industry, agricultural cottage industries, other modern industries, crafts and ..... L. Squire et J. Strauss, John Hopkins University Press, Baltimore. 20 Ram R. and ...
ADJUSTMENT, LIBERALIZATION AND WELFARE, IN PRESENCE OF HEALTH AND EDUCATION EXTERNALITIES: A CGE APPLIED TO BENIN by
Luc Savard and E piphane Adjovi
Cahier 97{07 du Centre de Recherche en E conomie et Finance Appliquees CRE FA
Mars, 1997
DE PARTEMENT D'E CONOMIQUE Faculte des Sciences Sociales We would like to thank GTZ and the Programme PARADI-ACDI for their nancial support. We would also like to thank C. Sinzogan, B. Decaluwe, M. Souissi, T. Muller, K. Meyer, J-L. Arcand, P-C. Ekue, M. Soede, M. Delieres and J. de Melo for their valuable comments and suggestions.
1 Introduction During the 1980-s Benin su ered through a severe economic and nancial crises. The government was forced to adopt a series of economic and nancial reform measures [the Structural Adjustment Program (SAP) and the \Programme de dimensions sociales du developpement" (DSD)] in order to obtain assistance from the International Monetary Fund (IMF) and the World Bank. The principal objectives of these reforms were to reduce external and domestic indebtedness, to establish a sustainable rate of growth, and to improve the welfare of the citizens. Several measures have been proposed to attain these objectives. Some of these may have signi cant, and possibly unwelcome, repercussions on the overall performance of the economy and on various classes of households, especially the poor. A computable general equilibrium model (CGEM) was used to assist in the analysis of the potential impacts on poor households and on the economy in general of the proposed policies, i.e. economic liberalization in some sectors, scal reform, and a major scaling back of the public sector. This model was adapted to account for speci c features of the Beninese economy, externalities related to expenditures on health care and education were introduced, and households are disaggregated in order to distinguish the impact of various economic policies on di erent groups, in particular on the poor. In general, models based on classical assumptions predict that trade liberalization will yield (slight) economic bene ts. The modi cations to the standard models proposed in this paper will allow us to verify whether quantitative or even qualitative deviations from the typical results are generated under simulations of the economic policies proposed under SAP. Section 2 contains a stylized presentation of the of the principal characteristics of the Benin economy. The following section 3 explains how we will model these phenomena. In section 4 we brie y describe the data, while section 5 gives a summary of the main equations in the model. The results of the simulation appear in section 6 and we conclude our discussion in section 7.
2 The Benin Economy ,
Benin is a small country 112; 662 km2 with 4.9 million inhabitants (1992). Agriculture is the cornerstone of Benin's economy, accounting for 37% of GDP. 2
The primary export is cotton, production of which has been in expansion since 1982. The industrial sector represents a mere thirteen percent of GDP, its primary output is consumption goods (soap, beverages, and sugar) along with several other products such as cement and textiles. Since 1982 there has also been a limited production of petroleum. The economy of Benin went into decline after 1983 and did not begin to recover until 1990. During this interval the rate of growth of GDP was negative ( ve years out of seven. Considering that the rate of population growth was 2.94% over this period, it is clear that a major impoverishment of the population occurred. The main causes of the economic decline were an overvalued CFA Franc, weak international markets for primary goods and an economic slowdown in the region (West Africa) (EIU 1994). This economic situation created signi cant internal and external disequilibria and caused a crises in public nances, in the banking system and in the balance of payments. The impoverishment of the population and defaults on payments to civil servants and students, combined with the collapse of the banking system, provoked a strike by public sector employees, students and professors. Under these pressures the government nally accepted the conditions of the IMF's Structural and Financial Adjustment Program (SAP), for 1989-1992. Subsequent to the implementation of this program, a series of studies and inquiries were undertaken in order to attain a better understanding of the characteristics and mechanisms underlying the Benin economy. Some stylized facts are presented here to underline the problems which confront the authorities. The size of the informal sector of the Beninese economy were studied within the framework of the \Programme d'enqu^etes d'etudes sur le secteur informel" (PEESI). This research revealed that a very high proportion of urban enterprise is in the informal sector. For example, 93% of businesses in Porto-Novo are in this sector, while only ve percent have legal status. Furthermore, 62% of the former have been in existence since less than two years while 44% of the latter are more than ve years old. Reductions in the civil service have contributed much to this increase. Given this context it is not surprising that the labour market is segmented into a formal (public and private) and an informal market. Wages paid to workers in the informal sector are about half those paid in the formal sector [Household Income-Consumption Survey (HIS), 1992], while those in the private and public branches of the formal sector tend to be rigid due to the impact of 3
regulation and collective agreements. The unemployment rate is 12.6% (HIS 1992, and \Observatoire de l'emploi", 1993). The unemployed and workers in the informal sector form a pool of labour from which the formal (modern) sector draws, and into which it releases, workers in response to increases (decreases) in its demand for labour. Wage rates in the informal sector adjust to these movements1. According to indices of human development released in the UNDP's 1993 Global Report on Human Development, the human development index for Benin ranked 162 of 173 countries examined in 1990. Average annual income was $360 US, and other indices were also among the lowest in Africa. About 77% of the population was illiterate and only 37% of school age children attended school, with 66% enrolled in primary school and 12% in high school (WDR, 1994). Average life expectancy was 47 years. Benin's performance in these areas was well below the average for sub-Saharan Africa, where the numbers are: $490 US annual average income, 51.8 years life-expectancy and 53% illiteracy. (Friedlander, 1993). Infant mortality, at 110 per 1000 is above the average of 91 for low income countries. The number of doctors and nurses is also below average (WDR, 1994). The SAP-s for 1989-94 and 1994-96 incorporate a long list of conditions for development. Notable are the reduction in the role of the public sector, a return to scal equilibrium, and promotion of the private sector in order to create conditions conducive to sustainable growth and a viable domestic and international nancial position. An array of measures have been proposed to achieve these aims. Signi cant cutbacks in the government payroll, loosening of labour market regulation, scal reform, and privatization of government corporations among others. Clearly these reforms will impact on the welfare of various sectors of the population. Despite the emphasis which the SAP placed on the importance of health and education, the voluntary departure program (VDP) implemented under the SAP did not discriminate according to the nature of the work, and consequently many teachers took advantage of the VDP and quit their jobs. This created a shortage which was not lled due to a freeze on hiring. Between 1985 and 1990 the rate of school attendance dropped from 61% to 49%. In addition, despite the reduced availability of public schooling, private schools play a minor role with only ve percent of pupils (Friedlander, 1993). Within the framework of the DSD a model was developed to analyse the 4
e ects of the measures in the SAP on several classes of poor households. The model constructed by Savard et al. (1994) introduced health and education as factor neutral production externalities. He also incorporated the dual labour market, but neither unemployment nor endogenous labour supply in the informal sector were included. In our paper, we build from this model and introduce health and education externalities that are distinct and have a di erentiated impact with respect to factors of production. We also provide a more detailed treatment of the labour market (\waiting unemployment" and endogenous labour supply on the informal market). These modi cations permit a more thorough analysis of the e ects of partial trade liberalization, of decreased income in the public sector and of a shrinking civil service. A description of the speci c assumptions of the model follows.
