Stochastic growth with short-run prediction of shocks

We study a variation of the one-sector stochastic optimal growth model with independent and identically distributed shocks where agents acquire information that enables them to accurately predict the next period??s productivity shock (but not shocks in later periods). Optimal policy depends on the forthcoming shock. A ??better?? predicted realization of the shock that increases both marginal and total product always increases next period??s optimal output. We derive conditions on the degree of relative risk aversion and the elasticity of marginal product under which optimal investment increases or decreases with a better shock. Under fairly regular restrictions, optimal outputs converge in distribution to a unique invariant distribution whose support is bounded away from zero. We derive explicit solutions to the optimal policy for three well-known families of production and utility functions and use these to show that volatility of output, sensitivity of output to shocks, and expected total investment may be higher or lower than in the standard model where no new information is acquired over time; the limiting steady state may also differ significantly from that in the standard model.     

Wealth inequality, preference heterogeneity and macroeconomic volatility in two-sector economies

We explore the link between wealth inequality, preference heterogeneity and macroeconomic volatility in a two-sector neoclassical growth model. First we prove that, if agents have homogeneous preferences, when the absolute risk tolerance is a strictly convex (concave) function, sufficiently high (low) levels of wealth inequality may lead to endogenous fluctuations in the neighborhood of the steady state. Second, we consider the effects of preference heterogeneity when agents are homogeneous with respect to their wealth. We show that when the utility function belongs to the HARA class, sufficiently high levels of preference heterogeneity may lead to endogenous fluctuations in the neighborhood of the steady state if the elasticity of intertemporal substitution in consumption is greater than one.     

On R&D spillovers, multiple equilibria and indeterminacy

Empirical studies often find significant and positive R&D spillovers across firms. In this note, we incorporate this spillover effect into a scale-invariant quality-ladder model. We find that the modified model features multiple steady states (1) a high-R&D steady state, (2) a low-R&D steady state and (3) a zero-R&D steady state. As for dynamics, when R&D spillovers are small, only the zero-R&D steady state is stable, and it emerges as a no-growth trap. In this case, the economy is subject to sunspot fluctuations around this trap (i.e., local indeterminacy). When R&D spillovers are large, both the zero-R&D and high-R&D steady states are stable and locally indeterminate. In this case, increasing patent breadth may cause the high-R&D steady state to become unstable and the economy to converge to the no-growth trap. Therefore, strengthening patent protection may stifle innovation through the occurrence of a bifurcation.     

Education for the masses? The interaction between wealth,educational and political inequalities

This paper presents a simple model of distribution dynamics, in which the distributions of wealth, education and political power are circularly endogenous. Different levels of education translate into different income and wealth levels. Political power may (or may not) vary with wealth, and in turn affects decisions on the level of public expenditure on education. Since the market for education credit is imperfect, some people might need to rely on public schooling, the quality of which depends on those expenditure levels. As a result, educational opportunities differ along the wealth distribution. The dynamic system displays multiple equilibria, some of which are characterized by a vicious circle of interaction between educational, wealth and political inequalities. These particular equilibria, which are more unequal, are also shown to be inefficient in terms of aggregate output levels. Switching equilibria may be achieved through redistribution of political power.
JEL classification: D31, D63.     

Entrepreneurship,Saving, and Social Mobility

This paper examines entrepreneurship in order to analyze, first, the degree to which the opportunity to start or own a business affects the household's saving behavior and the implication of this behavior for the distribution of wealth and, second, the relationship between the extent of entrepreneurship in the economy and socioeconomic mobility, that is, the movement of families across wealth classes over time.First, a number of stylized facts based on data from the Panel Study of Income Dynamics and the Survey of Consumer Finances are outlined. They show relevant differences in asset holdings and wealth mobility between entrepreneurs and workers. Second, a dynamic general equilibrium model with an explicit formalization of the entrepreneurial choice is developed. Through the modeling of the entrepreneurial activities, the model generates a concentration of wealth similar to the one observed in the U.S. economy and it replicates the main patterns of wealth mobility in which entrepreneurs experience higher upward mobility than workers. Journal of Economic Literature Classification Numbers: E21, D31, J23     

Wealth Effects, Distribution, and the Theory of Organization

We construct a general equilibrium model of firm formation in which organization is endogenous. Firms are coalitions of agents providing effort and investment capital. Effort is unobservable unless a fixed monitoring cost is paid, and borrowing is subject to a costly state verification problem. Because incentives vary with an agent's wealth, different types of agents become attractive firm members under different circumstances. When borrowing is not costly, firms essentially consist of one type of agent and are organized efficiently. But when the costly state verification problem is sufficiently severe, firm organization will depend on the distribution of wealth: with enough inequality, it will tend to be dictated by incentives of rich agents to earn high returns to wealth, even if the chosen organizational form is not a technically efficient way to provide incentives.Journal of Economic LiteratureClassification Numbers: D2, D31, J41, L2.     

