Hannu Törmä, Ph. D, Docent, Research Director

Hannu Törmä, Ph. D, Docent, Research Director

Hannu Törmä, Ph. D, docent, Research Director

University of Helsinki Ruralia Institute, Seinäjoki Finland

+358-40-5389 680,

Regional Macro, Employment, Allocation and Welfare Effects of Lapua Town’s Two

Development Projects: Simpsiö and NovaPark – A CGE RegFin Model Application[1]

A paper presented at the Ecomod International Conference of Regional and Urban Modeling, Brussels Belgium June 1-3.2006.

Abstract

The Lapua town in South Ostrobotnia Finland is planning to implement two large-scaled development projects. In the Simpsiö project an underground population shelter would be built inside the Simpsiö mountain, which would serve as a sports center during normal time. Several wooden log-houses would also be built on top of the mountain to increase the volume of tourism in the area. The NovaPark project contains building a new trading center in which there would be one to two bigger supermarkets and several smaller shops. The total value of these building investments would be about 63 million euros. The regional macro, employment, allocation and welfare effects of the two development projects has been analyzed through simulations of the Finnish RegFin model. This multi-regional CGE simulation model characterizes economic activity in the six provinces of South Ostrobotnia and rest of Finland. Unemployment, net migration, commuting and provincial trade flows of the households are included in the analysis. The RegFin-simulations aim to quantify the regional short-run effects of the building phase, the regional long-run effects of the new business activity and the so called secondary effects based on commuting and trade flows of the households.

Table of Contents

Abstract

The Simpsiö and NovaPark projects

The CGE RegFin regional model

Parameterization of the development projects

Provincial effects of the development projects

Ex post calculations of the secondary effects

Conclusions

Literature

The Simpsiö and NovaPark projects

The location of South Ostrobotnia Finland is presented below.

Map 1. The location of South Ostrobotnia in Finland.

The Lapua town is planning to implement two large-scaled development projects. In the Simpsiö project the plan is to build an underground tunnel and a population shelter inside the Simpsiö mountain. It is possible to rearrange the tunnel to serve as a skiing tube. The shelter could serve as a sports center during normal time.

A wooden log-house village is planned to be built on top of the Simpsiö mountain. It would then be possible to do renting business with the so called 1/6 houses and with weekly rented houses. There would also be a possibility for the clients to build log-houses of their own. There would be a multi-purpose club house, called the Center point, where would be accommodation and restaurant services. The Simpsiö project is complemented by the already existing down-hill skiing resort and by an outside swimming pool that will be finalized during the project.

The Simpsiö development project is motivated by the fact that the present population shelter does not cover all of Lapua’s population. It is also seen that the use of the tunnel as a skiing tube would support the business activities connected to the log-house village and the Center point.

The NovaPark development project is a plan to build a new trade center, that would consist of one to two bigger supermarkets, of several smaller shops and of a traffic service station. The project is motivated by the fact that the people of Lapua travel to the nearby Seinäjoki province, which is a regional center of South Ostrobotnia, to buy special goods such as clothing, household equipment and cars. It is seen that the new NovaPark trade center would reduce the present trade flow, worth of 32 million euros annually, from Lapua to the Seinäjoki province.

The CGE RegFin regional model

General equilibrium analysis and computable (CGE) simulation models have gained large interest among empirical economists during the last twenty years. Törmä (2005) reviews this modeling tradition in Finland and reports that there is at the moment ten active researchers. The largest group, four researchers, develop the dynamic CGE VATT model in the Government Institute for Economic Research in Helsinki.

The development work of the CGE RegFin regional model started in the beginning of the 1980’s. The starting point was the desire to quantify the regional effects of the state government’s budget cuts. The technical description of the model is in Törmä (1995) and in Törmä and Rutherford (1998). There are four other applications of the RegFin model, see Törmä and Rutherford (2002 and 2004), Honkatukia, Törmä and Vaittinen (2004) and Törmä and Honkatukia (2005). The structure of the model is in the following figure.

Figure 1. The structure of the RegFin regional model

The RegFin model pictures both factor and commodity markets. Each of the industries produce commodities by using two factors, capital and labor. The produce is sold in the commodity markets to the consumers of the own region[2], through domestic exports to the consumers of the other domestic regions and through foreign exports to the consumers of the foreign countries. The regional production demands also imported goods and services, such as intermediate raw materials. These are bought through domestic imports from the other domestic regions and through foreign imports from abroad.

The demand for commodities is divided between private consumption (one representative household per region including non-profit organizations) and public consumption (local and state government including the social security funds). The investments (including the change of the stocks) are treated as an aggregate. The disposable income of the regional household is affected by the income taxes and transfers of the local and state governments. The model also takes into account the transfer system between the local and state governments. RegFin also includes all factor and commodity taxes and subsidies.

