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Abstract
The aim of this paper is to analyse the regional economic impacts of a prolonged
period of recurrent droughts. The model used for analysis is TERM-H2O, a dynamic
successor to the bottom-up, comparative static TERM (The Enormous Regional
Model). We concentrate on the regions of the southern Murray-Darling basin.
Large change simulations are a challenge for modellers. Drought brings substantial
inward supply shifts for farm sectors. This paper outlines various theoretical
modifications undertaken to improve the modelling of drought in a computable
general equilibrium (CGE) framework and then applies them to the period from
2005–06 on. In particular, we apply a theory of sticky capital adjustment to
downstream processing sectors, whereby processors temporarily retire capital in
response to scarcer farm products, limiting upward price movements in farm outputs
and resulting in more realistic modelling of drought.
Results are explained using a back-of-the-envelope approach. This framework allows
us to estimate the economic impacts of allowing water trade. In addition, the approach
provides some estimate as to the impact of prolonged drought on structural change in
predominantly rural regions of south-eastern Australia.