Applied General Equilibrium Analysis

Edited by Herbert E. Scarf & John B. Shoven
Cambridge University Press, 1984

Preface

The present volume consists of a series of papers presented at the Conference on Applied General Equilibrium Analysis held in San Diego in August 1981. This conference and others with a similar orientation give adequate testimony to the fact that the technical problems associated with the numerical solution of large general equilibrium models have been overcome. Since the early 1970s a number of increasingly refined methods have been proposed for approximating the fixed points of continuous mappings. In their simplest form they involve decomposing the price simplex into a large number of small regions and utilizing information about the mapping to construct a pricewise linear path that can be shown to terminate at a fixed point. The chapters by Scarf and by Todd are an introduction to the mathematical techniques involved in approximating fixed points of a continuous mapping. These methods, whose development was spurred by the problem of calculating equilibrium prices, have become sufficiently rapid -in terms of computing time -so that numerical problems are no longer an effective constraint on our ability to solve general equilibrium problems of modest size, say, involving 30 to 40 disaggregated sectors. The constraints, to the extent that they exist, are to be found in the conceptual problems of formulating realistic models and in the insufficiency of data required to estimate with confidence the great number and variety of parameters of such a model.

The general equilibrium model has traditionally been used, and continues to be used, to analyze the effects of a change in economic policy such as the imposition of a tariff or quota on imported goods, the granting of export subsidies, or a modification of the tax code. It can be used to explore the consequences of an increase in the price or reduction in the supply of an imported good such as oil, the ramifications of an unexpected fall in the supply of food, or a major change in the regulation of an industry, to name several examples. In each of these cases, the parameters of the model are required to yield current price& and output levels as the solution of the general equilibrium model prior to the change. A recalculation is then done that predicts the consequences of the proposed change on a variety of economically significant variables: prices, levels of output, government receipts, and the distribution of income among the consuming units.

One of the major virtues of the general equilibrium model is its ability to trace the consequences of large changes in a particular sector through- out the entire economy. It shares this property with input-output analysis but permits a more flexible treatment of the consumer side of the economy and is less rigid in the requirements placed on the productive side. Major policy changes frequently have significant impacts on the distribution of income - indeed, they may be designed with this consequence in mind - and require, for their analysis, a conceptual framework that allows for the possibility of variations in income.

The consequences of a change in economic policy are frequently analyzed by assuming the changes to be small and using local linear approximations based on estimates of the relevant elasticities. If the number of sectors is small, diagrammatic techniques or explicit analytical results may also be available as in the two-sector models so frequently used in international trade theory. But if the model is disaggregated, and if the changes - possibly more than one - are large, there is no recourse other than the construction and explicit solution of a numerical general equilibrium model.

The imperfections of the general equilibrium model as a description of economic reality are well known to economists and in a less informed way to the general public. The model is inadequate in its treatment of money and financial institutions, it has great difficulty in allowing for unemployed resources, and it is unable to cope with large-scale industrial enterprises that are capable of exerting a significant influence on prices. Investments and roundabout methods of production are poorly treated if the model is formulated in static terms, and any attempt to rectify this by a dynamic model must find a replacement for the unrealistic assumption of perfect futures markets. But there are no competing formulations that avoid these shortcomings and provide the flexibility and conceptual wealth of the general equilibrium model. In spite of its imperfections, this method of analysis will retain its usefulness until economic theory is capable of providing compelling alternative formulations.

The chapters in the present volume deal with a variety of topics. Mansur and Whalley discuss the problems of data collection, parameter specification, and the feasibility of estimating an entire model attending to all of the cross-equation restrictions implied by the general equilibrium framework. Mansur and Whalley are pessimistic about full model estimation for all but the simplest structures and suggest the necessity of continued reliance on current methods of parameter specification. The chapter by Jorgenson is an ambitious and sophisticated attempt to estimate and report on a large general equilibrium model consisting of 36 sectors.

Fullerton, Henderson, and Shoven survey the structure of eight different applied general equilibrium models dealing with taxation. The sensitivity of such models to the level of disaggregation in production is investigated. The chapter examines several aspects of the eight models including their treatments of saving, the labor-leisure choice, foreign de, and the household sector. The chapter by Serra-Puche develops a model of the Mexican economy that is used to analyze the effect of introducing a value-added tax of the consumption type on income distribution resource allocation. His main result is that the welfare of rural consumer groups increases after this reform. Borges and Goulder use a model of the United States to simulate the impact of higher energy prices economic growth and to test the relative importance of several channels through which higher-priced energy affects growth. The chapter by bell and Harrison develops a regional model that predicts the incidence of fiscal policy in the California economy.

Ginsburgh and Waelbroeck discuss planning models and activity analysis. They propose that linearized economic models that can be formulated as optimization problems have advantages over computable general equilibrium models in the analysis of developing countries. The chapter by Dixon, Parmenter, and Rimmer also deals with a linearized model, but its most distinctive feature is its level of detail. The authors' model of Australia identifies 113 industries, 230 commodities, 9 types of or, and 7 types of land. It has been used for policy evaluation by several of the agencies of the Australian government.

The chapter by Robinson and Tyson discusses integrating features of financial and macroeconomic models (the nonneutrality of money, asset markets, nominally denominated securities,' etc.) with the structural detail of a computational general equilibrium model. Feltenstein's chapter resents a preliminary attempt to introduce monetary phenomena in a general equilibrium model of an open economy. In his formulation, the government sector issues a combination of bonds and money to finance acquisition of public goods.

The editors would like to express their thanks to the National Science foundation for their generous support of the conference at which these papers were presented and to Altheia Chaballa for the exceptionally fine assistance in organizing the conference and preparing this volume.

H. E. Scarf
J. B. Shoven

Contents

Chapter 1. The computation of equilibrium prices, Herbert E. Scarf

Chapter 2. Efficient methods of computing economic equilibria, Michael J. Todd

Chapter 3. Numerical specification of applied general equilibrium models: estimations, calibrations, and data, Ahsan Mansur, and John Whalley

Chapter 4. Econometric methods for applied general equilibrium analysis, Dale W. Jorgenson

Chapter 5. Money and bonds in a disaggregated open economy, Andrew Feltenstein

Chapter 6. Modeling structural adjustment: micro and macro elements in a general equilibrium framework, Sherman Robinson and Laura D'Andrea Tyson

Chapter 7. General equilibrium analysis of regional fiscal incidence, Larry J. Kimbell and Glenn W. Harrison

Chapter 8. Decomposing the impact of higher energy process on long-term growth, Antonio M. Borges and Lawrence H. Goulder

Chapter 9. A comparison of methodologies in empirical general equilibrium models of taxation, Don Fullerton, Yolanda K. Henderson, and John B. Shoven

Chapter 10. Planning models and general equilibrium activity analysis, Victor Ginsburgh and Jean Waelbroeck

Chapter 11. A general equilibrium model for the Mexican economy, Jamie Serra-Puche

Chapter 12. Extending the ORANI model of the Australian economy: adding foreign investment to a miniature version, Peter B. Dixon, B.R. Parmenter, and Russell J. Rimmer