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6 Analytical extensions and policy issues

1. Model of development in a resource-intensive economy (from class 5)

1. Model structure

2. Comparative statics: trade and policy shocks

2. Analytical extension: H-O manufacturing

3. Some related topics and papers

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Upland economy

Land Labor

Upland food Tree crops

Forest& forestry

Lowland economy

Land Capital

Lowland food Manufacturing

Labor

Labourmarket

Foodmarket

H-O upland economy

Ricardo-Viner lowland economy

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Cerebral comparative statics

1. Effects of price changes, e.g.:• Tree crops in uplands (H-O prediction?)• Manufacturing price increase, e.g. tariff. (Cf.

Deacon, JEEM 1995).

2. Effects of tech. progress and factor endowment growth

• ‘Green revolution’ in lowland food sector• Capital investment in manufacturing

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A mathematical statement

• Fundamental assumptions about technology, preferences

• General equilibrium• Intersectoral and interregional market-

clearing conditions• Spatial: labor market & migration• Food market clearing when non-traded• Open access to forest resource for land

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• Two regions, upland and lowland, with price-taking revenue-maximising

producers.

• In uplands, two goods are produced: food (n) and non-food, or tree crops;

vectors of upland prices and outputs are PU and YU respectively. Define p

as relative price of food to tree crops in uplands.

• Upland goods produced with VU inputs, containing labor (LU) and upland

land (T).

• Land must be cleared for production, using labor according to T = αL.

• Upla nd producer' s proble mi s captur ed by revenue funct :ion

R ( T , L

U

– α T , p ) = max

T , Y

{ P

U

⋅ Y

U

| V

U

}.

• 'Default' assumption upla ndfood is labor-intensiv ,e or RnL > 0; RnT < 0

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• Lowland region produces food (n) and manufactures (m) in output vector

YL. Price vector PL has elements p and q, where the latter is the price of

manufactures.

• Lowland food is different to that used in uplands.

• Each lowland industry uses a sector-specific factor (irrigated land and

manufacturing capital), which we summarize as a vector K = (Kn, Km), and

labor.

• Lowland producer's problem

S ( K , L – L

U

, p , q ) = max

Y

{ P

L

⋅ Y

L

| V

L

}.

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Consumption. Assumptions:

• Utility derived from consumption of goods and from existence of forest.

• Forest-clearing decision takes no account of consumer preferences so

quantity of land cleared is exogenous to the consumer.

• Consumer’s problem is to maximize utility subject to income and the

quantity of standing forest (utility is assumed separable between these).

• Forest is quantity-rationed to consumer, so we have conditional

expenditure function:

E(P, F, u) = min{P⋅C | u}

where u =util , ity F is quantity of forest la ,nd and P andC contain

prices a nd quantities of food, tree crops a nd th emanufactur .ed good

* T = 1 – F. ET,= virtual price of la ndcleare ,d –1*or marginal amount the

consumer is WTP to preserv estanding fores .t Therefore, we have ET ≤ 0.

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Equilibrium

• Assume manufactures (upland non-food, food) to be import-competing

(exportable, non-traded) with price q (1, p). q is exogenous, p endogenous.

Aggregate budget constraint:

E(p, q, T, u) = R(T, LU–αT, p) + S(K , –L LU, p, q).

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FONC:

Assume that food is not internationally traded, so at optimum:

Rn + Sn = En. (4.2)

Forest clearing for upland agriculture, at optimum:

RT − αRL = 0. (4.3)

Note: assumption that fores t cleari ng decisions do no t conside r socia l costs. Hence inequilibriu m ther e is mor etree-cleari ngthan is socially optimal, whi ch confers a .negexternalit y on consumers.

Labor migrates between regions in response to changes in productivity, so::

RL − SL = 0. (4.4)

• Th esolution to (4.1)-(4.4) provides values for endogenous variables T andLU, p, andu, give ne .xog variables L, K , q.

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Actual comparative statics

• Terms of trade shocks

• Tariff policy reforms

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ToT shock: a rise in q

(a) When food is a traded good and labor is regionally mobile

Eq. (4.2) does not hold. Taking total diff of (4.3) and (4.4) and solving:

Rvv

( RLT

− α RLL

)

( RLT

− α RLL

) ( RLL

+ SLL

)

⎡

⎣

⎢

⎢

⎤

⎦

⎥

⎥

dT

dLu

⎡

⎣

⎢

⎢

⎤

⎦

⎥

⎥

=

− ( RnT

− α RLn

) dp

SLq

dq − ( RLn

− SLn

) dp + SLL

dL + SLK

dK

⎡

⎣

⎢

⎢

⎤

⎦

⎥

⎥

Th edetermina nt of the coefficient matrix, DL, is positi ve by th estrictconcavity of the revenue function. A n increase inq gives:

dL

U

dq = Rvv

SLq

/ D

L

< 0 (4.6a)

dT dq = − ( RLT

− α RLL

) SLq

/ D

L

= − β

dLU

dq

⎛

⎝

⎜

⎞

⎠

⎟< 0 (4.6 )b

where β =

RLT

− α RLL

Rvv

⎛

⎝

⎜

⎞

⎠

⎟< 0

Higher labor productivity in lowlands causes dow -n sl ope migra ;tion higherlabor costs a nd diminished upla nd labor supply both cause the quantity ofupla ndcleare dfor agriculture to diminis .h

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ToT shock (food is traded good and labor is regionally mobile, cont’d)

