PhD dissertation. A Dynamic General Equilibrium Analysis of Jordan s Trade Liberalisation

Transcription

1 PhD dssertaton A Dynamc General Equlbrum Analyss of Jordan s Trade Lberalsaton Omar Ferabol Eultzstraße Chemntz emal: [email protected] PhD supervsor: Prof. Dr. Bernd Lucke Referee: Prof. Dr. Rchard Tol 1

2 1 Introducton Ths dssertaton ams at assessng the effects on the Jordanan economy of the preferental trade lberalsaton process undertaken by Jordan wth the European Unon (EU). The Assocaton Agreement (AA) between Jordan and the EU was sgned n 1997 and entered nto force n It elmnates progressvely tarffs on most ndustral goods mported by Jordan from the EU. Custom dutes on agrcultural products and processed agrcultural goods are gradually and only partally elmnated. After the 12-year transton perod n whch mport dutes are reduced, the Agreement ams eventually at creatng a free-trade area for most ndustral products between the EU and Jordan. The reducton of tarff rates on EU mports nto Jordan s expected to result n postve effects for the Jordanan economy. Lower mport dutes leads to lower mport prces of nvestment and consumpton goods, that n turn brngs about a postve mpact on consumer welfare. On the other hand, trade lberalsaton reduces government revenue. The magntude of the adverse effects wll be nfluenced by the measures taken by the Jordanan government to counteract the effects of revenue loss. Ideally, mport duty reducton ought to be accompaned by an approprate and parallel process of complementary economc reforms, such as reducton n government spendng, modernsaton of the tax system and broadenng of the tax base n order to offset the loss n custom dutes. Therefore, together wth the economc effects of trade lberalsaton on Jordan, ths work ams also at drawng mplcatons for domestc polcy responses accompanyng the trade lberalsaton process. In order to assess the mpacts of the Assocaton Agreement wth the EU on the Jordanan economy, a dynamc computable general equlbrum (CGE) model s specfed and then calbrated to the Jordanan economy. Ths methodology allows to capture fully the chan of events n the domestc economy, ther nteractons and ther dynamc effects when a polcy opton s mplemented. Partcular emphass s placed on the effects on consumer welfare. Usng a dynamc CGE model, the mpacts of gradually decreasng and eventually elmnatng tarff barrersnjordanformosteu ndustral goods are assessed. However, gven the need for domestc reforms parallel to the trade lberalsaton process, the mpacts of preferental trade lberalsaton are assessed along wth polcy choces amng at counterbalancng the negatve effects of trade lberalsaton on government revenue. 2

3 Computable general equlbrum models rely on socal accountng matrces (SAMs) to capture natonal ncome, producton and nput-output nformaton, and am at smulatng and evaluatng economc polces. The use of CGE models for polcy analyss has become wdespread for a wde range of applcatons for both developed and developng economes (de Melo, 1988). An appled CGE model should have the followng essental characterstcs: () consumers endowments of producton factors, () consumers preferences and demand functons for commodtes, () producton technology avalable to frms, and (v) set of equlbrum condtons (Shoven, 1983). Equlbrum n the model s charactersed by a set of prces and output levels n each ndustry such that, for all commodtes, market demand and supply are equal. Demand functons are homogeneous of degree zero and profts are lnearly homogeneous n prces. Therefore the absolute prce level has no mpact on the equlbrum outcome and only relatve prces are of any sgnfcance n the model. Market demands are the sum of ndvdual household demands, and they satsfy the Walras law (Shoven and Whalley, 1984). In dynamc models, household behavour s determned by the maxmsaton of the dscounted lfetme utlty. The nstantaneous utlty functon s defned over the doman of the consumpton goods n the economy and n some models t ncludes also lesure (Perera and Shoven, 1988). A complete equlbrum dataset for a sngle year must then be assembled. On the assumpton that the data represent an equlbrum of the economy, functonal parameters, such as share and shft parameters, are calbrated,.e. they are estmated n such a way that the model soluton reproduces the ntal dataset, called benchmark equlbrum. However, some parameters, namely the elastctes, are taken exogenously from the exstng lterature. Calbraton n a dynamc context requres addtonally the model to be parametersed to yeld an ntertemporal balanced growth path when the base polcy s mantaned. Exogenous shocks are then mplemented n the model, n order to compute a counterfactual equlbrum determned by the new polcy regme. The mpact of the polcy change s then assessed by comparson between counterfactual and benchmark equlbra (Shoven and Whalley, 1992). In analysng a wde range of polcy ssues, the general equlbrum approach has a man advantage over the partal equlbrum one, namely the possblty of capturng fully the chan of events and ther nteractons. In order to analyse the detaled effects of mport tarff reducton, the chan of events takng place when tarffs are cut should be examned (Bandara, 1991). A tarff rate reducton affects demand 3

4 patterns. The relatve prces of mports and domestc goods change and mports ncrease. Ths has an effect on the allocaton of resources wthn the tarff-reducng country. Consequently, changes n mport tarffs can not be consdered separately, snce ther repercussons are spread throughout the economy, through channels that affect producton, consumpton and nvestment decsons. Moreover, gven that trade lberalsaton s not mplemented n solaton, but t requres combnaton wth other approprate polces, ts economc effects should be computed together wth those brought about by the assocated polces. To my knowlege, there are two studes on Jordan s trade lberalsaton usng CGE models. D. Lucke (2001) mplemented a statc model to assess the fscal effects on Jordan of the Assocaton Agreement wth the EU, and to address the ssue of fscal responses amng at counteractng the loss n government revenue. Hosoe (2001) used a statc model to analyse the mpacts of the mplementaton of the Uruguay Round and the free trade arrangement wth the EU on Jordanan welfare. He fnds postve welfare effects brought about by the Uruguay Round and an addtonal welfare gan due to the EU-Jordan prefental trade agreement. The model mplemented n the frst part of the analyss s a neoclasscal dynamc computable general equlbrum (CGE) model, n whch one representatve household maxmses her future dscounted utlty by choosng optmal consumpton and nvestment paths. In the domestc economy full employment and perfect competton are assumed. Imperfect substtuton between domestc and foregn goods characterses nternatonal trade flows. Jordan s assumed to be a small economy,.e. t s a prce-taker n the nternatonal markets. The model s calbrated to 1998 dataset. Smulaton results of the process of preferental trade lberalsaton undertaken by Jordan show that the Assocaton Agreement wth the EU rases consumers welfare n Jordan and has postve mpacts on all macroeconomc varables n the long-run. However, n the short-run prvate consumpton s negatvely affected by trade lberalsaton, and ths may rase concerns about poltcal feasblty of the process of openng up domestc trade. Trade lberalsaton processes undertaken by many developng countres over the past years have been accompaned by wdespread concerns that openng up domestc trade n developng countres wll affect negatvely the poor and t wll deterorate the dstrbuton of ncome. Whereas most economsts agree on the fact that open economes perform better than closed ones, and open polces provde a sgnfcant 4

5 contrbuton to economc development and growth, many commentators fear that, both n the short and n the long-run, trade lberalsaton mght be harmful for poorer agents n the economy (Oxfam Internatonal, 2003 and 2005). In fact, t mght well be, as argued by Asbett (2005), that people s nterpretaton of the avalable evdence of the mpacts of trade lberalsaton on poverty s strongly nfluenced by ther values and by ther belefs about the process of globalsaton. Wnters et al. (2004) survey the emprcal work on trade lberalsaton and poverty. They pont out that there s plenty of evdence that trade lberalsaton affects each household groups, and that the ablty of households to respond to trade lberalsaton mpacts dffers across householdsgroups. Thetheory suggests that tradelberalsaton mght allevate poverty n the long-run and on average, and the emprcal evdence supports ths vew. However, they also warn that ths vew does not assert that trade polcy s always among the most mportant determnants of poverty reducton or that the effects of trade lberalsaton are always benefcal to the poor. Instead trade lberalsaton mples necessarly some dstrbutonal changes and, at least n the shortrun, t may reduce the welfare of some ndvduals and some of these may be poor. Wnters et al. (2004) also pont out that, gven the varety of factors that have to be taken nto account, t wll hardly be surprsng that there are no general comparatve statc results about the mpact of trade lberalsaton on poverty. However, n a WTO specal study, Wnters (1999) concludes that trade lberalsaton generally contrbutes strongly to poverty allevaton. He also recognses that most reforms mght create some losers, even n the long-run, and that some reforms could have temporarly a negatve mpact on poverty. The model wth one representatve household, descrbed above, s then extended to nclude heterogeneous consumers. Indvdual households tax rates, wage rates, ntal endowments of assets, transfers from government and abroad and ndvdual preferences are calbrated from data from a 2002 household survey. Introducng heterogeneous households nto a standard neoclasscal dynamc CGE model allows to address the ssue of how trade lberalsaton affects dfferent households. In the context of general equlbrum modellng several studes have been conducted to assess aspects of ncome dstrbuton (see Remer, 2002 for a survey). However, the approach used n ths dssertaton s the frst one analysng ncome dstrbuton n a dynamc general equlbrum framework wth utlty maxmsng agents as used by Ramsey (1928), Cass (1965) and Koopmans (1965). Theoretcal contrbu- 5

6 tons analyse the effects of mplementng heterogeneous consumers nto a neoclasscal framework (Chatterjee, 1994 and Casell and Ventura, 2000). However, the restrctons on the utlty maxmsng agents mposed by ths strand of lterature are not fulfllednthsmodelandwouldbeneglectedbytheavalablesurveydataforjordan. Specfcally, they assume the same rate of dscount for all household groups, whereas n the mult-household model mplemented n ths dssertaton the categores of households are charactersed by dfferent rates of tme preference, whch are calbrated from the dataset. Therefore, ths approach can be regarded as novel. As one would expect, effects of trade lberalsaton on Jordan are dfferent across ndvdual households, and n some smulatons one household group even experences a welfare loss. Therefore trade lberalsaton s not always Pareto mprovng for Jordan. In addton effects on welfare and ncome dstrbuton are opposte. Whle on the one hand welfare gans are slghtly larger for low-ncome households, on the other hand the gap n ncome between rch and poor ncreases, especally n the long run. The results are drven by the fact that captal stock of hgh-ncome households ncreases much more n the long run due to explotaton of nvestment ncentves. Moreover, poor households use ther amount of captal assets to smooth consumpton. The remanng fndngs confrms the analyss suggested by the model wth one representatve household on the aggregate level. Both models are programmed n the mathematcal software Gauss and are solved wth the relaxaton algorthm proposed by Trmborn et al. (2006). The dssertaton s structured as follows. Chapter 2 descrbes the Assocaton Agreement between Jordan and the EU and deals wth the update of the nputoutput table for Jordan. In chapter 3, the effects of preferental trade lberalsaton on the Jordanan economy are analysed by means of a standard trade CGE model, n whch one representatve consumer chooses optmal consumpton and nvestment path so as to maxmse future dscounted utlty. The model s calbrated to 1998 data. In chapter 4, the model s extended to nclude sx representatve households, n order to assess the welfare mpact of trade lberalsaton on each household class. As mentoned above, households represent dfferent ncome groups wth dfferent consumpton and tme preferences, levels of wealth, ncome, tax rates, and government transfers. The dataset s based on the 2002 socal accountng matrx (SAM) for Jordan, n whch households data are taken from the 2002 Jordanan Household Survey. For convenence, n the dssertaton the one representatve consumer model s denoted 6

7 as standard trade model, whle the model wth sx household classes s called poverty model. Chapter 5 draws the man conclusons. The appendces provde equatons and glossares of both the standard trade and poverty models, and tables and detals about the I-O table update. 7

8 2 Insttutonal framework and dataset 2.1 The EU-Jordan Assocaton Agreement The economc relatons between Jordan and the European Unon (EU) are governed by the Euro-Medterranean Partnershp, whch s mplemented through the EU- Jordan Assocaton Agreement (AA) and the regonal dmenson of the Barcelona Process. The EU-Jordan Assocaton Agreement s part of the blateral track of the Euro-Medterranean Partnershp. The ams of the Partnershp are to provde a framework for the poltcal dalogue, to establsh progressve lberalsaton of trade n goods, servces and captal, to mprove lvng and employment condtons, to promote regonal cooperaton and economc and poltcal stablty, and to foster the development of economc and socal relatons between the partes. The fnal am of the Assocaton Agreement s the creaton of a free trade area for most ndustral products between the EU and Jordan over a perod of 12 years, n conformty wth the provsons of the General Agreement on Tarffs andtrade(gatt). The Euro-Medterranean Partnershp was launched at the Euro-Medterranean Conference between the European Unon and ts orgnally 12 Medterranean Partners 1, and governs the polcy of the EU towards the Medterranean regon. The Euro- Medterranean Conference was held n Barcelona n 1995, and marked the startng pont of the Euro-Medterranean Partnershp, a wde framework of poltcal, economc and socal relatons between the Member States of the European Unon and Partners of the Mddle East and North Afrca (MENA) regon. The Euro-Medterranean Partnershp comprses two complementary tracks, the blateral and the regonal agenda. The framework for the blateral agenda s the Assocaton Agreement. The regonal agenda s mplemented through a number of regonal workng groups on a range of polcy ssues ncludng trade, customs cooperaton, and ndustral cooperaton. The latest EU enlargement, on 1st May 2004, has brought two Medterranean Partners (Cyprus and Malta) nto the European Unon, whle addng a total of 10 to the number of Member States. The Euro-Medterranean Partnershp thus comprses 35 members, 25 EU Member States and 10 Medterranean Partners (Algera, Egypt, Israel, Jordan, Lebanon, Morocco, Palestnan Authorty, Syra, Tunsa and Turkey). 1 The 12 orgnal partners are: Israel, Morocco, Algera, Tunsa, Egypt, Jordan, the Palestnan Authorty, Lebanon, Syra, Turkey, Cyprus and Malta. 8

9 Lbya has observer status snce Before the start of the Euro-Medterranean Partnershp, relatons between the EU and the countres n the MENA regon were ruled by the Cooperaton Agreements datng from the 1970s. Under the 1977 Cooperaton Agreement Jordan were granted duty-free access to the EU markets for most ndustral products and preferental access for agrcultural commodtes. The Cooperaton Agreement was unlmted n duraton, and t was not recprocal. In 1979 the Agreement allowed Jordan exports to enter the EU market free of quanttatve restrctons. The Euro-Medterranean Assocaton Agreement (AA) between Jordan and the European Unon was sgned n November It entered nto force on May 1 st, 2002, and replaced the 1977 Cooperaton Agreement. The Assocaton Agreement allows mports nto the EU of Jordanan products free of custom dutes and free of quanttatve restrctons, wth the excluson of agrcultural goods and processed agrcultural products. Custom dutes and charges on mports nto Jordan of EU products are progressvely abolshed, and dutes on agrcultural products are gradually and partally elmnated. The Agreement ams eventually at creatng a free-trade area for most ndustral goods between the EU and Jordan wthn 12 years by ts entry nto force. Table 2.1 shows the tme schedule of reducton of custom duty rates on EU mports to Jordan, provded by the Assocaton Agreement (Chapters 1 and 2 of Ttle II, Annex II and Lsts A and B of Annex III). Chapter 1 and Lsts A and B of Annex III of the Agreement apply to most ndustral goods, whle Chapter 2 and Annex II deal wth agrcultural goods and processed agrcultural products. The left column n table 2.1 shows the tme perod, n each other column the percentage of the baseyear mport tarff rates charged n the relevant perod are shown for four dfferent groups of goods lsted n the Assocaton Agreement. The group of commodtes n the second column of the table,.e. products lsted n Annex II, ncludes agrcultural products and processed agrcultural products. For these goods reducton of mport tarff rates starts four years after the entry nto force of the AA, and s only partal. The other groups of goods comprse the remanng ndustral products, for whch trade lberalsaton s complete. The establshment and the promoton of cross-border cooperaton wth the Medterranean Partners wll also be an mportant element of future regonal ntegraton. Jordan s already at the core of the man ntegraton process n the regon. It s a member of the Medterranean Arab Free Trade Area, the so-called Agadr agreement, that 9

10 was sgned n May 2001 wth Egypt, Morocco and Tunsa. Jordan has also sgned blateral FTAs wth several countres n the MENA regon, and s a member of the Great Arab Free Trade Area (GAFTA), wth other 13 countres who are members of the Arab League. After jonng the World Trade Organzaton (WTO) n Aprl 2000, as a step towards even broader trade lberalsaton Jordan sgned free trade agreements wth the Unted States n October 2000, and wth the European Free Trade Assocaton (EFTA) n June perod Annex II Lst A Annex III Lst B Annex III remanng entry nto force of the AA 100% 80% 100% 0% one year after 100% 60% 100% 0% two years after 100% 40% 100% 0% three years after 100% 20% 100% 0% four years after 90% 0% 90% 0% fve years after 80% 0% 80% 0% sx years after 70% 0% 70% 0% seven years after 60% 0% 60% 0% eght years after 50% 0% 50% 0% nne years after 50% 0% 40% 0% ten years after 50% 0% 30% 0% 11 years after 50% 0% 20% 0% 12 years after 50% 0% 0% 0% Table 2.1. Tarff reducton schedule of the AA. Trade lberalsaton n the form of a preferental trade agreement wth the EU s expected to provde benefts to Jordan n terms of lower mport prces of nvestment and consumpton goods that brng about hgher consumer welfare. The economc mpact of trade lberalsaton can be separated nto two types, statc and dynamc. The statc mpact s due to the nduced reallocaton of exstng resources, the dynamc mpact takes nto account the effect of openng up trade on the rate of captal accumulaton (Hoekman and Djankov, 1997). Therefore a key role n such a process s played by nvestment demand, that s potentally mportant to the dynamc behavour of output over the long-run (Francos et al., 1997 and Baldwn, 1993). On the other hand, trade lberalsaton reduces government revenue, due to decreasng mport tarff dutes. Such an mpact s lkely to be partcularly strong for Jordan, where government revenue reles heavly on custom dutes. 2 The magntude of the 2 Import dutes from EU trade n Jordan n the perod averaged 12% of total tax revenue and 2% of GDP, total mport dutes averaged more than one-thrd of total tax revenue and about 6% of GDP (Abed, 1998). 10

