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Lee C. Adkins∗ Dan S. Rickman April 20, 2002 Abid Hameed

Abstract Computable general equilibrium (CGE) models are often criticized for their use of restrictive functional forms and reliance on external sources for parameter values in their calibration. CGE proponents argue that in many instances reliable econometric estimates of important model parameters are unavailable because they must be estimated using small numbers of time-series observations. To address these criticisms, this paper uses a Bayesian approach to estimate a translog production function for use in a regional computable general equilibrium model. Using priors based on more reliable national estimates, and parameter restrictions required by neoclassical production theory, estimation is accomplished via Markov Chain Monte Carlo simulation. A stylized regional CGE model is then employed to contrast policy responses of a Cobb-Douglas speciﬁcation with those based on the estimated translog equation.

Key Words: Bayesian estimation, regional models, CGE modeling. JEL Classiﬁcation: C68, C11, R15

∗ Department

of Economics, Oklahoma State University, Stillwater, OK 74078.

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1

Introduction

A primary criticism leveled against regional computable general equilibrium (CGE) models is that they rely on external sources for the elasticity values required in calibration; routinely, they are drawn from national and international studies that are not comparable or are out-dated (Partridge and Rickman, 1998). The problem is that suﬃcient time-series data seldom exist to econometrically estimate CGE models (Mansur and Whalley, 1984; Shoven and Whalley, 1992, p. 106), particularly at the regional level. In addition, concerns exist regarding the statistical reliability of econometric estimates obtained from limited timeseries data for a single region (Treyz, 1993, p. 454). The absence of regionally estimated production functions has also led to widespread use of the Constant-Elasticity-of-Substitution (CES) class of functions. Whether or not a uniform constant-elasticity-of-substitution accurately portrays production in the region under examination typically is not addressed. Previous studies have shown that CGE model results can be quite sensitive to use of the CES class of functions versus ﬂexible functional forms (Hertel, 1985; McKitrick, 1998). Although qualitative insights obtained from a CGE model may be relatively insensitive to the choice of production elasticities, quantitative predictions are more likely to be greatly aﬀected. In their review of the regional CGE literature, Partridge and Rickman (1998) argue that practical approaches should be taken to overcome data limitations in the calibration of regional CGE models. One such practical solution is provided by Bayesian estimation of the desired parameters. In the Bayesian approach, prior information on the likely values of the elasticities or other parameters of the model can be directly incorporated into the estimation of regional production relationships. Given the greater avail-

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a noninformative prior. an out-of-sample forecast comparison is made between conventionally and Bayesian estimated translog functions. In addition. 2 Background Following common practice in applied general equilibrium modeling.ability and quality of national data. The weight placed on the prior mean and precision can be controlled using a single hyperparameter in the prior distribution. the Bayesian approach enables us to impose complex restrictions required by neoclassical production theory on the estimated regional translog function. The advantage of calibration is that it only requires the selection of a functional form and data for a benchmark year 3 . Because of the intractability of Bayesian estimation in multi-dimensional space. which places a very small weight on prior mean. Markov Chain Monte Carlo (MCMC) simulation is used. the Cobb-Douglas production function is compared to the translog within the Bayesian framework. In addition. regional CGE practitioners have favored the calibration approach in parameterizing their models over econometric estimation. is easily incorporated into the analysis if desired. Finally. a stylized regional CGE model is employed to contrast policy responses of calibrated Cobb-Douglas and estimated translog speciﬁcations. For evaluation purposes. consequently. they become a natural source of prior information for Bayesian estimation at the regional level. Therefore. Bayesian prior means and precisions matrices are obtained using estimates from national translog models. in this paper we use prior information estimated from national models in our implementation of a Bayesian approach to estimating translog production functions for the Oklahoma manufacturing sector.

such as elasticities. Hansen and Heckman. or from out-dated studies. Shackleton. 1984. and Wilcoxen 1999). Moreover. in which the elasticity of substitution equals one.1 The calibration procedure leads to routine use of the Constant Elasticity of Substitution (CES) class of functional forms. and McKibbin. and Whalley (2001) discuss the role of calibration in economics Kydland and Prescott (1982) and much of the real business cycle theory that followed assumed a Cobb-Douglas relationship between capital and labor in aggregate production 2 Likewise.(Shoven and Whalley. 1 Dawkins. 4 . Shackleton. only three did not employ production functions of the CES class. 1992. Among thirty-ﬁve regional CGE studies reviewed by Partridge and Rickman (1998). in which. 1996).g. Shoven and Whalley. the extent of estimation is limited by data considerations. were reported as being commonly used. McKibbin. 1998). Jorgenson. For example. However. p. 1992). and if time-series data are available an unnecessary loss of information occurs (McKitrick..2 Most studies also reportedly contained an input-output production component. Slesnick and Wilcoxen. And Cobb-Douglas production functions. reliance on one year of data makes the system under-identiﬁed (Lau. there is no mapping between the model and the time-series data in benchmark year calibration. 1984. 1992. In contrast to econometric modeling. Defenders of the calibration approach point out that typically insuﬃcient timeseries data exist to reliably econometrically estimate the models (Mansur and Whalley. parameters. 106). Yet. Srinivasan. and Wilcoxen (1999) eschew estimation of ﬂexible functional forms because of insuﬃcient data. a single non-negative substitution elasticity across all pairs of factors is imposed. may have been estimated for geographical and industry classiﬁcations that are inconsistent with those of the model. A few studies have incorporated econometric estimation into large-scale CGE models (e. which implicitly speciﬁes a zero elasticity of substitution.

