China - Long-term issues and options (Vol. 5 of 7) : Annex D : model and projections

Report No. 5206-CHA Chin a: Long -Term Issues and Options Annex D: Model and Projections May 22, 1985 East Asia and Pacific Regional Office FOR OFFICIAL USE ONLY Document of-the World Bank Thjisrpt has'a reticed di'stribution and may be used by recipients only in the Performance of,th& rofficial duties. Its conhtents may not otheirwise be 'disclosed. without World Baink autihorization. 74. vr - --.  CURRENCY EQUIVALENTS The Chinese currency is calLed Renminbi (RMB). It is denominated in Yuan (Y). Each Yuan is I Yuan = 10 jiao = 100 fen In early 1984 the official exchange rate of the Yuan to the US dollar was around Y 2 = US$1. The internal settlement rate (ISR) of Y 2.8 = $1, however, was used in most merchandise transactions. The official exchange rate is now about Y 2.8 = $1. On January 1, 1985, the Government abolished the ISR. WEIGHTS AND MEASURES Chinese statistics are usually in metric units; in addition, mu and jin are often used: 1 mu 0.1647 acres = 0.0667 hectares l jin = 0.5 kg FISCAL YEAR January 1 - December 31 TRANSLITERATION The Pinyin system is used in this report. TERMINOLOGY (1) With the recent reorganization of rural administration, "communes" have been replaced by "townships," and "production brigades and teams" by "villages." This report retains the former cerminology in one respect, however, by referring to "commune and brigade enterprises." (2) The term "national income" is used in this report to encompass both the Chinese measure (net material product) and the Western measure (gross national product). Where the context makes the distinction between these two measures important, they are more precisely identified. Note: In tables, individual items may not sum exactly to totals because of rounding errors.  FOR OFFICUIL USE ONLY CHINA: LONG TERM ISSUES AND OPTIONS ANNEX D: MODEL AND PROJECTIONS Table of Contents Page No. 1. INTRODUCTION .................................................. 1 2. EQUATIONS OF THE MODEL ..................1........... 1 Gross Output ............................................ 5 Fmployment-, Labor Force and Population ................... 6 Prices, Net Output, Wages and Profits .................... 7 Use and Distribution of National Income .................. 9 Sectoral Domestic Demand ................................. 11 Foreign Trade ............................................ 13 Investment Allocation and Capital Accumulation ........... 15 Supplementary Energy Equations ........................... 18 3. BASE YEAR DATA ................................................ 19 4. QUADRUPLE, MODERATE, BALANCE: ASSUMPTIONS .................... 20 Incremental Capital-Output Ratios ........................ 20 Energy Use ............................................... 22 Other Input-Output Coefficients .......................... 22 Consumer Demand Elasticities ............................. 26 Foreign Trade and Capital ................................ 29 Other Assumptions ........................................ 31 5. QUADRUPLE, MODERATE, BALANCE: RESULTS ........................ 33 6. URBAN-RURAL DISTRIBUTION .. 52 APPENDICES A. Glossary of Symbols ............................................ 55 B. Computer Program of the Model .................................. 63 C. Additional Results of QUAD RUPLE ............................... . 90 D. Additional Results of BALANCE ...... .... ........................ 98 List of Figures in the Text 1. Long Term Causation ........................................... 3 2. Short Term Causation .......................................... 4 This document has a restricted distribution and may be used by recipients only in the performance of their offwcial duties Its contents may not otherwise be disclosed without World Banlk authorization.  Page No. List of Tables in the Text 4.1 Incremental Capital-Output Ratios ............................. 21 4.2 Changes in Energy Use Coefficients ............................ 23 4.3 Assumed Composition of Refined Petroleum Products Use, 1981... 24 4.4 Changes in Nonenergy Input-Output Coefficients 1981-2000: QUADRUPLE and MODERATE ......................., 25 4.5 Input-Output Coefficients in BALANCE .......................... 27 4.6 Consumer Demand Elasticicies .................................. 