- METHODOLOGY
The impact on fiscal policy can be evaluated through computable general equilibrium model (CGE). The basic model will be used in the research is a combination of ORANI-F (Horridge et al. (1993), INDOF (Oktaviani, 2000), WAYANG (Wittwer, 1999) and ORANIGRD (Horridge, 2002). The modification of these models will be built to more focus on the macroeconomic policy change, which is emphasised on the fiscal policy change on poverty. Because the new model is different from the basic model, this model will be called Indonesian Poverty Model.
The impact of the reduction of fuel subsidies on the household welfare may channel through two ways: expenditure side and income side. The reduced subsidies on fuel, for instance, will push the price of fuel facing either industries for intermediate inputs or households for final demand. The type of households that suffers from such a shock is urban and rural low income households. Both households rely heavily on fuel (kerosene) for their cooking. This impact is very direct one, because households demand the fuel directly from the market. On the indirect side, some industries such as transportation sector and fertiliser industries demand fuel for their input factor. An increased price of fuel will impact of the demand for fuel in both industries and it is expected that the prices of transportation services and fertiliser will be higher than that of with subsidy. Again, low income household will experience a decline in their real income. Even low income rural households may have a worse decrease in their real income. Because in the fertiliser industry, approximately 30 % of total production cost is cost of fuel, subsidy cuts on fuel will definitively push the price of fertiliser to rise. The low income rural households whose income is mainly agricultural income encounter a difficult situation. They may reduce their demand for fertiliser due to the high price of fertiliser. However, it will lead to a decline in their agricultural output. Consequently their income may decrease. Or maintaining the current level of fertiliser application requires an additional input cost. It is estimated that their welfare may decline and the incidence of poverty may also rise.
The government decided to open the fuel market to the international market. This implies that the price of fuel at the domestic market will be subject to the fuel price fluctuations at the international level. However, the government realises the difficulties faced by the consumers when the domestic prices fluctuates following the price development at the international level. Figure 4.1. shows that to stabilise the fluctuation of the fuel price, the government provides amount of subsidy to maintain the price level at Pd (PwABPd). As the price at the international level rises and the government maintains the level of the domestic price, the government is required to increase the subsidy. Following hardship times faced by the government to finance the development reflected by the limited sources of income, the government faces a growing budget deficit every year. To reduce the budget deficit, the government decided to reduce the level of fuel subsidy and other subsidies (electricity, telecommunication and fertilisers). It is acknowledged that abolishing fuel subsidies at these times is impossible. Therefore the government reduces the level of subsidies periodically by setting up a new level of fuel price. In modelling issues, two possible simulations will be considered. The level of subsidies will be reduced by a required level, leaving the price level endogenous (the government provides reports on annual subsidy on certain products) or the price levels are adjusted periodically, leaving the level of subsidy endogenous. The later might be considered as a traditional approach since the direct target is the consumers.
Figure 4.1. The level of fuel subsidy
The transmitting of the subsidy cuts on the domestic and international price is exhibited in Figure 4.2. Following the reduction of fuel, the producers, e.g. farmers have to re-organise their production technology. The reduce their demand for fuel from xo to x1. This change in the fertiliser application will affect the level of output. Without no subsidy, the output is at the yo level. Because the price of fuel is higher than that of no subsidy, the current level of the output is y1. As a response to the reduced supply in the market, the current supply function is S’ with the current domestic price, PD1. It is seen that households in general face a higher output price than they did before. Given an unchanged nominal income, there will be a declining household real income. Assuming no export taxes on the agricultural sectors, a change in domestic prices will be channelled to the change in export price proportionally. Given a constant exchange rate, the export price is now higher than before.
Figure 4.2. The Impact of Subsidy Cut on Fuel on the Domestic and Export
Prices.
As the export prices rise, the country will lose their international competitiveness. To remedy such a problem, it may depreciate its currency in order to improve their competitiveness. If there is no depreciation of its national currency, those who are dependent on the export growth such as agricultural households will be badly hurt. As the decline in the demand for export occurs, the price of agricultural sector is expected to drop. As a result, more poverty incidence in the rural area will be observed.
