Description of the combination of the models

Fig. 1. Schematic working of the AGE model.

2. Description of the combination of the models

This section first describes the AGE model ‘Taxinc’ and then the material flow model ‘Flux’. Then, a general methodology of the way these two models can be combined is analysed. 2 . 1 . Taxinc-model Applied general equilibrium AGE models are general equilibrium models that are empirically calibrated. This type of model consists of a set of economic agents, e.g. households and production sectors. These agents demand and supply ‘goods’, which are either consumption goods or produc- tion factors. The demand and supply equations of production sectors and household groups are derived from standard neo-classical economic the- ory, implying that all agents behave rationally, firms maximise their profits given prices and ca- pacity, and households their utility given prices and transfers. The price of a product paid by buyers equals the market price plus taxes levied on the demand side of the market. Suppliers face a price equal to the market price minus supply- side taxes. The central mechanism of AGE models is that market prices are flexible and will adjust such that equilibrium is achieved on each market. The structural characteristics of the model, such as household preferences, production structure and technology are exogenous. The AGE model used in this study is the Tax- inc-model, which was originally developed to analyse the effects of changes in the tax structure in the Netherlands Keller, 1980; Cornielje, 1990; Statistics Netherlands, 1991 and has since then been adapted and applied to study the effects of energy levies Dellink and Jansen, 1995. Fig. 1 shows the general model structure graphically. The comparative-static model includes 61 pro- duction sectors and 44 household groups, allow- ing the analysis of sectoral and distributional consequences of policies. The tax structure is equally disaggregated: for each economic transac- tion the accompanying tax payments are recorded, using different empirical estimates for the tax rates. This relatively high level of disaggre- gation at least from a macro-economic point of view is one of the main strengths of the model. The interactions between all agents in the model are so complex indirect and non-linear that cal- culation of the results for individual production sectors or household groups requires numerical simulation. Each production sector is assumed to produce a single, unique good; individual firms within a sector are assumed identical. Each house- hold group represents several individual house- holds with assumed identical marginal behaviour. The utility functions of the household groups and the production function of the production sectors are of a nested CES-type Keller, 1980; Cornielje, 1990 2 , with several branches and sector-specific substitution elasticities for each knot in the CES ‘tree’. 2 An example of a nested utility function is as follows: aggregate consumption is divided into necessities and luxuries, the necessities are divided among food and clothes, food is divided into vegetables, milk and bread Keller, 1980. Thus, a nested function has a tree-structure. A CES production func- tion with output Q and three inputs K is capital, L is labour, R is resources has the following structure Q = AaK − ? + b L − u + g R − u − 1 ? with A, a, b, g \ 0, a + b + g = 1 and − 1 B u B 0. Fig. 2. Stages in production and consumption where material policies may be imposed. Arrows indicate material and product flows; numbers are explained in the text. The ‘small open economy assumption’ is used which implies that world market prices are exoge- nous. This assumption results in a strong reaction by the foreign sector to changes in prices. The Taxinc-model includes the ‘Armington assump- tion’ that distinguishes import and domestic pro- duction of a good as two different goods, with imperfect substitutability. The trade formulation is especially suited for a country like the Nether- lands which has a small domestic market and important links with foreign markets. 2 . 2 . The material flow model ‘ Flux ’ A material flow analysis MFA describes the flow of one or more specific materials in a geo- graphic area during a certain period of time Kan- delaars, 1999. The basis of an MFA is a database on stocks and flows of materials through the economic processes. The material flow model ‘Flux’ consists of a database that describes the physical flows of materials and products through the Dutch economy in 1990 Boelens and Ol- sthoorn, 1998. It is an input – output type of model in physical units, which consists of 167 distinguished domestic economic processes, a ‘for- eign sector’ that constitutes imports and exports and the environment divided into the compart- ments of atmosphere, soil and water. The inflow of materials into the domestic economic system originates from both the foreign economic sector i.e. imports and the environment i.e. extraction of new materials. The throughput of materials through the economic system is made up of all flows of material between the different economic processes. The outflow of materials from the do- mestic economic system consists of exports flow to the foreign sector and the disposal of materials flow to the environment. Fig. 2 illustrates graphically the stages in pro- duction and consumption where material or product policies may be imposed. Three stages are identified. In the first production stage, raw mate- rials are converted into intermediate products. Between the first and final production stages there may be one or more intermediate stages of pro- duction. All production sectors require inputs from, and supply products to, other economic sectors so all stages are connected through product flows as well as material flows. Moreover, the production stages require ‘inflows’ of materi- als from and have ‘outflows’ of materials to the environment and foreign economies. An example of the material flows in the dia- gram is the following: in the first stage the Zinc Industry produces zinc plates using raw zinc; in the intermediate stage the Metal Products Indus- try produces rain gutters; and, in the final produc- tion stage the Construction process fixes rain gutters to new houses. A feedback from later production stages to earlier production stages can be the building of a new Zinc Industry factory with zinc gutters by Construction. An example of the material outflow can in this context be the disposal of scrap zinc by the Zinc Industry or the export of zinc plates. 2 . 3 . Combining the material flow model ‘ Flux ’ with the AGE model ‘ Taxinc ’ The data on the material flows in the material flow model Flux are used to implement material policies in the economic model Taxinc. The phys- ical data on the material flows between economic sectors including extraction are connected to the data in monetary units in the Taxinc-model. A levy on an economic sector is determined by its use of materials in kg and its output in guilders. After the levy is imposed, the Taxinc-model calcu- lates a new equilibrium. The results of the Taxinc- model are imported into Flux to assess the effects on the material flows. Thus, the combination of Flux and the Taxinc-model allows for the con- struction of various fiscal policy scenarios to ex- amine the economic and physical environmental effects of these policies. The height of the material levy imposed on a production sector depends on the material inten- sity of the sector. In this study, two different types of material intensities are distinguished. First, the direct material intensity of a production sector is defined as the material inflow in kg in the sector, coming from outside the domestic economy i.e. coming from imports or from the environmental sector per guilder of production output. The second material intensity that is identified is the so-called compounded material intensity that measures the total embodied material content of the product produced in the sector. This com- pounded material intensity consists of the direct inflow of material in the sector from imports or the environment, but also encompasses the mate- rials that entered the economic system in earlier production stages. 3 In this way, the compounded material intensity depends also on the throughput of the materials through the economic system. The material flow model makes the calculation of these compounded material intensities possible, and it is these compounded intensities that are relevant for material policies. For practical reasons, it is assumed that the direct material intensity does not change when a levy is imposed. Changes in the output levels can then be translated into changes in material use. Clearly, this effect on materials will differ from the ‘true’ effects, primarily because changes in the material contents of inputs cannot be accounted for, and because substitution within a sector is not taken into account. However, substitution of one material by another is considered if the supplying production sector is different for both materials. Consequently, the compounded material intensi- ties are non-constant. The assumption of constant direct material intensities limits the interpretation of the results, but cannot be voided in the current framework see concluding section below for a discussion on how to improve the methodology in this respect.

3. Material and product policies