28 4.7 Foreign Trade Coefficients .. 30 4.8 Other Coefficients ............................................ 32 6.1 Urban-Rural Distribution of Employment, Capital and Output Under Alternative Projections, 1981-2000 ............. 53 6.2 Growth in Capital and Output per Worker in Urban and Rural Areas Under Alternative Projections, 1981-2000 ........ 54  -: ~ ~ ~ ~ ~ ~ ~ 1 1. INTRODUCTION 1.01 This annex contains a cechnical description of the multisectoral economic model used in preparing this report, together with more detailed results of the projections summnarized in the main report. It is designed to be read in conjunction with Chapter 2 of the main report. A possible combined reading sequence would be as follows: (a) Main Report, Chapter 2, Section A and Box 2A (brief description of the model); (b) Annex D, Chapter 2 (equations of the model); Cc) Annex D, Chapter 3 (sources of data for the model); (d) Main Report, Chapter 2, Section B (introductory discussion of the spirit and assumptions of the projections); (e) Annex D, Chapter 4 (more detailed information on the assumptions of the projections); (f) Main Report, Chapter 2, Sections C-F (discussion of the main results of the projections); and (g) Annex D, Chapter 5 (more detailed results of the projections). 1.02 Appendices to this annex contain a glossary of symbols, the computer program of the model (with explanatory notes), and additional results of the QUADRUPLE and BALANCE projections. 2. EQUATIONS OF THE MODEL 2.01 The model is a type of dynamic input-output model, designed to analyze long-term patterns of growth and structural change. (It is not suitable for short or medium-term analysis: see Main Report, para. 2.07.) The model is large because there are 20 sectors, but technically quite simple, with only about 30 (non-redundant) equations per sector. Like other models, its equations fall into two main categories: those - the great majority - which determine the values of variables within each period (year); and those which update the values of certain variables between periods - population and sectoral capital stocks being the most important such variables. 2.02 Within each period, demand and supply in individual traded-goods sectors are reconciled by endogenous changes in net foreign trade balances. In other sectors, this reconciliation is achieved by temporary changes in capacity utilization (deviations of sectoral capital-output ratios from their assumed long-term values). Between periods, however, the allocation of investment among sectors tends to eliminate unwanted trade imbalances and deviations from normal capacity utilization. over time, as a result, the  -2- composition of production is determined mainly by the composition of demand, even though the aggregate growth rate depends heavily on the pace of invest- ment in capacity expansion. Neither in individual sectors nor in aggregate is growth constrained by availability of labor, partly because skilled labor - which is scarce in China - is for statistical reasons not distinguished from unskilled labor, partly because there is assumed to be an unlimited pool of surplus labor in agriculture. 2.03 Prices play only a limited role in this model. Neither production, nor foreign trade, nor any component of domestic demand, responds directly to changes in (relative) prices. Nor are relative prices affected by demand- supply imbalances. Instead (as explained in the box on wages, profits and prices in Chapter 2 of the Main Report), they are determined by relative pro- duction costs - including labor, materials and capital. However, the relationship between average prices and average wages plays an important macroeconomic role: specifically, the distribution of national income between profits and wages is determined by the need to achieve the governmenc's target aggregate saving rate. It is thus adjustment of household income and consump- tion, rather than (as in some other models) saving or investment or the overall foreign trade balance, that equates aggregate demand and aggregate supply. 