11 adverse effects on government revenue wll be nfluenced by the measures taken by the Jordanan government to counteract the effects of revenue loss. As ponted out n chapter 1, trade lberalsaton should be accompaned by an approprate and parallel process of economc reforms, such as reducton n government spendng, modernsaton of the tax system and broadenng of the tax base n order to offset the loss n custom dutes. As measures of fscal reform, the Jordanan government has harmonsed the General Sales Tax (GST) rates on domestc and mported goods, has replaced the GST, ntroduced n 1994, by a Value Added Tax (VAT) n 2000, and has undertaken an ncome tax reform n Update of the nput-output table Jordan s economy s currently undergong a rapd process of trade lberalsaton and market-orented economc reform. As mentoned above, the general sales tax (GST) has been replaced by a value-added tax (VAT), prvatsaton of state enterprses ganed momentum and Qualfyng Industral Zones establshed n economc cooperaton wth Israel have proved very successful. In the past few years, Jordan accessed the WTO and sgned free trade agreements, among others, wth the European Unon and the USA, whch provde for a stepwse reducton of mport tarff rates. Scentfc analyss amed at assessng the mpact of varous polcy reforms has largely reled on the use of computable general equlbrum (CGE) models, gven that suffcently long and relable tme seres for econometrc analyss are not avalable. Unfortunately, even for CGE analyss major mpedments exst. One of the major obstacles s gven by the fact that no recent nput-output (I-O) table for the Jordanan economy s avalable. Such a table s essental n organsng the avalable data for a partcular base year n the socal accountng matrx (SAM) whch s of basc mportance for CGE modellng. The most recent nput-output table for Jordan dates back to The matrx s therefore rather old and mght not adequately reflect the structural changes whch took place n the Jordanan economy snce the begnnng of the reform perod n the md-1990s. And even worse, the classfcaton used n the 1987 I-O table s ncompatble wth the system of natonal accounts (NA) currently used, as the NA system was substantally revsed n Whle the sectoral nomenclature of the data before and after the revson s smlar, an uncrtcal dentfcaton of sectors 11

12 wth smlar labels s, n fact, napproprate snce the dfferences n the defntons are non-neglgble. Updatng the 1987 I-O table s a task wth huge data requrements. Many of the data necessary for the update are n realty not avalable, and therefore estmates must be used. In order to update the 1987 I-O table the bproportonate RAS method (Bacharach, 1970, Bulmer-Thomas, 1982) s mplemented. Ths method can be used to update an old nput-output table f at least the row sums and the column sums of the I-O table are known. The RAS method The vectors and matrces of the model are ntally defned. The column vector y s the sectoral supply n the domestc economy,.e. domestc sales plus mports, where y s supply of sector =1,.., n y = y 1.. y n (1) x s the column vector of sectoral output, whch s a composte of domestc sales and exports, where x s output of sector x = x 1.. x n (2) The square matrx Q s the nput-output table of ntermedate consumpton goods q 1,1.. q 1,n Q = (3) q n,1.. q n,n where q,j s the spendng of sector j for ntermedate nput good, for, j = 1, 2,.., n. 12

13 ThesquarematrxA s the table of nput-output Leontef coeffcents (Leontef, 1966): a 1,1.. a 1,n A = a n,1.. a n,n where each coeffcent a,j s the spendng of sector j for the ntermedate good produced by sector dvded through by output of sector j, for, j =1, 2,.., n (4) a,j = q,j x j (5) The equlbrum between sectoral supply and demand n the domestc economy s therefore gven by the dentty y = Ax + z (6) where z s the column vector of sectoral spendng for fnal goods,.e. the sum of prvate consumpton, government consumpton and nvestment. Then r s defned as the column vector of total ntermedates produced by each sector,.e. the row sums of the matrx Q r = Qι (7) where ι s a vector of ones. Ths vector may be thought of and may be defned as total ntermedate supply. Smlarly, let c be the column vector of total ntermedate consumpton of each sector,.e. the column sums of Q: c = ι 0 Q (8) Ths vector may be thought of as total ntermedate demand. The matrx Q s known for one base year only, 1987 n ths partcular applcaton. Denote ths matrx by Q. For all subsequent years matrx Q s unknown, but t s assumed that the vectors r and c are known. The RAS or bproportonal method (Bacharach, 1970, Bulmer-Thomas, 1982) conssts n adjustng the rows and the columns of the exstng matrx Q, such that the entres n the adjusted matrx wll 13

14 add up to the row and column totals relatve of the update year. For ths purpose, the RAS method assumes that each entry n the updated matrx Q s bproportonal to the known ntal matrx Q,.e. that there are weghts w and z j for the typcal element q,j such that q,j = w q,j z j (9) Clearly, the weghts must be chosen subject to the restrcton that the row and column sums of the adjusted matrx equal the known margnal totals P j q,j = r, =1,..,n P q (10),j = c j, j =1,.., n The problem can be solved usng an teratve algorthm. The algorthm s wrtten n GAUSS by Bernd Lucke. Ths however, assumes data avalablty to whch the next secton now turns. Data For the base year 1987 data provded by the Department of Statstcs (DOS) of Jordan nclude the nput-output table along wth data on the sectoral spendng for ntermedate consumpton goods, sectoral data on output, exports and mports. The nput-output table Q s a square matrx -.e. the number of actvtes s the same as the number of commodtes - and ncludes 51 economc actvtes. For subsequent years ( ) data on ntermedate consumpton, gross output, mports and exports are avalable. These data are publshed wthn the revsed system of natonal accounts and are thus nconsstent wth the sectoral classfcaton used n the 1987 I-O table. Revsed natonal accounts data for 1987,. e. data conformng wth the new classfcaton are also avalable. Unfortunately, ths s not the case for the I-O table. In order to mnmse errors ncurred by the change n the classfcaton the actvtes are aggregated to just nne sectors producng goods. Further, the lack of dsaggregated data for mports and exports of servces mpled that all eght servce sectors had also to be aggregated. Ths s certanly a drawback, partcularly for a country such as Jordan, where the servce sector plays a very mportant role n the economy and a more detaled dsaggregaton for servces would be approprate. Therefore, the updated I-O matrces end up wth 10 sectors, as shown n Table

15 No. Economc actvty 1 Agrculture, huntng, forestry, and fshng 2 Mnng and quarryng 3.1 Manufactures of food, beverage and tobacco 3.2 Manufactures of textles, apparels, and leather product 3.3 Manufactures of wood, paper, prntng 3.4 Manufactures of petrolum and chemcals 3.5 Manufactures of rubber and other non metallc mneral 3.6 Manufactures of basc metals and fabrcated metal execpt machnery and equpment 3.7 Other manufactures 4-9 Servces Table 2.2. DOS classfcaton wth aggregated servces. Unfortunately, both for 1987 and all subsequent years, the revsed data are not sutable to easy applcaton of the RAS method. Three man problems were encountered. The frst problem s that varables are often evaluated at dfferent prces, e.g. ntermedate consumpton at producer prces and output at basc prces. To adjust the data, all varables are thus evaluated at producer prces. Basc prce s the prce receved by the producer from the purchaser for a unt of good or servce, mnus any taxes payable and plus any subsdes recevable on that unt. Producer prce s the value receved by the producer for a unt of product, mnus any deductble tax (such as VAT) charged on the purchaser, but t ncludes non-deductble taxes and subsdes. Ths requres the transformaton of sectoral output evaluated at basc prces nto sectoral output at producer prces by applyng the relevant net tax rate on the basc-prce output level. A second problem faced wth the data concerns the dfferent classfcatons of nternatonally traded goods that make fgures for mports and exports of goods ncompatble wth the rest of the data. The classfcaton used by the DOS n the orgnal nput-output table s smlar but not dentcal to the Harmonzed System (H.S.), whch s a classfcaton ncludng only goods. Avalable external trade statstcs for goods are provded under the Brussels Tarff Nomenclature (B.T.N.) classfcaton for the perod and under the H.S. from 1994 onwards. Thus correspondences must be used to convert external trade data from B.T.N. and H.S. nto the approprate DOS classfcaton. Some of these correspondences had to be constructed partcularly for ths purpose. The appendx provdes detals about the concordances used. The thrd problem s certanly the major one. As explaned above, applcaton of the RAS method requres the use of data across producton sectors on total output 15

16 (x), domestc supply (y), and supply and demand of ntermedate goods (r and c). Whereas vectors x, y and c are known for all years, the vector of ntermedate goods supply r s known only for the base-year,.e The vector r needs therefore to be derved for the remanng years. Note that data on fnalusesacrossproducton sectors are not avalable ether, so that t s mpossble to compute r as the resdual from output mnus fnal uses. Instead, the strategy used here conssts n estmatng r by usng sectoral data on supply and by adjustng t to make total demand for ntermedate goods n the economy equal to ntermedate goods total supply. Scalars, vectors and matrces referrng to the orgnal 1987 data are denoted wth and tme ndces are omtted n order to keep notaton smple. Defne s as the rato of r, total ntermedate nput supply of sector n 1987, to ỹ, supply of sector n 1987: s = r ỹ (11) Collect these ntermedate producton shares n the vector s: s = s 1.. (12) The vector s s used to obtan estmates of r for each year, on the assumpton that each r s proportonal to the respectve y.thevarabley s referred to as domestc supply, not output. The reason for ths s gven by the fact that entres q,j s n the matrx Q are domestc sales - ncludng mports and excludng exports. Moreover, the elements of r must be adjusted to make total supply of ntermedates equal to total demand n the ntermedate goods market,.e. P r = P c. Theestmateofr for each year s therefore gven by: P j r = s y c j Pj s (13) jy j s n Snce the revsed 1987 data dffer qute substantally from the orgnal fgures, the frst step conssts n updatng the 1987 I-O table to the new classfcaton. Ths enables to check how strongly the change n the accountng system affects the Leontef coeffcents. In order to dstngush between the Leontef coeffcents of the orgnal 16

17 1987 nput-output table and Leontef coeffcents of the updated 1987 table (based on revsed data), the former are denoted as 1987o and the latter as 1987r. Table 2.3 below shows the orgnal 1987 Leontef coeffcents,.e. the nput-output coeffcents computed by makng use of the orgnal 1987 dataset on ntermedate consumpton and gross output. By comparson, Table 2.4 shows the 1987r Leontef coeffcents obtaned from applyng the RAS method ,067 0,000 0,215 0,000 0,000 0,000 0,000 0,002 0,001 0, ,000 0,118 0,000 0,000 0,000 0,048 0,041 0,002 0,004 0, ,167 0,000 0,122 0,007 0,003 0,001 0,001 0,001 0,000 0, ,000 0,000 0,000 0,499 0,003 0,000 0,000 0,001 0,001 0, ,000 0,002 0,013 0,006 0,222 0,011 0,018 0,008 0,004 0, ,031 0,112 0,016 0,016 0,050 0,144 0,192 0,035 0,035 0, ,010 0,002 0,012 0,010 0,002 0,007 0,056 0,014 0,206 0, ,002 0,031 0,024 0,014 0,023 0,014 0,022 0,177 0,084 0, ,011 0,050 0,004 0,016 0,014 0,003 0,006 0,021 0,294 0, ,148 0,160 0,200 0,102 0,101 0,040 0,150 0,087 0,250 0,178 Table 2.3. Orgnal 1987 Leontef coeffcents ,082 0,000 0,212 0,000 0,000 0,000 0,000 0,003 0,001 0, ,000 0,100 0,000 0,000 0,000 0,068 0,037 0,004 0,002 0, ,196 0,000 0,115 0,004 0,004 0,002 0,001 0,001 0,000 0, ,000 0,000 0,001 0,487 0,006 0,001 0,000 0,002 0,001 0, ,000 0,002 0,012 0,003 0,310 0,015 0,016 0,013 0,002 0, ,040 0,101 0,017 0,011 0,077 0,216 0,185 0,062 0,024 0, ,015 0,003 0,014 0,007 0,003 0,013 0,063 0,029 0,159 0, ,003 0,029 0,025 0,009 0,037 0,021 0,022 0,323 0,057 0, ,016 0,053 0,005 0,012 0,025 0,005 0,007 0,044 0,229 0, ,204 0,158 0,223 0,074 0,170 0,065 0,158 0,169 0,182 0,170 Table 2.4. Estmated 1987 Leontef coeffcents. Results and Conclusons Usng the RAS algorthm for all subsequent years from 1988 to 2001 allows to analyse how the nput-output coeffcents change between the base-year 1987o and over the perod 1987r In the analyss of the Leontef coeffcents, t s sensble to focus on those coeffcents that are n some sense mportant. Whle many dfferent approaches - all of them somehow arbtrary - to choose the level of mportance are avalable, two reasonable crtera seem to be: 17

18 ()toselectthosecoeffcents a,j, whose value s large n at least one perod, where large values are those equal to or larger than 0.1; () to take those coeffcents a,j, whose assocated spendng for ntermedate nputs q,j s large n at least one perod, where now large values are defned those equal to or larger than 10% of total spendng of sector j for ntermedate consumpton goods c j n ths perod. Clearly, the crteron defned n () dentfes a subset of the coeffcents dentfed by crteron (), snce () postulates that the value of a certan ntermedate be more than 10% of total output value, whle () merely postulates that t be more than 10% of total ntermedate consumpton expenses of the partcular sector. Table 2.5 shows the mean values and the standard devatons (n brackets) of all Leontef coeffcents, computed over the perod 1987r The coeffcents whose value s larger than 0.1 for at least one observaton are shown n bold. Accordng to such crteron, there are 23 large coeffcents. Fgures n talcs show the coeffcents whose ntermedate consumpton entry s larger than 10% of total sectoral spendng for ntermedates for at least one observaton. Under crteron (), the group of large coeffcents ncludes the same 23 coeffcents selected under crteron (), together wth addtonal 9 coeffcents (0.015) (0.000) (0.039) (0.000) (0.000) (0.000) (0.000) (0.001) (0.000) (0.001) (0.000) (0.013) (0.000) (0.000) (0.000) (0.011) (0.005) (0.001) (0.000) (0.001) (0.054) (0.000) (0.017) (0.003) (0.001) (0.000) (0.000) (0.000) (0.000) (0.001) (0.000) (0.000) (0.000) (0.059) (0.002) (0.001) (0.000) (0.001) (0.000) (0.001) (0.000) (0.000) (0.001) (0.002) (0.022) (0.005) (0.002) (0.002) (0.000) (0.001) (0.011) (0.012) (0.003) (0.007) (0.009) (0.050) (0.019) (0.004) (0.002) (0.005) (0.006) (0.001) (0.004) (0.007) (0.001) (0.005) (0.014) (0.005) (0.022) (0.008) (0.001) (0.004) (0.004) (0.006) (0.005) (0.006) (0.003) (0.030) (0.005) (0.006) (0.007) (0.012) (0.001) (0.011) (0.006) (0.002) (0.002) (0.008) (0.030) (0.007) (0.028) (0.020) (0.027) (0.034) (0.016) (0.012) (0.012) (0.020) (0.018) (0.018) Table 2.5. Means and standard devatons of the coeffcents As can be seen, most of the large coeffcents le along the man dagonal and on the bottom row. Ths means that most of ntermedate trade nvolves several 18

19 actvtes that buy ntermedate nputs from themselves -.e. ntra-sectoral trade between the same sector plays an mportant role - and sectors that buy ntermedate goods from the servces sectors. More mportantly, the standard devatons of all large coeffcents are small, suggestng that the RAS procedure computed farly smlar coeffcents for all the years. Ths may be nterpreted as an ndcaton that the approxmatons used to assemble the approprate data and the update method n general may have worked qute well, snce, despte large swngs n partcular mportexport data, smlar estmates have been obtaned for all of the years. In order to fnd out f and how much Leontef coeffcents have changed over tme, the large coeffcents are regressed on a constant and tme trend: a,j = α + βt (14) Table 2.6 shows the sgn of tme trends of large coeffcents, whose estmate of β s sgnfcant. By lookng at selected graphs depcted n appendx 1, the general mpresson s that trend-nduced changes n Leontef coeffcents are slow and far from dramatc. Wth few exceptons, tme trends of Leontef coeffcents are postve for ntermedates produced by non-servce sectors and negatve for ntermedates produced by servce sectors neg pos pos 3.2 neg pos pos pos pos 3.5 pos pos pos pos pos pos 4-9 pos pos neg neg neg neg neg Table 2.6. Tme trends of the Leontef coeffcent estmates. Trendng Leontef coeffcents can, n prncple, ether reflect technologcal change or changes n market structure. Technologcal change s dfferent to measure, hence one could try to explore the hypothess that changes n Leontef coeffcents are mostly due to changes n market structure. For ths purpose, data on the number of frms n each sector are checked snce an ncrease n a Leontef coeffcent mght be due to a decrease n vertcal ntegraton and thus an ncrease n the number of frms n 19

