Productivity and welfare in financially open economies


The goal of the project is to analyze the impact of financial openness on measured productivity and welfare. Specifically, we will tackle two questions particularly relevant for policy-makers. In regards to the impact on productivity, we will investigate the effect of foreign direct investment (FDI) on domestic investment expenditures. In regards to the impact on welfare, we will investigate how the elimination of trade imbalances among major economies would affect income and wealth inequality, as well as well-being of people located in different bins of income and wealth distribution (will the rich or the poor pay the price of global re-balancing)?

Our first main hypothesis is that FDI inflows have a positive impact on measured productivity on the macroeconomic level, even if empirical analysis would suggest that they crowd out domestic investment expenditures. Our second main hypothesis is that re-balancing will benefit wealthy households if it occurs via increased consumption expenditures in surplus economies, and will benefit poor households if it occurs via increased savings in deficit economies.


Źródło finansowania | FinancingNarodowe Centrum Nauki, OPUS 18

Projekt realizowany | Timeline: 06/2020 -- 05/2023

Kierownik | Principal Investigator: Jacek Rothert

Budżet łączny | Total budget: 383 676 zł

  • wynagrodzenia dla podstawowych wykonawców | compensation to researchers: 144 000 zł
  • stypendia dla młodych badaczy | scholarships for young scholars: 134 400 zł
  • komputery i oprogramowanie | hardware and software: 3 500 zł
  • konferencje i inne wyjazdy | conference travels: 30 550 zł
  • książki i opłaty publikacyjne | books and publication fees: 7 280zł
  • koszty pośrednie dla FAME | overheads for FAME: 63 946 zł

The first two papers focus on the relationship between FDI flows, domestic investment, exchange rate risk, and total factor productivity. Every single study of the impact of FDI on domestic investment uses a reduced form regression with domestic investment as a dependent variable and FDI as one of the regressors. The biggest challenge of such approach is, the problem of endogeneity – domestic investment and FDI are jointly determined, and the direction of causality may be reversed. This leads to inconsistent estimates of the empirical model parameters. Typical approach to deal with this problem is to use instrumental variables or Granger causality tests. Our approach is novel. We recognize that at the heart of FDI is the ownership of capital stock that is physically located in a different country. If it does not matter who owns capital, then FDI would completely crowd out domestic investment. If foreign ownership brings something to production that domestic ownership cannot, then crowding out will be limited, eliminated, or even reversed. The key parameter of interest is therefore the elasticity of substitution between the domestic and foreign ownership of capital. Our goal is to estimate that parameter, using an agent-based international business cycle model, where capital used in production is a composite of capital stocks owned by domestic and foreign residents. In the model, both FDI flows and domestic investment expenditures will be endogenous, as they are in the data. Because claims to capital are denominated in local currency units, FDI flows will respond to exchange rate risk, if investors are risk averse. The strength of such response will depend on the aforementioned elasticity of substitution, which we will then estimate using “indirect inference” – making sure that the partial correlation between exchange rate risk and FDI flows in the model and in the data are the same. The model will then be used to evaluated the impact of FDI on measured productivity at the macroeconomic level. The partial correlation in the data will be estimated using bilateral capital flows within the European Union – an environment that is as close free capital mobility as one can hope for – using fairly standard panel data methods.

The third paper will study the welfare effects of global re-balancing, using an open economy version of the state-of-the art macroeconomic model with uninsurable idiosyncratic risk. The model will endogenously generate an equilibrium outcome with surplus and deficit countries, and with a non-trivial distribution of income and wealth within each country. We will then introduce policies whose goal is to eliminate the external surpluses and deficits of all countries (global re-balancing), and simulate their effects on income and wealth distribution (and inequality). Finally, we will evaluate their welfare effects for different groups of people. We will analyze separately policy proposals that force the surplus economies to consume and invest more, and those that force the deficit economies to save more (focusing on both the private and the public sector).

Opublikowane | Published

  • Strategic inefficiencies and federal redistribution during uncoordinated response to pandemic waves | European Journal of Political Economy

    Optimal policy during an epidemic includes depressing economic activity to slow down the outbreak. Sometimes, these decisions are left to local authorities (e.g. states). This creates an externality, as the outbreak does not respect states' boundaries. The externality directly exacerbates the outbreak. Indirectly, it creates a free-rider problem, because local policymakers pass the cost of fighting the outbreak on to other states. A standard system of distortionary taxes and lump-sum transfers can implement the optimal allocation, with higher tax rates required if states behave strategically. A strategic system of taxes and transfers, rewarding states which depress their economies more than average, improves the outcomes by creating a race-to-the-bottom type of response. In a symmetric equilibrium, the optimal tax rate is lower if states behave strategically.


W toku | Work in progress

  • The Fragmented United States of America: The impact of scattered lock-down policies on country-wide infections

    Fragmented by policies, united by outcomes: This is the picture of the United States that emerges from our analysis of the spatial diffusion of Covid-19 and the scattered lock-down policies introduced by individual states. We first use spatial econometric techniques to document spillovers of new infections across county and state lines, as well as the impact of  individual states lock-down policies on infections in neighboring states. We find evidence that new cases diffuse across county lines and that the diffusion across counties was affected by the closure policies of adjacent states. Spatial impulse response functions reveal that the diffusion across counties is persistent. We then develop a spatial version of the epidemiological SIR model where new infections arise from interactions between infected people in one state and susceptible people in the same or in neighboring states. We incorporate lock-down policies  and calibrate the model to match both the cumulative and the new infections across the 48 contiguous U.S. states and DC. Our results suggest that lax  policies in the most lenient states translate into millions of additional infections in the rest of the country. In our spatial SIR model, the spatial containment policies such as border closures have a bigger impact on flattening the infection curve in the short-run than on the cumulative infections in the long-run.