SIMULATION RESULTS 5A. The Anatomy of Income Changes

504 F. Harrigan where dY row is the change in real endogenous income transfers that, in each period, maintains private real consumption at its preconservation baseline level, C t , r is the discount rate, Y is real gross domestic income GDI in the preconservation base- line economy, and t indexes time. We report income losses both in base year T 5 1990 GDI units and in units of the present value stream of GDI T 5 1999. We measure real income using a GDI rather than a constant price GDP measure because there are, as we shall see, large terms of trade changes associated with tropical forest conservation. GDI is equal to constant price GDP plus a terms of trade adjustment defined as the “capacity to im- port,” less the volume of exports. The “capacity to import” equals nominal exports divided by the import price deflator. This defini- tion of GDI is that used in the World Bank’s World Tables. To draw “welfare” implications from our analysis, our measure of the compensating variation would have to be adjusted to reflect the increase in the nonlumber value of forests created by conserva- tion. Note, however, that because we assume that trees and land area is permanently transferred to nonlumber uses, we do not have to account for the increase in the value of the terminal lumber stock. Our assumptions imply that the lumber value of trees is lost as nonlumber values are created through conservation. Although it would be interesting to consider policies that preserved trees today with a view to supporting larger sustainable harvests in the future, we do not have the stock-flow information that would be needed to calibrate the required model of lumber growth. Also, were the policy issue one of sustainable harvesting, the income losses in Equation 1 would be offset by the present value of the potentially infinite sequence of future lumber harvests made possible by the deferral of harvests in earlier periods.

5. SIMULATION RESULTS 5A. The Anatomy of Income Changes

To facilitate identification of the various mechanisms through which income losses are generated, we begin by measuring the effects of a 50 percent reduction in lumber flow outputs and stock inputs over their 1990 levels. This entails a uniform reduction in the levels of flow output and stock inputs in the lumber sector in each year. In all simulations, the reductions in flow output and stock inputs take effect in 1991 and continue through to the termi- nal year 1999. In 1990, investment demand is reduced to reflect TROPICAL FOREST CONSERVATION 505 the lower level of stock inputs applied in lumber activity in later years. In this simulation, we place no restrictions on agricultural extension and employ baseline A. The compensating variation NCV under these assumptions is 2.2 percent T 5 1990 of the capitalized stream of baseline GDI, and 18.2 percent when measured in base year GDI units T 5 1990. In Table 1 row 1 we show the values of the compensating transfers from the rest of the world in each period, expressed as a proportion of contemporaneous GDI. In the remaining rows we show lumber’s baseline and conservation income shares rows 2 and 3, and we also record the impact of our conservation assumptions on a variety of variables when compensating transfers are suppressed rows 4 to 14. On suppression of compensating transfers, GDI falls by 2.3 percent of its capitalized baseline value. This is very close to the income loss registered in the NCV. This is because the incidence of income losses falls almost entirely on households. Note also that the percentage reductions in private real consumption row 5 are about twice the magnitude of the percentage declines in income. This is because the incidence of income losses falls almost entirely on households, and the con- sumption base from which they are measured is less than 60 per- cent of GDI. Reductions in wealth to some degree accentuate consumption losses. The most notable aspect of these results is that the magnitude of the overall decline in income is large compared to the initial downsizing of lumber activity. Since, over the period 1990–99, the share of lumber in GDI averages 2.1 percent in our baseline, a 50 percent reduction in output and stock inputs leads to a direct withdrawal of income of around 1 percent of GDI, some of which is recovered when mobile factors released from lumber find em- ployment elsewhere in the economy. Therefore, it follows that the indirect loss of income is at least as great as the initial direct