3 The Adaptations of the Model The introduction of health and education as externalities, as well as the adaptation of the labour market to incorporate the facts set out in the previous section, sets our model apart from more traditional approaches. The standard aspects of our model derive from Model 3 by Decaluwe et al. (1993) and Savard et al. (1994).
3.1 Health and Education Externalities Starting with the work of Becker (1964) on human capital, a ourishing literature has developed on the relationship between improvements in human capital and improvements in productivity and growth [Romer (1986), Lucas (1988), etc.]. Nonetheless, to our knowledge no static CGEM has incorporated this relationship. The relationship between adjustment, productivity and education and health is of considerable interest, especially in the context of poor countries [Malenbaum (1971) and Willis (1986)]. Furthermore, a substantial body of literature emphasizes the importance of incorporating externalities in Ricardian and Hecksher-Ohlin international trade models [cf. Manning and McMillan (1979)]. Consequently, these externalities were introduced in order to verify their impact on the results of standard CGE models. In addition to the aforementioned literature, the assumptions of this model draw upon work examining the impact of education and health on productivity 5
gains such as the econometric studies by Hicks (1979), and Deolalikar (1980) among others1.
3.1.1 Education As in Lucas (1988), two types of externalities are postulated for the case of education. In one case the education externality has an impact on the productivity of the workers, while in the second its impact on production is neutral2 , as modelled by Becker (1964) and Welsh (1970). The former represents the productivity gains of workers who acquire new skills and knowledge during their education. For example, an employee of a manufacturing company is more productive if he can read. As to the neutral e ect on production, this is due in part to the fact that, as a worker's productivity increases his use of capital improves and so the productivity of the latter also increases. It is important to distinguish between these two e ects because, in the rst case the externality causes the producer to change the optimal ratio of capital and labour inputs, while in the second case no such change occur3. In addition, following Willis (1986), we introduce di erentiated categories of work. In other words, workers in the modern sector may bene t more, or less, from the externality than those in the informal sector2. The function of neutral externalities depends on the production of the good \education" relative to sectorial production na = fna (Xsed; na ) ; where Xsed represents government expenditure on education and na the education externality elasticity of production by branch3. We impose 0 < na < 1; so that fXsed > 0 and fXsed Xsed < 0, i.e. the marginal externality is decreasing. This correlates with the results of Grossman (1972) on health and Lucas (1988) on education. The non-neutral externality is also a function of government spending on education and has the same properties as the previous s ; na ) ; where na is the education expenditure elasticone, i.e. $na = gi (Xed ity of the factor labour. We impose: 0 < na < 1; implying that gXsed > 0 and gXsed Xsed < 04 . For more information, Dumont (1995) provides a review of the literature on the contribution of human capital to growth, and see Willis (1986). 2 A neutral impact on factors implies that the producer will have no incentive to change the capital / labour ratio. 3 Cf. Welsh (1970) for a detailed explanation. 1
6
3.1.2 Health Our approach to modelling the health externality derives from the literature on the relationship between the health of workers and their productivity. Lee's (1982) econometric studies for the U.S., Deolalikar (1988) for India and Weisbrod et al. (1973) for St. Lucia all conclude that household revenue is a function of health, and that an amelioration in the overall health of the population will increase labour productivity. Despite these results, literature on the link between health and productivity is less extensive and commands less unanimous support than that on education. This phenomenon is largely explained by the diculty in establishing reliable measures of health. However, according to the WDR 1995, expenditure on public health programs remains an important means of improving the quality of labour in developing countries. Furthermore, according to Hicks (1979),\The health related aspects of basic needs are at least as important as those associated to education with respect to raising productivity." In this paper we shall consider current government expenditures on primary health care, nutrition program or any other health expenditures that can be considered as determinants of public health. This e ect on worker productivity can be decomposed into two aspects. The rst is utilized by Pitt and Rosenzweig (1986), Deolalikar (1982), Weisbrod et al. (1973) and Malenbaum (1971) who consider that a healthy employee is in better physical condition and hence more productive. The second is presented by Ram and Shultz (1979), according to whom a healthier population lives longer. In consequence, there is a higher ratio of older, more experienced and more productive workers to their younger counterparts. In this case we only introduce the non-neutral variable for the health expenditure externality, na ; which is a function of public health expenditure and of the health expenditure elasticity of the factor labour, &na : So we have na = zna (Xssa ; &na ) with 0 < &na < 1; implying that zXsna > 0 and zXsna Xsna < 0. Consequently, production in each branch depends on three external variables5 in addition to the standard inputs (capital and labour). The function is as follows: Xsna = hna (Ldna ; Kna ; na ; $na ; na ) : (1) This function is concave in the externalities variables na ; $na ; na such that:
hna > 0; h$na > 0; h na > 0 7
(2)
and
hnana < 0; h$na $na < 0; h na na < 0:
(3) The relationship speci ed here implies that we are ignoring endogenous e ects on labour supply. In the case of education, Pitt and Rosenzweig (1986) and Willis (1986), among others, introduce a relationship under which increases in education decrease labour supply. If the supply of education increases, individuals who are taking advantage of this will not be available for work. In the case of health, improved health will induce people to supply more hours of work [Pitt and Rosenzweig (1986)] while the income e ect resulting from productivity gains will cause them to work less. Labour supply e ects are numerous and qualitatively di erent, making it dicult to model the net impact endogenously. Consequently, we assume that the net e ect is nil and exogenous and that we can simulate the e ects of an increase or decrease in the supply of labour combined with other simulations.
