Investment Demand and Structural Change

Accepted for publication in Econometrica; with Manuel García-Santana, Lucciano Villacorta

Downloads: working paper (March 2021, first version December 2016);

Abstract: We study the joint evolution of the sectoral composition and the investment rate of developing economies. Using panel data for several countries in different stages of development, we document three novel facts: (a) the share of industry and the investment rate are strongly correlated and follow a hump-shaped profile with development, (b) investment goods contain more domestic value added from industry and less from services than consumption goods do, and (c) the evolution of the sectoral composition of investment and consumption goods differs from the one of GDP. We build a multi-sector growth model to fit these patterns and provide two important results. First, the hump-shaped evolution of investment demand explains half of the hump in industry with development. Second, asymmetric sectoral productivity growth helps explain the decline in the relative price of investment goods along the development path, which in turn increases capital accumulation and promotes growth.

Growing like Spain: 1995-2007

International Economic Review, 2020, 61(1), 383-416; with Manuel García-Santana, Enrique Moral-Benito, Roberto Ramos

Shortlisted for the 2016 Vanguardia de la Ciencia Award

Downloads: published version; working paper (May 2019, first version February 2016); 

Media and Blogs: article in The Economist; article in El Pais (in Spanish); interview in La Vanguardia (in Spanish)

Abstract: Measured TFP fell at an annual rate of 0.7% in Spain during the boom years of 1995 to 2007. Using administrative data from the quasi-universe of firms for all sectors we show that deterioration in the allocative efficiency of productive factors across firms was at the root of the low TFP growth in Spain. Cross-industry variation reveals that the increase in misallocation was more severe in those sectors where connections with public officials are more important for business success, which represents novel evidence on the potential macroeconomic costs of crony capitalism. We write and estimate a simple model of cronyism in which heterogeneous firms invest in political connections. The model is consistent with the facts that (a) there is more dispersion in firm productivity in those sectors more prone to cronyism and (b) a general decline in the quality of institutions generates a larger increase in the dispersion of firm productivities in those sectors more prone to cronyism. Our quantitative exercise concludes that the institutional decline over this period costed 1.9% growth in TFP per year.

Investment Expensing and Progressivity in Flat Tax Reforms

SERIEs, 2019, 10(3), 365-399; with Javier Díaz-Giménez

Downloads: published version; working paper (February 2011), earlier version: working paper (July 2006)

Abstract: In this article we quantify the aggregate, distributional and welfare consequences of investment expensing and progressivity in Hall and Rabushka type of flat-tax reforms of the US economy. To do so we use a heterogeneous households model featuring both life cycle and dynastic elements as well as nonlinear wage dynamics. Our findings suggest that moving toward a progressive consumption-based flat-tax scheme could achieve the goals of raising government income, stimulating the economy, and providing a safety net for the households that have been hit the hardest by the recession. In particular, we find that investment expensing brings about sizeable output gains and a nontrivial increase in after-tax income inequality. However, it results in aggregate welfare gains in steady state because the large deduction in the labor income tax acts as a boon for the income poor, because the larger capital stock implies that workers earn higher wages, and because investment expensing allows households to abandon poverty faster. We also find that the progressivity of the reforms matters for welfare: economies with more progressive flat-tax schemes are better for the very poor and are ultimately preferred by a Benthamite social planner as they allow households to achieve better consumption smoothing and a better allocation of their work effort across time and states.

Labor Supply with Job Assignment under Balanced Growth

Journal of Economic Theory, 2016, 163, 110-140; with Claudio Michelacci

Downloads: working paper (July 2015) and published version

Abstract: We consider a competitive equilibrium growth model where technological progress is embodied into new jobs which are assigned to workers of different skills. In every period workers decide whether to actively participate in the labor market and if so how many hours to work on the job. Balanced growth requires that the job technology is complementary with the worker's total labor input in the job, which is jointly determined by his skill and his working hours. Since lower skilled workers can supply longer hours, we show that the equilibrium features positive assortative matching (higher skilled workers are assigned to better jobs) only if differences in consumption are small relative to differences in worker skills. When the pace of technological progress accelerates, wage inequality increases and workers participate less often in the labor market but supply longer hours on the job. This mechanism can explain why, as male wage inequality has increased in the US, labor force participation of male workers of different skills has fallen while their working hours have increased.

