The Impacts of Trade Liberalization Policy on theRegional Economyin Indonesia : An Inter‑Regional
Computable General Equilibrium Model
Suminori Tokunaga (University of Tsukuba)
Sun Lin (Institute of Social Science in Shanghai)
Nguyen Tien Dung (Nagoya University)
１．Introduction

２．The IRCGE model

In this paper,we examine the impacts of theThe primary data source were the 1995

trade liberalization policy on regional econ-

regional input-output (IO) table of Indonesia

omy in Indonesia, following the 1995 Inter-and the 1995 Interregional Social Accouting

regional Social Accounting M atrix (IRSAM) .

Matrix (SAM ) of Indonesia. The basic model

In this model,the Indonesia economy is divided

in this study follows closely that of Resosudar-

into three regions such as Java, Sumatra andmo, Wuryanto, Hewings, and Saunders (1999),

other region.

Furthermore Java region isWuryanto (1996), in which they were basicallydivided into three micro regions (east Java,

the CGE model by Thorbeckeʼs (1992) andcentral Java and west Java). We focus on thedivided only two regions of Java and outerreal side of the regional economy,and conveya

Java. Since the regional economy of outercomparative static-type of analysis.

Islands such as Sumatra,Kalimantan and Irian

This paper is organized as follows. Section

Jaya is dominated by oil/gas and natural, we

2 describes the Inter-Regional Computabledivide Indonesia economy into three regions ofGeneral Equilibrium (IRCGE)model. Section 3

Java, Sumatra and other region in this IRCGE

reports the analysis of impacts of some simula-model. This IRCGE model with three regions

tions of the trade liberalization policy. Finallyis specified in nine blocks: (1) spectoral pro-we present our concluding remarks.

duction and intermediate input,(2)factor market and income, (3) regional commodity markets, (4) institutional income and expenditure,

This paper was presented at the 7 PRESCO Sum-(5) government, (6) saving and investment, (7)mer Institute and 4 IRSA Conference Bali,Indonesia,

gross domestic product,(8)price structure,andJune 20‑21, 2002.
This 1995 IRSAM was made by Badan Pusat Statis-(9)market equilibrium conditions .
In the secotral production and intermediatetik (BPS)in Indonesia and JICA (Prof.Koichi Nidairaand S, Tokunaga)in March 1999.

inputs block, the production sector in each⎜ 99 ⎜macro region is divided into 15 sectors,and thefunction is derived according to the profit

classification follows exactly the sectoral clas-maximization principle. The result from thesification of the IRSAM for 1995. The produc-derivation shows that the sectoral labortion function in each sector and each region isdemand in each micro region depends on thepostulated as a homogenous CES (constantaverage wage in the corresponding category,elasticity of substitution) type in (E‑1). The

fixed labor demand proportionality (Ld ),andprimary production factors are aggregatethe value added price in the corresponding

labor (Lg )and capital stocks (K ). Aggregate

sector (PN )in (E‑4). The sectoral wage equa-labor demand is assumed to be mobile inter-tion employed in this studyfollows that applied

sectorally,but not interregionally. The capitalby Thorbecke (1992). According to his work,stocks in each sector are assumed to be fixed

the sectoral wage rates, which are derived

and immobile both inter-sectorally and inter-econometrically by taking into account theregionlly. The intermediate inputs are using

prevailing situation in the 1980s, are strongly

intra-regional and interregional coefficients,

influenced by the inflation rate (PQINDEX ),and there is no substitution between intermedi-

the price of the sectoral output (PX ), and theate inputs and production factors, and conse-

growth in labor productivity (OX /Lg ) (E‑5).

quently, there is no substitution among theAn import implication that underlies the for-intermediate inputs themselves in (E‑2).

mulation of the wage equations is that laborIn the factor market and income block, thefactor market specification follows exactly themarket segmentation exists in Indonesia, withwage being strongly sector specific.