3.2 The Labour Market In order to capture the e ects of some of the measures proposed under the SAP, especially public service cuts and changes in the level of previously rigid salaries, it was necessary to model some stylized facts about Benin's labour market. Savard, in his 1994 Social Accounts Matrix (SAM), classi es labour into three groups: informal labour, modern labour and bureaucrats. His model also adds a group for the unemployed, who are assumed to be in a state of waiting employment. They are primarily recent graduates who have diculty integrating into the job market because of the hiring freeze in the public service, and those called \de ates6." The market for skilled labour in Benin is characterized by a great deal of salary rigidity due to regulation and collective agreements. We formulate this rigidity by specifying that salaries in the modern sector and the civil service are xed. Consequently, only demand determines the level of employment in these sectors, and this demand is always satis ed from the pool of unemployed and workers in the informal sector. As to the informal sector, wages are exible and will fall to absorb the \de ates" or rise when hiring in the modern sector or civil service increases. Some of the \de ates" prefer remaining unemployed to working as unskilled labour in the informal sector [ELAM and Observatoire de l'emploi (1991). This follows the reasoning that Fortin et al. (1996) developed for Cameroun. A labour supply function is also introduced in a similar fashion 8
than Subramanian (1994), in which the unemployed increase their supply of labour if the real wage in the informal sector increases relative to the base year7. Labour supply in the informal sector consists of workers from this sector in the base year plus (minus) a proportion of the excess (shortfall) of workers from the other two sectors (modern and bureaucracy). This proportion is endogenous and rises with an increase in the ratio wif =w0if : The labour market is represented by equations (4) through (8):
Ldf =
!
X
X Ldomo Ldmo na , na + na na
X
X Ldofa , Ldfa a a
!
;
(4)
where Ldf represents the \de ates." If the demand for labour in the modern and public sectors increases with respect to the base year this variable will be negative. Ldomo na represents the demand for modern workers by branch in the mo base year, Ldna the same demand after the simulation, and Ldofa the demand for employees in the public administration4 in the base year and Ldfa the demand for labour in this sector after simulation5 . A proportion of \de ates" join the work force of the informal sector while the remainder (1 , ) prefer remaining unemployed. We have:
Lsd = Ldf ;
Udf = (1 , ) Ldf
and
(5)
where Lsd is the supply of labour in the informal sector from the \de ates" and U df represents those who prefer remaining unemployed. As mentioned earlier, is an endogenous function of the ratio wif =w0if : We have the following relationship: = 0 wif =w0if (6) where 0 is the proportion of the \de ates" supplying labour in the informal market at a xed wif =w0if and is the elasticity of labour supply8 . Labour supply in the informal sector is thus represented by:
Ls = Los + Lsd
(7)
where Los is the labour supply in the base year for the informalPmarket, which is also equal to the sum of individual informal labour demands Ldoifna : As to 4 5
The index a represents the three branches of government. These demands are exogenous and only change in response to an exogenous shock.
9
the level of unemployment, it is determined by the following equation:
U = U0 + Udf
(8)
where U0 is the unemployment level in the base year. This type of model captures some of the ingredients of the stylized representation of the labour market we presented (\de ates", waiting unemployment, informal labour market, wage rigidity)9 .
4 The Social Accounts Matrix (SAM) The Savard et al. (1994) SAM incorporates ten sectors, seven of which are in the private sector and three in the public administration. The public sector is disaggregated into education, health services and other administrative services. The private branches are: subsistence agriculture, industrial agriculture, agroindustry, agricultural cottage industries, other modern industries, crafts and shopkeeping. There are four classes of agents: households, government, rms and the rest of the world. Households are further disaggregated into: rural poor (RH), urban poor (UH), and non-poor (NH). The factors of production are capital and labour, of which the latter comprises informal, modern and public.
5 The Model Aside from the aspects discussed in the previous section, ours is a standard model. In this section we will brie y describe the main blocks of equations. The equations in their entirety are presented in the appendices.
5.1 Production Production by the private branches is represented by a Leontief function on value added and consumption of the intermediate good [equation (A.1.1)]. Value added, V Ai ; is represented by a nested CES, with the choice between two di erent types of labour at the rst level and the choice between a composite labour factor and capital at the second level. The functions are6: h
V A = Bx LLd 6
,1
+ (1 , ) K
,1 i 1,
;
(9)
The index na has been dropped from equations (9) through (12) to simplify notation.
10
where LLd is the demand for the labour composite, K the demand for capital, Bx the scaling parameter, the share parameter, and the elasticity of substitution:
h ,1 ,1 i LLd = Bz if $if Ldif + mo $mo (1 , ) Ldmo 1, ;
(10)
where Ldif is the demand for labour in the informal sector and Ldmo the demand for modern labour. In these equations the externalities variables, and $; are broken down into two aspects to di erentiate between the e ect on different types of labour. The values assumed by these variables must respect the following conditions:
v = v ; where v = fif; mog ; 0 < v < 1 and
X
$v = v $; where v = fif; mog ; 0 < v < 1 and
X
v v
v = 1:
(11)
v = 1:
(12)
In sectors which only use one type of labour we replace LLd from equation (9) by Ldif if the branch only uses informal labour and Ldmo if the branch only uses modern labour. In both cases the externalities and $ cannot be decomposed and appear in equation (9) as a coecient of labour. The functional form describing the externalities variables is as follows: & Xs Xs Xs ed sa ed = Xso ; $ = Xso ; = Xso : ed ed sd
(13)
In view of the conditions mentioned in section 3.1, the marginal productivity of expenditure on education and health care is positive and decreasing10. The total Cii are also represented by a Leontief function on the Cijij [cf. equation (A.1.14)]. Consequently, producers minimize costs under the constraint of these value added functions in order to solve for their optimal labour demand [equations (A.1.5)]. In this model capital is immobile11 . Production in the public sector [equation (A.1.2)] is exogenous and is also represented with a Leontief function on labour and intermediate goods.
