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Evaluating the Social Impact of Economy-Wide Policies
B. Essama-NssahWorld Bank Poverty Reduction
Group (PRMPR)April 2007
2
Introduction Impact Analysis
An assessment of variations in individual and social welfare attributable to an exogenous shock or implementation of a policy.
Attribution based on a comparison of the policy state and the counterfactual, ceteris paribus.
3
Introduction Economy-Wide Shocks and Policies
Affect potentially the whole population Are bound to have both macroeconomic,
structural and distributional effects that work through a number of flow-of-fund variables and individual good or factor markets.
Need for an analytical framework that accounts for interdependence between stabilization, structural and distributional issues.
General equilibrium analysis offers such a framework.
4
Introduction Approaches
Standard Representative Household (RH) Impact on functional distribution of income, mean
welfare within a few representative socioeconomic groups, and between-group inequality, but not on poverty.
Extended Representative Household Extends the RH approach by modeling the size
distribution within group, hence allowing poverty analysis in addition to what RH allows. e.g. Lognormal (Dervis, de Melo and Robinson 1982) or Beta
(Decaluwé, Savard and Thorbecke 2005) or Parameterized Lorenz (Essama-Nssah 2005)
5
Introduction Approaches, continued
CGE-Micro-Simulation Use unit record data from household survey to build
a household model of expenditure, or income generation to allow a rich analysis of poverty and inequality.
Focus of Presentation A Stylized ERH Framework
Positive component: a two-sector model of an open economy
Structure Specification
6
Introduction Stylized ERH, continued
Normative component: the Lorenz model of income distribution Structure Parameterization Recovering Inequality and Poverty Measures
Numerical Implementation Impact of Budgetary Policy
Policy Options Outcomes
7
A Two-Sector Model of an Open Economy
Structure A logical representation of a
socioeconomic system wherein the behavior of all participants is compatible.
Organized around the standard Walrasian template.
8
Structure, continued Two categories of agents: producers and
consumers, or firms and households. Supply and demand behavior: an observable
consequence of the optimization assumption. Market interaction: method of social
coordination by mutual adjustment among participants based on “quid pro quo” (Lindblom 2001).
Behavioral compatibility entails equilibrium on all markets.
9
Structure, continued Comparative statics entails comparison of
equilibrium states associated with changes in the socioeconomic environment.
Social desirability depends on chosen criterion Pareto efficiency focuses on how well the system
promotes individual objectives: efficiency implies no other situation is unanimously preferred by all participants.
Poverty-focused criterion: less poverty is preferred to more.
10
Structure, continued Incentives configuration such that
amount of effective demand equals amount supplied.
Alternatively: No feasible change in individual behavior is
worthwhile. No desirable change in individual behavior is
feasible.
11
Producers
Factor markets
Intermediate goods
ImportsExports
Factor services
Final goods
Circular Flow Chart for an Open Economy
Rest ofthe world
Households
Factor markets
Product markets
12
Structure of a SAM for a Basic Model of an Open Economy
Activity Commodity Household Rest of
World Total
Activity Domestic Sales Exports Total Sales Commodity Intermediate
Consumption Household
Consumption Total Absorption
Household Payments to Factors of Production
Balance of Trade
Total Household Income
Rest of World Imports Total Earnings of Rest of the
World Total Total Factor
Payments Total Supply of Consumption
Goods
Total Household
Expenditure
Total Expenditure by Rest of
World
13
Structure, continued Social Accounting Matrix (SAM)
An accounting framework that reflects the circular flow of economic activity.
A square matrix: dimension based on the number of sectors and agents considered.
Each entry represents a payment to a row-account by a column-account.
Consistency implies that row total must equal corresponding column total.
Also, if all but one accounts balance, the last one must balance as well (Walras’ law).
14
Specification Based on Devarajan, Lewis and
Robinson (1990) Two sectors of production:
Export good not sold domestically. Home good used for both intermediate and final
consumption Imported and domestic intermediate goods
enter the production process. Production process in each sector
represented by a Cobb-Douglas function .,;1; deiLKAX likiiiii
liki
15
Specification, continued The demand for labor is derived from first
order conditions for profit maximization
Similarly for capital [capital is mobile in the long run]
.,;)( deiw
XPVAL iilii
.,;)( deir
XPVAK iikii
16
Specification, continued The net price in sector i is given by
a2i is the amount of aggregate intermediate good (Q2) per unit of output in sector i.
.,,22 deiPQaPXPVA iii
17
Specification, continued Producer price of exports
Two aggregate commodities for final (j=1) and intermediate consumption (j=2)
eee tRPX )1(
2,1;)1(1
jDMBQ jjj
jjjjjj
18
Specification, continued Import demand functions derived from cost
minimization.
Demand for domestic components of aggregate goods (implication off cost minimization).
