Demonstration of capabilities of a bi-regional CGE model to assess impacts of rural development policies (RURMOD-E)

Demonstration WorkshopBrussels, 26.11.2008

THE BI-REGIONAL CGE MODEL:

CHARACTERISTICS AND

APPLICATION

Demetrios Psaltopoulos

Department of Economics

University of Patras

SAM & General Equilibrium models Major Part of TERA (FP6 – CT6469) project This Presentation deals with Aim (motivation), characteristics and implementation

StructureBackground Modelling Approach SAMs and CGE ModelsModel Structure Application

Introduction

Background

TERA: Economic development in remote rural areas

Aims:Role territorial factors which influence developmentreview whether existing policies take account of factorspropose new policy interventions.

“The trends and choices that affect rural areas cannot be studied in isolation from what is going on in non-rural areas” (Saraceno, 1994)

Approach Regional/Local Modelling within region rural-urban linkages

6 Case Study areas. Reflect different

Economic and Institutional Context Spatial Scale Rural-urban relationships

d

OECD Rural Classification:Nuts 3

The Bi-Regional CGE Model IFPRI CGE model (Lofgren et al., 2002):

sufficiently flexible to accommodate a fairly wide range of views on how regional economies adjust to specified policy shocks.

Modifications to allow specific characteristics of the study areas and moreover RURAL-URBAN INTERACTIONS such as:

a) the differentiation of rural and urban production sectors, factors and households

b) several specific characteristics of the regional economies under analysis.

The Modeling Framework

The Bi-Regional SAM The Bi-Regional SAM provides the base year values

which, in conjunction with other data (e.g. physical quantities, elasticities), are used to calibrate the CGE model.

Rural/ Urban Regions

Model Accounts Production Activities Commodities Factors of Production Households Other Institutions (G, ROW) Objective: Define accounts allowing analysis of R-U

questions.

The Modeling Framework

Key Elements

Remoteness and Distance

Spatial Disaggregation - production activities, factors and households

No Spatial Disaggregation - Commodities- Theoretical (Market Integration)- Practical (Data Collection)

Explicit transport sector – Data Collection – Policy Analysis

Factor Mobility - Spatial Disaggregation of certain

factors

The Modeling Framework

Social Accounting Matrix

Exhaustive Accounting all Flows in Regional Economy

Starting Point for CGE – Base Year

Empirical Applications - Other Data needed

Physical Quantities, e.g. sectoral employment, elasticities

Each SAM Account – Row and column

Row entries = payment from column account to row account.

The Modeling Framework

Example SAM Accounts Definitions

Production Activities Agricultural Rural Manufacturing Rural Manufacturing Urban Transport Services

Commodities Agricultural Manufacturing Transport Services

The Modeling Framework

Example SAM Accounts Definitions cont

Factors Unskilled Labour Rural Skilled Labour Rural Unskilled Labour Urban Skilled Labour Urban Capital Land Housing Rural Land Agricultural Rural

Land Housing Urban

The Modeling Framework

Households Rural Commuter Rural Other Urban

Other Institutions Direct Income Tax Collection Indirect Activity Tax Collection Indirect Sales Tax Collection Government Rest Of The World Savings-Investment

The Modeling Framework

Computable Equilibrium Model (CGE)

Behaviour of representative agents in economy Producers and Traders – maximise profits Consumers – maximise their well-being (have demand curves) Government collects taxes and makes transfers (tax rates and

transfers are exogenously set)

Model Closure rules – assumptions on how markets operate e.g. labour (study-area-dependent)

All transactions in “economy” accounted for.

TERA-CGE Models IFPRI Standard CGE Model (Lofgren et al., 2002)

(www.ifpri.org/pubs/microcom/micro5.htm)

The Modeling Framework

Production structure

Commodities

Set a activities, c commodities, f factors, h households.

Production Behaviour Each activity profit maximising firm

Activity Production Function (Cobb Douglas)

Factor Demand (PMAX conditions)

Intermediate Demand

Demand commodity c = constant*activity level a (i-o)

Domestic Commodity Output

Output commodity c = Sum over Activities ( constant*activity level a)

(Activities produce commodities in fixed proportions)

Commodities

Armington Assumptions – to prevent over-specialization

Imports/Exports/Domestic Commodities Imperfect Substitutes

Exogenous Import & Export Elasticity Required for each Commodity

Sales Tax Charged on Composite Commodity - Fixed rate derived from SAM

Households

Income Receive income - factors, transfers from Govt & ROW

Income from factor f = fixed share of factor return*wage* factor supply

Fixed Factor Shares derived from SAMExpenditure

Households pay income tax, save given proportion of income and demand commodities & demand housing services

Income Tax Rate, mps, Demand Shares derived from SAM

GovernmentExogenous Demand for Commodities, Transfers, receives indirect and income taxes

Investment DemandFixed shares across commodities consistent with SAM

How we construct a Regional CGE Model?

1. Construction of the SAM Table Carefully scrutinize the structure and characteristics of

the regional economy, Taking in mind the objectives of each study into

account and the problem(s) this leads into the definition of the structure of the SAM accounts,

Necessary regional information on the SAM accounts (I/O table, factor payments, household income, government spending-receipts, institutional income distribution and transfer payments)

Application of I/O regionalization techniques (such as GRIT)

Regional Application

Regional Application2. Parameterization Specification of elasticity coefficients (trade, production,

household elasticities) which quantify how production, consumption, etc. adjust to altered economic conditions,

Calibration of the CGE model: the values of the normalizing parameters replicate the flow values observed in the SAM.

3. Macroeconomic Assumptions (Closure Rules) Neoclassical: prices adjust and supplies are fixed, Keynesian: prices are fixed and supplies vary

Regional CGE Models and Policy Analysis CGE models are a very useful tool for rural policy

analysis due to their micro/non linear nature, CGE models capture a wide range of RD policy

effects:

a) short run (construction process)

b) long-run effects of new business activity (supply- or demand-driven)

c) secondary effects based on the migration, commuting and trade patterns of households.

CGE models can be used for carrying out a series of policy-related shocks (e.g. CAP reform, income transfers, population inflows) based on hypotheses

However there are some shortcomings: Numerous hypotheses and objective judgements

utilized for the parameterization of the model, The black-box criticism “models such as this one

often have lurking within them several key driving forces that originate in their SAM data base, algebraic structure and parameter assumptions, but whose influence on the model results remain hidden and open to misattribution” (Wing, 2005).

Limited applicability of single-region models at the small area level

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