A Computable General Equilibrium Model to Analyze Distributive Aspects in Brazil with a Trade Policy Illustration

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1 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl wth a Trade Polcy Illustraton Samr Cury Allexandro Mor Coelho Carlos Henrque Corseul EAESP, Getúlo Vargas Foundaton (FGV), Brazl Master n Economcs (FEA-USP) Insttute of Appled Economc Research (IPEA), Brazl, and Unversty College of London, UK RESUMO Neste artgo é apresentado um modelo de Equlíbro Geral Computável especfcado para smular os mpactos de polítcas na dstrbução de renda no Brasl. Para capturar os mpactos dstrbutvos, fatores de produção e nsttuções, como trabalho e famílas, são especfcados separadamente. O modelo apresenta três blocos: mercados de produtos e fatores, e outro bloco com especfcação das transferêncas de renda entre nsttuções. A especfcação do mercado de trabalho ncorpora recente avanço teórco que permte a determnação do desemprego nvoluntáro no equlíbro. No tercero bloco, especfca-se a dstrbução do valor adconado entre fatores de produção e a redstrbução de renda entre agentes/nsttuções. As smulações do fechamento parcal da economa mostram pequena redução de bem-estar para a maora dos trabalhadores e famílas. Verfcou-se anda que a homogenedade do modelo vale somente com plena ndexação de todos os fluxos de renda, o que tem mportantes conseqüêncas sobre a modelagem do processo de dstrbução de renda. PALAVRAS-CHAVE Brasl, modelo de equlíbro geral computável, bem-estar, homogenedade, avalação de polítca econômca externa ABSTRACT Ths paper presents a Computable General Equlbrum model specfed to smulate the polcy mpacts on ncome dstrbuton n Brazl, wth complex and systemc propagaton methods. To capture the dstrbutve mpacts, the model adopts a desgn focused on the separaton of producton and nsttutonal factors, as labor and households. The model has three blocks: product and factor markets, and a block that handles wth ncome transfers among nsttutons. The labor market specfcaton ncorporates a recent theoretcal advance that allows the determnaton of nvoluntary unemployment n the equlbrum. The thrd block specfes the dstrbuton of the value added among producton factors and the redstrbuton of ncome among agents/nsttutons. The smulatons of a partal economc closure show modest welfare reducton for most workers and famles. Also, we checked that the homogenety property of the model holds only wth full ndexaton of all ncome transfers, whch has mportant mplcatons for the ncome dstrbuton process modelng. KEY WORDS Brazl, computable general equlbrum model, welfare, homogenety, external economc polcy evaluaton JEL Classfcaton C68, D60, O15, F47, F14, O24 EST. ECON., SÃO PAULO, V. 35, N. 4, P , OUTUBRO-DEZEMBRO 2005

2 740 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl INTRODUCTION It s wdely known that the Brazlan economy has hstorcally presented one of the hghest ncome nequalty degree n the world, wth a Gn ndex around It s also known that the nequalty n ncome dstrbuton s the man determnant of the poverty level n the country, beng the average ncome level a secondary determnant. Snce last decade, the central Government started pursung to develop the country by mplementng macro and structural reforms. Thus, t s necessary to develop an analytcal framework to evaluate the dstrbutve mpacts of these polces n order to produce nformaton to help polcy makers n ther desgn. Havng ths purpose n mnd, ths paper has been developed usng a computable general equlbrum (CGE) modelng strategy that allows for the analyss of dstrbutve mpacts of macro shocks wth complex and systemc propagaton methods. The model s specfed to run comparatve statc smulatons and, n an attempt to capture dstrbutve mpacts, t s adopted a specfc desgn focused on the separaton of producton factors (partcularly labor) and nsttutonal components such as households, frms and governmental levels. In addton, the paper demonstrates the operaton of the model through dfferent smulatons of Brazlan external (trade and fnance) polces wth a focus on the results related to employment, wages and household ncome. The frst computable general equlbrum model specfed to evaluate the dstrbutve mpacts of publc polces n Brazl was presented by Cury (1998), who extended the CGE model structure proposed by Devarajan et al. (1991) by ncreasng the number of types of labor recognzed n the model and ntroducng another step n the nested producton functon, n whch the dfferent types of labor were aggregated n a composte labor factor. Another extenson was a more detaled specfcaton of the economc nsttutons. The socal securty system was specfed as a specfc agent apart from the Government, the frms were dvded n dfferent types and the representatve famly also was hghly dsaggregated. Thus, wth these extensons, t was possble to ntroduce n the base model a matrx wth nformaton on the ncome redstrbuton among the economc nsttutons, whch allowed a better specfcaton of the nsttutons ncome formaton process. Barros et al. (2000) evaluated the dstrbutve mpacts of the external (trade and captal flows) lberalzaton process n Brazl usng an extended verson of the model specfed by Cury (1998). Ths extenson was characterzed by the ntroducton of a more detaled specfcaton of the labor market, whch was completed n the new model presented n ths paper. Est. econ., São Paulo, 35(4): , out-dez 2005

