An introduction to computable general equilibrium modelling for regional and environmental analyses

Transcription

1 An introduction to computable general equilibrium modelling for regional and environmental analyses Course delivered at the Regional Research Institute, University of West Virginia, August 2009 Dr Karen Turner ESRC Climate Change Leadership Fellow Department of Economics, University of Strathclyde ESRC ref: RES

2 Course overview 1. Introduction to multi-sectoral accounting and modelling Input-Output analysis (Monday 9-11am) 2. Introduction to CGE modelling (1) Databases, calibration and specification (Monday 11.30am-12.30pm) 3. Introduction to CGE modelling (2) - Application: the single region, 3-sector AMOS model for Scotland, 1998, and introduction to Workshop 1 (Monday pm) 4. Workshop 1 AMOS worksheet: simulating fiscal policy (Tuesday 9-11am) 5. Review of AMOS fiscal policy simulations (Tuesday 11am-12.30pm) 6. Extending and developing the AMOS framework to model increases in energy and labour productivity and introduction to Workshop 2 (Tuesday pm) 7. Workshop 2 Simulating increased labour efficiency (Wednesday 9am-12pm) 8. Extending and developing the AMOS framework to model the interregional impacts of increases in labour productivity (Wednesday 12-1pm) 9. Using the AMOSUK interregional framework to demonstrate the value added from using CGE analysis to model the impacts of a simple demand shock on economic and environmental indicators (Wednesday 2-3pm)

3 1. Introduction to multi-sectoral accounting and modelling Input-Output analysis Monday 10 August, 9-11am

4 Input-output tables What is an Input-Output Table? Records flows of inputs and outputs into individual sectors of the economy Inputs intermediate goods, imports, labour, other property services, taxes and subsidies Outputs Intermediate demand, consumption, exports, tourism, government, investment, stock

5 1998 Scottish IO - 3-sector IxI Purchases by Sector Group (at basic prices): Final consumption expenditure: Manufacturing Non-Mfr Sheltered Sales to Total Final Gross output Traded ID Local Capital External Demand (Total Demand) Manufacturing Non-Manufacturing Traded Sheltered Total Intermediate Inputs Imports Net product & production taxes Income from Employment Other Value Added Total Primary Inputs TOTAL INPUTS Total employment (000 FTE) Empoyment-output coefficients (th/ 1m)

6 Sectoral gross value-added Composition of GDP GDP at basic and market prices Reconciliation income, output and expenditure measures of GDP

7 Social Accounting Matrices (SAMs( SAMs) IO tables give us value of goods and services produced i.e. generation of income But distribution of income? Extend IO tables to show income transfers income actually accruing to local residents Total income and expenditure GNP and GDP GNP = GDP plus transfers of income earned abroad by local residents minus income earned locally by foreign residents

8 SCOTTISH SAM (1998, million) Tourist Other Net. Commd. Manuft. Non-manu.tSheltered Households Corporate GovernmentCapital Stocks Expend RUK ROW Labour Value Added Tax Total Manuft Non-manu.t Sheltered RUK Goods and Services Transfers ROW Goods and Services Transfers Net commodity taxes Labour Other Value Added Sales by final demand Households Corporate Government Capital Total

9 History of input-output Francois Quesnay ( ) Physiocrat Tableau Économique Table showing how each part of the economy serves and is compensated by each of the others Wassily Leontief (Harvard) 1930s Nobel Prize for Economic Science 1973 Modern SNA (UN) Also, basis for accounting and modelling frameworks used for empirical general equilibrium analyses (Leon Walras, )

10 Input-Output tables as regional and national accounts Links for IO (and SAM) UN SNA UK National Statistics Scottish Government

11 Different formats of IO tables Supply and Use Tables (purchaser prices) Analytical IO tables Producer prices (basic prices) Symmetric IxI or CxC Appropriate for analytical purposes multiplier analyses and modelling

12 Analytical IO tables Quantities in value terms Basic/producer prices Example of single entry accounting 4 quadrants Balancing identities: Sectoral gross input = gross output Total intermediate demand = total intermediate expenditure Total primary demand = total final expenditure Aggregate gross input = gross output

13 1998 Scottish IO - 3-sector IxI Purchases by Sector Group (at basic prices): Final consumption expenditure: Manufacturing Non-Mfr Sheltered Sales to Total Final Gross output Traded ID Local Capital External Demand (Total Demand) Manufacturing Non-Manufacturing Traded Sheltered Total Intermediate Inputs Imports Net product & production taxes Income from Employment Other Value Added Total Primary Inputs TOTAL INPUTS Total employment (000 FTE) Empoyment-output coefficients (th/ 1m)

14 IO attribution and modelling analysis (1) Convert the IO accounts/tables into an economic model. Assumptions Regional IO models typically used for 3 primary forms of analysis: 1. identification of the ultimate source of regional economic activity 2. measurement of the interdependencies and interactions 3. impact analyses

15 IO attribution and modelling analysis 1&2 -attribution analysis; 3 - modelling or marginal analysis IO makes a key distinction between sales to intermediate and final markets sales to final markets exogenous sales to intermediate markets endogenous Particular causal sequence imposed Exogenous final demands drive endogenous intermediate demands Transmission mechanism multipliers

16 IO multiplier analyses Concept of multiplier Keynes IO facilitates multiplier analysis at sectoral level Distinguish direct, indirect and induced effects (Type I and Type II) Construct Leontief inverse or multiplier matrix Assumptions about average technologies input-output coefficients

17 Conventional demand-driven IO model (1) Output in each sector = sum intermediate and final demand. For our 3x3 (ixj, i=j) table: (1) X 1 = x 1,1 + x 1,2 + x 1,3 + Y 1 X 2 = x 2,1 + x 2,2 + x 2,3 + Y 2 X3 = x3,1 + x3,2 + x3,3 + Y3 Input-output coefficients: ai,j = xi,j/xj

