Laura Alfaro, Harvard University and NBER; Sebnem Kalemli-Ozcan, University of Houston and NBER; and Vadym Volosovych, Erasmus University Rotterdam
International Capital Allocation, Sovereign Borrowing, and Growth
The key in the investigation of capital inflows, relative to the neoclassical benchmark, is how we measure these inflows. The macro literature has been using three main yardsticks: the current account balance, returns to capital, and the volume of net capital inflows. Alfaro, Kalemli-Ozcan, and Volosovych argue that all of these measures will partly reflect non-private non-market activities, while the neoclassical predictions are about private market behavior. After a careful separation of public and private components of capital inflows for developing countries during the last three decades, four main findings emerge: 1) International capital inflows net of aid inflows are positively correlated with different proxies of growth and productivity consistent with the predictions of the neoclassical model. 2) Aid inflows are negatively correlated with growth. 3) International capital inflows net of government debt are also allocated according to the neoclassical predictions. 4) Government debt is negatively correlated with growth only if government debt is financed by another sovereign and not by private lenders. These results are general, in the sense that they also apply to the recent period of global imbalances and to a broader sample of developing and industrial countries.
Nicola Borri, LUISS, and Adrien Verdelhan, MIT and NBER
Sovereign Risk Premia
Emerging countries tend to default when their economic conditions worsen. If bad times in an emerging country correspond to bad times for the U.S. investor, then foreign sovereign bonds are particularly risky. Borri and Verdelhan explore how this mechanism plays out in the data and in a general equilibrium model of optimal borrowing and default. Empirically, the higher the correlation between past foreign and U.S. bond returns, the higher the average sovereign excess returns. A model of risk-averse lenders with external habit preferences illustrates a new link across countries: the impact of risk premia on optimal debt quantities, defaults, and prices.
Andrei Levchenko, University of Michigan and NBER, and Jing Zhang, University of Michigan
The Evolution of Comparative Advantage: Measurement and Welfare Implications
Using an industry-level dataset of production and trade spanning 75 countries and 5 decades, and a fully specified multi-sector Ricardian model, Levchenko and Zhang estimate productivities at sector level and examine how they evolve over time in both developed and developing countries. They find that in both country groups, comparative advantage has become weaker: productivity grew systematically faster in sectors that were initially at the greater comparative disadvantage. The global welfare implications of this phenomenon are significant. Relative to the counterfactual scenario in which an individual country's comparative advantage remained the same as in the 1960s, and technology in all sectors grew at the same country-specific average rate, welfare today is 1.9 percent lower at the median. The welfare impact varies greatly across countries, ranging from 0.5 percent to 6 percent among OECD countries, and from 9 percent to 27 percent among non-OECD countries. Remarkably, for the OECD countries, nearly all of the welfare impact is driven by changes in technology there; for the non-OECD countries, nearly all of the welfare impact is driven by changes in technology in there.
Nicola Gennaioli and Alberto Martin, CREI, and Stefano Rossi, Imperial College Business School
Sovereign Default, Domestic Banks, and Financial Institutions
Gennaioli, Martin, and Rossi build a model in which sovereign defaults weaken banks' balance sheets because banks hold sovereign bonds, causing private credit to decline. Stronger financial institutions boost default costs by amplifying these balance-sheet effects. This yields a novel complementarity between public debt and domestic credit markets, where the latter sustain the former by increasing the costs of default. The researchers document three novel empirical facts that are consistent with the model's predictions: public defaults are followed by large private credit contractions; these contractions are stronger in countries where banks hold more public debt and financial institutions are stronger; and, in these same countries, default is less likely.
Christopher Erceg and Jesper Linde, Federal Reserve Board
Asymmetric Shocks in a Currency Union with Monetary and Fiscal Handcuffs
Erceg and Linde investigate the impact of the asymmetric shocks within a currency union in a framework that takes account of the zero-bound constraint on policy rates, and also allows for constraints on fiscal policy. In this environment, they document that the usual optimal currency argument -- showing that the effects of shocks are mitigated to the extent that they are common across member states -- can be reversed. Countries can be worse off when their neighbors experience similar shocks, including policy-driven reductions in government spending.
Jonathan Eaton, Pennsylvania State University and NBER, and Samuel S. Kortum, Brent Neiman, and John Romalis, University of Chicago and NBER
Trade and the Global Recession
The ratio of global trade to GDP declined by nearly 30 percent during the global recession of 2008-9. This large drop in international trade has generated significant attention and concern. Did the decline simply reflect the severity of the recession for traded goods industries? Or , did international trade shrink because of factors unique to cross border transactions? Eaton, Kortum, Neiman, and Romalis merge an input-output framework with a gravity-trade model and numerically solve several general equilibrium counterfactual scenarios that quantify the relative importance for the decline in trade of the changing composition of global GDP and changes in trade frictions. The results suggest that the relative decline in demand for manufactures was the most important driver of the decline in manufacturing trade. Changes in demand for durable manufactures alone accounted for 65 percent of the cross-country variation in changes in manufacturing trade/GDP. The decline in total manufacturing demand (durables and nondurables) accounted for more than 80 percent of the global decline in trade/GDP. Trade frictions increased and played an important role in reducing trade in some countries, notably China and Japan, but decreased or remained relatively flat in others. Globally, the impact of these changes in trade at frictions largely cancel each other out.