2,1;)1( )1(1
)1()1(1 jQPMPDPMBM sjjjjjjjjj
jjj
jjjj
2,1;)1( )1(1
)1()1(1 jQPDPDPMBD sjjjjjjjjj
jjjjjjj
19
Specification, continued
Domestic price of imports inclusive of tariffs
Price of domestic sales includes a sales tax
2,1;)1( jtmRPM mjjj
2,1);1( jtxPXPD ddj
20
Specification, continued Producer price of the domestic good
Price of composite goods
2,1;)1(2
2
1
jtxX
DPDPX
d
jjj
e
2,1);( jMPMDPDPQ jjjjj
21
Specification, continued Rural household represents 60 percent
of the population, and owns a fraction RL of labor and a fraction RK of capital (to be determined by data in SAM).
Urban household represents 40 percent of the population, and owns a fraction (1- RK ) of capital and a fraction (1- RL) of labor.
22
Specification, continued Household income
Household demand for final good (no savings)
Government fiscal revenue
2
1
)(j
ddjmjjG XtxMRtmY
urhRSYrKSwLSY fhfGhghkhlh ,;)()(
h
dh
dhdh QQurh
PQY
Q 111
1 ;,;
23
Specification, continued Total demand for intermediate good
Equilibrium in the home good market
Material balance for composite goods
.,;22 deiXaQi
iid
2
1
2,1;j
jd jDX
2,1; jQQ dj
sj
24
Specification, continued Equilibrium condition for each factor market
under full employment of given amounts of capital and labor.
i i
ii deiKKSLLS .,;;
25
Specification, continued Government budget balance
Trade balance
urhYY Gh
Ghg ,;
jj
mjfee MSX
2
1
26
The Lorenz Model of Income Distribution Structure
A flexible statistical model of the distribution of some welfare indicator, x, among the population.
The Lorenz curve maps the cumulative proportion of the population (horizontal axis) against the cumulative share of welfare (vertical axis), where individuals have been ranked in ascending order of x.
x dtttfpLxFp
0
)()()(
27
Structure, continued
Alternative Expression based on : dp=f(x)dx
First-order derivative
dqqxpL
p
0
)()(
)()( pxpL
28
Structure, continued Second-order derivative
Parameterization Based on General Quadratic (Datt 1992,
1998) Lorenz
)(
111)(xf
dxdpdp
dxpL
2
122
2 )(21)( enpmpeppL
29
Quadratic model, continued
First Derivative
Second derivative
)(4
22
)(22
2
enpmp
nmppL
8)()(
23
222
enpmprpL
30
Recovering Inequality and Poverty Measures From a parameterized Lorenz model and the
mean of x, we can recover the following: X: based on the mean and the first order derivative of
the Lorenz function. Density function of x, f(x): based on the mean and
the second order derivative of the Lorenz function. This is all we need to compute all
inequality and poverty measures.
31
Numerical Implementation Data
Base Year SAM
Export Domestic Final Intermediate Labor Capital Rural Urban World Total Export 30.00 30.00 Domestic 73.00 2.00 75.00 Final 40.00 60.00 100.00 Intermediate 5.00 5.00 Labor 20.00 30.00 50.00 Capital 5.00 45.00 50.00 Rural Household 35.00 5.00 40.00 Urban Household 15.00 45.00 60.00 World 27.00 3.00 30.00 Total 30.00 75.00 100.00 5.00 50.00 50.00 40.00 60.00 30.00
Source: Adapted from Devarajan, Lewis and Robinson (1990)
32
Data, continued Calibrated Parameters
Calibrated Parameters f or the Two-Sector Model L K A M D B Export 0.80 0.20 1.98 Domestic 0.40 0.60 1.98 Final 0.38 0.62 1.89 I ntermediate 0.69 0.31 1.92
33
Data, continued A is tfp (total factor productivity) parameter in
the Cobb-Douglas production function ’s are factor shares (exponents in the
production function). ’s are shares in the Armington aggregation
function and B is a scale factor. Distribution of factor income in base year SAM:
RL=0.70, UL=0.30, RK=0.10, and UK=0.90 Distribution of government transfers: RG=0.60
and UG=0.40
34
Data, continued Distribution of foreign transfers: RF=0.20 and
UF=0.80 Base Year Income Distribution
Size Distribution of Income within the Two Socioeconomic Groups
Group Mean Poorest
Decile
2nd 3rd 4th 5th 6th 7th 8th 9th 10th
National 1.00 0.01 0.03 0.04 0.06 0.07 0.09 0.11 0.14 0.18 0.28
Rural 0.66 0.02 0.03 0.05 0.07 0.08 0.10 0.12 0.14 0.17 0.21
Urban 1.50 0.00 0.04 0.06 0.07 0.09 0.10 0.12 0.14 0.16 0.23
Source: Author’s calculations
35
Data, continuedBaseline Inequality (Extended Gini)
Focus National Rural Urban 1 0.00 0.00 0.00 2 0.41 0.32 0.32 3 0.57 0.47 0.47 4 0.65 0.56 0.57 5 0.71 0.62 0.64 6 0.74 0.66 0.69
Source: Author’s Calculations
36
Data, continued Parameters underlying the General Quadratic
Lorenz ModelParameterization of the Lorenz Model
Parameter National Rural Urban
1 1.52 2.16 1.46
2 -0.89 -1.42 -1.83
3 0.02 0.08 -0.15
e -1.65 -1.82 -0.48
m -5.29 -6.60 -2.51
n 2.86 4.84 2.37