Given that a FFF is an approximation to some underlying production function. Shakleton and Wilcoxen (1999) follow in a Bayesian vein by imposing 5 . Yet in addition to restricting themselves to the CES class of functions. An early use of Bayesian estimation of production can be found in Tsurumi and Tsurumi (1976). The likelihood of ill-behaved functions though. which also can be problematic (Perroni and Rutherford. 1998). the CES class of functions satisﬁes the requirement of global regularity. in which a Bayesian framework was noted as one possibility. they also employed a non-informative prior. well-behaved production function does not preclude a lack of global regularity. some approach is required that increases the ability to obtain a well-behaved regional FFF over some range of plausible values. In estimating nested CES functions. a locally. 1980). even allowing for the possibility of complementarity. the regions of regularity for FFF can be large (Caves and Christensen. even locally. which estimated a CES production function for Japan. In their assessment of the longstanding debate of calibration versus econometric estimation of CGE models. for some parameters. A FFF that does not possess proper curvature can cause numerical solution of a CGE to fail. Diewert and Wales (1987) also note that imposition of global concavity on FFF can destroy some of their desirable second-order ﬂexibility. Partridge and Rickman (1998) suggest practical remedies. care must be exercised to ensure that it satisﬁes neoclassical restrictions. McKibbin. To move beyond the CES class of functions then. For example. but at the expense of making strong assumptions about input substitution.Alternative ﬂexible functional forms (FFF) have the advantage of allowing for diﬀerent substitution elasticities between pairs of factors. In addition. Nevertheless. increases with the use of regional data that are of shorter time-series length and subject to greater measurement error.

6 . truncating the posterior. The posterior density was obtained using MCMC simulation. Chalfant and Wallace (1992) used a Bayesian approach and Monte Carlo integration to impose inequality restrictions for monotonicity and concavity in their estimation of the U. Using the Berndt and Wood (1975) data for the U. Ingram and Whiteman (2000) employ a Bayesian approach to parameterize a dynamic stochastic general equilibrium model. motor carrier industry.S. However. in which the estimates can lie on the boundary of the constraint. particularly using Bayesian methodology to estimate a FFF with desirable economic properties.S. Griﬃths and O’Donnell (2001) impose inequality restrictions in Bayesian estimation of a consumer demand system. Similarly. Chua. they specify an aggregate Cobb-Douglas production function. Point estimates were obtained by minimizing a quadratic loss function deﬁned over the truncated posterior density. DeJong. but did not incorporate realistic estimates of the prior mean and precision into his estimation of the model. Terrell incorporated an informative prior in terms of imposing monotonicity and concavity conditions over various ranges of factor prices. This diﬀers from quadratic programming. Terrell (1996) utilized a Bayesian approach in the estimation of ﬂexible national production functions. however. no study that we are aware of has estimated a regional production function for use in regional CGE modeling.some arbitrary lower energy elasticities to make the model better track timeseries movements of energy and output quantities.. and was only deﬁned over the parameter space in which the restrictions were met.

1996). Guilkey. n) (2) 7 . . The translog function is selected because of the additional ﬂexibility it provides over the Cobb-Douglas. such as the Generalized Leontief.1 Translog Cost Function Following convention. and the translog appears to be the most popular (Greene. and i=1 j=1 aij = 0.g. j. 1997. the literature has produced mixed results concerning which FFF possesses the most desirable properties (e. if the coeﬃcients of the additional quadratic and cross-terms are zero. Although other FFF are possible. p. We speciﬁcally assume a transcendental logarithmic (translog) cost function that exhibits constant returns to scale and a constant technology parameter: n ln c(p) = a0 + i=1 ai ln pi + 1 2 n n sij ln pi ln pj . 3.. we econometrically estimate factor share equations derived from the cost function. 695). 1983. (i = 1. the CobbDouglas is obtained as a limiting case. . also. Caves and Christensen. j=1 i=1 (1) where aij = aji ∀i. Terrell. Lovell and Sickles. 1980. . n n ai = 1. .3 Bayesian Estimation of the Translog Cost Function This paper therefore estimates a translog production function of Oklahoma manufacturing for use in a regional CGE model.

