EC 936 ECONOMIC POLICY MODELLINGEC 936 ECONOMIC POLICY MODELLING

LECTURE 7:LECTURE 7:

CGE MODELS CGE MODELS OF OF

STRUCTURAL CHANGESTRUCTURAL CHANGEANDAND

ECONOMIC REFORMECONOMIC REFORM

WASHINGTON CONSENSUS (Williamson, 1989)

• STRUCTURAL ADJUSTMENT POLICIES

• Budget deficit reduction• Public expenditure reform• Tax reform• Financial liberalization• Foreign exchange liberalization• Trade liberalization• Privatization of state-owned enterprises• Competition policy• Deregulation of foreign direct investment

AUGMENTED WASHINGTON CONSENSUS (Rodrik, 2002)

• Land reform

• Poverty reduction

• Social safety nets

• Anti-corruption policy

• Legal reforms

• Governmental/institutional reforms

WHY CGE MODELS?

• General vs partial equilibrium analysis

• Counterfactual modelling

• Decomposition of complex array of simultaneous influences (exogenous as well as policy decisions)

• Simulation exercises

• Evaluation of key parameters

CGE MODELS OF STRUCTURAL ADJUSTMENT AND ECONOMIC REFORM IN AFRICA

CAMEROON THE GAMBIAMADAGASCAR NIGER

• Key structural similarities:– High share of labour force in agriculture– Export oriented/primary commodities– Small industrial sectors

• Similar external shocks pre-reform:– Terms of trade shocks (falling commodity prices)– Real exchange depreciation (except for Cameroon)

• Structural divergences:– Budget balance – Nominal exchange rates– Financial stability

THE CORNELL CGE MODEL(Dorosh, Sahn et al)

• SAM based model– Four household sectors (urban non-poor, urban poor, rural non-poor, rural poor)– Cameroon 14 sectors (6 agric, 2 ind)– The Gambia 17 sectors (6 agric, 1 ind)– Madagascar 15 sectors (5 agric, 4 ind)– Niger 14 sectors (5 agric, 3 ind)

• CES value-added production function– Disaggregated labour (formal/informal by skill type)– Sector-specific fixed capital (formal/informal)– Disaggregated land by ecological type

• LES or fixed-share consumption functions

CLOSURE RULES

• Micro:– Market clearing in commodity and labour markets

– Aggregate labour supply fixed

– Armington elasticities for imports

– CET functions for exports

– Government spending exogenous

• Macro:– Savings driven

– Current account deficit held constant

FOUR SIMULATION EXERCISES

How might governments respond to external shocks?

I: Impose import quotas to maintain real exchange rate (‘de facto adjustment’)

II: Real exchange rate deprecation (‘foreign exchange liberalization’)

III: Real exchange rate depreciation and maintain budget balance (i.e. cut government expenditures)

IV: Real exchange rate depreciation and impose trade taxes to maintain level of government expenditure

CONCLUSIONS

• Terms-of-trade shocks lowered real incomes for most households

• Foreign exchange rationing and quotas exacerbate the negative effects on poor households, while raising incomes for the urban non-poor

• Foreign exchange rationing and quotas lower long-run growth potential via lowered savings/investment

• Cutting government expenditures raises savings/investment relative to raising trade taxes

• Cutting government expenditures increases urban poverty relative to raising trade taxes

• Political economy implications

POTENTIAL CRITICISMS

• Sensitivity of results to closure rules, both macro and micro (do markets clear? should economies be modeled as savings-driven or investment-driven? and so on)

• How well is the model calibrated to changes in variables as well as static representation of resource flows (via the SAM)?

• Is it appropriate to model households as homogenous within categories such as poor/non-poor; urban/rural?

• Is neo-classical modelling appropriate for evaluating neo-classical policy agendas?