VILLAGE/TOWN MICROREGION CGE RESULTS

How sensitive are these findings to the assumptions of perfectly elastic - or perfectly inelastic in the case of the constrained multipliers - supply response, linearity and non-binding resource constraints implicit in SAM multiplier models? A CGE model was used for the village/town economy to explore this question. The model was first estimated on the basis of information in the village/town SAM as the basic data input. The model was then used to simulate the impact of (a) exogenous household income transfers and (b) increases in agricultural supply response in the nonlinear, flex-price environment depicted in the CGE. These experiments were performed separately for each of two market scenarios. Scenario I assumes that there are perfect markets for commodities and factors and that all goods are tradables. Scenario II treats all goods and factors as non-tradables with local endogenous prices. These two scenarios bracket the possible impacts of the experiments on the village/town economy.

Implications of market closure assumptions

Scenario I: The neoclassical village/town with tradables

In a neoclassical world with perfect markets, all goods are tradables; the village/town microeconomy faces no transaction costs and is a price taker in all commodity and factor markets. This means that supplies of commodities and factors to village/town households and production sectors are perfectly elastic. Unlike the fixed-price SAM multiplier models, however, this perfectly elastic supply comes from markets outside the village/town. Within the village/town economy, household-farms and firms face resource constraints such as fixed capital and technological constraints, resulting in decreasing marginal returns to factor inputs and rising marginal costs of production; that is, their supply curves slope upward. In short, village/town production sectors act like individual agricultural households in a perfect-markets model (see Singh, Squire and Strauss, 1986), taking prices exogenously determined in outside regional or national markets and following first-order conditions for profit and utility maximization.

Because production and consumption decisions in the village/town economy do not influence regional prices, the entire village/town model, like its neoclassical household-farm model counterpart, is separable or recursive. Policy or market shocks influencing the production side of the economy affect consumption through the budget constraints. Exogenous changes in household incomes, however, influence consumption but do not affect village/town production, because under the assumption of exogenous prices the first-order conditions for profit maximization remain unchanged. These income changes do, however, affect net village/town marketed surplus, or trade with markets outside the village-town economy. In a recursive village/town model, exogenous changes in household incomes like those in our first two sets of SAM multiplier experiments do not generate any income multipliers within the village/town economy. The potential multiplier leaks out of the local economy immediately, through regional trade.

Scenario II: The village/town with non-tradables

The creation of multipliers in a CGE model requires price changes that transmit the impacts of exogenous income changes through the production side of the economy; that is, the presence of local non-tradables. In a SAM multiplier model, all demand for locally produced goods is implicitly assumed to be for non-tradables. Prices for these non-tradables are assumed to be fixed by excess capacity in the local economy, which results in perfectly elastic supply of commodities and factors.

Scenario II represents a CGE analogue to the SAM modelling assumption that all goods are non-tradables in the village-town economy. It corresponds to a village/town economy facing high costs of transacting with outside markets for goods and factors demanded in the local economy. It does not rule out trade with these markets; as in the SAM multiplier models, each production sector and some households satisfy a fixed share of their input and consumption demands from outside markets. These import shares represent a leakage from the local village-town economy into the rest of the world.

The fundamental difference between the CGE model in Scenario II and the SAM multiplier models used previously is that in the CGE model, prices of nontradables are endogenous; the village/town economy faces resource constraints that result in upward-sloping supply curves for all production sectors. The village/town model is no longer separable or recursive. Exogenous changes in household incomes, which shift the budget constraints outward, alter household demands for local non-tradables. This would be depicted graphically as an outward shift in local demand curves for normal goods. Given upward-sloping supply curves, the result is an increase in local prices of non-tradable commodities and factors. These price changes link the exogenous changes in household incomes to village/town production sectors, changing the first-order conditions for profit maximization. Local production expands to satisfy increases in household demands, increasing its demand for intermediate and factor inputs and generating new rounds of production and household-income increases. The result is a village/town CGE multiplier, analogous to the SAM multipliers presented earlier.