3 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul 741 The new specfcaton of the labor market, presented here, s characterzed by the ntroducton of wage curves, as proposed by Blanchflower and Oswald (1990, 1994), emprcally estmated for the Brazlan economy. 1 Another advance n relaton to the prevous model was the ncorporaton of a newer database that allowed the recognton of a larger number of sectors n the model, the 42 sectors lsted n the Brazlan Natonal Accounts. Other emprcal advances were the ncorporaton of the Armngton elastctes for the tradable sectors and the wage curve parameters, whch, for the frst tme, were estmated for the Brazlan economy. A fnal emprcal advance s the ntegrated usage of a household survey (PNAD) together wth a household revenue-expendture survey (POF). 2 Recently, the evaluaton of the dstrbutve mpacts n Brazl due to trade polces has receved attenton n the CGE modelng lterature. Hertel et al. (2003) and Harrson et al. (2003) evaluated the mpacts of dfferent blateral and multlateral trade agreements on poverty n Brazl, usng mult-country CGE models, n whch the Brazlan representatve famly s dsaggregated n several types. 3 The model presented n ths paper s dvded nto three blocks: product market, factors market (essentally labor), and one block about ncome transfers among nsttutons. The frst block assumes a general neoclasscal equlbrum for most markets n whch the agents respond to relatve prces changes as a result of the maxmzaton of profts or utlty by determnng levels of producton and consumpton. Ths specfcaton s very smlar to one adopted by Devarajan et al. (1991), that has recently proven be popular wth CGE modelers. The labor market block ncorporates a recent theoretcal advance, the wage curve, that allows for the determnaton of nvoluntary unemployment n the equlbrum. Tradtonally, CGE models follow the classcal labor market story, n whch jobs are avalable for everyone searchng for employment. As ths result does not seem to reflect the way the labor market operates n most countres, 4 advances have been dscussed n the lterature and ncorporated n the model. 5 1 Further detals on wage curves wll be presented n secton 2. 2 PNAD - Pesqusa Naconal por Amostra de Domcílos; POF Pesqusa de Orçamento Famlar. Both of 1996, the model's base year. 3 The usage of mult-regon CGE model s requred n ther case due to the knd of polces they are evaluatng. 4 Blanchflower and Oswald (1990, 1994) present supportng evdence of ths fact for 15 countres and also present a survey on other researches that found smlar results. 5 A more enhanced representaton of the labor market n CGE may be found n Bovenberg et al. (2000). Est. econ., São Paulo, 35(3): , out-dez 2005

4 742 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl The thrd block ncludes nformaton on the dstrbuton of the value added n the productve process among the producton factors, as well as ts redstrbuton among agents/nsttutons consdered n the model; these redstrbuton mechansms was not present n Devarajan et al. (1991). In the lterature on the applcaton of general equlbrum, the model used n ths paper may be consdered as a development of the CGE-RH Approach, n whch the focus s on the dsaggregated specfcaton of the agents. (Bourgugnon et al., 2002). Moreover, the attenton gven to transfer flows among nsttutons places the model n the drecton of a Tax Model, focusng on the redstrbute role of the publc sector. (Devarajan and Hossan, 1998). 6 The paper s structured n seven sectons. After ths ntroducton, the followng three sectons show each one of the 3 man model blocks dscussed above. In the fourth secton, an mportant attrbute of CGE type models wll be dscussed showng the homogenety of degree zero n prces; we descrbe the procedure adopted to guarantee the mantenance of ths property n the model besdes justfyng the reason for ths concern. Secton fve contans the descrpton of the smulaton results and last secton concludes the paper. 1. THE PRODUCT MARKET 1.1 Product Supply Foregn product supply s modeled as beng totally elastc, 7 whle domestc supply s represented n a more elaborated way, through a nested producton functon, whch consders three types of nputs: labor, captal and ntermedate nputs. Ths producton functon form s dentcal for all sectors and can be obtaned n three stages. 8 In the frst step, the amounts of the several types of exstng labor (F l ), gven by the frst order frm s proft maxmzaton condtons, 9 are combned n a composte labor 6 Currently, there s a strong emphass on the combned usage of dfferent structures (macro models, CGE and mcro smulaton). Barros et al. (2000a) appled the mpacts of some varables of the CGE model to smlar varables of a mcro database for calculatng poverty and nequalty ndcators n Brazl. For further dscusson on ths methodology, see Bourgugnon et al. (2002). 7 In ths sense, Brazlan demands for mported goods are fully satsfed wthout facng external supply constrants. 8 The model represents the 42 sectors of actvtes lsted n the 1996 Brazlan Natonal Accounts, whose tradable sectors are presented n the sxth secton of the paper. 9 See bellow, equaton 6 n secton 2. Est. econ., São Paulo, 35(4): , out-dez 2005

5 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul 743 (Ld) for each sector (), usng for ths purpose a Cobb-Douglas functon wth constant returns to scale. 10 The labor types recognzed n the model are: l1-unsklled nformal, l2-sklled nformal, l3-formal wth low skll, l4-formal wth average skll, l5-formal wth hgh skll, l6-low sklled publc servant and l7-hgh sklled publc servant, whch are aggregated n the followng form: Ld = l F β 1 l (1) where β l s the share of each type of labor. In the second step, aggregated labor (Ld) and captal (K) 11 are assocated usng a constant elastcty of substtuton (CES) functon to obtan the sector s producton values (X ) such as: 1/ p D ρp ρ ρ p = α + ( 1 α) X a Ld K D where a s the CES shft parameter, α s the labor share n the sector s producton value and ρ s the elastcty of substtuton between captal and labor. p Fnally, n the thrd step, varous ntermedate nputs levels, ( INT ), can be obtaned, based on a Leontef producton functon (e.g., fxed proporton to sector j s total product, X ): 12 j (2) INT = a X j j j (3) where a s the techncal coeffcent of nput j n sector. j However, ths output s not entrely offered to the domestc market. Producers react to the relatve prce of the domestc market vs-à-vs the nternatonal market. Thus, t s assumed that the producers do not specalze n only one market,.e., the domestc producton s totally dvded wth mperfect substtuton among products sold to the domestc market and products destned for the outsde market. The chosen functonal form presents constant elastcty of transformaton (CET) and assumes the followng form n the model: ( ) ( ) ( ρ 1/ 1/ 1/ t + ) ρt T ρt + ρt ρt + ρt = γ + ( 1 γ) X a E D (4) 10 Ths means that an dentcal ncrease of every type of worker results n an dentcal ncrease of the aggregate worker. 11 The model closure adopted n the smulatons determnes that the sectoral levels of captal are fxed. 12 It s worth mentonng that Devarajan et al. (1991) makes use only of the frst and thrd steps, by combnng captal wth labor and value added wth ntermedate nputs, n ths order. Est. econ., São Paulo, 35(3): , out-dez 2005

