GTAP COURSE 7x5 Aggregation with South Africa-EU FTA
This version of the model is similar to the base case, only it begins from a database with a FTA between the EU and SA in place for non-agricultural products (post-SEFTA7).
Note that all the prespecified experiments excepting SEFTA6 have been eliminated. This is because SEFTA 1-5 and 7-8 all involve elimination of EU-SA import barriers which are no longer in place.
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The 5 regions are:
SAFRICA SOUTH AFRICA
RESTSAF REST OF SOUTHERN AFRICA
RESTSSH REST OF SUB-SAHARAN AFRICA
EUNION EUROPEAN UNION
RESTWLD REST OF THE WORLD
The 7 goods are as follows:
AGRIC Agriculture
EXTRACT Natural Resource, Extractive and related ind.
FOOD Food manufacturing
LITMNFC Unskilled labor intensive manufactures
TECHMNFC Skilled labor intensive manufactures
HVYMNFC Capital intensive manufactures
SVCES Services
which are aggregated as follows:
AGRIC: Paddy rice, Wheat, Cereal grains nec, Vegetables, fruit, nuts, Oil seeds, Sugar cane, sugar beet, Plant-based fibers, Crops nec, Bovine cattle, sheep and goats, horses, Animal products, Raw milk Wool silk-worm cocoons, Bovine cattle, sheep and goat, horse meat prods,
FOOD: Meat products nec, Vegetable oils and fats, Dairy products, Processed rice, Sugar, Food products nec, Beverages and tobacco products
EXTRACT: Forestry, Fishing, Coal, Oil, Gas, Minerals nec, Petroleum, coal products
LITMNFC: Textiles, Wearing apparel, Leather products, Wood products,
HVYMNFC: Paper products, publishing, Chemical, rubber, plastic products, Mineral products nec, Ferrous metals, Metals nec,
TECHMNFC: Metal products, Motor vehicles and parts, Transport equipment nec, Electronic equipment, Machinery and equipment nec, Manufactures nec
SVCES: Electricity, Gas manufacture, distribution, Water, Construction Trade, transport, Financial, business, recreational services, Public admin and defence, education, health, Dwellings & Svces
Experiment relating to investment inflows (invest.cmf):
In this experiment, the required rate of return by foreign investors in South Africa falls from 18% to 15%, thereby stimulating an inflow of foreign investment. With S - I falling, so too, must X - M fall, and export are cut while imports increase.
In order to operationalize this experiment, use the standard closure in cSA7x5.cm, along with invest.shf.
Discussion of modelling method (by Gerard Malcolm)
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In general, increases in direct capital inflows occur because the investment climate becomes more attractive. In the case of South Africa in its transition from the apartheid system to a democratic system, this may be because
* negative impacts on the global operations of companies no longer occur as a result of investment in South Africa,
* the risk premium associated with investment in South Africa is lower under a more stable political climate,
* legal restrictions on investment no longer apply, or
* the economic outlook for South Africa is improved.
The risk premium can be modelled in a de facto way by the cgdslack variable, which enters the model as follows in the case where RORDELTA = 1:
(1) rore(r) = rorg + cgdslack(r) (from equation 11', Hertel 1997)
i.e. the rate of return on investment in region r is equal to the global rate of return plus some extra factor which is generally exogenous and set at zero in a general equilibrium closure.
It is possible to consider cgdslack as a risk premium (which is normalised to zero by default) denominated in percentage points. Therefore a decrease in the risk premium can be modelled as a negative shock to cgdslack.
Estimating an appropriate-sized shock is straight-forward. If we write
(2) RORE(r) = RORG.RP(r) where RP(r) is a risk premium scaling factor,
then by total differentiation and division through by RORE(r) we can obtain
(3) rore(r) = rorg + rp(r)
which is the analogue of equation (1) above, with cgdslack(r) = rp(r). RP(r) represents the ratio of equilibrium returns in region r to the global rate of return. For risky countries, this ratio will be above 1, and for safe countries below 1.
RORG does not represent a riskless return but a weighted average of returns around the world. This formulation differs therefore, from the more familiar representation of required returns in a country being equal to the riskless return plus some margin (expressed in percentage points).
We have
(4) rp(r) = dRP(r) = RP'(r) - RP(r)
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RP(r) RP(r)
where the superscript ' denotes the post-change value of a variable.
Using RP(r) = RORE(r)/RORG, this simplifies to
(5) rp(r) = RORE'(r) - RORE(r)
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RORE(r)
In order to determine an appropriate shock for rp(r) it is necessary to know what the original required rate of return in South Africa was, and how this will change.
If we assume that the change in South Africa will have a negligible impact on the global average, then it is not necessary to know the global required rate of return.
According to GVIEW.HAR, value of output in the capital goods industry in South Africa (i.e. gross investment) is 0.4% of the global total.
So for example, if the required rate of return falls from 18% to 15%, then the appropriate shock to rp(r) is -16.67.
For countries where no change to the risk premium occurs, rp(r) = 0. No shock to rp(r) is required.
In general, if we do not wish to make the 'small country' assumption, then
(6) rp(r) = ( RORE'(r)/RORG' ) / (RORE(r)/RORG) - 1
where RORG and RORG' are global required rates of return before and after respectively. In this case, rp(r) cannot be determined exogenously because RORG' is endogenous. Alteration of the GTAP Model would be required to reflect this.
CLOSURE REQUIREMENTS:
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In order to use cgdslack as a proxy for the risk premium in this way, the model closure must include cgdslack as an exogenous variable (this is the usual GE closure), and the parameter RORDELTA must be equal to 1 in the parameter file.