can easily be used with this procedure if preferred. The necessary condition for concavity requires that the matrix of second derivatives with respect to input prices be negative semi-deﬁnite. Monotonicity in input prices assures that the shares from the translog function are non-negative (Si > 0) and that they sum to one.3 Diﬀerentiation of (1) with respect to input prices and application of Shephard’s Lemma yields the following share equations (Si ): ∂ ln c = ai + ∂ ln pi Si = aij ln pj j ∀i (3) Using the estimated parameters of the share equations. 5 The restrictions implied on elasticities are as follows: σ ≤ 0 and σ σ 2 ii ii jj ≥ σij .5 3 We also assume weak separability of material inputs from the n primary inputs. 4 Other measures of substitution. which leads to inequality restrictions on the elasticities. This assumption is necessitated by the lack of suitable data on heterogeneous input materials. This condition is equivalent to the restriction that the matrix of substitution elasticities be negative semi-deﬁnite. Allen-Uzawa (σ) elasticities of input demand and substitution can be calculated:4 2 Si − Si + aii 2 Si σii = and σij = Si Sj + aij Si Sj (4) The neoclassical properties of monotonicity and concavity can be checked for any given set of factor input prices. For any cost function the matrix is singular. which is evidenced by alternating minors in the elasticity of substitution matrix being of opposite signs. The restrictions are imposed to ensure that the cost function is homogeneous of degree one with respect to factor prices and exhibits symmetry in its cross-price derivatives.pi is the price of input i. and n is the number of inputs. 8 . so negative semi-deﬁniteness requires checking the ﬁrst n-1 principal minors of n-dimensional matrix. like the Morishima (Blackorby and Russell. 1989).

Sources for the cost of labor and total man-hours are from various issues of the Annual Survey of Manufacturing (ASM) and the Census of Manufacturing. Appendix A provides more details of data construction.) The price of capital is constructed following the rental cost of capital approach of Hall and Jorgenson (1967).2 Markov Chain Monte Carlo Simulation The i equations (5) can be represented as a system of n seemingly unrelated regression equations y = Zβ + ε (5) 9 . mining. labor and energy. and agriculture. The price of labor per man-hour is computed as total labor cost (payroll) divided by total man-hours worked. Energy consumption data is from the Energy Information Administration and is reported for the industrial sector: the combination of manufacturing. The price of energy is calculated as total cost of fuels and electric energy divided by gross millions of BTUs consumed. Primary inputs include capital. 4. 4.4 Implementation We estimate our model for the manufacturing sector of Oklahoma over 1971-1991 (excluding 1979-1981 because of data unavailability). (The ASM stopped reporting estimates for fuel costs in the 1980s. forestry and ﬁsheries services. construction.1 Data Data for input prices and cost shares are constructed as follows.

ν) (7) (8) where Wn represents the n-dimensional Wishart distribution. ν is the degrees of freedom parameter and S −1 is the scale matrix. . . The location parameters of the share equations are assumed to be normally distributed β ∼ N (β. . the conditional distribution of H given β is H|β ∼ Wn ((S + S)−1 . ν + T ) (9) with S = E E. . εn }. β2 . . H ⊗ IT ) (6) where H is the matrix containing the variances and contemporaneous covariances. . . The model’s errors are ε|Z ∼ N (0. i = 1. . . H β ) where H β = [H β + Z (H ⊗ In )Z] and β = H β (H β β + Z (H ⊗ In )y) −1 (10) 10 . . H −1 ) β H ∼ Wn (S −1 . . y2 . β = {β1 .where y = {y1 . the distribution of β for given H is −1 β|H ∼ N (β. and εi = yi − Zi βi . n along the diagonal. ε = {ε1 . . n. E = {ε1 ε2 . yn }. . βn }. ε2 . . As in Terrell (1996). Then. combining the prior and likelihood. Implementation of the Gibbs sampling algorithm requires the full conditional distributions of β and H. . . . . . εn } and Z is a block diagonal matrix with Zi i = 1. . . .

3. 4.The basic steps in the Gibbs sampler are: 1. redraw β |H [0] until these conditions are met. Repeat steps (2)-(4) until satisﬁed that convergence of the Markov Chain has been achieved. If so proceed to [1] the next step. 4. The other is noninformative in the sense that it eﬀectively imposes only the monotonicity and concavity on the Oklahoma production function.000 Gibbs samples are drawn.3 Prior Information In the estimation that follows. ν) = νS −1 2. In our application we used the unrestricted SUR estimates as starting values of β. E(Wn (S −1 . Initialize the sample with starting values for β and S. the ﬁrst 15. 11 . In this study. Check to see if β [1] [1] satisﬁes concavity and monotonicity. Note. Then to ˆ ˆ ˆ ˆ ˆ generate a starting value for H [0] we took ν ∗ S −1 where S = E E and E is the T xn matrix of SUR residuals. The ﬁrst is an informative prior mean and precision that are determined based on estimates from a national model.000 are used for burn in and are discarded in the computations of the statistical characteristics of the posterior distribution. 25. Generate H [1] |β [1] using (10). If not. Chib and Greenberg (1994) show that under mild regularity conditions this sequence converges to the actual joint density of the parameters as the number of samples approaches inﬁnity. two sets of prior information are used. 5. Generate β |H [0] using (9).