18 Conventional demand-driven IO model (2) (2) X 1 = a 1,1 X 1 + a 1,2 X 2 + a 1,2 X 3 + Y 1 X 2 = a 2,1 X 1 + a 2,2 X 2 + a 2,3 X 3 + Y 2 X 3 = a 3,1 X 1 + a 3,2 X 2 + a 3,3 X 3 + Y 3 (3) (1-a 1,1 )X 1 a 1,2 X 2 a 1,3 X 3 = Y 1 a 2,1 X 1 (1-a 2,2 )X 2 a 2,3 X 3 = Y 2 a 3,1 X 1 a 3,2 X 2 (1-a 3,3 )X 3 = Y 3

19 Conventional demand-driven IO model (3) In matrix notation: (3) [I-A]X = Y Key equation: (4) X = [I-A] -1.Y [I-A] -1 is the Leontief inverse column totals give us the OUTPUT MULTIPLIERS

20 A-MATRIX (input coefficients) Manufacturing Non-Manufacturing Sheltered Household Traded Expenditure Manufacturing / = Non-Manufacturing Traded Sheltered Income from Employment I MATRIX Manufacturing Non-Manufacturing Sheltered Household Traded Expenditure Manufacturing Non-Manufacturing Traded Sheltered Income from Employment I-A MATRIX Manufacturing Non-Manufacturing Sheltered Household Traded Expenditure Manufacturing Non-Manufacturing Traded Sheltered Income from Employment

21 TYPE I LEONTIEF INVERSE Manufacturing Non-Manufacturing Sheltered RECREATING BASE ESTIMATED ACTUAL Traded FINAL CONSUMPTION GROSS OUTPUT GROSS OUTPUT Manufacturing Manufacturing Non-Manufacturing Traded TIMES Non-Manufacturing Traded EQUALS Sheltered Sheltered TYPE I OUTPUT MULTIPLIERS TYPE II LEONTIEF INVERSE Manufacturing Non-Manufacturing Sheltered Household RECREATING BASE ESTIMATED ACTUAL Traded Expenditure FINAL CONSUMPTION GROSS OUTPUT GROSS OUTPUT Manufacturing Manufacturing Non-Manufacturing Traded Non-Manufacturing Traded Sheltered Sheltered Income fromemployment Income from employment TYPE II OUTPUT MULTIPLIERS (i) TYPE II OUTPUT MULTIPLIERS (ii)

22 Type I and II multiplier analysis Type I multipliers capture direct plus indirect effects inter-industry (backward linkages) rounds of multiplier Household consumption treated as an exogenously determined final demand expenditure Conventional to endogenise household consumption, by moving out of vector of final demand and into Leontief inverse Type II multipliers capture direct plus indirect plus induced effects consumption and income effects Other possibilities e.g. endogenise trade and capital formation; activity driven by local final consumption demand

23 IO attribution analysis IO a snapshot picture of the economy for a given point in time (accounting period 1 year) Use multipliers to carry out descriptive analysis of structure of economic activity during that period Based on average technologies in A-matrix E.g. Type I manufacturing multiplier of 1.41 tells us that for every 1 of final demand for manufacturing output, 1.41 of output was generated in all 3 production sectors What share of total output, GDP and/or employment was supported by demand for manufacturing outputs? What share of total output, GDP and/or employment was supported by export demand for manufacturing outputs?

24 Ecological or carbon footprints Example of use of IO for attribution analysis Common to extend IO tables for environmental variables Pollution or resource use in physical units (as with employment) Partial application of Leontief (1970) pollution model Full Leonfief pollution model examines resource implications of dealing with pollution feasibility of internalising negative externality of pollution? Attribution of pollution generation in local economy to final demands that drive activity But in a single region analysis some pollution attributed to external demand, no account taken of pollution embodied in imports Use of inter-regional or multi-region environmental IO analysis to account for emissions from a consumption perspective e.g. carbon footprints; wide range of accounting perspectives

25 Average and marginal analyses (1) Accounting structure of the economy in the accounting period (IO as a snapshot ) E.g. Scottish production attributable to external consumption demand in the year the IO table are reported for: (5) X E = [I-A] -1.Y E Multipliers as a tool for average analysis

26 Average and marginal analyses (2) Modelling impact of a change in exogenous final demand E.g. An increase in external consumption demand: (6) ΔX = [I-A] -1.ΔY E Multipliers as a tool for marginal analysis Latter subject to restrictive assumptions: 1. Universal Leontief technology 2. No supply constraints

27 Extended IO method e.g. employment Output-employment coefficients (7) ei = Ei/Xi where Ei is the number of FTE workers employed in sector i E.g. Employment, E, attributable to external consumption demand: (8) EE = ei[i-a] -1.YE Output-employment multipliers: ei[i-a] -1 E.g. An increase in external consumption demand: (9) ΔE = ei[i-a] -1.ΔYE

28 IO Modelling example 20% increase in government final consumption (part of local exogenous final consumption demand) in 3-sector Here, for simplicity, assume same pattern as in base case sector Scottish IO tables

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35 IO Modelling assumptions Passive supply Supply-driven IO demand passive Silent on prices Price IO silent on quantities Universal Leontief (fixed proportions) technology Output rises by X%, use of all inputs rises by X% No response to changes in relative prices Short-run excess capacity? Long-run equilibrium (once all supply constraints relaxed)? Adjustment process?

36 IO as a long-run equilibrium model (1) Relax assumptions of universal Leontief technology and passive supply computable general equilibrium (CGE) Take a CGE and assume all constraints on supply are relaxed in long-run IO results may be recreated as a long-run equilibrium Crowding out and price changes in short-run, but, once all factor markets have adjusted, there will be no change in real prices

37 IO as a long-run equilibrium model (2) Only where appropriate to assume that the supply-side is able to fully adjust through capital accumulation and factor mobility Appropriate assumption for regional economies? Only in cases of pure demand-side shocks If we have changes in supply-side behaviour/relationships, long-run impacts on prices Generally, IO not appropriate for modelling supply-side disturbances

38 Developing CGE models using IO/SAM databases (1) We can augment the demand side provided by the I-O model to accommodate a corresponding supply-side (and more theory-consistent demand behavour) for each sector and for the economy as a whole, and incorporate dynamics SAM data plus additional information on labour market and investment demands A Computable General Equilibrium (CGE) model allows us to do this can easily capture constraints on capacity of each sector in the short-run and on total labour supply wages and competitiveness explicitly modelled dynamics through updating labour supply due to migration (if any) and sectoral capacity updated by sectoral investment

