The elasticity of derived demand, factor substitution, and product demand: Corrections to Hicks' formula and Marshall's Four Rules

The concept of the elasticity of substitution between capital and labor, introduced by John Hicks and Joan Robinson over 75 years ago, has had important implications in labor economics and several areas of economic inquiry. In his The Theory of Wages (1932/1963), Hicks developed a formula that has proven very useful in relating the substitution elasticity to the derived demand for productive factors, the distribution of factor incomes, and Marshall's Four Rules. This short paper shows that the original and subsequent derivations of Hicks' celebrated formula contained a slip (that factor shares are independent of the substitution elasticity and therefore constant), presents a new derivation and a corrected formula, and demonstrates that, with the corrected formula, Marshall's First Rule based on the substitution elasticity is no longer generally valid.     

Sustained endogenous growth with decreasing returns and heterogeneous capital

The possibility of sustained long-run growth is typically associated with the presence of some endogenous `engine of growth'. It may allow the economy to grow without bound despite the use of some non-reproducible resources. Such situations can lead to dynamic models combining the features of sustainable growth and decreasing returns. One-sector models of this kind have recently attracted much attention in macroeconomics applications. Their approximate linearity for the purposes of long-run analysis has been noted. This paper is aimed at establishing the general fact: dynamic models (one- or multi-sector) which are characterized by sustained endogenous growth with non-increasing returns display the patterns of optimal growth asymptotically equivalent to those generated by models with linear technology. I consider a neoclassical growth model with heterogeneous capital, develop its linear counterpart, and prove their asymptotic equivalence in terms of long-run optimal growth rates and cross-sectoral profiles of consumption, real interest rates and relative prices. This result also implies the `non-substitution' theorem for the neoclassical dynamic model of sustained growth: optimal input profiles, relative prices, and interest rates are asymptotically independent of intertemporal preferences.     

A sufficiency result for constrained economies

This paper presents a general sufficiency result for constrained economies. The result shows that, when an equilibrium allocation satisfies the first order necessary conditions for hybrid efficiency (a new type of constrained efficiency), there exists a marginal cost pricing equilibrium in an associated economy. If this equilibrium is Pareto efficient in the associated economy, then the original equilibrium allocation is hybrid efficient. Hence. the necessary conditions are also sufficient.     

Arbitrage, equilibrium, and gains from trade: A counterexample

We present a counterexample to a theorem due to Chichilnisky (Bulletin of the American Mathematical Society, 1993, 29, 189–207; American Economic Review, 1994, 84, 427–434). Chichilnisky's theorem states that her condition of limited arbitrage is necessary and sufficient for the existence of an equilibrium in an economy with unbounded short sales. Our counterexample shows that the condition defined by Chichilnisky is not sufficient for existence of equilibrium. We also discuss difficulties in Chichilnisky (Economic Theory, 1995, 5, 79–107).     

Growth, development and natural resources: New evidence using a heterogeneous panel analysis

This paper explores whether natural resource abundance is a curse or a blessing. To do so, we firstly develop a theory consistent econometric model, in which we show that there is a long run relationship between real income, the investment rate, and the real value of oil production. Secondly, we investigate the long-run (level) impacts of natural resource abundance on domestic output as well as the short-run (growth) effects. Thirdly, we explicitly recognize that there is a substantial cross-sectional dependence and cross-country heterogeneity in our sample, which covers 53 oil exporting and importing countries with very different historical and institutional backgrounds, and adopt the non-stationary panel methodologies developed by Pesaran (2006) and Pedroni (2000) for estimation. Our results, using the real value of oil production, rent or reserves as a proxy for resource endowment, reveal that oil abundance has a positive effect on both income levels and economic growth. While we accept that oil rich countries could benefit more from their natural wealth by adopting growth and welfare enhancing policies and institutions, we challenge the common view that oil abundance affects economic growth negatively.     

Housing tenure choice and the dual income household

Housing tenure choice has been the subject of a very large literature. Many treatments have sought to estimate the effect of household income on the likelihood of home ownership. To date, no study has ever disaggregated the household income of married couples into the separate labor income components to see if one partner’s income has a different effect than the other. Using a derived likelihood function to control for censoring in the wife’s income, this paper estimates the effect of separate incomes on housing tenure choice, accounting for possible endogeneity of the wife’s income. To compare the results of this estimation method, the paper also estimates the standard IV models, 2SLS and IV probit. While the results show that there is no endogeneity of the wife’s income, ignoring the censoring of the endogenous variable (when a large fraction of observations are censored) can possibly lead to biased coefficient estimates. Also, this paper confirms the importance of total household income, which has a larger effect than the total disaggregated components.     

Optimal regulation of technical progress in natural monopolies with asymmetric information

The focus of this paper is to characterize regulatory mechanisms for natural monopolies to provide for optimal technical progress when information is asymmetric. We model a Bayesian-Nash game where the monopolist has private knowledge of the cost-reducing effects of R&D investment to generate process innovations. In the first case, a price-regulated, profit-maximizing firm whose R&D level is unobservable sets its R&D level efficiently to maximize profits at the output level chosen by the firm. However, the level of technical progress achieved by the firm in this case is too high from the regulator's point of view since, in the second-best regulated solution of interest, the regulator has to provide for the R&D expenditures, assumed sunk, as well as for information rents transferred to the firm. In a second case, it can be shown that if the regulator can observe and set limits on the firm's investment in R&D, social welfare is improved, even though the regulated investment level is no longer efficient at the output level chosen by the firm. The reason for the welfare improvement is that losses in consumer surplus due to a decrease in output and an increase in the price are offset by a decrease in information rents and R&D costs transferred, causing the social costs of public funds to fall. Received: 31 July 1994 / Accepted: 15 January 1999     

Direct and indirect effects of FDI in emerging European markets: A survey and meta-analysis

We review a large body of literature dealing with the effects of Foreign Direct Investment (FDI) on economies during their transformation from a command economic system toward a market system. We report the results of a meta-analysis based on the literature on externalities from FDI. The studies on emerging European markets covered in our survey report direct and indirect FDI effects weakening over time, similarly as in other FDI destination countries. This is imputable to a publication bias that is detected and to the fact that more sophisticated methods and more controls can be used once a sufficient time span is available. Panel studies are likely to find relatively lower spillover effects. The choice of the research design (definition of firm performance and foreign firm presence) matters. More specific to the sampled studies is the role played by forward and backward spillovers which dominate other channels in driving FDI externalities.     