6 744 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl where X s sector s total domestc producton, E s the volume exported by sector, T and D s the domestc output of sector sold n the nternal market. a and γ are parameters of the model and s the elastcty of transformaton. 13 ρ t 1.2 Demand for Products Famles Famles are classfed nto eght categores, accordng to per capta household ncome, level of urbanzaton and household head characterstcs. The famly types consdered are: f1 poor urban famles headed by actve ndvdual, f2 poor urban famles headed by non-actve ndvdual, f3 poor rural famles, f4 urban famles wth low average ncome, f5 urban famles wth average ncome, f6 rural famles wth average ncome, f7 famles wth hgh average ncome, f8 famles wth hgh ncome. Ths separaton yelds more precson n the classfcaton of the famles by the degree of dependency to the varous sources of household ncome, ncludng the remuneraton of producton factors, socal securty monetary benefts, and net ncome from fnancal assets. As for the behavor of the famles, we assume that they choose ther consumpton levels to maxmze ther utlty subject to a budget constrant. 14 In the current verson of the model, we use a Cobb-Douglas functonal form (smlar to the producton functon presented above), whose arguments are the commodtes avalable for consumpton. The goods demanded by famles and frms, on the other hand, are not only those domestcally produced, snce these agents also demand goods from abroad. Followng Armngton (1969), we assume that goods are classfed accordng to ther source (domestc or external) and that consumers consder them as mperfect substtutes, whle ther utlty s measured (n product quantty) by a functon wth a constant elastcty of substtuton (CES) wth the followng form: ρ / ( ) ( ) ( 1 1/ 1/ c ρc ρ ) c ρc ρc ρc = δ + ( 1 δ) Q ac M D (5) 13 There are no emprcal estmates of Brazlan export elastctes usng a CET structure for a hghly dsaggregated sectoral specfcaton. Therefore, t was adopted the same procedure used n Cury (1998, p ), whch departed from the elastctes estmated by Holand-Holst, Renert and Shells (1994) to the Amercan economy. 14 Actually, ths utlty maxmzaton can happen along the consumers lfetme. From the pont of vew of most practcal applcatons, the maxmzaton s on the goods and servces avalable n a gven perod. Est. econ., São Paulo, 35(4): , out-dez 2005

7 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul 745 where M ndcates the mported volume of good, and D s the consumpton of the domestc good. a c and δ are parameters and ρ c s the elastcty of substtuton between D and M, whose values were taken from Tournho et al. (2002), who estmated these Armngton elastctes for the same sectors consdered n the model. Fnally, Q s an ndcator of the utlty derved from the consumpton of good, but t also can be nterpreted as a quantty of a hypothetcal composte good, whch adds mported and domestc goods. Ths composte good s what the consumers would demand. There s also a demand for domestc goods n the nternatonal market where agents react to changes n relatve prces as well. In a form analogous to that specfed for mport demand, the demand for exports arses from a CES utlty functon whch represents the mperfect substtuton between Brazlan products and products from the rest of the world. Frms Frms contrbute n two ways for product demand. Frst, they satsfy ther requrements of ntermedate nputs necessary to the productve process. Ths demand s determned by the techncal coeffcents from the nput-output matrx. Due to the statc nature of accumulaton n the captal market, nvestments are mportant for product demand. As for the case of consumpton, the nvestment s characterzed as the purchase of certan goods. In ths case, nvestment would be a type of fnal consumpton undertaken by frms. Savngs represent ths amount of resources, and we assume that a share of t corresponds to nvestment n stocks of fnshed goods, whle the remanng share corresponds to the avalable amount requred to purchase the fnal goods that must be used to expand producton. The frst share s defned based on a fxed proporton of the sector output, whle the second share s dstrbuted exogenously among the dfferent sectors, reflectng nformaton from the nput-output tables (goods by sector of orgn) and the matrx of sectoral composton of captal (goods by sector of destnaton and orgn). As mentoned before, t s beng consdered that the nvestment goods are beng produced but not consdered as ncrements of captal stock. Thus, the model closure s closer to a medum-run type: constant captal stock, prce flexblty and exstence of nvoluntary unemployment n equlbrum. Government We assume that government consumpton (GC) s derved from maxmzaton of a Cobb-Douglas utlty functon subject to the budgetary restrcton correspondng to the total expendture that s fxed accordng wth the total amount regstered for the base year. Est. econ., São Paulo, 35(3): , out-dez 2005

