InternalDiscussionPaper EUROPE, MIDDLE EAST AND NORTH AFRICA REGION Report No. IDP26 TheAdjustmentof a Dependent, Countryto a Oil Exporting Fallin WorldOil Prices WafikGrais and JamesParks 1988 December Office of the Vice President Europe,Middle East and North Africa Region DiscussionPapers are not formal publicationsof the World Bank They present preliminaryand unpolished results of country analysis or researchthat is circulatedto encouragediscussion and comment; citationand the use of sucha paper shouldtake accountof its provisional Thefindings, character. and interpretations, conclusions expressed and should in thispaperare entirelythoseof the author(s) not be attributedin any mannerto the WorldBank, organizations, to its affiliated or to members of its Boardof ExecutiveDirectorsor the countries they represert. THE ADJUSTMEN OF A DEPENDENT, OIL EXPORTINGCOUNTRYTO A FALL N WORLDOIL PRICES BY WafikGrais -d James Park December 1988 Theauthos are Divison Che and Eeonost in Europe,MiddleEast and North Africa Region(EMENA), of the Wod Bank. The paperwas origially presentedat the 25th h dI Conference Applied Enonetri AMPlnto n World Bank, Washington, D.C., Oetober 24-26, 1988. Abstract by a small, In this paper we analyzethe welfarelmpactof an adjustment oil exporting dependent, economy,facingforeign constraints, borrowing to a 30X regimesare compared: drop in the world oil price. Two adjustment devaluation and importrationing. Scenarios these two regimesare examined incorporating in the non- under fixedfactorprice closureand fixedfactorquantityclosure. oil sector. A numericalcomparison is made possibleby the use of a simple, two sector, encompassing CGE framework rent-seeking. to The CGE is calibrated 1979 Egyptiandata. The resultsindicate in response that,whilea devaluation oil price fall would have had a smallernegative impacton to a theoretical economic Egyptian welfarein 1979 thanimportrationing under eitheradjustment regime,the degreeof factorpriceflexibility wouldhave been a more important determinantof the adjustment's welfare impact. This result is arrived at not just the standard despitethe fact thatwe includein the cost of rationing loss,but also the entirerent generated. deadweight Slnce1973,world oil priceshave exhibited extremevolatility.As graph #1 shows,' the priceof a barrelof oil in 1985dollars, whichhad remained under $5 until 1973, then nearlyquadrupled in a singleyear. By 1978 the price had droppedfrom its 1974 high of almost $19 to about $15. Over the next decade, however,oil prices again skyrocketed; reachingover $32 per barrel by 1981 before plummetingto almost $11 in 1986, followedonce more by significant increases in 1987. Adjusting to theseoil shockshas proveddifficultfor many countries, especially those LDCs with small, dependenteconomies. While the direction of an oil price drop on any particular country's economywill depend mainlyon whetherit is a net exporteror importer of oil, the magnitude of the shockwill clearlydependon the methodof adjustment chosenand the degree of flexibility in the economy. In thispaper we model the adjustment of a small,dependentoil exporter to a 30% drop in the world oil price. Using comparativestaticswithin a computablegeneral equilibrium(CGE) framework,we compare the effects of adjustment throughreal devaluation vs. importrationing with rent-seeking on GDP and consumerwelfare. We also comparetbo effectsof fixed vs. flexible factor prices in the non-oil sector under both adjustmentregimes. In all comparisons we assume that the country faces a foreign borrowing constraint fixed in foreign currency and that domestic investment along with goternment consumption remainconstantin quantity. The model is based on a 1979 social accounting matrix (SAM) for Egypt. The model's basic structure draws upon numero-As CGE models previouslv developed at the World Bank to analyze the impactof trade distortions on the domestic 'Price data are from R. Duncan,"PrimaryCommodity PriceForecasts", p. 2. Data between1970 and 1980 are from the World Bank's IECCM office. GRAPH1 WORLD OIL PRICES $ pM 41 35- 364 .~~~~~~~~ I ~~~~~~~ ~ .a l.0 0 /~~~~~~~~~~~~~~~~~~~~ -oil ,.ice in current iollm I's o vap 29j. . .. . .. . 70 71 73 27 75 7 77 7879 80 1 82 3 94 8 86 8 * %~e*'% 1, -ol rcei ctstdolrs*@ol rcein185dll* -3- econamy(e.g.Amranandand Grais, 1984;Michel and Noel, 1984). Our methodof rent-seeking imbedding withina standard closelyfollowsthatused CGE framework by Grais at. the impactof rent-seeking al. in incorporating in analyzingthe of tradedistortions telaxation in Turkey (Grais,de Melo and Urata, 1984). Oi rent-seeking The importance activityto the socialcost of a quotawas to analyzedfirst by Krueger (1974). Her work was extendedand generalized distortions economic besidesquotasby Bhagwati (1980)and later and Srinivasan by Bhagvati amongothers. Amongthe most Interesting (1982), resultsof Bhagwati is that the socialimpactof rent (or revenue)seekingdepends and Srinivasan conditions on the p&rticular underwhich the rentsare sought. For example,the on