General Equilibrium Effects Research Articles

AGE‐DEPENDENT TAXES WITH ENDOGENOUS HUMAN CAPITAL FORMATION

AbstractWe assess the gains attained by the introduction of age‐dependent labor income taxes in an overlapping generations economy where individuals live a meaningful life cycle and endogenously accumulate human capital. The model is sufficiently rich to isolate the role of general equilibrium effects, credit market imperfections, and different forms of human capital accumulation. The large welfare gains we obtain cannot be attained without age dependence, nor can they be attained with age‐dependent taxes if progressivity of labor income taxes and capital income tax rates are not suitably adjusted to profit from the complementarity of these instruments.

Randomized controlled trials informing public policy: Lessons from project STAR and class size reduction

Randomized controlled trials (RCTs) and related research strategies are increasingly seen as the preferred methodology for evaluating policy interventions, but a single-minded focus on identifying causal effects limits their capacity to support actual policy decisions. A detailed look at Project STAR illustrates this point and offers some possible correctives. Initiated by the Tennessee legislature to help decide whether to enact state-wide class size reduction (CSR), STAR compared the test scores of students randomly assigned to classes of different size. It addressed a well-formed research question, but focused narrowly on refining a single link in a long chain of evidence necessary to address the policy question at hand: whether CSR would be a good use of a large increase in education spending. It disregarded the limitations of test scores as indicators of education quality and ignored general equilibrium effects on teacher quality and salaries. Moreover, the emphasis it placed on estimating average CSR effects in a given setting diverted attention from the heterogeneity of these effects and the conditions that mediated their impact, limiting its external validity. These observations continue to be relevant for the design of policy-oriented research, and for the academic training of empirical economists.

REGIONAL FLOOD IMPACTS AND ADAPTATION IN A FEDERAL SETTING: A SPATIAL COMPUTABLE GENERAL EQUILIBRIUM ANALYSIS FOR SWITZERLAND

Climate change, a growing population and inappropriate land use may lead to a significant increase in the frequency, intensity and the duration of water-related extreme events. We aim (1) to gain a better understanding of the direct and indirect economic impacts of floods, (2) to analyze the issue of efficient flood adaption as well as the issue of financing adaptation in a federalist system, where local and national governmental authorities interplay in the provision of local public good adaptation. Our numerical thought experiments are based on a dynamic, spatial differentiated Ramsey type Computable General Equilibrium Model. Regions are determined by exposure and vulnerability to floods and are not identical with territorial units. Our results indicate: (1) general equilibrium effects caused by flood damages in vulnerable regions lead in regions of low vulnerability also to considerable welfare and GDP losses. (2) Providing local public good adaptation can at low economic costs significantly reduce negative impacts on welfare, GDP as well as the allocation of resources between regions and sectors. (3) Funding adaptation by imposing a regional land tax should be preferred to a national output tax or a combination of both with transfers from national to regional governments.

RETAKING IN HIGH STAKES EXAMS: IS LESS MORE?

AbstractPlacement, both in university and in the civil service, according to performance in competitive exams is the norm in much of the world. Repeat taking of such exams is common despite the private and social costs it imposes. We develop and estimate a structural model of exam retaking using data from Turkey's university placement exam. Limiting retaking results in all agents gaining ex ante and most gaining ex post. This result comes from a general equilibrium effect: Retakers crowd the market and impose negative spillovers on others by raising acceptance cutoffs.

Firm Sorting and Agglomeration

To account for the uneven distribution of economic activity in space, I propose a theory of the location choices of heterogeneous firms in a variety of sectors across cities. In equilibrium, the distribution of city sizes and the sorting patterns of firms are uniquely determined and affect aggregate TFP and welfare. I estimate the model using French firm-level data and find that nearly half of the productivity advantage of large cities is due to firm sorting, the rest coming from agglomeration economies. I quantify the general equilibrium effects of place-based policies: policies that subsidize smaller cities have negative aggregate effects. (JEL D22, D24, R11, R32)