8 746 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl 2. THE LABOR MARKET As we have already seen, labor s modeled as a producton factor used by frms. Ths factor s classfed nto 7 types, reflectng dfferent forms of nserton n the labor market (contract status) and schoolng. 15 We assume that the frms am at maxmzng profts takng the prce of nputs, producton factors and output as gven. The frms also consder the technologcal constrants mposed by the producton functon specfed before. Therefore, as a result of ths maxmzaton, the wages for each type of labor equalze ther respectve margnal productvty so that a demand curve for each type of labor s defned by: 16 P X / F = W l l (6) As mentoned before, our alternatve to ncorporate nvoluntary unemployment n the equlbrum conssts of nteractng the demand for labor wth the wage curve. Ths curve s a statstcal regularty or emprcal 'law' of economcs orgnally reported by Blanchflower and Oswald (1990, 1994) that s descrbed by a negatvely sloped curve lnkng the employees wages to the unemployment rate n ther regon (or ndustry). The causalty s thought to run from the unemployment rate to wages and the curve emerged from mcroeconometrc earnngs equatons estmaton on large and comparable data sets for ffteen developed countres. 17 The wage curve mplemented n the model represents the negatve relaton between the unemployment rate (U l ) and the wage level (W l ) for the each type of labor l n Brazl, and that can be descrbed by the followng equaton: 18 lnw = α β lnu l l l (7) 15 The labor treatment that follows s appled for the 5 types of prvate labors. The 2 types of publc workers follow the tradtonal labor market closure of CGE models wth ether wage or employment beng fxed. Therefore, there s no substtuton between publc servants and the prvate knds of labor, n the sectors where there s no publc companes. In the sectors where publc and prvate frms coexst, the changes n the publc-prvate composton of labor are related to the changes n the publc-prvate composton of the sectoral representatve frm. 16 The dervatve of the proft functon n relaton to the demanded quantty of each factor must be equal to the factors prce (frst order condton). 17 The estmated curve held after controllng for workers' personal and demographc characterstcs, for regonal characterstcs, and for macroeconomc and other aggregate nfluences, and presented very smlar curvature of the functon n each of the ffteen countres n whch the curve has been found. Bhalotra (1993) and Hoddnot (1993), apud Blanchflower and Oswald (1994), found smlar results for Inda and Cote d Ivore, respectvely. 18 Another specfcaton of the wage curve that already was ncorporated to nterregonal CGE models. Ths specfcaton captures the relatonshp between regonal unemployment rates and regonal wage levels. See the specfcaton of the AMOS model (see Ferguson et al., 2003). Est. econ., São Paulo, 35(4): , out-dez 2005

9 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul 747 Blanchflower and Oswald (1994) also present the theoretcal foundatons that justfy the exstence of wage rgdty, that s, bascally effcency wages or unon barganng. Accordng to the frst theory, the frm tends to motvate an effcent behavor by means of attractve wages. However, when the unemployment rate s hgh, the worker feels threatened of losng hs job and tends to be naturally effcent and the frm does not need to offer an attractve wage. In an alternatve way, frms may feel pressured to rase wages when unemployment s low, as the barganng power of workers ncreases under ths stuaton. In sum, we can nterpret the wage curve as a frm s wage determnaton polcy that takes nto consderaton the competton among workers to occupy a job vacancy. When ths competton s hgh (hgh unemployment rate), the frm can offer a relatvely low wage. The senstveness of ths movement s gven by the parameter β, whose values were taken from Res (2002), who presents ther econometrc estmatons for the Brazlan case. The form n whch the wage curve operates n the labor market equlbrum determnaton can be vsualzed n the fgure below. 19 Pont E 0 represents the full employment equlbrum n a market affected only by supply (L o ) and demand (L d ). Wth the ntroducton of the wage curve (S), the equlbrum levels of employment and wages s determned by E, the ntersecton pont between the demand curve and the wage curve. The wage level defned by E does not correspond to the labor supply, and the dfference s the excess supply of labor that corresponds to the unemployment level n the economy. FIGURE 1 EQUILIBRIUM IN THE LABOR MARKET FOR A GIVEN TYPE OF LABOR W S E' E 0 L d L L o 19 In order to represent the relaton n axs L, W we must have n mnd that U = (L o L)/L o. Est. econ., São Paulo, 35(3): , out-dez 2005

10 748 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl Note that the labor market closure s not formulated by sector, but rather by type of labor. 20 Therefore, the adjustment mechansm s from the aggregate to the sectoral level. After an economc shock, frst, we have the defnton of the aggregate levels of employment, wages and unemployment for each type of labor by the nteracton of ther aggregate demand, aggregate supply and wage curves, as explaned earler. To defne the employment and wage levels n each sector, t s necessary to assume an addtonal behavoral rule n the labor market. The labor market specfcaton s complemented, therefore, by assumng that the wages of a gven type of worker are dfferentated by sector n the model, whch mples, n practcal terms, n sectoral mperfect segmentaton n the labor market (for example, a formal worker wth average qualfcaton employed n the mechanc/automoble sector receves a larger wage than a worker wth smlar schoolng degree and contract status would receve n the clothng sector). 21 In ths sense, there s mperfect moblty of workers among sectors and, thus, the sectoral wage dfferentals wll not be elmnated, that s the wage equalzaton among sectors can not be acheved, by means of the mgraton of workers from sector(s) payng low wages to sector(s) payng hgher wages. The mechansm used n ths process s the ncluson of an exogenous varable for relatve wage dfferentals among the sectors. Thus, from the average wage for each type of labor (w l ), we can determne the wage of each knd of worker n each sector (w l ). Wth ths nformaton, by means of a sector and labor type specfc demand curve (equaton 6), we can also determne the sectoral employment level of each type of labor (F l ), whch are aggregated by a Cobb-Douglas functon (equaton 1) to defne the sector s composte labor THE MECHANISMS OF INCOME TRANSFER In ths block of the model, we take nto consderaton the formaton of ncome flows receved by famles, frms, government, and the rest of the world. Ths process encompasses two parts: the defnton of the dstrbuton of the value added n the pro- 20 The same apples for labor supply. 21 The hypothess mplct n the adopted mechansm s that workers wth smlar observed productve characterstcs (schoolng and contract status) are pad n a dfferent way accordng to ther sector of employment/occupaton. The dea s to capture the fact that, although the mentoned smlartes, the workers have another characterstcs such as professon type and sector specfc tranng/qualfcatons that do not permt ther free moblty to all other sectors but also do not completely constran ther moblty to some other sectors. Pnhero and Ramos (1995) have not only proven ths fact but also demonstrate that t s stable along the tme. 22 In ths sense, the substtuton of a specfc type of worker, the change of ts share n the sectoral aggregated labor, depends of the changes n the amounts F l. Est. econ., São Paulo, 35(4): , out-dez 2005