socialwelfaredependson whether all the rents are effect of rent-seeking sought, in which the rents are sought,and on the on the economicenvironment with which the rentsare sought. Indeed,using a simple, degreeof competition generalequilibrium two good,two economy, Bhagwati analysis, show and Srinivasan that- givenincomplete specialization and initial - incomplete tradedistortions rent-seeking but competitive can actuallybe welfare-improving. therefore, It is important, to clarify rent-seeking the methodof modelling as fully competitive appliedhere. We model rent-seeking and complete. This is a typical empirical procedure which simplifies the measurement problem (Tollison 1985). Fully competitive and complete rent-seekinggenerally characterizes the long-run equilibrium under conditions of stablerentsand free 1984). entry (Corcoran of thispaper is organized The remainder as follows. Part II presentsan overviewof the model, discussing the centralequationsand the model's core brieflythe theoretical structure.Part III discusses of the rent- underpinnings used here. Part IV outlinesthe calibration seekingmodellingtechnique and solution for the model. The resultsof the base year calibration procedure and -4 K the four scenarios above are presented described in detail in PartV. Part VI the paper. concludes NodelMOR Part II: The GeneralRgullibrium The MQR (Misr Quantity Rationing)model has two productionsectors, and the rest of the economy. Each of these sectors supplies hydrocarbons markets. domestic and foreil,s sector also produces The non-hydrocarbon rent-seeking produced services.The domestically goods,otherthanrent-seeking into and non-hydrocarbons services,are combinedwith importedhydrocarbons composite goods. Domestic agents, households,government,investors and producers purchase the composite goods. Rent seekers/importers purchase the servicesup to the value rent-seeking of the rent the import rationing may generategiven the reaource and the technology the preferences endowments, in activities, the economy.The production rentseeking, including a value generate to households ad,edthat is distributed and government. The latter in addition due to the receives tax revenuesand a premium on exports of hydrocarbons betweentheirdomestic difference world prices. A given amountof foreign atnd jointly savingsis allowedto flow into the economyand to financeinvestments by the domestic with the savingsgenerated agents. The resourceflowscaptured in table2 whichprovides by the modelare fullydescribed the SocialAccounting the model. Matrixunderlying The complete set of equationsof the MQR model is contained in the appendix. It followsthe tradition models as of appliedgeneralequilibrium by Dervis,de countries by Johansen(1960)and appliedto developing developed Melo and Robinson(1982). It is most closelyrelatedto the models developed et al. (1985)for Egyptand Grais,de Melo and Urata (1984)for by Bhattacharya Turkey. Production with a CES function is modelled of non-hydrocarbons covering - 5 - intermediate inputsand value-added.Production takesplaceat the intersection of the marginalcost and marginalrevenueschedules where the marginalrevenue scheduleis the dual of a constantaiasticityof transformation, CET (Powell and Gruen (1967)), aggregation function. In a secondstep,producersallocate theirsalesso as to equatethe marginalrate of transformation betweenexports, domesticsuppliesof goods,and suppliesof rent seekingservices. The output of hydrocarbons is assumedexogenouswith Leontiefcost shares. Suppliesof hydrocarbons to the domestic and world markets are assumed perfectly substitutable.The price of domestically producedhydrocarbonsis a policy parameter. Both productionactivitiesface perfectlyelastic export demand functions. Householdconsumptionis allocatedover hydrocarbonsand other goods accordingto a linear expenditure system. Gcvernmentconsumption and total investment demand are fixed in quantityterms and allocatedbetweeu the two goods with fixed proportions. Tha exogeneityof governmentconsumptionand investment demandis in linewith the basic purposeof the analysiswhich aims at assessingthe impact of a decline in the world price of oil under the assumption that the authorities do not adjustdownwards their shareof domestic absorption. Foreignsavingsin foreigncurrency are determined exogenously in linewith the assumptionthat the economy does not adjust through foreign borrowing. Jointly with export earnings,foreignsavingsdeterminethe foreignexchange availableto the economy. This is first used for requiredtransfersabroad (e.g.interestpayments) and for importsof hydrocarbons.The foreignexchange left determinesthen, togetherwith world prices, the amount of importsof non-hydrocarbons the economycan afford. Thus,on the domesticmarketsupplies of hydrocarbon importsare perfectly elasticat the goingworldpricein domestic -6- currency whereasthoseof non-hydrocarbons are perfectlyinelastic. The Armington 2 is used to derivethe notional assumption demandsof imports and domestically producedgoods. Total