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Fuel Subsidies and the Global Oil Market(Preliminary)
Nathan Balke∗, Michael Plante and Mine Yucel
∗Southern Methodist UniversityFederal Reserve Bank of Dallas
July 29, 2013
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 1 / 24
Introduction
Introduction
I Fuel subsidies used by many developing countries
I Net oil exporters the largest subsidizers
I Fuel subsidies distort consumption and production decisions
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 2 / 24
Introduction
Top 10 Fuel Subsidizing Exporters
Country Share of GDP Cost ($B)
Iraq 17.8 20.4Iran 8.6 41.4Ecuador 8.2 5.44Saudi Arabia 7.7 46.1Venezuela 6.9 22.0Egypt* 6.5 15.27Libya 6.3 2.26Algeria 5.7 11.26Turkmenistan 3.0 0.83Malaysia 1.9 5.35
Table : 2011 – IEA data
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 3 / 24
Model
Model
I Analyze fuel subsidies with a two-country modelI Oil importing country, AI Oil exporting country, O
I Country A produces manufactured good
I Country O produces oil
I Households in both countries consume oil and the manufactured good
I Oil exporter has fuel subsidies
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 4 / 24
Model Oil Importing Country
Oil Importing Country
I Households consume both a manufactured good and oil
I Firms produce manufactured good, using capital, oil and labor
I Both households and firms pay world price for oil, Po
I Households receive wages, return on capital, profits from firm
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 5 / 24
Model Oil Importing Country
Oil Importing Country
I Households maximize utility
E0
∞∑t=0
βtU (Ca,t ,Na,t)
I Where β is the discount factor
I Ca,t is aggregate consumption in country a
I Na,t is hours worked
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 6 / 24
Model Oil Importing Country
Oil Importing Country
I Aggregate consumption:
Ca,t =[ωcaA
1−µcc,a,t + (1− ωc
a)O1−µcc,a,t
] 11−µc
I Ac,a,t is consumption of manufactured good in country a
I Oc,a,t is consumption of oil in country a
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 7 / 24
Model Oil Importing Country
Oil Importing Country
I Household budget constraint:
Aa,c,t + Pot Oc,a,t + Ia,t + φ(K ) = Wa,tNa,t + ra,tKt + Πa,t
I Pot is the relative price of oil
I Ia,t is gross investment in the capital good
I Wa,t is the wage
I ra,t is the return to capital
I φ(k) are adjustment costs
I Πa,t is re-numerated profits from the manufacturing firm
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 8 / 24
Model Oil Importing Country
Oil Importing Country
I Capital accumulation follows:
Ka,t − Ka,t−1 = Ia,t − δKa,t−t
I Adjustment costs are given by
φ(K ) =ψk
2(Kt − Kt−1)2
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 9 / 24
Model Oil Importing Country
Oil Importing Country
I Production technology:
Ya,t = Z ya,tN
αa,t
(ωyKK
1−νa,t−1 +
(1− ωy
K
)O1−ν
y ,a,t
) 1−α1−ν
I Ya,t is output in country a
I Z ya,t is a productivity
I Oy ,a,t is oil used by the firm in country a
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 10 / 24
Model Oil Importing Country
Oil Importing Country
I The firm maximizes profit
Πa,t = Ya,t − ra,tKa,t−1 −Wa,tNa,t − Pot Oy ,a,t
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 11 / 24
Model Oil Exporting Country
Oil Exporting Country
I Government produces oil using labor
I Oil is sold domestically at subsidized prices, Ps
I Remaining supply is exported at world prices, Po
I Government distributes oil profits to populace, transfer T
I Subsidy lowers transfers
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 12 / 24
Model Oil Exporting Country
Oil Exporting Country
I Households maximize utility
E0
∞∑t=0
βtU (Co,t ,No,t)
I Preferences identical to oil importing country