IRSAM classification. There are five cate-The average wage rates (W )for each laborgories for labor demand, corresponding to thecategory are formulated based on the sectoral

categories regional of households. To be usedwage rates (Ws )and share(ωϕ )for each typein the sectoral production function in eachof labor category in each sector (E‑6). The

macro region,the corresponding micro regionʼslabor supply in each labor category is assumed

labor demand (L )must first be aggregated. Into be fixed, and it is assumed that some labor

this circumstance, the aggregated laborslack prevailed (in the forms of unemployment

demand by sector (Lg )for each macro region,or underemployment)in 1995 (E‑7). Labor andwhich appears as an argument in production

capital income,which is defined respectively infunction,is postulated using the Cobb‑Douglas(E‑8) and (E‑9), is specified according to eachtype of function (E‑3).

micro region based on the fixed labor andTo obtain the sectoral labor demand in eachmicro region (L ), the sectoral production

capital income proportionality (wd and kd ,respectively).
In the regional commodity market block,

The system of equations and definition of parametersand variables in IRCGE model of Indonesia will be in

the commodity flows incorporate simultane-

appendix A and appendix B.

ously the demand and supply side of the⎜ 100 ⎜regional economies. In the demand block, theformulated to depend on the ratio of the pricesectoral composite goods demand is postulatedof domestically produced goods (PX ) to theusing the Armington rule,which allows imper-

world price of exported goods (PE )in (E‑16).

fect substitution between domesticallydemand-

In the institutional income and expenditures

ed goods (XD)and imported goods (XM )in theblock, institutions in this paper include

corresponding sector (E‑10).

Applying cost

regional household groups, which are divided

minimization principles, the optimal level of

into five categories (correspond to the number

imported goods can be obtained,as can be seenof micro regions), and companies, which arein equation (E‑11).

categorized into three categories (correspondThe demand level for

imported goods depends on the ratio of theto the number of macro regions).

price of domestically demanded goods (PD) toIn the government block, the total govern-

the price of imported goods (PM), and thement revenue is the sum of governmentʼs reve-demand for domestically demanded goods.

nues in three regions in (E‑26). The govern-

The sectoral level of domestically demanded

ment in region receives its income(CGR )fromgoods (XD )is also postulated using the Armin-a fixed proportion of each of micro-regionʼ
sgton rule, which allows imperfect substitution

capital income, from national direct taxes,

between intraregionally demanded goods

from net national indirect taxes (IDT −SUB ,(XS ) and interregionally imported goods

E‑29 and E‑30), from import tariffs (TM , E‑(XS )(E‑12). Again, applying cost minimiza-31), and from the exogenous remittance fromtion principles, the optimal level of inter-abroad (grw )in (E‑27). The total government

regionally imported goods can be obtained. As

current expenditure (CGE) is the sum of gov-shown in equation (E‑13),the demand level forernmentʼ
s expenditures in three regions in (E‑interregionally imported goods depends on the32). The expenditure (CGE )of government inratio of the price of domestically producedregion, which is postulated to be equal to its

goods (PX ) to the price of interregionally

revenue,comprises the expenditure for govern-

imported goods (PXment consumption (CGTC (E‑33)), exogenous), and the demand level

for intraregionally demanded goods.

direct transfers to regional household (cgth ),On the supply side,the total sectoral domes-exogenous direct transfers between govern-tic supply in each region is determined simplyments (govtp ), exogenous government debt

by aggregating the intraregional supply (XS )service for foreign borrowing (gdebts ), andand interregional supply (XS ), as shown insavings (CGSV )(E‑32).

(E‑14). The total sectoral supplyin each region

In the saving and investment block, having

is formed by aggregating the total domestic

determined the savings behavior for each insti-

supply (XS )with the export supply (XE )(E‑

tutional account, the total savings (TS)defini-15). The sectoral export supply level in eachtion is specified in equation (E‑35). The total

region is determined by an export functionsavings is the sum of household savings, com-⎜ 101 ⎜pany savings, government saving and foreign

indirect taxes in (E‑44). The value of the grosssaving in (E‑36)and (E‑37). In equation (E‑38),

domestic product is generated by add up thethe government investment expenditure ingross regional domestic product at the market

region (RGINVD ) is determined by a fixedvalue in (E‑45).

proportion. As can be seen, the government

In the price block,the model specifies eightinvestment expenditure in each sector of origin

definitions of price structure, which are gener-(GINVO )is determined endogenously by pro-ally straightforward. In treating the importportions derived from the IRSAM table in (E‑and export market,the model employs a “small39).