5.2 Income and Demand Household incomes are comprised of payments to factors, dividends and transfer payments7 Firms' income originates from return to capital and transfers from 7 Government, other households, rms and quasi-corporate enterprises, and the rest of the world.
11
agents. Finally, government income comes from taxes and transfers. Total demand is broken down into: demand by households by government, investment demand and demand for intermediate goods. Household demand function is derived from a LES-CD (Linear Expenditure System - Cobb Douglas) utility function [equation (A.2.2)] which is di erentiated by type of household. The government consumes all of its own production. Public and private8 investment demand (by good, Ivi ) is determined by equation (A.2.4).
5.3 Foreign Trade and Welfare Foreign trade is modelled according to the Armington hypothesis (1969) under the assumption of a small open economy. This assumption implies that prices on the world market are exogenous and, furthermore, that foreign demand for domestically produced goods is in nite. The Armington hypothesis suggests that imported goods are imperfect substitutes for domestically produced goods. Welfare measures are frequently used in CGEM-s. Our approach is to use the equivalent variation measure EV , as in Melo and Tarr (1992).
5.4 Closure and Calibration To close this model, choices of closure rules must be made on the basis of the features of the economy and on the type of simulations intended. Closure of the labour market is based on its stylized characteristics previously presented. As to foreign trade and savings, the introduction of welfare measures imposes certain constraints. For example, the model may not be closed under Keynesian assumptions, since then the current account balance will be nanced by foreign savings which introduces a bias into the measures of welfare. Consequently, the current account balance equilibrium is maintained with the exible exchange rate. Total investment is also kept constant. Government de cits are nanced from domestic private savings9 which also adjust to maintain constant investment. Households' marginal propensity to save must be endogenous in order to maintain equilibrium. The price index is a consumer price index and is exogenous. To solve the model, some parameters are drawn from the literature; the average salary in the informal economy is xed at 50% of the salary in the 8 9
Public and private investment are not di erentiated by their destination sector. This comprises savings by rms, Se; and by households Smh :
12
formal sector, since that re ects historical trends (HIS, 1993). Unemployment in the base year is set at 12.6% (Observatoire de l'emploi, 1993). The rate of absorption of \de ates" into the informal sector, ; is 80% (PEESI, 1993). Other parameters have been calibrated to reproduce the base year. For example, the level of employment in the informal sector Ldif was calibrated from the prevailing wage rate. Sensitivity tests were performed to verify the robustness of these parameters and within reasonable ranges, these parameters proved to be robust. As no estimates of the elastiticties of the externalities existed for Benin, these had to be generated. Two criteria were retained for this, the relative di erences between the sectors and the absolute level. Among the assumptions made, for example, is that the health externality impacts most on agriculture, less on manufacturing and least on the service sector. As to education, this order is inverted. As to the absolute level, the level chosen were relatively low (cf. section A.10 in the appendix for the selected parameters).
6 The Simulations and Results To analyse the e ects of some of the proposed economic policies, six simulations were run. The rst re ects a 10% decrease in import duties, Dtii . In the next four this condition is retained and combined with four di erent reductions in government expenditure to maintain budget neutrality (i.e. a constant budget de cit with respect to the base year). For the second simulation, all three government branches (the branches of the administration) are cut. In the third, education and health expenditures decrease, in the fourth the \other administrative services" is cut while health and education remain untouched, and in the fth wages to bureaucrats and modern labour are reduced.
13
Table I: Results of the Simulations, variations in %y
Variables
GDP Y mr Y mu Y mn EVr EVu EVn wi Sg u e Xs1 Xs2 Xs3 Xs4 Xs5 Xs6 Xs7
Base Sim. 1 Sim. 2 Sim. 3 Sim. 4 Sim. 5 sim. 6 430779.5 0.53 -0.05 -1.08 0.23 0.09 0.38 39458.4 0.32 0.45 -1.20 0.90 0.72 1.09 30037.5 0.75 0.05 -0.90 0.31 0.89 1.06 370385.0 0.51 -0.13 -1.09 0.14 0.05 0.34 14.7 128.6 -475.3 290.4 167.8 372.2 61.8 30.3 -282.2 116.0 224.8 352.7 82.8 -258.0 -274.9 423.0 250.0 1619.0 0.50 1.46 -2.46 -5.08 -1.71 4.13 7.41 -8976.0 27.73 - -13.20 10.0 -0.33 2.41 3.65 2.08 -1.77 -2.97 1.0 0.78 0.64 0.82 0.59 0.51 -0.27 171533.5 -0.01 -0.13 -0.68 0.02 0.01 0.38 27551.0 -0.01 -0.21 -1.31 0.09 -0.01 0.66 47591.9 0.20 -0.22 -1.31 0.07 0.42 1.02 72663.5 -0.08 -0.15 -1.28 0.15 -0.14 0.53 66916.4 0.20 0.08 -1.37 0.48 1.36 2.01 75737.5 -0.06 -0.05 -1.10 0.24 -0.02 0.52 293226.3 0.11 0.06 -1.48 0.47 0.48 1.15
The indices i = 1; 2; 3; 4; 5; 6; 7 refer to the branches: agriculture, industrial agriculture, agricultural cottage industries, other modern industries, other crafts, and shopkeeping respectively. The indices r; u; and n represent rural poor, urban poor and non- poor households respectively. All values are in millions of CFA Francs. y For all variables with the exception of EVh .
6.1 First Simulation The rst simulation involves a 10% reduction in import duties, Dtii ; yielding a (0.53%) increase in GDP and an output growth in four of the seven private branches. The greatest production Xs increase is in the agricultural cottage industries and other crafts (0.20%). The government's de cit Sg increases by 27.73%, indicating that the additional tax revenue generated by increasing economic activity is insucient to o set the lost tari revenue. As to households, income Y m of the three groups increases, by 0.32% (HR), 0.75% (HU), and 0.51% (HN). The welfare measures EV increase by 14.7 for the HR, 61.8 for the HU, and 82.8 for the HN. The unemployment rate u declines by 0.33% while wages of informal labour grow by 1.46%. Finally, the exchange rate e must fall 14
by (0.78%) in order to maintain the current account balance. This policy has bene cial e ects on production and household incomes and negative e ects on the government de cit and on the external de cit. Measures usually proposed to deal with these e ects include cuts in government spending and tax reforms such as the introduction of a value added tax, income taxes and other types of taxes. However, these increase taxes have limited value in a country like Benin, since so much economic activity takes place in the informal sector and tax evasion is relatively easy. Fortin et al. (1994) has shown that it is possible to have a reduction in government revenue subsequent to a tax increase if the informal sector constitutes an important part of the economy and tax evasion is endogenized10. Therefore, we assume here that for the government to reduce its de cit it must cut spending11 , as tax increases are an unreliable source of revenue Y gIn the remaining simulations, di erent options for reducing government expenditure are examined.