I β is the discount factor
I Co,t is aggregate consumption in country o
I No,t is hours worked
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 13 / 24
Model Oil Exporting Country
Oil Exporting Country
I The household budget constraint is
Ao,c,t + PstOc,o,t = Wo,tNo,t + Tt
I Pst is the subsidized price of oil
I Wo,t is the wage in the oil sector
I Tt is a lump-sum transfer from the government
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 14 / 24
Model Oil Exporting Country
Oil Exporting Country
I Production of oil is a function of labor:
Yo,t = Z yo,tN
α0o,t
I Yo,t is production of oil
I Z yo,t is productivity
I No,t is labor used to produce oil
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 15 / 24
Model Oil Exporting Country
Oil Exporting Country
I Firm maximizes profit
Πa,t = Pot (Yo,t − Oc,o,t) + Ps
tOc,o,t −Wo,tNo,t
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 16 / 24
Model Resource Constraints
Resource Constraints
I Oil importer:
Ac,a,t + Pot Oc,a,t + Ia,t + φ(K ) = Ya,t − Po
t Oy ,a,t
I Oil exporter:
Ac,o,t + Pot Oc,o,t = Po
t Yo,t
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 17 / 24
Model Market Clearing Conditions
Market Clearing Conditions
I Oil market:Oc,a,t + Oy ,a,t + Oc,o,t = Yo,t
I Manufactured good market:
Ac,a,t + Ia,t + Ac,o,t = Ya,t
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 18 / 24
Model Calibration
Calibration
Parameter or variable Value Source
Risk Aversion (σ) 2 Macro literatureElasticities of substitution 0.75 Graham & GlaisterElasticity of labor supply 1 Macro literatureDiscount factor (β) 0.96 U.S. real interest ratesOil Cons/GDP ratio in ROW 5% IO tablesFirm oil demand in ROW 2% IO tablesSubsidizer oil use 1.1% EIA IES DataLabor income/GDP in ROW 70% Developed country dataLabor income/oil production 50% Guesstimate
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 19 / 24
Model Cases Considered
Cases Considered
I Steady state with no subsidy
I Steady state with subsidy in OPEC countriesI Oil supply shock in OPEC countries
I OPEC does not subsidizeI OPEC subsidizes
I Productivity shock in non-OPEC countriesI OPEC does not subsidizeI OPEC subsidizes
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 20 / 24
Results
Change in Steady State with a Subsidy
Subsidy Cost (% of OPEC GDP)Variable 1% 5%
Po 0.99 4.97Ps -6.3 -25.4Yo 0.03 0.24Oc,o 5.24 26.06Oc,a -0.75 -3.64Oy ,a -0.75 -3.63T -0.98 -4.78Ac,o 0.23 1.15Ac,a -0.01 -0.07Na 0.03 0.16No 0.07 0.47
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 21 / 24
Results
Change in Steady State with an Oil Supply Shock inOPEC Countries
5% decline in OPEC supplyVariable No subsidy Subsidy (∆ from no subsidy)
Po 7.27 1.15Ps 7.27 -6.78Yo -5.00 0.00Oc,o -3.54 5.69Oc,a -5.22 -0.87Oy ,a -5.21 -0.87T 1.90 -1.07Ac,o 1.67 0.27Ac,a -0.10 -0.02Na 0.22 0.04No -0.48 0.07
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 22 / 24
Results
Change in Steady State with a Productivity Shock inNon-OPEC Countries
5% increase in non-OPEC productivityVariable No subsidy Subsidy (∆ from no subsidy)
Po 8.87 1.33Ps 8.87 -8.15Yo -1.47 0.05Oc,o 0.37 6.92Oc,a -1.75 -1.01Oy ,a -1.73 -1.00T 7.28 -1.31Ac,o 6.98 0.31Ac,a 4.72 -0.02Na -2.08 0.04No -2.91 0.04
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 23 / 24
Summary
Summary
I Subsidy in oil-exporting countries causes world oil prices to rise
I Oil consumption is crowded out in the oil-importing country
I Terms of trade effect crowds out oil-importing country’s consumptionof its own good
I Subsidies lower oil-exporting country’s transfers to its people
I Oil-exporter substitutes overall oil profits with a subsidy for aparticular fuel ⇒ could have distributional effects.
Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 24 / 24