domesticabsorption of each good is a CES &&,regation of importsand domestic goods. Importand domesticgoodsdemands are derived by minimizingthe cost of obtainingthe compositesof domestic absorption.For hydrocarbons the notionaland effective demandscoincide. For non-hydrocarbons, importers who obtaineda licenseto importwill supplya fixed quantityof imports. The price of the importson the domesticmarketwill rise above the landedprice until it clears the market. For a completedescription of the MQR model, two other features,the inwestment-savings balanceand the closureof factormarkets,deserveattention. Given that the economy maintains its level of government consumption, d vestments and foreign borrowing in the face of a deterioration in the terms of trade, the investment-savings balance is obtained through adjustment in the consumption of households. The latter are required to generate the savings to accommodate the investment objective. Two versions of the MQR model are envisaged regarding the closureof factormarkets. In one case,relative factorpricesare keptconstant and employment adjusts. In the second, factorprices are allowed to vary to maintain the levelof factoremployment. As the resultsbelow illustrate, factor priceflexibility is criticalin the adjustment of the economyto a deterioration in the terms of trade and may even compensatethe loss of efficiencydue to rationingand rent seeking. Finally,the MQR model is a real sector general equilibrium model where the numeraire is chosen to be the basket of goods consumed by households. 2 K. Dervis, J. de Melo and S. Robinson, General EquiLibrium Models for DevelouMent Polly, pp. 221-227. -7- Part III, t421lling Nonl-Hydrocarbon ImportRionitg in figure1. is illustrated of importsof non-hydrocarbons The rationing priceof importsby Pv, theirdomestic Denotethe marketclearing currencyprice by Pm, the notionaldemandcurve by Md and the level of rationingby So. If import licenses were free, importers could cash in a rent in the amount (Pv-Pm)*So. In order to obtain licenses, then, would be willingto importers services.Let for rent-seeking exactly(Pv-Pm)*So pay underperfectcompetition Pr be the priceand Qr the quantity services, of rent-seeking respectively.The level of activityof rent seekingserviceswill be determinedin the model by condition: the equilibrium (Pv-Pm)*So- Pr*Qr (1) assumesthat - while the of rent-seeking In essence,this specification officialprice of importsis Pm - consumers are actually paying the notional who then spend PN-Pm, is a rent going to importers price Pv. The difference, non-hydrocarbon services.Sinceour aggregate thisexa4tamounton rent-seeking production exhibits function constantreturnsto scale,the entirevalueof rent- seekingservicesis exhausted in payments and factors goodes for the intermediate whichgo intoproducing however, services, them. Rent-seeking differfromother productsin that they do not appear as an element of final non-hydrocarbon who consumethem are no betteroff than they would have demand. The importers to seek in the first no licenses) been had therebeen no rents (or equivalently place. and one can breakdown the lossto the economyfrom rationing Conceptually subsequent parts. Consider intoseparate rent-seeking figure2 wherothe economy raisesthe market-clearing intoa singlesector. Importrationing is aggregated or notional price inputs therebyraisingproduction of importedintermediate costs an inward and inducing supplycurve. In figure2 shift in the aggregate Pigur1 ImpQon H-OUsehldi Oemond Impont Under Rfotongn Ij 1S * S, 1 \1 1'~~~~~~~~~~~~~~~~ \l ''~~~~~~~~~~~~~~~~~ 0~ ~~d hr -9- 2 Figure Cost of Potioning ond Rent-Seeking WqlC3re PO a P0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ XD' P02~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ a~~~~~~ ___---I~~a I/ / Xx: I I t ~~~~~~~Qonm w - 10 - this is shownby the shift fromXXabto XX?SbeyondX%, the pointwhere rationing becomeseffective. Therefore, rationing, withoutany rent-seeking, resultsin a deadweight loss in the domesticgoodsmarketgiven by ADE. Rationing, however,createsrentswhich inducerent-seeking in accordance with equation 1. The diversion of resources away fromproductive outputtowards rent-seeking to xV. The resultis a shiftsthe supplycurve furtherleftwards price increase (in terms of the numeraire)to PD 2. ABD is the additional deadweight loss from increased production of rent seekingservices.At the rew equilibrium, FG and BF are the added costs per unit of domesticgoods output due to rationing and increased rent-seeking, respectively. Similarly, BC is the amount of output that is foregonein orderto meetthe increased demandfor rent. seeking services. FLnally,the area HCBI is equal to the value of the rents. Now considerthe comparative staticsof a tightening of the importquota. Any tightening of the quota will directlyshift the aggregatesupply curve furtherto the left as before. This will be accompanied by an inducedshift through increasedproductionof rent-seeking servicesonly if the decreased ration (i.e. lower So) leads to