r 8.11 10.50 2.82
Source: Author’s calculations
37
Policy Options Case 1: Reference
Tax on domestic sales: 15.4 percent Tariff on imports of final and intermediate
goods: 12.5 percent Case 2: Reform Option A
Increase domestic sales tax by 5% (from reference)
Lower tariff on final import by 17.6% Increase tariff on intermediate by 46.4 %
38
Policy Options, continued Case 3: Reform Option B
Lower sales tax by 5% Increase tariff on final goods by
18.4% Lower tariff on intermediate by 44%
39
Policy Options, continued
Tax Rates (percentage)
Case Domestic Good Final I mports I ntermediate I mports
1 15.4 12.50 12.50 2 16.17 10.3 18.30 3 14.63 14.80 7.00
40
Social I mpact of Budgetary Policy Base Case 1 Case 2 Case 3
Exports 30.0 100.0 102.2 97.7 Domestic Good 75.0 100.0 99.3 100.8 Final I mports 27.0 100.0 102.3 97.6 I ntermediate I mports 3.0 100.0 101.1 98.8 Total Consumption 100.0 100.0 100.0 100.0 Rural Consumption 40.0 106.7 107.1 106.3 Urban consumption 60.0 95.6 95.3 95.8 Total Poverty I ncidence 59.2 97.5 97.3 97.6 Rural Poverty I ncidence 78.3 95.2 94.9 95.5 Urban Poverty I ncidence 30.5 106.4 106.8 106.0 Overall Poverty Gap 29.7 95.8 95.6 96.1 Rural Poverty Gap 38.7 93.5 93.1 93.9 Urban Poverty Gap 16.3 104.1 104.4 103.9
41
Outcomes, continued Case 1:
Pattern of production and imports unchanged from the base case where there is no government intervention.
Optimal configuration of taxes to the extent that they do not distort private production decisions.
The redistributive policy associated transfers to households causes an increase in rural consumption and a decrease in urban consumption.
As a consequence overall poverty incidence decline by about 2.5 percent.
Rural poverty decreases by 5 percent while urban poverty increase by more than 6 percent.
42
Outcomes, continued Case 2:
Production of exports increases, that of the domestic good declines. Both categories of imports increase.
Pattern of change in poverty incidence is similar to the reference case, but reduction in rural poverty and increase in rural poverty are a bit higher than in the reference case.
Case 3: Production of exports and all imports fall while
production of domestic good increases. Change in poverty similar to previous cases.
43
Conclusion Evaluating the social impact of economy-wide policies
requires a social policy model framed within the logic of general equilibrium analysis.
Such a model has two basic components A structural representation of individual behavior and social
interaction based on the principles of optimization and quid pro quo.
A social evaluation function reflecting a chosen set of value judgments (e.g. efficiency and fairness).
A stylized analysis of the social impact of budgetary policy revealed the following:
The outcome hinges crucially on the underlying mechanisms allocating burdens and advantages among individuals.
Aggregate welfare effects may be negligible while structural and distributional impacts are significant.
the latter drive the political economy of policy-making.
44
References
De Melo Jaime and Robinson Sherman. 1989. Product Differentiation and the Treatment of Foreign Trade in Computable General Equilibrium Models of Small Economies. Journal of International Economics, Vol. 27:47-67.
Devarajan, Shantayanan, Jeffrey D. Lewis, and Sherman Robinson. 1990. Policy Lessons From Two-sector Models. Journal of Policy Modeling 12 (4): 625-657.
Dervis, Kemal, de Melo, Jaime, and Robinson, Sherman. 1982. General Equilkibrium Models for Development Policy. Washington, D.C.: the World Bank.
Decaluwé, B., Savard. L. and Thorbecke, E. 2005. General Equilibrium Approach for Poverty Analysis: With an Application to Cameroon. African Development Review, Vol. 17, No.2: 213-243.
45
Dinwiddy, C.L. and F.J. Teal. 1988. The Two-Sector General Equilibrium Model: A new Approach. Oxford: Philip Allan.
Essama-Nssah, B. 2006. Macroeconomic Shocks and Policies. In Aline Couduel and Stefano Paternostro (eds) Analyzing the Distributional Impact of Reforms. Washington, D.C.: The World Bank.
Essama-Nssah, B. 2005. Simulating the Poverty Impact of Macroeconomic Shocks and Policies. World Bank Research Working Paper No. 3788. Washington, D.C.: The World Bank.
Lindblom Charles E. 2001. The Market System: What Is It, How It Works and What to Make of It. New Haven: Yale University Press.
Varian Hal R. 1984. Microeconomic Analysis (Second Edition) New York: Norton & Company.
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THE END