2.04 The following discussion goes through the equations of the model in groups, concentrating on the principles of the equations (see also the simpli- fied flow charts in Figures 1 and 2). To make the model easier to solve in practice, some additional lags (to reduce the degree of within-period simul- taneity), and some damping factors (to prevent oscillations) were inserted. These can be found in the computer program of the model (Appendix B), which also contains additional (redundant) equations, some of which are used to derive MPS (Chinese-style) national accounts from the SNA (Western-style) national accounts generated by the model, while the rest calculate other variables (e.g., shares and ratios) that are useful in studying and presenting the results. 2.05 The 20 sectors of the model, which are referred to in the equations by the subscript i, are as follows: 1. Crops (including forestry) 2. Animal husbandry (including fishing) 3. Metallurgy 4. Electricity 5. Coal 6. Petroleum extraction 7. Petroleum refining, which has two different products 71. Fuel oil 72. Distillates 8. Chemicals 9. Machinery (including metal products) 10. Building materials 11. Food processing 12. Textiles and clothing 13. Other manufacturing (including paper and wood products)  Figure 1: LONG-TERM CAUSATION 1 ~~~~~~~~Growth I~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ L ~~~~~~~~~~~~ ..............ComTposlHion .. | TofePlc  Fgure 2: SHORT-TERM CAUSATION o C |ectoral Tfcde Sectoralo In-balarI Gross Output | Imbalanc.s r ornpo*iOn ~~~Spilt Between Profits of Dornestic Sa 9o & '&Wages Demond Consum ption Hoshold . ~ ~ ~ ~~~ * Consumfptbon Pa7ttern . . . @..v *. - roded Goocds Nontraded Goods Lagged Effect  -5- 14. Construction 15. Transport (including passenger transport and communications) 16. Commerce 17. Miscellaneous services 18. Education and health 19. Public administration and defense 20. Housing 2.06 These are sometimes consolidated into the following five sectors: Agriculture = sector 1 + sector 2 Light industry = sector 11 + sector 12 + sector 13 Heavy industry = sector 3 + sector 5 + sector 6 sector 7 + sector 8 + sector 9 + sector 10 Infrastructure = sector 4 + sector 14 + sector 15 Services = sectors 16 to 20 Gross Output 2.07 Within-period gross output in eaci: sector is determined in one of three ways - by the inherited sectoral capital stock (via a production func- tion), by demand, or by an exogenously given growth rate. Inherited sectoral capital stocks and production functions determine within-period output in sectors 2, 3, and 8-13, i.e., in animal husbandry and in all manufacturing sectors (except oil refining). In the infrastructure and service sectors (sectors 4 and 14-20), within-period output is determined by demand, in accor- dance with the material balance equations: QSi = DDi + Xi - Mi (1.1) where DDi is domestic demand, Xi exports, and M- imports.l/ In sectors 1, 5, 3. 6 and 7, i.e., in crops, coal, petroleum extraction, and petroleum refining, output grows at an exogenously given rate. (Growth of petroleum refining is set to be consistent with growth of petroleum extraction: refined petroleum output is divided between fuel oil and distillates in exogenously specified proportions.) 2.08 The sectoral production functions are (with one exception) of the form: 1/ Exports and imports in infrastructure and services are zero, except for transport and commerce, where they are exogenously specified fractions of (i.e., transport and trade margins on) other exports and imports.  -6- K.(-1) QSi = 1 + a. i = 2-20 (1.2) i ak. where QS. is gross output, Ki(-l) is the capital stock at the beginning of the period, aki is the incremental capital-output ratio, and a: is a constant term. The exception is the crop sector, in which, to take'account of the diminishing returns to inputs applied to a fixed quantity of Land, the produc- tion function is of the form: QS1 = T.K (-l)01 . NB2 1 + 32 < 1 (1.3) where N is a fixed-proportions aggregate of intermediate inputs and T repre- sents the state of technology. Both N and T increase at exogenously specified rates. As explained later, the role of the production functions in sectors in which within-period output is determined by demand or exogenously is to deter- mine investment requirements. Employment, Labor Force and Population 2.09 In all sectors, production requires not only capital, but also specified amounts of both intermediate inputs and (except in crops) labor. Specifically, employment in each sector except crops is 2etermined by gross output and an exogenous labor productivity coefficient:- Li aL.iQS. i = 2 - 20 (2.1) Employment in the crop sector, where labor is assumed to be in surplus, is the difference between the total labor force, L, and employment in all other sectors. L = L L. i = 2 - 20 (2.2) The labor force, and the total population, POP, are both exogenous. 