# **2. Methodology, transmission channels, and scenarios**

# **2.1 Global computable general equilibrium model Envisage**

The quantitative findings in this paper are based on simulations using a version of the Envisage model calibrated to GTAP Version 10A (Aguiar et al. (2019); see Annex 1 for aggregation mappings). The latter has a 2014 reference year and the model is being used in its comparative static specification. Envisage is a relatively standard computable general equilibrium (CGE) model.<sup>2</sup> The model has been configured for a short-term closure with the following assumptions:

- Production elasticities have been reduced to near zero, so there is little substitution possibility across inputs in production.

- In order to capture the typically durable relationship within global value chains, trade elasticities for goods have been reduced from their standard values to represent the short-run inability to replace imported components and final goods with products from other countries. The elasticity between domestic and imported goods has been set to 0.4. The elasticity of substitution across import sources has been set to 0.8.

- Labor supply is exogenous, while wages adjust to equate demand and supply of labor. The return to capital is fixed, while supply of capital is endogenous.

# **2.2 Transmission channels**

The shocks have been divided into four sets, but all are assumed to occur simultaneously, i.e. the final shock encompasses all shocks.<sup>3</sup> The duration of the shocks is currently unknown, though, based on prior events, it is likely to last from 8-12 weeks and most likely unsynchronized across countries.

1. The first shock is a drop in employment by 3 percent below the baseline. With lower availability of labor, we would expect wages, ceteris paribus, to rise, while return to capital is unchanged under our assumptions. Lower labor also means lower demand for capital, as firms need a combination of labor and capital to produce goods and services.

Underutilization of capacity takes place due to factory closures (workers stay home, leaving capital and natural resources idle) as well as social distancing forcing workers to stay at home. Due to higher rates of contagion, immediate unemployment consequences of COVID-related business closures and negative demand shock, we conservatively assume the underutilization of the labor force to be 3% on average over the whole year across all sectors of the economy.<sup>4</sup> There is a lot of uncertainty surrounding these assumptions, and the country-specific employment effects will depend on the duration and intensity of the pandemic and containment measures, the sectoral composition of employment, and the flexibility of the labor market.

> 2 A full description of the Envisage model is available at

> https://mygeohub.org/groups/gtap/File:/uploads/ENVISAGE10.01_Documentation.pdf.

> 3 The shocks are scaled down as compared with the shocks derived for Liberia under the Ebola epidemic, as in Evans et al. (2014).

> 4 This is a conservative estimate. Some estimates put potential reduction of employment at the annual level at 10%, assuming unemployment of over 30% in Q2 and returning to pre-crisis level in Q3 and Q4. <u>https://www.stlouisfed.org/on-the-economy/2020/march/back-envelope-estimates-next-quartersunemployment-rate</u>

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