withdrawal. In this particular simulation the dynamic general equi- librium income multiplier is of the order of 2. To understand why income losses are magnified, it helps if they are decomposed. We start with a simple household income identity: y ; W P c · L 1 u · R P c · K. 2 In Equation 2, y is household income measured in consumption units, W is the nominal wage, P c is the consumption deflator, L 506 F. Harrigan Table 1: Summary of the Effects of Log Harvest Restrictions Differences from Baseline A 1 Row Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 1 Remittances GDI 0.03 4.48 2.97 2.55 2.44 2.31 2.16 2.02 1.83 1.72 2 Baseline share lumber GDI 3.06 2.88 2.67 2.51 2.32 2.18 2.04 1.91 1.78 1.66 3 Conservation share lumber GDI 3.06 1.43 1.34 1.26 1.16 1.09 1.02 0.95 0.89 0.83 4 GDI 2 0.02 2 3.23 2 2.87 2 3.07 2 2.75 2 2.40 2 2.28 2 2.19 2 2.01 2 1.85 5 Consumption 2 0.12 2 8.46 2 6.05 2 2.62 2 3.71 2 4.84 2 4.39 2 3.88 2 3.79 2 3.78 6 Exports 0.46 4.19 1.94 2 1.03 0.56 1.98 1.55 1.19 1.40 1.62 7 Imports 2 0.46 2 2.23 2 1.45 2 1.07 2 0.75 2 0.57 2 0.49 2 0.39 2 0.22 2 0.10 8 Terms of Trade 2 0.13 2 4.35 2 3.25 2 1.90 2 2.31 2 2.63 2 2.29 2 2.00 2 1.93 2 1.88 9 External debt to GDI 2 2 0.36 2 2.33 2 1.55 1.39 1.94 1.48 1.67 2.02 2.03 1.83 10 Real consumption wage 2 0.23 2 8.41 2 6.38 2 4.45 2 4.29 2 4.58 2 4.24 2 3.78 2 3.49 2 3.36 11 Unemployment rate unskilled 2 0.01 2 1.07 0.36 0.84 0.15 2 0.04 0.17 0.18 0.08 0.03 12 Lending rate 2 2 0.01 2 0.22 1.86 1.00 0.02 0.18 0.36 0.18 0.02 2 0.03 13 Aggregate physical capital stock 0.00 2 2.55 2 2.53 2 2.36 2 2.24 2 2.12 2 1.99 2 1.87 2 1.75 2 1.65 14 Agricultural labor force 0.00 2 0.02 2 0.63 2 1.23 2 1.73 2 2.05 2 2.25 2 2.41 2 2.51 2 2.57 1 Lines 4 to 14 refer to results from a simulation in which we compare pre- and postconservation outcomes, having relaxed the consumption constraint. A discount rate of 10 percent is applied in the calculation of the compensating variation. Because the discount rate enters both the numerator and denominator of Equation 1, the compensating variation is comparatively insensitive to the choice of discount rate see also Table 4. 2 This is the level difference in this ratio. Level differences are also reported for the unemployment rate and the interest rate. TROPICAL FOREST CONSERVATION 507 is aggregate labor units assume full employment of labor, R is the nominal capital rental rate, K is the stock of capital and 0 , u , 1 is the share of “profits” accruing to households. To prevent the algebra from getting cluttered, taxes are suppressed, labor is aggregated over markets and capital over sectors, and household claims on profits are assumed to be parameteric in Equation 2. Applying the difference operator to Equation 2 and manipula- tion gives 19 Dy ; t 1 · Dw · L 2 c · L F 1 u · D r · K 2 c · K F 1 Dt · y 2 t 1 · w · c · L F 1 u · r · c · K F 2 w 1 · c · L F 1 1 2 l · u · r 1 · c · K F , 3 where D is the difference operator, w is the real product not consumption wage, r is the real product rental, t is the ratio of current period local producer prices to consumption prices, c is the percent reduction in lumber activity over the period ex- pressed as a decimal fraction, l is the share of the lumber capital stock that is immobile, the subscripts 0 and 1 index the periods before and after the reallocation of labor and the loss of lumber capital, and the superscript F denotes factor quantities initially in the lumber sector. The first term in parenthesis on the RHS of Equation 3 is a measure of the change in household income arising from changes in real product factor prices for given endowments of labor and capital. The second term measures the loss in the command of initial household income over consumption goods when consumer prices rise relative to the cost of local output. We attribute this effect to terms of trade changes. The third expression has two components. The first part is the direct loss in household income that would occur if a fraction c of lumber capital and labor income were eliminated, and all factors were immobile. The second term is the recovery of household income that occurs when mobile factors initially employed in lumber are reallocated to other sectors. Using Equation 3 we can now condense the income changes that are reported in Table 1. We do this for the change in GDI 19 Changes in factor incomes are weighted by the current ratio of producer to consumer prices the “terms of trade”, and the “terms-of-trade” change in the second term of Equation 3 is measured from base income. Income changes can also be decomposed where the weight on factor income changes is the base ratio of producer to consumer prices, and “terms-of-trade” changes could be measured for current rather than base household income. 