Economic Growth Small Group

A conference on Economic Growth Small Group held in San Francisco on February 23. Faculty Research Fellows Ezra Oberfield of Princeton University and Michael Peters of Yale University organized the meeting. These researchers' papers were presented and discussed:

Jeremy Greenwood, University of Pennsylvania and NBER; Pengfei Han, University of Pennsylvania; and Juan M. Sanchez, Federal Reserve Bank of St. Louis

Financing Ventures

Greenwood, Han, and Sanchez examine the relationship between venture capital and growth using an endogenous growth model incorporating dynamic contracts between entrepreneurs and venture capitalists. At each stage of financing, venture capitalists evaluate the viability of startups. If viable, VCs provide funding for the next stage. The success of a project depends on the amount of funding. The model is confronted with stylized facts about venture capital, viz., statistics by funding round concerning the success rate, failure rate, investment rate, equity shares, and the value of an IPO. Raising capital gains taxation reduces growth and welfare.

Markus K. Brunnermeier, Princeton University and NBER; Pierre-Olivier Gourinchas, University of California at Berkeley and NBER; and Oleg Itskhoki, Princeton University and NBER

Consumption-led Growth

What is the relationship between trade and current account openness and growth? Can a catching-up economy borrow like Argentina or Spain and grow like China? To address these questions, Brunnermeier, Gourinchas, and Itskhoki develop a model of endogenous converge growth, which they study under various policy regimes regarding trade and capital account openness. In the model, entrepreneurs adopt heterogenous projects based on their profitability. Trade openness has two effects on the relative profitability of tradable projects. First, the foreign competition effect unambiguously discourages tradable innovation. Second, the relative market size effect may favor or discourage tradable innovation. The researchers show that balanced trade ensures that the two effects exactly offset each other, while trade deficits unambiguously favor non-tradable innovation. The increase in domestic consumption associated with international borrowing results in a relative market size effect that reinforces the foreign competition effect to discourage tradable innovation, as well as the aggregate innovation rate and the pace of productivity convergence. The researchers further show that net exports relative to domestic absorption is a sufficient statistic for the feedback effect from aggregate allocation into sectoral productivity growth, and they find empirical support for the predictions of the model in the panel of sectoral productivity growth rates in OECD countries. A sudden stop in capital flows during the transition phase results simultaneously in a recession due to a fall in local demand and a sharp rebound in tradable productivity growth, provided the labor market can adjust flexibly via a sharp decline in the wage rate.

Kiminori Matsuyama, Northwestern University

Engel's Law in the Global Economy: Demand-Induced Patterns of Structural Change, Innovation, and Trade

Endogenous demand composition across sectors due to nonhomothetic demand (Engel’s Law) affects i) sectoral compositions in employment and in value-added, ii) variations in innovation rates and in productivity change across sectors, iii) intersectoral patterns of trade across countries, and iv) migration of industries from rich to poor countries. Matsuyama offers a unifying perspective on how economic growth and globalization affects the patterns of structural change, innovation and trade across countries and across sectors in the presence of Engel's Law. To this end, Matsuyama develops a two-country model of directed technological change with a continuum of sectors under nonhomothetic preferences, which is rich enough to capture all these effects as well as their interactions. Among the main messages is that globalization amplifies, instead of reducing, the power of endogenous domestic demand composition differences as a driver of structural change.

Pablo Fajgelbaum, University of California at Los Angeles and NBER, and Cecile Gaubert, University of California at Berkeley and NBER

Optimal Spatial Policies, Geography and Sorting

Fajgelbaum and Gaubert study optimal spatial policies in quantitative geography frameworks with spillovers and sorting of heterogeneous workers. Due to the spillovers, the spatial allocation is inefficient except under a particular set of net transfers across regions and workers. The researchers first characterize spatially efficient transfers, as well as the labor taxes and subsidies that would implement them. Then, they quantify their aggregate and distributional effects in the U.S. economy. Relative to the current equilibrium, spatial efficiency requires stronger redistribution towards low-wage cities and leads to smaller spatial income disparities, including a smaller urban skill premium. By reaching the utility frontier, the welfare of both college and non-college workers increases by 3.4%.

Berthold Herrendorf, Arizona State University; Richard Rogerson, Princeton University and NBER; and Akos Valentinyi, University of Manchester

Structural Change in Consumption and Investment: A Unified Approach

Existing models of structural change typically assume that all of investment is produced within the goods producing sector. Herrendorf, Rogerson, and Valentinyi show that this assumption is strongly counterfactual. In the U.S. economy, services value added account for a growing share of final investment expenditure and are now a larger share of investment than goods value added. The researchers develop and analyze a new model that offers a unified treatment of structural change in both the investment and consumption sectors. Relative to the existing literature the model has distinct answers for the conditions required for balanced growth as well as the asymptotic behavior of growth. In particular, constant TFP growth in all sectors is inconsistent with balanced growth and the sector with slowest TFP growth may absorb all resources.

Alexander Monge-Naranjo and Luciene T. Pereira, Federal Reserve Bank of St. Louis, and Pedro Cavalcanti Gomes Ferreira, Fundacao Getulio Vargas

Of Cities and Slums

The emergence of slums is a frequent feature of a country's path toward urbanization, structural transformation, and development. Based on salient micro and macro evidence from Brazilian labor, housing, and education markets, Monge-Naranjo, Cavalcanti Gomes Ferreira, and Pereira construct a simple dynamic model to examine the conditions for slums to emerge. They use the model to determine whether slums are barriers or stepping-stones for the ascension of low-skilled households and the development of the country as a whole, exploring the dynamic interaction of slums, housing costs and sectoral productivities with the human capital formation and structural transformation of a country. The researchers calibrate their model to Brazilian data, and use it to conduct counterfactual experiments. They find that cracking down on slums could slow down the acquisition of human capital in the low-end of the distribution, the growth of cities proper (outside slums) and induce even larger slums in the future. The researchers find that the impact of housing costs in the city depends crucially on the human capital distribution of the country. Finally, procuring slum-dwelling children some access to schools in the city would eventually lead to larger cities and smaller slums.

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