39 Developing CGE models using IO/SAM databases (2) The CGE therefore significantly adds to what I-O can do: supply and demand both captured and matter generally both simultaneously determine prices and quantities though I-O results would still apply under some circumstances (IO models are in fact a special case of CGEs, with simple supply and technology assumptions and so linearity) Theoretical basis Walrasian general equilibrium theory, but no longer limited to classical economy (market clearing etc)

40 2. Introduction to CGE modelling (1) databases, calibration and specification Monday 10 August, 11.30am-12.30pm

41 Indicative reading Pyatt, G. and J.I. Round (1985) eds. Social Accounting Matrices: A Basis for Planning, The World Bank, Washington, D.C., U.S.A. Reinert, K. A. and D. W. Roland-Holst (1997) Social Accounting Matrices, J. F. Francois and K. A. Reinert (eds), Applied Methods for Trade Policy Analysis: A Handbook, Cambridge University Press, Cambridge Devarajan, S., Go, D.S., Lewis, J.D., Robinson, S. and P. Sinko (1997), Simple General Equilibrium Modelling in J.F. Francois and K. A. Reinert eds. Applied Methods for Trade Policy Analysis, Cambridge University Press, Cambridge. Greenaway, D., Leybourne, S.J., Reed, G.V. and J. Whalley (1993), Applied General Equilibrium Modelling: Applications, Limitations and Future Developments, HMSO, London.

42 The basics and essentials Applied/computable general equilibrium analysis involves simulating numerically the general equilibrium structure of the economy. Basic theoretical framework: the Walrasian general equilibrium system Essential feature: Supply equals demand in all markets at a set of relative prices that can be identified In practice, general equilibrium models are not restricted to the conventional Walrasian model of perfect competition. The essential assumption is that an equilibrium for the economy exists and it is unique

43 The key issues/steps in CGE model development Greenaway et al (1993) give a succinct outline of the key issues in laying out the structure of a general equilibrium model (first step in any CGE analysis) 1. Dimensionality the level of sectoral disaggregation of total economic activity (i.e. the number of products/production sectors and factors of production) 2. General specification of key relationships (including functional form) supply and demand equations (including the interdependencies and interactions between sectors) 3. Collection of benchmark data to model the benchmark case/initial equilibrium 4. Calibration of the model s parameters to that data set while key parameter values will be pre-specified, calibration involves choosing the remaining parameter values so that the model can reproduce the data set as an equilibrium solution

44 The key issues/steps in CGE model development Once the structure is in place the model is solved for general equilibrium. Then: equilibrium relationships and interdependencies can be traced and examined counterfactual equilibria can be computed for exogenous changes questions of policy evaluation, including distributional effects, can be addressed. The CGE framework is a very flexible one, so it is useful to go through these issues for a particular type of application e.g. IO

45 The key issues/steps in CGE model development Dimensionality What and how many sectors from the IO accounts should be identified in the model? Data collection. Data on sectoral demand and supply, factor use and rewards, total GDP etc are collected to build the transactions table last week. This forms the benchmark equilibrium data set. Choice of functional form To move from accounting (transactions/io tables) to IO modelling, the conventional basic IO assumption is that: (1) X ij = a ij X j where aij is a constant. What this tells us is that IO assumes fixed technical coefficients in production: Leontief technology. Thus, all IO relationships are of a fixed linear form, and are not subject to any supply constraints. Calibration to benchmark equilibrium Calibration to the base year equilibrium involves specifying the value of some parameters and running the model so that it recreates base year, solving for all unknown parameters This is done for IO through the key equation: X=[I-A] -1 Analysis using model. With the model calibrated for the benchmark equilibrium, in the case of IO, exogenous demand changes (e.g. 20% increase in government expenditure) can be specified, counterfactual equilibria can be computed, and policy appraisal carried out based on comparison between the counterfactual and benchmark equilibria.

46 Core CGE database the Social Accounting Matrix, SAM From this morning, IO table augmented with information on income transfers between aggregate transactors (households, firms, government, external sector(s), capital account Construct a set of income-expenditure accounts Balance manually (retain integrity of initial, published, IO table)

47 Schematic Structure of a Basic SAM Expenditure by Production Activities Institutions Factors of Production (the I production sectors) H C G CF E Labour (L) Capital (K) Income to Production T U Activities Institutions: H C G V W X CF E Factors of Production : L Y (Value Added) K

48 Template for constructing income-expenditure expenditure accounts Income Expenditure Income from employment (H)* IO final demand expenditure Income from OVA* (incl expend taxes)* Net commodity taxes (G)* Payments from corporations** Payments to corporations ** Payments from government** Payments to government** Payments from households** Payments to households** Transfers from UK** Transfers to UK** Transfers from REU** Transfers to REU** Transfers from ROW** Transfers to ROW** Payments to capital (savings)***

49 IN C O M E -E X P E N D IT U R E A C C O U N T S - S C O T L A N D Households Incom e 68, Expenditure 68, Incom e from em ploym ent 38,396 IO expenditure 42,812 Profit incom e (O VA ) 3,036 Paym ents to corporations 6,139 Incom e from corporations 13,883 Paym ents to governm ent 12,950 Incom e from governm ent 10,528 Paym ents to capital 6,122 Transfers from RUK 2,180 68, , SE S total Scot exp Corporations Incom e 27, Expenditure 27, Profit incom e (O VA) 17,892 Paym ents to households 13,883 Incom e from households 6,139 Paym ents to governm ent 5,080 Incom e from governm ent 1,536 Transfers to RUK 3,266 In c o m e fro m R U K T ra n s fe rs to R O W 3,3 9 9 In c o m e fro m R E U n /a P a ym e n ts to c a p ita l (s a vin g s ) 1,6 1 0 Incom e from R O W , , G o v e r n m e n t Incom e 33, Expenditure 33, Profit incom e (O VA ) 1, IO expenditure N et com m odity taxes 10, Paym ents to corporations 1, Incom e from households 12, Paym ents to households Incom e from corporations 5, Transfers to R U K 3242 Incom e from R U K 3, Transfters to R O W 0 In c o m e fro m R O W P a ym e n ts to c a p ita l (s a vin g s ) , G ER S total exp C a p ita l Incom e 11, Expenditure 11, H ouseholds 6, IO expenditure Corporate 1, G ovt R U K/R O W 3, , External U K incom e from Scotland 37, U K expenditure in Scotland G oods & Services 30, G oods & Services Transfers 6, Transfers R O W incom e from Scotland 20, R O W expenditure in Scotland G oods & Services 17, G oods & Services Transfers 3, Transfers Tourist expenditure in S cotland Total incom e 58, Total expenditure 55, Surplus/deficit