6.2 Second Simulation For the second simulation, a 3.78% reduction of government spending is spread across the three branches of the administration. This reduction in Xsa results in a 0.05% fall in GDP, with production declines in ve of the seven branches. The cut in government expenditure undermines the exchange rate which depreciates by 0.64%. Government layo s swell the population of \de ates" and increase the unemployment rate (2.41%) as well as the supply of informal labour. As a result of this increased labour supply, wages in the informal sector fall by 2.46%, causing a reduction in this component of household income. This fact, in conjunction with the decrease in GDP, partially explains the loss in revenue (vis-a-vis the rst simulation) to two of the household groups: from 0.51% to -0.13% for the HN and from 0.75% to 0.05% for the HU. Since only a very small proportion of the income of HR households comes from the civil service payroll (which falls with the shrinking of the bureaucracy), they are hardly a ected by this measure, with an increase from 0.32% to 0.45%. Furthermore, this group's EV increases from 14.7 to 128.6. 10 The results are obtained from a CGEM applied to Cameroon in which tax evasion is endogenized. 11 Either reducing output of the administrative branches or cutting costs (eg. wage rollbacks).
15
6.3 Third Simulation For the third simulation only expenditure on health and education are reduced12 . A 16.4% reduction is required to maintain a constant government de cit. As in the previous case, we have a negative externality, but now the loss in GDP is greater, -1.08% rather than -0.05%. The depreciation of the exchange rate is also greater, at 0.82%. Production falls in all sectors along with the demand for labour in the modern sector. Since wages of modern labour do not adjust, excess workers shift into the informal sector where the labour supply swells. In tandem these two e ects cause a greater fall in wages in the informal sector, which falls by -5.08% as opposed to -2.46%. The unemployment rate increases by 3.65% compared to 2.41%. The overall fall in the civil service payroll combined with the decrease in the wage bill of the formal sector contributes to an income loss to all three household groups: 1.20%, 0.90%, and 1.09% for the HR, HU, and HN respectively. The corresponding EV-s fall by 475.3, 282.2 and 274.9. HR households su er a greater decrease than HU households because a larger share of their income is from the informal sector. Under this simulation, all three groups are worse o than under the previous two simulations.
6.4 Fourth Simulation The fourth simulation implies a 4.9% reduction in the \other administrative services" branch (non-health and education). Unlike in the previous two simulations, this one generates no externalities since the\other administrative services" branch is not associated with externalities. In this case GDP increases by 0.23% while production increases in all branches of the private sector. Depreciation of the domestic currency is less than in previous simulations, at 0.59%. There are also fewer \de ates" and the absence of an externalities e ect attenuates the downward pressure on salaries in the informal sector, where the reduction now is on the order of 1.71% as the \de ates" integrate into this labour market. The increase in the unemployment rate is also less than under the previous simulation, at 2.08%. Household income increases are 0.90%, 0.31% and 0.14% for the HR, HU and HN respectively, since the increase in the wage bill of the expanding modern sector more than compensates for losses due to a fall in wages in the informal sector and to the reduction in the civil service payroll. The EV increases are: 290.4 for HR, 116.0 for HU and 423.0 for HN households, re ecting again welfare improvements accruing to all three groups. 16
6.5 Fifth Simulation For this fth simulation rigid salaries (modern and administrative labour) are reduced by 4.7%. In this case GDP rises by 0.09% along with production in four of the seven branches. The depreciation in the exchange rate is milder than what we have seen yet, at 0.51%. Since there are no layo s in the civil service and real wages decrease, the demand for modern labour increases in every branch using this factor. Consequently, the informal sector is characterized by a declining supply of labour and rising wages (4.13%), which in turn prompts branches which use informal labour to reduce their demand. The unemployment rate falls by 1.77% subsequent to the increased demand for labour in the modern sector, while the increase in wages in the informal sector motivates some individuals who were previously unemployed to begin supplying their services in the informal labour market. The income of all three groups increases: 0.72%, 0.89% and 0.05% for HR, HU and HN households respectively. Increases in employment in the formal economy combined with decreasing unemployment are the primary reasons for this growth in household income. The greatest e ect of the decline in rigid wages is on non-poor households, since they draw a larger proportion of their income from these sectors than do other household groups. The EV measures for these groups are 167.8, 224.8 and 250.0 for HR, HU and HN households respectively. Welfare increases under this simulation are similar to in the preceding one, though HU-s bene t more here than do HR-s.
7 Conclusions In this paper we have presented a CGEM with externalities a ecting factors of production which are generated by public expenditure on education and health care, and we have adapted our modelling of the labour market to re ect certain stylized facts of the situation in Benin. These externalities have formed the focus of study in several branches of economics, but have received little attention in the literature on computable general equilibrium models12 . Our results demonstrate that the impact of introducing some speci c modi cations to standard models yields qualitatively di erent results. The fourth simulation may be considered representative of a standard model. A decrease in tari rates generally increases households' welfare while adding to the government de cit, which 12
This holds for dynamic as well as for static models.
17
must be compensated by a decrease in government expenditure. However, in the presence of externalities created by some types of government expenditure these results may be inverted, even if the externalities are of relatively small magnitude. (Compare simulations two and three which generate externalities with simulation four which does not). Furthermore, massive layo s in the public sector exercise a downward pressure on the informal wage wif ; which has a negative e ect on all households (especially the poor) who receive a large share of their total income from wages paid in the informal market. These layo s also increase unemployment. Consequently, if we wish to minimize the negative impact of various economic policies proposed in the framework of the SAP on the welfare of poor households, we must analyse the e ects of these policies with models which capture the essential elements of the economies in question or signi cant biases will underestimate impact of policy simulations. Expenditure on education and primary health care are deemed high priorities in the reports of the IMF and the World Bank, but little seems to have been done to avert the decline in supply of these services. The results generated by our model reveal that it may be much more bene cial to reduce civil service salaries and to remove the constraints on wages in the modern sector in order to relieve the pressures on the government's budget. Admittedly our model does not incorporate all aspects of the role of health and education in the context of SAP-s and liberalization, however, it provides important information with respect to the limitation of standard models to analyse welfare impact of such policies. To improve the realism of this model, extentions such as endogenizing tax evasion, incorporating public good in the utility function, improving the production aspects of educational and public health services are avenues envisaged. Nevertheless, this model clearly shows the importance of adapting standard models to take into account key features of economies studied for economic reforms for developing countries.
