Land use in computable general equilibrium models

Abstract

Constant Elasticity of Transformation (CET) functions are widely used to allocate land across uses in Computable General Equilibrium (CGE) models. These models fail to maintain the physical area of land in balance. This paper examines this issue. It shows that heterogeneity in land prices (rents) is the main source of imbalance in land area, not the curvature of the CET function. It also shows that the available approaches that restore balance to physical area either introduce ad hoc adjustments in land allocation or undermine the conventional welfare assessments of the CET results. An alternative approach involves implementing stochastic productivity distribution functions (e.g. Fréchet) to allocate land among uses maintain area of land in balance, thereby respecting conventional welfare assessments. A particular feature of these models is that the aggregate production functions of the land using sectors exhibit decreasing returns to scale even if land is the only factor of production. This approach also requires equalization of land rents across uses. This is not consistent with empirical observation. Both the CET and stochastic methods consider the implicit opportunity costs of moving land across uses but fail to take into account preparation costs associated with land use conversion.