The findings from the village-town CGE experiments are presented in two parts: first, the household-income transfer experiments; second, the simulated increases in agricultural and livestock productivity.

Household income experiments

Scenario I: The neoclassical village/town with tradables

Table 12 shows the impacts on the village/town economy of a US$100 exogenous increase in household incomes, distributed across households in proportion to their initial income levels. This experiment is identical to the SAM income-transfer experiment shown in Table 11. The first two columns of the Table present impacts on the village first, then the town if the income increase goes to village households. The third and fourth columns report the impacts of an exogenous increase in town-household incomes.

The figures in this table illustrate clearly the assumptions implicit in the perfect neoclassical village/town model. Because all goods are tradables and all prices exogenous, the impacts of the household-income increase are not transmitted to the production side of the economy, and there is no change in village or town real gross domestic products (GDPs). The village income transfer, the first two data columns in the table, directly favours village commercial households, whose initial incomes are higher. These increases in village household income result in higher demands for normal goods. Without an accompanying increase in local production, these increased demands simply reduce the supply of goods available outside the village/town economy. Village marketed surplus falls by US$28. Because part of the increased village demand is satisfied by the town, marketed surplus there falls as well, by US$23. In this scenario of exogenously determined prices, the village/town consumption linkages have no effect on production or household income in the town.

The effects of increased town incomes, the second and third data columns of Table 12, are qualititatively identical to those of increased village incomes; as in the SAM experiments, however, linkages are smaller from town to village than the other way round. Nearly half of the exogenous income change in the town goes to net-buyer households, which are the highest-income household group there. As a result of increased consumption demands by households, town marketed surplus falls by US$22 and village marketed surplus falls by less than US$1.

TABLE 12
General equilibrium effects of a US$100 increase in household incomes^a (all goods tradable)

^a Distributed across households in proportion to initial income shares.
Prices are those of commercial and subsistence activities, where applicable.

Scenario II: The village/town with non-tradables

In contrast, exogenous household-income changes generate significant production and income multipliers in the village/town economy when all goods are assumed to be non-tradables. The figures in Table 13 reveal the extent to which price changes transmit transfer-induced changes in household incomes to village/town production sectors. In most cases, the production impacts of the income changes from the CGE model lie in between those for the unconstrained and constrained SAM multiplier models shown in Tables 9 and 10. Among production sectors, the largest beneficiaries of the village income transfer is commerce. Higher village demand for commercial-sector goods generates a positive income/growth linkage with the town, because village households and production activities spend income in the town, unleashing an endogenous price multiplier there.

TABLE 13
General equilibrium effects of a US$100 increase in household incomes^a (all goods non-tradable)

^a Distributed across households in proportion to initial income shares.
Prices are those of commercial and subsistence activities, where applicable.

Real income in the village/town economy increases substantially as a result of the exogenous increase in village-household incomes; the impact is dampened by higher village-town prices for nontradables, however. In the village, total real income rises by US$124, less than in the constrained and unconstrained SAM models. Village-town income linkages stimulate a US$9 increase in town incomes, more than in either the constrained or unconstrained SAM models. Commercial households benefit most, directly and indirectly, in real terms from the income change. The smallest beneficiaries of the income shock in the village are the net-buyer households. In the town, real incomes increase for subsistence and net-buyer households, but they fall slightly for commercial households.

The openness of the town economy results in a leakage of most of the potential multiplier effects of income changes into the outside world. The US$100 increase in town incomes, the third and fourth data columns of Table 13, raises town real income indirectly by US$12, a respectable increase but small compared with the village income effect of the increase in village incomes, and not much different from the impact of village income increases on town income. The impact on total town income is smaller than in either of the two corresponding SAM multiplier experiments. As in the SAM experiments, the largest beneficiaries of the exogenous income increase are net-buyer households in the town. The largest indirect real benefits, however, accrue to commercial households. Subsistence households lose in real terms as a result of higher prices for consumer non-tradables.

