HKS Center for International Development Publications

This paper addresses the complex relationship between geography and macroeconomic growth. We investigate the ways in which geography may matter directly for growth, controlling for economic policies and institutions, as well as the effects of geography on policy choices and institutions. We find that location and climate have large effects on income levels and income growth, through their effects on transport costs, disease burdens, and agricultural productivity, among other channels. Furthermore, geography seems to be a factor in the choice of economic policy itself. When we identify geographical regions that are not conducive to modern economic growth, we find that many of these regions have high population density and rapid population increase. This is especially true of populations that are located far from the coast, and thus that face large transport costs for international trade, as well as populations in tropical regions of high disease burden. Furthermore, much of the population increase in the next thirty years is likely to take place in these geographically disadvantaged regions.

Using a unique data set, we study the trading behavior of foreign portfolio investors in Korea before and during the currency crisis. Different categories of investors have significant differences as well as similarities. First, non-resident institutional investors are always positive feedback traders, whereas resident investors before the crisis were negative feedback (contrarian) traders but switch to be positive feedback traders during the crisis. Second, individual investors herd significantly more than institutional investors. Non-resident (institutional as well individual) investors herd significantly more than their resident counterparts. Third, differences in the Western and Korean news coverage are correlated with differences in net selling by non- resident investors relative to resident investors.

This paper uses a dynamic general equilibrium model based on corner solutions to formalize the classical theory of investment and capital which considers investment to be a vehicle for developing a high level of division of labor in roundabout productive activities. If it takes time for a specialist producer of tractors to learn the right method in producing commercially viable tractors, specialization in producing tractors is infeasible in the absence of investment in terms of consumption goods which are consumed by the specialist producer of tractor before he can sell tractors. If specialized learning by doing can speed up accumulation of professional knowledge so that roundabout productive machines becomes cheap, such investment for increasing the level of division of labor in roundabout productive activities will speed up economic growth. Due to the tradeoff between economies of specialized learning by doing and transaction costs, the model can be used to investigate the effects of a change in the transaction cost coefficient, which can be affected by policy, the legal system, and urbanization, on the evolution of division of labor, on real interest rates, and on saving rate.

This paper presents a model in which a high growth economy becomes susceptible to a sudden financial crisis. In the model firms are motivated to over-invest because of government subsidies and then bear the burden of the inefficiencies caused by the government distortion. We assume that the firms compensate for their losses by obtaining bank loans and domestic banks will continuously lend money to the firms as long as the total amount of accumulated loans remain within the limit of the collateral value of real estate. Domestic banks borrow from foreign investors to provide loans for the firms. With these assumptions, we obtain the following results that may well be consistent with the recent experience of East Asian countries. First, a higher growth economy with a higher government subsidy shows higher investment and GDP growth rates, a higher level and growth rate of real estate prices, and a higher level of current account deficits. Second, the rapid growth caused by higher government subsidies makes the economy very vulnerable to adverse shocks. When adverse shocks hit the economy and the expected loan- to-collateral value ratio rapidly increases, foreign investors become suspicious about the safety of domestic banks and begin to withdraw their loans. Subsequently, financial panic and economic crisis suddenly occur. Third, capital market liberalization, by provoking huge foreign capital inflows and outflows, increases the possibility of crisis and amplifies the scale of crisis.

This paper applies the infra-marginal analysis, which is a combination of marginal and total cost-benefit analysis, to a model with both constant returns and increasing returns in production and with exogenous and endogenous comparative advantages. It demonstrates that as transaction conditions are improved, the general equilibrium discontinuously jumps from autarky to partial division of labor with a dual structure, then to the complete division of labor where dual structure disappears. Two types of dual structure may occur in the transitional stage of economic development and globalization. One of them involves the division of labor in the developed economy and autarky in the less developed economy, generating increasing disparity of per capita real income between the two types of economies. The other involves a domestic dual structure in the less developed economy, where the population is divided between commercialized sector which trades with foreign country and self-sufficient sector which is not involved in trade. All gains from trade go to the developed economy. This paper shows that deterioration of a country’s terms of trade may concur with an increase of gains that this country receives from trade provided productivity progress from an expanded network of division of labor outpaces the deterioration of terms of trade. In the model with both endogenous and exogenous comparative advantages, a country may exports a good with exogenous comparative disadvantage if endogenous comparative advantage dominates this exogenous comparative disadvantage.

Pricing costs and information problems are introduced into a framework with consumer-producers, economies of specialization, and transaction costs to predict the endogenous and concurrent evolution in division of labor and in the information of organization acquired by society. The concurrent evolution generates endogenous growth based on the tradeoff between gains from information about the efficient pattern of division of labor, which can be acquired via experiments with various patterns of division of labor, and experimentation costs, which relate to the costs in discovering prices. The concept of Walras sequential equilibrium is developed to analyze the social learning process which is featured with uncertainties of the direction of the evolution as well as a certain trend of the evolution.