Heterogeneity in Expected Longevities

Demography, 2014, 51(6), 2075-2102; with Víctor Ríos-Rull

Downloads: working paper (July 2014) and published version; Life tables for Figures 2 to 4 (zip file)

Media and Blogs: VoxEU column; The Region

Abstract: We develop a new methodology to compute differences in the expected longevity of individuals of a given cohort who are in different socioeconomic groups at a certain age. We deal with the two main problems associated with the standard use of life expectancy: that people's socioeconomic characteristics change and that over time mortality has gone down. Our methodology uncovers a large amount of heterogeneity in expected longevities, yet much smaller than what arises from the naive application of life expectancy formulae. We decompose the longevity differentials into differences in health at age 50, differences in the evolution of health with age, and differences in mortality conditional on health. Remarkably, education, wealth, and income are health protecting but have very little impact on two-year mortality rates conditional on health. Married people and nonsmokers, however, benefit directly in their immediate mortality. Finally, we document an increasing time trend of the socioeconomic gradient of longevity in the period 1992-2008, and we predict an increase in the socioeconomic gradient of mortality rates for the coming years.

The Reservation Laws in India and the Misallocation of Production Factors

Journal of Monetary Economics, 2014, 66, 193-209; with Manuel García-Santana

Downloads: working paper (March 2014) and published version; technical appendix

Abstract: The Small Scale Reservation Laws (SSRL) in India are a unique case of firm-level size restrictions. We quantify their aggregate productivity costs by use of a span-of-control model extended into a multi-sector setting. We show how the reallocation of top managers away from the distorted sector partly offsets the effect of the distortions. Using plant level data from India, we calibrate our model to 2001. Lifting the SSRL increases output per worker by 6.8% in manufacturing and 2% in the overall economy, while TFP increases by 2% and 0.75% respectively. These are large numbers given the small size of the restricted sector. However, this size-dependent policy cannot account for the large gap in manufacturing TFP between the US and India.

Intertemporal Labor Supply with Search Frictions

Review of Economic Studies, 2012, 79(3), 899-931; with Claudio Michelacci

Downloads: working paper and published version; technical appendix

Abstract: Since the 70's, the number of hours worked on the job by US prime age male workers and wage inequality have both increased. We argue that the two facts are related. We use a labor market search model with on the job search where by working longer hours individuals acquire greater skills. Since job candidates are ranked by productivity, greater skills not only increase worker's productivity in the current job but also help the worker to obtain better jobs. When job offers become more dispersed, wage inequality increases and workers work longer hours to obtain better jobs. As a result average hours per worker in the economy increase. This mechanism accounts for around two-thirds of the increase in hours observed in the data. Part of the increase is inefficient because workers obtain better jobs at the expense of other workers competing for the same jobs.

Spain is Different: Falling Trends of Inequality

Review of Economic Dynamics, 2010, 13(1), 154-178; with Virginia Sánchez-Marcos

Part of an international project of comparison of trends in inequality. See the other articles.

Downloads: working paper and published version. Data.

