KS   Ki ; i  e, d .
i
i
24

Specification, continued

Government budget balance

hg
YG YG ; h  r , u
h

Trade balance
2
 e X e  S f   M j
j 1
m
j
25
The Lorenz Model of Income
Distribution

Structure


A flexible statistical model of the distribution
of some welfare indicator, x, among the
population.
The Lorenz curve maps the cumulative
proportion of the population (horizontal axis)
against the cumulative share of welfare
(vertical axis), where individuals have been
ranked in ascending order of x.
p  F ( x )  L( p )  
x
0
tf (t )dt

26

Structure, continued

Alternative Expression based on : dp=f(x)dx
L( p )  
p
0

x(q )

dq
First-order derivative
L ( p ) 
x( p)

27

Structure,

Second-order derivative
L ( p) 

continued
1 dx

 dp
1
1

dp
f ( x)

dx
Parameterization

Based on General Quadratic (Datt 1992, 1998)

Lorenz
1

1
2
2 2
L( p)     2 p  e  (mp  np  e ) 
2

28

Quadratic model, continued

First Derivative
2
2mp  n
L( p)   
2 4 (mp 2  np  e 2 )

Second derivative
r (mp  np  e )
L( p) 
8
2
2
2

3
2
29

Recovering Inequality and Poverty Measures

From a parameterized Lorenz model and the mean
of x, we can recover the following:



X: based on the mean and the first order derivative of
the Lorenz function.
Density function of x, f(x): based on the mean and the
second order derivative of the Lorenz function.
This is all we need to compute all inequality
and poverty measures.
30
Numerical Implementation

Data

Base Year SAM
Export Domestic Final Intermediate Labor Capital Rural Urban World Total
Export
30.00 30.00
Domestic
73.00
2.00
75.00
Final
40.00 60.00
100.00
Intermediate
5.00
5.00
Labor
20.00 30.00
50.00
Capital
5.00 45.00
50.00
Rural Household
35.00 5.00
40.00
Urban Household
15.00 45.00
60.00
World
27.00
3.00
30.00
Total
30.00 75.00 100.00
5.00 50.00 50.00 40.00 60.00 30.00
Source: Adapted from Devarajan, Lewis and Robinson (1990)
31

Data,

continued
Calibrated Parameters
Calibrated Parameters for the Two-Sector Model
L K A M D B
Export
0.80 0.20 1.98
Domestic
0.40 0.60 1.98
Final
0.38 0.62 1.89
Intermediate
0.69 0.31 1.92
32

Data, continued





A is tfp (total factor productivity) parameter in
the Cobb-Douglas production function
’s are factor shares (exponents in the production
function).
’s are shares in the Armington aggregation
function and B is a scale factor.
Distribution of factor income in base year SAM:
RL=0.70, UL=0.30, RK=0.10, and UK=0.90
Distribution of government transfers: RG=0.60 and
UG=0.40
33

Data, continued


Distribution of foreign transfers: RF=0.20 and
UF=0.80
Base Year Income Distribution
Size Distribution of Income within the Two Socioeconomic Groups
Group
Mean Poorest
2nd
3rd
4th
5th
6th
7th
8th
9th 10th
Decile
National
1.00
0.01
0.03
0.04 0.06 0.07 0.09 0.11 0.14 0.18 0.28
Rural
0.66
0.02
0.03
0.05 0.07 0.08 0.10 0.12 0.14 0.17 0.21
Urban
1.50
0.00
0.04
0.06 0.07 0.09 0.10 0.12 0.14 0.16 0.23
Source: Author’s calculations
34

Data, continued
Baseline Inequality (Extended Gini)
Focus
National
Rural
1
0.00
0.00
2
0.41
0.32
3
0.57
0.47
4
0.65
0.56
5
0.71
0.62
6
0.74
0.66
Source: Author’s Calculations
Urban
0.00
0.32
0.47
0.57
0.64
0.69
35

Data, continued

Parameters underlying the General Quadratic Lorenz
Model
Parameterization of the Lorenz Model
Parameter National Rural Urban
1
1.52
2.16
1.46
2
-0.89
-1.42
-1.83
3
0.02
0.08
-0.15
e
-1.65
-1.82
-0.48
m
-5.29
-6.60
-2.51
n
2.86
4.84
2.37
r
8.11
10.50
2.82
Source: Author’s calculations
36


Policy Options
Case 1: Reference



Tax on domestic sales: 15.4 percent
Tariff on imports of final and intermediate goods:
12.5 percent
Case 2: Reform Option A