Bayesian inference in a time varying cointegration model

There are both theoretical and empirical reasons for believing that the parameters of macroeconomic models may vary over time. However, work with time-varying parameter models has largely involved vector autoregressions (VARs), ignoring cointegration. This is despite the fact that cointegration plays an important role in informing macroeconomists on a range of issues. In this paper, we develop a new time varying parameter model which permits cointegration. We use a specification which allows for the cointegrating space to evolve over time in a manner comparable to the random walk variation used with TVP–VARs. The properties of our approach are investigated before developing a method of posterior simulation. We use our methods in an empirical investigation involving the Fisher effect.     

Foreign and domestic growth drivers in Eastern Europe

This paper analyses the growth effects of capital formation, exports and FDI as major, drivers of economic development in Eastern Europe. The fundamental innovations are, identified by empirically and theoretically motivated short- and long-run restrictions in, structural cointegrated vector autoregressions. Impulse responses and variance, decompositions reveal quite different growth effects in various Eastern European countries. Generally, a strong reliance on exports goes along with higher GDP, and FDI bears, substantial potential for fostering economic growth. It is shown that the recent worldwide, recession clearly hit Eastern Europe through the export channel, whereas the recovery is, mainly supported by positive demand shocks.     

The effect of raising deposit insurance coverage in times of financial crisis – Evidence from Croatian microdata

Typically, depositors in transition countries react very sensitively to the safety of deposits. Faced with rising deposit outflows in October 2008, many transition countries were forced to extend the limits of deposit insurance coverage. Has this calmed private agents? Or has it caused more uncertainty? We analyze these questions by employing household survey data for Croatia from exactly the time deposit insurance was extended. First, we provide evidence how the financial crisis has affected trust in banks and trust in the local currency. Then, we show that the increase in deposit insurance coverage had an immediate and positive impact on how people perceived the safety of deposits and the credibility of the local currency. Therefore, our results suggest that this policy measure helped to prevent a more serious and dangerous meltdown of deposits and a further shift towards foreign currency denominated assets. However, despite this effect the perceived safety of deposits remained lower than it was before the financial crisis. We also consider this finding to be of relevance for other countries of Central, Eastern and Southeastern Europe.     

Active intermediation in a monetary overlapping generations economy

This paper establishes that the profit-seeking activities of private intermediaries can ensure Pareto efficiency in the standard pure-exchange monetary overlapping generations economy without the need for government monetary or fiscal policy intervention. Moreover, these profit-seeking activities are shown to rule out all aperiodic and k-periodic cycles for k greater than 2. Contrary to much recent work on intermediation, the profit opportunities that arise for intermediaries in this context are not due to assumed frictions or asymmetric information. Rather, they are due to the dynamic open-ended structure of the economy, which permits debt roll-over.     

Implementation in generalized matching problems

We search for (Nash) implementable solutions on a class of one-to-one matching problems which includes both the housing market (Shapley and Scarf, Journal of Mathematical Economics, 1974, 1, 23–28) and marriage problems (Gale and Shapley, American Mathematical Monthly, 1962, 69, 9–15). We show that the core correspondence is implementable. We show, furthermore, that any solution that is Pareto efficient, individually rational, and implementable is a supersolution of the core correspondence. That is, the core correspondence is the minimal solution that is Pareto efficient, individually rational, and implementable. A corollary of independent interest in the context of the housing market is that the core correspondence is the only single-valued solution that is Pareto efficient, individually rational, and implementable.     

Metonymy and cross-section demand

Cross-section consumer expenditure data are frequently used to draw conclusions about consumer demand behavior. Such conclusions, however, are justified only under certain assumptions, which are often left unstated in the empirical demand literature. An assumption of this type, the metonymy hypothesis, was stated rigorously and exploited by Härdle et al. when analyzing the monotonicity of aggregate demand functions. The purpose of the present paper is to examine the metonymy hypothesis in more detail. We prove that the distribution of demand vectors derived from a not necessarily metonymic population is identical with the distribution derived from some metonymic population. This implies, in particular, that the metonymy hypothesis cannot be rejected or confirmed on the basis of data from a single cross-section.     

With a little help from abroad: The effect of low-skilled immigration on the female labour supply

We examine whether and how the inflow of female immigrants who specialize in household production affects the labour supply of Italian women. To identify the causal effect, we exploit the family reunification motives and network effects (i.e., the tendency of newly arriving female immigrants to settle in places where males of the same country already live) which is used as an instrument for the geographical distribution of female foreign workers. We find that when the number of immigrants who provide household services is higher, native Italian women spend more time at work (intensive margin) without affecting their labour force participation (extensive margin). This impact is concentrated on highly skilled women whose time has a higher opportunity cost. These results also hold after a battery of robustness checks. We present some further evidence that is also consistent with the idea that the impact works through substitution in household work rather than complementarities in the production sector. Finally, we show that immigration arises as a substitute to publicly provided welfare services, although this phenomenon raises concerns regarding the fairness and sustainability of this private and informal welfare model.