EC 936 ECONOMIC POLICY MODELLING LECTURE 7: CGE MODELS OF STRUCTURAL CHANGE AND ECONOMIC REFORM ECONOMIC REFORM

WASHINGTON CONSENSUS (Williamson, 1989) STRUCTURAL ADJUSTMENT POLICIES Budget deficit reduction Public expenditure reform Tax reform Financial liberalization Foreign exchange liberalization Trade liberalization Privatization of state-owned enterprises Competition policy Deregulation of foreign direct investment

AUGMENTED WASHINGTON CONSENSUS (Rodrik, 2002) Land reform Poverty reduction Social safety nets Anti-corruption policy Legal reforms Governmental/institutional reforms

WHY CGE MODELS? General vs partial equilibrium analysis Counterfactual modelling Decomposition of complex array of simultaneous influences (exogenous as well as policy decisions) Simulation exercises Evaluation of key parameters

CGE MODELS OF STRUCTURAL ADJUSTMENT AND ECONOMIC REFORM IN AFRICA CAMEROON THE GAMBIA MADAGASCARNIGER Key structural similarities: –High share of labour force in agriculture –Export oriented/primary commodities –Small industrial sectors Similar external shocks pre-reform: –Terms of trade shocks (falling commodity prices) –Real exchange depreciation (except for Cameroon) Structural divergences: –Budget balance –Nominal exchange rates –Financial stability

THE CORNELL CGE MODEL (Dorosh, Sahn et al) SAM based model –Four household sectors (urban non-poor, urban poor, rural non-poor, rural poor) –Cameroon 14 sectors (6 agric, 2 ind) –The Gambia 17 sectors (6 agric, 1 ind) –Madagascar 15 sectors (5 agric, 4 ind) –Niger 14 sectors (5 agric, 3 ind) CES value-added production function –Disaggregated labour (formal/informal by skill type) –Sector-specific fixed capital (formal/informal) –Disaggregated land by ecological type LES or fixed-share consumption functions

CLOSURE RULES Micro: –Market clearing in commodity and labour markets –Aggregate labour supply fixed –Armington elasticities for imports –CET functions for exports –Government spending exogenous Macro: –Savings driven –Current account deficit held constant

FOUR SIMULATION EXERCISES How might governments respond to external shocks? I: Impose import quotas to maintain real exchange rate (‘de facto adjustment’) II: Real exchange rate deprecation (‘foreign exchange liberalization’) III:Real exchange rate depreciation and maintain budget balance (i.e. cut government expenditures) IV: Real exchange rate depreciation and impose trade taxes to maintain level of government expenditure

CONCLUSIONS Terms-of-trade shocks lowered real incomes for most households Foreign exchange rationing and quotas exacerbate the negative effects on poor households, while raising incomes for the urban non-poor Foreign exchange rationing and quotas lower long-run growth potential via lowered savings/investment Cutting government expenditures raises savings/investment relative to raising trade taxes Cutting government expenditures increases urban poverty relative to raising trade taxes Political economy implications

POTENTIAL CRITICISMS Sensitivity of results to closure rules, both macro and micro (do markets clear? should economies be modeled as savings-driven or investment-driven? and so on) How well is the model calibrated to changes in variables as well as static representation of resource flows (via the SAM)? Is it appropriate to model households as homogenous within categories such as poor/non-poor; urban/rural? Is neo-classical modelling appropriate for evaluating neo-classical policy agendas?