Showing papers by "National Bureau of Economic Research published in 1997"

Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?

Abstract: No. This paper investigates the relationship between financing constraints and investment-cash flow sensitivities by analyzing the firms identified by Fazzari, Hubbard, and Petersen as having unusually high investment-cash flow sensitivities. We find that firms that appear less financially constrained exhibit significantly greater sensitivities than firms that appear more financially constrained. We find this pattern for the entire sample period, subperiods, and individual years. These results (and simple theoretical arguments) suggest that higher sensitivities cannot be interpreted as evidence that firms are more financially constrained. These findings call into question the interpretation of most previous research that uses this methodology.

Financial Development and Economic Growth: Views and Agenda

Abstract: This critique argues that the preponderance of theoretical reasoning and empirical evidence suggests a positive, first-order relationship between financial development and economic growth. The body of work would push even most skeptics toward the belief that the development of financial markets and institutions is a critical and inextricable part of the growth process and away from the view that the financial system is an inconsequential sideshow, responding passively to economic growth. Many gaps remain, however, and the paper highlights areas in acute need of additional research.

Aid, Policies, and Growth

Abstract: Aid has a positive impact on growth in developing countries with good fiscal, monetary, and trade policies. Aid appears not to affect policies systematically either for good or for ill. Any tendency for aid to reward good policies has been overwhelmed by donorse pursuit of their own strategic interests. Burnside and Dollar use a new database on foreign aid to examine the relationships among foreign aid, economic policies, and growth of per capita GDP. In panel growth regressions for 56 developing countries and six four-year periods (1970-93), they find that the policies that have a great effect on growth are those related to fiscal surplus, inflation, and trade openness. They construct an index for those three policies and have that index interact with foreign aid. They have instruments for both aid and aid interacting with policies. They find that aid has a positive impact on growth in developing countries with good fiscal, monetary, and trade policies. In the presence of poor policies, aid has no positive effect on growth. This result is robust in a variety of specifications, which include or exclude middle-income countries, include or exclude outliers, and treat policies as exogenous or endogenous. They examine the determinants of policy and find no evidence that aid has systematically affected policies, either for good or for ill. They estimate an aid allocation equation and show that any tendency for aid to reward good policies has been overwhelmed by donors' pursuit of their own strategic interests. In a counterfactual, they reallocate aid, reducing the role of donor interests and increasing the importance of policy. Such a reallocation would have a large positive effect on developing countries' growth rates. This paper - a product of the Macroeconomics and Growth Division, Policy Research Department - is part of a larger effort in the department to study the effectiveness of foreign aid. The study was funded by the Bank's Research Support Budget under research project Economic Policies and the Effectiveness of Foreign Aid (RPO 681-70).

A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets

Abstract: We assume that the instantaneous riskless rate reverts towards a central tendency which in turn, is changing stochastically over time. As a result, current short-term rates are not" sufficient to predict future short-term rates movements, as would be the case if the central" tendency was constant. However, since longer-maturity bond prices incorporate information" about the central tendency, longer-maturity bond yields can be used to predict future short-term" rate movements. We develop a two-factor model of the term-structure which implies that a" linear combination of any two rates can be used as a proxy for the central tendency. Based on" this central-tendency proxy, we estimate a model of the one-month rate which performs better" than models which assume the central tendency to be constant.

Exceptional Exporter Performance: Cause, Effect, or Both?

Abstract: A growing body of empirical work has documented the superior performance characteristics" of exporting plants and firms relative to non-exporters. Employment, shipments and capital intensity are all higher at exporters at any given moment. This paper asks whether good" firms become exporters or whether exporting improves firm performance. The evidence is quite" clear on one point: good firms become exporters, both growth rates and levels of success measures" are higher ex-ante for exporters. The benefits of exporting for the firm are less clear. Employment" growth and the probability of survival are both higher for exporters; however growth is not superior, particularly over longer horizons.

Public Goods and Ethnic Divisions

Abstract: We present a model that links heterogeneity of preferences across ethnic groups in a city to the amount and type of public good the city supplies. We test the implications of the model with three related datasets: US cities, US metropolitan areas, and US urban counties. Results show that productive public goods -- education, roads, libraries, sewers and trash pickup -- in US cities (metro areas/urban counties) are inversely related to the city's (metro area's/county's) ethnic fragmentation, even after controlling for other socioeconomic and demographic determinants. Ethnic fragmentation is negatively related to the share of local spending on welfare. The results are mainly driven by observations in which majority whites are reacting to varying sizes of minority groups. We conclude that ethnic conflict is an important determinant of local public finances.