higher rents, i.e., to an increase in the lefthand side of equation1. One shouldnote severalcharacteristics of modellingrent-seeking in this way. The firstquestionis exactlywhat formis appropriate for the production function underlying rent-seeking.Lackingany detaileddata for estimation, we assumethat the production of rent-seeking utilizesthe same technology as the production of non-hydrocarbons, or put differently, at equilibrium the production of rent-seeking utilizesthe same ratio of value added to intermediate inputs 3 See:W. Grais,J. de Nelo and S. Urata, "A GeneralEquilibrium Estimation of the Effectsof Reductions in Tariffsand QuantitativeRestrictionsin Turkey in 1978",pp. 9-14, for a relateddiscussion on modellingrent- seeking. - 11 - of non-hydrocarbons. as the production This result,which followsdirectlyfrom the CES/CETproduction described specification restrictive. above,would seerm Bhagwati and Srinivasan show,however, is complete that as long as rent-seeking as assumed and fullycompetitive, here, the economic does cost of rent-seeking used to produce it." Therefore, not dependon the technology our assumptlon seemsjustified. technology about rent-seeking is totally we assumethat rent-seeking Secondly, i.e.,its unproductive, outputdoes not appearas a good in any agent'sutilityfunction. Clearlythis although assumption, in the literature, standard affects of rent- the measurement seeking ls fully competitlve.It is costs. We also assumethat rent-seeking whether traderswould be ready to spend the total of the rent they uncertain licenses.The equilibrium may earn on purchasing identifled conditlon abovemay not fullyreflectactualbehaviorto the extentthat traderswould seek to fully may be incomplete, cash at least a part of the rent. Finally,rent-seeking i.e.,it is posslblethatnot all rentswillbe sought. As notedabove,hovever, fully competitiverent-seekingof all available rents can at least be the resultsto as a stable,long run equilibrium.In interpreting rationalized follow,one must keep in mind thatthe approach rent-seeking to modelling chosen assumptions eachof which involves here is only one of a numberof alternatives, affectthe results. which couldpotentially 4J.Bhagwati "Revenue and T. N. Srinivasan, A Generalization Seeking: of the Theoryof Tariffs", p. 1075. - 12 - and Solution part LV, Calibration Procedure on the 1979 data for Egypt shown in The model1sbase year is calibrated scenariosare run on the and subsequent table 2.5 The base year calibration Hercules modelling algebraic system. Herculesoperatesby combiningthe SAH's between the describingthe interaction data with functionalspecifications and agentswhich make up the rows or columnsof the SAM. variousinstitutions In Hercules,these functional are detailed specifications by creatinga second with acronyms the data entries SAN and replacing forms the functional indicating desired. Table1 contains chosenfor the NQR model. The functional the acronyms SAN (table1), together specification with a list of closures(listedat the bottom of table 1 for the MQR model) are formallyequivalentto the set of equations contained about the Hercules in the appendix. For more information system, includingthe set of functional available,the rules specifications algoithm used,see Drud of the numerical theiruse, and a description governing and Kendrick(1986). Results Part V: Macroeconomic Given our methodof modelling resultsof and the theoretical rent-seeking the to report that--under it is not too surprising Bhagwatiand Srinivasan, of our model- conditions -Egypt,if facedwitha drop in oil pricesin 1979,would have beenbetteroff devaluing its currency imports ratherthanrationing through however,is the result of the model that quotas. Somewhatmore interesting, import rationingcombinedwith a moderateamountof factorprice flexibility e. one whichwouldmeet the (i. devaluation an equivalent wouldhave outperformed 5 rhe M. Khorsid, data in table2 are from,A. Hallouda, and H. Kheir-El-Din, M. Abdel-Fadil, SocialAccounting Matricesand EconomicModellingfor Egypt",p. 118. sI 133Utlium A 113115533 ti ro1 . llus lms30 aoum2ln3 3 3 3 3 3 3 3 3 3 3 3 3 3' 3 3 3 3 3 3 3 3 3 3 3 3 1 S '33W383 3 3 n 3 3 3 3 3 3 3 3 3 3 1 3 1 n 3 3 o A 3 A 3 3 0 3 * "3£mJ io 1wA I t n 3 3 3 3 3 3 3 3 3 3 i 3 3 i a 3 A A 3 a I I I * d311 3U13MN MN M1113 13t 331313 X 31 X X X 1 31V 5X UI1S31911 11 311E1 11 01 131M M MU a a 31131:W 1 , ~ ~~~-- duwp iw.g owuA j 3uw .. lila.-... . __ _ . ,0lltM SS101 Islal 151113S PIJII q1 Ia ep! 