Welfare change

Denote the excess demand for manufactures by

Zq = Eq(p, q, T, u) – Sq(K, L–LU, p, q),

and noting that Zq > 0 for a net import and Zq < 0 for a net export.Taking an increase in q we obtain:

Eu

∂ u

∂ q

+ ET

∂ T

∂ q

= − Zq

< 0. (4.10)

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ToT shock

(b) when labor is immobile but food is non-traded

Eq (4.4) does not hold. By total differentiation of (4.1)–(4.3):

Eu

0 ET

− μ Eu

− Znn

( RnT

− α RLn

)

0 ( RnT

− α RLn

) Rvv

⎡

⎣

⎢

⎢

⎢

⎤

⎦

⎥

⎥

⎥

du

dp

dT

⎡

⎣

⎢

⎢

⎢

⎤

⎦

⎥

⎥

⎥

=

− Zq

dq + RL

dLU

+ SK

dK + SL

dL

Znq

dq − RnL

dL

U

− SnK

dK − SnL

dL

0

⎡

⎣

⎢

⎢

⎢

⎢

⎤

⎦

⎥

⎥

⎥

⎥

.

Th edetermina nt of the coefficient matrix, Dp < 0. Fora n increas e i nq:

dp dq = − Znq

− mZq( )

Rvv

/ D

p > 0 if m = 0 (4.13a)

dT dq = Znq

− mZq( )

RnT

− α RLn

( )/ D

p < 0 if m = 0 (4.13 )b

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Tariff reform in manufacturing

Equilibrium:

E(p, q, T, u) = R(T, LU–αT, p) + S(K , –L LU, p, q) + tZq, (4.30)

(a) When food marke tclears through trade, resul ts are as for terms of trade

shock (4.6).

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Tariff change

(b) When labour is immobile and food market clears through domestic price

adjustment,

dp

dt

= −

τ Znq

+ mtZqq( )

Rvv

D

p , t> 0 if m = 0 (4.33a)

dT

dt

= −

RnT

− α RLn

Rvv

⎛

⎝

⎜

⎞

⎠

⎟

dp

dt

⎛

⎝

⎜

⎞

⎠

⎟< 0 if m = 0. (4.33 )b

Overa ll welfare when the tari ff rate is altered depends on interactionsbetween the trad e policya nd th eenvironmental externality. (4From .30),

Eu

( 1 − tcM

)

du

dt

+ ET

dT

dt

= tZqq

+ tZnq

dp

dt

.

or, using (4.33b) to eliminate ∂ /∂p t,

Eu

( 1 − tcM

)

du

dt

= tZqq

− ET

+ t

Znq

RnT

− α RLn

( )

Rvv

⎛

⎝

⎜

⎜

⎞

⎠

⎟

⎟

dT

dt

< 0. (4.34)

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Other comparative static experiments

• ‘Green revolution’ in lowland agriculture• Other technical change shocks• Exogenous growth of endowments:

– Labor– Mfg. capital stocks– Lowland land stocks

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Concluding remarks

• U-L model combines two ‘small’ models to obtain richer specification and results

• Predictions of comparative static effects depend on key parameter values– Can define different economic ‘types’ based on

alternative parameter sets (see OEE Chapter 3)

• Empirical and micro research should guide structural and parameter assumptions.

<---

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Analytical extension: H-O manufacturing sectors

• Heckscher-Ohlin manufacturing sector, R-V-J agriculture (Coxhead/Jayasuriya 2003)

• Simplification: only one upland sector

• Extension: clean and dirty mfg industries

• All traded goods (for simplicity!)

• Other aspects same as before: • Open access to forests for ag. land

• Migration is costless and immediate

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Two regions, four sectors

0A L 0M rM rU

rF

LF LA LM LH

wA wM

cF cU cX cH

A= agricultural ‘region’, producing upland (U) and food (F) crops.

M = manufacturing ‘region’, producing labor-intensive (X) and capital-intensive (H) goods.

cj = unit cost (i.e. zero profit) frontier for industry j

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Price increase for upland agriculture

0A L 0M rM rU rF

LF LA LM LH

wA wM

cU cF cX cH

Increase in upland agr. price increases upland land demand &returns to upland land, reduces rF, rM and industrial output

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Tariff reduction for import-competing industry

0A L 0M rM rN

rT

LF LA LM LH

wA wM

cU cF cX cH

NB.: Assumes large employment share of EOI industry

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Some conclusions

• Extended model provides different prediction on NR effect of tariff change

• More generally, issue of multiple env./NR problems– And added complexity of establishing welfare

results in economy with multiple distortions, insufficient instruments

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Some related topics and issues in analytical models

1. Individual and firm motivations for changes in NR or env. use patterns

• Subsistence farmers and ag. land expansion (Indonesia): Angelsen, WD 1995

• ‘Household EKC’ and cooking smoke (Pakistan): Pfaff, manuscript, 2003.

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Other topics and issues

2. Sectoral policies other than trade measures• Commercial farmers and deforestation

(Brazil): Binswanger, WD 1991• Ag. subsidies, land titling measures

• Capital subsidies, poverty interactions (Latin America): Lopez, WD, Feb. 2003

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Other topics and issues

3. Macro measures and shocks• Structural adjustment and stabilization

measures: Munasinghe and Cruz, WB Env. Paper #10, 1995

• Exchange rate instability and depreciations: Sunderlin et al., WD 2001; Coxhead et al., Land Econ. 2001

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Other topics and issues

4. Voluntary and informal controls • Informal regulation of industrial pollution

(Indonesia): Pargal and Wheeler, JPE 1996• Legal and community institutions in lake

management (Philippines): Malayang, 1993