508 F. Harrigan in the impact period, 1991, reported in row 1 of Table 1. It is important to understand that these are the income changes that would occur in the absence of compensation. Also, to facilitate comparison, the left and right hand sides of Equation 3 are divided through by base GDI in 1991. All values in Table 2 are calculated directly from the results of model simulations or are defined by the nature of the experiment itself. Table 2 identifies “terms-of-trade” changes, as reflected in the change in the relative price of producer to consumption goods, as the effect that contributes most to the net income loss, account- ing for just under half of the total decline. 20 Next in importance is the decline in the real product wage that occurs when lumber capital is withdrawn from production. This accounts for around one-quarter of the net decline in income. The incidence of real wage reductions would, of course, be felt most directly by those workers and households in the agricultural sector, and by unskilled workers elsewhere. Therefore, it seems that conservation would be likely to have an adverse effect on the distribution of worker and household income. 21 However, the reduction in household income caused by increased taxes is small, and accounts for only 5 percent of the net loss. Our computations also make it clear that a substantial proportion of the direct loss of lumber income is recovered both when mobile factors are reallocated, and when the return to capital increases as its stock shrinks. Taken together, just under 65 percent of the direct loss of lumber income is recov- ered through the reallocation of mobile factors and through in- creased profits. The terms-of-trade–induced income losses that are highlighted in Table 2 and row 8 of Table 1 occur as the price of imports rise relative to the price of exports. The real exchange rate also depreciates as the price of traded to non-traded goods increases. 20 This ranking and the respective contributions may, however, change over time. Spe- cifically, once wages fall in the agricultural sector this will lead to out-migration and there will be income losses as migrants experience temporary unemployment in nonagricultural labor markets. These effects are, however, small, and wage adjustments are fast. Also, when investment is reduced in agriculture to mimic land restrictions, this will represent an additional source of income loss. Space considerations preclude a decomposition for each and every year. 21 There is only one household identified in the version of the model used in these simulations so that it is not possible to measure distributional effects directly. It is unlikely that households with unskilled workers are likely to benefit much from the increase in capital income. TROPICAL FOREST CONSERVATION 509 Table 2: The Decomposition of Income Changes in 1991 Household income changes to GDI Value GDI Annotation Total 2 4.48 Value of NCV for 1991, Table, row 1. Terms of trade 2 2.20 Calculated as in Equation 3, expressed in real GDI units Labor share of factor product 2 1.40 Calculated as in Equation 3, expressed in real GDI units Capital share of factor product 1 0.33 Calculated as in Equation 3, expressed in real GDI units Note: households total claim on operating surplus is approx. 38 percent, and total profits increase by 1 percent of GDI in our simulation. The factor t 1 equals 0.868. Direct loss of lumber income 2 1.30 Calculated as in Equation 3. This is 50 percent of baseline share of GDI recorded in Table 1 Recovery of mobile labor income 1 0.51 Calculated as in Equation 3. Expressed in real GDI units Note: initial share of labor in Lumber value-added is 0.43 percent, and that the product wage of mobile labor falls in the simulation Recovery of capital income 0.00 Capital is assumed ex-post immobile l 5 1 see p. 6 Tax losses 2 0.27 Calculated from model simulation Total losses 2 4.33 Summation of above Income changes not elsewhere included. 2 0.17 510 F. Harrigan These relative price changes facilitate a movement of resources into the traded goods sector and leads to the recovery of some of the foreign exchange that is lost as lumber exports contract. In raising the cost of consumption relative to the price of domestic output, the deterioration in the terms of trade reduces real income through the LaursenMetzler effect. 