Poverty Impact Analysis: Approaches and Methods - Chapter 9 pptx

CHAPTER 9

Computable General Equilibrium—

Microsimulation Model: Economic and

Poverty Impacts of Trade Liberalization

in Indonesia

Guntur Sugiyarto, Erwin Corong, and Douglas H. Brooks

Introduction

The Indonesian government has actively pursued unilateral, bilateral,

regional, and multilateral trade liberalization for the last two decades. All

liberalization was done in the context of Indonesia’s membership in the World

Trade Organization (WTO), Asia-Pacifi c Economic Cooperation (APEC),

Association of Southeast Asian Nations (ASEAN) Free Trade Area, ASEAN–

China Free Trade Area, and ASEAN–China, Japan, Korea (ASEAN+3).

Indonesia has also played an active role in the WTO by coleading the Group

of 33 (G33) countries in the ongoing negotiations for the Doha Development

Agenda (DDA).1 The main objective of the DDA is to help developing

countries by removing distorting tariffs and subsidies and improving market

access to help promote economic development and reduce poverty.

The government’s involvement in these various trade agreements, as well as

in structural adjustment programs with the World Bank and the International

Monetary Fund, has intensifi ed the country’s trade liberalization process.

As a result, Indonesia has, in some instances, unilaterally hastened the

liberalization pace beyond its commitments with the WTO (WTO 2003).

The rapid pace of unilateral trade liberalization and the imminent

agricultural liberalization resulting from the DDA have been the subject of

policy debates. Questions have been raised, such as: What are the economy￾wide and poverty impacts of trade liberalization? Is there any justifi able

reason for still protecting the agricultural sector? What are the effects of farm

trade liberalization that might result from the DDA? Since most farm workers

are among the very poor, will they benefi t from the DDA and, if so, how?

1 G33 was co-led by Indonesia and the Philippines during the 2001 WTO ministerial

meeting.

Applications of the CGE Modeling Framework for Poverty Impact Analysis

274 CGE—Microsimulation Model: Economic and Poverty Impacts of Trade Liberalization in Indonesia

The objective of this study is to shed light on these issues by examining the

economy-wide and poverty impacts of unilateral, but DDA-consistent, trade

liberalization in Indonesia using a computable general equilibrium (CGE)

microsimulation model (or CGE macro-micro model) for Indonesia. Clarity

on these issues is important as further liberalization may bring about different

economy-wide and poverty impacts on different households.

Literature Review

Trade liberalization of agricultural products under the DDA is aimed at

achieving a long-term objective of establishing a fair and market-oriented

trading system through fundamental reform. The DDA calls for substantial

reductions in trade-distorting domestic supports, all forms of export subsidies,

and improvements in market access. These are the three pillars in agricultural

trade liberalization.

Improvement in market access is the key to successful liberalization. The

potential gains from improvement in market access have been shown to be

the most important among the three pillars, accounting for two thirds of the

potential global gains. Moreover, over half of the potential gains will go to

developing countries (Hertel and Keeney 2005). Within the scope for market

access, empirical studies have shown that agricultural market access is one

of the most potentially signifi cant issues in the DDA (Sugiyarto and Brooks

2005).

Hertel and Winters (2006) led a team of researchers in analyzing the

possible poverty impacts of DDA on a number of developing countries,

including Indonesia. The study concluded that a more ambitious DDA would

lead to signifi cant poverty reductions in the long run and that developing

countries must not only allow for deeper tariff cuts, they must also implement

complementary policies aimed at helping households take advantage of

greater opportunities arising from the DDA.

For Indonesia, Robillard and Robinson (2005) analyzed the economy￾wide and poverty impacts of the DDA and found that full liberalization under

the DDA results in a reduction in poverty, as the wage and employment

gains outweigh the changes in commodity prices critical to poor households.

More importantly, they warned that the poverty impacts of DDA crucially

depend on households gains in the labor market. Similarly, Sugiyarto and

Brooks (2005) analyzed the economic and welfare impacts of the DDA using

a conventional CGE model with representative household groups (RHGs).

They observed that the removal of only agricultural tariffs would generate

adverse effects, whereas the removal of agricultural tariffs in combination with

Poverty Impact Analysis: Tools and Applications

Chapter 9 275

the elimination of agricultural commodity taxes would marginally benefi t the

economy. Comprehensive tariff elimination—involving all sectors—appeared

to be even more benefi cial.

Trade and Poverty Linkage

Winters (2001), Winters et al. (2004), and Hertel and Reimer (2004) stressed

the need to investigate possible channels through which trade liberalization

may affect households and poverty. These channels include:

price and availability of goods;

factor prices, income, and employment;

government taxes and transfers infl uenced by changes in revenue

from trade taxes;

incentives for investment and innovation affecting long-run economic

growth;

external shocks, in particular, changes in terms of trade; and

short-run risk and adjustment costs.

CGE modeling frameworks, because they involve counterfactual analysis,

have been the preferred tool in identifying channels through which a certain

policy change affects the economy. The models act as policy laboratories

by providing numerical evaluation of the economy-wide impacts of a policy

shift in a controlled environment, free from infl uences of other policies.

The use of CGE models to analyze poverty and income distribution can

be traced to the initial work of Adelman and Robinson (1978) and Lysy and

Taylor (1980). Since then, different approaches have emerged. A popular

but restrictive approach is to assume a lognormal distribution of household

income within each category where the variance is estimated from the base￾year data (De Janvry, Sadoulet, and Fargeix 1991a). Meanwhile, Decaluwé et

al. (2000) argued that a beta distribution is preferable to other distributions

because it can be skewed to the left or right and thus may better represent

the types of intra-category income distributions commonly observed among

households. Regardless of the distribution, the CGE model is used to provide

the changes in average income for each household category, while the

variance of this income is assumed to be fi xed.

Robillard and Robinson (2005) employed a sophisticated approach to

analyzing the poverty impacts of the DDA for Indonesia. Considering the

importance of the labor market, the model employed a CGE-microsimulation

model containing a microsimulation of labor allocation. In this case, the

CGE model produces price, wage, and aggregate employment vectors, and

these vectors are then fed to the microsimulation model to generate changes

in individual wages, incomes, employment status, and poverty. Overall

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