The GEM-E3 Model and its extensions. Prof. P. Capros ICCS/NTUA MODELS The GEM-E3 Model and its extensions. Prof. P. Capros ICCS/NTUA

Objectives To install operational versions of GEM-E3 on the computer system of the European Commission for in house use. To support a series of policy applications with GEM- E3 on issues related to the Lisbon agenda and the assessment of impacts from regulation and legislative initiatives of the Commission. To improve the GEM-E3 computable general equilibrium model. March 2007

The GEM-E3 model. GEM-E3 is a multi-region Computable General Equilibrium model built to evaluate the economic impacts of structural policies. GEM-E3 provides the user with many modelling options: a European model, a World model, and a series of different model closures. GEM-E3 is developed using GAMS and uses MS-Excel for the data and the results. A non-developer user may run GEM-E3 after a short training, example IPTS of EC/JRC. March 2007

Model Extensions Internal Market under imperfect competition and economies of scale. Bottom up energy sub-model and depletable energy resources mechanism. Endogenous technical progress. Imperfect markets for labour and capital. March 2007

Model versions delivered to Commission March 2007

“Internal market, competition and trade” (GEME3 v. ICT). This version will serve as the basis for all model developments. Standard version featuring: Market integration and trade with imperfect competition and economies of scale Energy and environmental module Option for unemployment (wage curve introduction). March 2007

“Endogenous Growth, Internal Market, Competition and Trade” (GEME3 – v “Endogenous Growth, Internal Market, Competition and Trade” (GEME3 – v. EGICT). Model with endogenous technical change. Combines the advanced trade model version with endogenous growth driven by technology progress and innovation. The EGICT version will be used to study: the knowledge society, the internal market, the business climate and the environmental sustainability aspects of the Lisbon strategy March 2007

“Social structures, Internal market, Competition and Trade” ” (GEME3 – v. SICT). SICT version features: disaggregated and improved labour, capital, skills and households improved representation of the services sector and the trade for services in the Internal Market. SICT model version enables to study: Distributional and social impacts on employment. Advanced analysis on double dividend issues (employment and environment). March 2007

Links between model versions and Lisbon policy agenda. The model extensions The Knowledge Society The Internal Market The Business Climate The Labour Market Environmental Sustainability Endogenous Technical Progress Market Integration under imperfect competition and product varieties Capital market and investment flows Labour market under imperfect competition Energy-Environment sustainability driving innovation, demand for equipment goods and exports March 2007

Schedule Phase A The GEM-E3 team will: Perform the necessary updates, Check the operation of the model, Improve the user interface Provide the user manual and Install the ICT GEM-E3 version at the Commission. Phase B Install EGCT and SICT versions at the Commission Finalisation of user interface User manual provision Provide support in designing and implementing the policy scenarios Timeline Month 5 : Installation of improved model version (ICT) to the Commission . Month 17: Policy applications as per Phase A. Month 19: Installation of final model versions to the Commission. Month 35: End of policy applications as per Phase B. March 2007

Regional and sectoral coverage (current and proposed) GEM-E3 Regional and sectoral coverage (current and proposed)

GEM-E3 Data Bases The European version of GEM-E3 is entirely based on Eurostat statistics. The World version of GEM-E3 is based on the GTAP-6 database which covers the whole world aggregated in 87 regions and 57 sectors (base year 2001). March 2007

GEM-E3 Regional aggregation. Proposed: E.U. 27 (separately) Rest of Europe North America Latin America and Mexico Rest of OECD C.I.S. Rest of Asia Africa Sub Sahara Middle East and N. Africa Current: Oceania Japan East Asia China India Rest of Asia U.S.A. Canada Mexico & Venezuela Latin America E.U. 27 Other Europe C.I.S. Middle East Mediterranean South Africa Rest of Africa March 2007

GEM-E3 Sectoral aggregation Proposed AGRICULTURE COAL OIL GAS ELECTRICITY NON FERROUS METALS FERROUS METALS CHEMICAL PRODUCTS OTHER ENERGY INTENSIVE ELECTRONIC EQUIPMENT TRANSPORT EQUIPMENT OTHER EQUIPMENT GOODS OTHER MANUFACTURING PRODUCTS CONSTRUCTION FOOD INDUSTRY TRADE AND TRANSPORT TEXTILE INDUSTRY COMMUNICATIONS FINANCIAL SERVICES INSURANCE BUSINESS SERVICES NEC RECREATIONAL AND OTHER SERVICES PUBLIC ADMINISTRATION, DEFENSE, EDUCATION, HEALTH Current AGRICULTURE COAL OIL GAS ELECTRICITY NON FERROUS METALS FERROUS METALS CHEMICAL PRODUCTS OTHER ENERGY INTENSIVE ELECTRONIC EQUIPMENT TRANSPORT EQUIPMENT OTHER EQUIPMENT GOODS OTHER MANUFACTURING PRODUCTS CONSTRUCTION FOOD INDUSTRY TRADE AND TRANSPORT TEXTILE INDUSTRY OTHER MARKET SERVICES NON MARKET SERVICES March 2007

WP 2.1: Internal Market and world trade under imperfect competition and economies of scale Extension of GEM-E3

Basic modelling idea Goods are differentiated by origin (Armington assumption) Differentiation by consumers is reflected through the form of the demand nesting hierarchy. The selling price of a good is a function of an endogenous mark-up and the eventual barriers to trade. The mark-ups reduce when enlarging the market, as a result of more intensive competition. March 2007