1987). capital. 1998). nonenergy materials. ˆ ˆ The prior scale parameter for the Wishart distribution. 1975). The inverse of the SUR covariance estimate is used as the prior precision. Rather than simply locate national elasticities in the literature. Thus. and purchased business services (KLEMS) for aggregate manufacturing and twenty two-digit SIC (20-39) manufacturing industries.. The national model is estimated using SUR and the resulting parameter estimates are used for β.g. and S = 102 In . S −1 is set equal to E E ˆ and E is the T xn matrix of SUR residuals from the national model. which were produced to provide various multifactor productivity indexes (Gullickson and Harper. The hyperparameter. Two sources of national data are used to develop the informative priors. The noninformative prior used sets β = 0. the priors are eﬀectively constructed based on elasticities obtained within the same framework as they are used (e. The ﬁrst source is data from the Bureau of Labor Statistics for 1949-1996. where K is the number of parameters in β. ν. H β = 106 IK . As seen in the results. H β . labor. 6 Increasing 12 . natural sources of prior information for a regional translog system are national estimates of the translog system. the same production inputs and the same restrictions). we estimate the translog system using the national data and use the estimates to construct the Bayesian priors. (sometimes referred to as the size of the notional sample6 ) is set equal to 20. which includes annual manufacturing data for the years 1947 through 1971. these choices eﬀecthe size of ν is another way of placing greater weight on the sample information and less weight on the prior. Included are data on annual price and quantity for output.Given the conventional approach of using nationally-based elasticities in the calibration of regional CGE models (Partridge and Rickman. The second source is the commonly used Berndt-Wood (BW) data (Berndt and Wood.

7 Of course. the national model cannot be evaluated at 1999 share levels due to the fact that data for it end in 1981 for the BLS sample and in 1971 for the Berndt Woods sample.1 Translog Estimates The US SUR results from Table 3 indicate that. The system satisﬁes the monotonicity restriction at the 1999 shares.tively exclude the national data from having any eﬀect on the regional model and only the restrictions implied by economic theory are employed. 5 Results First. Table 3 contains the Allen-Uzawa elasticities. The capital/energy substitution elasticity in each case is negative. as expected. all own price elasticities are negative. The estimated national production functions are both monotonic and concave at the means for both the BLS and BW samples. but is not concave. Tables 1 and 2 contain the estimated parameters of the share equations for each of the models considered. Homogeneity and symmetry are imposed as exact restrictions on the system. which are computed at the mean values of the shares for the US and at the 1999 values for each of the Oklahoma models. The latter was chosen because the CGE model used later will be calibrated to the year 1999. the translog share equations are estimated using SUR with each of the two national data sets and the Oklahoma data set. 13 .7 5. The energy share equation is omitted and its coeﬃcients are recovered using the aggregation restrictions. indicating that these inputs are complements. labor is substitutable with both capital and energy. The estimated SUR system for Oklahoma is not so well-behaved.

7% of the BW-based draws. To remedy this. while the capital/labor elasticity is much greater in absolute value. Note that all own price elasticities are now negative and lie in between those of the US SUR and the Oklahoma SUR estimates. Interestingly. the substitution elasticity between capital and energy is now positive–a consequence of forcing the own energy demand elasticity to be negative with the Bayesian prior.The energy own-elasticity has the wrong sign. Concavity was not violated using either informative prior.000 successful draws are used to compute various distributions of interest. The Gibbs sampler is initiated using 15. The Allen-Uzawa elasticities of substitution associated with the BLS and BW based informative priors are presented in the third column of Table 3. with the informative prior. The Gibbs sampler is used to simulate the posterior distribution using each national data set under both informative and noninformative priors. The results from the noninformative prior appear in the last column of Table 3. the diﬀerences are that the energy demand elasticity is negative and substantial in magnitude. another 10. while that between capital and energy is predicted to be positive 14 . After the burn-in. all demand elasticities are negative (by imposition of concavity). Again.000 successful draws. Labor and energy are no longer estimated to be substitutes. The capital and labor elasticities are quite similar to the unrestricted SUR estimates. The parameter estimates are calculated as the means of the posterior distributions. the Bayesian approach is applied. Table 6 documents the proportion of the used draws violating the concavity and monotonicity conditions. In fact. These results point to the diﬃculty in obtaining reliable estimates with limited time-series data for a single region. all inputs are estimated as substitutes.5% of the total draws using the BLS-based prior and in only 10. monotonicity is violated in 90.

