Research

Foreign Firms and Domestic Productivity

Foreign Firms, Domestic Entrepreneurial Skills and Development

In this paper I examine the impact of foreign firms for the accumulation of domestic skills in a developing country. The presence of  foreign firms unleashes two countervailing forces. The first is a "diffusion effect" that boosts skill accumulation as local entrepreneurs are exposed to more advanced knowledge. The second is a "competition effect" that busts skill accumulation as local entrepreneurs foresee heightened competition in the future. I consider two opposite models for diffusion. In the first, knowledge is a local public good and diffusion takes place via "spillovers". In the second, the costs and benefits of skill accumulation are fully internalized and diffusion is the result of efficient market transactions.

When diffusion takes place via spillovers, two stable steady states may arise and initial conditions determine the dynamics of the country. I show that opening to foreign firms can be welfare decreasing and that leapfrogging can occur because less backward countries converge more slowly or not at all while more backward countries always converge. When diffusion is fully internalized, opening is always welfare increasing. However, the presence of foreign firms leads to a reduction in the productivity of existing domestic firms, which is consistent with some empirical evidence.

Foreign Know-How, Firm Control and the Income of Developing Countries (with A. Burstein)

Managerial know-how shapes the productivity of firms by defining the set of available technologies, production choices, and market opportunities. This know-how can be reallocated across countries as managers acquire control of factors of production abroad. In this paper, we construct a quantitative model of cross-country income differences to study the aggregate consequences of international mobility of managerial know-how. We use the model and observed aggregate data to infer the relative scarcity of this form of know-how in a sample of developing countries. We also conduct policy counterfactuals and find that on average, developing countries gain up to 22% in output and 9% in consumption when they eliminate all barriers to foreign control of domestic factors of production.

Human Capital Accumulation

Human Capital Formation with Endogenous Credit Constraints (with L. Lochner; under revision for resubmission AER)

This paper considers a human capital investment framework in which borrowing limits are endogenously derived from repayment incentives and, therefore, linked to future earnings prospects. Because human capital investments and credit limits are jointly determined, optimal investments differ considerably from those in standard models with exogenous constraints. Re-payment incentives induce a positive relationship between credit limits and the ability, initial wealth, and human capital investments of individuals.

In our framework, investment responses to government policy are substantially different from those of a standard exogenous constraint model. Government policies affect incentives to default and, hence, optimal limits on private borrowing. Subsidies for investment in human capital should be accompanied by increases in borrowing limits, since borrowers are able to commit to repaying higher debts. Thus, education subsidies and student loans should be viewed as complements. Also, schooling subsidies, which relax credit limits, increase the dispersion of investment across ability types when constraints are endogenous, but not when constraints are exogenous. Contrary to conventional wisdom, public spending on education can crowd-in private spending, especially for the poor. Furthermore, when constraints are endogenous, higher labor income tax rates restrict borrowing and reduce investment in human capital (even when investments are tax deductible). We calibrate our model and show that the differences in predictions with standard models are quantitatively important.

Human Capital Investment and Default with Government Student Loans (with L. Lochner; under revision)

This paper examines data on student loan default from the Baccalaureate and Beyond Survey. The main findings include: (1) conditional on debt, the probability of default is declining in both predicted and actual post-school earnings; (2) conditional on earnings, the probability of default is increasing in debt; (3) default rates vary across undergraduate majors, but those differences disappear when controlling for debt and earnings; and most interestingly, (4) there is a U-shaped relationship between ability and the probability of default even after controlling for debt and earnings.

We next develop a model of endogenous human capital investment and default that attempts to replicate these facts. The model incorporates a lending scheme that ties borrowing to investment in schooling but does not make repayments explicitly contingent on the subsequent earnings of borrowers. Punishments on borrowers who default follow those in practice under the current government student loan program, and limits on those punishments cause some borrowers to choose default over repayment. Within the context of the model, we ask the following questions: (1) what types of heterogeneity and market shocks explain our empirical findings? (2) Given the answer to the first question, how different are consumption and investment under the current program with respect to the optimal (un-contingent) lending program? More generally, the model is useful for studying the interaction between borrowing constraints, default, and investment in human capital. In contrast to conventional wisdom, the model suggests that, given the current lending system,  credit constraints do not necessarily imply under-investment but instead a steeper profile in consumption for constrained individuals.

Social and Production Coalitions (work in progress)

Most human relationships are “assortive” as individuals with similar characteristics seek each other for social interactions such as leisure activities, family formation, reproduction and child rearing. An important exception, however, is in the organization of production of goods and services. Efficiency often entails hierarchies in which highly skilled individuals lead teams of individuals with lower skills. In the model, an infinite horizon OLG economy, individuals choose a partner to reproduce and another partner to produce. The skills of both members of the reproduction team determine the probability distribution of the skills of their offspring; the skills of the members of the production team determine the skills of (surviving) individuals in the next period. In an equilibrium in which individuals fully internalize the impact of their social and production partners, I study the long-run aggregate accumulation and cross-section distribution of skills and income. I also explore the conditions under which, despite the social forces that lead the economy to segregate, the economy exhibits social mobility because the production forces lead to mixing. 