The Determinants and Implications of Corporate Cash Holdings

Abstract: We examine the determinants and implications of holdings of cash and marketable" securities by publicly traded U.S. firms in the 1971-1994 period. Firms with strong growth" opportunities and riskier cash flows hold relatively high ratios of cash to total assets. Firms" that have the greatest access to the capital markets (e.g. large firms and those with credit" ratings) tend to hold lower ratios of cash to total assets. These results are consistent with the" view that firms hold liquid assets to ensure that they will be able to keep investing when cash" flow is too low relative to planned investment and when outside funds are expensive. The" short run impact of excess cash on capital expenditures, acquisition spending and payouts to" shareholders is small. The main reason that firms experience large changes in excess cash is" the occurrence of operating losses. There is no evidence that risk management and cash" holdings are substitutes.

Capital-Market Imperfections and Investment

Abstract: Over the past decade, a number of researchers have extended conventional models of business fixed investment to incorporate a role for financial constraints' in determining investment. This paper reviews developments and challenges in this empirical research, and uses advances in models of information and incentive problems to motivate those developments and challenges. First, I describe analytical underpinnings of models of capital-market imperfections in the investment process, and illustrate the principal testable implications of those models. Second, I motivate tests and describe and critique existing empirical studies. Third, the review considers applications of the underlying models to a range of investment activities, including inventory investment, R&D, employment demand, pricing by imperfectly competitive firms, business formation and survival, and risk management. Fourth, I discuss implications of this research program for analysis of effects of investment on monetary policy and tax policy. Finally, I examine some potentially fruitful avenues for future research.

Openness, Productivity and Growth: What Do We Really Know?

Abstract: For over a century social analysts have debated the connection between trade policy and economic performance. This controversy continues today, even as the world is experiencing an unprecedented period of trade liberalization, and in spite of numerous empirical studies that claim to have found a positive effect of openness on growth. Two issues have been at the core of these controversies: first, until recently theoretical models had been unable to link trade policy to faster equilibrium growth. And second, the empirical literature on the subject has been affected by serious data problems. In this paper I use a new comparative data set for 93 countries to analyze the robustness of the relationship between openness and TFP growth. I use nine alternative indexes of trade policy to investigate whether the evidence supports the view that, with other things given, TFP growth is faster in more open economies. The regressions reported here are robust to the use of openness indicator, estimation technique, time period and functional form, and suggest that more open countries have indeed experienced faster productivity growth. Although the use of instrumental variables goes a long way towards dealing with endogeneity, issues related to causality are still somewhat open, and will require time series analyses to be adequately addressed.

Computing Inequality: Have Computers Changed the Labor Market?

Abstract: This paper examines the effect of technological change and other factors on the relative demand for workers with different education levels and on the recent growth of U.S. educational wage differentials. A simple supply-demand framework is used to interpret changes in the relative quantities, wages, and wage bill shares of workers by education in the aggregate U.S. labor market in each decade since 1940 and over the 1990 to 1995 period. The results suggest that the relative demand for college graduates grew more rapidly on average during the past 25 years (1970-95) than during the previous three decades (1940-70). The increased rate of growth of relative demand for college graduates beginning in the 1970s did not lead to an increase in the college/high school wage differential until the 1980s because the growth in the supply of college graduates increased even more sharply in the 1970s before returning to historical levels in the 1980s. The acceleration in demand shifts for more-skilled workers in the 1970s and 1980s relative to the 1960s is entirely accounted for by an increase in within- industry changes in skill utilization rather than between-industry employment shifts. Industries with large increases in the rate of skill upgrading in the 1970s and 1980s versus the 1960s are those with greater growth in employee computer usage, more computer capital per worker, and larger shares of computer investment as a share of total investment. The results suggest that the spread of computer technology may "explain" as much as 30 to 50 percent of the increase in the rate of growth of the relative demand for more-skilled workers since 1970.

Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study

Abstract: This paper reports measures of preference parameters relating to risk tolerance, time preference, and intertemporal substitution. These measures are based on survey responses to hypothetical situations constructed using an economic theorist's concept of the underlying parameters. The individual measures of preference parameters display heterogeneity. Estimated risk tolerance and the elasticity of intertemporal substitution are essentially uncorrelated across individuals. Measured risk tolerance is positively related to risky behaviors, including smoking, drinking, failing to have insurance, and holding stocks rather than Treasury bills. These relationships are both statistically and quantitatively significant, although measured risk tolerance explains only a small fraction of the variation of the studied behaviors.

