Harris-Todaro Model

The Harris-Todaro model was created to explain how internal migration occurs from rural to urban sectors through the difference in the expected wage. Pritchett points out that migration can benefit developing countries and their population much more significantly than any aid attempts. Industrial world transfer are around $70bn a year in aid, but by simply allowing a 3% rise in their labour force (taken up by migrants), the gains would be $300 billion: 4.5x greater. Fundamentally it was used to explain migration within an economy, but we attempt to expand the model to an international level. The model begins by accepting that the assumption of (near) full employment in urban labour markets isn’t particularly appropriate for developing countries which are beset by a chronic (under/)unemployment problem whereby many uneducated and unskilled rural migrants cannot find a job in the formal sector so become unemployed or join the informal sector. Thus in deciding whether to move to the city or stay at home on the farm, an individual has to weigh up the probability and risks of being unemployed for a considerable period of time against the positive urban-rural real income differential.

The Household Demand Model

We may be interested in understanding fertility decisions, because it is generally believed that population growth is detrimental to economic development (c.f. the Solow growth model and lessons from the British Industrial Revolution) and so we would advise policymakers to try and reduce population growth. The death rate has been falling across the globe since the 1960s (by 50% according to Schultz) as a result in medical advancements and the cheapening of drugs (as well as globalisation which meant this knowledge could diffuse across the world more easily), yet many LDCs have not followed the same transition path with respect to birth rates as developed countries did. By understanding why a couple decide to have a child (at the margin) we may be able to reduce these incentives, so as to limit population growth.

Wage compression and the decline in inequality in Latin America

This blog posts explores some questions behind an article written by Levy Yeyati and Pienknagura – Wage compression and the decline in inequality in Latin America: Good or bad?“. We summarise the authors claims behind the decline in Latin American income inequality, and explain whether the decline is good or bad for Latin America.

The authors claim that there are 3 possible factors behind the decline in Latin American income inequality: increasing access to education, a decline in the demand for skill-intensive industries or a worsening of the educational system. Before we analyse these effects, it is important to note that the compression of the educational premium only accounts for half of the decline in inequality, so other factors must also be involved. [...]

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. [...]