2. Global Trade Analysis Project Country Risk and Capital Flows The case of South Africa by group no. 2

3. Global Trade Analysis Project South Africa has undergone a great deal of political change The implication were among a number of thinks a significant reduction in the country risk associated with investments in SA. Implementation in the GTAP model: –standard model and GE closure –no need for swaps Background

4. Global Trade Analysis Project Shock: Estimate based on ‘real observations’ Measure based on Deutchmark bond issues fell by 13.5 per cent We shock the cgdslack by this amount (- 13.5 per cent) Implementation

5. Global Trade Analysis Project Expected rate of return rore(r) = rorg = cgdsslack Allocation of investments: rore(r) = rore(r) - RORFLEX*(ke(r)-kb(r)) Model equations

6. Global Trade Analysis Project Results

7. Global Trade Analysis Project Derived direct demand from cap. good sector –Techmnfc –Svces Factor market effects –factor intensities in expanding sectors –factor prices (+) Supply prices (zero profits) Trade effects (effects on other regions) Results - demand for intermediates and factors

8. Global Trade Analysis Project Risk Premium decline: FTA among SA and Rest of Southern Africa Pre-shock data FTA and Non-FTA Post-shock data FTA and Non-FTA Welfare effects on Rest of S. Africa

9. Global Trade Analysis Project Pre-shock trade flows RESTSA - SA (US$ m)

10. Global Trade Analysis Project Pre-shock inputs to capital goods industry, SA

11. Global Trade Analysis Project Post-shock: Welfare effects

12. Global Trade Analysis Project Post-shock: Increased Allocative Efficiency, Rest of Southern Africa Allocative effect 37 EU 21 ROW 25 mtax 47 - Light manf Tech manf Heavy manf Light manf Tech manf Heavy manf Increased imports to RESTSAF from EU and ROW

13. Global Trade Analysis Project Small Group II Extension: Effects of Changing RORFLEX parameter

14. Global Trade Analysis Project Introduction: The RORFLEX and The Rate of Return Approach The sensitivity of the RORFLEX Backward shock   

15. Global Trade Analysis Project RORE( r )=RORC( r)[KE( r ) / KB( r )] -RORFLEX( r ) This rate declines as capital stock rises.. The rate at witch this decline is expected is a function of the flexibility parameter RORFLEX(r ) > 0 So Investment depends on ‘expected’ rate of return in next period

16. Global Trade Analysis Project Expected rate of return RORE( r )=RORC( r)[KE( r ) / KB( r )] -RORFLEX( r ) Current period rate of return End of period Capital stock Beginning capital stock ROR Flexibility(parameter) Thanks, to Soren and Rob More about RORE( r)...

17. Global Trade Analysis Project Modeling risk The global bank equalizes risk-adjusted rates of return, so that risk-adjusted rates for all regions are egal to some global average; with: RORE( r)= non risk-adjusted expected rate of return RISK( r)= ratio of equilibruim returns in region r to the global average rate of return

18. Global Trade Analysis Project We have RORE(r )/RISK( r)=RORG => RORE( r) = RISK( r) * RORG by total differentiation rore(r ) = rorg + risk( R) We have also rore(e)= rorg + cgdslack(s ) [equation 11’, Hertel and Tsigas] so cgdslack(r )=risk(r ) ==> cgdslack is equivalent to the percentage change in the variable RISK We can refer to this, rather than risk A risk premium

19. Global Trade Analysis Project RORFLEX …and regional investment changes A small RORFLEX needs large changes in end of capital stock, KE(r ), to induce small changes in RORE(r ) THEN –Low values of RORFLEX(r ) lead to big changes in regional investment –High value lead to small changes:” In this case the supply of new capital goods is not very sensitive to changes in the expected return We assume that investors behave that changes in regional rates of return are equalized across regions; the global rate of return changes by the same percent ::

20. Global Trade Analysis Project RORE=f [RISK(r)] (Supply Capital) 5% 10% 20% RORFLEX THE SENSITIVITY OF THE RORFLEX dK -13% Cgdslack(r )

21. Global Trade Analysis Project Impacts of RORFLEX Impacts on net capital inflow and welfare effects. Simulations: change value of RORFLEX Shock is always the same (cgdslack = -13.5%) RORFLEX = 10% (base run) RORFLEX = 5% RORFLEX = 20% RORFLEX is changed for all five regions.