5.2 Conﬁdence Intervals and Forecast Comparison In order assess the possibility that the data can be adequately described using a Cobb-Douglas production. So it does not appear that the Cobb-Douglas model is supported in the three factor model since the energy substitution elasticities are diﬀerent from unity. The conﬁdence interval for the capital-energy elasticity includes both possibilities of substitutability and complementarity. the capital/labor interval includes the value 1.S. McDaniel and Wong (2001) could not reject unity as the elasticity of substitution between capital and labor in 20 of 28 goods-producing industries. Balistreri. Using the noninformative prior. 15 .when evaluated at the actual 1999 factor shares in Oklahoma. both the capital/labor and capital/energy substitution elasticities are large and positive. In Figure 1 the posterior density functions are plotted for each of the elasticities estimated using the BW informative prior. none of the 90% intervals include one. Plots of the posterior pdfs give one a general sense of both the precision with which the parameters are estimated 8 Using a recently released data set by the U. 90% conﬁdence intervals (CI) are constructed for the substitution elasticities.8 In Figures 1 and 2 are the posterior distributions of each of the elasticities. Figure 1 is for the BW-based informative prior. If each conﬁdence interval includes the value 1. there is no support for the simpler speciﬁcation. For the informative BW elasticities. In fact. then there would be insuﬃcient evidence to reject the Cobb-Douglas speciﬁcation. again only the capital/labor coeﬃcient includes one in the 90% interval. while the other intervals do not. while Figure 2 is for the uninformative prior. Bureau of Economic Analysis. In the estimated model with the BLS-based informative prior.

and the Bayesian results lie somewhere in between. Using the Bayesian alternative. each sample point can be removed from the estimation of the model and be forecasted. The other parameters have much more dispersed distributions. The row labeled US SUR contains the results obtained using the national SUR estimates. Other elasticities are more precisely estimated. the RMSE standard errors appear in parentheses. The density is widely dispersed from -5. 1 step-ahead root-mean-square forecast errors (RMSE) are computed for each of the estimations. The own-price energy elasticity is imprecisely estimated and badly skewed. the OK SUR results are most accurate. Also. for each model a total of 17 1-step forecasts can be made. The US SUR results are least accurate. there are a couple of interesting things to note about the densities associated with use of the noninformative prior.8. As another exercise. In Figure 2. as required economic theory. and the Bayesian rows contain the results from the Bayesian procedures. In fact. the latter violate concavity and possibly other restrictions implied by economic theory. So. Since the model is not dynamic. This was also evidenced in the conﬁdence intervals. 16 . Making predictions or forecasts using inconsistent models is risky in the sense that nonsensical results can go undetected. although somewhat skewed as well. the OK SUR row contains the results using the Oklahoma unrestricted SUR estimates. note that the capital/energy and energy/energy elasticities are highly skewed.as well as any propensity for the estimators to yield truncated or skewed distributions. the energy demand elasticity is truncated at zero. violation of restrictions is avoided. First. notice the relative precision with which the σLL and σKL are measured.6 to -2. These are averaged by model and again over shares to obtain the results in Table 4. Although the Bayesian RMSEs are inferior to those of the Oklahoma SUR.

Correspondingly. 5. and (1 − α − δ). twosector. δ. Oklahoma production (Q) is divided into manufacturing and nonmanufacturing. (11) Cost minimization subject to equation (11) produces the factor costs shares of α. or by the translog input demand equations derived from equation (3). Manufacturing goods can be purchased either 17 .and information on local production relationships is incorporated. Nonmanufacturing production is governed by a constant-returns-to-scale CobbDouglas function: Q = AK δ Lα E 1−δ−α . In the regional CGE model. Thus. labor and energy.3 CGE Simulation Comparison of Cobb-Douglas and Translog Models A question that naturally arises is how much diﬀerence does it make to use the Cobb-Douglas production function instead of the translog in a regional CGE model? Despite similarities in the estimated elasticities. Manufactured goods are assumed to be basic goods (B). Manufacturing is alternately speciﬁed according to the input demands derived from the Cobb-Douglas cost shares. each employing capital. and the predicted economic responses to exogenous policy changes by the Cobb-Douglas versus the various estimated translog equations are compared. to answer this question a simple comparative static. predicted outcomes of the two may be quite diﬀerent because of interactions with key components of the CGE model. Cobb-Douglas and translog cost functions (C) are derived. regional CGE model is formulated. while nonmanufacturing goods are nonbasic (N B).

which precludes nonresident factor ownership. (14) (15) where s denotes supply. eL . the factors become perfectly mobile. As eL and eK approach inﬁnity. is calculated as the unit expenditure function from the CD utility function. pBX is the price of export goods and εx is the export elasticity. γ. and eK are the elasticities of factor response to reward diﬀerentials. equalizing the regional factor returns with those of the nation. Returns to labor and capital generated by production in the region determine regional income. Regional utility is also given by the Cobb-Douglas function: φ γ U = BR BI N B 1−φ−γ . w is the relative before-tax wage rate in the region. and cpi is the regional consumer price index. (12) As the numeraire good. pBX (13) where the asterisk (*) denotes base year value. r is the relative rate of return to capital in the region. Manufactured exports (BX ) are price elastic: ∗ BX = BX ( 1 εx ) .from within the region (R) or imported (I). Capital and labor are assumed imperfectly mobile: LS = eL ln (w(1 − t)/cpi)L∗ S ∗ KS = eK ln (r)KS . t denotes the tax rate on labor. Taxes are assumed spent on private goods 18 . Maximizing equation (12) subject to regional income yields expenditure shares of φ. The variable. Energy is assumed perfectly elastically supplied at exogenous national prices. cpi. the price of imports is set equal to unity. and (1−φ−γ).