country”assumption. As a consequence, theTotal regional private investment by desti-

world prices for imports and exports are taken

nation (RPINVD ) in this study is determined

as exogenous variables. The sectoral imported

endogenously by the current total output in thegoods prices by macro region (PM )are equalcorresponding region, previous year total out-

to the world imported goods prices (pwm ),put in the same region,and the annual interest

measured in domestic currency and adjusted

rate(IRATE)in (E‑40). To obtain the regional

for indirect taxes (idt ), import tariff (tim ),private investment by origin (PRINVO ), theand trade and transport margins (ttm ) in (E‑amount of total regional private investment by46). The sectoral exported goods prices (PE )destination must be pre-multiplied by regionalby macro region are postulated to be propor-

capital coefficient matrix (IMATT ′) in (E‑tionally related to the world export goods41).

prices (pwe ), adjusted for indirect taxes andThe amount of total regional private

investment by destination multiplied by thetrade and transport margins in (E‑47).

sectoral proportions derived from the IRSAM

In the market equilibrium conditions, thistable makes the sectoral private investment byblock of equations defines the closure rules ororigin (PINVO )in (E‑42). The final equation

system constraints that the model economy

specifies the total investment (TINV ), whichmust satisfy.

incorporates private investment and the gov-equilibrium in the product market. This equi-ernmentʼs investments in (E‑43).

librium is formulated in the Leontief material

The first condition concerns

In the gross domestic product block, thisbalance equilibrium condition. Therefore, theblock of equations contains only definitions for

total supply of composite goods i in r must

the gross regional domestic product at market

equal the sum of intermediate demand andvalues (GRDP ) from the income approach

final consumption demand by both the privateside, and the gross domestic product (GDP).

and the government (public)sector in (E‑54).

The gross regional domestic product is defined

The second condition concerns equilibriumas the sum of the regional production by sector

in the external market. The model specifies

multiplied by the corresponding net (or valuethat the sum of sectoral exports abroad byadded) price (PE ), plus the income from net

region, plus the institutional (the regional⎜ 102 ⎜

household, companies, and the government)

view of the policy direction for development

remittance from abroad, plus the government

plan in which Indonesian government is con-and private foreign borrowings must equal toducting the policy reforms towards market

the sum of sectoral imports abroad by region,oriented economy.

plus repatriated profits, plus capital (service)

To analyze the impact of a tariff reduction

payments to the rest of the world,and plus thefor the trade liberalization policy on thegovernment foreign debt service (E‑55). It canregional economy,we conducted the simulation

be seen that the exchange rate (ER)argument

analysis that the tariff is decreasing by 50% in

does not appear in this equation, because the1995 and the other exogenous variables areequilibrium condition is stated in US$ cur-fixed in 1995.

rency.

In simulation, we found that the direct

The third condition is related to the central

effects with the tariff cut are the reduction ingovernmentʼ
s budget constraints to financetariff revenue and the reduction in the import-

investment expenditures. Equation (E‑56) ex-

ed goods price. The tariff cut affects the realpresses that the deficits of the government

gross regional domestic products (GRDP) ininvestment expenditure is financed througheach region directly through definition equa-foreign borrowing (CGFBR). And the finaltion (E‑44)of GRDP. However,since tariff cut

equilibrium is concerning the situation inlowers the imported goods price and the com-which the total (or aggregate) savings must

posite goods price, the value-added price isalways be equal to the total investment in (E‑increasing due to cost reduction.

57).

industry activity, exports sectors such as tex-Then, in

In order to obtain the optimal solutions oftile sector in Jawa benefit, while import-

this IRCGE model,all equations must be solved

competing sectors are more likely to suffer

simultaneously in such a way that all thedamage in Figure 1A‑1C as was noted bymarkets are clear .

Haddad (1999). Thus,the real GRDP of Java isincreasing than in outer‑Java (Sumatra and３．Policy Simulation of Trade Liberalization

other region). The regional government revenue of Java is slightly decreasing, but government expenditure of Java does not change,thus

As we got the good baseline simulation

central government borrowing from abroad isresults for the IRCGE model,in this section,weincreasing. Table 1a summarizes the simula-examine the impacts of the trade liberalization

tion results on main macro variables. The realpolicy on regional economy in Indonesia, inGDP is increasing by 0.33 %, but the central
government revenue is decreasing by 8.96 %.

we utilize the GAM S release 2.5 optimization pro-Regarding the price index, the regional thegram.