This paper studies whether there exists private information in the foreign exchange market, and whether speculation reduces or exacerbates volatility. It makes use of a recent data set on foreign currency positions by large market participants that include positions on options and other derivatives. This is the first data set that describes comprehensive currency positions of market participants. There are two main findings. First, not only the absolute value of the options position but also that of spot, forward and futures positions by large participants Granger-causes exchange rate volatility. This suggests that the large participants' currency speculation does not stabilize exchange rate volatility. Second, regression analyses do not find any positive association between large participants' position in a foreign currency with its subsequent appreciation. A non-parametric approach finds some weak support for a positive association but not on a systematic level. This casts into doubt the view that large participants have better information about the future movement of exchange rates. It further strengthens the case that the large players trade on noise rather than on information.

In the paper we introduce technological comparative advantage and transaction costs into the Heckscher-Olin (HO) model and refine the HO theorem, the Stolper-Samuelson theorem, the Rybczynski theorem, and factor equalization theorem. The refined core theorems can be used to accommodate recent empirical evidence that is at odds with the core theorems.

In this paper a general equilibrium model is constructed to explain the emergence of firms and change in firm size by the tradeoff between economies of specialization and transaction cost. We show that firms emerge from the development of division of labor if the transaction efficiency for labor is smaller than that for intermediate goods. Given the emergence of firms, change in the average size of firms (average employment) will depend on the change in transaction efficiency for intermediate goods relative to that for labor. If the transaction efficiency is improved in such a way that the transaction efficiency for intermediate goods becomes higher than that for labor, average employment will decrease. We present evidence showing that it is not uncommon that average employment declines as the economy develops. The general equilibrium model provides an explanation for the concurrent increase of productivity and decrease in average employment which is observed in a number of countries. Models based on economies of scale instead of economies of specialization would have yielded the opposite prediction.

This paper applies the infra-marginal analysis, which is a combination of marginal and total cost-benefit analysis, to the Ricardian model. It demonstrates that the rule of marginal cost pricing does not always hold. It shows that in a 2x2 Ricardian model, there is a unique general equilibrium and that the comparative statics of the equilibrium involve discontinuous jumps -- as transaction efficiency improves, the general equilibrium structure jumps from autarky to partial division of labor and then to complete division of labor. The paper also discusses the effects of tariff in a model where trade regimes are endogenously chosen. It finds that (1) if partial division of labor occurs in equilibrium, the country that produces both goods chooses unilateral protection tariff, and the country producing a single good chooses unilateral laissez faire policy; (2) if complete division of labor occurs in equilibrium, the governments in both countries would prefer a tariff negotiation to a tariff war. Finally, the paper shows that in a model with three countries the country which does not have a comparative advantage relative to the other two countries and/or which has low transaction efficiency may be excluded from trade.

The paper introduces asymmetric production conditions between firms and asymmetric transaction conditions between countries into the Murphy-Shleifer-Vishny model of industrialization. It explores a general equilibrium mechanism that generates circular causation loop that each firm's profitability and its decision of involvement in a network of industrial linkages and trade flows is determined by the size of the network, while the network size is in turn determined by all firms' decisions of participation. It shows that the very function of the market is networking relevant self-interested decision makers and utilize the network effects of industrialization, though this function is not perfect. Hence, market led industrialization will gradually spread until the whole world economy is integrated in a single network of trade and industrial linkages as transaction conditions are improved. Also, this general equilibrium mechanism predicts empirical observation that temperate zone is involved in this industrialization process more early than the tropic zone because of its better climate and public health conditions. This paper devises a new approach to specifying zero profit condition for a marginal modern firm, while keeping original feedback loop between positive profit and the extent of the market of the MSV model. Hence, this new method and the trade off between economies of scale and transaction costs can be used to endogenize the number of modern sectors and increases applicability of this type of models which is featured with compatibility between economies of scale and competitive market.

The paper introduces differences in production and transaction conditions between countries into the model of monopolistic competition to investigate the interplay between trade policies and development strategies. It applies inframarginal analysis, which is total benefit analysis between corner solutions in addition to marginal analysis of each corner solution, to show that as transaction conditions are improved, the general equilibrium may discontinuously jump across different patterns of trade and economic development. It compares the marginal and inframarginal comparative statics of equilibrium in the model of monopolistic competition with the core theorems in the neoclassical trade models and with conventional wisdom in development economics. It shows that as analytical framework is altered, the meanings of concepts and related empirical observations will be changed too.

This paper develops a general equilibrium model with transaction costs and endogenous and exogenous comparative advantages. In the model, the governments are allowed to choose between tariff war, tariff negotiation, and laissez faire regimes. The model shows that the level of division of labor and the volume of trade increase as transaction conditions improve. In the process of moving to a high level of division of labour, a country may receive more gains from trade even if its terms of trade deteriorate. This is because an expansion of the network size of division of labour can generate productivity gains that outweigh the adverse effect of the terms of trade deterioration. When a high level of division of labor occurs in general equilibrium, if both countries play a Nash tariff game, a tariff war may break out, which can dissipate all the gains from trade. Facing this risk, all governments would prefer trade negotiations to a trade war. A Nash tariff negotiation would result in zero tariff rates. If a medium level of division of labor occurs in general equilibrium, then unilateral tariff protection and unilateral laissez faire policies would coexist. The result provides a plausible story about the evolution of trade policy regimes, and highlights the importance of trade negotiations in achieving trade liberalization.