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IS S41- ___ - £ I - ___ 5679 174 1r It f rmat. 6Ad" Iwsg 254 n 61 m 3 n If1cbmui1iksiss Vu-Iswo 196 n 11466 4169013234 to bao-tradesod ub ba-fiw 56*155 N1fthTrafstSwiss lumpwq low51 23 IqeW busu bamtug - a 539 III" 22 wpntdnS wissbauip - s n 23 lsw SO"" Imp 2010 2601 24l igate du smb-Iaw__ 3154 25laiseecl ame 23 III 20 151 29 al 26bslmEIwld -W69 202 55 46 5318 6665 Source: Ballouda, Khorsid, Kheir-El-Ditt and Abdel-Fadil, #Social Acecounting Matrices and Economic -tModelling for EgyptS CAPKAS, 1984, p. 118. - 15 - under conditions same fo-eignborrowingconstraint) of completefactor price rigidity. In other words, simulationresults indicate that factor price wouldhave been a more important flexibility of the welfareimpact determinant on Egyptof a fall in world oil pricesthan the choicebetweenimportrationing or devaluation.0 in Egyptwas negligible For the baseyear 1979we assumethatrent-seeking data). The currentaccount (seetable2 for a matrixof the model'scalibration deficit is held constant in foreign currency in all cases. Additionally, consumption government are held constant and totalinvestment in quantityterms. exceptfor valuation Consequently, pricemovements, effectsdue to relative the entiredomesticimpactof the terms of tradedeterioration falls on household and rent-seeking. consumption services As rent-seeking are assumedto be totally we use the index of real household unproductive, as a short-term consumption incomeand realGDP serveas somewhat welfareindicator.Real household longer- run indicators. The accountingidentityin equation2 can help clarifyour assumptions. In equation2; Y, C, I, G, X, and M all have their standard interpretations services: while RS standsfor rent-seeking Y C + I G + X - M + RS + (2) world oil priceleadsto a drop in X. Givena fixedtrade A fallin the relative deficit M must dropto compensate.If, however, target, as in our modeldomestic M cannotfallwithouta reduction goodsand importsare not perfectsubstitutes, (C + I + G + RS). If absorption in absorption falls,then GDP will fall. Under therefore, our assumptions, causes GDP to fall. a termsof tradedeterioration Since we hold I and G constant in quantityterms, exceptingrelativeprice 6 Notethatin this model in each sectorall factorsare aggregated into a singlevalue-added quantity. - 16 - effects only the householdconsumption(C) and rent-seekingservices (RS) of absorption components are affectedin real termsby the oil price fall. (column Table 3 presentsselectedresultsfor the base year calibration 1) and four simulated scenarios adjustment followinga 30% drop in world oil prices. Column 2 presentsresultsfor adjustmentthroughdevaluation with a relative constant factorprice in the non-oilsector. Column3 presentsreults throughimportrationing--also for adjustment with full relativefactorprice rig4dity in the non-oilsector. Columns4 and 5 in table 3 presentcomparable with full factoremployment resultsfor devaluation with and importrationing respectively. full factoremployment, real GDP at factorcost,it is clearthata fall in oil prices Considering has a negativeimpactin all scenarios relative by a to the base year--falling minimumof 51 under conditions and fixed factor quantities of devaluation in and of importrationing the non-oilsectorto a maximumof 10% under conditions fixed relative outperforms factorprices. Devaluation under. import rationing either factor market closure.e.g. under fixed factor prices GDP following devaluationis 10,953 million Egyptian pounds vs. 10,914 followingimport and underfixedfactorquantities rationing numbersare 11,475vs. the analogous disposable hold for household 11,425. Similarcomparisons income. diverts Devaluation to exports resources services. ratherthanrent-seeking Followinga drop in the terms of trade under either factor market closure, devaluation therefore, requires of fewerresources the diversion to restorenet exports exchange.Furthermore, to theirtargetvaluein foriegn does devaluation deadweight not generate adjustment losses. Consequently, comes underdevaluation under importrationing. at a lowercost to GDP than adjustment realhousehold In comparing the difference consumption, betweendevaluation and rationingbecomes greater, e.g., given fixed factor prices household - 17 - Tble 3.i Efflects of a 30 DX_ -inthe Price of Oil / 1 2 3 4 5 ................................... .............................. . ........... GDP Sumam Oil Value-addede 300 311 312 311 312 Oil Rents 1608 1098 1083 1065 1026 Non-oilValued-added 10161 9544 9519 10100 10087 GDP at FactorCost 12069 10953 10914 11475 11425 Net IndirectTaxes 602 564 561 591 588 GDP at Market Prices 12671 11517 11475 12066 12013 ouMsehold * Consumption 8222 7147 7068 7707 7560 Savings œ 1033 1696 1735 1557 1643 * Disposable Income 9255 8843 8803 9264 9203 electedGDP Ratios DomesticSavings 24.3 26.8 26.9 25.3 25.8 , Investment 32.8 36.1 36.2 34.4 34.6 *Current AccountDeficit 8.4 9.3 9.3 9.1 8.8 , Non-oilExports 13.7 14.6 14.2 15.1 14.5 , Oil Rents 12.7 9.5 9.4 8.8 8.5 , ImDort Quota Rents ---- ---. 0.7 *-- 1.6 RelativePxices ExchangeRate 1.000 1.013 1.000 1.031 1.000 Non-oilSector Value-added 1.000 1.000 1.000 0.994 0.993 Non-oilIntermediates 1.000 1.002 1.002 1.002 1.002 Oil Intermediates 1.000 0.945 0.943 0.948 0.943 Gross Output 1.000 0.999 0.999 0.997 0.996 ….......... .......................... … 1. Initial State of the Economyin 1979. 2. Drop in the oil price; fixed quantity of real imestment and of government expenditure; no increase in foreign borrowlng; floating exchange rate; and fixed value added price. 