Macroeconomics

This paper develops a dynamic industry model with heterogeneous firms to analyze the intra-industry effects of international trade. The model shows how the exposure to trade will induce only the more productive firms to enter the export market (while some less productive firms continue to produce only for the domestic market) and will simultaneously force the least productive firms to exit. It then shows how further increases in the industry's exposure to trade lead to additional inter-firm reallocations towards more productive firms. The paper also shows how the aggregate industry productivity growth generated by the reallocations contributes to a welfare gain, thus highlighting a benefit from trade that has not been examined theoretically before. The paper adapts Hopenhayn's (1992a) dynamic industry model to monopolistic competition in a general equilibrium setting. In so doing, the paper provides an extension of Krugman's (1980) trade model that incorporates firm level productivity differences. Firms with different productivity levels coexist in an industry because each firm faces initial uncertainty concerning its productivity before making an irreversible investment to enter the industry. Entry into the export market is also costly, but the firm's decision to export occurs after it gains knowledge of its productivity.

This report offers a new strategy for investing in health for econom- ic development, especially in the world’s poorest countries, based upon a new global partnership of the developing and developed countries. Timely and bold action could save at least 8 million lives each year by the end of this decade, extending the life spans, productivity and economic well- being of the poor. Such an effort would require two important initiatives: a significant scaling up of the resources currently spent in the health sec- tor by poor countries and donors alike; and tackling the non-financial obstacles that have limited the capacity of poor countries to deliver health services. We believe that the additional investments in health—requiring of donors roughly one-tenth of one percent of their national income— would be repaid many times over in millions of lives saved each year, enhanced economic development, and strengthened global security. Indeed, without such a concerted effort, the world’s commitments to improving the lives of the poor embodied in the Millennium Development Goals (MDGs) cannot be met.

Two key facts about European unemployment must be explained: the rise in unemployment since the 1960s, and the heterogeneity of individual country experiences. While adverse shocks can potentially explain much of the rise in unemployment, there is insufficient heterogeneity in these shocks to explain cross-country differences. Alternatively, while explanations focusing on labor market institutions explain cross-country differences explain current heterogeneity well, many of these institutions pre-date the rise in unemployment. Based on a panel of institutions and shocks for 20 OECD nations since 1960, we find that the interaction between shocks and institutions is crucial to explaining both stylized facts. We test two specifications, and each offers significant support for our interactions hypothesis. The first speculation assumes that there are common but unobservable shocks across countries, and that these shocks have a larger and more persistent effect in countries with poor labor market institutions. The second constructs series for the macro shocks, and again finds evidence that the same size shock has differential effects on unemployment when labor market institutions differ. We interpret this as suggesting that institutions determine the relevance of the unemployed to wage-setting, thereby determining the evolution of equilibrium unemployment rates following a shock.

w o r l d e c o n o m i c scenario for international business over the past two decades, a n d then goes on to examine its implications for the location of foreign direct investment and multinational enterprise activity. It suggests that many of the explanations of the 1970s a n d early 1980s need to be modified a

We formulate an optimizing-agent model in which both labor and product markets exhibit monopolistic competition and staggered nominal contracts. The unconditional expectation of average household utility can be expressed in terms of the unconditional variances of the output gap, price inflation, and wage inflation. Monetary policy cannot achieve the Pareto-optimal equilibrium that would occur under completely flexible wages and prices; that is, the model exhibits a tradeoff in stabilizing the output gap, price inflation, and wage inflation. We characterize the optimal policy rule for reasonable calibrations of the model. We also find that strict price inflation targeting generates relatively large welfare losses, whereas several other simple policy rules perform nearly as well as the optimal rule.

When local cost discovery generates knowledge spillovers, specialization patterns become partly indeterminate and the mix of goods that a country produces may have important implications for economic growth. We demonstrate this proposition formally and adduce some empirical support for it. We construct an index of the "income level of a country's exports," document its properties, and show that it predicts subsequent economic growth.

This Discussion Paper is issued within the framework of IZA's research area Internationalization of Labor Markets. Any opinions expressed here are those of the author(s) and not those of the institute. Research disseminated by IZA may include views on policy, but the institute itself takes no institutional policy positions.