Value Versus Growth: The International Evidence

Abstract: Value stocks have higher returns than growth stocks in markets around the world. For 1975-95, the difference between the average returns on global portfolios of high and low book-to-market stocks is 7.60% per year, and value stocks outperform growth stocks in 12 of 13 major markets. An international CAPM cannot explain the value premium, but a two-factor model that includes a risk factor for relative distress captures the value premium in international returns.

On the Number and Size of Nations

Abstract: This paper studies the equilibrium determination of the number of countries in different political regimes, and in different economic environments, with more or less economic integration. We focus on the trade-off between the benefits of large jurisdictions and the costs of heterogeneity of large and diverse populations. Our model implies that (i) democratization leads to secessions; (ii) in equilibrium one generally observes an inefficiently large number of countries; (iii) the equilibrium number of countries is increasing in the amount of economic integration.

Relational Contracts and the Theory of the Firm

Abstract: We combine Simon's conception of relational contracts with Grossman and Hart's focus on asset ownership. We analyze whether transactions should occur under vertical integration or non-integration, and with or without self-enforcing relational contracts. These four models allow us to re-run the horse race Coase proposed between markets and firms as alternative governance structures, but with four horses rather than two. We find that efficient ownership patterns are determined in part by the relational contracts that ownership facilitates, that vertical integration is an efficient response to widely varying supply prices, and that high-powered incentives create bigger reneging temptations under integration than under non-integration. Note: this paper was formerly titled "Implicit Contracts and the Theory of the Firm"

Legal Determinants of External Finance

Abstract: Using a sample of 49 countries, we show that countries with poorer investor protections, measured by both the character of legal rules and the quality of law enforcement, have smaller and narrower capital markets. These findings apply to both equity and debt markets. In particular, French civil law countries have both the weakest investor protections and the least developed capital markets, especially as compared to common law countries.

How to Compete: The Impact of Workplace Practices and Information Technology on Productivity

Abstract: Using data from a unique nationally representative sample of businesses, the Educational Quality of the Workforce National Employers Survey (EQW-NES), matched with the Bureau of the Census' Longitudinal Research Database (LRD), we examine the impact of workplace practices, information technology and human capital investments on productivity. We estimate an augmented Cobb Douglas production function with both cross section and panel data covering the period of 1987-1993 using both within and GMM estimators. We find that what is associated with higher productivity is not so much whether or not an employer adopts a particular work practice but rather how that work practice is actually implemented within the establishment. We also find that those unionized establishments that have adopted what have been called new or transformed' industrial relations practices that promote joint decision making coupled with incentive based compensation have higher productivity than other similar non-union plants maintain more traditional labor management relations have lower productivity. We also find that the higher the average educational level of production workers or the greater the proportion of non-managerial workers who use computers, the higher is plant productivity.

Experimental Estimates of Education Production Functions

Abstract: This paper analyzes data on 11,600 students and their teachers who were randomly assigned to different size classes from kindergarten through third grade. Statistical methods are used to adjust for non-random attrition and transitions between classes. The main conclusions are: (1) on average, performance on standardized tests increases by 4 percentile points the first year students attend small classes; (2) the test score advantage of students in small classes expands by about one percentile point per year in subsequent years; (3) teacher aides and measured teacher characteristics have little effect; (4) class size has a larger effect for minority students and those on free lunch; (5) Hawthorne effects were unlikely.

Are Ghettos Good or Bad

Abstract: Spatial separation of racial and ethnic groups may theoretically have positive or negative effects on the economic performance of those groups. We examine the effects of segregation on outcomes for blacks in schooling, employment, and single parenthood. We find that blacks in more segregated areas have significantly worse outcomes than blacks in less segregated areas. We control for the endogeneity of location choice using instruments based on political factors, topographical features, and residence before adulthood. A one standard deviation decrease in segregation would eliminate one-third of the black-white differences in most of our outcomes.