As discussed earlier, there will be contracting sectors following the subsidy cut of fuel. Figure 4.3 shows the impact of contracting sectors on the demand for labour and the wage level. As the sectors contract (Q1 to Q2), the demand for labour will be declined from N1 to N2. Another consequence is that the wage level will be lower. The decline in the demand for labour in the contracting sectors implies that some households will be losing their income. Their household’s welfare even becomes worse as the income from that sector is the main source of income. As we see industries largely operate in the urban area. Therefore urban households will be encountering the decline in their welfare not due solely to the decline in their income but also due to the increase in the prices of some outputs.
Figure 4.3. Output and the Demand for Labour.
4. 1. Sector Aggregation
The model will not use all sectors, which are available in the current Indonesian Input-Output Table. Sectors specified in the model can be seen in Table 2.3. The aggregation of sectors as described above refers to the objectives of this research. One of the research objectives is to examine the impact of the subsidy reduction of fuel on the macroeconomic parameter. Therefore, refinery oil, fertilizer and transportation sectors are explicitly disaggregated. Explicitly disaggregating the transportation sector is due to the fact that this sector demands fuel. Any increase in the price of transportation cost will have a domino impact of the price of other commodities. According to the Central Bureau of Statistics transport cost or the price transportation means contributes to the inflation rate. Therefore, examining the impact of the subsidy reduction of fuel requires such a sectoral disaggregation. In addition the number of sectors is considered to be manageable and relevant to the research objectives.
4.2. Model Structure
The notation system in the model parallels the ORANI-F (Horridge, 1997), INDOF (Oktaviani, 2000), WAYANG (Wittwer, 2002) system. It was established by the ORANI modelers to be both efficient in use and easy to interpret. The system of notation uses lower case letters for names of variables in the linear equations and upper case for the coefficients of these equations. Upper case is also used to refer to other coefficients and parameters and for the names of sets of items. Lower case is used for the indices of items, which form a set. Finally, in presenting the model, it is often convenient to present the underlying non-linear equations themselves, and thus in terms of the levels of variables rather than percentage changes. Variables in this form are written in upper case but in bold. Names may be shown in italics or non-italics, with no change in meaning, as convenient for presentation.
Sets and indices
Variables and coefficients often apply to sets of items. There are nine major sets, all with upper case names. The sets and the indices, which are generally used to refer to an item from the sets, are as follows:
industries (IND) i
source (namely domestic or foreign) (SRC) s
occupation (OCC) o
commodities (COM) c
household (HH)h
There are four sets defining subsets of commodities:
margin type commodities (MAR)m
(ie., commodities facilitating flows of other commodities)
non-margin type commodities (NONMAR)n
traditional export commodities (TRADEXP)c
non-traditional export commodities (NTRADEXP)c
Finally, there is a sequence set:
a sequential list of integers (YEARS)t
Variables
Each variable name is alphanumeric. The generic form of a name is "basicnamesubscripts_sets". Here "basicname" is the primary indicator of the meaning of the variable. It follows a general structure as described below. Often a variable is applicable to a set of items. To refer to the individual item from a set, one or more subscripts specifying the element are added to the "basicname". For example, "basicnamecs" refers to a variable applying to a commodity c from a particular source s. Rather than identifying a particular individual item by its index, an individual items may itself be named. For example, a commodity can be sourced from domestic or foreign sources. For referring to a variable pertaining to, say, the domestically sourced commodity, "basicnamec"dom"" is sometimes used, where dom is the name of the source. The item name, enclosed in "", is used as the subscript. Finally, some variables are aggregates or averages over the various items in a set. This type of variable is indicated by appending an underscore character (as a subscript) with one or more following indices identifying the set or sets of items over which the aggregate or average is formed. For example "basicnameci_s" refers to a variable applying to a commodity c in a particular industry i and it has been formed by aggregating or averaging over all sources
The basicname component of the names of most variables consists of two or three parts, as follows:
1) The type of variable is indicated in a letter or letters. The main ones are:
atechnical change
delordinary or absolute (rather than percentage) change
fshift variable
pprice (000 Rp)
pfprice, foreign currency
ttax
wmonetary value( 000 Rp)
x quantity
Additionally, a number of minor variable types have relatively limited application. These are
employemployment
levactual level rather than change of variable value
phiexchange rate
qnumber of households
utilityhousehold utility level
2) The digits 0 to 6 indicate the activity or purpose of use.
1current production
2investment
3consumption
4export
5other (government)
6inventories
0either all users, or user distinction irrelevant
The inclusion of the digit, even when the particular use is irrelevant (the 0 digit) to the variable serves to separate the alphabetic characters from components (1) above and (3) below.