20 aspecfc sector. Tme-seres data for the perod are avalable for sectors 2 to 3.7, whereas they are only partally avalable for sector 4-9, and not avalable at all for sector 1. The complete dataset s shown n the appendx. After excludng sector 1 because of lack of data and ncludng dummes for the mssng fgures n sector 4-9, the number of frms n each sector s regressed aganst a constant and tme. The number of frms shows sgnfcantly postve tme trend over the perod for all sectors. Ths can be taken as an evdence supportng the vew that vertcal ntegraton has decreased, and that competton has ncreased, partcularly n the manufacturng sectors. Regressng the Leontef coeffcents aganst a constant and the number of frms s supposed to yeld some nformatve and suggestve result. However, only 11 Leontef coeffcents depend sgnfcantly on the number of enterprses, as shown n table neg 3.1 neg pos pos pos 3.5 pos pos pos pos pos pos Table 2.7. Effects of number of frms on Leontef coeffcents. 20

21 3 The Standard Trade Model General equlbrum modellng approach for polcy analyss has become wdespread for both developed and developng economes. In developng countres, CGE models are commonly used for a wde range of polcy ssues. The polcy applcatons range from long-run development strateges on growth and resource allocaton, to tax and trade polcy reforms. As ponted out by de Melo (1988), the ssue of foregn trade polcy has occuped a center place n most of the applcatons. Even n the applcatons that do not focus on foregn trade, the way foregn trade s modelled plays a fundamental role n determnng the outcome of polcy smulatons. Over the past decades, the nterest generated by computable general equlbrum (CGE) modellng n applcatons to developng countres can be explaned by many factors. Frstly, the CGE modellng approach s approprate when analysng polcy changes and external shocks that affect the whole economy. Secondly, constructon of CGE models has been facltated by the development n many developng countres of relevant and statstcal data bases, such as socal accountng matrces (SAMs). Fnally, the computatonal constrants on the mplementaton of CGE models have been removed by advances n numercal soluton technques (Bandara, 1991). Many general equlbrum studes have assessed the economc mpacts of tarff reform and domestc complementary polces n developng countres. Harrson et al. (1996) assess the mpacts on Turkey of a custom unon arrangement wth the EU. Regonal ntegraton wth the EU s found to rase welfare n Turkey between 1% and 1.5%, dependng on the complementary polces adopted by the Turksh government. By usng a standard statc general equlbrum, Hoekman and Konan (1999) nvestgate the effects of the free trade agreement between Egypt and the EU on Egypt s welfare. They fnd large gans n welfare condtonal on elmnatng regulatory barrers and red tape. In a statc general equlbrum model for Syra, B. Lucke (2001) studes dfferent scenaros of preferental trade lberalsaton wth the EU, and focuses on the effects of tarff reform on government budget. The study fnds that government revenue losses caused by reducton n the EU mport dutes are farly large, but stll manageable. Go (1994) uses a model n a parsmonous and dynamc framework to examne ntertemporal effects of external shocks and adjustment polces n the Phlppnes, and concludes that complementary measures, consstng of domestc tax reform, are needed. Devarajan and Go (1998) present a smlar model, and analyse the 21

22 response of the Phlppnan economy to a terms-of-trade shock, tarff lberalsaton and fscal polcy changes. Harrson et al. (1997), usng a multregonal model, fnd that the mplementaton of the Uruguay Round has a negatve mpact on welfare n countres of the MENA regon. Prevous studes by Hosoe (2001) and D. Lucke (2001) on Jordan s trade lberalsaton mplemented statc models wth homogenous agents and focused on aggregate welfare and fscal effects. Hosoe (2001) nvestgates the mpacts of two trade polcy scenaros for Jordan, the Uruguay Round mplementaton and the establshment of a free trade area wth the EU, by usng a statc model based on Devarajan et al. (1990). Smulaton of the Uruguay Round shows that ts mplementaton would ncrease Jordan s welfare by 0.28%. The EU-Jordan FTA scenaro would further ncrease Jordan s welfare by 0.16%. The work by D. Lucke (2001) focuses on fscal effects of the EU-Jordanan Assocaton Agreement, and dscusses fscal responses amng at overcomng the loss n government revenue, such as smplfyng and harmonsng tax rates, and broadenng the tax base. However, these models do not account for ntertemporal effects due to captal accumulaton. The model mplemented n ths chapter s a neo-classcal open-economy snglecountry ntertemporal model, t bulds on prevous work done by Ferabol et al. (2003), whch s based on the dynamc framework developed by Devarajan and Go (1998). Dscounted lfetme utlty of the representatve consumer s maxmsed by choosng optmal consumpton and nvestment paths. In the domestc economy there are ten producton sectors, nne of whch producng goods and one producng servces. Producton sectors wll be denoted by the subscrpt. Perfect competton and full employment are assumed n all sectors. Frms use ntermedate nputs and value added output to produce fnal output wth a Leontef producton technology. Value added output s n turn a constant elastcty of substtuon (CES) composte of prmary nputs, captal and labour. Producton factors are assumed to be perfectly moble across sectors. Internatonal trade flows are charactersed by mperfect substtuton between domestc and foregn goods. Fnal sectoral output Q s allocated across domestc sales D and exports E through a constant elastcty of transformaton (CET) functon. Total sectoral absorpton X s an Armngton (1969) composte of domestc good D andmportedgoodm. Itsdfferentated among four uses: prvate consumpton C, government consumpton G, ntermedate nput q, nvestment I. The parameters n the Armngton functons are the same for all uses, as well as prces. 22

23 The domestc country s assumed to be a prce-taker n the nternatonal markets, that s world prces of mports and exports are exogenously determned. The model s mplemented by means of the mathematcal software Gauss and by employng the relaxaton algorthm proposed by Trmborn (2006). 3.1 Consumers The representatve consumer chooses consumpton and new captal so as to maxmse her dscounted lfetme utlty, subject to the budget constrant, the moton equaton of captal, the equalty between savngs and nvestment, and the gven ntal captal stock. The optmsaton problem s gven by: subject to max Z 0 u (C t ) e ρt dt (15) K = I δk = YD P C C P I δk (16) K (0) = K 0 (17) where C, YD, K are aggregate consumpton, dsposable ncome and captal of the representatve household, respectvely, I s aggregate nvestment, P C s the composte consumpton prce, P I s the composte prce of nvestment. The household dscounts future utlty wth dscount rate ρ, whch s calbrated from the data. The deprecaton rate of captal, δ, s also calbrated from the data. Dsposable ncome of the representatve household s gven by YD= 1 t Y wl + 1 t K rk + TR+ erf REM (18) where L s the fxed labour supply, w sthewagerate,t Y s the ncome tax rate, t K s the captal rent tax rate, r s the rate of return to captal, TR s government transfer to households, FREM are foregn remttances, expressed n foregn currency, and er s the exogenous exchange rate, whch s chosen as numerare. The nstantaneous utlty functon s gven by the constant relatve rsk averson (CRRA) utlty functon: u (C) =lnc (19) 23

24 whch mples an elastcty of substtuton between consumpton at any two ponts n tme equal to 1. Solvng the above dynamc optmsaton problem yelds the Euler equaton Ċ 1 t Y C = 1 t K r ρ δ (20) P I Equatons (16) and (20) characterse the dynamcs of the model. Household aggregate consumpton s a Cobb-Douglas composte of consumpton sectoral goods C = Ω C N Y =1 c θc ; Ω C > 0; 0 < θ C < 1 (21) where c s prvate consumpton of good produced by sector, N =10sthe number of sectors n the Jordanan economy, Ω C s the shft parameter and θ C s the share parameter of good n the Cobb-Douglas consumpton functon. Solvng the statc problem max c Ω C NY =1 c θc (22) subject to the constrant P C C = NX =1 P X c (23) yelds the functons of demand for consumpton good produced by sector c = θ C P C C P X (24) where c s prvate consumpton demand for the good produced by sector, P C s the prvate consumpton prce ndex and P X s the prce of the fnal good produced by sector. Household consumpton of each good and servce c s are n turn compostes of domestc and mport goods, modelled through the Armngton (1969) assumpton of constant elastcty of substtuton (CES) between domestcally-produced consumpton good cd and mported consumpton good cm. The representatve household chooses the optmal level of each domestc and mport good and servce for a gven value of 24

25 total consumpton, by takng the Armngton specfcaton as constrant of the costmnmsaton statc problem: subject to mn P C cm,cd c = P M cm + P D 1+vat D cd (25) γ 1 c = Φ ε (cm ) γ +(1 ε )(cd ) 0 < ε < 1; γ > 0, γ 6=1 γ 1 γ γ 1 γ (26) where P M s the composte mport prce, nclusve of all taxes and mport dutes, P D s the prce of the domestc good (net of taxes), and vat D s the VAT rate that apples to domestc goods; γ s the elastcty of substtuton between domestc goods and mports, Φ s the shft parameter, ε s the mports share parameter, and the subscrpt s the ndex for sectors. The demand functons for mports and domestc goods resultng from the mnmsaton problem gven by (25) subject to constrant (26) are gven by µ cm =(Φ ) (γ 1) ε P X γ c (27) P M and cd =(Φ ) (γ (1 1) ε ) P X γ c (1 + vat D ) P D (28) Aggregate mports of consumpton goods are then dsaggregated across mports from the EU and from the rest of the world, through a Cobb-Douglas specfcaton. 3 The optmsaton problem for the households apples to each sectoral producton and s gven by: mn {cm j } P M cm = X j PM j cmj (29) s.t. cm = Φ M Q j cm j ε j ; X j ε j =1 (30) 3 Imports can be dsaggregated across several dfferent regons or countres (e.g. Arab countres, EFTA countres, USA), but for the purpose of ths work, the basc dsaggregaton between the EU and the rest of world s consdered. 25

26 where cm j s households consumpton of foregn good mported from regon j, PM j s the prce of good mported from regon j nclusve of all taxes, Φ M s the shft parameter, and ε j s the share parameter of mports of good from regon j, wth each ε j 0. The elastcty of substtuton between mports s therefore constant and equal to one, beng the Cobb-Douglas specfcaton a partcular case of CES functon. The soluton to the above mnmsaton problem yelds the demand functons for mports dsaggregated across foregn regons: cm j = εj P M PM j cm ; =1, 2,.., N; j = EU,RW (31) The domestc prces of mported goods are determned exogenously, snce they depend on the fxed world prce of mports, PW M, the mport tarff rate, tm j,the VATrateonmportedgoods,vat M, and the exchange rate er: PM j = erp W M 1+tm j 1+vat M ; j = EU,RW (32) 3.2 Frms On the supply sde, constant returns to scale and perfect competton are assumed. Sectoral output n the domestc economy Q s determned by a two-stage producton technology, whch exhbts at the top ter a Leontef fxed-proportons specfcaton between ntermedate nput q j, produced by sector j andusedntheproducton process of sector, and value-added output VA : ½ VA Q =mn, q ¾ j,,... (33) a 0, a j, where a 0, s the fxed requrements of valued-added output VA,anda j, s the fxed requrements of ntermedate nput q j, for producton of aggregate output Q. At the second ter, ntermedate nput q j, s an Armngton CES composte of domestc and foregn ntermedate consumpton goods, qd j, and qm j,.totalmport of ntermedate goods s n turn a Cobb-Douglas composte of ntermedate nput regonal mports. Value-addedproductonneachsector s determned by a technology charactersed by a constant elastcty of substtuton between the two prmary nputs, captal 26

27 and labour, whch are perfectly moble across sectors: σ 1 σ VA = A "α LD +(1 α ) KD 0 < α < 1; σ > 0; σ 6=1 σ 1 σ # σ σ 1 (34) where LD and KD are sector s demand for labour and captal respectvely,a s a tme-nvarant technologcal parameter, α s the labour share parameter and σ s the constant elastcty of substtuton between labour and captal. At the value-added producton stage, subject to the above technology constrant (34), frms mnmse producton costs, gven by P VA VA = wld + rkd (35) where P VA s the value-added prce, w s the nomnal wage rate and r s the nomnal rate of return to captal. Cost-mnmsaton subject to the technology constrant yelds the demands for labour and captal µ LD =(A ) (σ 1) α P VA σ VA (36) w (1 KD =(A ) (σ 1) α ) P VA σ VA (37) r Sectoral producton Q can be sold on the domestc market or abroad. Exports and domestc sales are modelled accordng to a constant elastcty of transformaton (CET) functon, that represents the constrant for the producer maxmsng total sales: max E,D S P Q Q = P E E + P D D (38) 1+Ψ Ψ s.t. Q = χ "θ E +(1 θ ) D 1+Ψ Ψ # Ψ 1+Ψ (39) where Q s total sectoral domestc producton, E s exports, D s domestc supply, P Q s producer output prce (.e. net of taxes), P E 27 s producer exports prce

28 (whch turns to be equal to the world prce of exports PW E, gven the absence of export subsdy), P D s producer domestc sales prce (.e. net of VAT), θ s the export share parameter, χ s the shft parameter, and Ψ s the elastcty of transformaton betweendomestcgoodandexportgood,wth0< θ < 1, χ > 0andΨ > 0. Solvng the above maxmsaton problem yelds the followng supply functons of domestcally-sold and exported goods D = Q (χ ) (1+Ψ ) ³ P Q µ P D Ψ 1 λ Ψ (40) E = Q (χ ) (1+Ψ ) ³ P Q µ P E Ψ λ Ψ (41) Total exports are allocated across the EU and the rest of the world by means of the optmsaton problem, n whch, as above, a constant elastcty of transformaton (CET) specfcaton s adopted: max {E j } P E E = X j PE j E j (42) s.t. E = χ E " P j θ j 1+ψE E j ψ E # ψe 1+ψ E ; X j θ j = 1 for j = EU,RW (43) where total sectoral exports E s a composte of regonal exports E EU and E RW, PE j are producer export prces (all of them equal to the fxed world prce of exports, PW E ), χ E > 0stheshftparameter,θ j s the share parameter of exports to regon j = EU,RW, ψ E s the elastcty of transformaton between exports, wth ψ E > 0, and PE j s the producer prce of exports to regon j. The supply functons of exports to each foregn regon j produced by sector are gven by E j = E (P E ) ΨE (χ E )(1+ΨE ) Ã! PE j ΨE λ j ; =1, 2,,.., N; j = EU,RW (44) Prces of the export good, produced by sector and exported to regon j are equal to exogenous and fxed world export prces tmes the exchange rate: PE j = erp W E ; j = EU,RW (45) 28

29 Aggregate nvestment I s a Cobb-Douglas composte of sectoral nvestment goods, nv. Each sectoral nvestment good nv s charactersed by a CES Armngton specfcaton between nvestment domestc goods nvd and total mports nvm,andbya Cobb-Douglas functon for dsaggregated mports. Gven that functonal parameters and prces are the same for all knds of uses, optmal nvestment s determned n the same fashon as (25)-(31). 3.3 Government The government consumes an exogenous amount of goods, rases taxes and tarffs, provdes a transfer to consumers, and runs a balanced budget. Although at frst sght the assumpton of balanced budget mght look unrealstc, t s actually approprate and roughly consstent wth government fscal balance data for Jordan provded by the IMF. 4 Aggregate government consumpton G s a Cobb-Douglas composte of sectoral goods g. In turn, each government sectoral consumpton s determned by a CES Armngton specfcaton between domestcally-produced goods gd and mports gm n the same way as n (25)-(31). Government revenue s generated from the Value Added Tax (VAT), that apples wth dfferent rates to domestc and mported goods (vatd and vatm), the tax on captal rent (t K ), the ncome tax (t Y ), mport dutes, that apply wth dfferent rates to the EU and the rest of the world (tm), and foregn grants, FRG, expressed n foregn currency. The expendture s gven by transfer to household TR, and consumpton of good G. The government budget s therefore gven by VAT D + VAT M + TY + TK + TM + erf RG = TR+ G (46) where VAT D s revenue of VAT on domestc goods, VAT M s revenue of VAT on mports, TY s ncome tax revenue, TK s revenue of tax on captal rent, and TM s mport tarff revenue. 4 The IMF reported the Jordan s government fscal balance n percent of GDP to equal -4.9 n 2002, -1.0 n 2003 and -1.7 n 2004 (see IMF, 2006). 29

30 3.4 Market clearng The equlbrum on the factors markets requres aggregate endowment of labour be equal to aggregate labour demand and aggregate captal stock be equal to aggregate demand for captal L = NX LD j (47) j=1 K = NX KD j (48) j=1 where L s labour supply (fxed), K s aggregate captal stock, and LD j and KD j are demands for labour and captal of producton sector j. The equlbrum n the domestc good markets s gven by X = NX q,j + c + nv + g (49) j=1 where X s total sectoral absorpton, =1 j=1 NP q j, s total ntermedate nputs producton, c s prvate consumpton, nv s nvestment demand, and g s government consumpton, n sector. The equlbrum n the balance of payments s gven by NX NX PW M M = PW E E + FREM + FGR (50) =1 where M and E are, respectvely, total mports and total exports of sector, PW M and PW E are the exogenous world prces of, respectvely, mports and exports of sector, FGR s foregn grant to the Jordanan government, and FREM are foregn remttances to households. 3.5 Data and calbraton The dataset s based on the Socal Accountng Matrx (SAM) for Jordan constructed by D. Lucke (2001). The SAM s based on 1998 data, and ncludes the 1987 nputoutput coeffcent matrx updated to The SAM has nne sectors producng goods and one sector producng servces. 30

