Village modeling : a Chinese recipe for blending general equilibrium and household modeling

The transformation of China into an outward-looking and increasingly industrialized country resulted in unprecedented growth rates. Benefits of economic growth, however, have not been distributed evenly and rising income inequality threatens social stability and future growth. High urban incomes attract a large number of rural migrants, transmitting the rising income inequalities to rural villages. This study provides the first quantitative analysis of the impact of rural-urban migration on a Chinese village economy. Existing village models do not reflect findings of the household literature on the importance of market imperfections. Prevailing imperfections in factor markets in rural China, however, necessitate an analysis that takes into account the nonseparability of household production and consumption decisions. This study therefore develops a methodology for analyzing interactions among households in a village economy, that bridges the current gap between household and village models. The resulting model is able to capture the impact of market imperfections on household decisions, as well as the impact of household decisions on other households in the village. Applying this model to a village in Jiangxi Province allows us to analyze the impact of rural-urban migration on households with and without access to migration. The Chinese village model builds on a village social accounting matrix that reflects nonseparability of household production and consumption decisions. This nonseparability is also reflected in the village model by introducing standard household modeling features in a general equilibrium model of the village economy. The village model is developed in three stages: (i) a model focusing on interactions among households with easy to calibrate Cobb-Douglas utility and production functions; (ii) a model focusing on the impact of migration by introducing Stone-Geary utility functions to account for the impact of migration on household consumption; and (iii) a model focusing on production decisions by introducing nested CES production functions. In contrast to most existing general equilibrium models, all elasticities in the village model are estimated from household survey data. The different versions of the Chinese village model are used to analyze three aspects of an exogenous increase in rural-urban migration on household decisions and welfare: (i) the impact of village interactions; (ii) a rise in remittances (without a change in household size) versus a rise in migration; (iii) the robustness of results to changes in utility and production functions. In qualitative terms results are robust across model versions. An increase in migration induces a shift to less labor-intensive rice production for households with migrants, while households without migrants move to more intensive rice production. The increased availability of cash in the village economy induces an increase in intensive livestock production. All households benefit from an increase in migration through village markets for village-produced consumption goods and animal traction. Comparing separate households models with a village-level analysis, we find that accounting for interactions within a village economy roughly halves household production response. Comparing an increase in remittances with an increase in migration, we find similar results in terms of household income. Welfare increases and production response, however, are much larger with migration due to the reduction in household size. Introducing Stone-Geary utility functions results in a shift in consumption, which translates to a higher demand for locally produced consumption goods. As a result households lacking access to migration experience a higher welfare increase. Introducing a nested CES production function has the opposite effect; increased input substitution possibilities temper changes in household input demand. As a result, benefits from an increase in migration largely remain with households involved in migration, causing a stronger increase in within-village income inequality.