3) Three or more letters forming a descriptor for the variable. The descriptor adds clarity of meaning to a name where necessary.
accumaccumulation
basbasic, not including margins or taxes
capcapital
cifimport at border price
impimports (duty paid)
lab labor
lndland
luxlinear expenditure system (supernumerary part)
marmargins
octother cost tickets (e.g., other miscellaneous production
cost)
primprimary factors as a group (land, labor or capital)
purat purchasers’ prices
sublinear expenditure system (subsistence part)
tartariffs
taxindirect taxes
tottotal or average over all inputs for some use or activity
Variables used in the study are listed in Table 4.1.
Table 4.1. List of Variables Used in the Study
Variable / Set / Descriptionx1csi / COM x SRC x IND / Demand for commodity c, from source s, by industry i for current production
x2 csi / COM x SRC x IND / Demand for commodity c, from source s, by industry i for capital formation
x3 csh / COM x SRC x HH / Demand for commodity c, from source s, by household
x4 c / COM / Export demand for commodity c
x5 cs / COM x SRC / Demand for commodity c, from source c by government
Delx6cs / COM x SRC / Ordinary change for commodity c from source s, by inventories
p0cs /
COM x SRC
/ Basic price of commodity c, source sa1csi / COM x SRC x IND / Input-augmenting technical change for commodity c, from source s for current production in industry i
a2csi / COM x SRC x IND / Input-augmenting technical change for commodity c, from source s for capital formation
a3cs / COM x SRC / Taste changes variable for commodity c from source s
f5cs / COM x SRC / Shifter for commodity c from source s for "other" (government) demand
a1marcsim / COM x SRC x IND x MAR / Intermediate margin tech change
a2marcsim / COM x SRC x IND x MAR / Investment margin tech change
a3marcsm / COM x SRC x MAR / Household margin tech change
a4mar cm / COM x MAR / Export margin tech change
a5marcsm / COM x SRC x MAR / Government margin tech change
x1marcsim / COM x SRC x IND x MAR / Margin usage for commodity c from source s for current production in industry i and margin m
x2marcsim / COM x SRC x IND x MAR / Margin usage for commodity c from source s for capital formation in industry i and margin m
x3marcsmh / COM x SRC x MAR x HH / Margin usage for commodity c from source s for household and margin m
x4marcm / COM x MAR / Export margin usage for commodity c and margin m
x5marcsm / COM x SRC x MAR / Margin usage for commodity c from source s for "others" and margin m
t1csi / COM x SRC x IND / Power of sales tax on commodity c from source s for current production in industry i
t2csi / COM x SRC x IND / Power of sales tax on commodity c from source s for capital formation in industry i
Table 4.1. (Continued)
Variable / Set / Description
t3cs / COM x SRC / Power of sales tax on commodity c from source s for household consumption
t4c / COM / Power of sales tax on commodity c for export
t5cs / COM x SRC / Power of sales tax on commodity c from source s for "other" demand
p1csi / COM x SRC x IND / Purchaser’s price of commodity c from source s for current production in industry i
p2csi / COM x SRC x IND / Purchaser’s price of commodity c from source s for capital formation in industry i
p3csh / COM x SRC x HH / Purchaser’s price of commodity c from source s for household consumption
p4c / COM / Export price of commodity c
p5cs / COM x SRC / Purchaser’s price of commodity c from source s for consumption by "other"
x1labio / IND x OCC / Employment of occupation o in industry i
p1labio / IND x OCC / Wage of occupation o in industry i
f1labio / IND x OCC / Wage shift variable of occupation o in industry i
x1capi / IND / Current capital stock in of industry i
p1capi / IND / Rental price of capital of industry i
x1lndi / IND / Use of land for industry i
p1lndi / IND / Rental price of land for industry i
x1octi / IND / Demand for "other cost" tickets for industry i
p1octi / IND / Price of "other cost" tickets for industry i
a1octi / IND / "other cost" tickets augmenting technical change for industry i
f1octi / IND / Shift in price of "other cost" tickets for industry i