Increase domestic sales tax by 5% (from
reference)
Lower tariff on final import by 17.6%
Increase tariff on intermediate by 46.4 %
37


Policy Options, continued
Case 3: Reform Option B



Lower sales tax by 5%
Increase tariff on final goods by 18.4%
Lower tariff on intermediate by 44%
38

Policy Options,
continued
Tax Rates (percentage)
Case Domestic Good Final Imports Intermediate Imports
1
15.4
12.50
12.50
2
16.17
10.3
18.30
3
14.63
14.80
7.00
39
Social Impact of Budgetary Policy
Base
Case 1
Case 2
Case 3
Exports
30.0
Domestic Good
75.0
Final Imports
27.0
Intermediate Imports
3.0
Total Consumption
100.0
Rural Consumption
40.0
Urban consumption
60.0
Total Poverty Incidence
59.2
Rural Poverty Incidence
78.3
Urban Poverty Incidence 30.5
Overall Poverty Gap
29.7
Rural Poverty Gap
38.7
Urban Poverty Gap
16.3
100.0
100.0
100.0
100.0
100.0
106.7
95.6
97.5
95.2
106.4
95.8
93.5
104.1
102.2
99.3
102.3
101.1
100.0
107.1
95.3
97.3
94.9
106.8
95.6
93.1
104.4
97.7
100.8
97.6
98.8
100.0
106.3
95.8
97.6
95.5
106.0
96.1
93.9
103.9
40

Outcomes,

continued
Case 1:



Pattern of production and imports unchanged from the
base case where there is no government intervention.
Optimal configuration of taxes to the extent that they do
not distort private production decisions.
The redistributive policy associated transfers to
households causes an increase in rural consumption and a
decrease in urban consumption.


As a consequence overall poverty incidence decline by about
2.5 percent.
Rural poverty decreases by 5 percent while urban poverty
increase by more than 6 percent.
41

Outcomes,

Case 2:



continued
Production of exports increases, that of the domestic
good declines. Both categories of imports increase.
Pattern of change in poverty incidence is similar to
the reference case, but reduction in rural poverty
and increase in rural poverty are a bit higher than in
the reference case.
Case 3:


Production of exports and all imports fall while
production of domestic good increases.
Change in poverty similar to previous cases.
42
Conclusion


Evaluating the social impact of economy-wide policies requires a
social policy model framed within the logic of general equilibrium
analysis.
Such a model has two basic components



A structural representation of individual behavior and social
interaction based on the principles of optimization and quid pro quo.
A social evaluation function reflecting a chosen set of value
judgments (e.g. efficiency and fairness).
A stylized analysis of the social impact of budgetary policy
revealed the following:


The outcome hinges crucially on the underlying mechanisms
allocating burdens and advantages among individuals.
Aggregate welfare effects may be negligible while structural and
distributional impacts are significant.

the latter drive the political economy of policy-making.
43
References




De Melo Jaime and Robinson Sherman. 1989. Product Differentiation
and the Treatment of Foreign Trade in Computable General Equilibrium
Models of Small Economies. Journal of International Economics, Vol.
27:47-67.
Devarajan, Shantayanan, Jeffrey D. Lewis, and Sherman Robinson.
1990. Policy Lessons From Two-sector Models. Journal of Policy
Modeling 12 (4): 625-657.
Dervis, Kemal, de Melo, Jaime, and Robinson, Sherman. 1982. General
Equilkibrium Models for Development Policy. Washington, D.C.: the
World Bank.
Decaluwé, B., Savard. L. and Thorbecke, E. 2005. General Equilibrium
Approach for Poverty Analysis: With an Application to Cameroon.
African Development Review, Vol. 17, No.2: 213-243.
44





Dinwiddy, C.L. and F.J. Teal. 1988. The Two-Sector General
Equilibrium Model: A new Approach. Oxford: Philip Allan.
Essama-Nssah, B. 2006. Macroeconomic Shocks and Policies.
In Aline Couduel and Stefano Paternostro (eds) Analyzing
the Distributional Impact of Reforms. Washington, D.C.:
The World Bank.
Essama-Nssah, B. 2005. Simulating the Poverty Impact of
Macroeconomic Shocks and Policies. World Bank Research
Working Paper No. 3788. Washington, D.C.: The World Bank.
Lindblom Charles E. 2001. The Market System: What Is It,
How It Works and What to Make of It. New Haven: Yale
University Press.
Varian Hal R. 1984. Microeconomic Analysis (Second
Edition) New York: Norton & Company.
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
THE END
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