THE 2005 LAWRENCE R. KLEIN LECTURE: EMERGENT CLASS STRUCTURE*

This article presents a model of the emergent class structure, in which a society inhabited by inherently identical households may be endogenously split into the rich bourgeoisie and the poor proletariat. For some parameter values, the model has no steady state where all households remain equally wealthy. In this case, the model predicts emergent class structure or the rise of class societies. Even if every household starts with the same amount of wealth, the society will experience “symmetry‐breaking” and will be polarized into two classes in steady state, where the rich maintain a high level of wealth partly due to the presence of the poor, who have no choice but to work for the rich at a wage rate strictly lower than the “fair” value of labor. The nonexistence of the equal steady state means that a one‐shot redistribution of wealth would not be effective, as wealth inequality and the class structure would always reemerge. Thus, the class structure is an inevitable feature of capitalism. For other parameter values, on the other hand, the model has the unique steady state, which is characterized by perfect equality. In this case, the model predicts dissipating class structure or the fall of class societies. Even if the society starts with significant wealth inequality, labor demand by the rich employers pushes up the wage rate so much that workers will escape from the poverty and eventually catch up with the rich, eliminating wealth inequality and the class structure in the long run. In an extension, we introduce self‐employment, which not only provides the poor with an alternative to working for the rich, but also provides the rich with an alternative to investment that creates jobs. Due to this dual nature of self‐employment, the effects of self‐employment turn out to be quite subtle. Yet, within the present framework, it is possible to offer a complete characterization of the steady states even in the presence of self‐employment.     

Increasing returns,exhaustible resources,and optimal growth

It is shown that in an optimal growth model having inputs of flows from an exhaustible resource and services of reproducible capital, constant returns to scale is boundary separating paths of non-steady state development from those of steady development including asymptotic steady state growth. The absence of growth in output was observed by Dagsupta and Heal, and Solow for the case of non-increasing returns to scale.     

A Spatial Econometric Analysis of Cultural Dimensions,Technology Knowledge and Economic Growth

Using data from 65 countries over the period 1980–2003, this paper investigates the role that cultural dimensions play in the process of technological change, innovation and adoption and consequently on the steady state level of output per worker and its growth, using spatial econometrics techniques to account for spatial dependence between countries. Initial findings indicate that differences across cultural dimensions act as a leveling effect but not as long run growth determinants. In addition, when controlling for physical and human capital accumulation, culture plays a much smaller role in explaining differences in income per capita than initially thought, with little effect on output per worker growth along the transitional dynamics path. Spatial econometric considerations are relevant in explaining differences across rates of growth of per worker output, but not in terms of steady‐state levels of income.     

Median‐voter Equilibria in the Neoclassical Growth Model under Aggregation*

We study a dynamic version of Meltzer and Richard's median‐voter model where agents differ in wealth. Taxes are proportional to income and are redistributed as equal lump‐sum transfers. Voting occurs every period and each consumer votes for the tax that maximizes his welfare. We characterize time‐consistent Markov‐perfect equilibria twofold. First, restricting utility classes, we show that the economy's aggregate state is mean and median wealth. Second, we derive the median‐voter's first‐order condition interpreting it as a tradeoff between distortions and net wealth transfers. Our method for solving the steady state relies on a polynomial expansion around the steady state.     

Distribution shocks in a Kaleckian model with hysteresis and monetary policy

This study presents a dynamic Kaleckian model with different demand and distribution regimes, a monetary policy rule and hysteresis in the natural output level. We analyse the local stability of the steady state and the transitional dynamics in different combinations of demand and distribution regimes. Our model indicates that the initial condition in an economy matters for the steady state selection from multiple ones. Using impulse response function analysis, we show that a temporary shock to the income distribution can cause permanent effects on the dynamics of endogenous variables. Moreover, the degree of hysteresis influences the magnitude of impact on output levels. Monetary policy cannot stabilise output levels in the face of temporary shocks. Finally, we find that in a wage-led demand regime, a rise in inequality of functional income may lead to secular stagnation.     

Public budget composition,fiscal (de)centralization,and welfare

Abstract We study the optimal degree of fiscal decentralization in a dynamic federal economy where governments decide on budget size and its allocation between public education and infrastructure spending. We find that full centralization of tax and expenditure policies is optimal when infrastructure productivity is similar across regions. When differences are not too large, partial centralization is optimal. With strong differences, full decentralization becomes optimal. National steady‐state output tends to be highest under full decentralization. We provide a justification for the mixed evidence regarding the Oates conjecture by showing that full dominates partial decentralization, despite being inferior to complete decentralization.     