q1ci / COM x IND / Output of commodity c by industry i
t0impc / COM / Power of tariff of industry i
fx6cs / COM x SRC / Shifter on rule for stocks
x1ci_s / COM x IND / Demand for import/domestic commodity composite c for current production in industry i
x2ci_s / COM x IND / Demand for import/domestic commodity composite c for capital formation in industry i
x3ch_s / COM x HH / Household demand for import/domestic commodity composite c
x3luxch / COM x HH / Household–supernumerary demands for import/domestic commodity composite c
x3subch / COM x HH / Household – subsistence demands for import/domestic commodity composite c
p1ci_s / COM x IND / Effective prices of import/domestic commodity composite c for current production in industry i
Table 4.1. (Continued)
Variable / Set / Description
p2ci_s / COM x IND / Effective prices of import/domestic commodity composite c for capital formation in industry i
p3ch_s / COM x HH / Effective prices of import/domestic commodity composite c for household
a1ci_s / COM x IND / Technical change for import/domestic composite commodity c for current production i
a2ci_s / COM x IND / Technical change for import/domestic composite commodity c for capital formation in industry i
a3ch_s / COM x HH / Technical change for import/domestic composite commodity c by household
a3luxch / COM x HH / Technical change for import/domestic composite commodity c by household – supernumerary demand
a3subch / COM x HH / Technical change for import/domestic composite commodity c by household – subsistence demands
x1facfi / AGRIFAC x AGIND / Primary factor demands, agriculture
p1facfi / AGRIFAC x AGIND / Primary factor prices, agriculture
a1facfi / AGRIFAC x AGIND) / Primary factor tech. change, agriculture
a1facofi / AGRIFAC x N_AGIND / Prim. factor tech. change, other
x1facofi / N_AGRIFAC x N_AGIND / Primary factor demands, other
p1facofi / N_AGRIFAC x N_AGIND / Primary factor price, other
f0taxc_s / COM / General sale sax shifter
f4pc / COM / Price (upward) shift in export demand schedule
f4qc / COM / Quantity (right) shift in export demands
pf0cifc / COM / C.I.F. foreign currency import prices
p0comc / COM / Output price of locally-produced commodity
p0domc / COM / Basic price of domestic goods
p0impc / COM / Basic price of imported goods
x0comc / COM / Output of commodities
x0domc / COM / Total supplies of domestic goods
x0impc / COM / Total supplies of imported goods
a1primi / IND / All factor augmenting technical change
a1toti / IND / All input augmenting technical change
a2toti / IND / Neutral technical change-investment
employi / IND / Employment by industry
Table 4.1. (Continued)
Variable / Set / Description
f1labo_i_x / OCC / Skill-specific labour shifter
f_accumi / IND / Capital accumulation shifter
f1reti / IND / Rate of return shifter
p1labi_o / IND / Price of labor composite
p1labo_i / OCC / Price of labour for each skill
p1primi / IND / Effective price of primary factor composite
p1toti / IND / Average input/output price
p2toti / IND / Cost of unit of capital
pec / COM / Basic price of export commodity
x1labo_i / IND / Effective labor input
x1primi / IND / Primary factor composite
x1toti / IND / Activity level of value-added
x2toti / IND / Investment by using industry
x1labo_i / OCC / Employment by occupation
x1laboh_i_h / OCC x HH / Household labour supply
delB / 1 / (Balance of Trade)/GDP
delFudge / 1 / "Fudge Factor": set to unity for dynamic simulation
delUnity / 1 / Dummy variable. Always exogenously set to unity
f3tot / 1 / Ratio, consumption/income
f3toth_h / HH / Ratio, consumption/income by hh
f1labo_io / 1 / Overall wage shifter
f1tax_csi / 1 / Uniform % change in power of taxes on intermediate usage
f2tax_csi / 1 / Uniform % change in power of taxes on investment
f3tax_cs / 1 / Uniform % change in power of taxes on household usage
f4p_ntrad / 1 / Upward demand shift, non-trad export aggregate
f4q_ntrad / 1 / Right demand shift, non-traditional export aggregate
f4tax_ntrad / 1 / Uniform % change in power of taxes on non-traditional exports
f4tax_trad / 1 / Uniform % change in power on taxes on traditional export