3. Same as 2, except: i) fixed exchange rate ii) import rationing and rent seeking. 4. Same as 2, except fixed quantLty of value added instead of fixed price. 5. Same as 3, except fixed quantity of value addsd instead of fixed price. ^Flrst nine rows are ln millions of 1979 Egyptian pounds. - 18 - income fallsby 0.5% in moving from devaluation disposable to rationing while falls by 1.1. consumption Devaluation allows the currentaccount deficit-- fixed in foreign currency--tofill a larger share of the fixed quantity investment demand. Devaluation alsodoesnot divertresources intorent-seeking. together Theseeffects, with the smallerinvestment/GDP ratiounderdevaluation, takesomeof the pressure off household savings.Therefore, underthe conditions of the model, the short-rundifferentialimpact of devaluationvs. import rationing on householdconsumption is greaterthan the longerrun differential impacton householdincome. Clearly,the larger the devaluation, the greater the gap in differential impactsbecomes. This effectis evidentin the Domestic Savings/GDPratios in table 3. The differencein savings rates between devaluationand import rationingis five times greater under fixed factor quantityclosurethan under fixedfactorprice closure. Whileit is truethatdevaluation outperforms importrationing undereither factormarketclosure,a comparison of columns2 and 5 in table3 showsclearly that import rationingunder a fixed factor quantityclosureproduceshigher welfare levels than a devaluation under a fixed factor price closure. This result,which holds for all threeof our selectedwelfareindicators, provides for the assertion the evidence thatfactorpriceflexibility wouldhavebeenmore important than the choicebetweenimportrationing for an Egypt or devaluation faced with a 301 drop in world oil prices in 1979. Note that the degree of factorpriceflexibility involved is verymodest. As table3 shows,the relative factorprice drop in movingfrom scenario2 to scenario5 is only 0.71. How can we analyzethis result? In our model,GDP at factorcost consists of threecomponents: oil sectorvalue-added, oil sectorrents,and non-oilsector valued-added. A comparison of thesecomponents for the two scenarios in question (table3, rows 1-3, columns/scenarios 2 and 5) indicates that the increasein - 19 - under importrationing non-oilsectorvalue-added with fixed factorquantities is not nearlyoffsetby slightly with fixed greateroil rentsunder devaluation factorprices. in non-oil What causesthe difference As noted,the oil price value-added? fall impacts upon Egyptianabsorption negatively causinga drop in GDP. Part of this incomeeffectfallson the demandfor domesticnon-oiloutput. In the of non-oilvalued- modelgrossoutputin the non-oilsectoris a CES-aggregation goods, and oil intermediate added, non-oil intermediate goods. The negative is reflected income effecton demandfor non-oilgross outputconsequently in a fall in demand by non-oil producers for non-oil value-added,non-oil and oil intermediates. intermediates, price of any one of these If the relative componentsrises with respect to the relativegross output price, then the negative income effect on demand for that componentis exacerbatedby an negative accompanying, effect. This is precisely substitution what happensfor non-oil in scenarios value-added 2 and 3. In scenarios4 and 5, a relativeprice-induced, positive substitution effectexactlyoffsetsthe negativeincomeeffecton demand for non-oilvalue- added in order to keep the quantitydemanded constant. of non-oilvalue-added of the model, the requireddrop in the relativeprice of Under the conditions non-oil is small. The result,therefore, value-added is an increasein realnon- levelsin scenarios oil value-added 4 and 5 relative 2 and 3.7 to scenarios of our model the positivesubstitution Under the assumptions effect of non-oilfactor flexible the deadweight pricesoutweighs lossof importrationing ?In terms of equation2, flexiblefactorprices allow substitution away from intermediateswith theirhigh importcontent;therebycushioning the negative impact of a drop in imports on absorptionand allowing the requiredtradetargetto be reachedat a lowercost to GDP and consumption. - 20 - effect of by more than enough to offset the sum of the negativesubstitution fixed non-oil factor prices and the slightly positive income effect of is largeenoughto overwhelm the difference on oil GDP. Furthermore, devaluation due to increased negativeimpacton consumption additional importrationing's rent-seeking. For these reasons adjustmentthrough import rationingwith with fixed devaluation tnirough adjustment flexiblefactorprices outperforms welfare is measured in terms of GDP or household factor prices--whether consumption. Now, considerthe stateof the externalsectorin the four scenarios.The current accountdeficit,fixed in foreigncurrency,rises as a share of GDP thoughby equalor greateramounts underall four scenarios, under devaluation, as the addedstimulus relative of a devaluation production to domestic to import rationingis not enough in percentageterms to keep