10 Table 7 reports the percent changes in key variables for the three model speciﬁcations.by government consistent with private consumption patterns. The lower costs stimulate manufacturing exports. the loss of deductibility against the federal government is ignored. No problems of nonconvergence or nonuniqueness of equilibrium were encountered in any simulation. Using the above CGE model. 1998). labor demand increases far exceed those of capital. 19 . In general. A comparison of predicted responses to the policy change across speciﬁcations of manufacturing appears in Table 7. Partridge and Rickman. consumption of all goods rises. with nonmanufacturing (nonbasic) goods increasing the most because of their greater reduction in price. Increased production leads to an increase in real income. Static equilibrium requires full employment of factors. A comparison of the ﬁrst two columns shows the dramatic diﬀerences in results that occur from specifying manufacturing by a calibrated Cobb-Douglas (CD) function versus using a translog function esti9 Since the federal government is omitted. Thus. however. Because of the lower relative costs. and zero proﬁts in each sector. the equilibrium conditions can be calibrated to a benchmark data set (Mansur and Whalley. The omission should not aﬀect the comparison of the results across models. and for translog speciﬁcations of manufacturing corresponding to the elasticities reported in Table 3. the economic eﬀects of removing the personal income tax in Oklahoma is simulated. particularly in labor-intensive nonmanufacturing. Given values for elasticities in the model. eliminating the tax on labor reduces production costs. zero excess demand in product markets.9 Simulations are performed using benchmark Cobb-Douglas production shares for manufacturing (consistent with the typical CGE calibration approach). Key elasticities and benchmark data are presented in Appendix B. 10 A variant of Newton’s method was used to solve the model. leading to possible overstatement of the eﬀects. 1984.

mated based solely on Oklahoma data. With lower estimated substitutability between labor and energy. in contrast to a predicted increase by the calibrated CD. manufacturing capital is predicted to decline. we formulated Bayesian priors based on comparable 20 . the Bayesian BW prior produces lower estimated expansion in the demand for labor.6 percent in predicted responses between columns (1) and (2). The simulation results obtained using the Bayesian noninformative prior (column 3) are close to those of the Oklahoma SUR results. The results from using the Bayesian informative priors. The BLS prior results are remarkably close to the CD results. Overall. which only diﬀer because of the monotonicity and concavity imposed during Bayesian estimation. The predicted response of real income diﬀers by over ﬁfteen percent of the estimated response. overall. are closer to the CD results than the Oklahoma-based results. This appears attributable to the near proximity of the BLS translog labor substitution elasticities to unity.7 percent. Because of the greater Oklahoma translog capital-labor elasticity of substitution. we employed a Bayesian approach in estimating a translog production function for the Oklahoma manufacturing sector. In the estimation of regional translog production relationships. there is an average absolute diﬀerence of 42. and an absolute average deviation in predicted responses of 7. The intractability of Bayesian estimation in multi-dimensional space led to the use of Markov Chain Monte Carlo (MCMC) simulation. This occurs because of the similarity in estimated elasticities. 6 Summary and Conclusion In an attempt to address the criticism of regional CGE models regarding their parameterization.

The policy responses from a stylized regional CGE model depended greatly upon whether a calibrated CD function for manufacturing or a translog function estimated with Oklahoma data was used. The within-sample rejection of the Cobb-Douglas speciﬁcation during estimation of the translog cautions against blind use of the CD. Francois. The out-of-sample forecast accuracy of the Bayesian uninformative prior model suggest its use in the regional CGE model since it will then better track time-series movements in Oklahoma production quantities. and imposed restrictions required by neoclassical production theory. which is a criterion receiving increasing emphasis in applied general equilibrium modeling (e. We demonstrated how. In addition. The Bayesian approach also provides posterior distributions of the parameters that can be used to assess the eﬀects of their uncertainty in sensitivity analysis. 2001). out-of-sample forecasts produced by the Oklahoma translog functions were most accurate. Using informative national priors produced results closer to the Cobb-Douglas. and ill-behaved ﬂexible functional forms can be overcome. with the Bayesian approach. problems of insuﬃcient data. Yet. indicating the need for the Bayesian estimation approach. Ingram and Whiteman. the SUR Oklahoma results violated neoclassical restrictions. and did not violate the neoclassical restrictions. 2000.g. The results of using an uninformative Bayesian prior produced results close to the SUR Oklahoma results.. With FFF. CGE practitioners should seek to determine whether the CD ﬁts their economy under study.national translog estimates. Advances in computing technology have made Bayesian approaches to evaluation and estimation much more feasible. CGE practitioners also can examine how sensitive the results 21 . DeJong. We rejected the Cobb-Douglas production function as a limiting case within the sample.