22. Global Trade Analysis Project Net Capital Inflow

23. Global Trade Analysis Project Welfare Effects

24. Global Trade Analysis Project Backward shock Time shock -13.5% Net Capital Inflow in SA 15’676 5’726 5‘027 -414 +13.5%

25. Global Trade Analysis Project Why an Adjustment? Time 5’726 5‘027 -414-1’797 7’523 5’441 Net Capital Inflow in SA

26. Global Trade Analysis Project Possibilities of Adjustment Problem: Change of Investment is too big compared with the historical Values Possibilities: Shock; Assumption is still the same (Shock cgdslack=+13.5%) RORFLEX; Increase of RORFLEX reduces Investment

27. Global Trade Analysis Project Calculated Value for RORFLEX 5’441 13.25

28. Global Trade Analysis Project EXTENSIONAL GROUP 2 SINICHI YAMAGUCHI MANABU SHIMASAWA SIMULATION

29. Global Trade Analysis Project How to shock ? SHOCK BASE SHOCK capital inflow into South Africa: negative shock to “cgdslack” cgdslack("safrica") = -13.5 ADDITIONAL SHOCK technical progress at TECHMNFC & SVCES: positive shock to “ao” ao("TECHMNFC","SAFRICA") = 1.0 ao("SVCES","SAFRICA") = 1.0

30. Global Trade Analysis Project Initial effects induced by Tech change Capital inflow = Direct Investment Capital Stock increase Management resource ( know-how, hi-tech etc) increase Technical ProgressPrice fall (equation (6’)) Output increase (equation(35)(36))

31. Global Trade Analysis Project Welfare Decomposition (1) A : summarized welfare report

32. Global Trade Analysis Project Welfare Decomposition (2) C1 : TECH decomp. Tech changeC11 : AO cont. output augm. tech change

33. Global Trade Analysis Project Market Price (pm) change % change

34. Global Trade Analysis Project Volume change in Endowments BASE EXT

35. Global Trade Analysis Project Export quantities change % change

36. Global Trade Analysis Project SOME CONCLUSIONS Additional impacts on “ao(, )” cause : SVCES sector growth endowments concentration to SVCES Other sectors scale decrease Total export decrease (more capital inflow)

37. Global Trade Analysis Project Endogenous capital stock Gregg Watts and A. Salazar Brandao

38. Global Trade Analysis Project K’ long run capital stock Y” Y’ Y KK’ Y’Y’ YY K Y

39. Global Trade Analysis Project VariableOriginalEndogenous Capital Stock Gross investment36 US$ b30 US$ b Depreciation19 US$ b22 US$ b Net Investment17 US$ b8 US$ b Capital Stock0%18% Rental price7.6%-8.5% qgdp0.6%6.1%

40. Global Trade Analysis Project OriginalEndogenous Capital Stock Bal. of Trade-10 US$ b-1 US$ b Welfare3 US$ b 8 US$ b cnt_tot+1.9 US$ b-0.3 US$ b pexport (share)99% 100% -------------------------------------------------------------------------------- Perc. changes Exports PriceQty.PriceQty. Extraction3.0-13-0.2+0.7 Hvymnfc6.3-21-1.6+6.4 Svces7.0-18-0.8+2.2

41. Global Trade Analysis Project Perc. changesOriginalEndogenous Capital Stock PriceQty.PriceQty. Capital 80-918 Land-120 150 Nat. Res,-130 60 Unsklab 80 40 Sklab 100 40 -------------------------------------------------------------------------------- Agriculture4.9-3.9-0.4+3.3 Hvymnfc6.3-8.4-1.6+7.2 Svces7.0+2.7-0.8+6.0