11 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul 749 ductve process (prmary ncome dstrbuton) and the transfers among the mentoned agents (secondary ncome dstrbuton). The frst part conssts n attrbutng to frms the remuneraton of captal and to workers the remuneraton of labor. It s worth mentonng that the model consders two types of frms: small (self-employed people) and large (other frms). In each sector, the payments to captal are dstrbuted to the frms accordng to the ntal proporton n the total earnngs of captal. Thus, the large frms receve a hgher share of ths payment, whle the small frms receve the remanng parcel. The dstrbuton of the earnngs of the seven types of labor to the eght types of famles s made accordng to the ntal dstrbuton of these workers by famles. The share of ncome of each type of worker that goes to famly h s gven by the proporton of ths type of labor that s n ths type of famly (ε hl ). Famles also receve the remuneraton of captal transferred by frms (large and small), YK. The dstrbuton among each type of famly s gven by the famly h s proporton n each of these ncome flows (matrx ε hk ). Besdes these remuneratons, the net remttances from abroad (R Eh ), adjusted by the exchange rate (R), and the share of transfers made by the government and drected to the famles (TG), complete the determnaton of the household ncomes. Ths last transfer s made n two alternatve ways: as payment of benefts n the form of drect ncome transfers, 23 and as other transfers from the government to famles (essentally domestc debt nterest). The sharng of these resources among the dfferent types of famles n the model s fxed accordng to the proporton observed n 1996 (θ ht for the government transfers). Therefore, the ncome of the famly h can be represented as follows: Y = ε W + ε YK + pndexθ TG+ R RE h hl l hk ht h (8) Note that the government plays a very mportant role n the process of determnaton of secondary ncome. Besdes the transfers to famles mentoned above, the government also drects a share of ts transfers to frms 24 under the form of nterests on the domestc debt and consumes products n the way descrbed n the prevous secton. As n the case of famles, the sharng of government transfers by type of frms follows the proportons observed n the base year (θ k ). Fnally, the government also transfers resources abroad (GE) and government expendtures can be represented as follows: 23 These transfers nclude the socal securty benefts as well as other programs such as unemployment benefts, ncome transfer socal programs and other cash benefts. 24 The same apples for labor supply. Est. econ., São Paulo, 35(3): , out-dez 2005

12 750 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl GG = CG + pndex. ( θ ht + θ k). TG + R. GE (9) To face all the mentoned expendtures, the government reles on three types of collectons. Frst, there are drect taxes leved on frms and famles that correspond to a fracton of these agents ncome (φ h and φ k, respectvely). There are ndrect taxes leved on domestc and mported goods, whch are proportonal to the produced (X) and mported (M) amounts. The government also receves transfers from abroad (gfbor) and, fnally, there s the balance of the socal securty system (SOCBAL). 25 Thus, the Government total revenue s gven by: φ RG =. Y h +. Y. K +. X + κ. M + R. PR + SOCBAL h φ k ξ j (10) An eventual lack of government resources s defned as a government defct that, together wth prvate (from frms and famles) and foregn savngs, defnes the amount of resources spent n the form of nvestments. 4. CHECKING THE HOMOGENEITY HYPOTHESIS Due to the partculartes of ths model that tres to explore the complex ncome flows among the nsttutons, the usual property of homogenety of degree zero n CGE models can no longer be vald, f at least one transfer flow s not ndexed by the prce ndex. In practcal terms, ths property means that the real varables are mmune to a homogeneous shock n prces. 26 By ntuton, ths result arses from the fact that relatve prces reman unchanged. As the reacton of agents n both markets (goods and factor) n ths type of model s a functon of relatve prces, there are no reasons to beleve that agents wll change ther behavor after a shock that changes all prces n the same proporton. The model expands substantally the number of redstrbutve transactons. In that way, t s necessary to check the valdty of the homogenety restrcton due to ts mportance for the results nterpretaton. From a theoretcal pont of vew, the soluton would 25 In fact, socal securty s treated as an agent apart from the Government n the model, not only because of the consderable amount of resources that t handles n Brazl, but also because of the contrbutons that t apples on ether the company s ncome (here agan n a dfferent form), or on the nstallments of the added value of labor. 26 Gnsburgh and Keyzer (1997) puts the theoretcal ssue on homogenety n the followng form: In any problem of optmzaton nvolvng producers and consumers, the substtuton of vector p, the equlbrum prce, by λp, wth a λ scalar greater than zero, results n the nomnal varaton of the producers proft, but does not alter ther decson; on the other hand, for consumers, both sdes of the budget restrcton are modfed, wthout varyng the set of possble optons. Therefore, as the preferences are not modfed, the optmal decson s not affected. Est. econ., São Paulo, 35(4): , out-dez 2005

13 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul 751 be to ndex all the ncome transfers wth a general prce ndex. Thus, from an operatonal pont of vew, we ndex the governmental drect transfers to the remanng resdent people n the country wth the model s prce ndex, and wth the nomnal exchange rate all the ncome flows wth the rest of the world. Nevertheless, an emprcal test s necessary, as the complexty of the operatonal detals of our extensons could have yelded devatons from the theoretcal result. Thus, from an emprcal pont of vew, the checkng of ths hypothess s made by changng the model s numerare-prce. In our specfc case, ths smulaton took the form of doublng the exchange rate and then checkng the effects on prces and quanttes. Actually, the results of ths smulaton ndcate that there was no change n the set of real varables (quanttes; see Appendx 1). For the prces, there was a complete duplcaton and, consequently, n all nomnal magntudes n the model. Thus, we have opted for ths model specfcaton that attends the homogenety property. The counterpart of ths procedure s to assume that all the ncome flows that we have modeled are perfectly ndexed; a phenomenon that may not occur n the real world due to nformaton problems and/or dstrbutve conflcts. 5. SIMULATING A TRADE POLICY SHOCK The mpacts of alternatve trade polces n the Brazlan economy have largely been evaluated by the usage of CGE models, focusng on the analyss of the mpacts on producton and employment, gven the fact that the country has been nvolved n dscussons related to trade block agreements and broader negotatons under the WTO negotatons. 27 The man exogenous varables, whose values are, n practce, defned by the Brazlan trade polcy, are the mport tarffs. In 1990, the trade lberalzaton process was accelerated and so, n order to not smulate an arbtrary polcy, we wll smulate a partal closure of the Brazlan economy by mposng the 1990 s mport tarff levels. Then, the smulaton results can be nterpreted as beng the famles welfare changes n the absence of the tarff lberalzaton process observed from 1990 to The objectve of ths smulaton s to evaluate whch would be the dstrbutve mpacts n Brazl at 1996 (base year) f the economy present the tarff structure of 1990, whch s presented n Table 1 below: 27 Bonell and Hahn (2000) and Castlho (2002) present surveys of these studes. Other recent study that has evaluated these mpacts s Haddad et al. (2002). Est. econ., São Paulo, 35(3): , out-dez 2005