price index is decreasing ranging from −1.16⎜ 103 ⎜

Figure 1a Production Effects of a 50% Tariff Reduction : Java

Figure 1b Production Effects of a 50% Tariff Reduction : Sumatra

Figure 1c Production Effects of a 50% Tariff Reduction : Other⎜ 104 ⎜

Figure 2a Imports Effects of a 50% Tariff Reduction : Java

Figure 2b Imports Effects of a 50% Tariff Reduction : Sumatra

Figure 2c Imports Effects of a 50% Tariff Reduction : Other⎜ 105 ⎜

Figure 3a Prices Effects of a 50% Tariff Reduction : Java

Figure 3b Prices Effects of a 50% Tariff Reduction : Sumatra

Figure 3c Prices Effects of a 50% Tariff Reduction : Other⎜ 106 ⎜

% (other region)to −1.38% (Java).

donesia Decentralize Successfully? Plans, Problems and Prospects,”Bulletin of Indonesian Economic Studies, Vol. 37, No. 1, 2001, pp. 83‑102.
Agenor,Pierre‑Richard and Peter J.M ontiel,Develop-４．Conclusion

ment Macroeconomics, second edition, Princeton

In this paper, following the 1995 Interregional Social Accounting Matrix (IRSAM ),we constructed an interregional Computable
General Equilibrium (IRCGE) M odel for three
regions of Java, Sumatra and other region inIndonesia, and examined the impacts of theUniversity Press, 1999.
Azis, Iwan, J., “Impacts of Economic Reform on
Rural‑Urban Welfare: A General Equilibrium
Framewark,”Review of Urban & Regional Development Studies, Vol. 9, No. 1, 1997, pp. 1‑19.
Fukuchi,Takao and Suminori Tokunaga,“Simulation
Analysis of Exchange Rate Dynamics: The Caseof Indonesia,”The Developing Economies, Vol.
XXXVIII, No. 1, M arch 1999, pp. 35‑58.

trade liberalization on regional economy.
From simulation of the tariff reduction byHulu,E.and G.J.D.Hewings,“The Development anduse of interregional input-output models for In-

50% in 1995, we found that the direct effects

donesia under conditions of limited information,”with the tariff cut are the reduction in tariff

Review of Regional Development Studies, Vol. 5,revenue and the reduction in the importedgoods price. The tariff cut affects the real

1993, pp. 135‑153.
Wuryanto, Luky Eko, Fiscal Decentralization andEconomic Performance in Indonesia : An Inter-

GRDP in each region directly through equation

regional(E‑44). However, since tariff cut lowers theApproach, Ph. D. Dissertation of Cornell Univer-

imported goods price and the composite goods

Computable General

Equilibrium

sity, 1996 May.
Nidaira,Kouichi,“An Analysis of the Regional Struc-price,the value-added price is increasing due toture in Indonesia by SAM”
, Studies in Regional

cost reduction.

Science, 2000.

Then, in industry activity,exports sectors such as textile sector in Jawa

Robinson,S.,“Multisectoral Models,”in Handbook ofDevelopment Economics, H. Chenery and T. N.

benefit, while import-competing sectors are

Srinivasan (eds.), Vol. 2, North‑Holland, New

more likely to suffer damage. Thus, the realYork, 1989, pp. 885‑947.

GRDP of Java is increasing than in outer‑Java.
The regional government revenue of Java is

Resosudarmo,B.P.,L.E.Wuryanto,G.J.D.Hewings,and L. Saunders, “Decentralization and Income
Distribution in the Inter Regional Indonesia Econ-slightly decreasing, but government expendi-omy”in Hewings, G. J. D, M. Sonis, M . Madden,

ture of Java does not change, thus centraland Y. Kimura, Understanding and Interpretinggovernment borrowing from abroad is increas-

Economic Structure,Springer Verlag,Heidelberg,1999.

ing. Regarding the price index,the regional theSilver, Christopher, Iwan J. Azis, and Larry

price index is decreasing ranging from −1.16

Schroeder, “Intergovernmental Transfers and% (other region)to −1.38% (Java).

Decentralization in Indonesia,” Bulletin of Indonesian Economic Studies, Vol. 37, No. 3, 2001,pp. 345‑362.
Thorbecke, E., Adjustment and Equity in Indonesia.

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