50 SCOTTISH SAM (1998, million) Tourist Other Net. Commd. Manuft. Non-manu.tSheltered Households Corporate GovernmentCapital Stocks Expend RUK ROW Labour Value Added Tax Total Manuft Non-manu.t Sheltered RUK Goods and Services Transfers ROW Goods and Services Transfers Net commodity taxes Labour Other Value Added Sales by final demand Households Corporate Government Capital Total

51 Additional Data Requirements for CGE The IO table and SAM contain information on which sectors outputs are used for the purposes of capital formation. However, what they do not tell us is which sectors the demand for this capital formation comes from, so require (even estimated) investment demand data (we base on share other value-added, payments to capital, in base year) IO tables tend to also report FTE employment by sector This is sufficient labour market data for a demand-driven general equilibrium model like IO. However, for a more flexible CGE framework with an active supply-side, more information is required on supply conditions in the labour market. We also require data on on the structure of the aggregate labour market, such as base year working age population, participation rate and unemployment. Prices of labour, capital; some prices indexed to 1

52 CGE model specification CGE modelling more difficult to generalise than IO modelling: CGEs characterized by huge variety of model types Heterogeneity of views of supply-side, of technology Nonetheless, it is possible to identify some common features: Theoretial roots in Walrasian GE theory Elements of model construction Motivated by an attempt to shed light on key aspects of economic policy

53 Common theoretical antecedents Schematic of a typical CGE reminiscent of simplest micro circular flow diagram, often characterized by disaggregation of households and industries/commodities all commodity and factor markets clear simultaneously factor prices and employment levels just sufficient to generate incomes and demands that equal commodity supplies Formal CGE theory initially: assumed universal perfect competition focused on providing existence of equilibrium in exchange and then production economies

54 Existence of equilibrium typically taken as given Contemporary CGE modelling Solved routinely without Scarf-type algorithms software developments C++, GAMS etc CGEs different degrees of imperfect competition now e.g. development; monopolistic competition, public economics CGE requires simultaneous equilibrium in all markets Flows? Source of supply and demand in each type of market? can be complex many goods and factor markets; other transactors: government, ROW; possible imperfections in markets

55 CGE model specification and calibration As with IO, we must decide What sectors/activities/transactors we want to identify (dimensionality/specification) For CGE also macroeconomic closure Development models often assume Keynesian closure and involuntary unemployment (large excess capacity) Many models assume full employment - e.g. NAFTA studies Closure matters!! Models may have range of alternatives Degree of competition Perfect competition still common in public economics Monopolistic competition and returns to scale (Dixit/Stiglitz) commonly assumed in trade models Dynamic models Intertemporal or recursive dynamic Single country/region and multi-country/region

56 Parameterisation and calibration (1) Also require data to inform parameters/calibration IO just the A-matrix CGE more complex, but rooted in economic theory E.g. utility maximizing hhs and profit maximising/cost minimising firms Need to specify/estimate functional forms and parameters (may involve nonlinearity) Common use of hierarchical production and consumption structures (separability assumptions)

57 Three ways parameters are determined Parameterisation and calibration (2) 1. By base year data (e.g. labour intensity = sectoral FTE employment /sectoral output) structural parameters (change with structure of economy) 2. Exogenously imposed e.g. estimated/informed elasticities of substitution in production, price elasticity of demand etc key parameters 3. Calibrated solve for unknown parameters

58 Parameterisation and calibration (3) Calibration is normally to base year SAM Values of key parameters identified first Ideally, econometric estimation of individual relationships by modeler or external (secondary) Then all remaining parameters determined through reconciliation to base year SAM Features of calibrated models source of criticism assume no errors or omitted variables and estimate parameters on a single observation no statistical measure of goodness of fit

59 Parameterisation and calibration (4) However: Complete econometric estimation of CGE models not yet feasible and few pure econometric models Can conduct sensitivity analysis (not only parametric also model closures) Can accommodate benefits of econometric estimation where available Particularly key parameters (e.g. current work on AMOS Chicago, UK energy model) Model uses should reflect nature (recognise no precise point estimates) Indeed, focussed and systematic sensitivity analysis can help develop theoretical understanding (e.g. current work using Scottish and UK energy CGE models to understand rebound effects of increased energy efficiency)

60 Model solution Complex algorithms won t go into here but can purchase software such as GAMS for this (choices of solver) Compare to IO linearity means [I-A] -1 Leontief inverse is all required

61 Analysis using CGE models Common motivating feature of CGEs: analyzing and evaluating the impacts of policies But also other (non-policy) disturbances e.g. energy CGEs in 1970s; resurgence from 90s to address climate change issues Policies addressed include regional, environmental, development and structural policies Effects on economy, energy, environment often overall welfare impacts Model dimensionality and specification will depend both on the target economy and the type of problem(s) it is designed to analyse E.g. AMOS CGE modelling programme at FAI and Economics, University Strathclyde

62 3. Introduction to CGE modelling (2) Application: the single region, 3-sector 3 AMOS model for Scotland, 1998 Monday 10 August, pm

63 Basic reading AMOS summary paper (document WVU course Aug 09_AMOS summary paper ), which is based on Harrigan, F., McGregor, P.G., Dournashkin, N., Perman, R., Swales, J.K. and Yin, Y.P. (1991) AMOS: A macro-micro model of Scotland, Economic Modelling, Vol.10, pp

64 Dimensionality/model specification (1) The initial AMOS framework incorporates: 3 transactor groups households, firms and government 3 commodities and activities manufacturing (M), non-manufacturing traded (NMT), and non-traded/sheltered (NT) 2 exogenous external transactors for the case of Scotland (or any UK region), these are the rest of the UK (RUK) and the rest of the world (ROW) There are four main components of final demand: 1. (Household) consumption, which is a linear homogenous function of real disposable income. 2. Investment is treated in various ways, dependent upon the particular model closure that is chosen:

65 Dimensionality/model specification (2) In the short- and medium-run the capital stock and its sectoral composition are fixed so that, even where investment is endogenous, capital stocks are not updated. In long-run equilibrium investment for each sector is endogenous and equal to depreciation with sectoral capital stocks set at their desired, cost-minimising levels. In the multi-period variant of the model, investment in each period is equal to depreciation plus some fraction of the gap between actual and desired capital stock

66 Dimensionality/model specification (3) 3. Government expenditure, which is taken to be exogenous, or can be made endogenous linked to changes in income tax 4. Exports, where exports and imports are determined via an Armington link, making them relative price sensitive. The Armington trade substitution elasticity determined by the model user (or informed by econometric work). User can choose between perfect and imperfect competition and between different macroeconomic and labour market closures

67 Database IO tables augmented with other data for SAM Here (teaching model), 1998 Scottish IO tables (aggregated) augmented with other data for SAM

68 Parameterisation/calibration Production and consumption structures fixed until recently (varying in current research with energy model) but option varies across application in terms of functional forms, parameter values etc Figure 1 Production Structure In The Basic (3-sector) AMOS Framework GROSS OUTPUT INTERMEDIATES VALUE-ADDED ROW composite UK composite LABOUR CAPITAL RUK composite LOCAL composite Comm. j = 1 3

69 Production in AMOS (1) In all model configurations cost-minimisation in production is imposed multi-level production functions generally of constant elasticity of substitution (CES) form so there can be input substitution in response to relative price changes but with Leontief and Cobb-Douglas (CD) available as special cases. In the CES functions, elasticities of substitution, σ, as with all parameter values, can be set for individual applications according to econometric or best guess estimates.

70 Production in AMOS (2) The production inputs are labour (L), capital (K) and intermediates (J), with a choice between locally produced intermediate commodities and imports from RUK or ROW. The prices of the intermediate goods that make up the intermediate composite are required. All local input prices are endogenous to the system All import prices are exogenous. The precise nature of the intermediate composite, J, depends on relative prices and the possibilities for substitution between different sources and types of intermediate input at each level. The precise form of the wage equation depends on what type of labour market regime is assumed to exist.

71 Regional labour markets in AMOS (1) One of the key features of the AMOS framework is that it incorporates five alternative labour market closures. The specification of the wage equation in each is fairly standard: 1. Neo-classical/continuous market clearing. Here the wage adjusts so as to equate labour demand and labour supply. 2. Keynesian/national bargaining. The nominal wage is exogenously determined at the regional level. The motivation for this would generally be a national bargaining regime. The aggregate labour supply function is suspended up to full employment. 3. Real wage resistance. The real wage is fixed - i.e. the nominal wage is a mark up on the consumer price index.

72 Regional labour markets in AMOS (2) 4. Exogenous labour supply. A fixed proportional relationship exists between employment and working population (this is often taken to be the closure for national CGE models). 5. Regional wage bargaining (also referred to as the bargained real wage, BRW, closure). The regional consumption wage is directly related to workers bargaining power and inversely related to the regional unemployment rate via a bargained real wage function. Note that this closure does imply that local wages are flexible in that they respond to the local excess demand for labour.

73 Dynamics AMOS can be run as a recursive dynamic model Capital stock updating Each sector's capital stock is updated between periods via a simple capital stock adjustment procedure According to which investment equals depreciation plus some fraction of the gap between the desired level of the capital stock and its actual level Labour market/population The regional economy is initially assumed to have zero net migration (as in the short-run in the static model), and ultimately, net migration flows re-establish this (long-run) population equilibrium. Net in-migration in any one period is taken to be positively related to the regional real wage differential in the target region relative to the national economy and negatively related to the regional unemployment rate This migration model is based on that in Harris and Todaro (1970) (LNJ, 1991)

74 An illustrative practical application of AMOS - lead into Workshop 1 A simple application value-added from CGE relative to IO in modelling a demand disturbance Scotland: very small, very open economy Shock: 20% step increase in total government expenditure, pattern unchanged Model Assume BRW closure Migration possible and investment fully endogenous (i.e. no long-run supply constraints) Perfect competition and no macroeconomic constraints i.e. BOP passive and, initially, no government budget constraint Now go to the document titled WVU course Aug 09_CGE_AMOS_workshop

75 4. Workshop 1 AMOS worksheet: simulating fiscal policy Tuesday 11 August, 9-11am Refer to worksheet in document WVU course Aug 09_CGE_AMOS_workshop

76 5. Review of AMOS fiscal policy simulations Tuesday 11 August, 11am-12.30pm

77 An illustrative practical application of AMOS - Fiscal policy simulations Start with a simple application value-added from CGE relative to IO in modelling a demand disturbance Scotland: very small, very open economy Shock: 20% step increase in total government expenditure, pattern unchanged Model Assume BRW closure (initially) Migration possible and investment fully endogenous (i.e. no long-run supply constraints) Perfect competition and no macroeconomic constraints i.e. BOP passive and, initially, no government budget constraint Then we introduce a binding constraint so that the income tax rate in Scotland has to rise to fund the additional expenditure (i.e. income tax passive) in the Workship 1 exercise you simulated an increase in income tax with government expenditure passive

78 Increase in government expenditure - scenarios Take 2 basic cases: 1. Leontief technology in all production and consumption functions (except trade parameters too inflexible: solution problem) 2. Some substitution possible in all parameters (CES = 0.3 for local and 2.0 for trade) We also examine a third and fourth case 3. As 2, but with a binding government budget constraint income tax rises to fund increased expenditure 4. As 3, but assume national rather than regional wage bargaining in UK

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81 Cases 1 and 2 discussion of results (1) Both reach the same long run result i.e. when all supply constraints are fully relaxed Increase in all quantities (sectoral outputs, employment and value added, total investment, consumption and GDP) except exports No change (relative to base) in prices sectoral output prices, CPI, wages But how did the economy adjust to this result?