14 752 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl TABLE 1 AVERAGE NOMINAL TARIFF (%) Sector Agrculture and Lvestock 5,9 7,3 Mneral Extracton 9,6 3,7 Coal and Ol Extracton 3,3 - Non-Metallc Mnerals 31,5 10,5 Metallurgy 14,5 7,8 Non-Iron Metallurgy 17,6 8,8 Other Metallurgc Products 34,8 15,9 Machnes and Tractors 37,2 15,5 Electrcal Materal 44,1 17,2 Electronc Equpment 40,6 15,6 Automobles, Trucks and Buses 78,7 52,4 Parts and Other Vehcles 37,4 16,1 Wood and Furnture 25,4 11,0 Paper and Publshng 23,6 10,3 Rubber 46,6 12,5 Chemcal Elements 24,8 6,5 Ol Refnery 19,4 4,1 Other Chemcal Products 21,8 7,8 Pharmaceutcals and Perfumes 31,5 8,0 Plastc Items 39,0 15,2 Textles 31,8 16,3 Apparel 51,1 19,8 Shoes 29,6 15,3 Coffee Industry 28,9 12,0 Vegetal Products Processng 34,6 12,0 Anmal Slaughter 19,7 9,2 Dary Products 32,7 18,9 Sugar Industry 25,7 16,0 Vegetal Ols 16,6 8,4 Other Food Products 45,0 15,1 Mscellaneous Industres 41,6 13,5 Smple Average 30,5 13,0 Source: Kume et al. (2000) In relaton to the role of these varables n the Brazlan trade polcy, t s worth mentonng that ths polcy covers a range of nstruments that goes beyond the tarffs. There s a seres of non-tarff barrers that mght have substantally affected the country s n- Est. econ., São Paulo, 35(4): , out-dez 2005

15 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul 753 ternatonal trade flows. 28 In ths sense, the smulated polcy s the reconsttuton of the tarff structure and not the rebuldng of the complete trade barrers structure prevalng n 1990, whose mpacts would possbly be larger than n the prevous case, snce the non-tarff barrers n ths year were hgher than n Another feature of the mplemented smulatons s that the results reflect the nternal mpacts from the unlateral tarff polcy change, whch are, at most, a lttle dfferent from the ones that would be obtaned wth a mult-country model, whch also take n account the external sde of these mpacts. Ths happens because n a sngle-country model the external regons are not modeled, n the sense that the model database does not present ther economc matrces, and, therefore, the feedbacks from them are not captured. Snce Brazl s a small country, even though the effects presented here do not capture all the mpacts, they capture the all the nternal mpacts, whch correspond to the stronger effects and to the larger part of the total mpacts. In ths sense, the changes n the Brazlan economy due to the polcy smulated n ths research would not cause sgnfcant effects n the rest of the world, especally n the case of only Brazlan unlateral tarff lberalzaton. Thus, also, we beleve that the sngle-country model employed s well-suted to analyze the mpacts of the Brazlan external tarff lberalzaton and, even the partal closure scenaros are stylzed, they offer a useful benchmark for assessng the potental dstrbutve mpacts. Before we comment on the results, t s worth mentonng how the smulated polcy affects the labor market ndcators n the model. In general, the tarffs rse affects the productve structure that, by ts turn, affects the demand for the dfferent types of workers. The transmsson mechansms present n these changes are shown n Box 1. BOX 1 TRANSMISSION MECHANISMS OF THE CHANGE IN THE TARIFF ON THE DEMAND FOR LABOR Tarff Demand for Domestc Goods (a) Labor Demand ( ) Resources Avalable for the Government Government Consumpton (b) Prvate Consumpton va Government Transfers (c) Labor Demand Investment va Government Savngs (d) 28 Among the hstorcally more relevant non-taxable barrers, there are the mposton of quotas, the specfcaton of mnmum prces for mported goods and the pror lcensng, wth complex bureaucratc procedures. Est. econ., São Paulo, 35(3): , out-dez 2005

16 754 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl The hgher tarffs, on one hand, nduce consumers to substtute mported goods by domestc goods because they become relatvely cheaper than the former ones. On the other hand, the external demand for domestc goods can fall due to possble valuaton of the real exchange rate and prce ncrease of mported nputs. At the other source of demand, the government can ether ncrease or decrease ts revenue collectons wth the tarffs rse, dependng on the fall n consumpton of mported goods vs-à-vs the larger tax levy per product. In ths case, the government s forced to ncrease ether ts expendtures or ts savngs. In ths case, the demand for domestc goods would be altered. Wth changes n expendtures, government consumpton and the level of transfers to famles would also change. In the case of changes n savngs, the amount avalable for savngs would change, that n the model would mean a change n the demand for goods. Therefore, the effect on the demand for labor s unknown a pror. The demand for each type of labor, by ts turn, wll also depend on whch sectors have benefted the most from the mport substtuton and on whch sectors have been affected the most by the change n government consumpton or famly transfers. Based on the nformaton dsplayed n Box 1, we can say that the effect on labor demand depends on a combnaton of the mpacts (a), (b), (c) and (d). It s mportant to stress the need of an adequate nterpretaton of the smulaton results so that they can be consdered for polcy evaluaton. It s beng evaluated only the dstrbutve effects of the reconsttuton of the 1990 s tarff structure, n envronments wthout and wth the changes n the external captal flows, that s, f these were the only changes occurred n the country. Obvously, the Brazlan economy experenced other macroeconomc and nsttutonal changes durng the consdered perod, as the reducton or complete removal of non-tarff barrers, technologcal change, labor productvty ncrease and the Real stablzaton plan and the effects of Mexcan fnancal crses. In ths sense, the comparson of the smulated mpacts wth observed facts could not produce accurate conclusons, because these facts resulted from the nteracton of many changes n the country, of course, ncludng the smulated ones. Est. econ., São Paulo, 35(4): , out-dez 2005