To summarize, the village/town CGE model with non-tradables produces estimated income impacts of exogenous income changes that are in most cases smaller than those predicted by the constrained (low) and unconstrained (high) SAM multiplier models. Nevertheless, in a few cases the non-linearities and relative price changes permitted in the CGE model result in village/town sectoral impacts that are larger than in the fixed-price SAM models; in other cases estimated real impacts are negative in the CGE model, a plausible result that is ruled out in SAM models by construction.

Technology-change experiments

One of the advantages of a CGE approach is that sectoral supply responses are assumed to be neither perfectly elastic nor perfectly inelastic. Because of this, the experiments do not exactly replicate the exogenous increase in agricultural and livestock supply in the constrained SAM model using the CGE approach.Instead, the village/town economy-wide implications of a technological change is explored that initially increases production in the agricultural and livestock sectors by US$100, distributed across these sectors in proportion to their initial production levels. In the first instance, output in the affected sectors increases, shifting the supply curves outward. In the model with non-tradables, this drives down local prices for non-tradables. In both models, payments to factors and households increase, which together with a higher demand for intermediate inputs shifts the local demand curves outward. When goods and factors are non-tradables, upward pressure is put on local prices. In the CGE model with non-tradables, the ultimate effect on local prices is generally indeterminate.

Scenario I: The neoclassical village/town with tradables

The results of the technological change, estimated using the perfect neoclassical variant of the village/town CGE model, are shown in Table 14. The neoclassical model appears to exaggerate the impacts of the technological change on the village/town economy. In the village technological change experiment, village/town real income rises by US$308, more than three times the initial production increase resulting from the technological change. Because livestock output is highest to begin with, this sector receives most of the direct benefit of the technological change. All non-agricultural sectors in the villages and all agricultural and non-agricultural sectors in the town are unaffected by the technological change in this model, because there are no endogenous prices to transfer the impacts to them. Most of the increase in value-added accrues to family labour. Unlike the income transfer experiments, the initial impacts of the technological change experiment are on the production side, and commercial households are most closely linked to these activities. Because there are no price linkages to stimulate town production in this model, town incomes are unaffected by the technological change in village agriculture.

The marketed surplus effects of the technological change are ambiguous. On one hand, production of agricultural and livestock goods increases. This induces increases in household incomes, however, which in turn increases the demand for normal goods in the village/town economy. The net impact on marketed surplus equals the change in village supply minus the change in village/town demand for each good.

Net marketed surplus increases slightly by US$5 for staples, decreases by US$40 for other crops and increases sharply by US$230 for livestock. For all other village and town goods, net marketed surplus decreases, because demand rises while production remains unchanged. The largest decrease in town marketed surplus is predictably in the commercial sector, where the increased village demand results in a US$25 increase in purchases from outside markets. These represent a leakage in the village/town economy but a potential growth linkage elsewhere in Mexico.

Impacts of technological change in the town are similarly exaggerated. Total income in the village/town economy increases by US$550, driven by a huge increase in town livestock output. As in the village technological change experiment, commercial households receive the bulk of the income gain; net-buyer households also gain, however, by virtue of their supply of factors to agricultural and livestock production.

TABLE 14
General equilibrium effects of an increase in productivitya (all goods tradable)

^a Distributed across activities in proportion to initial production shares.

Scenario II: The village/town with non-tradables

The results of the technological change experiments are more plausible and closer to those from the SAM experiments where all locally produced goods are treated as non-tradables (Table 15). In both town and village, agricultural and livestock production increases while the impacts on other production sectors tend to be small or negative. They benefit from an income-induced increase in demand for their output and from lower prices of agricultural and livestock inputs. They lose, however, when there is an increase in the prices of the non-tradable factors they employ.

TABLE 15
General equilibrium effects of an increase in productivity^a (all goods non-tradable)

^a Distributed across households in proportion to initial income shares.

Much of the impact of technological change is on agricultural and livestock prices; the terms of trade turn sharply against these sectors. This results in large increases in real household incomes for all village and town households. There is a small positive linkage effect from technological change in the town to village production of livestock, other crops and especially services.