8 Applied GE modeling of economy & environment

1. 875-8.ppt 8 Applied GE modeling of economy & environment • Rationales • Basics of applied GE models • Incorporating environmental issues • An application Main source: OEE Ch. 5. Additional: Shoven & Whalley, JEL 1984; Ginsburgh & Keyzer, Structure of applied general eq. models (MIT Press, 1997); Coxhead, World Development 28(1),2000.

2. 875-8.ppt Pros and cons of AGE modeling • Importance of economy-wide mechanisms and implications • Intractability of higher-dimension analytical models • Opportunities for ‘structural sensitivity analysis’ X Limitations • Time is usually not explicitly taken into account • Micro details such as risk/uncertainty or credit market imperfections usually ignored • aggregations can mask important differences (e.g. intra-industry variations) • AGE approach is highly time and energy-intensive: benefits over PE approach obtained at high cost.

3. 875-8.ppt 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. 875-8.ppt An N-good, F-factor economy • General structure • Equilibrium conditions • Closure rules and decisions

5. 875-8.ppt Variables in the basic model

6. 875-8.ppt

7. 875-8.ppt

8. 875-8.ppt 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) solves for Y, W, R, X, D, S and U as endogenous variables. • Endogenous: income, factor prices, quantities produced and demanded, trade, and utility. • Exogenous: factor endowments, traded goods’ prices and a numeraire price.

9. 875-8.ppt 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.

10. 875-8.ppt Other features • Can add in: • Intermediate inputs • Products distinguished by source (domestic, imported) • Different kinds of labor • Many sources of final demand • Trade and transport ‘margins’ • Tariffs, taxes, and other policies … etc.

11. 875-8.ppt 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 from SAM, elasticities from other sources) • Simulation results are additive in separate shocks

12. 875-8.ppt 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) • Models in OEE, Ch.6–8

13. 875-8.ppt Data • Social accounting matrix: base year data • Input-output accounts of industries • Factor markets, household incomes & expenditures • Trade and final demand • Taxes and G. expenditures • Micro and macro balance • Elasticities • Estimated (see www.aae.wisc.edu/coxhead/apex ), or more commonly ‘guesstimated’.

14. 875-8.ppt Schematic social accounts Expenditures Receipts

15. 875-8.ppt Social accounting matrix

16. 875-8.ppt ‘Standard’ national accounts ignore environment • Assumptions: • Property rights on resources • No externalities • No non-marketed amenity values

17. 875-8.ppt Open access to natural capital

18. 875-8.ppt Addressing env. damages and natural resource depletion • Pigovian taxes (Bovenberg & Goulder, AER 1996) • Private purchase of abatement services • Public provision of abatement or clean-up services • Quotas or limits on resource use or emissions (command & control)

19. 875-8.ppt 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: ‘side calculations’ • Natural resource degradation • Questions about institutions.

20. 875-8.ppt 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

21. 875-8.ppt 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’.

22. 875-8.ppt 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 property rights.

23. 875-8.ppt ‘Structural sensitivity analysis’ • Alter assumptions about market clearing • Alter assumptions about property rights • Alter assumptions about macroeconomic closure • e.g. Adjustment to equilibrium through domestic tax system vs. adjustments through accommodating international capital flows.