17 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul Results and Analyss of Tarff Rse Smulaton TABLE 2 SIMULATING AN IMPORT TARIFFS RISE Percentage Change n Employment Total Formal Informal Sklled Unsklled Total -0,405-0,413-0,577-0,137-0,536 Tradtonal Tradable -2,240-1,821-2,713-0,948-2,407 Modern Tradable 0,357 0,330 0,485 0,173 0,414 Non-Tradable 0,117-0,070 0,337-0,090 1,594 Table 2, above, reports the mpacts on the level and the structure of employment followng the tarff shock smulaton. The table reveals that the reacton to the mport tarff rse would be a declne of less than 0.5% n aggregate employment. Although relatvely small, ths change ponts to a negatve balance n the generaton of employment, and as such, ths result contradcts those who support polces that protect the domestc frms. Concernng to the grouped sectors above, we notce that the negatve effect on aggregate employment s due to the declne of employment n tradtonal tradable sector (see the frst column of the table). In our nterpretaton, wth lower mports there wll be a pressure to overvalue the exchange rate that wll tend to make exports more expensve, whch wll be renforced by an ncrease n nput prces used to produce exported goods. The sectors n whch exports are more sensble to prce changes are the most tradtonal ones. Thus, by exportng less, there would be a tendency for these sectors to produce less and, therefore, to employ less workers. Regardless the economc sector and consderng only the type of labor, the results are more homogeneous n the job contract status dmenson (type of nserton n the labor market), snce both wll tend to present modest reducton n the employment level. On the other hand, one can notce an employment reducton concentrated among the unsklled workers. TABLE 3 SIMULATING AN IMPORT TARIFFS RISE Percentage Change n the Average Wage Worker 1 Worker 2 Worker 3 Worker 4 Worker 5 Worker 6 Worker 7 Total -0,673-0,522-0,483-0,724-0,007-0,587-0,76 Note: l1- unsklled nformal; l2- sklled nformal; l3 - formal wth low skll; l4 - formal wth average skll; l5 - formal wth hghly sklled; l6 - low sklled publc servant; l7- hghly sklled publc servant. Est. econ., São Paulo, 35(3): , out-dez 2005

18 756 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl As regards the wages, t s worth rememberng that, n the model, the sectoral wage dfferentals are rgd. Thus, the wage structure can only react to the type of labor. As a consequence, we report, n Table 3, the changes n real wages for each type of worker wthout any sector desegregaton. Note that the general effect s a real wage fall. Among the nformal workers, the man losers would be the less sklled, and for the formal ones, the man losers would be the unsklled and the average sklled. The formal hgh-sklled workers present a dfferentated result snce ths type of workers does not seem to have ther real wages affected, actually, becomng benefcary of ths polcy and confrmng the same type of behavor observed for the level of employment. The hgh reducton of publc servants remuneraton s due to the fact that ther employment levels are fxed n the model; thus, the total effect goes to ther salares. TABLE 4 SIMULATING AN IMPORT TARIFFS RISE Percentage Change n Household Income Famly 1 Famly 2 Famly 3 Famly 4 Famly 5 Famly 6 Famly 7 Famly 8-0,512-0,229-0,452-0,458-0,478-0,428-0,5-0,462 Note: f1 - poor urban famles headed by actve ndvduals, f2 - poor urban famles headed by nonactve ndvduals, f3 - poor rural famles, f4 - urban famles wth low average ncome, f5 - urban famles wth average ncome, f6 - rural famles wth average ncome, f7 - famles wth hgh average ncome, f8 - famles wth hgh ncome. Table 4 shows that all types of households have ther ncomes affected by the mport tarff rse. The results show ncome falls that range between 0,229 (f 2 poor household headed by an nactve member) and 0,512 (f 1 poor urban household). These results demonstrate two factors: the least affected household s the one wth a lower dependency on labor ncome, and the largest fall s observed for the poorest type of household. In the Brazlan economy, the labor ncome has a large weght n the generaton of the household ncome. Nevertheless, ncome transfers have an mportant partcpaton, manly for the poor households through the socal securty benefts and the socal programs of drect transfers, and, n the case of rch households, through nterest rate transfers and retrement pensons receved from the publc sector. Therefore, despte the fact that the results partally reflect these characterstcs, they are lmted by the dentcal ndexaton of these transfers, whch smoothes possble larger adjustments n the household ncome. Est. econ., São Paulo, 35(4): , out-dez 2005