22 The dynamics as well as the composition of income losses are of some interest. Although the negative impact of conservation on income and consumption recedes as lumber activity contracts, losses nevertheless persist see Table 1, rows 1 and 4. Because we have assumed that the withdrawal of lumber capital is permanent, lower product wages in the agricultural labor market and capital incomes in the lumber sector endure. Also, an emerging deficit on the current account reduces private sector wealth and, with a lag, leads to a stabilizing fall in private consumption rows 5–9 of Table 1. Finally, the resource gap that the current account deficit mirrors, causes a small increase in domestic real interest rates. This raises the user cost of capital, lowers Tobin’s “q,” causing the aggregate capital stock to fall row 13 of Table 1. This further reduces the real product wage and household wealth. The qualitative nature of the resource switching effects that occur with lumber conservation are exactly as would be predicted by a real trade model. Output in those sectors that are compara- tively sheltered from world trade Construction, Utilities, Public Services, Private Services, and Domestic Manufacturing contract following conservation. The largest gains in output are in those sectors that we assume are most open to world trade Export Manufacturing. By the terminal year of our simulation 1999, constant price value added in Construction falls over baseline by 2.8 percent and value added rises by 4.2 percent in Export Manufacturing. 5B. The Results with Alternative Baselines and Alternative Conservation Policies Having now explained the basic mechanisms through which conservation reduces “metered” income, we now turn to the issue 22 The income effect of exchange rate changes is often referred to as the LaursenMetzler effect. TROPICAL FOREST CONSERVATION 511 Table 3: Variations in the NCV with Baseline and Conservation Assumptions Conservation assumptions Baseline Harvests Land use NCV T 5 1999 NCV T 5 1990 Stationary A 2 50 — 2.23 18.23 2 8 pa B 2 50 — 1.10 8.91 2 8 pa B 2 50 Restricted 2.16 17.62 Stationary A 2 50 Restricted 3.34 31.20 2 8 B 2 97.5 — 3.30 26.77 2 8 B 2 97.5 Restricted 4.32 35.37 Stationary A 2 97.5 — 4.39 35.41 Stationary A 2 97.5 Restricted 5.46 44.85 of how losses change with variations in our baseline and conserva- tion assumptions see Table 3. Consider first what happens when baseline lumber flows and stocks fall at an annual rate of 8 percent annum i.e., baseline B, rather than remain constant as in base- line A. 23 Not surprisingly, this reduces income losses and the NCV index falls to 1.1 percent of the capitalized stream of GDI, and to 8 percent measured in base year 1990 GDI units. We noted earlier that the conversion of forest land area, espe- cially for commercial agricultural uses, has been a major source of deforestation in Malaysia. It seems likely, therefore, that conser- vation would also restrict agricultural encroachment on forest land area and inhibit the growth of agricultural output. If gross investment in the agricultural sector is set to replacement level, growth of agricultural output can then only occur either through technological progress or the application of more labor. This is precisely the way in which production possibilities in agriculture would be constrained if capital and land were complementary and further agricultural extension on forest area was prohibited. Of course, it is possible that agricultural extension could still take place on nonforest lands so that our treatment may exaggerate the effect of land restrictions on income. Moreover, to the extent that capital and land are substitutable, output losses could be ameliorated through the adoption of more capital intensive meth- ods of farming. Although substitution possibilities are likely to increase with the elapse of time, it would appear that in the 23 In this simulation baseline lumber output is in fact a little lower than conservation output in the terminal year but is larger in all earlier years. 512 F. Harrigan production of Malaysian tree crops capital cannot be easily substi- tuted for other factors. 24 In our baseline simulation, the growth of output of the tree crop sector averages 3.7 percent per annum. This is very close to the 3.8 percent increase in the volume output that was observed between 1990–93. On the imposition of land restrictions, output growth falls to an average of 1 percent per annum over the period 1990–99. As a consequence, income is further eroded and the NCV T 5 1999 increases by about 1 percent. This result is largely insensitive to the baseline assumptions applied. 