RegFin is a so called Walrasian CGE model. According to the basic principles taught by Léon Walras (1834-1910), “everything is affecting everything in the economy”. The central assumption of the model is, that the prices are flexible and will adjust until the economy has reached a new equilibrium after a shock. Mathematically a CGE model is a big system of linear and non-linear definition, behavior and equilibrium equations. Applied mathematics has developed numeric algorithms that can be used to find the new equilibrium prices and quantities. Comparing the benchmark and new equilibrium, the researcher can do comparative-static calculations to see how the key macro variables of the economy, such as GDP, unemployment, consumer prices etc., has been affected by the shock.

The RegFin model allows the labor markets to be out of equilibrium, because unemployment is a serious problem in Finland. Unemployment has been modeled as classical, where the excess supply of labor compared to the demand of labor is explained by too high real wages. This is motivated by the facts that the power of the labor unions is high and that union membership rates are very high. The union negotiated real wages are thus too high and rigid especially down-ward, in order the demand and supply of labor to be equal. In the RegFin model this real wage gap has been calibrated to a level that reproduces the regional benchmark unemployment rates. Modeling unemployment consist also of setting a lower bound to real wages, because we assume that the supply curve of labor is first horizontal and begins to rise only after all unemployment has disappeared.

The other special feature of the RegFin model is that regional net migration (out migration minus in migration) has been included. Net migration is explained by the economic growth and unemployment differentials. The former is measured by the ratio of GDP of the region to the GDP of the whole country. The latter is measured by the ratio of regional unemployment rate to the unemployment rate of the whole country. If the economic growth of the region is higher than in the whole country, this prevents out migration and strengthens in migration, so net migration decreases. The economic growth will lower region’s unemployment rate causing out migration to decrease and in migration to increase, so net migration will decrease. The net migration equation coefficients were estimated by using a pooled cross-section and time-series data. The RegFin model will solve for the regional GDP growths and the unemployment rates after a shock. The net migration calculations can then be done as ex post calculations.

The RegFin regional model is static in its character, so it does not reveal the path from the benchmark equilibrium to the policy distorted one. We have plans to develop the model to be dynamic. The model assumes perfect competition and constant returns to scale.

The data base of the RegFin model is the regional Social Accounting Matrices (SAMs), which are based on the 1995 input-output tables (see Statistics Finland, 2000). The SAMs have been updated to the production and consumption levels of 2002 and they are expressed as 2000 constant prices. This application covers six provinces of South Ostrobotnia and the Rest of Finland. There are seventeen industries in the model.

The model can be tailored to the needs of the client. He first chooses the regions, provinces and the industry mapping that suit the research question. Then he specifies the additional features that are of interest to him. The model is then modified and tailored to meet these demands. In this application we are interested to do ex post calculations about the effects of commuting and interprovincial trade patterns of the households. An interested reader can refer to for more information about general equilibrium analysis and prior applications of the CGE RegFin regional model.

Parameterization of the development projects

RegFin simulations demand assumptions about:

  • Building costs divided by sub-projects
  • Financing from the state and from outside of South Ostrobotnia sources
  • New turnover by sub-projects
  • Regional allocation of the subcontracts

After studying the planning documents of the development projects and regional building statistics, the following assumption were specified.

Simpsiö project / Building costs, mill.euros / Share of outside financing, % / New turnover, mill. euros
Tunnel and shelter / 15.4 / 50* / 0.5
Rearrange costs, skiing tube and sports center / 3.7 / 24* / 0.0
Log-house village, 1/6 / 2.0 / 50 / 1.5
Log-house village, weekly rentals / 4.0 / 50 / 2.7
Log-house village, own cottages / 5.6 / 50 / 0.0
Center point / 4.5 / 100 / 1.2
Down-hill skiing resort / 0.0 / 0 / 0.6
Outside swimming pool / 0.1 / 60 / 0.0
Service and maintenance of the cottages / 0.0 / 0 / 0.5
Simpsiö, total / 35.3 / 7.0
NovaPark project / Building costs, mill.euros / Share of outside financing, % / New turnover, mill. euros
Big supermarket / 10.0 / 100 / 20.0
Medium sized supermarket / 6.0 / 100 / 10.0
Smaller shops / 10.0 / 50 / 15.0
Traffic service station / 1.0 / 50 / 3.5
NovaPark, total / 27.0 / 48.5

Table 1. Assumptions of the building costs, share of outside financing and new turnover

(* = state government financing).

The Lapua town in Härmänmaa has to finance half of the building costs of the tunnel and shelter. This will limit the growth effects of the main subproject. On the other hand, the considerable share of financing that comes from outside South Ostrobotnia, will decrease the building cost burden of the private sector. These will be direct investments and they will enhance the growth effects. The assumption is that the Simpsiö project will create 7.0 million euros worth of new turnover annually.

It was assumed that the building of the two supermarkets that would settle down in Lapua in Härmänmaa would be fully financed from outside of South Ostrobotnia sources. This would make it possible for several smaller shops to enter the new trade center. It was assumed that half of their building costs would be financed by investors from outside South Ostrobotnia. The assumption is that the NovaPark project will create 48.5 million euros worth of new turnover annually.