18
Notes 1 The Z emidjans (motorcycle taxis) serve to illustrate this point. Before the implementation of the voluntary departures program in the civil service and the restructuring programs (liquidation and privatization of public corporations) there were about 7000 chau eurs earning approximately 4000 CFA Francs gross income daily. In 1994, due to the in ux of former civil servants and laid o workers, there were about 20,000 earning between 1500 and 2000 per day (PEESI, 1993). 2 The standard terminology di erentiates between skilled and unskilled labour, we refer to the modern and informal sectors to maintain compatibility with the usage in the national accounts of Benin. This assumption is only pertinent for branches of the economy which use both types of workers as an input, namely agriculture and shopkeeping. 3 The functional form we use to model this, and the following two, relationships is a single factor Cobb-Douglas. It is given in section 5.1. The index na represents the branches of production of non-administrative branches of the economy. 4 In this model we ignore private education because it is a relatively insigni cant factor in Benin and because we do not account for the choice between private and public schooling by household. If consumers had signi cant substitution possibilities between private and public education this externality would be decreased, becoming nil when the two are perfect substitutes. In any case, the stylized representation of the Benin economy presented in the previous section indicates that these substitution possibilities are very limited since there was no marked increase in enrollment in private schools subsequent to the reduction in the supply of public education. 5 It is important to note that externality variable are not choice variables for the producer and therefore this function does not exhibit increasing returns to scale. 6 The term \d e ate" is used in Benin to describe laid-o former bureaucrats and employees of public corporations. We shall not attempt to translate this term. 7 In this model we assume waiting unemployment. Other types are not explicitly modeled. Statistics from ELAM reveal that these latter are very low, at about 2%.
,
,
In equation 6 we should have wif =Pindex = w0if =Pindex ; but since the price index Pindex is exogenous in the model, we simplify the notation. 8
It is important to note that the mechanism we have used obtains if and only if wif < wmo : However, given the large gap between the wages in the informal and the modern sector, and given the large number of workers in the informal sector and of unemployed, this condition held for all the simulations we ran. 9
10 Other functional forms could have been used to exhibit a maximum level of the e ect, however, considering that government spending is exogenous and that the simulations are of moderate changes in expenditure (variations of less than 15% from the base year data) this formulation possesses the desired properties. For example, if government expenditures are considered endogenous, a functional form such as a function could solve for an in nite level of government spending. 11 Grossman and Levinsohn (1989) provide empirical evidence that supports the assumption that capital is not intersectorially mobile. 12 Recall that the ten percent tari reduction (Dti) and the constant government de cit still obtain. The results of this simulation are similar to those generated by standard models as the externalities do not enter into the picture. However, the speci cs of the labour market still play a role.
19
References [1] Armington, P.S. (1969), \The Geographic Pattern of Trade and the E ects of Prices Changes" IMF Sta Papers, Washington, XVI, 176-199. [2] Asselin, L.M., (1996), \Qualite de l'education publique et privee et developpement economique," Phd. thesis, Universite Laval. [3] Becker, G. (1964), \Human Capital: A Theoretical and Empirical Analysis, with Special Reference to Education". New York: Columbia University Press. [4] de Melo, J., D. Tarr, (1992), \A General Equilibrium Analysis of U.S. Foreign Trade Policy," MIT Press, Cambridge. [5] Deolalikar, A.B., (1988), \Nutrition, Labour Productivity in Agriculture: Estimates for Rural India," The Review of Economics and Statistics 70:3, 406-413. [6] Dumont, J.C., (1995), \La contribution des facteurs humains a la croissance: une revue de litterature des evidences empiriques," DIAL, No. P96011. [7] Dousso, A. (1992), Recensement des Activites economiques, Ville de PortoNovo, Analyse des resultats, PEESI, (BIT/UNDP/INSAE), Cotonou. [8] Friedlander, T. (1993), \E tat actuel des connaissances sur la pauvrete au Benin," Ministere du Plan et de la Restructuration E conomique, Cotonou. [9] Fortin, B., N. Marceau and L. Savard, (1996), \Taxation, Wage Control, and the Informal Sector" Forthcoming in Journal of Public Economics. [10] Grossman, G.M., and J.A. Levinsohn, (1989), \Import Competition and the Stock Market Return to Capital", American Economic Review 79, 10651087. [11] Grossman, M. (1972), \The Demand for Health: A Theoretical and Empirical Investigation," NBER Occ. Paper 119, Columbia University Press. [12] Hicks, N., (1979), \Growth vs. basic needs: Is there a trade o ?, World Development, 7 985-994. 20
[13] Lee, L.F., (1982), \Health and Wages: A Simultaneous Equation Model with Multiple Discrete Indicators," International Economic Review 23:1, 199-222. [14] Lucas, R. (1988), \On the Mechanics of Economic Development," Journal of Monetary Economics 22, 3-42. [15] Maldonado, C. (1994), \Analyse des resultats du recensement national des etablissements urbains du Benin," BIT/UNDP/INSAE, Cotonou. [16] Malenbaum, W., (1971), \Progress in Health: What Index of What Progress?" The Annals of the American Academy of Political and Social Science, 393 109-21. [17] Manning, R., and J. McMillan (1979) \Public Intermediate Goods, Production Possibilities, and International Trade." Canadian Journal of Economics, 12, pp. 87-98. [18] Decaluwe, B., M.C Martin, et M. Souissi, (1993), \Modele 3: E conomie ouverte avec gouvernement," E cole PARADI de Modelisation de politiques economiques de developpement, Vol. II, CRE FA, Universite Laval. [19] Pitt M. and M. Rosenzwieg, (1986) \Agricultural Prices, Food Consumption and the Health and Productivity of Indonesian Farmers," in Agricultural Household Models: Extensions, Applications and Policy, ed. I. Singh, L. Squire et J. Strauss, John Hopkins University Press, Baltimore. [20] Ram R. and T.W. Shultz, (1979) \Life Span, Health, Savings and Productivity," Economic Development and Cultural Changes 27, 399-423. [21] Razin, A., (1976), \Economic Growth and Education: New Evidence," Economic Development and Cultural Change, pp 317-324. [22] Romer, P., (1986) \Increasing Returns and Long-Run Growth," Journal of Political Economy , 94 1002-37. [23] Savard, L., E . Adjovi, P.C. E kue, C. Sinzogan, M. Soede, (1994), \Une Matrice de comptabilite sociale du Benin 1987: version Dimension sociale du developpement," INSAE, Cotonou.