19 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul An Alternatve Smulaton Wth Trade Polcy and Captal Flow Shocks In ths alternatve smulaton, we reproduce the former smulaton addng a dfferent value for external drect nvestment through the net flow of captal account. In ths way, we mplemented the values verfed n 1990 for the tarffs on mports and the external drect nvestment level, whch was 34% lower than n the base year. The smulaton results can be nterpreted as beng the famles welfare changes n the absence of the external lberalzaton process. 29 As an answer for ths combned movement, the trade defct would have a forced reducton of 56 % due to the fall of mports (around 10 %) and the ncrease of exports (around 3,5 %). 30 Despte the exogenous mplementaton of the new captal flow, we beleve that ths hypothess s very consstent wth a closed economy movement that reduces the level of captal nflows, as verfed n the Brazlan economy before the recent process of external lberalzaton. TABLE 5 SIMULATING AN IMPORT TARIFFS RISE AND CAPITAL INFLOW REDUCTION Percentage Change n Employment Total Formal Informal Sklled Unsklled Total -0,982-0,857-1,185-0,671-1,092 Tradtonal Tradable 0,767 0,913 0,628 1,887 0,657 Modern Tradable 1,267 1,298 1,065 1,233 1,284 Non-Tradable -1,776-1,604-2,077-1,115-2,075 Table 5, above, shows the employment varatons. There s a total fall of 0,982%, whch s larger than n the former smulaton. However, the type of adjustment s totally dfferent. Now, the losers are the non-tradable sectors due to a fall of nvestment and of household consumpton of servce goods. Constructon and Famly Servces are the actvtes wth man decreases n employment. On the other hand, the results for the tradtonal tradable sectors are no longer negatve. The man reason s that exports wll ncrease to compensate the decrease of captal nflows. Anyway, the most benefted sectors stll would be the modern tradable protected by hgher tarffs, such as chemcal and automoble ndustry. 29 Not consderng the effects of the non-tarff barrers changes. 30 Comparng wth the former smulaton, we have export ncreases nstead of reducton. Est. econ., São Paulo, 35(3): , out-dez 2005

20 758 A Computable General Equlbrum Model to Analyze Dstrbutve Aspects n Brazl Independently of the economc sectors, the employment reducton s more concentrated on nformal and unsklled workers confrmng the unequal tendency of jobs reducton. TABLE 6 SIMULATING AN IMPORT TARIFFS RISE AND CAPITAL INFLOW REDUCTION Percentage Change n the Average Wage Worker 1 Worker 2 Worker 3 Worker 4 Worker 5 Worker 6 Worker 7 Total -1,229-1,587-0,972-1,639-0,681-1,696-1,684 Note: l1-unsklled nformal; l2-sklled nformal; l3-formal wth low skll; l4-formal wth average skll; l5- formal wth hghly sklled; l6- low sklled publc servant; l7- hghly sklled publc servant. Analyzng Table 6, we realze that there are a generalzed loss of real wages. As n the prevous smulaton, the hgher reducton of publc servants remuneraton occurs because ther employment s fxed n the model and so, the total effect goes to salares. The dfferentated mpact among labor groups seems to compensate the loss of quanttes (jobs). Anyway, t s evdent that a polcy to reduce the trade defct, through mport tarffs, causes a reducton at total labor expendture. Lookng to labor groups n the prvate sector, we see that the major decreases are for formal wth average sklls (type 4) and sklled nformal (type 2). The reason for ths dfferentaton can be the effect of the wage curve that arbtrates between loss of jobs or loss of real wages. TABLE 7 SIMULATING AN IMPORT TARIFFS RISE AND CAPITAL INFLOW REDUCTION Percentage Change n Household Income Famly 1 Famly 2 Famly 3 Famly 4 Famly 5 Famly 6 Famly 7 Famly 8-1,791-0,553-1,866-1,522-1,268-1,413-1,176-1,176 Note: f1 - poor urban famles headed by actve ndvduals, f2 - poor urban famles headed by nonactve ndvduals, f3 - poor rural famles, f4 - urban famles wth low average ncome, f5 - urban famles wth average ncome, f6 - rural famles wth average ncome, f7 - famles wth hgh average ncome, f8 - famles wth hgh ncome. The analyss of household ncome allows a better dentfcaton of whch group s more affected by ncludng all the effects n quanttes and prces together. The man losers Est. econ., São Paulo, 35(4): , out-dez 2005

21 Samr Cury, Allexandro Mor Coelho, Carlos Henrque Corseul 759 are the rural poor (type 3) and urban poor (type 1) famles. On the other hand, the households wth smaller losses are the non-actve urban poor (type 2) and hgh-ncome (type 8) famles. These two groups share an mportant characterstc: ther ncomes have a sgnfcant partcpaton of non labor ncome, such as socal securty benefts for the frst and cvl servants socal securty benefts and captal nterest for the second Senstvty Analyss Fnally, to test our results aganst mportant model parameters, we have performed a smulaton combnng the tarff rse wth a 10% ncrease of CES mport elastctes for all tradable sectors. Appendx 2, reported results replcate Tables 3 and 4 (prevously presented), wth and wthout elastctes changes, showng that the resultng magntudes are sensble for these parameters but they do not change the drectons and herarchy of results among labor groups. CONCLUSION In ths paper, we have nvestgated the effect of a change n the external polcy on some ndcators related to socal welfare. More precsely, we have estmated how the structures of wages and employment, as well as the dstrbuton of household ncome would react to an mport tarff rse back to the levels observed n the Brazlan economy n Also, these reactons were nvestgated n an envronment characterzed by tarffs rse together wth a declne n captal nflows. Despte the modest aggregate effects for employment and wages, the reactons are dfferent for each type of worker. The effects on the employment structure have been slghtly more pronounced. The tradable sectors that employ unsklled workers more ntensvely presented falls n employment n our mport tarff rse smulaton. When we mplemented the second smulaton, wth reducton of captal nflow, the sgnfcance of results were ncreased, renforcng the reducton of total ncome amount that was approprated for all dfferent group of workers. From a dstrbutve pont of vew, two hypotheses deserve attenton. Concernng the wage structure, we have mposed rgdty n the wage dfferentals by sector of actvty. Therefore, one would expect greater reactons n the employment levels rather than n the wages. 31 Agan we emphasze that the same ndexed factor s used to correct all types of ncome flows. Est. econ., São Paulo, 35(3): , out-dez 2005