up with its revaluation effecton the deficit. Son-oilexportsriseas a shareof GDP in all scenarios with a fixed currentaccount in reactionto the terms of trade deterioration greaterunder a devaluation.This deficit. However,the rise is consistently resultreflectsthe added stimulusof an increasein the relativeprice of non- the exportbias of a quota. oil exportsor, conversely, Finally,considerrents in the economy. Given a fixed levelof domestic oil output,oil rents fall as the drop in world pricesnarrowsthe gap between the worldpriceand the fixed,lowerdomestic however, price. Devaluation, works in the opposite widening direction, the gap betweenthe domesticprice and the of the world price in domestic equivalent oil rents are currency. Therefore, higher in real and percentage consistently than under termsunder devaluation importrationing.Relative actually importration,devaluation to an equivalent increasesthis distortionlAs for importrents,they are higher in percentage than under fixed factorprices. Clearly, terms under fixed factorquantities - 21 - the higherGDP under the formerclosureresultsin a greaterdemandfor imports at the officialprice, which - with the fixed real exchangerate - cannotbe exports. The result is higher notionalprices and fully offsetby inn.reased Preater rents. Therefore,a higher degree of rent-seekingcan be fully with a higherwelfarelevel--even consistent of complete underconditions rent- long as thereare sufficient seeking--as unusedfactorresources. PartVl: Conclusion In this paper we have analyzedthe welfareimpactof an adjustment by a oil exporting small,dependent, economy,facingforeignborrowingconstraints, regimes to a 302 dropin the worldoil price. Two adjustment have been compared: and import devaluation incorporating rationing.Scenarios thesetwo regimeswere examinedunder fixed factorprice closureand fixed factorquantityclosurein the non-oilsector. A numerical was made possible comparison by the use of a simple, for Egyptencompassing two sector,CGE framework rent-seeking.The CGE to 1979 data. The resultsindicate was calibrated in that,whilea devaluation to a theoretical response oil pricefallwouldhavehad a smallernegativeimpact on Egyptian economic welfare in 1979 than import rationingunder either regime,the degreeof factorpriceflexibility adjustment wouldhave been a more determinant important welfare of the adjustment's impact. This resultis arrived at despite the fact that we include in the cost of rationingnot just the deadweight standard loss,but also the entirerent generated. - 22 - Ahmed, S., A. Bhattacharya,W Grail and B. Pleskovic(1985), 'Macroeconomic Effects of Pricing Efficiency in the PublicSectsrin Egypt",World Bank StaffWorkin_g ra No. 726. Amranand,P. and W. Grais(1984), and Distributional "Macroeconomic Implications of Sectoral PolLcyInterventious:An Applicationto Thailand",WorldJBank StAffiTgrking Paner No. 627. J. (1982),"Directly Bhagwati, Unproductive, (DUP)Activities", Profit-seeking Economy, Journalof Political vol 90, pp. 988-1001. Bhagvati, (1980), J. and T. N. Srinivasan "RevenueSeeking: of A Generalization the Theoryof Tariffs", Journalof goliticalEconomy,pp. 1069-87. Corcoron, s J. (1984),"Long-Run .- Equilibrium in Rent- and Total Expenditures SeecIng', bllc Ch ,* 43, pp. 89-94. K., J. de Melo and S. Robinson(1984), De.rvi.i, nodfls for GeneralEcuilibrium DeveLooment PQoU,, Cambridge Press. University A System for Large Econoaywide Drud, A. and D. Kendrick (1986),"Hercules, Models",Draft. Duncan,R. (1988),"Primary World Bank Memorandum. PriceForecasts", Commodity of Estimation Grais,W., J. de Melo and S. Urata (1984),"A GeneralEquilibrium the Effects of Reductionsin Tariffs and Quantitative in Restrictions Turkey in 1978",D Discuasion PagerNo. DRD98. H., M. Khorsid, Hallouda, and M. Abdel (1984),"Social Kheir-El-Din, Accounting Matricesand EconomicModellingfor Egypt",CAPFAS,Draft. North Grogth,Amsterdam, Studvof Economic A Multi-Sectoral L. (1960), Johansen, Holland. Krueger,A. (1979),"ThePolitical Amercn Society", Economyof a Rent-Seeking 1 &onomic Ravia. pp. 291-303. Responsesto Trade and Incentive Michel, G. and M. Noel (1984), "Short-Term Policies in the IvoryCoast",World Bank StaffWorkingPaper No.. 647. Neary, J. P. and K. Roberts (1980),"The Theory of HouseholdBehaviorUnder Rationing", EuroLeanEconomicReview,vol. 13, pp. 25-42. Powell, A. and P. Gruen (1968), "The ConstantElasticity of Transformation Production Frontierand the LinearSupplySystem", Economic International Revie, vol. 9, no. 3, pp. 315-28. George Issuesin the Theoryof Rent Seeking", R. (1985),"Unresolved Tollison, Kimeo. Mason University - 23 - APPENDIX OF THEMQRMODEL THEEQUATIONS This appendixpresentsthe completeset of equations the describing model. Emogenou variables are denotedby Roman letters and parameters with a bar 1 and sectorshave subscripts and nonhydrocarbon or Greek letters. The hydrocarbon 2 respectively. bunt Demand INTt, a t Xt ; i D 12 ; demandsby the hydrocarbon sector for intermediate inputs; MNTl,a Oa , a (PDa/ft X ; a X i 1,2; demands