82 Fig 1. Impact on sectoral output of a 20% increase in government expenditure after 5 years Case 1 Manufacturing Case 2 Manufacturing Case 1 Non- Manu Traded Case 2 Non- Manu Traded Case 1 Sheltered Case 2 Sheltered Sector/case % change from base

83 Cases 1 and 2 discussion of results (2) Initially, we observe crowding out The sheltered (non-traded) sector, which receives the largest direct demand effect, draws labour, capital and other inputs away from the other two sectors Capital and labour cannot adjust straight away (though they are elastic over time through investment and migration of labour) This is reflected through increases in prices the economy only adjusts to long-run equilibrium when supply relaxes sufficiently to allow prices to adjust to their initial levels

84 Cases 1 and 2 discussion of results (3) With Leontief technology the negative effects of increase prices are smaller because producers cannot switch away from inputs that are relatively more expensive As a result, the economy adjusts to long-run equilibrium more quickly with Leontief technology but note that, here, even in the partial Leontief case, the economy only tends toward long-run equilibrium (zero change in prices) after a long time, still not quite making it after 30 years

85 Impact of a 20%increase in government expenditure on CPI and wages (Leontief case) 5 Impact of a 20%increase in government expenditure on wages and CPI (CES) % change from base Nominal before-tax wage Real T-H consumption wage Consumer price index Period (year) % change from base Nominal before-tax wage Real T-Hconsumptionwage Consumer price index Period (year)

86 Cases 1 and 2 discussion of results (4) Full activity increase will not be realised until supply constraints are fully relaxed and there is no upward pressure on prices Note that during the period of adjustment, the rise in prices has negative competitiveness effects This causes export demand to fall in the long run, when we see them at base year levels, this is due to the zero change in prices This must be of interest to policymakers (whose timeframe is likely to be much less than years)

87 Impact on total export demand from a 20% increase in government expenditure % change from base % change in export demand (Leontief) % change in export demand (CES) Period (years)

88 Cases 1 and 2 discussion of results (5) So, even with a pure demand shock, we are likely to get a supply-side response, except in conditions of huge excess supply Also, is the assumption of universal Leontief technology realistic i.e. no price induced substitution in production and consumption? Elasticities of substitution may be difficult to measure but is it better to assume zero? Not theory consistent! But, leaving this aside, the assumption of passive supply is a very strong one What if there is a direct supply-side disturbance? For example, so far we haven t discussed how an increase in government expenditure would be financed.see Case 3

89 Case 3 discussion of results (1) Case 3 assumes CES technology (but qualitatively results would be no different if we assumed Leontief) This time, we set the model up so that income tax is passive here it adjusts to ensure that the increase in government expenditure is matched by an equal increase in tax revenues (qualitatively the same as the worksheet simulation only difference there is you have specified the tax rate and allowed expenditure to change endogenously) This will happen when a government budget constraint applies Note that we do NOT get IO results in the long-run i.e. even when all supply constraints are eventually relaxed, prices do not return to their pre-shock levels Why not? The supply side of the economy has changed Workers seek to bargain to restore their previous real take home consumption wage. Therefore, a permanent increase in before tax wage ( tax-shifting onto employers)

90 Impact of a 20% increase in goverment expenditure on real wages (balanced budget) % change from base Real B-Tx consumption wage Real T-H consumption wage Period (years)

91 Case 3 discussion of results (2) See full results for Case 3 and 4 below For workers to maintain their original take-home real wage (purchasing power), there is a lasting impact on the supply side of the economy Note that while unemployment returns to its initial rate, the levels of unemployment and employment fall A balanced-budget fiscal expansion here actually leads to a big contraction in activity! Why? Adverse supply shock through the hike in pre-tax wages, but during adjustment, fall in real wages induces outmigration. Note the fall in working population Scotland s real take home pay relative to the rest of the UK falls initially, so workers leave there is net out-migration This outweighs beneficial demand effect associated with Keynesian BB multiplier However, note assumption of BRW closure

92 Case 4 discussion of results (1) If instead assume national bargaining closure: Essentially IO results (though combination of a reduction in C and increase in T) there is a fall in take-home wage, but all other prices return to base levels. In this case workers simply accept the cut in their real take home wage. no negative competitiveness effects, because no attempt to shift tax incidence net in-migration due to net increase in activity levels (gross out-migration due to increased taxes) fall in umemployment rise in all aggregate activity except household consumption Importance of labour market closure

93 Impact of a 20% increase in government expenditure on real wages (national bargaing, balanced budget) Real B-Tx consumption wage Real T-H consumption wage % change from base Period (years)

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96 Alternative fiscal simulations Workshop 1 results NB The rise in the income tax rate that would be required here is more than the + or 3 pence in the pound that the Scottish Parliament can introduce It may be interesting to look at this problem from the other side what change in government expenditure is possible within the powers of the Parliament this is what you have simulated in Workshop 1 There we noted that you could also take into account whether private households value government expenditure as a substitute for their own private expenditure in contrast to what is assumed here Discussion of your simulation results?

97 6. Extending and developing the AMOS framework to model increases in energy and labour productivity and introduction to Workshop 2 Tuesday 11 August, pm

98 Modelling increased energy efficiency in a CGE modelling framework: rebound, backfire and disinvestment effects Session 6 in Course delivered at the Regional Research Institute, University of West Virginia, August 2009 (Tuesday 11 August, pm) Dr Karen Turner ESRC Climate Change Leadership Fellow (ESRC ref: RES ), Department of Economics, University of Strathclyde The research reported in this session has been funded under the ESRC First Grants Programme, Ref: RES

99 Energy-Economy-Environment CGE modelling (1) Policy concerns: Energy supply issues (from 1970s); impacts of changes in economic conditions and/or policy on environmental/sustainability indicators (renewed interest early 90s) Sustainability and climate change global and local concerns UK regional and national focus Supply-side issues Modelling energy use in production (KLEM; energy-capital substitutability etc) Energy and/or carbon taxation Resource productivity, energy efficiency Changes in technology Demand-side issues Nature and structure of energy demand and use Elasticity of energy demand

100 Energy-Economy-Environment CGE modelling (2) Requirements for energy-economy-environment modelling: Multi-sectoral modelling Different energy-use and pollution generation characteristics of different production and consumption activities Link physical energy use and pollution generation to economic activity System-wide Interaction between different production and consumption activities

101 Energy-Economy-Environment CGE modelling (2) Bergman, L. (1988) Energy Policy Modelling: a Survey of General Equilibrium Approaches, Journal of Policy Modelling, 10, pp Bergman, L. (2005) CGE Modelling of Environmental Policy and Resource Management, Chapter 24 in Mäler and Vincent (eds) Handbook of Environmental Economics, Volume 3: Economywide and International Environmental Issues, Elsevier, North Holland. Conrad, K. (1999) Computable General Equilibrium Models for Environmental Economics and Policy Analysis, in J.C.J.M. van den Bergh ed. Handbook of Environmental and Resource Economics, Edward Elgar Publishing Ltd, Greenaway, D. Leyborne, S., Reed, G., Whalley, J. (1993) Applied General Equilibrium Modelling: Applications, Limitations and Future Developments, HMSO, London.