2/ Decreases in these labor input coefficients, reflecting technical progress and increased efficiency, are in this model the single most important source of total factor productivity (TFP) growth. The rate of TFP growth is also influenced by changes in sectoral capital-output ratios, and in intermediate input coefficients, as well as by inter- sectoral shifts in resource alLocation.  -7- Prices, Net Output, Wages, and Profits 2.10 Prices (which in the base year are all set equal to one) are deter- mined by unit costs of production, including capital costs. a. (-1 ) Pi a .P 4a"Li Wi Q . PAI. (3.1) where a. * are input-output coefficients. W. is the sectoral wage rate, PAI. is the sectoral profit rate on capital (gross of depreciation), and K (-l)/QS. is the sectoral average capital-output ratio. Seccoral profit rates 3epend on the overall level of profits in the economy, whose determination is explained below, and on exogenouslv given relationships among profit rates in u'ifferent sectors. FormaLly, all profit rates are linked to the profit rate in one of the sectors, PAI = ZETA iPAI3 i = 1, 2, 4-17 (3.2) where ZETAi is the ratio of the profit rate in sector i to the profit rate in sector 3 (the choice of sector 3 is arbitrary, and makes no difference). In sectors 18 and 19 (education and health, and public administration and defense), the profit rate is simply the depreciation rate, and in sector 20 (housing), it is the rental rate. 2.11 These price equations are capable of determining only relative prices. The absolute price level is determined by requiring in addition that the ratio of nominal to real national income (PBAR) remains constant and equal to its base year value of one. (Other normalization rules would be possi- ble.) Given this normalization rule, and the wage rates, W; (whose determina- tion is explained below), equatioi7 3.1 and 3.2 together determine all sectoral prices and profit rates.- 2.12 Net output in each sector is computed by subtracting from gross out- put all intermediate uses. NQi = QSi (P. a...P.) (3.3) 3/ These sectoral prices and profit rates evidently also depend on inherited sectoral capital stocks and gross output levels, which between them determine average sectoral capital-output ratios. The relationship between the absolute amount of profit in each sector, PROF., and the sectoral profit rate also depends on the price of capital goods, PK (equation 7.18). Algebraically, PROF. = PAI. K1(-1). PK. In the crop sector, LlIQSl is used instead of an exogenous labor input coefficient.  -8- 2.13 The wage rates in each sector depend on the overall Level of wages in the economy (whose determination is explained in para. 2.23), but also on exogenously given relativities a. among sectoral wage rates, and on the L levels of employment in the various sectors. Specifically, the wage rates in other sectors are arbitrarily normalized on the wage rate of the metallurgy sector. Wi a W3 i = 1, 2, 4-20 (3.4) 2.14 The wage bill in each sector is simply the product of the wage rate and employment: WBi = Wi I Li (3.5) And the sum of all sectoral wage bills is the economy's total wage biLl, WB. WB = IWB. (3.6) -1 Given WB, which (as explained below) is governed by the level of national income and by saving and consumption targets, and given also sectoral employ- ment levels, equations 3.4, 3.5 and 3.6 together determine all sectoral wage bills and wage rates. 2.15 Profit (including depreciation and taxes) in sectors 1-17 is the difference between net output and the wage bill: PROF. NQi - WBi i = 1,2...,17 (3.7) 1 i I 2.16 For education and health, public administration and defense, and housing, depreciation and rent are likewise calculated as DEPR. = NQ. - WB. i = 18,19 (3.8) L 1. 