21
[24] Subramanian, S., (1994), \Modelisation de la reforme de la politique agricole en Inde," in \La modelisation de la reforme des echanges," ed. Goldin, I., O. Knudson and A.S. Brand~ao, Centre de developpement, OCDE, Paris. [25] Welsh (1970), \Education in Production," Journal of Political Economy 78, 35-59. [26] Weisbrod, B., R.L. Andreano, R. Baldwin, E. Epstein and A.C. Kelley, (1973) Disease and Economic Development: The impact of Parasitic Diseases in St.Lucia, Madison: University of Wisconsin Press. [27] Willis, R.J., (1986), \Wage Determinants: A survey and reinterpratation of human capital earnings function," in Handbook of Labour economics, eds. O. Ashenfelter & R. Layard. Elsevier Sciences Publishers, Amsterdam. [28] Enqu^ete Budget Consommation. Resultats, Volume 6:Budget, Revenus et Depenses, MPRE/INSAE, Cotonou, Juillet 1992. [29] Observatoire de l'Emploi, Sources et donnees disponibles sur l'emploi, (1993) MTEAS/UNDP, Cotonou. [30] Caracteristiques et comportement des menages et des groupes vulnerables en situation de PAS. methodologie et resultats de l'E LAM realisee a Cotonou et a Parakou en 1990, (1991), INSAE/PNUD, Cotonou. [31] Country Pro le: Togo, Benin 1994-95, (1994), The Economist Intelligence Unit London. [32] World Development Report 1994: Infrastructure for development (WDR), (1994), World Bank, Washington. [33] World Development Report 1995: Le Monde du Travail dans une E conomie sans frontiere, (1995), World Bank, Washington.
22
A The Model's Equations A.1 Production Number Equation A.1.1 A.1.2 A.1.3 A.1.4 A.1.5 A.1.6 A.1.7 A.1.8 A.1.9 A.1.10 A.1.11 A.1.12 A.1.13 A.1.14
De nition
Xsna = min[V ana ; Cina ] Output of non-Admin. Branches Xsa = min[Ldf a ; Cia ] Output of Administrative Branches V ana = CES (LLdna ; Kna ; na ) Value Added LLdna = CES ? (V ana ; wwna ; rna ) Demand for Labour Composite if mo n n LLdna = CES (Ld na ; Ld na ; $ na ; na ) CES of dem. { Labour Compos. Ldctna = CES ? (wif ; wmo ; LLdna) Derived Demand for Labour P Ldfa = (Pa Xsa , j P c j Cijj;a )=wf Derived Demand for Labour n = n $na $na Education speci c Externality
n na = n na Health speci c Externality Xsed ) na na = ( Xso Neutral Education Externality ed Xsed )na $na = ( Xso Non-Neutral Education Externality ed Xssa )&na
na = ( Xso sa Cii = ioi Xsi Ciji;j = aiji;j Cij
Non-Neutral Health Externality Total Intermediate Cons. Total Intermediate Cons.
23
A.2 Demand
Number Equation A.2.1
A.2.2 A.2.3 A.2.4 A.2.5
De nition
P
i Ci = i Cmhi + Cg Hous.'s & Govt.'s Total Cons. by Good Pci P (Ctm , Pc minh ) Cmhi = minhi + i h Pcij j j Households' Total Consumption by Good Ctmh = Y dmh , Smh Households' Total Consumption iv i It Ivi = Pc Investment Demand by Good i P DIj = i Ciji;j Intermediate Demand by Good
24
A.3 Income
Number Equation A.3.1 A.3.2
A.3.3 A.3.4
A.3.5 A.3.6 A.3.7 A.3.8 A.3.9 A.3.10 A.3.11 A.3.12 A.3.13 A.3.14
De nition P
va V ana , ct Rkna = Pna Return to Capital ct wct Ld na P P Y mh = ct 'h;ct wct i Ldct i + P P na #na %h;na Rkna + Dih na (1 , #na )Rkna +eTrmh + Tgmh Household Income P P Y e = na (1 , #na )Rkna + Tge h Tmeh +Tee + eTre Firms' Revenue P P Y g = h TtmhY mh + Tk na (1 , #na )Rkna P P +Id + na Taxxna + na Taxmna P + na Taxena + eTrg Government Revenue Y dmh = Y mh (1 , Tyh , Ttmh , Trmh) ,Tmeh Household Disposable Income Smh = pmshY dmh Household Savings P P Sg = Y g , Tge , i Cgi , h Tgmh , Tgr Government Savings Se = Y e , Ter , Tye , Tee ,(1 , Tk , Ph Dih ) Pna (1 , #na )Rkna Firms' Savings P Id = h Tyh + Tye Direct Income Taxes Tye = TeY e Corporate Taxes Taxxna = Txna Pna Xsna Revenue from Taxes on Prod. Taxmna = Dtina Pwmna eMna Revenue from Dti Taxena = na Pena Exna Revenue from Taxes on Exports V Eh = E [P o ; U (P 0 ; Ctm0h )] ,E [P o; U (P o ; Ctmh o )] Equivalent Variation
25
A.4 The Labour Market Number Equation A.4.1 A.4.2 A.4.3 A.4.4 A.4.5 A.4.6
P
De nition
P
Ldf = ( Ldomo na , Ldmo na ) P P +( Ldof a , Ldf a ) \De ates" Lsd = Ldf \De ates" in the Informal Market Udf = (1 , )Ldf Unemployed \De ates" = o (wif =wif o ) Proport. of \De ates" in the Informal Market U = Uo + Udf Number of Unemployed U Unemployment Rate u = P P Ldocti i
ct
A.5 Prices
Number Equation A.5.1 A.5.2 A.5.3 A.5.4 A.5.5 A.5.6 A.5.7 A.5.8
De nition P
PINDEX = i pwtsi P c i Consumer Price Index P va na = (Pn aXsna , Pic cij(i;j) )=V ana Value Added P mna = P wm na (1 + Dtina )e Domestique Price of Imports we P exna e P ex na = (1+ Domestique Price Exports na ) Pna = (P d na Dna + P ex na Exna )=Xsna Producer Prices P cna = (P d na Dna + P mna Imna )=Qna Price of the Composite Good P ca = Pa Price of the Composite Good wwna = (wif Ldif na + wmo Ldmona )=LLdi Composite Wage
26