This paper presents recent research on access to finance by small and medium-size enterprises (SMEs). SMEs form a large part of private sector in many developed and developing countries. While cross-country research sheds doubt on a causal link between SMEs and economic development, there is substantial evidence that small firms face larger growth constraints and have less access to formal sources of external finance, potentially explaining the lack of SMEs' contribution to growth. Financial and institutional development helps alleviate SMEs' growth constraints and increase their access to external finance and thus levels the playing field between firms of different sizes. Specific financing tools such as leasing and factoring can be useful in facilitating greater access to finance even in the absence of well-developed institutions, as can systems of credit information sharing and a more competitive banking structure.

Women's empowerment and economic development are closely related: in one direction, development alone can play a major role in driving down inequality between men and women; in the other direction, empowering women may benefit development. Does this imply that pushing just one of these two levers would set a virtuous circle in motion? This paper reviews the literature on both sides of the empowerment-development nexus, and argues that the inter-relationships are probably too weak to be self-sustaining, and that continuous policy commitment to equality for its own sake may be needed to bring about equality between men and women.

This paper estimates the eects of trade liberalization on plant productivity. In contrast to previous studies, we disentangle the productivity gains that arise from reducing taris on nal goods from those that arise from reducing taris on intermediate inputs. Lower output taris can produce productivity gains by inducing tougher import competition whereas cheaper imported inputs can raise productivity via learning, variety, and quality eects. We use Indonesian manufacturing census data from 1991 to 2001, which includes plant level information on imported inputs. The results show that a 10 percentage point fall in input taris leads to a productivity gain of 12 percent for rms that import their inputs, at least twice as high as any gains from reducing output taris.

Markets: The Lessons from 1995 THE MEXICAN PESO crisis of December 1994, and its reverberations in the financial markets of developing countries around the world, has intensified the debate over the nature of balance of payments crises in developing countries. Many simple explanations have been given for the crisis and its aftermath, but none of them does very well at accounting for the main patterns of behavior in emerging markets during late 1994 and 1995. For example, many observers claim that it was Mexico's yawning current account deficit in 1994 that led to the drying up of capital inflows, and thereby to the collapse of the peso. Nonetheless, countries such as Malaysia and Thailand ran comparably large current account deficits in 1990-94 (as a percentage of GDP) without suffering reversals of capital inflows. Other observers claim that investor panic spread contagiously from Mexico throughout emerging markets. This story fits well with the strong adverse market reactions experienced by Argentina and Brazil in early 1995, but not with the experiences of In preparing this paper we benefited from conversations with

This paper explores similarities and differences between the run-up of oil prices in 2007-08 and earlier oil price shocks, looking at what caused the price increase and what effects it had on the economy. Whereas historical oil price shocks were primarily caused by physical disruptions of supply, the price run-up of 2007-08 was caused by strong demand confronting stagnating world production. Although the causes were different, the consequences for the economy appear to have been very similar to those observed in earlier episodes, with significant effects on overall consumption spending and purchases of domestic automobiles in particular. In the absence of those declines, it is unlikely that we would have characterized the period 2007:Q4 to 2008:Q3 as one of economic recession for the U.S. The experience of 2007-08 should thus be added to the list of recessions to which oil prices appear to have made a material contribution.

The large differences in income per capita across countries are mostly accounted for by differences in total factor productivity (TFP). What explains the differences in TFP across countries? Empirical evidence points to factor misallocation across heterogeneous production units as an important factor. We study factor misallocation in a model where establishment-level productivity is endogenous. In this framework, policy distortions not only misallocate resources across a given set of productive units, but also worsen the productivity distribution of establishments and this effect is substantial quantitatively. Reducing the dispersion in revenue productivity by half to the level of the U.S. benchmark in the model implies an increase in aggregate output and TFP by a factor of 7.8-fold. Improved factor allocation accounts for 38 percent of the gain, whereas the change in the productivity distribution accounts for the remaining 62 percent.

The Empirics of Growth: An Update. by Barry P. Bosworth , Susan M. Collins THE PAST DECADE HAS seen an explosion of empirical research on economic growth and its determinants, yet many of the central issues of interest remain unresolved. For ins.

The idea of libertarian paternalism might seem to be an oxymoron, but it is both possible and legitimate for private and public institutions to affect behavior while also respecting freedom of choice. Often people's preferences are ill-formed, and their choices will inevitably be influenced by default rules, framing effects, and starting points. In these circumstances, a form of paternalism cannot be avoided. Equipped with an understanding of behavioral findings of bounded rationality and bounded self-control, libertarian paternalists should attempt to steer people's choices in welfare-promoting directions without eliminating freedom of choice. It is also possible to show how a libertarian paternalist might select among the possible options and to assess how much choice to offer. Examples are given from many areas, including savings behavior, labor law, and consumer protection.