Aggregate Consequences of Limited Commitment

Interest Rate Shocks, Creation and Liquidation of Firms and Aggregate Fluctuations (under revision)

This paper models the impact of interest rates in an economy with limited commitment. A firm's temptation to default endogenously induces credit constraints in their optimal long-term relationship with banks. The history of the relationship determines the credit limits generating a non-trivial life-cycle for firms. Collateral takes time to accumulate and raises the scale of operations and firm's survival probabilities.

Firms in many different stages of their life-cycle will coexist in the economy. In this environment, a positive interest rate shock decreases the survival probability of constrained firms while unconstrained firms respond primarily by adjusting their scale of operations. Increases in the interest rate affect the mass and cross-section of active firms, partly through a reduction of the number of new ones. Higher interest rates also tighten constraints of newly created firms, raising the number of periods needed to achieve maturity.

The model generates persistent and asymmetric aggregate output dynamics.

Optimal Dynamic Contracts with Limited Commitment and Aggregate Fluctuations (work in progress)

In this paper I study the optimal contract under limited commitment when the prices relevant for the contract fluctuate over time. I consider the problem of an entrepreneur who has access to a productive technology and a bank with access to the resources needed to finance the firms operations. Every period, the entrepreneur has the option to renege on the contract but the bank has full commitment. I formulate this standard infinite horizon one-side limited commitment problem in continuous time, which allows me to characterize the optimal solution as finding the time needed for the firm to achieve maturity (defined as one in which the age of the firm no longer impacts the allocations.) This result allows a full characterization of the cross-section distribution of firms of an economy in steady state and of the aggregate output and welfare cost of limited commitment.

Then, I study the optimal contract allowing for any C² deterministic time paths for wages and interest rates. Since the optimal contract is also determined by the age-to-maturity the aggregate variables can be computed and wages and interest rates path can be iterated until general equilibrium conditions are satisfied. I use the model to explore for the response of the economy to three events: (a) movements on the international interest rate of a small open economy with non-tradeable labor; (b) an innovation in the productivity of all firms; and (c) innovation in the new vintage of technologies (active entrepreneurs would need to liquidate their old technologies to access the higher productivity). In all three cases the response of the aggregate economy is compared with an economy with full commitment.

Life Cycle Consumption with Limited Commitment (work in progress)

I study the timing of solvency constraints in a standard life-cycle consumption model in general equilibrium. In any point in time, individuals have the option to renege on financial liabilities. I assume that the punishment of defaulting consists of having a negative credit report which implies that, for a finite amount of time an agent (i) loses a fraction of its labor income, (ii) loses access to formal financial markets (can only save at a lower rate or borrow at a higher rate). I characterize the optimal consumption profile for agents with different initial assets and life-income profiles and show that, participation constraints are binding only at an intermediate age.

Other

Financial Markets, Entrepreneurship and the Distribution of Wealth. (2000).

Monetary Policy, Distributional Shocks, and Aggregate Fluctuations, Mimeo. (1998)

More Applied Work

"Economic Growth in Paraguay" (with Carlos Fernandez) in Sources of Growth in Latin America. What Is Missing? Inter American Development Bank, Fernández-Arias, E., Manuelli, R. and Blyde, J. eds. (January 2006)

Also in:

Economic Growth in Paraguay, in Economic and Social Study Series, RE1-04-009, Inter-American Development Bank, (May 2004.)

"Comment on Ernesto López-Córdova's: `NAFTA and Manufacturing Productivity in Mexico' " in Economia, The Journal of the Latin American and Caribbean Economic Association, Fall 2003, Volume 4, Number 1.

"Access to Credit and the Performance of Firms in Costa Rica" (with Luis J. Hall) in Credit Constraints and Investment in Latin America. Galindo, A. and Schiantarelli,F. eds. Inter-American Development Bank (July 2003)

"Enforcement Mechanisms, Default, and Contract Design: Exploring the Credit Markets in Costa Rica". in Defusing default : incentives and institutions: Incentives and Institutions. Pagano, Marco, editor. Washington, DC: Inter-American Development Bank. (November 2001)

Un Modelo Económico para la Proyección y el Análisis de los Sistemas de Pensiones en Costa Rica. (An Economic Model for the Proyection and Analysis of the Sustainability of the Pension System in Costa Rica) Commissioned by the Super Intendency of Pensions, Costa Rica, (December 2003)

The Impact of NAFTA on Foreign Direct Investment flows in Mexico and the Excluded Countries. (2002; commissioned by the World Bank)

Aggregate Fluctuations and Co-Movement in Central America, Mexico and USA (with Hall, L. and E. Robles, E. ) Research commissioned by The World Bank (1999)

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This page was last updated on March 4, 2007