Long horizon versus short horizon planning in dynamic optimization problems with incomplete information

Summary. This paper compares the implications of short and long horizon planning in dynamic optimization problems with the structure of a standard one-sector growth model if agents have incomplete knowledge about the production function. Agents know the output and rate of return at the current capital stock and use an estimation of the production function based on this knowledge to determine current consumption. For standard utility functions without wealth-effects both long and short planning horizons yield convergence to the steady state - however at a faster rate than optimal -, or fluctuations around the steady state, and in both cases, long horizon planning yields a policy which locally at the steady state is closer to the optimal one than short horizon planning. On the other hand, for preferences with wealth effects where the intertemporal optimal path exhibits fluctuations, long horizon planning destabilizes the path and short horizon planning can generate paths which are qualitatively closer to the optimal one and yield higher discounted utility.Received: 5 April 2001, Revised: 15 September 2003, JEL Classification Numbers: C61, D83, D90.Herbert Dawid: The author would like to thank Richard Day for numerous stimulating discussions which led to this article and an anonymous referee for helpful comments     

Capital in the Twenty-First Century: Reinterpreting the fundamental contradiction of capitalism

At a theoretical level this article discusses Piketty’s hypothesis that the distribution of income and wealth tends to become more concentrated over time when the rate of return on capital is greater than the growth rate of real output. We develop a post Keynesian model of growth and distribution showing that once capital is differentiated from wealth, the increase in income and wealth concentration actually occurs when the rate of valorization of financial and real estate assets is greater than the growth rate of real output, and that this situation may be triggered by financial liberalization.     

Collective Organizations versus Relative Performance Contracts: Inequality, Risk Sharing, and Moral Hazard

This paper studies collective economic organizations that share risk and mitigate moral hazard and compares them with relative performance contracts. Information-constrained optimal distributions of organizations and contracts are shown to be functions of the underlying primitives, in particular, the distribution of Pareto weights, and hence degree of inequality. Internal inequality of a potential, local group is a force for collective organization. That is, multi-agent organizations exist in order to extract wealth from some but not necessarily all members. The group organization is also shown to be information-constrained Pareto optimal at extremes of local wealth relative to an outsider. But the group organization is susceptible to both agents simultaneously deviating, colluding against the outsider, and this distortion makes an individualistic, relative performance contract an attractive alternative. More generally, organizations, contracts, and allocations are jointly determined. These implications could be distinguished in cross-sectional, time series data. Journal of Economic Literature Classification Numbers: D70, D82.     

Envy and Inequality*

We present an overlapping generations economy, populated by heterogeneous agents who care about both consumption relative to others and the bequest they leave to their offspring. We show that saving and bequest rates vary across the income distribution, and we obtain several interesting results. First, envy reduces the steady‐state capital stock and increases the degree of inequality in consumption, capital ownership, and bequests. Second, if the bequest motive is sufficiently strong the equalizing effect of bequests disappears. Third, income inequality for a given cohort increases with age. Fourth, the distribution of inherited wealth becomes more unequal than that of wealth in general. Fifth, economic position becomes more persistent across generations.     

Is Altruism Important for Understanding the Long-Run Effects of Social Security?

This paper quantifies the effects of social security on capital accumulation and wealth distribution in a life-cycle framework with altruistic individuals. The main findings of this paper are that the current U.S. social security system has a significant impact on capital accumulation and wealth distribution. I find that social security crowds out 8% of the capital stock of an economy without social security. This effect is driven by the distortions of labor supply due to the taxation of labor income rather than by the intergenerational redistribution of income imposed by the social security system. In contrast to previous analysis, I found that social security does not affect the savings rate of the economy. Another interesting finding is that even though the current U.S. social security system is progressive in its benefits, it may lead to a more dispersed distribution of wealth. Journal of Economic Literature Classification Numbers: D31, D58, E2, E6, H55, J22, J26.     

An endogenous growth model with embodied energy-saving technical change

In this paper, we extend the Romer [Journal of Political Economy 98 (Part 2) (1990) S271] model in two ways. First we include energy consumption of intermediates. Second, intermediates become heterogeneous due to endogenous energy-saving technical change. We show that the resulting model can still generate steady state growth, but the growth rate depends negatively on the growth of real energy prices. The reason is that real energy price rises will lower the profitability of using new intermediate goods, and hence, the profitability of doing research, and therefore have a negative impact on growth. We also show that the introduction of an energy tax that is recycled in the form of an R&D subsidy may increase growth. We conclude that in order to have energy efficiency growth and output growth under rising real energy prices, a combination of R&D and energy policy is called for.     

Public Expenditure,Environment, and Economic Growth

This paper attempts to develop a model of endogenous growth with special consideration to the role of productive public expenditure in the presence of congestion effect of private capital and environmental pollution. We analyze the properties of the optimal fiscal policy in the steady‐state equilibrium when the level of production of the final good is the source of emission. Government allocates its income tax revenue between pollution abatement expenditure and productive public expenditure. In the steady‐state equilibrium, optimum ratio of productive public expenditure to national income is less than the competitive output share of the public input; and this ratio varies inversely with the magnitude of the emission‐output coefficient. The steady‐state equilibrium appears to be a saddle point; and the market economy growth rate is not necessarily less than the socially efficient growth rate in the steady‐state equilibrium.