The neo-classical approach to the question of why growth rates differ between countries, typified by the meticulous studies of Denison (1967; 1976) and Maddison (1970; 1972), concentrates on the supply side of the economy using the concept of the production function. Having specified the functional form, the growth of output is apportioned between the growth of capital, the growth of labour, and the growth of total factor productivity obtained as a residual. By this approach, growth rate differences are " explained " in terms of differences in the growth of factor supplies and productivity. While the approach is fruitful, interesting and mathematically precise, it does not tell us why the growth of factor supplies and, productivity differs between countries. To answer this question some would say that a more Keynesian approach is required which stresses demand. For the Keynesian, it is demand that " drives " the economic system to which supply, within limits, adapts: taking this approach, growth rates differ because the growth of demand differs between countries. The question then becomes why does demand grow at different rates between countries? One explanation may be the inability of economic agents, particularly governments, to expand demand. This explanation by itself, however, is not very satisfactory. The more probable explanation lies in constraints on demand. In an open economy, the dominant constraint is the balance of payments. In this paper it is shown how closely the growth experience of several developed countries approximates to the rate of growth of exports divided by the income elasticity of demand for imports, which, on certain assumptions, can be regarded as a measure of what I call the balance of payments equilibrium growth rate. In fact, the rate of growth of exports divided by the income * Paper originally published in vol. 32 n. 128 (1979), pp. 45-53, of BNL Quarterly Review. Current author contacts are reported in the first article of the present issue.

The Current Account and Macroeconomic Adjustment i n t he 1970s DURING THE PAST DECADE, the behavior of international capital flows, current account balances, and exchange rates have puzzled economists and preoccupied policymakers. The period has been marked by widely fluctuating exchange rates, huge OPEC surpluses, burgeoning debt of less developed countries (LDCs) and unprecedented current account deficits in many developed countries. The nature, direction, and scope of international borrowing have also shifted dramatically. The proportion of private to official capital inflows to LDCs has grown substantially; the international money market has expanded dramatically; and capital controls have been liberalized in many economies. The need for analysis is greatest on two sets of questions. First, what factors have determined the size and direction of current account imbalances in recent years? Second, what has been the relation between the current account and movements in the exchange rate? Answers to the first question have tended to focus on OPEC price increases and surpluses. Observing that the large surpluses must be balanced in the aggre-This paper is part of a research project on the effects of OPEC price increases on macroeconomic adjustment in the world economy, in collaboration with Michael

The Growth of Earnings Instability in the U.S. Labor Market THE WIDENING EARNINGS distribution in the U.S. labor market over the 1970s and 1980s has been one of the most remarkable shifts in the structure of labor compensation in recent history-the last major shift in this distribution having occurred during the 1940s.I In the postwar period, earnings and income distributions have been regarded as stable bedrock-that is, until recently-with a common theme being the stability of those distributions in light of massive changes in labor markets and public spending on redistributive programs. Entire books were written on the subject.2 This view of long-term stability has been dramatically altered by an enormous, and still growing, series of investigations showing a widening of the income and wage distributions.3 As documented in an article by Frank Levy and Richard Murnane, the widening of the earnings distribution began gradually in the 1970s and accelerated in the 1980s.4 Earnings differentials by education and experience grew rapidly in the 1980s. A debate has now ensued concerning the causes of these trendswhether they are the result of general shifts in supply or demand caused by skill-biased technological change, shifts in the pattern of interna-We would like to thank Bill Dickens and Larry Katz for comments, and Carol Kallman and Thomas Vanderveen for research assistance. 1992). 2. See, for example, Reynolds and Smolensky (1976). 3. Two of the earliest studies were Dooley and Gottschalk (1984) and Lawrence (1984). 4. Levy and Murnane (1992). 217 218 Brookings Papers on Economic Activity, 2:1994 tional trade, changes in union rents or the minimum wage, or other factors-.