f5tax_cs / 1 / Uniform % change in power of taxes on "other" usage
f5tot / 1 / Overall shift term for "other" demands
f5tot2 / 1 / Ratio between f5tot and x3tot
p0cif_c / 1 / Import price index, CIF, billion Rp
p0gdpexp / 1 / GDP price index, expenditure side
p0imp_c / 1 / Duty-paid import price index, billion Rp
p0realdev / 1 / Real devaluation
Table 4.1. (Continued)
Variable / Set / Description
p0toft / 1 / Terms of trade
p1cap_i / 1 / Average capital rental
p1lab_io / 1 / Average nominal wage
p2tot_i / 1 / Aggregate investment price index
p3tot / 1 / Consumer price index
p4_ntrad / 1 / Price, non-traditional export aggregate
p4tot / 1 / Exports price index
p5tot / 1 / "Other" demands price index
p6tot / 1 / Inventories price index
phi / 1 / Exchange rate
qh / HH / Number of households
realwage / 1 / Average real wage
utilityh / HH / Utility per households
w0cif_c / 1 / CIF value of imports
w0gdpexp / 1 / Nominal GDP from expenditure side
w0gdpinc / 1 / Nominal GDP from income side
w0imp_c / 1 / Value of imports plus duty
w0tar_c / 1 / Aggregate tariff revenue
w0tax_csi / 1 / Aggregate revenue from all Indirect taxes
w1cap_i / 1 / Aggregate payments to capital
w1lab_io / 1 / Aggregate payments to labor
w1lnd_i / 1 / Aggregate payments to land
w1oct_i / 1 / Aggregate other cost ticket payments
w1tax_csi / 1 / Aggregate revenue from indirect taxes on intermediate
w2tax_csi / 1 / Aggregate revenue from indirect taxes on investment
w2tot_i / 1 / Aggregate nominal investment
w3luxh / HH / Total nominal supernumerary household expenditure
w3tax_cs / 1 / Aggregate revenue from indirect taxes on households
w3tot h_hh / HH / Nominal total consumption, each household
w4tax_c / 1 / Aggregate revenue from indirect taxes on "other" demands
w4tot / 1 / Billion Rp Border Value of Exports
w5tax_cs / 1 / Aggregate revenue from indirect taxes on "other" demands
w5tot / 1 / Aggregate nominal value of "other" demands
w6tot / 1 / Aggregate nominal value of inventories
x0cif_c / 1 / Import volume index, CIF weights
x0gdpexp / 1 / Real GDP from expenditure side
x0imp_c / 1 / Import volume index, duty-paid weights
Table 4.1. (Continued)
Variable / Set / Description
x1cap_i / 1 / Aggregate capital stock, rental weights
x1prim_i / 1 / Aggregate output: value-added weights
x2tot_i / 1 / Aggregate real investment expenditure
x3tot h_hh / HH / Real consumption, each household
p3tot h_hh / HH / Price consumption good, each household
w3tot / 1 / Nominal total household consumption
x4_ntrad / 1 / Quantity, non-traditional export aggregate
x4tot / 1 / Export volume index
x5tot / 1 / Aggregate real "other" demands
x6tot / 1 / Aggregate real inventories
ggro i / IND / Gross growth rate of capital = Investment/capital
gret i / IND / Gross rate of return = Rental/[Price of new capital]
finv1 i / IND / Shifter to enforce DPSV investment rule
finv2 i / IND / Shifter for "exogenous" investment rule
finv3 i / IND /
Shifter for longrun investment rule
invslack / 1 / Investment slack variable for exogenizing aggregate investmentf2tot / 1 / Ratio, investment/consumption
x0loc c / COM / Real percent change in LOCSALES (domestic + import)
fandecomp cf / COM x FANCAT / Fan decomposition
fgov ht_h / HH x TYPE / Shift in transfers: government. -- households
fgov _f(t) / TYPE / Shift in transfers: government -- foreign
gov ht_h / HH x TYPE / Transfers: government -- households
gov _f(t) / TYPE / Transfers: government -- foreign
w0hhtax h / HH / % change in personal income tax
w0hhinc h / HH / Aggregate nominal take-home income earned by households
delbudget / 1 / Rupiah change in budget balance G-T
w0govt _t / 1 / Aggregate government revenue
w0govt_g / 1 / Aggregate government expenditure
f1inc_tax / 1 / Overall income tax shifter
employ_i / 1 / Aggregate employment: wage bill weights
emptrend / 1 / Trend employment
delempratio / 1 / Ordinary change in (actual/trend) employment
delwagerate / 1 / Change in real wage index
delfwage / 1 / Shifter for real wage adjustment mechanism
Source: Horridge et al. (1993), Wittwer (2002) and Oktaviani (2000), Horridge (2002) adapted and appended by the writer.