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

1. Demonstration of capabilities of a bi-regional CGE model to assess impacts of rural development policies (RURMOD-E) Demonstration WorkshopBrussels, 26.11.2008

2. THE BI-REGIONAL CGE MODEL: CHARACTERISTICS AND APPLICATION Demetrios Psaltopoulos Department of Economics University of Patras

3. Introduction SAM & General Equilibrium models • Major Part of TERA (FP6 – CT6469) project • This Presentation deals with Aim (motivation), characteristics and implementation Structure • Background • Modelling Approach SAMs and CGE Models • Model Structure • Application

4. Background TERA: Economic development in remote rural areas Aims: • Role territorial factors which influence development • review whether existing policies take account of factors • propose 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)

5. Approach • Regional/Local • Modelling within region rural-urban linkages 6 Case Study areas. Reflect different • Economic and Institutional Context • Spatial Scale • Rural-urban relationships

6. OECD Rural Classification:Nuts 3 d

7. The Modeling Framework 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.

8. 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.

9. 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

10. 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.

11. The Modeling Framework Example SAM Accounts Definitions Production Activities • Agricultural Rural • Manufacturing Rural • Manufacturing Urban • Transport Services Commodities • Agricultural • Manufacturing • Transport Services

12. 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

13. 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

14. 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)

16. Production structure

17. Commodities

18. 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)

19. 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

20. 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 SAM Expenditure Households pay income tax, save given proportion of income and demand commodities & demand housing services Income Tax Rate, mps, Demand Shares derived from SAM Government Exogenous Demand for Commodities, Transfers, receives indirect and income taxes Investment Demand Fixed shares across commodities consistent with SAM

21. Regional Application How we construct a Regional CGE Model? • 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)

22. Regional Application • 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. • Macroeconomic Assumptions (Closure Rules) • Neoclassical: prices adjust and supplies are fixed, • Keynesian: prices are fixed and supplies vary

23. 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: • short run (construction process) • long-run effects of new business activity (supply- or demand-driven) • 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

24. 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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