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

  • Local containment policies and country-wide spread of Covid-19 in the United States: an epidemiologic analysis | Regional Studies

    We analyze spatial diffusion of new Covid-19 cases and country-wide impact of state-specific containment policies during the early months of the Covid-19 pandemic in the United States. We first use spatial econometric techniques to document direct and indirect 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 consistent statistical evidence that new cases diffuse across county lines, holding county level factors constant, and that the diffusion across counties was affected by the closure policies of adjacent states. 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 into our model 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, had the states with the less restrictive social distancing measures tightened them by one level, the cumulative infections in other states would be about 5% smaller. 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.

    Replication package

  • Non-traded goods, factor markets frictions, and international capital flows | Review of Economic Dynamics

    The canonical one-sector model over predicts international capital flows by a factor of ten. We show that introducing a non-traded goods sector can reconcile the differences between the theoretical predictions and the observed flows. We analyze the quantitative impact of the non-traded sector using a calibrated model of a small open economy, in which non-traded goods are used in consumption and investment, and need capital and labor to be produced. The model features international frictions directly affecting international borrowing and lending, as well as domestic frictions that limit the scope of inter-sectoral reallocation of capital and labor. We find that: (1) the impact of domestic frictions on the size of international capital flows is similar to the impact of international frictions, and (2) the median elasticity of capital flows with respect to international frictions in the two-sector model with costly inter-sectoral reallocation is about 50-60% lower than that same elasticity in the one-sector model.

    The full set of replication codes and data is available here.

  • Optimal federal transfers during uncoordinated response to a pandemic | Journal of Public Economic Theory

    An outbreak of a deadly disease pushes policymakers to depress economic activity due to externalities associated with individual behavior. Sometimes, these decisions are left to local authorities (e.g., states). This creates another externality, as the outbreak doesn't respect states' boundaries. A strategic Pigouvian subsidy that rewards states which depress their economies more than the average corrects that externality by creating a race-to-the-bottom type of response. In a symmetric equilibrium nobody receives a subsidy, but the allocation is efficient. If states are concerned about unequal burden of the lockdown costs, but cannot easily issue new debt to finance transfer payments, then lock-downs will be insufficient in some areas and excessive in others. When that's the case, federal stimulus checks can limit the extent of local outbreaks.

  • Optimal teleworking agreements vs. yearning for normality when vaccine is on the horizon | Economics Bulletin

    During a pandemic, companies may adopt teleworking agreements even if they lower current productivity. If managers (or policymakers) want to project an image of ``return to normality'', completely orthogonal to any economic or health outcomes, the scope of teleworking agreements is lower but constant in a stationary equilibrium. In response to the news about upcoming vaccine, rational managers always increase the scope of teleworking agreements, unless the desire to project the image of ``return to normality'' is sufficiently strong, effectively creating a reopening-smoothing motive. The ``return to normality'' may be premature if managers do not understand Lucas' Critique.

  • 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.

    Replication package


W toku | Work in progress

  • Foreign direct investment over the international business cycle

    Among the G7 economies gross foreign direct investment (FDI) positions are very large, averaging 100% of GDP and dwarfing the absolute values of net FDI positions in most countries. Additionally, inward and outward FDI flows exhibit robust, positive correlation over the business cycle. In the standard international business cycle (IBC) model gross FDI stocks and flows are not well defined, and only net flows matter. We extend the standard model by allowing domestic and foreign ownership of physical capital in the aggregate production function to be imperfect substitutes. We estimate that elasticity of substitution using the co-movement of gross FDI flows, and find it to be less than 2.5 – a value much smaller than the implicitly assumed infinity in the IBC literature. Our results uncover a new source of welfare gains from openness to FDI among otherwise identical, developed economies – a capital diversity channel, akin to product variety in trade models. The channel is quantitatively important – openness to FDI yields steady-state welfare gains equivalent to at least a 4-5% increase in life-time consumption.