A A. 22 . They could even explore how sensitive the choice of functional form is to other closures of the CGE model.are to functional form. (16) where rt is the interest rate. Such exercises would surely produce greater conﬁdence in the quantitative predictions of CGE models among their consumers. Incorporating taxes produces a slightly revised version Ct = TXt (Pt rt−1 + δPt − ∆Pt ).1 Data Construction Price of Capital Following Hall and Jorgenson (1967). δ is the depreciation rate. the user cost of capital is calculated as the sum three components: Ct = Pt (rt + δ − ∆Pt /Pt ). and Zt is the present value of depreciation deductions for tax purposes on a dollar’s investment over the lifetime of the good. and ∆Pt /Pt represents the price changes of the capital goods. (17) TXt is the eﬀective rate of taxation on capital income: TXt = 1 − γZt /(1 − γ). where g is the eﬀective corporate income tax rate.

The reason for this diﬀerent approach is that it overcomes some of the estimation problems with the standard perpetual inventory methodology. any estimation errors will be magniﬁed over a relatively long time period and will be compounded for most recent years. See Hameed (2001) for additional details of the construction of the capital stock.A. Capital stock reﬂects ﬁxed business investment. this approach does not require a regional gross investment series that extends back to the early 1900s and thus is not hampered by regional data limitations. To implement equation (18) we use the Reverse Perpetual Inventory Methodology of Schnorbus and Giese (1989). D is annual depreciation (D).2 Capital Stock The capital stock series for Oklahoma is constructed using a variant of the perpetual inventory method (PIM). which incorporates expenditures on nonresidential structures (plant) and producers’ durable equipment. First. any estimation errors in this new method will accumulate over a relatively shorter period of time and will be compounded for earlier years. We pick 1986 as the base year and estimate regional net capital stock for this year and then use the perpetual inventory methodology in reverse to calculate 1985 to1970 estimates and forward to calculate 1987 to 1989 estimates. Schnorbus and Giese (1989) recommend begin by picking a base year and then using perpetual inventory methodology in reverse to calculate regional net capital stock. In contrast. Instead of building capital stock estimates from a gross investment series. and adjusted by a price deﬂator: n RNKt = t=1 ((HGIt − Dt )/PGIt ) (18) where HGI is historical dollar gross investment time series. Also. 23 . net capital stock is calculated. In addition. and PGI is a price deﬂator. which takes into account depreciation. with the perpetual inventory methodology.

92.65 24 . natural gas liquids. – Nonmanufacturing: Q = 66. and coke not reported as HLP. Inc. Light. • Regional Utility: φ = . and fuel (primarily crude oil. Further. Total feedback price and quantity inputs are estimated by a Tornqvist price index of crude oil. δ = . the feedstock component of the total energy is calculated from data on reﬁnery input of crude oil. Crude oil input is taken from Energy Information Administration (EIA).594 (Source: Minnesota IMPLAN Group. Finally. and Power (HLP) applications. Natural gas liquids are taken from American Petroleum Institute (API). δ = . 480. and coke prices. 248.A. α = .91. natural gas liquids. B CGE Parameters • Value Added (Source: 1999 BEA Gross State Product): – Manufacturing: (Cobb-Douglas) Q = 18.070976.3896.462. Coke input quantities are taken from EIA. 722.108529. The HLP input price and quantities are based on the Census Bureau’s Census of Manufactures (CM) and Annual Surveys of Manufactures (ASMs). gases. ex = 1. total energy-input prices and quantities are estimated by a Tornqvist price index of HLP and feedstock prices. α = .1996). and the Producer Price Indices (PPI) for various fuel types. γ = .538. ∗ • Exports: BX = 12..4104.3 Energy Prices Energy input prices and quantities include aggregate fuel and electricity used in Heat. and coke) used as feedstock input in the production process.

1986. Production: An Argument for Cobb-Douglas. Blackorby. and David O. Edward J. "Energy Price Shocks and Productivity Growth in U. eK = 5. pp.028.. eL = 0. "Will the Real Elasticity of Substitution Please Stand Up? (A Comparison of the Allen/Uzawa and Morishima Elasticities). U. Robert Russell.0. References Balistreri." Review of Economics and Statistics 57. 1993. ______. Cassella. 1989. Manufacturing. and the Derived Demand for Energy. 1975. International Trade Commission Office of Economics. 1-31.738. 25 "Explaining the . Prices. Working Paper 2001-12-A.S." Oxford Review of Economic Policy 2. pp. George. McDaniel and Eina Vivian Wong. pp. An Estimation of Industry-Level Capital-Labor Substitution Elasticities for U. George and Edward I. 882-888.555. • Income tax rate: t = 0. 376-384.S.92 S ∗ – KS = 38331.K.• Factor Supply (Source: 1999 BEA Gross State Product): – L∗ = 41820. Charles and R. "Technology." The American Economic Review 79(4). Ernst R. Berndt. and U. Wood. Christine A.S. 2001.

