The Adaptive Investment Effect: Evidence from Chinese Provinces

A paper of mine, “The Adaptive Investment Effect: Evidence from Chinese Provinces“, co-authored with Dr Kamiar Mohaddes, has recently been published in Economic Letters.

In the paper, we outline that the Adaptive Investment Effect (AIE) is the diversion of investment resources from productive to adaptive capital in response to the effects of climate change. We would expect this diversion to reduce the productivity of investment on economic growth.

For instance, we can imagine that climate change might increase temperatures in some areas. It is well known that higher temperatures reduce labour productivity and so to ameliorate this loss in productivity, firms might invest in air-conditioning units in offices. [...]

Trade Agreements and Reciprocity

Reciprocity, a mutual or reciprocal reduction in tariffs, is a key feature of trade agreements between large countries. Explain why reciprocity is a necessary feature for a trade agreement to yield higher welfare to both parties. Can a trade agreement be sustainable (or “self-enforcing”) if it is not characterized by reciprocity?

Following McLaren, let us consider two large countries, A and B which are symmetric both countries produce goods a and b, but A has a comparative advantage in the production of a whilst B has a comparative advantage in the production of b. To placate the domestic industry country A has an incentive to impose a tariff on good b which imposes a terms of trade loss for B and efficiency loses for both countries, whilst B has an incentive to impose a tariff on good a causing a terms of trade loss for A and efficiency losses for both country. [...]

Social Interactions and Fertility Behaviour

The most important macro externality that high fertility can have is its effect on economic development. If high fertility leads to more rapid economic growth and development then we may consider the externality positive, if not we would say it is negative. This works if we consider the mortality rate to be below high fertility, such that high fertility means high population growth.

Yield Curves

The yield curve shows us the interest rate of bonds maturing at different dates. We might generally expect – in normal times – that the yield curve would be upward sloping, which would imply that short term yields are lower than long-term yields. This would reflect the fact that investors expect interest rates to be higher in the future which would occur if they expect monetary policy to be tight, in order to fight inflationary pressures caused by an expanding economy. Hence we might think that an upward sloping yield curve is a positive reflection on the future of the economy, as investors believe that it will be overheating and will require contractionary monetary policy. However this analysis is only true if we focus on the long end of the yield curve: that long-term interest rates will be fairly high. It might be the case that we have an upward sloping yield curve because the current short term yield is low (and the long-term yield is at an average level); this will obviously imply that expectations are such that future activity will improve, but may not be particularly reassuring about the magnitude of such activity.

Big Push Model

A coordination problem is a situation where agents are unable to coordinate their behaviour, such that they end up in an equilibrium that leaves all agents worse off than in an alternative Pareto efficient equilibrium. This exists because complementarities between several conditions are necessary for successful development and the externalities arising from these complementarities are often not considered by decision making agents. Rosenstein-Rodan developed the big push theory which suggests that a government, or coalition of firms/organisations/individuals, needs to overcome these preconditions before growth can occur. Ellis describes this Big Push theory as a "minimum level of resources that must be devoted to... a development programme if it is to have any chance of success. Launching a country into self-sustaining growth is a little like getting an airplane off the ground. There is a critical ground speed which must be passed before the craft can become airborne....".

Political Commitment Theory of Trade Agreements

The political commitment theory of trade agreements argues that trade agreements arise due to the desire of the government to signal to private investors that they wish to pursue pro-growth policies. If announced unilaterally, this signal is not binding and so may not induce investors to invest, as they may not be confident that the government will stick to its announcement. However, when signalled via the signing of an international treaty, this may increase confidence that the government will stick to its promise, because the punishment from breaking its international commitments is much higher than if it broke a unilaterally declared promise. This theory therefore complements are understanding of why governments sign-up to trade agreements, and more importantly, explains why small countries enact tariff reductions when they don’t benefit from reductions in the terms of trade externality, due to their economic size.

Should changes in consumption be predictable?

The classical consumption models (Modigliani’s Life-Cycle hypothesis and Friedman’s Permanent Income hypothesis) tell us that consumption is dependent on life-time income. This is based on the assumptions of credit market access (so we don’t have liquidity constrained individuals) and certainty. In short this means that consumption will only change if income changes, and a temporary income change will cause consumption to rise by less (i.e. MPC is low) than a permanent income change (i.e. MPC is close to 1).

Due to the theory of consumption smoothing – whereby individuals prefer to have similar incomes over two periods (or a lifetime) than extremities in either period – we would expect change in consumption to be low over a lifetime. [...]

Labour Matching Models

Labour matching models stem from the fact that when a worker becomes unemployed, he needs to look for a job and such a process is not instantaneous. He cannot simply occupy any vacancy, but has to search for a job in a certain area, in a certain profession and which matches a list of criteria such as wage, hours of work and subjective factors like “would I enjoy working here”. This all takes time and requires effort. Before such matching models were devised, economists assumed in their models that unemployment could instead be modelled by looking at the number of unemployed and the number of vacancies and then working out how many of the unemployed could take these vacancies. [...]

Neoclassical Business Cycles

According to Prescott the reason for business cycles is due to technology shocks which manifest itself as changes in the TFP productivity term (or Solow residual) A. Summers criticises this explanation believing that Prescott doesn’t provide evidence for where these technology shocks come to. Furthermore he cites Berndt who shows that the oil shock crisis – recessionary periods in the 1970s for both the US and the UK – had little effect on labour productivity which would cast doubt on Prescott’s story. Summers also points out that US GNP declined by 50% between 1929 and 1933, and questions whether it is really plausible that such an output shock could be caused by a productivity shock which lead to inter-temporal substitution on such a scale, as Prescott’s model would predict.

Measuring Inequality

Inequality is the difference between the incomes of the rich and the poor and there are a number of different measures to see how inequality has been changing over time and between countries. National accounts do not provide any data on how income, consumption or wealth is distributed across households [OECD] instead they provide overall income for the country, and dividing this by the population gives us the average income of the nation. Instead we need to use household survey data to give us a measure of inequality. Such surveys are not consistent across countries and therefore make international comparisons of inequality difficult. To overcome these issues, and allow more precise measures of international inequality, we might consider aggregating the national accounts data with the survey data. Unfortunately, this is a very difficult task, and may cause more issues than it solves. One such issue is that in survey data, households who own their home when asked their income may not include an imputed value of their rent, but this is done when we construct the national accounts. Deaton believes that this factor alone is responsible for explaining a large majority in the difference between national income as given by the national accounts versus the household surveys.