1 RENT = NQ. - WBi i = 20 (3.9) 2.17 Nominal gross domestic product, Y, is determined as the sum of sectoral net output, adjusted for losses incurred in foreign trade. (These losses, which arise for reasons explained in para. 2.37, could alternatively have been subtracted from the profits of the commerce sector.) Thus, Y = I NQi - XLOSS - MLOSS (3.10)  -9- where XLOSS and MLOSS are, respectively, losses on exports and imports, defined as XLOSS = IP.X. - DOLX EXCHR(3.11) and MLOSS = -(2P.X. - DOLM . EXCHR) 1 L 2.18 In the above formulas, DOLX and DOLM are, respectively, total exports and imports denominated in US dollars and EXCER is the yuan/dollar exchange rate (discussed further below). 2.19 Nominal gross domestic product is by definition also the sum of wage bill, profit (net of.foreign trade losses), and rent. Y = WB + PROF + L DEPR. + RENT - XLOSS - MLOSS (3.12) L 1 i = 18, 19 where PROF = PROF. i = 1 - 17 (3.13) Use and Distribution of National Income 2.20 The aggregate saving rate is exogenously given by government policy. It determines domestic saving. SD = PY (4.1) 2.21 The difference between gross domestic product and domestic saving is total consumption; an exogenously specified share, g, also determined by government policy, is used for public consumption, GN, and the rest constitutes household consumption, CN. GN = g (Y - SD) (4.2) CN = Y - SD - CN (4.3) 2.22 Households save an exogenously given proportion, s, of their income, which consists of wages and rent: CN = (1-s) Y(4.4)  - 10 - where Y = WB + RENT (4.5) H 2.23 The importance of these last two equations is that they show how the government's decision on division of national income between saving and con- sumption in this model determines the distribution of national income between wages and profits. In particular, by rewriting these equations as WB = CN/(l - s) - RENT it can be seen that the size of the aggregate wage bill is governed by the availability of resources for household consumption (the consumption fund). A corresponding equation can be written for aggregate profits, showing that they are determined by domestic saving (less household saving) plus public consumption requirements. 2.24 Aggregate gross investment is determined by domestic saving, SD, plus net foreign capital inflow, which in turn is equal to foreign borrowing, SF, plus net transfers (such as remittances) from abroad, NTR, and minus interest payments on foreign debt, DS. IN = SD + SF + NTR - DS (4.6) where SF = DOLSF . EXCHR, (4.7) NTR = DOLNTR . EXCHR, (4.8) and DS = DOLDS . EXCHR (4.9) DOLSF, DOLNTR and DOLDS are, respectively, foreign borrowing, net transfers, and interest expressed in foreign currency (dollars). 2.25 Foreign borrowing, net of amortization, is determined by a tgyget ratio, f, between the stock of external debt and the level of exports.- Therefore, foreign borrowing (in dollars) is determined in each period as DOLSF = f . DOLX - DOLDEBT (-1) (4.10) where DOLX and DOLDEBT are, respectively, total exports and outstanding debt denominated in dollars. 2.26 Interest payments on debt are determined as the product of an exoge- nous interest rate and the debt stock 4/ This ratio is closely related to the debt-service ratio. For example, assuming an average maturity of ten years and a 10% average rate of interest, a debt-service ratio of 20% would be equivalent to f equal to unity.  - 11 - DOLDS = interest . DOLDEBT(-1), (4.11) and outstanding debt is updated each period as DOLDEBT = DOLDEBT(-l) + DOLSF. (4.12) Sectoral Domestic Demand 2.27 Public consumption is divided among sectors by a set of exogenousLy given share parameters: G. = e. . GN, le. 1 (5.1) L. 11 2.28 Similarly,,household consumption is divided among sectors according to a set of exogenously given sectoral consumer demand elasticities (cde-). Specifically, it is postulated that in each sector the increase in real per capita household consumption depends on its consumer demand elasticity and the increase in total real per capita household consumption, REALPCC, which is defined as REALPCC p C 100 (5.2) POP . CP*10 CPI is the consumer price index, defined as CPI = CN (-1)/(l C. (-I) / P.) (5.3) 1 I 1 2.29 In order to ensure that sectoral consumption sums to total consump- tion, a two-stage procedure is used. First, sectoral incremental consumption claims, CCLAIMi, are determined. These are then all scaled up or down propor- tionately to make their t Yal nominal value equal to the aggregate increment in household consumption.