" in Handbook of Econometrics: Volume 5. pp.. 269-291. W. 1987. Whiteman. H. 1980. Caves. 43-68. and T. and Nancy E. James A. Chua. "A Bayesian Approach to Dynamic Macroeconomics. Leamer.N. "Calibration. Christensen.J. C.J. David N. Wales. "Bayesian Model Averaging in Consumer Demand Systems with Inequality Constraints. pp.J. Motor Carrier Industry.E. Griffiths. J. Elsevier Science. pp.. pp. Whalley. pp..S. 2000. W.. DeJong.Gibbs Sampler. Elsevier Publishers.E." Journal of Econometrics 92. "Global Properties of Flexible Functional Forms.." Canadian Journal of Agricultural Economics 49. Bock. Beth F. 2001. Chalfant." Econometrica 55." The American Statistician 46. Lutkepohl and M. Srinivasan and J.E." American Economic Review 70.L. 26 . Dawkins. W. Wallace. "Bayesian Analysis and Regularity Conditions on Flexible Functional Forms: Application to the U. C. Diewert. O’Donnell. Ingram. 422-432. T. Griffiths. and C. eds." in Readings in Econometric Theory and Practice. 2001. "Flexible Functional Forms and Global Curvature Conditions. Douglas W. and Charles H. 1992. eds. 167-174. 203-223. Heckman and E. and Laurits R.

Joseph. "Bayesian Estimation of a Regional Production Function for Oklahoma Manufacturing. 721-741. "Tax Policy and Investment Behavior." Journal of Economic Perspectives 10. and Dale W. 1983. Gullickson." Monthly Labor Review 110. Hall. 2001. K." PhD dissertation. Sickles.Francois. Stuart and Donald Geman. 391-414. 1947-1983. pp. Harper. 1996. Adelaide University Center for International Economic Studies. Hansen. Discussion Paper No. Guilkey.. Lovell and R. "A Comparison of the Performance of Three Flexible Functional Forms. "Stochastic Relaxation. and James J. Gibbs Distributions and the Bayesian Restoration of Images. Robert I. New Jersey: Prentice Hall. Abid. pp." IEEE Transactions on Pattern Analysis and Machine Intelligence 6. Heckman. Oklahoma State University. 591-616. pp. D." American Economic Review 57. William and Michael J. Geman. William H. 1984. pp. Hertel. 2001. "The Empirical Foundations of Calibration. Greene.. Jorgenson. "Multifactor Productivity in U. Manufacturing. Econometric Analysis. 87-104.S. Hameed." International Economic Review 24.. 1985.P. 1967. Flexible Estimation and Inference within General Equilibrium Systems. 1987. W. 1997. "Partial vs General Equilibrium Analysis and Choice of 27 . 18-28. L. 0129. T.

pp. Ross R. 543-573.J. Microeconomics. L." In Applied General Equilibrium Analysis. "Comments. 1999. Implications for Policy Modeling. 1998. Wilcoxen. 319-46.E. Mansur." Journal of Policy Modeling Jorgenson. and John Whalley. 1982. eds. Daniel T. Herbert New York: Cambridge University Press.. "Time to Build and Aggregate Fluctuations. pp. Lau. Scarf and John Shoven. Kydland. "The Econometric Critique of Computable General Equilibrium Modeling: the Role of Functional Forms. and Data." Resource and Energy Economics 21. 1992. Warwick J. 1984." In Applied General Equilibrium Analysis. 393-441.C." Econometrica 50.. pp. eds. 1984. "Carbon Taxes and Economic Welfare. Prescott. and Peter J. pp.. Calibration. "Numerical Specification of Applied General Equilibrium Models: Estimation. McKibbin. Shackleton. 28 . Slesnick. 1345-1370.. F. New York: Cambridge University Press. and E. Dale W." Economic Modeling 15.. 281-303. A.Functional Form: 7. pp. Robert and Peter J. Herbert Scarf and John Shoven." Brookings Papers on Economic Activity. Wilcoxen. McKitrick. "What to Expect from an International System of Tradable Permits for Carbon Emissions.

IMPLAN Professional. Stillwater. pp. pp. "Incorporating Monotonicity and Concavity Conditions in Flexible Functional Forms. York: Cambridge University Press. Rutherford. Inc. George I. Economic Forecasting and Policy Analysis. 1976. New Terrell. 1993. Shoven. and John Whalley.. Regional Economic Modeling: A Systematic Approach to Boston: Kluwer Academic Publishers." International Regional Science Review 21. John B. 1996.Minnesota IMPLAN Group. Tsurumi. Rickman. Treyz. and Y. pp. pp. 1998. 1992. 1996. Performance of "A Comparison of the Flexible Functional Forms for Use in Applied General Equilibrium Modeling. 1-25. Carlo and Thomas F. "Regional Computable General Equilibrium Modeling: A Survey and Critical Appraisal. MN. Applying General Equilibrium. Tsurumi." Computational Economics 11(3). Partridge." Journal of Econometrics 4. and Dan S." Journal of Applied Econometrics 11(4).. 205-248. 1998. H. "A Bayesian Estimation of Macro and Micro CES Production Function. 245-63. Mark D. 29 . 179-194. D.. Perroni.

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