Dervis et. al.: General Equilibrium Models for Development Policy

Dervis, Kemal, Jaime De Melo and Sherman Robinson. (1982). General equilibrium models for development policy. Cambridge [Cambridgeshire] ; New York: Cambridge University Press.

“Our basic objective in this book is to present the theoretical structures underlying these applied models and hence to clarify their relationship to economic theory, particularly general equilibrium, growth, and trade theory” (xvii)

The book traces out different models of economic development, specifically with an eye towards bridging the gap between reality and economic theory. The claim is that much of economic theory provides helpful insights on how an economy should function, but that, in reality, most economies (all?) are mixed economies. It becomes important to model the mixed nature of these economies.

“It must be stressed that different general equilibrium models may focus on different kinds of economy-wide consistency” (3). “A multisector, general equilibrium model need not always conform to Walrasian theory. Indeed, we specify various forms of general equilibrium models with rationing of foreign exchange and persistent excess demands in some important markets. Although the equilibrium described may not be Walrasian, neoclassical resource allocation theory remains the fundamental framework of analysis” (3).

“In order to achieve greater policy relevance, it is clear that the fiction of a central command economy must be abandoned in the very specification of the model and be replaced bay a framework in which endogenous price and quantity variables are allowed to interact so as to simulate the workings of at least partly decentralized markets and autonomous economic decision makers. Such price endogeneity and general equilibrium interaction cannot be achieved using the standard linear programming formulation. The crucial difficulty lies in the fact that economic behavior and relations such as budget constraints, consumption functions, and saving functions must be expressed in current endogenous factor and commodity prices” (132).

“The existing models fall into four general categories according to the problems on which they focus. First, there are a number of models of developing and developed countries that focus on issues of international trade, growth, economic structure, and/or income distribution. Second, there are a number of models of developed countries that focus on issues in the theory of public finance…Third, there are a few multicountry, international trade models that explore issues concerning the volume and direction of trade and its impact on particular regions…Finally, there has been some work both with single-country and multicountry models focusing on energy…In this book, we focus on models of developing countries and on issues of resource allocation, growth, structural change, foreign trade strategies, and the impact of different strategies on the distribution of income” (137-8).

“The simple model developed in the early sections of the chapter was extremely Walrasian and neoclassical in spirit. With the exception of taxes on factor incomes and a brief allusion to fixed wages for certain labor categories, there was essentially no difference between the technologically feasible production possibility set and the resulting transformation set reflecting market behavior and institutional characteristics of the economy. All markets cleared. Applied models, whoever, although close in spirit to the Walrasian construct, can be characterized as reflecting a “constrained” general equilibrium. For example, the discussion of fragmented capital and labor markets in the two-stage formulation of the dynamic model indicated that the extent of factor mobility between time periods is affected by the degree of structural rigidities in the economy” (180).

I did not read this book in any detail, though it offers a very thorough explanation of CGE models in contrast to linear models.