Executive Summary
The economy-wide effects of an economic development or industry policy are often ignored when developing or evaluating such a policy. However, these effects may be important for national welfare and can be estimated using CGE modelling. This paper explains the basics of CGE modelling in general and for the two models used in this paper. It then applies CGE modelling to four industry policy scenarios for the New Zealand economy to illustrate how it can be used and the range of results (including counter-intuitive results) that such models can provide. The scenarios span a range of topics: the effect of a 10% increase in demand for exports; comparing the effect of a 10% productivity improvement in large but low value-added sectors to the same improvement in small but high value-added sectors; a 15% R&D tax credit; and a 10% improvement in international freight productivity.
Each industry policy studied had both predictable and unexpected effects on the wider economy. Increased export demand increased export prices and caused the exchange rate to appreciate, but it also resulted in the balance of trade deteriorating. Increased productivity had a bigger effect when it occurred in bigger sectors (agriculture rather than manufacturing), but the imports used by the sector were as important as the level of value-added provided by the sector. A BERD subsidy has a generally positive effect on the whole economy, but a few sectors with high value-added but no direct R&D productivity benefits are negatively impacted by the increased cost of factors of production. Improving international freight efficiency has an overall positive effect on the New Zealand economy, with the best effect when routes to and from New Zealand (but not elsewhere) improve; however it is the lowest value-added sectors that benefit most, and many higher value-added sectors suffer.
While a variety of results have been given in this paper, they are still a selection of the most interesting aspects of the results for each scenario. The raw results contain a much richer array of information that can be analysed and interpreted to learn more about the economy-wide effects of a possible policy. However, it is important when doing this to know enough about the modelling and the underlying economics to understand the real-world situations where the results are relevant. To interpret the results and get the best value from a CGE model requires opening the black box to gain some understanding of how the model works.