31 Themodeldescrbedntheabovesectonhasbeenntallyapplednasmplfed verson wth only two producton sectors, producng respectvely goods and servces. Later, as shown n the set of smulatons below, the sze of the model has been enlarged to nclude the orgnal 1998 SAM wth ten sectors, lsted n Table 3.1. The base-year dataset s assumed to reflect a statonary steady state economy. Parameters are then calbrated n order to obtan a soluton reproducng the benchmark equlbrum. No. Economc actvty 1 Agrculture, huntng, forestry and fshng 2 Mnng and quarryng 3.1 Manufactures of food, beverage and tobacco 3.2 Manufactures of textles, apparels and leather product 3.3 Manufactures of wood, paper and prntng 3.4 Manufactures of petroleum and chemcals 3.5 Manufactures of rubber and other non-metallc mnerals 3.6 Manufactures of basc metals and fabrcated metal except machnery and equpment 3.7 Other manufactures 4-9 Servces Table 3.1. Producton sectors. The world prces of export PW E and mport PW M are exogenously fxed to one. Real varables are then derved from the base-year nomnal varables provded n the SAM. Elastcty values are taken from exstng lterature, as Table 3.2 shows. Elastcty Value Source Substtuton between domestc goods and mports 0.6 Devarajan et al. (1999) Transformaton between domestc goods and exports 1.5 Devarajan et al. (1997) Transformaton between regonal exports 3 Martn (2000); Lucke B. (2001) Substtuton between labour and captal 0.9 Devarajan and Go (1998) Table 3.2. Elastcty values. The assumpton of steady state allows to calbrate the dynamc parameters δ and ρ. From the captal accumulaton equaton (16) and from the statonary steady-state condton K t = K ss, t follows that the deprecaton rate of captal s: δ = I ss (51) K ss where the subscrpt ss ndcates steady state. 31

32 The steady-state ntertemporal condton for prvate consumpton, gven by the Euler equaton (20), allows then to calbrate the consumers dscount rate as: ρ = 1 t Y 1 t K r ss δ (52) Pss I The steady-state condtons apply also as termnal condtons. 3.6 Smulatons The basc feature of each scenaro, exogenous and common to all smulatons, s gven by the gradual reducton of tarff rates on EU-mport goods, provded by the EU- Jordan Agreement, and descrbed n table 3.3. For agrcultural goods and ndustral goods contanng agrcultural components the mport duty reducton s only partal, whereas t s complete for the remanng ndustral goods. Agrculture Mnng Food Textle Paper Chemcals Mnerals Metals Others Entry nto force of the AA 100% 60% 100% 60% 60% 60% 60% 60% 60% One year after 100% 53% 100% 53% 53% 53% 53% 53% 53% Two years after 100% 47% 100% 47% 47% 47% 47% 47% 47% Three years after 100% 40% 100% 40% 40% 40% 40% 40% 40% Four years after 90% 30% 90% 30% 30% 30% 30% 30% 30% Fve years after 80% 27% 80% 27% 27% 27% 27% 27% 27% Sx years after 70% 23% 70% 23% 23% 23% 23% 23% 23% Seven years after 60% 20% 60% 20% 20% 20% 20% 20% 20% Eght years after 50% 17% 50% 17% 17% 17% 17% 17% 17% Nne years after 50% 13% 50% 13% 13% 13% 13% 13% 13% Ten years after 50% 10% 50% 10% 10% 10% 10% 10% 10% 11 years after 50% 7% 50% 7% 7% 7% 7% 7% 7% 12 years after 50% 0% 50% 0% 0% 0% 0% 0% 0% Table 3.3. Import tarff reducton schedule (percent of the base-year tarffs). The mmedate effect of a reducton n custom dutes on mports of a specfc trade partner can be seen by consderng the frst-order condtons for the Armngton specfcaton between mports and domestcally-produced goods: 5 cm cd = εp D (1 ε) P M and the frst-order condtons for the Cobb-Douglas regonal mports: cm EU cm RW γ (53) = εeu PM RW ε RW PM EU (54) 5 For convenence, the subscrpt denotng the producton sector has been dropped. 32

33 Prces of regonal mports are defned as: PM j = erp W M 1+tm j 1+vat M (55) where tm j s the tarff rate on goods mported from regon j and vat M s the VAT rate appled to mports. From (55), a decrease n tm EU wll clearly reduce PM EU. From (54) t follows that, ceters parbus, regonal mport demand cm j s decreasng n the regonal mport prce PM j. Moreover, snce P M s a composte of PM EU and PM EU, a fall n one regonal mport prces wll decrease P M. Therefore, a reducton n the tarff rate on EU mport wll determne a fall n the EU mports prce and n the composte mports prce, and a rse n EU mports. The gradual reducton of the mport duty rate decreases prces of mported goods. Domestc prces wll also decrease. The fall n domestc prces boosts drectly demand, nvestment mght go up and output s expected to ncrease n the long-run. The loss n government revenue due to the mport duty reducton mght be partally offset by the expanson n the tax base n the longer run. However, the government must compensate the fall n revenue by undertakng counteractng fscal measures, such as an ncrease n the domestc tax rates or a reducton n spendng. Therefore the smulaton of the AA s accompaned by a parallel change n the domestc polcy. Moreover, some ntersectoral mpact s expected. The sector n whch tarff reducton s complete s lkely to attract more resources n the long-run, although t mght suffer from a short-run negatve mpact due to the move from protectonsm to free trade. The mpact on welfare mght be n prncple ambguous. On the one hand, lower domestc prces ncrease consumpton and hence households welfare. On the other hand, the reducton n government revenue due to cuttng mport duty rates forces the government to mplement panful fscal measures, such as ncrease n domestc tax rates or reducton n transfer to households. Ths wll negatvely affect dsposable ncome of households, who must ceters parbus reduce consumpton. Such an mpact on welfare s therefore negatve. The overall mpact on households consumpton and welfare depends therefore on the magntude of the effects of lower consumpton prces and lower dsposable ncome. However, the smulatons results show that under all scenaros of trade lberalsaton welfare rses. Table 3.4 lsts the scenaros and summarses the welfare effects. 33

34 Scenaro Polcy varables Welfare change % 1 Government transfer 0,06 2 Income tax rate 0,03 3 Government consumpton 0,16 4 Government transfer; VAT 10% ncrease 0,03 5 Government consumpton; VAT 10% ncrease 0,07 Table 3.4. Scenaros and welfare changes. All scenaros are charactersed by two-polcy smulatons. Trade polcy s determned exogenously, t s establshed by the Assocaton Agreement wth the EU and s common to all scenaros, whle the responses of domestc polcy are a mx of endogenous and exogenous optons. In scenaro 1, government transfer to households s the endogenous polcy varable. In scenaro 2, the reform of the domestc ncome taxaton s the government endogenous polcy choce. In the thrd scenaro, the endogenous polcy choce s government consumpton. In scenaros 4 and 5, respectvely government transfer and government consumpton are endogenous, whle an addtonal exogenous polcy response s put nto effect n both scenaros, namely an ncrease by 10% n the VAT rates. Scenaro 1: Assocaton Agreement and endogenous government transfer As ponted out above, the reducton of the mport duty rates on EU mports wll mmedately decrease the prces of mported goods. Ths wll cause, ceters parbus, a fall of fnal nternal prces, whch are a composte of prces of mports and domestcally-produced commodtes. As fgure 3.1 shows, composte prces of prvate consumpton (PC), government consumpton (PG) andnvestment(pi) fall relatvely to ther benchmark levels, whch have been ntalsed to one, and approach the new steady-state level from above. Alongsde the exogenous mport dutes reducton, the endogenous polcy varable playng a role n the smulaton s government transfer to households. Clearly, gven the fall n government revenue, transfer to households s expected to decrease. As shown n fgure 3.2, durng the gradual reducton of the EU mport tarff rates, the drop n government revenue forces the government to cut transfer to households, whch falls relatvely to the benchmark value equal to one, has a decreasng trend untl the 13th year, ncreases very slghtly and fnally approaches the steady state from below. 34

35 1,005 1 PC PI PG 0,995 0,99 0,985 0,98 0,975 tme Fgure 3.1. Prces under scenaro 1. The path of transfer n the ntal 15 years shows ups and downs. Ths rather unexpected tme path characterses also the trend of government revenue, shown n fgure 3.3. Ths s due to the fact that, whereas tme s contnuous, the mport tarff reducton s a dscrete-tme process,.e. t takes place at a specfc pontntme. Ths causes a dscrete adjustment n government revenue, that fluctuates around the trend. The behavour of government revenue n turn affects the path of transfer to households. 0,9 0,85 0,8 0,75 0,7 0,65 0,6 Fgure 3.2. Government transfer to households under scenaro 1. tme The mplementaton of ths two-polcy smulaton has two mpacts on the revenue of government: () an mmedate and drect effect brought about by the reducton n 35

36 mport dutes, that lowers government revenue; () the expected effect of ncreased nternal demand, determnng a larger domestc tax base, that rases government revenue. The outcome depends on the magntudes of the above two effects. Altogether the frst effect s larger, as both government revenue and transfer to households are, for all tme perods, below ther benchmark values. However, along the transton to the new steady state, t mght well be that n some perods the second effect s larger than the frst one, and thereby government revenue and transfer ncrease relatvely to the prevous tme perod. In fact, after the negatve trend n the ntal perods, government revenue ncreases slghtly and approaches the steady-state level from below. 0,985 0,98 0,975 0,97 0,965 0,96 0,955 0,95 0,945 0,94 tme Fgure 3.3. Government revenue under scenaro 1. One of the most mportant and most relevant results of the smulaton concerns the mpact on prvate real consumpton, snce welfare of households depends on consumpton. As fgure 3.4 shows, prvate consumpton reaches n the long-run a hgher level than the ntal benchmark value. However, although the mpact on welfare s postve, consumpton ntally falls relatvely to the benchmark level, afterwards t keeps ncreasng n all perods, and t s below the benchmark value untl the 8th year after the entry nto force of the AA. The mplcaton of ths analyss suggests that consumers must gve up some current consumpton n order to acheve hgher future consumpton. Ths clearly rases the queston concernng the poltcal feasblty of the trade lberalsaton process undertaken by the Jordanan government. 36

37 1,03 1,02 1,01 1 0,99 0,98 0,97 Fgure 3.4. Prvate consumpton under scenaro 1. tme Whereas openng up domestc trade leads unambguously to an ncrease n welfare, the government wllngness to follow consstently a trade lberalsaton polcy mght be harmed, gven the poltcal prce to be pad n terms of short-run decrease n prvate consumpton. Captal and nvestment are n all perods above ther benchmark levels. The fall n domestc prces pushes up nternal demand, whch, n turn, boosts new captal formaton. As shown by fgures 3.5 and 3.6, captal keeps ncreasng and reaches the new long-run equlbrum value from below, whereas nvestment follows a dfferent pattern. Aggregate nvestment s much above the benchmark value n the ntal perods, then t falls slowly, and fnally reaches from above the new steady state, whch s hgher than the ntal level. 1,06 1,05 1,04 1,03 1,02 1,01 1 0,99 tme Fgure 3.5. Captal stock n scenaro 1. 37

38 1,14 1,12 1,1 1,08 1,06 1,04 1,02 1 tme Fgure 3.6. Investment n scenaro 1. Trade lberalsaton s expected to have also sectoral effects. The formerly protected sectors mght experence a long-run ncrease n output, due to a shft of resources from other sectors. However, they may be negatvely affected n the very short-run, due to ncreased foregn competton. 1,17 Agrculture Mnng Food Textles Paper Chemcals Mnerals Metals Others Servces 1,12 1,07 1,02 0,97 tme Fgure 3.7. Sectoral outputs under scenaro 1. Nevertheless, smulaton results support the vew that trade lberalsaton brngs about postve effects also n the short-run, and penalses sectors n whch trade openness s ncomplete,.e. agrculture and food sectors, n terms of slowdown n the very short-run and lower long-run equlbrum levels. Fgure 3.7 shows how outputs of all good sectors are affected by openng up domestc trade. The agrculture and food sectors, n whch trade lberalsaton begns 38

39 four years after the entry nto force of the Assocaton Agreement and n whch tarff rates are only partally reduced, experence ntally a slowdown n producton, and the lowest percentage ncreases n the fnal steady-state values. Sectors n whch trade lberalsaton s complete and faster avod the short-run negatve mpact on output and acheve hgher long-run equlbrum levels. Table 3.5 lsts the output level for each sector at the perod when the Assocaton Agreement enters nto force,.e. when the frst shock occurs, and the steady-state values n the long-run equlbrum. From both fgure 3.7 and table 3.5 t can be seen that agrculture and food sectors are those that beneft least from trade lberalsaton, and are actually harmed n the short-run. The same concluson on sectoral outputs effects can be drawn by analysng results of the remanng scenaros. Sector frst shock fnal steady state Agrculture 0,9796 1,0201 Mnng 1,0035 1,0500 Food 0,9801 1,0196 Textle 1,0313 1,1751 Paper 1,0210 1,0400 Chemcals 1,0032 1,0565 Mnerals 0,9981 1,0249 Metals 1,0149 1,0347 Others 1,0467 1,1367 Servces 0,9992 1,0138 Table 3.5. Sectoral outputs. Scenaro 2: Assocaton Agreement and endogenous ncome tax rate Under ths scenaro the ncome tax rate s the endogenous polcy varable used by the Jordanan government to counteract the fall n revenue. Gven the mmedate decrease n government revenue, the endogenous ncome tax rate s expected to be set above the benchmark value of of 0.072, to keep ncreasng durng the 12-year transton perod towards the free-trade area, and fnally to stablse or perhaps slghtly fall, gven the possbly larger domestc tax base. In the smulaton the optmal ncome tax rate moves to a value around 0.08 n the ntal perods, t ncreases steadly, after 12 years t decreases very slghly, and t approaches from above the new steady-state rate of 0.089, as shown n fgure 3.8. Although ths s a smplfcaton, snce n realty the ncome tax rates are sx, the smulaton provdes a clear and expected nsght for fscal polcy reform. 39

40 0,095 0,09 0,085 0,08 0,075 0,07 tme Fgure 3.8. Optmal ncome tax rate. Qualtatve results for all macroeconomc varables are the same lke under the other scenaros. Fgure 3.9 shows the tme path of captal, whch s very smlar under all scenaros. Gven the fall n domestc prces, nvestment demand goes up, captal stock rses over tme and approaches the new steady-state level from below. It has to be notced that the new steady-state level of captal s 1.02, whch s lower than the steady-state value of 1.05 under scenaros 1 and 3. Ths dfference s probably due to the dstortonary effect ntroduced by the endogenous ncome tax rate. The hgher ncome tax rate has a negatve effect on consumers ncome, and t also creates a dstorton n the optmal choces of consumers. In ths smulaton therefore, optmal nvestment choce mght be negatvely affected by the endogenous ncome tax rate, whch s not present n the other scenaros, snce t Y s constant there. Due to such dstorton, ceters parbus, captal grows less than under the other scenaros, and reaches a lower long-run equlbrum value. 1,025 1,02 1,015 1,01 1, ,995 tme Fgure 3.9. Captal stock under scenaro 2. 40

41 Scenaro 3: Assocaton Agreement and endogenous government consumpton In ths smulaton, macroeconomc varables follow a path whch s qualtatvely the same as n scenaros 1 and 2. Quanttavely, t has to be notced that the ncrease n welfare s larger than under the other two scenaros, due to a faster and hgher growth n prvate consumpton, as shown n fgure It s n fact no surprse to fnd that welfare ncrease under scenaro 3 s larger than under the other two smulatons. In the prevous two scenaros the polcy choce mplemented by the government reduces household ncome. Therefore, ceters parbus, prvate consumpton and utlty wll also fall. The reducton n government consumpton, nstead, does not reduce welfare, because government spendng plays no role n utlty of consumers. However, the credblty of such result mght be questoned, gven that the govenrment s lkely to face a problem of feasblty n cuttng consumpton. 1,05 1,04 1,03 1,02 1,01 1 0,99 tme Fgure Prvate consumpton n scenaro 3. Under scenaros 1 and 2, households consumpton reaches the benchmark value of 1 between 6 and 7 years after the start of the tarff reform, and ends wth long-run equlbrum levels whch are 1.01 n scenaro 3 and 1.02 n scenaro 1. Wthout the negatve mpact on ncome due to lower government transfer and hgher ncome tax rate, consumpton under scenaro 3 reaches the benchmark level after 2 years and ends wth a new steday-state value very close to The endogenous polcy varable,.e. government consumpton, s expected to fall relatvely to the benchmark value of one, to keep fallng gven the government budget 41

42 constrant, and perhaps ncrease slghtly n the long-run, when the negatve short-run effect of trade lberalsaton on government revenue s compensated by the postve effect brough about by the larger domestc tax base. 0,985 0,98 0,975 0,97 0,965 0,96 0,955 0,95 Fgure Endogenous government consumpton. tme Fgure 3.11 depcts the dynamc path of endogenously-determned government consumpton, that les always below the benchmark level, falls n the ntal perods, follows an ncreasng trend after 12 years, and fnally approaches the new steady state from below. Scenaro 4: Assocaton Agreement, endogenous government transfer and exogenous VAT rates ncrease Ths scenaro mplements an exogenous ncrease n the VAT rates by 10% together wth the endogensaton of government transfer to households, lke n scenaro 1. One would expect a postve mpact on household welfare, brought about by trade lberalsaton. Moreover, the ncrease n welfare s expected to be smaller than under scenaro 1, gven that the reducton of dstortonary mport tarffs saccompanedby dstortonary sde-effects brought about by the exogenous ncrease n the VAT rates. The results are consstent wth expectatons. Welfare rses by 0.03%, whereas under scenaro 1 the ncrease was 0.06%. Consumpton follows a slghlty dfferent path from the one under scenaro 1. As fgure 3.12 shows, prvate consumpton ntally falls below the benchmark value, but the ntal decrease relatve to the benchmark level s smaller than the drop under scenaro 1. Prvate consumpton rses afterwards, t reaches the benchmark level after 10 years, and then approaches the fnal steady-state value from below. After normalsng the 42

