CGE models and policy making: notes and examples David Roland-Holst MARD Modeling Workshop Bangkok, Thailand June 2004

Policy analyst’s balancing act Modeling technique computing parameters data etc Policy making trade-offs timing balancing interests Policy analyst

The GE model brings Indirect (and otherwise invisible) effects Effect of economywide resource and other constraints Substitution patterns

The process of policy analysis Preliminary steps Understand the problem and how it has been addressed in the past Understand the things that most concern the policy maker

The process of policy analysis The modeling Think about the GE aspects of the problem Why are we using a GE model for this issue? Get the modeling right Make sure the problem is represented in the model eg must have base tariffs if they are to be removed Understand and explore the results What key parameters or data drive the results How do changes in these change the results

The process of policy analysis The communication Explain without any technical detail Cover policy makers concerns Repeat all the steps as necessary

Some examples Agricultural Policy Trade policy Tax policy Environmental regulation and reform

Agricultural Policy The issue Why a CGE model? Key insights What does agriculture contribute to the economy and what does the (domestic and international) economy contribute to agriculture What are the detailed effects of agriculture policy? Why a CGE model? Agriculture is the dominant sector in Vietnam, and will experience many transitions in the next generation Key insights Agriculture can be a main driver for growth and poverty alleviation, but the composition of this growth will be very complex Big contrast with partial equilibrium analysis

Trade policy The issue Why a CGE model? Key insights Effect of changes in tariffs and other forms of industry assistance Why a CGE model? Trade policy is the classic GE problem Key insights For dynamic exporters like Vietnam, it is a rich story about how the benefits and costs of protection were distributed

Tax policy The issue Why a CGE model? Key insights Effect of replacing wholesale sales tax with goods and services value added tax Why a CGE model? Very complicated initial structure of taxes Key insights Overall gains very small and very sensitive to some key assumptions

Environmental regulation The issue Effects of regulations such as: pollution Resource (water, fisheries, forestry) policy Why a CGE model? Still emerging in a live policy debate Energy and water, for example, key inputs to all production processes Key insights Environmental policies have many indirect effects

Analytical Economic Model The MARD Model Analytical Economic Model CGE Forecasting Model Social Accounting Matrix Aggregation Facility Satellite Accounts

Analytical Economic Model Supply – Firm-level production technology with Leontief intermediate use. Demand-Domestic consumption functions by household and commodity type. Dynamic specification of factor growth and demographic transitions. Extensive accounting for transfer relationships between institutions (fiscal, capital flows, remittances, etc.).

MARD Modeling Strategy Policy makers need visibility. Economic models make a lasting contribution to this under three conditions: They must incorporate advanced data and methods. Their results must be transparent. They must be locally implemented. In order to achieve these three goals, we propose a modeling facility with a user-friendly interface and a sophisticated analytical kernel.

Schematic Modeling Facility Social Accounting Matrix Econometric Parameter Estimates Development Policy Scenarios CGE Model Baseline Calibration Data Simulation Numerical Results Graphical Output Analysis Box Color Key to Software Implementation: Green – Microsoft Excel Yellow – GAMS

Database: A New 2000 SAM for Vietnam Includes the new 2000 GSO Input-Output Table 112 domestic production activities 114 commodities 14 factors of production 12 labor categories Capital Land 12 household types, sampled from the VLSS 3 enterprises (Private, Public, and Foreign) State (detailed fiscal instruments) Consolidated capital account 194 international trading partners

Satellite Accounts Macroeconomic data series Structural parameters Demographic data Other resource data

Forward-looking Policy Analysis Policy Scenarios CGE Forecasting Model Projections for Vietnam to 2020 Baseline Economic Conditions

Trade and Economic Growth: Real GDP to 2020

Export and Import Composition by Partner (2000 SAM Data)

Direction of Trade: Exports by Destination (2000 SAM Data)

Direction of Trade: Imports by Origin (2000 SAM Data)

Scenarios Baseline: calibrated macro trends without reform or WTO. Reform-WTO: Coordinated external and domestic reform. USBTA: Bilateral trade liberalization with respect to the United States. USBTAg: USBTA with 2% annual growth of total factor productivity in Vietnamese agriculture. EUBTA: Bilateral trade liberalization with respect to the European Union. EUBTAg: EUBTA with 2% annual growth of total factor productivity in Vietnamese agriculture.

USBTA – Real GDP Growth (indexed to year 2000=100) NB: Results indexed to year 2000 = 100.

Vietnam’s Trade with the EU (trillions of 2000 Vietnam Dong)

USBTA – Real Consumption Growth (indexed to year 2000=100) NB: Results indexed to year 2000 = 100.

USBTA – Macro Results Percent changes with respect to Baseline in 2020

Sectoral Output (billions of 2000 Dong) USBTAg EUBTAg

USBTA – Sectoral Export Growth (indexed to year 2000=100)

USBTAg – Sectoral Export Growth (indexed to year 2000=100)

USBTAg – Sectoral Exports (billions of 2000 Dong)

USBTA – Agricultural Output Growth (indexed to year 2000=100)

USBTAg – Agricultural Output Growth (indexed to year 2000=100)

USBTAg – Agricultural Output (billions of 2000 Dong)

USBTAg – Agricultural Exports (billions of 2000 Dong)

Preliminary Conclusions External reform is necessary, but not sufficient for dynamic and sustained economic growth. Passive external liberalization will lead to intensification of traditional, low wage comparative advantages. Vietnam’s export patterns are not representative of regional counterparts and do not take full advantage of existing markets.

Opportunities for Vietnamese Agriculture Regional Cereals Demand China Japan OECD Fishery Demand Global marine stocks are being depleted Dietary shifts in protein/fat content Significant potential for agricultural diversification Fruit Salad vegetables Horticulture

Challenges for Vietnamese Agriculture Institutional constraints Price transparency Cost of capital Trade and transport margins Process constraints Technology Diversification Quality Value-added

Opportunities for Growth, Productivity, and Investment Patterns Vietnam has important advantages among emerging economies. Very attractive education/wage ratios High levels of social coherence and discipline Important geographic characteristics Transport access Regional (East Asian) market centrality Significant energy potential

Constraints on Growth, Productivity, and Investment Patterns At the same time, Vietnam’s industrialization faces significant challenges. Some are the same as in agriculture. More serious in manufacturing, however, are Capital Insufficiency, public and private, which critically limits Industrial growth and diversification of Labor productivity (= real wages) Domestic savings and reinvestment Market Failure In the Asian Pacific region, market forces have achieved increases in material living standards that defied two generations of more interventionist development planning. While the government should never abdicate its responsibility for basic needs and security, in economic matters it can best play the role of facilitator.

Lessons for Domestic Policy Product markets – reduce barriers to market access/entry, especially for domestic private interests Invest in infrastructure, transport, and communications Reduce trade margins due to administration/regulation Reduce direct and indirect financial bias favoring state enterprises Capital markets – greater respect for market forces More equal private/public access to domestic and external savings Promote a transparent relationship between risk and return Labor markets – increase investments in education Fiscal policy – nondistortionary standards for taxation, uniformly applied

Lessons for External Policy Fuller participation in the global economy will improve efficiency, leverage domestic production capacity and employment, and accelerate modernization. To facilitate this, the government can Minimize price distortions in tradable commodities More equal market access for domestic and international participants Liberalize direct foreign investment and harmonize banking and financial market standards with international norms Share more of the burden of development risk with foreigners Promote Vietnamese enterprises abroad and negotiate balanced market access with trading partners