# **B. Confronting History and Theory: A General Equilibrium Analysis of Dutch Disease in Mount Lebanon of 1912**

With the mono-export of silk and net transfers from the Americas accounting respectively for 41 and 54 percent of GDP, the economy of Mount Lebanon was both particularly globalized and highly vulnerable to external shocks. The data set available for the year 1912 is suitable for a simple general equilibrium analysis.

# **_1. Dependence and Vulnerability to External Shocks: The Case of Mount Lebanon through a Simple General Equilibrium Framework_**

In the following, I use the simple general equilibrium framework of the 1 2 3 Model developed by Devarajan et al ( _Simple general equilibrium modeling – 1997 & The simplest general equilibrium model of an open economy - 1998_ ) to assess the effect of external shocks on the economy of Mount Lebanon.

The 1 2 3 Model builds on the Harrod-Samuelson-Balassa two-sector (tradable and non-tradable sectors) model to examine the effects of remittances, inflows, and external shocks. The model involves one country, two producing sectors and three goods. The country has a small open economy and is a price taker on the international market. The two producing sectors are (i) one sector that produces goods for export only and (ii) another sector producing goods for the domestic market only. The three goods are (a) export goods, (b) goods produced and consumed domestically (mainly non-tradable goods), and (c) imported goods. Remittances, export prices and import prices are set as exogenous variables. The model does not take factor markets into consideration. In this model, the RER is weighted by the shares of imports and exports in the total foreign trade of the economy, _PD M PD E_ according to the following equation: _RER_ = + where PD is the price of domestic _PM FT PE FT_

> goods, PM the price of imported goods, PE the price of exported goods, FT foreign trade, M

> imports and E exports _._ In this equation, real appreciation is equivalent to an increase.

The model fits the case of Mount Lebanon because: (i) Mount Lebanon was a small open economy; (ii) it had a large industry producing a single good dedicated for exports (silk) and (iii) relied on imports for almost all other types of goods, including food. The simulation aims to: (i) assess the impact of external shocks on GDP, income, and prices and, (ii) test the relation between remittances and exports. While the model assesses the spending effect of foreign inflows, it cannot assess the impact in terms of resource movement since it neglects factor markets.

# **_2. A Simple General Equilibrium Analysis for Mount Lebanon: Simulation and Results_**

The analysis below is done through four scenarios: a drop by 90 percent in remittances, an increase by 10 percent in remittances, a decline by 10 percent in the prices of exports, and a compensation for the effect of that decline on consumption through a rise in remittances. The four scenarios are designed in a way both to confront theory with history and to understand the latter through the former. Table 4 summarizes the results of all four scenarios. Prior to the simulations, I have brought the current account surplus to zero by increasing imports in resources and raising consumption and investment in uses. This is equivalent to assuming that Mount Lebanon did not build up reserves and used all the funds available. This modification neutralizes the effects, however limited, of a large 6