The New Neoclassical Synthesis and the Role of Monetary Policy

Abstract: Macroeconomics is moving toward a New Neoclassical Synthesis, which like the synthesis of the 1960s melds Classical with Keynesian ideas. This paper describes the key features of the new synthesis and its implications for the role of monetary policy. We find that the New Neoclassical Synthesis rationalizes an activist monetary policy which is a simply system of inflation targets. Under this "neutral" monetary policy, real quantities evolve as suggested in the literature on real business cycles. Going beyond broad principles, we use the new synthesis to address several operational aspects of inflation targeting. These include its practicality, the response to oil shocks, the choice of price index, the design of a mandate, and the tactics of interest rate policy.

Implications of skill-biased technological change: international evidence

Abstract: Demand for less skilled workers decreased dramatically in the US and in other developed countries over the past two decades. WE argue that pervasive skill-biased technological change, rather than increased trade with the development world, is the principal culprit. The pervasiveness of this technological change is important for two reasons. Firstly, it is an immediate and testable implication of technological change. Secondly, under standard assumptions, the more pervasive the skill-biased technological, the greater the increase in the embodied supply of less skilled workers and the greater the increase in the embodied supply if less skilled workers and the greater the increases in the embodied supply of less skilled workers and the greater the depressing effect on their relative wages through world goods prices. In contrast, in the Heckscher-Ohlin model with small open economies the skill-bias of local technological changes does not affect wages. Thus, pervasiveness deals with a major criticism of skill-biased technological as a cause. Testing the implications of pervasive, skill-biased technological change, we find strong supporting evidence. Firstly, across the OECD, most industries have increased the proportion of skilled workers employed, despite rising or stable relative wages. Secondly, increases in demand for skills were concentrated in the same manufacturing industries in different developed countries.

Corruption, Public Investment, and Growth

Abstract: Corruption, particularly political or "grand" corruption, distorts the entire decision-making process connected with public investment projects. The degree of distortions is higher with weaker auditing institutions. The evidence presented shows that higher corruption is associated with (i) higher public investment; (ii) lower government revenues; (iii) lower expenditures on operations and maintenance; and (iv) lower quality of public infrastructure. The evidence also shows that corruption increases public investment while reducing its productivity. These are five channels through which corruption lowers growth. An implication is that economists should be more restrained in their praise of high public sector investment, especially in countries with high corruption.

A Model of Investor Sentiment

Abstract: Recent empirical research in finance has uncovered two families of pervasive regularities: underreaction of stock prices to news such as earnings announcements; and overreaction of stock prices to a series of good or bad news. In this paper, we present a parsimonious model of investor sentiment that is, of how investors form beliefs that is consistent with the empirical findings. The model is based on psychological evidence and produces both underreaction and overreaction for a wide range of parameter values.

Employer Learning and Statistical Discrimination

Abstract: We provide a test for statistical discrimination or rational stereotyping in in environments in which agents learn over time. Our application is to the labor market. If profit maximizing firms have limited information about the general productivity of new workers, they may choose to use easily observable characteristics such as years of education to 'statistically discriminate' among workers. As firms acquire more information about a worker, pay will become more dependent on actual productivity and less dependent on easily observable characteristics or credentials that predict productivity. Consider a wage equation that contains both the interaction between experience and a hard to observe variable that is positively related to productivity and the interaction between experience and a variable that firms can easily observe, such as years of education. We show that the wage coefficient on the unobservable productivity variable should rise with time in the labor market and the wage coefficient on education should fall. We investigate this proposition using panel data on education, the AFQT test, father's education, and wages for young men and their siblings from NLSY. We also examine the empirical implications of statistical discrimination on the basis of race. Our results support the hypothesis of statistical discrimination, although they are inconsistent with the hypothesis that firms fully utilize the information in race. Our analysis has wide implications for the analysis of the determinants of wage growth and productivity and the analysis of statistical discrimination in the labor market and elsewhere.(This abstract was borrowed from another version of this item.)

