elasticities that could not be estimated econometrically due to lack of data, we use international standards numbers based on IFPRI research: For the substitution between intermediate inputs and value added in the production function, we use a constant elasticity of transformation (CES). For the factor substitution elasticity we choose 1.2, the elastic of transformation is 4.0; and the Armington elasticity is 6.0 for all goods and services.

The model is recursive dynamic; that is, the dynamics occur between 2010 and 2015 in each year. In the baseline scenario as well as in all other scenarios, we assume that the nominal exchange rate is flexible. Exogenous variables in the model include the government consumption, transfers to households, foreign inflows, population growth and hence growth of the workforce—which all grow exogenously according to their trends in recent years. Investments are savings driven, which means that an increase of either private or public savings increases the economy-wide investment rate. The government budget is flexible in the model, which means that the government can adjust to changes in revenues and spending by increasing or decreasing the budget deficit (or its savings). For example, if petroleum subsidies are reduced, the government savings increase. This leads to an overall increase of savings in the economy, and thus to higher investment. It is important to note that real sector CGE models in general cannot capture the long-term benefits of low public debt/GDP levels and related lower interest rates for borrowing capital.

At the sector level, total factor productivity (TFP) increases exogenously to account for the differential growth patterns across sectors. Non-hydrocarbon capital is fully mobile across all sectors, and its intertemporal allocation follows the highest profitability by sector and period. Capital employed in the hydrocarbon sector is sector specific and cannot move to other sectors. Population growth, land, and productivity growth are all exogenously determined. Baseline growth in the model is driven by population growth (3 percent), supply of labor (3 percent), annual TFP growth changes of 3 percent in all nonagricultural sectors from 2010 to 2015, and an increase in government spending consistent with annual growth rates (3 percent). Changes of growth rates in the different scenarios relative to the base are mainly due to endogenous processes, such as the change of relative prices for factors and commodities from subsidy removal. Changes in public spending from subsidy reform are accounted for by exogenous changes in government transfers to households and sector level changes in TFP. For the size of these changes see Table 6.

To capture the distinct nature of the Yemeni labor market, mainly characterized by public/private employment and different skill levels, the model includes six types of labor. Accordingly, there are different wage rates for labor employed with the government and the private sector. Within each of the groups, workers are fully mobile and wage rates differ among skilled, semi-skilled, and unskilled labor. With this set-up the model can capture some of the distributional effects of growth that has characterized the Yemeni economy over the past years. Growth of the past years has been oil driven and did not trickle down to the poor and rural areas (World Bank 2007). One of the reasons were the segmented labor markets, where only few highly skilled laborers in the oil sector and government employees benefited from oil production and related government revenues.

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