102 AMOSENVI CGE modelling programme (1) Project commissioned by the States of Jersey from the Fraser of Allander Institute: Programme to provide a regional database and IO and CGE models of Jersey (PIs: Peter McGregor and Kim Swales) Turner, K. (2002), Modelling the impact of policy and other disturbances on sustainability policy indicators in Jersey: an economic-environmental regional computable general equilibrium analysis, Ph.D. thesis, University of Strathclyde. The importance of the regional/local dimension of sustainable development: an illustrative computable general equilibrium analysis of the Jersey economy by D. LEARMONTH, P.G. MCGREGOR, J.K. SWALES, K.R. TURNER and Y.P. YIN, Economic Modelling, Vol.24, pp , The additional precision provided by regional-specific data: the identification of fuel-use and pollution generation coefficients in the Jersey economy by K.R. TURNER, Regional Studies, Vol. 40, No.4, pp , 2006.

103 AMOSENVI CGE modelling programme (2) ESRC-funded project, Modelling the impact of sustainability policies in Scotland, ESRC Grant No. R PIs: P. G. McGregor, J. K. Swales and N.D. Hanley (University of Glasgow) Incorporating sustainability indicators into a computable general equilibrium model of the Scottish economy, by P.G. MCGREGOR, I. H. MCNICOLL, J.K. SWALES, K.R. TURNER and Y.P. YIN, Economic Systems Research, Vol. 17, No.2, pp , The impact of a stimulus to energy efficiency on the economy and the environment: a regional computable general equilibrium analysis by N.D. HANLEY, P.G. MCGREGOR, J.K.SWALES and K. TURNER, Renewable Energy, Vol. 31, pp , The impact of increased efficiency in the industrial use of energy: a computable general equilibrium analysis for the United Kingdom, by G. ALLAN, N.D. HANLEY, P.G. MCGREGOR, J.K.SWALES and K. TURNER, Energy Economics, Vol. 29(4), pp , Do increases in energy efficiency improve environmental quality and sustainability? by N.D. HANLEY, P.G. MCGREGOR, J.K.SWALES and K. TURNER, Ecological Economics, 68,

104 AMOSENVI CGE modelling programme (3) Project under ESRC First Grants Initiative: An empirical general equilibrium analysis of the factors that govern the extent of energy rebound effects in the UK economy. October 2007 September [ESRC Reference: RES ]. PI: Karen Turner Negative rebound and disinvestment effects in response to an improvement in energy efficiency in the UK Economy, by K. TURNER, Energy Economics, proofs in press doi:10:1016/j.eneco Results reported in this presentation are extracted from this paper. Rebound and disinvestment effects in refined oil consumption and supply resulting from an increase in energy efficiency in the Scottish commercial transport sector by S. ANSON and K. TURNER, accepted to Energy Policy, April Do productivity improvements move us along the Environmental Kuznets Curve? by K. TURNER, N.D. Hanley and J. De Fence, submitted to Environmental and Resource Economics, February A computable general equilibrium analysis of the relative price sensitivity required to induce rebound effects in response to an improvement in energy efficiency in the UK economy by K. TURNER, submitted to Economic Systems Research, April 2009.

105 AMOSENVI environmental component N-sector identify sectors with distinct energy supply/use and/or pollution generation characteristics Initial version (Jersey project) emphasis on pollution generation Leontief ouput-pollution coefficients Captures changes in pollution due to scale and composition effects But not due to input substitution and technology effects Current version (ESRC projects): KLEM production structure Input- and output-co 2 coefficients

106 Figure1. Production structure of each sector i in the 25 sector/commodity AMOSENVI KLEM framework GROSS OUTPUT INTERMEDIATES VALUE-ADDED ROW composite UK composite LABOUR CAPITAL RUK composite LOCAL composite ENERGY composite NON-ENERGY composite Non-energy comm. j = 1.20 ELECTRICITY NON-ELECTRICITY composite composite RENEWABLE NON-RENEWABLE (comm j=24) (comm j=25) OIL (comm j=22) NON-OIL composite COAL GAS (comm j=21) (comm j=23)

107 The rebound effect Jevons (1865) confusion of ideas regarding productive use of fuel and diminished consumption increase utility, impact on implicit prices Rebound and backfire effects see e.g. Khazzoom 1980; Brookes 1990; Herring, 1999; Birol and Keppler, 2000; Saunders, 1992, 2000a,b; Schipper, 2000 Initial UK Policy context House of Lords (2005) Assessment of evidence by UKERC Sorrell (2007) Direct, indirect and economy-wide rebound effects, production and consumption

108 General equilibrium analysis E.g. Semboja, 1994,; Dufournaud et al, 1994; Grepperud and Rasmussen, 2004; Glomsrød and Wei, 2005; Hanley et al, 2006, 2009; Allan et al, 2007 ESRC funded project: An empirical general equilibrium analysis of the factors that govern the extent of energy rebound effects in the UK economy, Oct 2008-Sept 2010 Main finding so far importance of supply-side response to changes in energy prices Wei (2007) and Saunders (2008) theoretical prediction of rebound effects that are bigger in long-run than in short run due to increased productive capacity Turner (2009), Anson and Turner (forthcoming Energy Policy, 2009) negative rebound and disinvestment effects Wei (2009) development of theoretical analysis emphasising importance of supply-side