Moving to Greener Pastures? Multinationals and the Pollution-Haven Hypothesis

Abstract: Eskeland and Harrison find almost no evidence that investors in developing countries are fleeing environmental costs at home. Instead, the evidence suggests that foreign-owned plants in four developing countries are less polluting than comparable domestic plants. Are multinationals flocking to pollution havens in developing countries? Using data from four developing countries (Cote d`Ivoire, Mexico, Morocco, and Venezuela), Eskeland and Harrison examine the pattern of foreign investment. They find almost no evidence that foreign investors are concentrated in dirty sectors. They also examine the behavior of multinationals doing business in these four countries, testing whether there is any tendency for foreign firms to pollute more or less than their host-country counterparts. To do this, they use consumption of energy and dirty fuels as a proxy for pollution intensity. They find that foreign plants in these four developing countries are significantly more energy-efficient and use cleaner types of energy than their domestic counterparts. Eskeland and Harrison conclude with an analysis of U.S. outbound investment between 1982 and 1994. They reject the hypothesis that the pattern of U.S. foreign investment is skewed toward industries in which the cost of pollution abatement is high. This paper - a product of the Public Economics Division, Policy Research Department - is part of a larger effort in the department to analyze environmental policy problems. The study was funded by the Bank's Research Support Budget under the research project Pollution and the Choice of Economic Policy Instruments in Developing Countries (RPO 676-78).

Do Gasoline Prices Respond Asymmetrically to Crude Oil Price Changes

Abstract: The authors test and confirm that retail gasoline prices respond more quickly to increases than to decreases in crude oil prices. Among the possible sources of this asymmetry are production/inventory adjustment lags and market power of some sellers. By analyzing price transmission at different points in the distribution chain, the authors attempt to shed light on these theories. Spot prices for generic gasoline show asymmetry in responding to crude oil price changes, which may reflect inventory adjustment effects. Asymmetry also appears in the response of retail prices to wholesale price changes, possibly indicating short-run market power among retailers.

Learning in Cities

Abstract: Alfred Marshall argues that industrial agglomerations exist in part because individuals can" learn skills from each other when they live and work in close proximity to one another. An" increasing amount of evidence suggests that the informational role of cities is a primary reason for" their continued existence. This paper formalizes Marshall's theory in a model where individuals" acquire skills by interacting with one another, and dense urban areas increase the speed of" interactions. The model predicts that cities will have a higher mean and higher variance of skills." Cities will attract young people who are not too risk averse and who benefit most from learning" (e.g. more patient people). Older, more skilled workers will stay in cities only if they can" internalize some of the benefits that their presence creates for young people. The level of" urbanization will rise when the demand for skills rises, when the ability to learn by imitation rises or when the level of health in the economy rises. Empirical evidence on urban wages supports the" learning view of cities and a variety of other implications of the theory are corroborated" empirically.

New Evidence on the Money's Worth of Individual Annuities

Abstract: This paper presents new information on the expected present discounted value of payouts on individual life annuities. The annuity we examine is the single premium immediate life annuity, an insurance product that pays out a nominal level sum as long as the covered person lives, in exchange for an initial lump-sum premium. This annuity offers protection against the risk of someone outliving his saving, given uncertainty about longevity. For reasonable estimates of behavioral parameters, we calculate that individual annuities are currently priced so that retirees without bequest motives should find these policies of substantial value in configuring their portfolios to smooth retirement consumption. We also find that the expected present discounted value of payouts, relative to the initial cost of the annuity, has increased over the last decade. These findings bear on the policy debate regarding the role of individual choice and self-reliance in retirement planning.

Protection for Sale: An Empirical Investigation

Abstract: A prominent model in the recent political-economy literature on trade policy is Grossman and Helpman's (1994) Protection for Sale' model. This model yields clear predictions for the cross-sectional structure of trade protection. The objective of our" paper is to check whether the predictions of the Grossman-Helpman model are consistent with the data and, if the model finds support, to estimate its two key structural parameters: the government's valuation of welfare relative to contributions, and the fraction of the voting population represented by a lobby. We find that the pattern of protection in the U.S. in 1983 is consistent with the basic predictions of the model. Our estimate of the government's valuation of welfare relative to contributions is surprisingly high; the weight of welfare in the government's objective function is estimated to be between 50 and 88 times the weight of contributions.

An Economic Theory of GATT

Abstract: Despite the important roel played by GATT in the world economy, economist have nto developed a unified theoretical framework that interprets and evaluates the principles that form the foundation of GATT. Our purpose here is to propose such a framework. Working within a general equilibrium trade model, we represent government preferences with a very general formulation that includes all the major political-economy models of trade policy as special cases. Using this general framework we establish three key results. First, GATT's principle of reciprocity can by viewed as a mechanism for implementing efficient trade agreements. Second, through the principle of reciprocity countries can implement efficient trade agreements if and only if they also abide by the principle of nondiscrimination. And third, preferential agreements undermine GATT's ability to deliver efficient multilateral outcomes through the principle of reciprocity, unless these agreements take the form of customs unions among partners that are sufficiently similar.