Computable General Equilibrium Model for EAS
Appendix V Computable General Equilibrium Model for EAS
The approaches discussed earlier have limited scope in dealing with the effects in the external sector. Moreover, the implications of trade liberalisation and other policy shocks on different segments of the domestic economy, and other related economies may not be examined by the partial equilibrium approach. For this purpose the CGE model is used relying on the Global Trade Analysis Project (GTAP) database
The GTAP is a multi-regional Computable General Equilibrium (CGE) database which covers world economic activities of 57 different industries (version 7). In order to make the analysis meaningful and manageable, the aggregated version of this database is clubbed into
21 sectors across several regions including eight RTAs. As discussed earlier, India’s exports are diversified and they reach many export
destinations. The export performance of all the export products originating from India is not the same in all the export destinations. While some of them perform exceedingly well in some destinations, others are yet to pick up. Taking this trend into consideration, India’s new export strategy will be to tie up with those regions, where export performance remains impressive in recent years. Under the regional approach, India can associate with specific regions under certain preferential arrangements or it can single out some key countries for closer economic cooperation. Thus, in order to understand the implications of the regional approach, multiple CGE models are used to assess the overall situation in specific regions.
The theory behind the GTAP model is similar to that of the standard multi-regional CGE model. The underlying equation system of GTAP includes two different kinds of equations, accordingly. One part covers the accounting relationships, which ensures that receipts and expenditures of every agent in the model economy are balanced. The other part of the system consists of behavioural equations, which are based on microeconomic theory. These equations specify the behaviour of the optimizing agents in the economy such as demand functions.
There are three principal factors of production in the GTAP model, namely, labour, capital and land. Out of these three factors, the first two are considered to be perfectly mobile across sectors. Consequently, these factors earn the same market return regardless of where it is employed. In the case of immobile or sluggish endowment commodities, returns in the equilibrium may differ across sectors.
The GTAP model employs the Armington assumption in the trading sector which provides the possibility to distinguish the imports by their origin, and explains intra- industry trade in similar products. Thus, imported commodities are assumed to be separable from domestically produced goods, and they are combined in an additional nest in the production tree. The elasticity of substitution in this input nest is equal across all uses. Under these circumstances, the firms decide on the sourcing of their imports, based on the composite import price, and then determine the optimal mix of imported and domestic goods.
The market structure in all the sectors of the model is assumed to be perfect competition. 77 This is definitely a weakness of the model. 78 Commodity supplies are based on single output production functions. Substitution between inputs is modeled with two- level nested production functions. Demand for land, labour and capital are based on Constant Elasticity of Substitution (CES) functions. International trade clears commodity markets, with each commodity being differentiated by its place of origin. Trade polices operate as ad valorem distortions, which in addition to transportation costs, form a wedge between domestic and world prices.
Households maximize the utility derived from market goods (i.e. consumption and savings) subject to regional income, which consists of primary factor payments and net tax collections. Regional production of new capital goods is financed by domestic savings and net capital inflow.
In the present study, we have taken a number of regions to examine the implication of an expanding trade relationship with them, along the path of preferential trade liberalisation.