No. 3 - Department of Treasury - The Western Australian Government

Western Australian Economic Summary2006 No.3The foreign ownership variable should then flow through to subtractforeign-owned capital income from the income available to domesticconsumers. Linking domestic private consumption to tax-adjusted GrossNational Product (GNP) can do this.In comparative static models, the trade balance should be made exogenousin the long-run closure, with consumption endogenous to the model. Thetrade balance should be shocked to a (positive) level equivalent to after-taxoverseas income and debt repatriations (CREA, 1990, p. 17)).Labour Market and Interstate Migration AssumptionsLabour marketThe standard labour market assumption for most comparative static anddynamic CGE models is that national employment is variable in the shortrun with the national wage level fixed. In the long run, national employmentis fixed with the national wage level endogenous (Dixon and Rimmer,p. 32) 1 .An additional assumption for regional (State-level) CGE models 2 is that thenominal wage differential between States is not affected by the project (i.e. itis exogenous), and migration adjusts to maintain this wage differential. Thismeans that interstate migration will be large and instantaneous in responseto any policy change 3 .As noted in Section 3.2, these are simply assumptions and are not proven bytheir use in the model, but have a well-founded theoretical justification(Dixon and Rimmer, p. 32).It is recommended that modellers use these assumptions as a default labourmarket closure 4 . However, there is no reason why a modeller cannot usedifferent assumptions to the defaults if an external justification can beprovided and substantiated.1 In dynamic models, the path between the short and long run is facilitated by apartial wages adjustment mechanism (Dixon and Rimmer, p. 205).2 With each region modelled as a separate economy.3 This might be considered unrealistic, but is acceptable in the absence of a soundtheory for interstate migration.4 Although there is an argument for fixing the real wage differential (deflated byconsumer prices) between States rather than the nominal differential (Layman, 2006,p. 23).86 Department of Treasury and Finance