Distributing Incomes Between Representative Households In Dynamic CGE Models: Empirical Tests of Alternative Structures

The purpose of this paper is to test the empirical implications of alternative approaches to the household sector that have been used in dynamic CGE models based on the dominant recursive-dynamic approach. Drawing on a review of the literature, we identify three alternative treatments of RH shares in the total incomes from factors and other sources: 1. fixed shares: no link between (a) the shares of each RH in different incomes; and (b) the growth in its population and, typically implicitly, its labor force (which may be split into multiple types), or its savings; 2. fixed per-capita shares: the shares of each RH in different income flows depend on the growth of its population but not on its shares in one or more segments of the labor force or its savings; and 3. links between (a) the shares of each RH in different income flows; and (b) its endowments of different factors, driven by its labor force growth (for labor shares), its savings (for shares in private capital rents), and its population growth (for other incomes). This discussion raises an empirical question: to what extent do different approaches generate different results? To analyze this issue, we simulate the impact of export price and remittance shocks using alternative approaches and disaggregations. The analysis is done with the help of a fairly standard recursive-dynamic CGE model, applied to a database for Guatemala. The main anticipated finding is that the approaches generate significantly different results with the largest gaps between approaches 1 and 3; approach 3 dominates since the results are consistent with basic economic principles. The differences are smaller if the database is more aggregated and hence less able to capture changes in income distribution.