Trade reform in the short run - Agriculture and Food Security in China - page 232

and saving. Government saving, or the government surplus, S G = T - G , is
simply revenue from direct taxes, τY F , and from the many indirect taxes
incorporated in the microeconomic part of the model, T I , 5 less government
spending, G , which could be exogenous or fixed as a proportion of GDP.
Thus, S G = T I + τY F - G . The prvate savng and consumpton decson s
represented by a reduced form exponental consumpton equaton wth
wealth effects ncluded va the dependence of consumpton (and hence
savngs) on the nterest rate. Each regon contrbutes ts total domestc
(private plus government) saving, S D =S P + S G , to the global pool from which
nvestment s derved. 6
For each region, the above relations imply the balance of payments
identity, which sets the current account surplus equal to the capital account
deficit: X - M = S P + S G - I . 7 From the pool of global savings, investment is
allocated across regons and t places demands on captal goods sectors
in each region. In the short run considered, however, investment does
not add to the installed capital stock. Also, at this length of run, nominal
wages are sticky in some regions (the industrialised regions of the US, the
EU, Canada and Australia, and those developing countries with heavily
regulated labour markets: China and Vietnam) but flexible elsewhere.
In the spirit of comparative statics, although price levels do change in
response to shocks, agents represented in the model do not expect any
continuous inflation and so there is no distinction between the real and
nomnal nterest rates.
In allocating the global savings pool as investment across regions, we
have opted for the most flexible approach, implying a high level of global
'captal' moblty. 8 Where controls exist on international capital flows we
introduce these explicitly. In the absence of capital controls, the allocation
to regon j (net nvestment n that regon) depends postvely on the
expected long-run change in the average rate of return on installed capital,
r j e , which, in turn, rises when the marginal product of physical capital is
expected to ncrease. Ths allocaton falls when the opportunty cost of
financing capital expenditure, the region's real interest rate, r j , rises. This
rate depends, in turn, on a global capital market clearing interest rate, r w ,
calculated such that global savngs equals global nvestment: Σ j S j D = Σ j I j (r j e ,
r j ) . Here I j s real gross nvestment n regon j . 9 The regon's home nterest