A.6 Foreign Trade Number Equation
De nition
A.6.1 A.6.2
Xsna = Bxna ( na Exna na + (1 , na )Dna na )1=na , Qna = Bmna na Imna ,na + (1 , na )Dna ,na ,1=na
A.6.3
na
A.6.4 A.6.5
! Exna = PPexd nana
ex na
ex (1, na ) ! na D
!im na
!im na
Output CET CES of Composite Good Export Supply
na
na Imna = PPmd nana Dna (1,na ) P P Bc = na Imna P wm na + 1e (Ter + Tgr + h Tmrh) , Pna Exna P we na , Tre , Trg
Import Demand Current Account Balance
A.7 Equilibria Number Equation A.6.6 A.6.7 A.6.8
De nition
Qi = CI + Ivi +PDIi It = Sg + Se + h Smh Ls = Ls o + Lsd
Equilibrium on the Goods Market Savings / Investment Equilibrium Informal Labour Market Equilibrium
27
A.8 Variables and Parameters Variable
Xsi V ai LLdi Ki i
n i
i
$n i $i Ldcti Cii Ciji;j Ci Cmh na Cgi Ctmh Ivi DIi Rkna Rna wct Y dmh Y mh Ye Yg Smh Sg Se Trmh Tgmh Tge
De nition
Sectorial Production Sectorial Value Added Demand for the Labour Composite Sectorial Capital Neutral Education Externality Non-Neutral Education Externality Non-Neutral Education Externality Non-Neutral Health Externality Non-Neutral Health Externality Labour Demand by Category Total Intermediate Sectorial Consumption Intermediate Consumption Total Consumption by Good Consumption by Good by Household Group Consumption by Good by Government Total Consumption by Household Group Investment Demand by Good Intermediate Demand by Good Return to Capital by Branch Rate of Return to Capital by Branch Wage by category of Labour Disposable Income of Households Household Income Firms' Revenue Government Revenue Household Savings by Group Savings by Government Savings by Firms Transfers from Rest of World to Households Transfers from Government to Households Transfers from Government to Firms 28
Variable
Tmeh Tee Tre Trg Trmh Tgr Tye Id Taxxna Taxmna Taxena V Eh E Ldf Lsd Udf U u PINDEX P va na P ci Pi P m na P wmna P ex na P we na e P dna Dna Imna Exna
De nition Transfers from Households to Firms Transfers from Firms to Firms Transfers from Rest of World to Firms Transfers from Rest of World to Government Transfers from Rest of World by Household Group Transfers from Government to Rest of World Revenue from Corporate Income Taxes Direct Income Taxes Revenue from taxes on Production Revenue from Import Tari s Revenue from Export Tari s Equivalent Variation by Households Group Expenditure Function \De ate" \De ate" working in Informal Market Unemployed \De ate" Rate of Absorption of Informal Labour Market Unemployed Unemployment Rate Price Index Valeur Added Price of Consumer Goods Price of Producer Goods Domestic Prices of Imports International Prices of Imports Domestic Prices of Exports Export Prices of Imports Exchange Rate Prices of Domestic Goods Domestic Goods Import Goods Export Goods 29
Variable
Qna Ls !im na !ex na na na Bmna na na Bxna na Dtina pwtsi Txna Te #na Dih pmsh Ttmh Tyh Tk 'h;ct iiv i mini aiji;j ioi n n na na &i
De nition Composite Goods Supply of Informal Labour Elasticity of Substitution of CES Elasticity of Substitution of CET Substitution Parameter { CES Distribution Parameter { CES Scale Coecients { CES Substitution Parameter { CET Distribution Parameter { CET Scale Coecients { CET Tax Rate on Exports Tari s on Imports Weight of Good i in Households' Consumption Rate of Taxation on Production Rate of Taxation on Exports Proport. of Return to Capital going to Households Proport. of Dividends going to Households Marginal Propensity to Save Rate { Direct taxes by Household Group Rate of Direct Taxation Taxes on Return to Capital Allocation by Households of Payments Informal Labour Share of Good i in Investment Share of Good i in Household Consumption Minimum quantity of good i needed by Household h Input-Output Coecients Leontief Technical Coecients Elasticity of the labour supply Allocation of (Health) Externality Parameter Allocation of (Education) Externality Parameter Neutral Education Externality Elasticity Non-Neutral Education Externality Elasticity Non-Neutral Health Externality Elasticity 30
A.9 The Branches
i = I f1; 2; 3; 4; 5; 6; 7; ed; sa; 10g na I f1; 2; 3; 4; 5; 6; 7g a I fed; sa; 10g ct = ct fif; mo; f g v ctfif; mog h = h fr; u; ng Symbol 1 2 3 4 5 6 7
ed sa
10
if mo f r u n
De nition Subsistence Agriculture Industrial Agriculture Agro-industry Agricultural Cottage Industries Other Modern Industries Other Crafts Shopkeeping Education Services Health Services Other Administrative Services Informal Labour Modern Labour Civil Service Labour Rural Poor Urban Poor Non-Poor
31
A.10 Externalities Parameters Parameter
Branches
1
$
2
3
4
0.02 0.04 0.06 0.05 0.01 0.012 0.005 0.01 0.03 0.018 0.005 0.025
32
1 5
6
7
0.03 0.035 0.055 0.008 0.009 0.012 0.003 0.005 0.004