109 Defining the rebound effect (1) If there is energy augmenting technical progress at a rate ρ, the relationship between the percentage change in physical energy use, and the energy use measured in efficiency units is given as: (1) ε = ρ + E Impact on price, measured in efficiency units: (2) p =p ε E ρ

110 Defining the rebound effect (2) With physical energy prices constant, we expect a fall in the price of energy in efficiency units to generate an increase in the demand for energy in efficiency units : (3) ε = ηp ε Change in energy demand in natural units can be found by substituting equations (2) and (3) into equation (1), giving : (4) E=( η 1) ρ

111 Defining the rebound effect (3) For an efficiency increase of, rebound, R, expressed in percentage terms, is defined as: : (5) (6) E R = ρ R = η 100 Defining boundaries of the efficiency change: (7) E R = 1+ T 100 αρ

112 General equilibrium price elasticity of demand for energy 0 (perfectly inelastic) Rebound effect 0% Implication for energy efficiency improvement All of the energy efficiency improvement is reflected in a fall in the demand for natural energy units. 0 to 1 (relatively inelastic) 1 (unitary elasticity) 0 100% 100% Some of the energy efficiency improvement is reflected in a fall in the demand for natural energy units, but partly offset by increased (direct and derived) demand for energy as effective and/or actual energy prices fall. The reduction in energy demand from the efficiency improvement is entirely offset by increased demand for energy as prices fall. > 1 (elastic) >100% The energy efficiency improvement leads to an increase in the demand for energy in natural units that outweigh the reduction in demand from the efficiency improvement. Such a phenomenon is labelled as a backfire effect.

113 General equilibrium responses to increased efficiency 1. Efficiency effect 2. Substitution effect 3. Output/competitiveness effect 4. Composition effect 5. Income effect 6. Disinvestment effect

114 The disinvestment effect Previous rebound research focus on demand response to changing energy prices Price falls direct and derived demands for energy rise However, where actual energy prices affected (e.g. local energy supply) Price falls if quantity demanded does not rise sufficiently to offset decline in revenue, profitability falls (more inelastic demand larger drop in price) Return on capital decreases in energy supply Shedding of capital stock disinvestment Energy supply becomes more inelastic, energy prices rise Constrains size of rebound effect

115 UKENVI 3 internal transactor groups (households, firms, government), plus Rest of World 25 commodities/sectors, including 5 energy sectors (coal, refined oil, gas, two electricity) Capital labour energy materials (KLEM) production structure using multi-level CES production functions. Assumes cost minimisation. Calibrated to 2000 UK SAM Recursive dynamic investment = depreciation plus proportion of difference actual and desired capital stock, where desired capital stock determined on cost minimisation criteria and reflects changing profitability at sectoral level Labour market wage bargaining

116 Production structure of each sector in the 25 sector/commodity UKENVI framework GROSS OUTPUT INTERMEDIATES VALUE-ADDED ROW composite UK composite LABOUR CAPITAL ENERGY composite NON-ENERGY composite ELECTRICITY composite NON-ELECTRICITY composite Non-energy comm. j= RENEWABLE (comm. j=24) NON-RENEWABLE (comm. j=25) OIL (comm. j=22) NON-OIL composite COAL (comm. j=21) GAS (comm. j=23)

117 Energy efficiency shock Permanent, exogenous (and costless) 5% increase in energy augmenting technological progress Initially targeted at all 25 production sectors Rebound calculated as R E 1 T = αρ Distinguish electricity and non-electricity energy use, focus on local energy supply and total domestic use

118 Table 2. The aggregate impact of a 5% increase in energy efficiency (locally supplied inputs) in all production sectors in the UK economy (Percentage changes from base year equilibrum) - Base Case Scenario Short-run Long-run GDP (income measure) Consumption Investment Exports Imports Nominal before-tax wage Real T-H consumption wage Consumer price index Total employment (000's): Unemployment rate (%) Total population (000's) Total consumption UK electricity Electricity rebound effect (%) Total consumption UK non-electricity energy Non-electricity energy rebound effect (%)

119 Figure 4. Impact on capital rental rates in the UK energy supply sectors of a 5% increase in energy efficiency in all production sectors (% change from base) Coal (Extraction) Oil processing and nuclear refining Gas Electricity - Renewable (hydro and wind) Electricity - Non-renewable (coal, nuke and gas) Period/year

120 Figure 5. Impact on UK energy supply sector capital stocks of a 5% increase in energy efficiency in all production sectors (% change from base) Coal (Extraction) Oil processing and nuclear refining Gas Electricity - Renewable (hydro and wind) Electricity - Non-renewable (coal, nuke and gas) Period/year

121 Figure 6 Percentage change in UK local energy supply prices in response to a 5% improvement in energy efficiency in all production sectors (applied to locally supplied energy) - (% change from base) COAL (EXTRACTION) OIL (REFINING & DISTR OIL AND NUCLEAR) GAS Electricity - Renew able (hydro and w ind) Electricity - Non-renew able (coal, nuke and gas) Period/year

122 Disinvestment effects Wei (2007) and Saunders (2008) rebound bigger in long run than in short run because positive supply shock leads to expansion in set of production possibilities Here, true for non-energy supply sectors Crucial for theoretical predictions Wei (2007) assumes fixed/exogenous return on capital If profitability falls as local energy prices fall, return on capital in local energy supply falls, leading to contraction in capacity in these sectors However, if demand is sufficiently elastic, prices can fall without reducing profitability Use of UKENVI for analytical work to understand basic drivers of rebound vary key assumptions one at a time; here focus on elasticities of substitution in production and trade elasticities (imports and exports)

123 Table 4. Results of sensitivity analysis of non-electricity energy rebound effects in the UK economy in response to a 5% exogenous improvement in energy efficiency in production (applied to use of locally supplied energy) LONG RUN NON-ELECTRICITY REBOUND Production CD (0.064) * * * * * CD ( ) * * *

124 Figure 7. Qualitative non-electricity energy rebound and disinvestment results for Scotland Trade Production 0 (0.064) CD (0.064) CD ( ) A B C A. LR R > SR R Short run rebound dampened by weak competitiveness effects; long run rebound dampened by disinvestment B. SR R > LR R Long run rebound dampened by disinvestment C. LR R > SR R Long run rebound not constrained by disinvestment effects

125