Chapter 21. Income Distribution in Computable General Equilibrium Modeling

Studying the poverty and income distribution effects of macroeconomic policies or shocks requires a methodology that accounts on the one hand for the nature of the policy or shock being studied and their aggregate impact on the economy and, on the other hand, the heterogeneity of their overall effects among individuals or households at the micro level. Standard evaluation methods are of little use here. Methods based on the comparison between individuals exposed and not exposed to the policy or shock are clearly not applicable since, by definition, all individuals are affected by any policy with some macroeconomic dimension. The evaluation methodology thus needs to rely not only on a micro but also on a macro counterfactual within some kind of general equilibrium setting. This chapter reviews the growing literature that addresses this challenge by combining macro and micro modeling in various ways. It describes existing methodologies and their underpinning links with economic theory and presents some applications. The chapter is structured according to the nature of the computable general equilibrium (CGE) macro model being used and how the macro and micro components of the methodology are connected together and/or integrated. It thus starts from a simple framework where the two components are handled separately: the CGE model is static and Walrasian and the unidirectional link from the macro to the micro component essentially consists of changes in prices. It then moves to more integrated variants, where results from both the CGE and micro models are looped back and forth, and also to non-Walrasian specifications where both price and aggregate quantity changes link the macro and the micro components. Finally the chapter considers dynamic settings where the static CGE model on the macro side is replaced by a recursive-dynamic model, whereas the micro data base is allowed to change over time through both exogenous demographic and policy-induced endogenous economic transitions. Illustrations of that approach are drawn from the Global Income Distribution Dynamics (GIDD) model recently developed at the World Bank.