43 benchmark level to 1, the long-run equlbrum value of consumpton s 1.012, smaller than the long-run consumpton under scenaro 1, whch s equal to As ponted out above, ths can be explaned by the effects due to the VAT rates ncrease. 1,015 1,01 1, ,995 0,99 0,985 tme Fgure Consumpton under scenaro 4. There are two mpacts on the consumpton prce ndex brought about by exogenous polcy choces. The reducton n mport dutes determnes a declne n domestc prces, whch rases demand. On the other hand, the ncrease n the VAT rates brngs about a rse n prces, whch has a negatve mpact on consumpton. The consumpton prce ndex has qute a dfferent behavour than the one observed under scenaro 1, as fgure 3.13 shows. 1, ,998 0,996 0,994 0,992 0,99 tm e Fgure Consumpton prce ndex under scenaro 4. 43

44 Whereas prevously the consumpton prce was below the benchmark value for all perods, under scenaro 4, t ncreases slghtly n the ntal perods, t drops along the transton perod, and then t approaches the long-run value from above. The fnal steady-state prce s 0.992, hgher than the long-run prce under scenaro 1, whch was The exogenous ncrease n the VAT rates, compared wth scenaro 1, reduces aggregate demand and hence also nvestment demand. Ths determnes therefore a lower growth rate of the captal stock, whch reaches the long-run equlbrum level of 1.032, as shown n fgure 3.14, whereas under scenaro 1 ths was ,035 1,03 1,025 1,02 1,015 1,01 1, ,995 tme Fgure Captal stock under scenaro 4. Fnally, t s worthwhle to note that, whereas under scenaro 1, the burden of the fall n government revenue was borne only by transfer to households, under scenaro 4 the ncrease n the VAT rates determnes, ceters parbus, hgher values of government transfer. As shown n fgure 3.15, transfer to households s above the benchmark value n the ntal three years and falls steadly afterwards. The long-run equlbrum value s 0.87, farly above the steady-state value under scenaro 1, equal to

45 1,1 1,05 1 0,95 0,9 0,85 0,8 Fgure Government transfer to households under scenaro 4. tm e Scenaro 5: Assocaton Agreement, endogenous government consumpton and exogenous VAT rates ncrease In ths scenaro the smulaton performed n scenaro 3 s extended, by addng an exogenous ten-percent ncrease n the VAT rates to the endogenous change n government consumpton. Lke n scenaro 4, domestc prces are affected through two exogenous channels. The gradual reducton n mport tarff rates leads to lower prces n the domestc economy, whch boosts nternal demand. On the other hand, the ncrease n the VAT rates ncreases domestc prces and hence affects negatvely domestc demand. As a result, the consumpton prce ndex s at the very begnnng of the tme-horzon above the benchmark value when preferental trade lberalsaton and the VAT rate ncrease take place, as t s shown n fgure The prce ndex falls thereafter, t reaches the benchmark level at the second year, and approaches the long-run equlbrum value, equal to 0.992, from above. As expected, the fnal steady-state consumpton prce s hgher than under scenaro 3, gven the addtonal effect brought about by the ncrease n the VAT rates. Lke n the other scenaros, prvate consumpton drops below the benchmark level, t rses steadly and approaches the fnal long-run equlbrum from below. The fnal steady-state level of prvate consumpton s 1.021, far below the long-run consumpton value determned by scenaro 3. As a result, mplementng the exogenous ncrease n the VAT rates has decreased the welfare gan under scenaro 3 from 0.16% to 0.07%. 45

46 1, ,998 0,996 0,994 0,992 0,99 tm e Fgure Consumpton prce ndex under scenaro 5. Comparng these smulaton results wth those of scenaro 3, the exogenous ncrease n the VAT rates determnes also hgher government consumpton, as one would expect. As fgure 3.17 shows, government consumpton s above ts benchmark value n the frst two perods, t then drops, overshoots and reaches the long-run equlbrum equal to 0.98, whereas t was 0.96 under scenaro 3. 1,01 1, ,995 0,99 0,985 0,98 0,975 0,97 Fgure Government consumpton under scenaro 5. tm e 3.7 Conclusons In ths chapter the blateral trade lberalsaton process undertaken by Jordan has been assessed by means of a dynamc CGE model, n whch one representatve consumer chooses consumpton and new captal n order to maxmse her dscounted 46

47 lfetme utlty. The standard trade model s able to capture ntertemporal effects on Jordan of openng up domestc trade, wth partcular emphass on consumer welfare. The polcy mplcatons for the Jordanan economy of the PTA wth the EU have also been analysed. The man conclusons drawn from the set of two-polcy smulatons are therefore: () the Assocaton Agreement wth the EU brngs about n Jordan postve long-run effects on all macroeconomc varables; () the mpact of trade lberalsaton on welfare s postve under all scenaros; () the government should counteract the negatve mpact of openng up domestc trade on government revenue by mplementng fscal polcy reforms; (v) trade lberalsaton and government counteractng actons affect negatvely prvate consumpton n the short-run and rase concerns about poltcal feasblty of the trade lberalsaton process; and (v) sectors n whch trade lberalsaton s complete and faster beneft more than sectors n whch mport dutes are only partally removed. 47

48 4 The Poverty Model Trade lberalsaton processes undertaken by many developng countres over the past years have rased many concerns that lberalsaton of domestc trade n the developng countres wll affect negatvely the poor and t wll ncrease the ncome gap between the rch and the poor. Gven the lack of studes about effects of trade lberalsaton on poverty and ncome dstrbuton n Jordan, ths dssertaton ams at provdng evdence that trade lberalsaton has dfferent mpacts across dfferent household classes. The process of openng up domestc trade mght lead to unequal dstrbuton of welfare gans, and mght even make some specfc groupsworseoff. As mentoned n chapter 1, n the context of general equlbrum modellng several studes have been conducted to assess aspects of ncome dstrbuton related to trade lberalsaton (see Remer, 2002 for a survey and Wnters et al., 2004 for an overvew). However, ths s the frst approach that analyses ncome dstrbuton n an appled dynamc neoclasscal general equlbrum framework n whch heterogeneous households are assumed to have dfferent dscount rates. In the general equlbrum analyss of poverty and dstrbuton ssues, there are manly two approaches. One s to use a CGE model wth one sngle representatve consumer. The changes n commodty and factor prces generated by a trade lberalsaton experment are appled to household data to compute the mpacts on poverty and ncome dstrbuton. Ths approach has been followed, among others, by Ianchovchna et al. (2001), who smulate unlateral trade lberalsaton n Mexco and estmate that, combnng prce and ncome changes, welfare ncreases for all households, wth larger proportonate changes for poorer households, and by Hertel et al. (2001), who examne the effects of multlateral lberalsaton on seven countres and fnd that lberalsaton reduces poverty n four countres and ncreases t n three countres. The second approach s to embed the household dssaggregaton wthn the CGE model. As ponted out by Wnters et al., ths approach has the advantage of beng nternally consstent. Smulatons help therefore to dentfy the household classes that are vulnerable even when trade lberalsaton s benefcal on average. All studes fnd that trade lberalsaton has dfferent mpacts on dfferent household categores. Decaluwé et al. (1999) ncorporate the analyss of ncome dstrbuton and poverty nto the socal accountng matrx (SAM) and computable general equlbrum (CGE) 48

49 methodology n an archetype Afrcan economy, charactersed by sx dfferent household categores. Bourgugnon at el. (1991) carry out llustratve smulatons of a stablsaton package for a representatve economy, and fnd a large adverse mpact on the dstrbuton of ncome. Harrson et al. (2003) develop a mult-regonal and mult-sectoral model to evaluate the trade polces optons faced by Brazl,.e. regonal arrangements and multlateral trade lberalsaton. Households are dsaggregated across 20 groups, ten rural and ten urban, that are dstngushed by ncome levels. The smulatons suggest that most of the trade polces optons result n an overall welfare gan to Brazl, and n larger gans to the poorest households. Cockburn (2001) apples a CGE model to study the mpacts of Nepal s trade lberalsaton on poverty and ncome dtrbuton. Poverty falls urban areas and ncreases n rural areas. Impacts are larger wth hgher ncome levels, leadng therefore to an ncrease n ncome nequalty. Löfgren (2001) studes the mpact of alternatve development strateges on growth and poverty n a dynamc model for Egypt. Households are dsaggregated nto sx groups, accordng to ther ncome,.e. rch, mddle and poor, and the area where they lve,.e. urban and rural. He fnds postve mpacts of prce lberalsaton on welfare of all household groups. However, the effects are smaller for the poor, and nequalty ncreases. The same knd of household dsaggregaton s appled n a dynamc framework by Löfgren et al. (1999), who assess the effects of the Assocaton Agreement wth the EU on Morocco. Smulaton results show that trade lberalsaton has small aggregate effects, but dsfavours the rural poor. However, trade lberalsaton combned wth complementary domestc polces lead to welfare ncreases for all household groups. Bautsta et al. (1998) stress the mportance of mplementng fscal adjustment measures that accompany the process of trade lberalsaton, and conclude that falure to undertake complementary polces may explan why trade lberalsaton efforts n many Afrcan countres dd not contrbuted to egaltaran growth. As mentoned n chapter 3, prevous studes on Jordan s trade lberalsaton by B. Lucke (2001) and Hosoe (2001) used statc CGE models wth one homogeneous household. To my knowledge, there s no work on Jordan s trade lberalsaton based on a dynamc CGE model wth heterogeneous households. The Jordanan economy s modelled as a dynamc small open economy buldng on a model whch s very smlar to the one presented n the prevous chapter. The man dfference les on the consumpton sde. Whereas n the standard trade model one 49

50 representatve household maxmses her dscounted lfetme utlty, the poverty model captures household heterogenety. The household dsaggregaton s embedded wthn the CGE model. In detal, households are dsaggregated nto sx dfferent classes ranked by ther dsposable ncome. Wthn each of sx dfferent household groups one typcal consumer maxmzes dscounted ntertemporal utlty subject to a budget constrant. Households groups ndvdual tax rates, wage rates, ntal endowments of assets, tranfers from the government and from abroad and consumpton preferences are calbrated from data from a 2002 households survey. Moreover, dfferent households tme preferences are also calbrated from survey data by assumng that consumpton levels of all households are statonary n the long-run. In the domestc economy there are nne producton sectors, eght of whch producng goods and one producng servces. Aggregate prvate consumpton, government consumpton and aggregate nvestment are Cobb-Douglas compostes of nne dfferent sectoral outputs, whch n turn are compostes of domestcally produced and mported goods modelled through the Armngton (1969) specfcaton. Frms n each of the nne producton sectors use a Leontef producton technology between ntermedate goods and value added output, whch s n turn a CES composte of captal and sx dfferent knds of labour. Total output can be sold domestcally or exported accordngtoacetspecfcaton. The government rases taxes and collects tarffs. Revenues are spent for a fxed amount of government consumpton as well as transfers to households. The domestc economy s a prce-taker on nternatonal markets. Perfect competton and full employment are assumed n all sectors. Producton factors are perfectly moble across sectors. The model s mplemented by means of the mathematcal software Gauss and by employng the relaxaton algorthm proposed by Trmborn (2006). Ths allows for smulaton exercses regardless of the dmenson of the state space. The smulaton results ndcate changes n per-capta level of welfare n Jordan between -0.03% and 0.21%, provdng evdence that trade lberalsaton has ndeed dfferent mpacts across heterogeneous households. More precsely, low ncome households gan slghtly more from trade lberalsaton n terms of welfare, snce they can overcome losses n government transfer by an ncreasng wage ncome due to aggregate captal accumulaton. However, ncome nequalty ncreases, snce hgh ncome households can explot the benefts of ncreased ncentves for nvestment. Ths results n hgher captal ncome and, therefore, a wdenng ncome gap. Remarkably, the behavor of aggregate 50

51 varables s qualtatvely consstent wth the one-representatve-household model. 4.1 Households The problem of each nfntely-lved household s to maxmze dscounted ntertemporal utlty subject to Z 0 log (C ) e ρ t dt, =1,...,H (56) K = SAV δk = YD P C C δk P I (57) K (0) = K,0 (58) where C, SAV, YD, K are respectvely consumpton, savng, dsposable ncome and captal asset of household, δ s the captal deprecaton rate, P C s the consumpton prce ndex of household, andp I s the composte prce of the nvestment good. The representatve household n each class dscounts future utlty wth dscount rate ρ, whch s specfc to each household group. Dsposable ncome of each household class s gven by YD =(1 τ )(w L + rk + Tr + erf T ) (59) where w, L, K, Tr and FT denote the ndvdual wage rate, labour endowment, captal endowment, government and foregn transfers to each household group, respectvely. The exchange rate er s the model numerare. The nterest rate r s dentcal for each household snce captal s a homogenous good. Each household pays a dfferent ncome tax τ. The soluton to the above dynamc maxmsaton problem yelds the Euler equaton Ċ = (1 τ ) r ρ C P I δ (60) Consumpton of each household group s a Cobb-Douglas composte of sectoral consumpton C = Ω C NY j=1 c θc,j,j, ΩC > 0, 0 < θ C,j < 1, =1, 2,.., H, j =1, 2,.., N (61) 51

52 where c,j s household s consumpton of good j, θ C,j s the share parameter of good j and Ω C s the shft parameter n the Cobb-Douglas consumpton functon of household, H = 6 s the number of household groups and N =9sthenumberof producton sectors n the Jordanan economy. Each household solves the statc constraned maxmsaton problem max c,j Ω C NY j=1 c θc,j,j s.t. P C C = NX Pj X c,j (62) j=1 whch yelds the household s functons of demand for consumpton good produced by sector j c,j = θ C,j P C C P X j where c,j s consumpton demand of household for good j, andpj X of the fnal good produced by sector j. Aggregate government transfers to households are gven by (63) s the prce TR = HX Tr (64) =1 whle government transfers to each household class are fxed proportons of aggregate transfers: Tr = π TR;0< π < 1; HX π =1 (65) =1 where π s the fxed share of aggregate tranfers pad to household group. 4.2 Frms Sectoral output n the domestc economy s determned by a two-stage producton process, whch exhbts at the top ter a Leontef (or fxed-proportons) specfcaton between ntermedate nput and value-added output. Each representatve frm of actvty j produces total output accordng to the followng producton technology ½ VAj Q j = mn, q 1,j,..., q ¾ 9,j ; j =1,...,N (66) a VA,j a 1,j a 9,j 52

53 where Q j and VA j are sectoral output and value added, respectvely. q,j s ntermedate nput produced by sector and used n the producton of actvty j. Leontef coeffcents are denoted by a ( ). N = 9 s the number of producton sectors n the domestc economy. 6 At the second ter, ntermedate nput q,j s a CES composte of domestc and foregn ntermedate consumpton goods. Value-added producton s determned by a technology characterzed by a constant elastcty of substtuton between the prmary nputs, captal KD and sx dfferent types of labour LD, appendant to each household class : " HP VA j = A j =1 σ j 1 µ σ α,j LD j P,j + 1 H =1 α,j KD P α,j > 0; 0 < H α,j < 1; σ j > 0; σ j 6=1 j=1 σ j 1 σ j j # σ j σ j 1 where A j s the tme-nvarant technologcal parameter, α,j s the share parameter of labour of type, σ j denotes the constant elastcty of substtuton between prmary nputs, and H = 6 s the number of households. At the value-added producton stage, frms mnmze producton costs subject to the above technology constrant. (67) 4.3 Government The government consumes an exogenous amount of goods, rases taxes and tarffs and provdes transfers to consumers. The government balance budget s assumed to be balanced. As noted already n the prevous chapter, although at frst sght the assumpton mght look unrealstc, t s actually approprate and roughly consstent wth government fscal balance data for Jordan provded by the IMF. 7 Aggregate government consumpton G s a Cobb-Douglas composte of sectoral goods g. Government consumpton of good s determned by a CES Armngton specfcaton between domestcally-produced goods and mports. Government revenue s generated from the Value Added Tax, on domestc goods VAT D and on mports VAT M, that apply wth dfferent rates, vat D and vat M, to domestc and mported goods, the ncome tax, TY, and mport dutes, TM, that apply wth dfferent rates to the EU and the rest of the world, tm EU and tm RW, and foregn grants, FRG, 6 In the standard trade model the number of producton sectors s N =10. 7 The IMF reported the Jordan s government fscal balance n percent of GDP to equal -4.9 n 2002, -1.0 n 2003 and -1.7 n 2004 (see IMF, 2006). 53