25 By comparing the effects of a 50 percent reduction in harvests with those of a 97.5 percent reduction, some indication of the marginal costs of conservation can be obtained. 26 For those cases where baseline lumber harvests are assumed to remain stationary at 1990 levels, marginal costs are almost constant. Over the first 50 percent reduction in lumber activity, the compensating variation averages 0.0446 percent of GDI for each one percent reduction in activity. Over the next 47.5 percent reduction in the level of lumber activity, the average compensating variation increases to 0.0455 percent of GDI. Where we assume that baseline lumber activity declines by 8 percent per year, a different picture seems to emerge. Now, over the first 50 percent reduction in lumber activity, the average loss is 0.022 percent of GDI for each percent reduction in activity. But this figure rises to 0.046 percent of GDI over the next 47.5 percent reduction. This increase in cost occurs because with declining baseline output, the proportional contraction in lumber output approximately doubles as the level 24 In recent years, output of the tree crop sector in Malaysia has been constrained by shortages of unskilled labor. This in itself has helped slow the pace of forest land conversion. Opportunities for the adoption of more capital intensive techniques seem limited Govern- ment Press, 1994. 25 It should be understood that the apparent invariance of the cost of land restrictions to the underlying level of harvests reflects the assumed independence of capital and land inputs in lumber and agricultural sectors. We cannot draw any inferences from these results about an “optimal” policy mix of restrictions on output and land use. Such a judgment would ultimately rest upon whether the objective is to preserve lumber stocks, forest area, or some combination of both. It would also reflect the desired attributes of the preserved forest area and of the implementation and monitoring costs of the different restrictions. 26 For technical reasons, it was not possible to eliminate lumber harvests completely. In any case, a complete ban on lumber logging would be almost impossible to police. It is likely that illegal logging would persist even under the strictest conservation regime. TROPICAL FOREST CONSERVATION 513 Table 4: Calculations of NCV T 5 1999 n 5 0.04 g 5 n 5 r 0.08 0.07 0.06 0.05 0.04 0.03 g 5 0.03 0.10 0.803 1.131 1.421 1.677 1.905 2.108 1.597 0.09 0.615 1.000 1.338 1.638 1.905 2.143 1.564 0.08 — 0.802 1.214 1.580 1.905 2.195 1.523 0.07 — — 1.009 1.483 1.905 2.281 1.469 0.06 — — — 1.289 1.905 2.454 1.398 0.05 — — — — 1.905 2.971 1.298 n 5 0, r 5 0.1 0.604 0.853 1.072 1.267 1.441 1.597 reduction increases from 50 to 97.5 percent of initial 1990 output. Therefore, it appears that income losses increase almost linearly with the decline in lumber output. A limitation of our analysis is that we have calculated costs over a time horizon that is short relative to the life cycle of tropical lumber species. It is also short relative to the period over which the benefits from conservation could be expected to accrue. As we have already observed, lengthening the simulation period would render our results sensitive to speculation about the rate and form of Malaysian economic development into the distant future. Nonetheless, by extrapolating from our results we can provide some indication of what costs might be over a longer period. An infinite horizon, approximation to Equation 1 is: 27 NCV 5 NCV 1990 · l 1 1 2 l · NCV 1999 · r 2 g · 1 1 n r 2 n · 1 1 g u r . g, n T 5 1999, 4 where g is the post-1999 assumed steady-state growth rate of GDI, n is the assumed steady-state growth rate of income compen- sation, r is the discount rate, NCV 1990 is the observed NCV T 5 1999 value for the period 1990–99, NCV 1999 T 5 1999 is the observed ratio of compensating income remittances to GDI in the terminal year, and lg, r measures discounted GDI over the period 1990–99 relative to the limit of the series. In table 4, we 27 This is the limit of Equation 1 as time approaches infinity assuming all variables follow steady-state trajectories from 1999 onwards. 