Abstract: In this article we characterize the evolution of inequality in hourly wages, hours of work, labor earnings, household disposable income and household consumption for Spain between 1985 and 2000. We look at both the  Encuesta Continua de Presupuestos Familiares and the  European Household Community Panel . Our analysis shows that inequality in individual net labor earnings and household net disposable income has decreased substantially. The decreases in the tertiary education premium and in the unemployment rate have been key ingredients to understand this falling trend. However, the inequality reduction has not been monotonic over the period: while it fell in years of economic expansion, there was an inequality surge in the recession of the early nineties. Public transfers have played a crucial role in smoothing out the inequality arising in the labor market, but instead the Spanish family does not seem to have been an important insurance mechanism. Regarding household consumption, inequality has fallen much less than inequality in household net disposable income, with the decrease mostly concentrated in the second half of the eighties. This suggests that the reduction in income inequality has affected the sources of permanent differences between households only during the second half of the eighties. Our estimates of the earnings process for the period are consistent with this view.

Pricing Risk in Economies with Heterogeneous Agents and Incomplete Markets

Journal of the European Economic Association, 2007, 5(5), 987-1015

Downloads: working paper and published version. Computational appendix

Abstract: Habit formation has been proposed as a possible solution to the equity premium puzzle. This paper extends the class of models that support the habits explanation in order to account for heterogeneity in earnings, wealth, habits and consumption. I find that habit formation does indeed increase the equity premium. However, contrary to earlier results, the habit hypothesis does not imply a price for risk as big as the one measured in the data. There are three reasons for this. First, households in a habits economy modify their consumption/savings decision. Second, they modify their portfolio choice. These two changes in behavior diminish the consumption fluctuations faced by households. And third, the composition of the set of agents pricing risk in the economy changes so that relatively better self-insured households end up pricing risk.

Precautionary Savings or Working Longer Hours?

Review of Economic Dynamics, 2006, 9(2), 326-352

Downloads: working paper and published version. File with the Markov chain and some instructions for replication.

Abstract: This paper quantifies the macroeconomic implications of the lack of insurance against idiosyncratic labor market risk. I show that in a model economy calibrated to observed individual level data, households make ample use of work effort as a consumption smoothing mechanism. As a consequence,aggregate consumption is 0.6% lower, work effort is 18% higher and labor productivity is 12% lower than they would be in a complete markets setting. Not surprisingly, the welfare benefits of moving towards complete markets are very large. Accounting for the whole transition to the new complete markets steady state I find the welfare costs of market incompleteness above 16% of individual lifetime consumption.

Flat Tax Reforms: a General Equilibrium Evaluation for Spain

Investigaciones Económicas, 2006, 30(2), 317-35; with Marta González

Awarded the Fundacion SEPI Essay Prize for the best paper on the Spanish Economy published in Investigaciones Económicas during 2006-2007

Downloads: working paper and published version

Media and Blogs: article in El Confidencial (in Spanish); article in Libre Mercado (in Spanish)

Abstract: This paper quantifies the aggregate and distributional implications of an array of revenue neutral flat tax reforms for Spain. A standard general equilibrium economy with heterogeneous agents is used to infer the behavioral parameters of individuals and to evaluate the impact of the tax reforms. We find that different flat tax reforms may generate important changes of aggregate allocations in opposite directions. Among all the reforms, we find that a marginal tax equal to 23.11% and a fixed deduction equal to 30% of per capita income will yield increases in aggregate output, aggregate consumption and labor productivity equal to 5.1%, 4.8% and 2.8% respectively. Admittedly, this type of reforms also generate increases in the gini indices of after tax income and consumption. However, the proposed reform reduces the tax bill of the bottom 60% of the income distribution.

Precautionary Savings and Wealth Distribution under Habit Formation

Journal of Monetary Economics, 2003, 50(6), 1257-1291; with Antonia Díaz and José-Víctor Ríos-Rull

Downloads: working paper and published version

Abstract: We study the role of habit formation in shaping the amount of precautionary savings and the wealth distribution in heterogeneous agents model economies with idiosyncratic uncertainty. We adjust preferences to equate the Intertemporal Elasticity of Substitution in all model economies. We find that habit formation brings a hefty increase in precautionary savings and very mild reductions in the coefficient of variation and in the Gini index of wealth. These findings hold for both persistent and non persistent habits, with the effects of the former being much larger.