54 whch are exogenous and fxed. The expendture s gven by aggregate transfers to households TR, and aggregate and fxed consumpton of goods and servces, G. The government budget s therefore gven by VAT D + VAT M + TY + TM + erf RG = TR+ G (68) where on the left-hand sde there are tax revenues, tarff revenue and foregn grants, and on the rght-hand sde there s total expendture. 4.4 Market clearng The equlbrum n the factors markets requres that for each type of labour aggregate endowment of labour s equal to aggregate labour demand and that aggregate captal stock s equal to aggregate demand for captal NX L = LD,j (69) j=1 HX NX K = KD j (70) =1 j=1 where L and K are labour and captal suppled by household, andn =9sthe number of producton sectors n the domestc economy. The equlbrum condton n each good market j s gven by NX HX X j = q j, + c h,j + nv j + g j (71) =1 h=1 where X j s total absorpton n sector j, NP q j, s total ntermedate nputs pro- HP ducton, c h,j s total demand of prvate consumpton, nv j s nvestment demand h=1 and g j s government consumpton, n sector j. The equlbrum n the balance of payments s gven by =1 PW E j NX NX HX PWj M M j = PWj E E j + FT + FGR (72) j=1 j=1 =1 where M j and E j are, respectvely, mports and exports of sector j, PWj M and are the exogenous world prces of, respectvely, mports and exports of sector j, andfgr s the foregn grant donated to the Jordanan government. 54

55 4.5 Data and calbraton procedure The calbraton procedure s based on the Socal Accountng Matrx (SAM) for Jordan constructed for the year The model s parameters are calbrated such that the SAM represents a soluton of the model where all varables are statonary, except asset accumulaton of ndvdual households. The reason s that the fractons of savngs and assets are not the same across households and therefore the assumpton of statonarty for ndvdual captal accumulaton would volate the SAM. Household survey data allow dsaggregaton nto sx dfferent groups of households, ranked by ther ncome levels. Each group dffers wth respect to labour ncome, captal ncome, transfer from government and from abroad, ncome-tax payments, savngs as well as total consumpton and ts composton. Wthn the calbraton process ths results n dfferent exogenous varables for each group of households as well as dfferent parameters. It has to be notced that accordng to Jordan s new tax system there s no dstncton between labour and captal ncome taxaton. Households are taxed wth a progressve, general ncome tax. Ths results n dfferent net nterest rates and therefore each household faces dfferent ncentves for savng. Tme preference rates are calbrated such that they exactly offset ths effect n the long run. 9 In addton, ndvdual households preferences are reflectedndfferent consumpton baskets accordng to the consumpton pattern of each household n the benchmark year. Fgure 4.1 shows the levels of per capta ncome of the sx households classes. For convenence and throughout the chapter, the poorest household class s denoted as HH1, and the rchest household group as HH6. Total per capta ncome of the rchest household group (HH6) has been normalsed to one. The pcture provdes nformaton on the ncome gap between rch and poor household groups. It provdes also some nsght about the ncome composton, whch dffers across household classes. 8 The SAM was constructed by Ferabol and Kolev. 9 Precsely ths means that all households consumpton grows wth the same rate n the long run snce otherwse some would vansh asymptotcally. 55

56 1 labour ncome captal ncom e transfer foregn remttances 0,8 0,6 0,4 0,2 0 HH1 HH2 HH3 HH4 HH5 HH6 Fgure 4.1. Per capta ncome. The ncome composton of each household group, together wth the sze, s reported n table 4.1. Class Indvduals Labour Captal Gov. Transfer Foregn remt. HH % 27% 14% 11% HH % 24% 10% 8% HH % 27% 8% 7% HH % 32% 9% 7% HH % 39% 8% 8% HH % 57% 6% 7% Table 4.1. Sze and ncome composton of the household groups. In fgure 4.2 the ncome composton of the sx household groups s shown graphcally. As expected, poor households rely on labour ncome and government transfer more strongly than rch consumers do, whle rch household have a much larger share of captal ncome n ther total ncome than the poorer The share of captal ncome n total ncome of the two poorest household classes s unexpectedly hgh. The suspect s that ths s n realty self-emplyoment labour ncome whch has been reported wrongly. However, ths does not affect the man smulaton results, gven that poor households have stll lower captal ncome shares than rch households. 56

57 Labour Captal Government transfer Foregn remttances 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% HH1 HH2 HH3 HH4 HH5 HH6 Fgure 4.2. Income composton. Elastctes of substtuton are obtaned agan from the exstng lterature (Devarajan et al., 1997 and 1999, Devarajan and Go, 1998, Martn, 2000 and B. Lucke, 2001). Once these parameters have been fxed, the remanng parameters are calbrated from the SAM on the assumpton that the base-year dataset reflects a statonary steady state economy. The model s programmed n Gauss and solved wth the relaxaton procedure as proposed by Trmborn et al. (2006). Very mportantly, the relaxaton procedure can smulate transtonal dynamcs on multdmensonal stable manfolds. Ths means that an ncrease n the dmenson of the model, especally n the state space, does not cause any conceptual problems. 4.6 Smulatons As llustrated n chapter 3 the economc effects of the EU-Jordan Assocaton Agreement can be summarzed by a gradual reducton of tarff rates on EU mports n Jordan accordng to the tme schedule shown n table 4.1. Snce the data avalable for the calbraton procedure represent the Jordan economy of the year 2002 ths s the benchmark year. In the smulatons tarff rates are then gradually reduced n the subsequent years. Lke n the trade model, each scenaro has two components: () the prefental trade lberalsaton mplemented through the Assocaton Agreement, and () the domestc 57

58 polcy responses accompanyng the trade lberalsaton process. Table 4.2 shows the schedule of tarff reducton over the 12-year transton perod. Tarff lberalsaton s partal for agrcultural goods and ndustral goods wth agrcultural components. The reducton n the tarff rates on EU mports s complete for the remanng manufacture goods. Agrculture Mnng Food Textle Paper Chemcals Mnerals Others Entry nto force of the AA 100% 60% 100% 60% 60% 60% 60% 60% One year after 100% 53% 100% 53% 53% 53% 53% 53% Two years after 100% 47% 100% 47% 47% 47% 47% 47% Three years after 100% 40% 100% 40% 40% 40% 40% 40% Four years after 90% 30% 90% 30% 30% 30% 30% 30% Fve years after 80% 27% 80% 27% 27% 27% 27% 27% Sx years after 70% 23% 70% 23% 23% 23% 23% 23% Seven years after 60% 20% 60% 20% 20% 20% 20% 20% Eght years after 50% 17% 50% 17% 17% 17% 17% 17% Nne years after 50% 13% 50% 13% 13% 13% 13% 13% Ten years after 50% 10% 50% 10% 10% 10% 10% 10% 11 years after 50% 7% 50% 7% 7% 7% 7% 7% 12 years after 50% 0% 50% 0% 0% 0% 0% 0% Table 4.2. Import tarff reducton schedule (percent of the base-year tarffs). Whle the mplementaton of the AA s a feature common to all scenaros, the government responses are specfc to each smulaton. Snce the government revenue s expected to decrease, counteractng fscal measures by the government must be taken nto account. In scenaro 1 ths s a reducton n aggregate government transfers to households. Precsely total transfers from government granted to households are endogenous whereas the share that each household receves s fxed. Ths assumpton guarantees that the reducton of dstortonary tarffs snotaccompanedbydstoronary sde-effects due to addtonal taxaton. In scenaro 2, aggregate government transfers are endogenous and addtonally t s nvestgated how a ten-percent ncrease n all VAT rates affects the economy. In scenaro 3, aggregate government tranfers are endogenous, and an exogenous change n the transfer shares to the households s smulated,.e. a change n the values of the parameters π s, n order to yeld a more equal dstrbuton of welfare gan across the households groups. In the fourth smulaton experment, government consumpton s the endogenous varable. The mmedate effect of reducng mport rates on EU mports s a change n the relatve prces n the domestc economy. The prce of EU mports falls relatvely to the prce of mports from the rest of world. The composte mport prce wll also decrease relatve to the prce of domestcally-produced goods. The fall n the mport prces 58

59 ncreases ncentves for nvestment, whch n turn leads to faster captal accumulaton. In the long-run equlbrum ths leads to a hgher value of aggregate captal stock. Output s also expected to ncrease n the long-run. The loss n government revenue due to reducton n mport dutes s partally offset by the expanson n the tax base n the long-run. In the short-run government transfers to households are expected to fall to compensate for the mmedate drop n government revenue. Consumpton s lkely to ncrease n the long-run on aggregate and also for each household class, but n the short-run consumpton of specfc household groups or even aggregate consumpton mght fall. 11 The mpact on welfare on ndvdual household classes s therefore ambguous. On the one hand, the long-run ncrease n consumpton ncreases welfare. On the other hand, reducton n the government revenue brought about by trade lberalsaton forces the government to cut transfers to households, at least n the short-run. Ths affects negatvely dsposable ncome of households, who are forced, ceters parbus, to reduce consumpton. Ths wll clearly have an adverse mpact on welfare. Moreover, whereas on the aggregate level consumpton mght ncrease also n the short-run, the benefts mght be dstrbuted unevenly across dfferent households, and some specfc household group can be worse off after the trade lberalsaton takes place. Table 4.3 summarses the mpacts on the welfare under the four scenaros. The two-polcy smulatons result n welfare gans for most household classes, and n larger gans to the two poorest household groups than to the rchest. The only household category that loses from trade lberalsaton s the second-rchest household group (HH5), that s better off only under scenaro 3, n whch an exogenous and arbtrary change n government transfers shares s mplemented. Therefore, trade lberalsaton s not always Pareto-mprovng snce some households,.e. group denoted HH5, are worse off under two scenaros, namely scenaro 1 and 2. Scenaro Polcy varables HH1 HH2 HH3 HH4 HH5 HH6 1 Government transfers 0,06 0,19 0,08 0,04-0,03 0,06 2 Government transfers; VAT 10% ncrease 0,05 0,14 0,02 0,00-0,07 0,03 3 Government transfers; change n Tr shares 0,06 0,03 0,08 0,04 0,01 0,06 4 Government consumpton 0,10 0,21 0,10 0,07 0,00 0,08 Table 4.3. Scenaros and welfare changes. 11 Ths s the case n the standard trade model analyss, consdered n chapter 3. 59

60 Fgure 4.3 provdes a pcture of the welfare results and the absolute sze of each household group. 0,25 Scenaro 1 Scenaro 2 Scenaro 3 Scenaro 4 0,2 0,15 0,1 0,05 0-0,05 HH1 HH2 HH3 HH3 HH4 HH4 HH5 HH5 HH5 HH6 HH6-0,1 Indvduals Fgure 4.3. Welfare changes and szes of household classes. Inequalty s measured wth the Gn ndex of ncome (Gn, 1912), whch s shown n fgure 4.4. From the ntal value of , the Gn ndex follows dfferent paths under the four scenaros. Under scenaro 3, the Gn ndex ncreases mmedately very sharply wth trade lberalsaton, and ends up wth a value of 0.281, whch s the hghest Gn ndex n the long-run under all scenaros. Under scenaros 1 and 4, the Gn ndeces follow a very smlar pattern, wth a small ntal ncrease and a long-run value around The ndex under scenaro 2 follows a qute dfferent path. It falls at the very begnnng of the trade lberalsaton process, but t rses mmedately and approaches the long-run equlbrum from below, reachng the value of The reason for ncreasng Gn ndeces s that households rely dfferently on varous sources of ncome. Government transfers are reduced mmedately when trade lberalsaton begns and they are decreasng n the followng years. Ths clearly affects relatve strongly ncome of poor households. Furthemore, poor households use ther amount of captal assets to smooth consumpton, snce they have to overcome temporary decreases n ncome. Therefore, the mmedate response of ncome to trade lberalsaton s postve for the rch and negatve for the poor. In addton, the ncrease n ncome s larger the 60

61 rcher the household s, whch over tme leads to a larger ncome gap between rch and poor hosuseholds. Fgure 4.8 wll show graphcally how ncome reacts to the shocks. Scenaro 1 Scenaro 2 Scenaro 3 Scenaro 4 0,281 0,28 0,279 0,278 0,277 0,276 0,275 tme Fgure 4.4. Gn ndex of ncome. Scenaro 1: Assocaton Agreement and endogenous government transfers In the frst smulaton experment the Assocaton Agreement s mplemented and aggregate government transfers to households, TR, are endogenous. Whle aggregate transfers are endogenous, the shares of aggregate transfer receved by each household group, π s, are fxed. As ponted out above, the gradual reducton n the EU tarff rates nduces a fall n the composte prce of mported goods. Ths leads to an ncrease n the domestc demand for consumpton and nvestment goods. The upward movement n nvestment results n an ncrease of aggregate captal stock and n hgher producton n the long-run. Fgure 4.5 shows the consumpton path of heterogeneous households. The three poorest household groups,.e. HH1, HH2 and HH3, are mmedately dentfable as wnners, snce ther consumpton level s at all tme above the benchmark value. Hence, regardless of ther dscount rate, they are expected to experence an ncrease n welfare, as already ndcated by table 4.3. For the remanng household classes, the mpact on welfare depends crucally on the rate at whch they dscount future consumpton. Fgure 4.5 explan how the welfare mpact shown n table 4.3 are determned. The households denoted as HH4 and HH6 experence an 61

62 ntal drop n consumpton. However, consumpton ncreases steadly and reaches the fnal equlbrum well above the benchmark value, suggestng that the dynamc effect of trade lberalsaton on welfare of these two household classes s postve. The consumpton path of the second-rchest household group, HH5, s rather dfferent. Consumpton falls abruptly below the benchmark level, thereafter t grows slowly, and t ends wth a long-run equlbrum value whch s lttle above the benchmark level. Ths explans therefore where the welfare loss for HH5 comes from. 1,06 HH1 HH2 HH3 HH4 HH5 HH6 1,04 1,02 1 0,98 0,96 0,94 tme Fgure 4.5. Consumpton under scenaro 1. The dynamc path of aggregate transfers to households s shown n fgure 4.6. As expected, endogenous aggregate transfers start below the benchmark level, and ncrease slghtly. Thereafter they drop steadly, they overshoot and then approach the long-run equlbrum value from below. The ups and downs n the transfers tme path can be explaned as follows: whereas tme s contnuous, the mport tarff reducton occurs n a dscrete-tme way; after the tarff reducton, government revenue adjusts over the contnuous-tme horzon untl the next tarff reducton step occurs, and hence t fluctuates around the trend; n turn the tme path of government revenue affects government transfers to households. 12 Fgure 4.7 shows the behavour of government revenue durng the process of trade lberalsaton under scenaro The same phenomenon characterses the standard trade model, as shown n chapter 3. 62

63 0,96 0,955 0,95 0,945 0,94 0,935 0,93 0,925 0,92 0,915 0,91 tme Fgure 4.6. Aggregate government transfer under scenaro 1. 0,989 0,987 0,985 0,983 0,981 0,979 0,977 0,975 tme Fgure 4.7. Government revenue under scenaro 1. Fgure 4.8 depcts the response of ncome to trade lberalsaton. Ths explans why the Gn ndex s ncreasng over tme. As mentoned above, households rely dfferently on the four sources of ncome. Gven the fall n government transfers, ncome of poor households s affected adversely. In order to enjoy hgher consumpton, poor households use ther amount of captal assets. On the other hand, rch households can better explot nvestment opportuntes,.e. they can accumulate more captal stock, and they are also weakly affected by the drop n transfers, compared to poor households. As a consequence, the ncome nequalty ncreases over tme. 63

64 1,035 HH1 HH2 HH3 HH4 HH5 HH6 1,03 1,025 1,02 1,015 1,01 1, ,995 tme Fgure 4.8. Income under scenaro 1. Fgure 4.9 shows how the captal stock of each specfc household class s affected under scenaro 1. The pcture s consstent wth the above results. The four rchest households accumulate captal stock over tme, whereas poor households deaccumulate captal n order to smooth consumpton. The trade lberalsaton leads therefore to a reallocaton of captal assets whch s adverse to the poor. 1,06 HH1 HH2 HH3 HH4 HH5 HH6 1,05 1,04 1,03 1,02 1,01 1 0,99 0,98 0,97 tme Fgure 4.9. Captal stock under scenaro 1. 64

65 Fnally, the aggregate nvestment level s shown n fgure The fall n mport prces due to the reducton n tarff provdes strong ncentves for nvestment. The level of aggregate nvestment starts well above the benchmark value, t decreases steadly and approaches the equlbrum level from above. 1,25 1,2 1,15 1,1 1,05 1 0,95 tme Fgure Investment under scenaro 10. Scenaro 2: Assocaton Agreement, endogenous government transfers and exogenous ncrease n the VAT rates Under ths scenaro, further to endogenous transfers to households the government s assumed to undertake the fscal measure of a ten-percent ncrease n the VAT rates to overcome losses n revenue. Ths leads to two man effects. Prces of consumpton and nvestment goods ncrease relatvely to scenaro 1. Ths effect leads to a fall n demand, t reduces ncentves for nvestment, and t s expected to have a negatve mpact on welfare. On the other hand, government revenue are expected to be hgher than under scenaro 1. Hence transfers to households are lkely to ncrease relatve to the prevous scenaro, snce the fscal burden s now taken by two polcy nstruments,.e. transfers to households and VAT. As a result, ths smulaton s expected to yeld smaller welfare gans and larger welfare losses than scenaro 1. Moreover, larger transfers than under scenaro 1 mply that poor households wll beneft relatvely to the rch from the addtonal fscal measure. Therefore ths scenaro leads to a lower Gn ndex than under scenaro 1. Ths can be seen n fgure 4.4, whch shows that scenaro 65