This paper examines the links between demographic change and economic growth in Asia during 1965-90. We show that the overall rate of population growth had little effect on economic growth, but that changes in life expectancy, age structure, and population density have had a significant impact on growth rates. We also find strong evidence of feedback from higher income to population change via lower fertility, though a significant component of the demographic changes appears to have been exogenous. Our results suggest that the demographic transition can act both as a catalyst and as an accelerator mechanism, and that demographic effects can explain most of East Asia’s economic “miracle”. East Asia benefited from a “virtuous spiral” of income growth and fertility decline, while South Asia seems to remain caught in a low-level population-income trap.

In the paper, an analytical framework with both increasing returns and transaction costs is developed to investigate the general equilibrium with endogenous specialization and division of labor. In this framework, each individual’s optimum decision in choosing her pattern of specialization is always a corner solution and general equilibrium network of division of labor is based on one of myriad combinations of corner solutions. We establish the existence and efficiency theorems of the general equilibrium for large economies. But for a finite economy, the general equilibrium may fail to exist. It is shown that the function of the market is not only to allocate resources for a given network structure of division of labor, but also to coordinate all individuals’ decisions in choosing their patterns of specialization to utilize positive network effects of division of labor net of transaction costs. With the analytical framework, the spirit of classical mainstream economics can be resurrected in a modern body of mathematical formalism.

This paper applies the inframarginal analysis, which is a combination of marginal and total cost-benefit analysis, to investigate the relationship between division of labor, the extent of the market, productivity, and inequality of income distribution. The model with transaction costs and exogenous and endogenous comparative advantages shows that as transaction conditions are improved, the general equilibrium discontinuously jumps from autarky to partial division of labor with a dual structure, then to the complete division of labor where dual structure disappears. In this process different groups of individuals with different transaction conditions get involved in a certain level of division of labor at different stages of development. As the leading group gets involved in a higher level of division of level, leaving others behind dual structure emerges and inequality increases. As latecomers catch up dual structure disappears and inequality declines. When the leader goes to an even higher level of specialization, dual structure occurs and inequality increases again. Inequality decreases again as the latecomers catch up. Hence, the equilibrium degree of inequality fluctuates in this development process. The relationship between inequality and productivity is neither monotonically positive nor monotonically negative. It might not be of inverted U-curve. The key driving force of economic development and trade is improvement in transaction conditions.

This paper centers around the question of ownership of firms and managerial competition and how these affect managers and employees' incentives to invest in human capital. We argue that employees' incentives in human capital investment are affected by both ownership and competition since both ownership structure and competition provide bargaining chips to employees. Ownership provides protections which may improve or dull employees' incentives for human capital investment. When there is fierce market competition and no lock-in the allocation of ownership does not play a role (as one might expect), provided that human and physical assets are sufficiently complementary. If asset complementarity is low, ownership matters even in the absence of lock-in. In general, the most efficient ownership arrangement is that which maximizes managerial competition inside the firm.

What is the effect of factor mobility on income convergence? Why are population flows so persistent? Extending the neoclassical growth model to allow for mobile labor, in a long run steady state, individuals and firms receive equal levels of utility and profits across localities. But frictions in the form of a cost to installing capital proportional to the rate of gross investment and an analogous cost to moving proportional to the rate of net migration effect extended equilibrium transition paths during which rents will be associated with living and owning capital in some localities relative to others. The speed of income convergence depends mostly on capital mobility (i.e. the installation cost) and is relatively insensitive to the degree of labor mobility. Persistent population flows result from relatively small changes in local productivity or quality of life, even with very high labor mobility; but even when population is relatively distant from its steady state level, wages and land prices remain relatively close to their steady-state levels. Local growth theory admits several other results. The speed of income convergence varies considerably in a neighborhood very close to the steady state. Consumption smoothing causes steady-state asset wealth and hence steady-state population density to be history dependent. Steady-state land prices rise at exactly the right rate to offset any flow of population from high productivity to high quality-of-life locales as per capita income rises.

This paper explores some of the central debates in the application of political economy to development policy making. It is particularly concerned with the connection between theory, empirical observation, and the practice of policy decision making. It explores distinct traditions of political economy, some drawn from economics, others based in sociological theory, that generate distinct insights about why and when change is likely to occur in policies and institutions. The paper then raises the question of whether such traditions provide effective guidance about the politics of decision making and the process of policy reform and whether they generate helpful insights for reformers interested in encouraging such processes. It suggests that current approaches to political economy present a stark tradeoff between parsimony and elegance on the one hand and insight into conflict and process on the other. Both both traditions of political economy borrow assumptions about political interactions from contexts that may not be fully relevant to developing and transitional countries. In addition, when theory is compared to the extensive empirical literature that now exists about experiences for policy and institutional change, it fails to provide convincing explanations for some of the most important characteristics of real world politics--leadership, ideas, and success. Further, much theoretical and empirical work in political economy has fallen far behind in exploring the policy agendas that now confront developing and transitional countries.