The following regional allocation of the building subcontracts were used in the simulations.

Simpsiö project/ region / Share of building subcontracts, tunnel and shelter, % / Share of building
subcontracts, log-house village, Center point and outdoor swimming pool
Järviseutu / 5 / 50
Kuusiokunnat / 5 / 0
Härmänmaa / 35 / 50
Suupohja / 0 / 0
Eteläiset / 0 / 0
Seinäjoki / 25 / 0
Rest of Finland / 30 / 0
Simpsiö, total / 100 / 100
NovaPark project/
region / Share of building subcontracts, the two supermarkets, % / Share of building subcontracts, smaller shops and the traffic service station, %
Järviseutu / 10 / 15
Kuusiokunnat / 10 / 10
Härmänmaa / 30 / 40
Suupohja / 0 / 0
Eteläiset / 0 / 0
Seinäjoki / 40 / 35
Rest of Finland / 10 / 0
NovaPark, total / 100 / 100

Table 2. The regional allocation of the building subcontracts, %.

The share of the Rest Of Finland is fairly high in the Simpsiö project, because in South Ostrobotnia there are no firms or equipment suitable for the drilling work of the tunnel and shelter. The shares of Seinäjoki province are also high because we assumed that its firms will win the planning contest and also do some part of the actual building work. The shares of Järviseutu, Kuusiokunnat and Härmänmaa are also high and this is because these provinces have a lot of potential construction firms.

We cannot be sure that the assumptions we have chosen will materialize. We feel, however, that they are reasonable. It is also true that numeric calculations and model simulations are sensitive to the parameter values chosen.

Provincial effects of the development projects

In the RegFin model simulations the short-run means about five years and the long-run about ten years. The provincial economy adjusts during the short-run to the growth of building and the new turnover begins to show. In the long-run the provincial economy adjusts to the new business turnover. All reported changes in the variables correspond to cumulative full adjustment. All reported price changes are in real terms, so inflation has been removed. For the NovaPark project we assumed that the new trade center will replace 20% of the present turnover of the trade industry in Härmänmaa. All simulations have been conducted by assuming that the local and state government income tax yields stay constant.

1

The RegFin regional model reports policy distorted changes of several macro variables. We present first the effects of the projects on provincial GDP.

Figure 2. The effect of the Simpsiö project on GDP in Härmänmaa, %.

The Simpsiö project will produce, with chosen assumptions, economic growth and welfare especially to the Lapua town in Härmänmaa. Provincial GDP will grow by 2.7% in the short-run and by 2.3% in the long-run. This economic growth rate corresponds to a GDP growth of one good year. The value of Härmänmaa’s GDP is about 500 million euros, so the money value of the extra output is about 11-14 million euros. The provincial economy of Härmänmaa will move to a higher long-run growth path.

The most important part of the Simpsiö project is the log-house village, which contributes most to the total growth. The two other parts are of importance too, but especially the tunnel and shelter do not contribute much. It is important to note, however, that the tunnel and shelter produce positive growth effects despite the fact that they bring the economic burden to the Lapua town who must pay half of the building costs.

Figure 3. The effect of the NovaPark project on GDP in Härmänmaa, %

1

The NovaPark project produces much higher effect on GDP compared with the Simpsiö project. The big supermarket and smaller shops and the traffic service station contribute most to the economic growth. The medium sized supermarket is important too. Provincial GDP of Härmänmaa will grow by 9.5% in the short-run and by 9.2% in the long-run. This corresponds to an economic growth rate of about three good years. In money the growth means that the NovaPark project would bring 46-47 million euros worth of new production.

We now turn to the other results, which we present in a more summative way.

Figure 4. The long-run effect of the Simpsiö project on some macro variables in Härmänmaa, % (%-units for the unemployment rate).

The Simpsiö project has positive macroeconomic effects. The unemployment rate decreases by one fourth and the income of the representative consumer grows a little. The consumer prices will decrease somewhat despite the fact that the price of capital grows. The Simpsiö project will favor labor intensive industries because the wages stay the same when capital becomes dearer. Both domestic and foreign exports will grow faster than the corresponding imports, so the trade and service accounts of Härmänmaa develop into surplus. The growth of exports mean that the Simpsiö project will increase tourism in Härmänmaa.

Figure 5. The long-run effect of the NovaPark project on some macro variables in Härmänmaa, % (%-units for the unemployment rate).

The NovaPark project has also positive macroeconomic effects, but they are much stronger. The unemployment rate falls so much that this problem will be fully solved. The simulations predict high competition among the trade industry, and this explains the result that the consumer prices will decrease. The growth effects of NovaPark increase total demand in Härmänmaa, this will cause the demand of capital to increase, so the price of capital will increase considerably. Domestic exports will grow much faster than imports, so the domestic trade and service account of Härmänmaa will move to a favorable direction. The situation in foreign trade is quite balanced. The strong growth of domestic exports mean that the new trade center will have much customers from the other provinces of South Ostrobotnia.