The objective of the REFORM model is to provide users with the ability to evaluate macroeconomic effects of changes that impact industries e.g. changes to taxes, productivity and degree of competition. The model utilises the interactions between the industries in the Danish economy by taking into account allocation of labour, the accumulation of capital and distortions resulting from imperfect competition. The REFORM model is a static model which describes the long-term structural effects on the Danish economy. The relationships in the model represent a long-run equilibrium in a model with rational consumers and businesses.
The REFORM model’s strength lies in its ability to extensively describe the interactions between the many industries in the economy. In total, there are 73 industries, which are described by their own unique production structure. Firms within each industry sell goods and services which are registered as either inputs for further production, investment, or as public or private consumption. In addition, inputs and outputs for production and investment, as well as goods and services for final use, are accounted for if they are imports or exports. The extent of these flows is determined on the basis of national accounts data for the industry.
The division of the economy by industry allows one to specifically target a particular industry to assess shocks and reforms. This means that, compared to other models, the individual industry characteristics are elicited more extensively, which provides a more detailed evaluation of shock or reform effects on GDP.
The REFORM model is often used to make counterfactual experiments (also called “what if experiments”). For example, what would be the effect on the economy if the tax on sugar or vehicle registration were to increase? The REFORM model has the ability to assess the effect of such reforms by assessing the industries that are directly affected by these changes and subsequently how the entire economy is affected.
One of the strengths of the REFORM model is that it is relatively simple to use and can be easily adjusted to fit the requirements of the user so that it is tailored to analyse a given policy. Despite its simplicity, the model has a high level of detail in relation to taxes. The simplicity and detail that the model provides has attracted many institutions to use the model instead of using complex models that require specialists to operate.
One of the users of the model is the Ministry of Finance. The Ministry of Finance has the responsibility of quantifying the effects of potential new legislation on GDP, for example, if the effect on GDP is evaluated to be larger than 100 million kroner or if the direct economic impact is greater than 50 million kroner. Under most cases, the REFORM model is used by the Ministry of Finance as their tool for evaluating the effects on real GDP to see how the political initiative in question affects economic productivity.
The estimated GDP effects must be reported in the draft bill when submitted to parliament. In addition to informing politicians of GDP effects of new legislation, the estimates also include the GDP effects of the business-oriented initiatives that are in discussed in the government’s budgeting committees or in the context of political negotiations. This means that the model is often run several times a week in the Ministry of Finance. As such, the ministry works closely with our team to continually update and validate the assumptions made by the model.
The Finance ministry runs the REFORM model with 73 branches of industry as its baseline model to calculate effects on GDP. The model is calculated for a large variety of potential political initiatives which range sector specific regulation to requirements or easing of regulation that can affect many sectors in the economy. There are many possible methods for shaping these counterfactual experiments in the model, but typically the effects on GDP are calculated by changing labour force productivity, factor productivity or tax rates.
REFORM was developed in 2014 in a collaborative effort by the DREAM group and the Ministry of Finance. Since then, the model has been refined, developed and updated. The DREAM group uses the REFORM model to perform analysis for external clients who wish to assess the consequence of various financial initiatives. The DREAM group is also responsible for developing and continuously updating the model.
REFORM is a static multisector-CGE-model for a small open economy. The model makes it possible to choose between different aggregation-levels for industries in the economy. Usually, either the broadest aggregation (13 industry levels), which corresponds to the ADAM models industry divisions, or the most specific aggregation (73 industry levels), which roughly corresponds to the national accounts 69 levels, is run.
Each industry has their own production function with inputs of materials from other sectors, property capital, machine capital, energy and labour.
Households consist of consumers that are either employed, unemployed or outside of the labour force. Consumers in the labour force supply their labour to firms. There is a specified structural vacancy in the model that is given by the proportion of people in the labour force employed or unemployed. Additionally, consumers receive public transfers and profits from firms which they partially own. Lastly, consumers pay a variety of taxes such as income tax and VAT. Wages are set to ensure equilibrium in the labour market corresponding to a given structural unemployment.
Economic welfare gains are calculated in the REFORM model by the so-called equivalent variation, which measures the value of the extra consumption that the Danes are estimated to achieve as a result of the political initiative. The economic welfare gains are comprised of seven components: the price effect (the effect of changes in relative prices), income effect (effect of income and returns on assets), benefits of leisure, effect of foreign ownership, transfers and taxes on current income and capital income.