66 2 results n the lowest Gn ndex n the long-run equlbrum. Moreover, under ths scenaro, ncome nequalty decreases n the ntal years of the trade lberalsaton process. Fgure 4.11 shows the prvate consumpton tme path. The fall n mport prces boosts consumpton demand n the very short-run. As can be seen graphcally, consumpton of all household groups starts above the benchmark value, equal to one. A second postve effect on consumpton s brought about by the hgh level of government transfers, whch le above the benchmark value, as shown n fgure ,04 HH1 HH2 HH3 HH4 HH5 HH6 1,03 1,02 1,01 1 0,99 0,98 0,97 tme Fgure Consumpton under scenaro 2. However, the ncrease n the VAT rates has a negatve mpact on aggregate demand. Ths reduces the ncentves to nvest, nvestment starts below the benchmark level, t ncreases sharply, t overshoots ts long-run value and then t approaches the equlbrum level from above, as fgure 4.13 shows. Consumpton also falls sharply, and after seven years of the entry nto force of the AA t ncreases slowly towards the long-run equlbrum value. Comparson between the consumpton paths under scenaro 1 and 2 explans the dfferent mpacts on welfare. Under scenaro 2, the negatve effect on demand brought about by the VAT ncrease results n lower longrun consumpton levels for all households categores. Ths n turn leads to a adverse mpact on welfare of all household groups. 66

67 1,13 1,11 1,09 1,07 1,05 1,03 1,01 0,99 tme Fgure Government transfer under scenaro 2. 1,1 1,05 1 0,95 0,9 0,85 0,8 tme Fgure Investment under scenaro 2. However, although the addtonal VAT ncrease affects negatvely welfare compared wth scenaro 1, t reduces nequalty. As argued above, hgher transfer values than under scenaro 1 mply a benefcal mpact for those household groups who rely more heavly than other on government transfer. Therefore, the ncome gap between rch and poor s reduced compared to the result under scenaro 1, as comparson 67

68 between fgures 4.8 and 4.14 suggests. 1,015 HH1 HH2 HH3 HH4 HH5 HH6 1,013 1,011 1,009 1,007 1,005 1,003 1,001 0,999 tme Fgure Income under scenaro 2. Scenaro 3: Assocaton Agreement, endogenous government transfers and exogenous changes n government transfer shares Ths smulaton addresses the ssue of a more even dstrbuton of welfare gans across household groups. Scenaro 1 s therefore extended to nclude an exogenous component,.e. the change n the shares of government transfers to households, π, n order to compensate losers n scenaro 1. Table 4.4 reports the shares of aggregate transfers that each household class receves n the benchmark equlbrum. Intal shares of transfer of each household n aggregate transfers have been calbrated from the dataset. Addtonally, the table shows the transfer shares n scenaro 3. The percent share of aggregate transfers receved by HH5 has been ncreased by 2.5, and the proporton to HH2 has been decreased by the same amount. The remanng shares have not been changed. Whle the exogenous change n the π s s clearly arbtrary, nevertheless t reflects the objectve of a more equal dstrbuton of welfare gans across dfferent households. HH1 HH2 HH3 HH4 HH5 HH6 calbrated shares 1,04% 6,76% 11,08% 19,91% 26,97% 34,23% shares n scenaro 3 1,04% 4,26% 11,08% 19,91% 29,47% 34,23% Table 4.4. Changes n transfers share. 68

69 As ndcated n table 4.3, the change n transfer shares results n a much lower welfare gan for HH2, whose welfare now ncreases only by 0,03% nstead of 0.19%. The welfare loss for HH5 under scenaro 1 turns now nto a welfare gan by 0.01%. HH1 HH2 HH3 HH4 HH5 HH6 1,05 1,04 1,03 1,02 1,01 1 0,99 0,98 0,97 0,96 tme Fgure Income under scenaro 3. The change n transfer shares results nto an ncome beneft for HH5 and nto an adverse effect to HH2 s ncome, as can be seen by comparng results under scenaro 3, shown n fgure 4.15 wth the outcome of scenaro 1, n fgure ,04 HH1 HH2 HH3 HH4 HH5 HH6 1,03 1,02 1,01 1 0,99 0,98 0,97 0,96 TIME Fgure Consumpton under scenaro 3. 69

70 Ths change s reflected n the consumpton paths of the two households affected by the polcy change. The dfferences n terms of tme path and long-equlbrum values can be seen by comparson of fgure 4.16 wth fgure 4.5. Scenaro 4: Assocaton Agreement and endogenous government consumpton In ths smulaton, the endogenous varable s government consumpton. As already ponted out n chapter 3, trade lberalsaton combned wth endogensaton of government consumpton s expected to brng about larger welfare changes than the remanng scenaros, gven that government consumpton does not enter the utlty functon. Therefore, the measure taken by the government does not affect prvate ncome. Households can fully explot the benefts of trade lberalsaton. In the longrun, the consumpton levels of all household classes are hgher than the respectve long-run values under the remanng scenaro, as fgure 4.17 shows. 1,06 HH1 HH2 HH3 HH4 HH5 HH6 1,04 1,02 1 0,98 0,96 0,94 tme Fgure 17. Consumpton under scenaro 4. As shown n table 4.3, the welfare gans under scenaro 4 are larger than those brought about by scenaro 1. Moreover, the only household group that experences a welfare loss under scenaros 1 and 2,.e. HH5, s now unaffected. However, the credblty of ths smulaton result s clearly questonable, gven the feasblty problem n mplementng a reducton n government spendng. 70

71 4.7 Conclusons In ths chapter the queston of how preferental trade lberalsaton affects dfferent households has been nvestgated. The model mplemented here s based on the standard trade model presented n chapter 3, augmented by ntroducng heterogeneous households. Each of the sx household group dffers wth respect to ncome, ntal endowments of assets, transfers from the government and from abroad, wage rate, ncome tax rate and ndvdual preferences. Whereas several studes have mplemented general equlbrum models to address poverty and ncome dstrbuton ssues n a dynamc framework, the approach used n ths chapter ntroduces the fundamental assumpton that dfferent household classes are charactersed by dfferent dscount rates, whch are calbrated from the avalable data. Aggregate results confrm the fndngs provded by the standard trade model n chapter 3. Specfcally, mport tarff reducton lowers domestc prces of mported goods, t boosts consumpton and nvestment demand. In turn ths leads to faster aggregate captal accumulaton. Trade lberalsaton reduces government revenue, due to foregone mport dutes. Ths requres domestc complementary polces amng at counterbalancng the adverse mpact on government revenue. Polcy optons consdered here are the endogenous decrease n government transfers to households and government spendng, and the exogenous ncrease n the VAT rates. Effects of openng up domestc trade and mplementng adjustment polces are dfferent across household groups. Most smulatons result n postve welfare effects. However, one specfc household group, the second rchest one, s worse off under two scenaros. Therefore trade lberalsaton s not Pareto mprovng. Poor households experence slghtly larger welfare gan than rch households. However, nequalty, measured wth the Gn ndex, ncreases over tme under all scenaros. Ths result s drven by the much hgher rate of captal accumulaton of rch households than the one of poor. Ths occurs because households rely dfferently on varous sources of ncome. The drop n government transfer affects poor households relatvely strongly. As a result, ther ncome falls, and they use ther amount of captal assets to smooth consumpton. Overall t can be seen that ntroducng heterogeneous households nto a dynamc CGE model yelds nterestng nsghts about welfare and the dynamc behavor of ncome dstrbuton across households. Snce dstrbutonal aspects are of great m- 71

72 portance, ths analyss hopes to provde addtonal theoretcal nsghts as well as useful polcy mplcatons. 72

73 5 Conclusons In ths dssertaton a dynamc CGE model has been constructed to study the mpacts of preferental trade lberalsaton on the Jordanan economy. The dynamc general equlbrum approach allows to capture fully the chan of events takng place when tarffs, ther nteractons and ther ntertemporal effects. The standard model dscussed n chapter 3 s charactersed by one representatve household, who maxmses dscounted lfetme utlty by choosng future paths of optmal consumpton and nvestment. The model has been calbrated to 1998 data, and t has been used to analyse how the Assocaton Agreement wth the EU affects consumers welfare and macroeconomc varables n Jordan. Revenue losses due to foregone mport dutes force the government to mplement complementary measures such as reducton n transfers to household or tax reform. Therefore, together wth the Assocaton Agreement wth the EU, smulatons nclude domestc polcy responses accompanyng the trade lberalsaton process. The Jordanan economy benefts from the Assocaton Agreement n terms of lower mport prces of consumpton and nvestment goods. Ths brngs about postve long-run effects on all macroeconomc varables and welfare gan. Whereas the mpact on welfare s postve under all scenaros, mplementaton of domestc polcy reforms amng at allevatng the loss n government revenue affects negatvely prvate consumpton n the short-run and rase concerns about poltcal feasblty of the trade lberalsaton process. The standard trade model has been augmented by ntroducng heterogeneous households. The sx household classes have dfferent ncome, ntal endowments of assets, transfers from the government and from abroad, wage rate, ncome tax rate and ndvdual preferences. Very mportantly, t s also assumed that households are charactersed by dfferent dscount rates, whch are calbrated from the 2002 households survey. Ths assumpton makes ths approach new and dfferent from all other prevous studes on poverty and ncome dstrbuton. The results on aggregate varables are qualtatvely the same as those yelded by the standard trade model. Introducng heterogeneous households nto a dynamc CGE model yelds very nterestng nsghts about welfare and the dynamc behavor of ncome dstrbuton across households. The analyss confrms that dfferent households respond dfferently 73

74 to trade lberalsaton mpacts, and t suggests that trade lberalsaton allevates poverty n the long-run. Moreover, poor households n the economy are those who experence larger welfare gan, contrary to the wdespread fear that trade lberalsaton mght be harmful for the poor. However, the analyss suggests also trade lberalsaton creates also losers,.e. some specfc household group that experences a drop n welfare. Trade lberalsaton, therefore, s not Pareto mprovng. Fnally, trade lberalsaton leads to ncreasng ncome nequalty over tme. Gven the mportance of poverty and ncome nequalty ssues, ths analyss hopes to provde theoretcal contrbutons and useful polcy mplcatons. 74

75 6 Appendces 6.1 Appendx 1. Update of the I-O table Table A.1 below shows the correspondence between the H.S. for goods - at the top level of dsaggregaton - and the classfcaton used by the DOS for actvtes 1 to 3. The concordance s drect and straghtforward for most of the sectors, except for the HS categores IX and XIV. HS Classfcaton DOS Classfcaton I 1 II 1 III 3.1 IV 3.1 V 2 VI 3.4 VII 3.5 V III 3.2 IX 1 and 3.3 X 3.3 XI 3.2 XII 3.7 X III 3.5 XIV 3.5 and 3.6 XV 3.6 XVI 3.7 XVII 3.7 XVIII 3.7 XX 3.7 XXI 3.7 Unspecfed 3.7 Table A.1. Correspondence table 75

76 Table A.2 shows the further correspondence needed for top categores IX and XIV of the H.S.. In order to match the H.S. categores wth the DOS ones, a hgher degree of dsaggregaton had to be used, specfcally 2-dgt for one sub-category and 4-dgt for the remanng ones. Further dsaggregaton for HS man categores IX and X IV HS-top HS-2dgt HS-4dgt DOS IX XIV Table A.2. Correspondence for IX and XIV. 76

77 Table A.3 below provdes the lst of codes and commodty descrptons of the H.S. used by the DOS n dealng wth external trade statstcs. Code I II III IV V VI VII VIII IX X XI XII XIII XIV XV XVI XVII XVIII XX XXI Commodty Descrpton Lve anmals; anmal products Vegetable products Anmal or vegetable fats and ols and ther cleavage products; prepared edble fats; prepared anmal or vegetable waxes Prepared foodstuffs;beverages, sprts and vnegar; tobacco and manufactured tobacco substtutes Mneral products Products of the chemcal or alled ndustres Plastcs and artcles thereof; rubber and artcles thereof Raw hdes and skns, leather, furskns and artcles thereof; saddlery and harness; travel goods. handbags and smlar contaners; artcles of anmal gut (other than slk-worm gut) Wood and artcles of wood; wood charcoal; cork and artcles of cork; manufactures of straw of esparto or of other platng materals; basketware and wckerwork Pulp of wood or of other fbrous cellulosc materal; waste and scrap of paper or paperboard; paper and paperboard and artcles thereof Textles and textle artcles Footwear, headgear, umbrellas,sun umbrellas, walkng-stcks, seat-stcks, whps, rdng-crops and parts thereof; prepared feathers and artcles made therewth; artfcal flowers; artcles of human har Artcles of stone,plaster, cement, asbestos mca or smlar materals; ceramc products; glass and glassware Natural or cultured pearls, precous or sem-precous stones, precous metals, metals clad wth precous metal and artcles thereof; mtaton jewellery;con Base metals and artcles of base metals Machnery and mechancal applances; electrcal equpment; parts thereof; sound recorders and reproducers, televson mage and sound recorders and reproducers, and parts and accessores of such artcles Vehcles, arcraft, vessels and assocated transport equpment Optcal, photographc, cnematographc, measurng, checkng, precson, medcal or surgcal nstruments and apparatus; clocks and watches; muscal nstruments; parts and accessores thereof Mscellaneous manufactured artcles Works of art, collectors' peces and antques Unspecfed Table A.3. H.S. top classfcaton. The concordance table between the B.T.N. and the DOS classfcaton s not ncluded because ts sze s too large. The remanng tables below show the complete dataset used n the update. As ponted out above, data for 1987 are revsed and dffer from the orgnal prelmnary dataset, and data for 2001 are mostly prelmnary. At the end of appendx 1 there are graphs showng the trends of some coeffcents. 77

78 Table A.4. Dsaggregated ntermedate demand (producer prces, mllon JD) Table A.5. Dsaggregated output (producer prces, mllon JD) 78

79 Table A.6. Supply (mllon JD) Table A.7. Number of frms a(4-9, 3.5) o 1987r Fgure A.1. Coeffcent a(4-9,3.5)

80 0.30 a(4-9, 1) o 1987r Fgure A.2. Coeffcent a(4-9,1) 0.35 a(3.7, 3.7) o 1987r Fgure A.3. Coeffcent a(3.7,3.7) a(4-9, 3.7) o 1987r Fgure A.4. Coeffcent a(4-9,3.7) 80

81 0.30 a(4-9, 3.2) o 1987r Fgure A.5. Coeffcent a(4-9,3.2) 0.12 a(3.5, 3.5) o 1987r Fgure A.6. Coeffcent a(3.5,3.5) a(3.2, 3.2) o 1987r Fgure A.7. Coeffcent a(3.2,3.2)

82 0,25 a(4-9, 4-9) 0,20 0,15 0,10 0,05 0, o 1987r Fgure A.8. Coeffcent a(4-9,4-9) ,40 a(3.1, 1) 0,35 0,30 0,25 0,20 0,15 0,10 0,05 0, o 1987r Fgure A.9. Coeffcent a(3.1,1)

83 6.2 Appendx 2. The Standard Trade Model 2.A. Lst of equatons (tme ndex dropped for smplcty) Captal accumulaton equaton K = I δk Dsposable ncome Euler equaton YD= 1 t Y wl + 1 t K rk + TR+ erf REM Composte prvate consumpton Ċ 1 t Y C = 1 t K r ρ δ P I C = Ω C N Y =1 c θc ; Ω C > 0; 0 < θ C < 1 P C C = NX =1 P X c Consumpton prce ndex c = θc Pj X c j θ C j P X ;, j =1, 2,..,N P C = 1 Ω C NY =1 Prvate consumpton demand functons µ P X θ C j ; N =10 θ C c = θ C P C C P X 83

84 Composte government consumpton G = Ω G N Y =1 g θg ; Ω G > 0; 0 < θ G < 1 P G G = NX =1 P X g g = θg Pj X g j θ G j P X Government consumpton prce ndex ;, j =1, 2,.., N P G = 1 Ω G NY =1 Government consumpton demand functons µ P X θ G j θ G ; N =10 Composte nvestment g = θ G P C G P X I = Ω I N Y =1 nv θi ; Ω I > 0; 0 < θ I < 1 P I I = NX =1 P X nv nv = θi Pj X nv j θ I j P X ;, j =1, 2,.., N Investment prce ndex 84

85 P I = 1 Ω I Investment demand functons N Y =1 µ P X θ I j ; N =10 θ I Leontef producton functon nv = θ I P I I P X Value-added producton functon σ 1 σ VA = A "α LD ½ VA Q =mn, q ¾ j,,... ;, j =1, 2,.., N a 0, a j, +(1 α ) KD σ 1 σ # σ σ 1 ;0< α < 1; σ > 0; σ 6=1 P VA VA = wld + rkd Labour demand functon KD w = LD r σ (1 α ) α µ LD =(A ) (σ 1) α P VA σ VA w Captal demand (1 KD =(A ) (σ 1) α ) P VA σ VA r Value-added prce P VA = 1 A w (1 σ ) (α ) σ + r (1 σ ) (1 α ) σ 1 1 σ 85

86 CES Armngton functon The equatons below have been used n the calbraton procedure n a general form; more specfcally, n the model the same equatons apply to prvate consumpton, government consumpton, nvestment and ntermedate nputs: therefore X has to be replaced by c, g, nv and q j, ; M has to replaced by cm, gm, nvm and qm j, ; and cd, gd, nvd and qd j, wll replace D, where the subscrpts and j ndcate the producton sector; functonal parameters and prces are the same for all specfc forms. γ 1 X = Φ ε (M ) γ +(1 ε )(D ) γ 1 γ γ 1 γ Φ > 0; 0 < ε < 1; γ > 0; γ 6=1; =1, 2,..., 10 P X X = P M M + 1+vat D P D D Imports demand functon D (1 ε ) P MF = M ε (1 + vat D ) P D γ Domestc goods demand functon µ M =(Φ ) (γ 1) ε P X γ X P M Composte CES Armngton prce D =(Φ ) (γ (1 1) ε ) P X γ X (1 + vat D ) P D P X = 1 n P M (1 γ ) Φ (ε ) γ + 1+vat D o 1 P D (1 γ ) (1 ε ) γ 1 γ Cobb-Douglas total mports The equatons for total mports have been used n the calbraton procedure n the general form descrbed below; n the model, the same equatons apply to prvate consumpton, government consumpton, nvestment and ntermedate nputs: therefore 86