by the nonhydrocarbon sector for intermediate inputs; VAs = ('%2a (PDS/PNt)f 3 Xa demad by the nonhydrocarbon sector for value added; Sumoie Of GOO and S SI-. AaI (PDaIPD)'tXa; a a U, (PD2/PDS)Oll xa supplyof non-hydrocarbon to the domestic markets; e a < 0; Xa is total output; 8t pat(?DaIPKa) tKX; supplyof nonhydrocarbonexports; 2 < 0; X2 is totaloutput; 83 R t(iDa/Us)X a supplyof rent-seeking services; es < 0; XK is total output; XI -K 1 ; fixed supplyof hydrocarbons. ' - 24 - Demands and Services Domesic and anDotedGoods, for VT a # ?. (P1 IRM1)A Q1; demandfor imported n1 > 0; hydrocarbons; 0 (c f I 1; Q, is real demandfor composltehydrocarbons; Vt . ? , (P 1) 1/x'D 3 Qa demandfor domestic hydrocarbons; 1 > 0; 0 < 9 I < 1; v?u ( 9' 3 )^ (P 2 /PV Q' ; notional demandfor importsof non- hydrocarbons; ns > 0; 0 (< a < 1; PV: is the black marketpriceof imports; Q, is realdemandfor composite hydrocarbons; VI .9 "2 (P:IPDa) t Qa; nonhydrocarbons; demandfor domestic na ) 0; 0 ( a ( 1; RetiM_ Betweo PMm Alsn) (I + ; Marketprice of doestic hydrocarbons; PDa . PD: (I + F2) ; Marketprice of domesticnonhydrocarbons; pH, = T , (1+ r mi)E i *1,2 Landedpricesof Imports; PV2 . Ka Ma . PM2 + RUa Virtualprice (PVa)of rationedimports and the associated of nonhydrocarbons rent (UN,); PE, - ir? ER ;i - 1,2 ; Exportpricesin domesticcurrency; P& . El PDi Es + RZ& betweenthe RentRE, on the differential domesticPD, and export (PE,)pricesof hydrocarbons; [( J composite; Priceof the hydrocarbon Pa gJr 2s V, - 2+ 24PDVA 1/- composite; Price of the nonhydrocarbon PDa 413 f PD[It-' PEH i.p ? PRI ilal revenueof the nonhydrocarbon sector,including r4venuefor rent-seeking services; - 25 - PDs 4oU $a PI 6l aNa a Pas4 2, sector; Ma inal costof'thenonhydrocarbon rent (RXU)of the hydrocarbon Production sector; PG a PiGi + PaGp consumption; Price indexof Government PC * phPa Consumerprice index; PI = PiT + Pai 3 Price indexof investments. Meke-CIen CouIi , Gt + It + INTI., + INT 1 I, * Q. hydrocarbon; Demandfor composite = Qa Ca + Ga + It + IIT,1 + 1NTa,a Demandfor composite nonhydrocarbon; a X- Vt Exportsof hydrocarbons are the excessof production Xi over domestic demand Vt; 8s a vi on the domestic Equilibrium marketof nonhydrocarbons; domestically-produced Si a Ea The supplyof nonhydrocarbonexportsfacesa perfectlyelasticworld demand at world priceJr'; PRa . S a RM, The valueof the supplyof rent-seeking services (PRa.S2)exhausts the available rents to be sought (RHO). VAa . VAa sectorfactorendowment The nonhydrocarbon is given; VAi VAL The hydrocarbon sectorfactorendowment is given; RX3 8 VA& . PR1 The rent price relatesnominalhydrocarbon production rentsto the quantityof value added used In production; ii 1 + Ft (F + Fs) + ER * FS + Psi . Et + PEa . Et FtA + EA + IAGA +ERyt +ERM T 7f: Balanceof payments, with givenforeign savings in foreign currency FS. - 26 - The GbausetiootGDP Z, a* RX rent in the hydrocarbon Production sector; 2a PN: . VA* Valueadded In the nonhydrocarbon sector; Z, a RgE betweenthe domestic Rent due to the differential and world priceof hydrocarbonexports; GDP - Z, + Zs + Z2 GDP at factorcost; n stribuatiof GDP FIR a (f,e) Z, Hydrocarbon value added distributed to enterprises; F,1 a (f,h) Z1 Hydrocarbon value added distributed to households; FIE a (fae)Zs Non-Hydrocarbon value added distributed to enterprises; FaH a (fah) Za Non-Hydrocarbon value added distributed to households; F1G - (fai) Za Non-Hydrocarbon value added distributed to Government.; FsA * (f2a) Za Non-tydrocarbon value added distributed to abroad; FIG a Zs Rent on hydrocarbon exports distributed to Government: Dlstdbuiosl of titutioanomes EN a (eh) Y. Enterprises income distributed to households (dividends); E¢ * (eg) Yz Enterprises income distributed to Government (taxes); ES a (08) Ys Enterprises income share saved (savings); EA a (ea) Y. Enterprises income distributed to abroad; - 27 - H a (he)Yx Households to enterprises incomedistributed payments); (interest RDI * (6d1)Ye Households disposable income; EG - (Qj) Yu Households taxes; HA - (ha) Yu transfers Households to atroad; *IDI * EDIC + EDIS Households disposable incomeis exhausted by their consumptionand savings; PICS a is HDIC , O < hi < I , = 1,2 , hi + ha * I Allocation expensitures of household betweenthe two composite goods; GE Government transfers to enterprises; e;_ Government transf6ra to households; Government transfers to abroad; G1 *-g 6, O <1 f < I , L a 1,2 )Allocation of Governmt consumption GC a FG . G* + Pac 2 ) betweenthe two composite goods; Ij * iJI , O < ij < 1 j 1, ) Investment demandby INV * PI . I a PtIl + PaIl ) sector of orisu; IRntIo evmns YT g Fig FaE BE GE +AS revenues; Enterprises uv Yu a Fig + +Ilk + G* + AR Households revenues; YO * FaG + F,G + 8C + NG + NIT + AG Government revenues; NIT * ' z 1DF.VD t + r, 2 .V + PFD ' im U MN + rmg '7h. ER MH Net indirect taxes; AZ a U F Transfersfrom abroadto enterprises; AR a ER Fa Transfers from abroad to households; AG - U Fis Transfers from abroad to Government; - 28 - DM a SS + 18SDI. + + DUf.