- 2.30 Total investment, IN, is divided between fixed investment, FI, and circulating capital investment, SK. This division depends on the allocation of investment by sectors of destination, Ii, whose determination is explained below; and also on the ratio, rhoi, of circulating to total capital within each sector of destination. Specifically, 5/ For the specific equations used in these two steps, see Appendix B.  -12- SK. = rho. [1I - delta. FK.(-1)] (5.4) and FI. I. - SK. (5.5) 1 1 1 where the rho. are given exogenously, and the deltai are depreciation rates on sectoral fixed capitaL stocks, FKi.. Hence, SK = I SK. (5.6) and FI = IN - SK (5.7) 2.31 These total needs for fixed and circulating investment goods are then provided by the various sectors. Fixed investment goods are supplied in exogenously fixed shares, bi; circulating capital goods are supplied by mater- ial producing sectors in proportion to their gross output, with the exception of crops. Specifically, o0 =SKO +b . FI (5.8) 1 1 1 I= phi (SK - SKO1) + b FI, phii = bi = 1 (5.9) i = 2,3,5-13 where SKO1 is the increase in circulating capital in the form of crops, bi are 1~~~~~~~ given exogenously, and phii are determined by: phi. = QS.IQSMAT , (5.10) where QSMAT is the total output of the material production sectors other than crops, i.e., QSMAT = I QS. i = 2,3,5-13 (5.11) i1 2.32 The change in crop stocks, SKOj, is normally determined as a propor- tion (0.75) of the change in crop output: SKO1 = 0.75 . [QS1 - QS1(-1)] . p1 (5.12) But if crop exports hit a predetermined ceiling, XMAX1, additional crop stocks are accumulated to balance crop demand and supply (this is to prevent unrea- sonably high crop exports). 2.33 Total real domestic demand DDi in each sector is thus the sum of total intermediate demand, government and household consumption, and provision of investment goods.  - 13 - DDi = a.. * QSi + (C. + G. i 10.)/P. (5.13) 'j Foreign Trade 2.34 As mentioned earlier, foreign trade in particular sectors adjusts in each period to fill the gap between domestic demand ai,d supply (although over time investment adjusts so as to attain certain foreign trade targets - see below). But there is also a requirement that each sector maintain in each period a certain minimum amount of exports and imports. Thus if the demand for domestically produced goods is greater than suppiy, imports will fill this gap and exports will be fixed at a predetermined ratio (xshare-) of gross out- put. 'onversely, if the demand for domestically produced goods is smaller than supply, exports will fill the gap and imports will be fixed at a prede- termined ratio (msharei) of domestic demand. 2.35 In symbols, if (1 - mshare.) . DDi > (1 - xshare.) , QSi, (6.1) then 1 1 X. = xshare . QS; (6.2) 1 1. - 1 otherwise X. = QSi - (1 - mshare.) . DD. i = 1-3, 5-6, 72, 8-13 (6.3) 2.36 Imports, M-, are simultaneously determined with exports and are obtained from the fotlowing material balance equation once exports are deter- mined by (6.2) or (6.3). QS. = DD. + X. - M. i = 1-3, 5-6, 72, 8-13 (6.4) Fuel oil is an exception: both its exports and its imports are exogenously determined (for reasons to be explained below). In transport and commerce, exports and imports are exogenously specified ratios of other exports and imports. In construction and the service sectors, exports and imports are exogenously set at zero. Total exports and imports in domestic currency at constant prices are: X Xi (6.7) and M . (6.8) .~~~~~~~~~~  - 14 - 2.37 Foreign Trade and Payments in Current Dollars. Exports and imports in domestic currency are converted to dollars as follows: DOLX. = X. . WPINDX. . CFX. (6.9) and i L 1 1 DOLM. = M. . WPINDXI. . CFM. (6.10) 'I I I L where WPINDX- is the world price index in dollars, and CFX- and CFMi are the ratios of world prices to domestic prices in the base year for exports and imports respectively. (They are needed because domestic relative prices are in some cases quite different from relative world prices, so that conversion between dollars and renminbi at a uniform exchange rate is inappropriate. The existence of different ratios in different sectors is the main reason for XLOSS and MLOSS - which in principle could be negative, i.e., profits rather than losses.) 2.38 Total dollar exports and imports are, respectively DOLX = I DOLU (6.1