87 M has to replaced by cm, gm, nvm and qm j, ;andm j wll be replaced by cm j, gm j, nvmj and qm j,k,where and k are producton sector ndeces and j s ndex ndcatng the foregn regon; functonal parameters and prces are the same for all specfc forms. Φ M M = Φ M > 0; 0 < ε EU, ε RW M EU ε EU < 1; ε EU M RW ε RW + ε RW =1; =1, 2,..,N P M M = PM EU M EU + PM RW M RW M EU M RW Regonal mports demand functons = εeu ε RW PM RW PM EU M j = ε j P M M PM j ; =1, 2,.., 10; j = EU,RW Import composte prce Import prces P M = 1 Φ M µ PM EU ε EU ε EU µ PM RW ε RW ε RW PM j = erp W M 1+tm j 1+vat M ; j = EU,RW CET functon Q = χ λ (E ) 1+Ψ Ψ +(1 λ )(D ) 1+Ψ Ψ 1+Ψ Ψ χ > 0; 0 < λ < 1; Ψ > 0; =1, 2,..., N P Q Q = P E E + P D D 87

88 Export supply functon D λ P D = E (1 λ ) P E Ψ E = Q (χ ) (1+Ψ ) ³ P Q µ P E Ψ λ Ψ Domestc good supply functon D = Q (χ ) (1+Ψ ) ³ P Q µ P D Ψ 1 λ Ψ Composte output prce P Q CET composte exports " = 1 P E (1+Ψ ) P D (1+Ψ # ) 1 1+Ψ + χ (λ ) Ψ (1 λ ) Ψ E = χ E " λ EU 1+ΨE E EU Ψ E + λ RW E RW 1+ΨE Ψ E # ΨE 1+Ψ E χ E > 0; 0 < λ EU, λ RW < 1; λ EU + λ RW =1;Ψ E > 0; =1, 2,,.., N P E E = PE EU E EU + PE RW E RW Exports supply functons E EU E RW = µ λ RW PE EU λ EU PE RW Ψ E E j = E (P E ) ΨE (χ E )(1+ΨE ) Ã! PE j ΨE λ j ; =1, 2,,.., N; j = EU,RW 88

89 Export composte prce Export prces P E = 1 χ E " PE EU 1+Ψ E (χ E )ΨE + PE RW 1+Ψ E (χ D )ΨE # 1 1+Ψ E Domestc goods VAT revenue PE j = erp WE ; j = EU,RW Imported goods VAT revenue VAT D = NX =1 vat D P D D VAT M = Imports tarffs revenue NX X vat M =1 j=eu,rw 1+tm j erp W M M j TM = NX X =1 j=eu,rw tm j erp W M M j Captal rent tax revenue TK = t K rk Income tax revenue Government budget TY = t wl + 1 t K rk + TR+ erf REM VAT D + VAT M + TY + TK + TM + erf RG = TR+ G 89

90 Labour market equlbrum L = NX LD =1 Captal goods market equlbrum K = NX KD =1 Domestc goods markets equlbrum X = NX q,j + c + nv + g j=1 External equlbrum NX =1 PW M M = NX =1 PW E E + FREM + FGR 2.B. Glossary N: number of producton sectors (N =10) er: exchange rate (numerare) L: labour supply K: captal supply C: prvate consumpton P C : prvate consumpton prce ndex YD: personal dsposable ncome TR: government transfers to households FREM: foregn remttances to households t Y : ncome tax rate t K : tax on captal ncome ρ: household s dscount rate δ: deprecaton rate of captal 90

91 P X :composteprceofgood c : household s consumpton of good Ω C : shft parameter n the Cobb-Douglas prvate consumpton functon θ C :good s share parameter n the Cobb-Douglas prvate consumpton functon I: aggregate nvestment P I : prce ndex of aggregate nvestment nv :sector s nvestment demand Ω I : shft parameter n the Cobb-Douglas nvestment functon θ I :good s share parameter n the Cobb-Douglas nvestment functon G: aggregate government consumpton P G : prce ndex of aggregate government consumpton g : government consumpton of good Ω G : shft parameter n the Cobb-Douglas government consumpton functon θ G :good s share parameter n the Cobb-Douglas government consumpton functon VA :sector s value-added producton P VA :sector s value-added prce LD :sector s demand for labour KD : sector s demand for captal A : shft parameter of the value-added producton functon n sector σ : elastcty of substtuton between prmary nputs n sector α : share parameter of labour used n the producton of good w: nomnal wage rate r: nomnal return to captal Q : total output of sector P Q : composte output prce of sector q j, : ntermedate nput produced by sector j used n the producton of sector a 0, : fxed coeffcent of value-added output for sector s producton a j, : fxed coeffcent of ntermedate nput j n the producton of good X : total domestc absorpton of sector M : total mports of sector cm : prvate consumpton demand for mport good produced by sector gm : government consumpton demand for mport good produced by sector nvm : nvestment demand for mport good produced by sector 91

92 qm j, : mported ntermedate nput produced by sector j used n the producton of sector D : total domestc producton of sector cd : prvate consumpton demand for domestc good produced by sector gd : government consumpton demand for domestc good produced by sector nvd : nvestment demand for domestc good produced by sector qd j, : ntermedate nput produced domestcally by sector j used n the producton of sector Φ : shft parameter n the CES Armngton functon of sector ε : mports share parameter n the CES Armngton functon of sector γ : sector s elastcty of substtuton between mports and domestcally-produced output P X : composte prce of domestc absorpton of sector : mport prce of sector P M P D :prceofsector s domestcally-produced good vat D : VAT rate on sector s domestcally-produced good M j : mports of sector from regon j cm j : prvate consumpton of good mported from regon j gm j : government consumpton of good mported from regon j nvm j : nvestment demand for good mported from regon j qm j,k : ntermedate nput consumpton of good used n the producton of sector k and mported from regon j :sector s prce of mports from regon j PM j Φ M : shft parameter n the mports CES functon of sector ε j :regonj s share parameter n the mports CES functon of sector tm j : mport tax rate applyng to sector s mports from regon j vat M : VAT rate on sector s mported goods PW M :sector s world prce of mports E : total exports of sector P E : export prce of sector χ : shft parameter n the CET functon of sector λ : export share parameter of sector Ψ : elastcty of transformaton between exports and domestcally-sold output of sector 92

93 E j : total exports of sector to regon j χ E : shft parameter n the CET exports functon of sector λ j : share parameter of exports to regon j n sector Ψ E : elastcty of transformaton between exports to dfferent regons of sector PE j : prce of exports to regon j of sector PW E : world prce of exports of sector VAT D : domestc goods VAT revenue VAT M : mported goods VAT revenue TM: aggregate mport tarffs revenue TK: captal tax revenue TY: ncome tax revenue FRG: foregn grants to the government 93

94 6.3 Appendx 3. The Poverty Model 3.A. Lst of equatons (tme ndex dropped for smplcty) Captal accumulaton equaton K = SAV δk = YD P C C δk, =1, 2,.., H P I Dsposable ncome Euler equaton YD =(1 τ )(w L + rk + Tr + erf T ) Ċ = (1 τ ) r ρ C P I δ Composte prvate consumpton C = Ω C NY j=1 c θc,j,j ; ΩC > 0; 0 < θ C,j < 1; =1, 2,.., H; j =1, 2,.., N P C C = NX j=1 P X j c,j c h, Consumpton prces = θc h,pc j c h,j θ C h,j pc ;, j =1, 2,.., N; h =1, 2,,.., H P C = 1 Ω C Ã NY P X j θ C j=1,j! θ C j Prvate consumpton demand functons c,j = θ C,j P C C P X j 94

95 Composte government consumpton G = Ω G N Y j=1 g θg j j ; Ω G > 0; 0 < θ G j < 1; j =1, 2,..., N P G G = NX =j P X j g j g = θg Pj X g j θ G j P X Government consumpton prce ndex ;, j =1, 2,.., N P G = 1 Ω G Ã NY P X j j=1 θ G j! θ G j Government consumpton demand functons g j = θ G j P C G P X j Composte nvestment I = Ω I N Y j=1 nv θi j j ; ΩI > 0; 0 < θ I j < 1; j =1, 2,.., N P I I = NX j=1 P X j nv j nv = θi Pj X nv j θ I jp X ;, j =1, 2,.., N Investment prce ndex 95

96 N Y Ã P X j! θ I j P I = 1 Ω I j=1 θ I j Investment demand functons nv j = θ I j P I I P X j Leontef producton functon Value-added producton functon " HP VA j = A j =1 ½ VAj Q j =mn, q ¾,j,... a 0,j a,j σ j 1 µ σ α,j LD j P,j + 1 H =1 =1, 2,..,H; j =1, 2,.., N α,j KD σ j 1 σ j j # σ j σ j 1 Labour demand functons P VA j VA j = HX w LD,j + rkd j =1 Captal demand Ã! L,j =(A j ) (σj 1) α,j P VA σj j VA j w µ 1 N P α,j P K j =(A j ) (σj 1) j VA VA j =1 r σ j Value-added prce 96

97 P VA j " = 1 N Ã X (w ) (1 σj) (α,j ) σ j + r (1 σ j) 1 A j =1 NX =1 α j! σj # 1 1 σ j CES Armngton functon The equatons below have been used n the calbraton procedure n a general form; more specfcally, n the model the same equatons apply to prvate consumpton, government consumpton, nvestment and ntermedate nputs: therefore X has to be replaced by c h,, g, nv and q j, ; M has to replaced by cm, gm, nvm and qm j, ; and cd, gd, nvd and qd j, wll replace D, where the subscrpt h stands for household and the subscrpts and j ndcate the producton sector; functonal parameters and prces are the same for all specfc forms. γ 1 X = Φ ε (M ) γ +(1 ε )(D ) γ 1 γ γ 1 γ Φ > 0; 0 < ε < 1; γ > 0, γ 6=1; =1, 2,..., N P X X = P M M + 1+vat D P D D Imports demand functon D (1 ε ) P MF = M ε (1 + vat D ) P D γ Domestc goods demand functon µ M =(Φ ) (γ 1) ε P X γ X P M Composte CES Armngton prce D =(Φ ) (γ (1 1) ε ) P X γ X (1 + vat D ) P D P X = 1 n P M (1 γ ) Φ (ε ) γ + 1+vat D P D (1 γ o 1 ) (1 ε ) γ 1 γ 97

98 Cobb-Douglas total mports The equatons for total mports have been used n the calbraton procedure n the general form descrbed below; n the model, the same equatons apply to prvate consumpton, government consumpton, nvestment and ntermedate nputs: therefore cm h,, gm, nvm and qm,k replace M ;andcm j h,, gmj, nvmj and qmj,k,where the subscrpts and k are producton sector ndeces, the superscrpt j ndcates the foregn regon, and the ndex h stands for household. Φ M M = Φ M > 0; 0 < ε EU, ε RW M EU ε EU < 1; ε EU M RW ε RW + ε RW =1; =1, 2,..,N P M M = PM EU M EU + PM RW M RW M EU M RW = εeu ε RW PM RW PM EU Regonal mports demand functons M j = ε j Import composte prce P M M PM j ; =1, 2,.., N; j = EU,RW Import prces P M = 1 Φ M µ PM EU ε EU ε EU µ PM RW ε RW ε RW PM j = erp W M 1+tm j 1+vat M ; j = EU,RW CET functon h Q = χ λ (E ) 1+Ψ Ψ +(1 λ )(D ) 1+Ψ Ψ 1+Ψ Ψ χ > 0, 0 < λ < 1, Ψ > 0, =1, 2,..., N 98

99 P Q Q = P E E + P D D Export supply functon D λ P D = E (1 λ ) P E Ψ E = Q (χ ) (1+Ψ ) ³ P Q µ P E Ψ λ Ψ Domestc good supply functon D = Q (χ ) (1+Ψ ) ³ P Q µ P D Ψ 1 λ Ψ Composte output prce P Q CET composte exports " = 1 P E (1+Ψ ) P D (1+Ψ # ) 1 1+Ψ + χ (λ ) Ψ (1 λ ) Ψ E = χ E " λ EU 1+ΨE E EU Ψ E + λ RW E RW # ΨE 1+ΨE 1+Ψ E Ψ E χ E > 0; 0 < λ EU, λ RW < 1; λ EU + λ RW =1;Ψ E > 0; =1, 2,,.., N P E E = PE EU E EU + PE RW E RW Exports supply functons E EU E RW = µ λ RW PE EU λ EU PE RW Ψ E 99

100 E j = E (P E ) ΨE (χ E ) (1+ΨE ) Export composte prce µ P E ΨE λ j ; =1, 2,,.., N; j = EU,RW P E = 1 χ E " P E 1+Ψ E (χ E )ΨE + P D 1+Ψ E (χ D )ΨE # 1 1+Ψ E Export prces Domestc goods VAT revenue PE j = erp W E ; j = EU,RW VAT D = NX =1 vat D P D D Imported goods VAT revenue VAT M = Import dutes revenue NX X vat M =1 j=eu,rw 1+tm j erp W M M j TM = NX X =1 j=eu,rw tm j PWM M j Income tax revenue TY = HX τ (w L + rk + Tr + erf T ) =1 Aggregate government transfers to households TR = HX Tr =1 Government transfer to each household class 100

101 Tr = π TR;0< π < 1; HX π =1 =1 Government budget VAT D + VAT M + TY + TM + erf RG = TR+ G Labour market equlbrum condtons L = NX LD,j ;foreach =1,.., H j=1 Captal goods market equlbrum HX K = =1 NX KD j j=1 Domestc goods markets equlbrum X j = NX HX q,j + c h,j + nv j + g j =1 h=1 External equlbrum NX PWj M M j = j=1 NX PWj E E j + j=1 HX FT + FGR =1 3.B. Glossary H: numberofhouseholds(h =6) N: number of producton sectors (N =9) er: exchange rate (numerare) SAV :savngofhousehold YD : dsposable ncome of household 101

102 Tr : government tranfer to household FT : foregn remttances to household C : total consumpton of household P C : consumpton prce (ndex) of household τ : ncome tax rate applyng to household ρ :household s dscount rate Ω C : shft parameter n the prvate consumpton Cobb-Douglas consumpton functon of household c,j :household s consumpton of good j Pj X :composteprceofgoodj θ C,j: share parameter n the prvate consumpton Cobb-Douglas functon of household for good j I: aggregate nvestment P I : prce ndex of aggregate nvestment nv :sector s nvestment demand Ω I : shft parameter n the Cobb-Douglas nvestment functon θ I :good s share parameter n the Cobb-Douglas nvestment functon G: aggregate government consumpton P G : prce ndex of aggregate government consumpton g : government consumpton of good Ω G : shft parameter n the Cobb-Douglas government consumpton functon θ G :good s share parameter n the Cobb-Douglas government consumpton functon δ: deprecaton rate of captal L,j : sector j s demand for labour of type K j: sector j s demand for captal A j : shft parameter of the value-added producton functon n sector j σ j : elastcty of substtuton between prmary nputs n sector j α,j : share parameter of labour of type used n sector j VA j :sectorj s value-added producton Pj VA :sectorj s value-added prce w : nomnal wage rate of labour of type r: nomnal return to captal X : domestc absorpton of sector 102

103 M : total mports of sector cm : prvate consumpton demand for mport good produced by sector gm : government consumpton demand for mport good produced by sector nvm : nvestment demand for mport good produced by sector qm j, : mported ntermedate nput produced by sector j used n the producton of sector D : domestc producton of sector cd : prvate consumpton demand for domestc good produced by sector gd : government consumpton demand for domestc good produced by sector nvd : nvestment demand for domestc good produced by sector qd j, : ntermedate nput produced domestcally by sector j used n the producton of sector Φ : shft parameter n the CES Armngton functon of sector ε : mports share parameter n the CES Armngton functon of sector γ : sector s elastcty of substtuton between mports and domestcally-produced output P X : composte prce of domestc absorpton of sector : mport prce of sector P M P D :prceofsector s domestcally-produced good vat D : VAT rate on sector s domestcally-produced good M j : mports of sector from regon j cm j : prvate consumpton of good mported from regon j gm j : government consumpton of good mported from regon j nvm j : nvestment demand for good mported from regon j qm j,k : ntermedate nput consumpton of good used n the producton of sector k and mported from regon j :sector s prce of mports from regon j PM j Φ M : shft parameter n the mports CES functon of sector ε j :regonj s share parameter n the mports CES functon of sector tm j : mport tax rate applyng to sector s mports from regon j vat M : VAT rate on sector s mported goods PW M :sector s world prce of mports Q : total output of sector P Q : composte output prce of sector 103

104 E : total exports of sector P E : export prce of sector χ : shft parameter n the CET functon of sector λ : export share parameter of sector Ψ : elastcty of transformaton between exports and domestcally-sold output of sector E j : exports of sector to regon j χ E : shft parameter n the CET exports functon of sector λ j : share parameter of exports to regon j n sector Ψ E : elastcty of transformaton between exports to dfferent regons of sector PE j : prce of exports to regon j of sector PW E : world prce of exports of sector VAT D : domestc goods VAT revenue VAT M : mported goods VAT revenue TM: aggregate mport tarffs revenue TY: ncome tax revenue TR: aggregate government transfers to households FRG: foregn grants to the government 104

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