514 F. Harrigan summarize the results that we obtain by applying this formula. Results are based on the same assumptions used for Table 1. It can be seen that lowering the assumed steady-state growth rate of output increases measured costs. This is because the promi- nence of lumber activity in the economy now increases. Although, in general, lowering the discount rate reduces costs, it does so only where the rate of growth of output g is greater than the rate of growth of compensating remittances n. If remittances grow more quickly than aggregate output, suggesting a post-1999 increase in the contribution of lumber to aggregate Malaysian income something that is highly unlikely, a reduction in the discount rate will, in fact, magnify costs. Note also that varying the rate of growth of compensating remittances has a larger effect on costs the smaller the discount rate, and rate of growth of output. It is reasonable to infer from these results that long-run costs are likely to be less than our finite horizon estimates, but it is difficult to be precise by how much. 5C. Sensitivity to Model Assumptions Finally, we consider how sensitive our results are to our model specification. There is, of course, in any CGE model a large num- ber of “free parameters” and a large number of behavioral assump- tions that can be varied. Even where theory informs us about the qualitative effect of such changes, their quantitative implications may not be clear. Therefore, in Table 5, we report and annotate the effects that variations in some of our more important assump- tions have on costs. Again, all changes are measured from the results reported in Table 1. As we cautioned earlier, terms of trade effects are likely to be sensitive to our assumptions about export price elasticities for lumber and nonlumber products. In Table 5, we report the result of three experiments that bear on this matter. First, we halve all nonlumber export and import price elasticities, and recalculate income losses. Recall, that some evidence Muscatelli et al., 1993 suggests that our reference elasticities may be biased upwards. When elasticities are halved, income losses as measured by the NCV increase by 0.242 percent of GDI over their reference value 2.2 percent of GDI. Next, in a symmetrical fashion, we double all reference nonlumber export and import price elasticities. This reduces income losses by 0.176 percent of GDI. Taken together, these results suggest that income losses respond nonlinearly to TROPICAL FOREST CONSERVATION 515 Table 5: Summary of Sensitivity Tests D in NCV percent Assumption GDI base 5 2.2 Explanation Halving trade price elasticities in all but those sectors 1 0.24 Greater independence of domestic from world prices, where Malaysia is assumed to be a price taker in world terms of trade losses are increased markets. Doubling trade price elasticities in all but those sectors 2 0.18 Model more closely reflects a “law of one price” economy, where Malaysia is assumed to be a price taker in terms of trade losses are now more muted world markets. Unit price elastic lumber exports 2 1.1 Lumber foreign exchange revenues are invariant with respect to the flow of lumber output, income losses are reduced Imposition of a constraint on the ratio of terminal external 1 0.8 The current account now exerts stronger effect on terms debt to GDI of trade, income losses are increased. No lumber capital income accrues to domestic households 2 0.29 Partial elimination of the income losses that arise because of capital immobility, income losses are reduced 516 F. Harrigan trade price elasticities, with marginal changes in the NCV tapering off as price elasticities increase. If nonlumber trade price elasticit- ies were, in fact, as low as 0.5 see, Muscatelli et al., 1993, then losses would rise from 2.2 percent to 3.1 percent of GDI. We now examine the effect of the lumber export price elasticity on income losses. Recall that we have assumed that the foreign exchange price of Malaysian lumber is set independently of Malay- sia’s supply see, Section 3. Now we model income losses assuming that there is a unitary export price elasticity for Malaysian lum- ber. 28 Accordingly, as Malaysia’s lumber exports decline the price of Malaysia’s lumber rises to maintain lumber foreign exchange revenues. Not surprisingly, the “sterilization” of lumber foreign exchange losses ameliorates the impact of the deterioration in Malaysia’s terms of trade. The compensating variation falls by about 1 percent of GDI. Reassuringly, this change in income compensation is consistent with the share of total losses that we attributed to terms of trade changes in Table 2. A lower export price elasticity for lumber implies that a larger incidence of conser- vation costs fall on nonresidents. 