Supply Technologies Calibration Entry/exit of firms Minimum Efficient Scale Cost Gradient (engineering studies) Number of equivalent equal size firms from Herfindahl index Calibration of mark-up Entry/exit of firms Symmetric firms Number of firms endogenous To ensure zero profits or non-zero profits (optional) Endogenous mark-ups Depending on concentration Depending on average cost March 2007

Demand nesting hierarchy Structural changes such as the EU Internal Market March 2007

The love of variety effect Hypothesis about horizontal product differentiation between firms within the same sector and country When varieties increase, the consumer obtains the same aggregate quantity more efficiently (i.e. with lower quantities hence lower cost) This relaxes short-term supply constraints, leading to lower market prices and magnifies the effect of market enlargement The number of varieties increase with more intensive competition as the effect from the market enlargement dominates over the effect from market concentration. March 2007

Imperfect competition Various modelling options (Cournot, monopolistic competition, Ramsey-Boiteux pricing, etc.) In any case the market price depends on costs and an endogenous mark-up: Under free entry/exit of firms, the number of firms adjusts in a sector, depending also on the efficient size of company as related to the market size. Enlargement leads to increase of number of firms hence varieties and a reduction of the mark-ups March 2007

WP 2.2: Engineering economic model integration for the energy and environment systems Extensions of GEM-E3: - Engineering oriented energy sub-model - Depletable energy resources - Endogenous energy efficiency and savings - Environmental impact sub-model - Sub-model for cost-benefit environmental assessment - Double dividend analysis: environment and employment

Basic modelling idea The core GEM-E3 already covers energy issues and the interactions with the environment Linkage to a detailed environmental sub-model Calibration to energy projections by PRIMES and POLES. However, the core model lacks Discrete representation of power producing technologies. Non-linear (decreasing return to scale) mechanism for the supply of energy resources, such as the depletable fossil fuels. March 2007

Bottom-up for power generation Explicitly represents a variety of old and new technologies of power generation. Endogenous investment into new power generation plants. Energy investment is linked to the demand for equipment goods. Technology progress incorporated through the capital vintages. Emissions from power generation linked to the environmental sub-model and policy instruments influence power sector decisions. March 2007

Bottom-up for power generation Dispatching under capacity constraints Investment in new power plants Price of electricity – options Mark-up (under IC) Ramsey-Boiteux to recover fixed costs Influenced by Fuel and technology costs Environmental policies March 2007

Depletable energy resources The price of energy resources become a function of The rate of extraction from proven reserves and the rate of discovery of new reserves. The accumulated use of the resources The reserves are introduced as a separate production factor. In the presence of climate change policies, abatement costs increase as a result of lower fossil fuel prices related to lower demand; opposite effects in case of dash for gas. March 2007

Endogenous energy savings Endogenous decision to invest in energy saving equipment. Production and consumption functions are extended with the energy saving considered as an additional factor Energy saving draws from a limited potential for savings per sector, hence follows decreasing return to scale Investment in energy saving induces expenses taken into account in the least cost decision of the agent. The purchase of goods to implement energy saving influences total demand for goods and services March 2007

WP 2.3: Endogenous Growth through technology and innovation Extension of GEM-E3

Basic modelling idea Combination of two production functions: Knowledge production function: generation of new innovation Output production function: standard KLEM function extended to account for the impact of endogenous technology innovation March 2007

Endogenous innovation: supply Main modelling hypothesis: R&D investment of firms show decreasing return to scale with accumulated knowledge Spillovers represented as positive externality leading to higher productivity of R&D expenditure The combination determines the supply function of innovations (price and quantity locus) Public R&D subsidies support innovation but are subject to the effects from GE budget constraint March 2007

Endogenous Innovation: demand Decision of a firm to purchase innovation: Endogenous, positively affects productivity of factors but induces expenditure Applies to the new capital vintage Simultaneously with the demand for all production factors (L,E,M) and productive investment, so as to maximise expected net present value of the firm In the model dynamics depends on firm sales expectations and the unit costs of factors March 2007

Sub Package 2.4: Model improvement of labour market, households sector and capital market Extensions of GEM-E3 : - Improvement of the formulation of labour markets. - Inclusion of multiple household classes. - Improvement of capital market and capital mobility.

Capital and labour formulation of standard GEM-E3 Labour supply is derived from consumption-leisure-savings choice, labour demand depends on the KLEM optimisation Capital demand is derived from investment function, capital supply depends on general equilibrium closure (Walras law) Current modelling options for labour market: Wages determined from equilibrium of supply-demand Current modelling options for capital market: Rate of return on capital derived from national budget equilibrium, a reduced form reflecting differentiated interest rates and risk premia Rate of return on capital derived from multinational income-savings closure March 2007

Labour market extension Categories of households are introduced with different patterns about consumption and savings Skills of labour are introduced. Skills are linked with household categories and the mechanism of income distribution Each market is imperfect, reflecting negotiation power of unions and the influence of unemployment Labour is imperfectly mobile across countries. March 2007

Capital market extension Capital flows financing investment are differentiated per origin and destination in the presence of differentiated rates of return and risk premia Capital is imperfectly mobile across regions and market clearing is imperfectly coordinated This extension allows to understand the adjustments to the global economy when structural policies, such trade liberalization, environmental sustainability etc. are undertaken. March 2007