THE POLITICAL and intellectual leaders of Eastern Europe's revolution of 1989 describe their aim as a "return to Europe." Their overwhelming judgment is that the postwar division of Europe into East and West was artificially imposed by the Soviet Union, at enormous human and economic cost. They underscore the artificiality of the division by referring to their region as East Central Europe (or Middle Europe), rather than Eastern Europe, thereby stressing their countries' place in the mainstream of European history, politics, arts, and economy.

Looting: The Economic Underworld of Bankruptcy for Profit DURING THE 1980s, a number of unusual financial crises occurred. In Chile, for example, the financial sector collapsed, leaving the government with responsibility for extensive foreign debts. In the United States, large numbers of government-insured savings and loans became insolvent-and the government picked up the tab. In Dallas, Texas, real estate prices and construction continued to boom even after vacancies had skyrocketed, and then suffered a dramatic collapse. Also in the United States, the junk bond market, which fueled the takeover wave, had a similar boom and bust. In this paper, we use simple theory and direct evidence to highlight a common thread that runs through these four episodes. The theory sug-We would like to give special thanks to James Pierce and William Black. In their capacities as executive director and deputy director of the National Commission on Financial Institutions, Reform, Recovery, and Enforcement, they have been pursuing an independent inquiry into the savings and loan crisis. They have reached many conclusions that we share and they have provided us with much useful corroborating evidence. We are also grateful to Halsey Rogers for invaluable research assistance.

Firms and workers are much more productive in large and dense urban environments. There is substantial evidence of such agglomeration economies based on three aproaches. First, on a clustering of production beyond what can be explained by chance or comparative advantage. Second, on spatial patterns in wages and rents. Third, on systematic variations in productivity with the urban environment. However, more needs to be learned about the causes of agglomeration economies. We have good models of agglomeration through sharing and matching, but not a deep enough understanding of learning in cities. Despite recent progress, more work is needed to distinguish empirically between alternative causes.

This paper compares the dynamic impact of fiscal policy on macroeconomic variables implied by a large class of general equilibrium models with the empirical results from an identified vector autoregression. In the data we find that positive innovations in government spending are followed by strong and persistent increases in consumption and employment. We compare these findings to several variations of a standard real business cycle model and we find that the positive conditional correlation in the responses of employment and consumption cannot be matched by the model under plausible assumptions for the values of the calibration parameters.

Syndication arises when venture capitalists jointly invest in projects. We model and test two possible reasons for syndication: project selection, as an additional venture capitalist provides an informative second opinion; and complementary management skills of additional venture capitalists. The central question is whether venture capitalists are engaged primarily in selection or in managerial value added. These alternatives imply contrasting predictions about comparative returns to syndicated and standalone investments. Our empirical analysis, using Canadian data, finds that syndicated investments have higher returns, favoring the value-added interpretation. We also discuss risk sharing and project scale as possible reasons for syndication.

Research on the macroeconomic impact of capital account liberalization finds few, if any, robust effects of liberalization on real variables. In contrast to the prevailing wisdom, I argue that the textbook theory of liberalization holds up quite well to a critical reading of this literature. Most papers that find no effect of liberalization on real variables tell us nothing about the empirical validity of the theory because they do not really test it. This paper explains why it is that most studies do not really address the theory they set out to test. It also discusses what is necessary to test the theory and examines papers that have done so. Studies that actually test the theory show that liberalization has significant effects on the cost of capital, investment, and economic growth.

These two excellent books address the same basic question: What can the performance of the U.S. economy in the 1980s tell us about America's economic future? Although they draw many of the same lessons from recent economic history, the books differ profoundly in style, scope, and intended audience.

Large and persistent global financial imbalances need not be the harbinger of a world financial crash. Instead, we show that these imbalances can be the outcome of financial integration when countries differ in financial markets deepness. In particular, countries with more advanced financial markets accumulate foreign liabilities in a gradual, long-lasting process. Differences in financial deepness also affect the composition of foreign portfolios: countries with negative net foreign asset positions maintain positive net holdings of non-diversifiable equity and FDI. Abstracting from the potential impact of globalization on financial development, liberalization leads to sizable welfare gains for the more financially-developed countries and losses for the others. Three empirical observations motivate our analysis: (1) financial deepness varies widely even amongst industrial countries, with the United States ranking at the top; (2) the secular decline in the U.S. net foreign asset position started in the early 1980s, together with a gradual process of international capital markets liberalization; (3) net exports and current account balances are negatively correlated with indicators of financial development.

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