III. AGE analysis of trade, policy reform and environment

1. III-A III. AGE analysis of trade, policy reform and environment

2. III-A Concepts and structural features • Overview and a simple AGE structure • Solution procedures for ‘Johansen’ models • Incorporating environmental analysis • Dealing with institutional issues • Dealing with political economy

3. III-A 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.

4. III-A 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!

5. III-A An N-good, F-factor economy • General structure • Equilibrium conditions • Closure rules and decisions

6. III-A Variables in the basic model

7. III-A

8. III-A

9. III-A 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.

10. III-A 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.

11. III-A 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.

12. III-A 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

13. III-A 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

14. III-A The AGE model • 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)

15. III-A Variables solved within model • 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)

16. III-A 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.

17. III-A 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.

18. III-A Industrial emissions: AHTI

19. III-A 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)

20. III-A 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’.

21. III-A Institutional issues • Trees may be cut (or planted) to establish property rights over land. • In open access forests (non-commercial), opportunity cost of forest is set by ag. land values and clearing costs. • 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.

22. III-A 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.

23. III-A Dealing with political economy • Economists’ welfare weights seldom coincide with those of policy-makers! • This extends to valuations of environment-economy tradeoffs. • AGE results can be re-cast to reflect alternative sets of priorities…