29 Note, however, that if conserva- tion were to entail the complete cessation of lumber trade, then, irrespective of the price elasticity of demand for lumber, there could be no mitigation of foreign exchange losses. The composition as well as the scale of output losses change when foreign exchange losses are sterilized. A more moderate depreciation of the real exchange rate now means that the local currency price of traded to non-traded goods does not rise by as much as previously. Real profits in non lumber export sectors are, as a consequence, comparatively depressed: Tobin’s “q” falls, and the incidence of output losses falls more heavily on real investment expenditure. Net exports expand by much less than previously, 28 Our objective is to “sterilize” foreign exchange losses as lumber exports are withdrawn. We cannot do this exactly because different users of lumber have different price elasticities of demand, and face different markups over basic price to accommodate taxes, transporta- tion, and distribution margins. In the simulation reported in the text, direct foreign exchange losses are sterilized almost exactly in the base period, but the effectiveness of sterilization is gradually eroded and by the end of the simulation period only 80 percent sterilization of the impact foreign exchange losses is achieved. 29 If the market elasticity for lumber were below unity, collusion between producing nations might both increase their income and help conserve forest area, perhaps even eliminating the need for compensation. If the elasticity facing Malaysia as a single producer were below unity, it could improve its terms of trade by restricting output without coordinat- ing its actions with other producers. TROPICAL FOREST CONSERVATION 517 and private consumption falls by much less. However, as reduced real investment cuts into the capital stock, the growth of real wages in inhibited. This changes the temporal profile of consump- tion losses. Real consumption losses, though smaller, now show much more persistence. Next, we consider the effect that our “external closure” has on measured income losses. External debt rises in our reference simulation, but by only 1.83 percent of GDI by the terminal year of our simulation see Table 1. Although this could probably be easily financed, it is worth considering what might occur if there were a constraint on foreign saving. In such circumstances, the income losses associated with conservation would increase. Do- mestic absorption, including household consumption, would then have to fall to accommodate the reduction in the supply of saving from nonresidents. To a degree, we can mimic the required adjust- ments by precluding substitution between domestic and foreign liabilities. The current account deficit now contracts and the in- come compensation needed to compensate domestic consumers rises by 0.22 percent of GDI. The smaller current account deficits that now occur reduce the ratio of terminal debt to GDI by 0.5 percent. We infer from these responses that if a constraint on foreign borrowing were to be expressed in terms of a cap on the ratio of external debt to GDP, say set equal to its baseline terminal value, this would increase overall income losses from 2.2 percent to about 3.0 percent of GDI. 30 Finally, we consider what would happen to income losses if households received no rents or operating surplus from lumber activities. This has the effect of eliminating some income losses because we have assumed that lumber capital income is entirely lost when lumber values are surrendered to other forest uses. Imposition of this assumption, reduces income losses fall by nearly 0.3 to 1.9 percent of GDI. However, because labor productivity is still adversely affected by the immobility of the lumber capital stock, not all indirect losses are eliminated in this simulation. If we were to assume that lumber capital were fully mobile, the results of Table 2 row 5 less row 6 suggest that income losses 30 It is not possible to impose this constraint directly in the model. We arrive at this inference by dividing the 1.8 percent increase in terminal debt Table 1 by the reduction of 0.5 percent reported in the text. If income losses respond linearly to changes in debt, multiplying 1.8 4 0.5 by the 0.22 percent increase in income losses, gives an overall increase in income losses of about 0.8 percent of GDI. 518 F. Harrigan of up to 0.8 percent of GDI might be recovered in the impact period 1991. 31

6. CONCLUSIONS