Be careful what you calibrate for: Social discounting in general equilibrium

Concerns about intergenerational equity have led to an influential practice of setting social utility discount rates based on ethical considerations rather than to match household behavior, particularly in climate change economics (e.g., Stern, 2006). This paper formalizes the broader policy implications of this approach in general equilibrium by characterizing jointly optimal environmental and fiscal policies in a climate-economy model with differential planner-household discounting. First, I show that decentralizing the optimal allocation requires not only high carbon prices but also fundamental changes to tax policy: If the government discounts the future less than households, implementing the optimal allocation requires an effective capital income subsidy (a negative intertemporal wedge), and, in a setting with distortionary taxation, an effective labor-consumption tax wedge that is decreasing over time. Second, if the government cannot subsidize capital income, the constrained-optimal carbon tax may be up to 50% below the present value of marginal damages (the social cost of carbon) due to the general equilibrium effects of climate policy on household savings. Third, given the choice to optimize either carbon, capital, or labor income taxes, the socially discounting planner's welfare ranking is ambiguous over a standard range of parameters. Overall, in general equilibrium, a policy-maker's choice to adopt differential social discounting may thus overturn conventional recommendations for both environmental and fiscal policy.

Towards agent-based integrated assessment models: examples, challenges, and future developments

Understanding the complex, dynamic, and non-linear relationships between human activities, the environment and the evolution of the climate is pivotal for policy design and requires appropriate tools. Despite the existence of different attempts to link the economy (or parts of it) to the evolution of the climate, results have often been disappointing and criticized. In this paper, we discuss the use of agent-based modeling for climate policy integrated assessment. First, we identify the main limitations of current mainstream models and stress how framing the problem from a complex system perspective might help, in particular when extreme climate conditions are at stake and general equilibrium effects are questionable. Second, we present two agent-based models that serve as prototypes for the analysis of coupled climate, energy, and macroeconomic dynamics. We argue that such models constitute examples of a promising approach for the integrated assessment of climate change and economic dynamics. They allow a bottom-up representation of climate damages and their cross-sectoral percolation, naturally embed distributional issues, and traditionally account for the role of finance in sustaining economic development and shaping the dynamics of energy transitions. All these issues are at the fore-front of the research in integrated assessment. Finally, we provide a careful discussion of testable policy exercises, modeling limitations, and open challenges for this stream of research. Notwithstanding great potential, there is a long way-to-go for agent-based models to catch-up with the richness of many existing integrated assessment models and overcome their major problems. This should encourage research in the area.

The Labor Market Impacts of Universal and Permanent Cash Transfers: Evidence from the Alaska Permanent Fund

What are the effects of universal and permanent cash transfers on the labor market? Since 1982, all Alaskan residents have been entitled to a yearly cash dividend from the Alaska Permanent Fund. Using data from the Current Population Survey and a synthetic control method, we show that the dividend had no effect on employment, and increased part-time work by 1.8 percentage points (17 percent). Although theory and prior empirical research suggests that individual cash transfers decrease household labor supply, we interpret our results as evidence that general equilibrium effects of widespread and permanent transfers tend to offset this effect, at least on the extensive margin. Consistent with this story, we show suggestive evidence that tradable sectors experience employment reductions, while non-tradable sectors do not. Overall, our results suggest that a universal and permanent cash transfer does not significantly decrease aggregate employment.

Optimal adaptation in cities

Due to their vulnerability and their special role as being a center of economic activities cities are particularly important in the context of adaptation to adverse events derogating land quality, e.g. resulting from long-term climate change. This paper analyzes economic efficiency of public investments in adaptation within a spatial general equilibrium framework that focuses on the level of cities. We provide a theoretical analysis that highlights the fundamental forces determining efficient public investment in urban adaptation. We further extend the approach to a spatial computable general equilibrium model thereby identifying optimal urban adaptation investment strategies. Our analyses suggest that full adaptation can be an inefficient strategy even in urban areas due to a wide range of direct and indirect spatial general equilibrium effects. Setting investments optimally only reduces a small fraction of the welfare loss of non-adaptation. The findings are robust with respect to assumptions on the marginal returns of adaptation, the degree of possible relocation as a response to an adverse event (intra-urban relocation and inter-urban migration), and the funding scheme applied to finance adaptation (land tax vs. labor tax). Interestingly, adverse urban effects of adaptation could make non-adaptation more efficient than full adaptation. However, if adaptation measures like building dikes or even relocating cities are available and sufficiently productive, full adaptation could become an efficient policy option being able to offset a large fraction of the potential welfare loss of extreme events. Distributional effects of urban adaptation investment (absentee landowners vs. urban renters) as well as a misleading orientation of policymakers to maximize urban GDP rather than social welfare can result in overinvestment in urban adaptation.

Targeted Carbon Tax Reforms

In the presence of intersectoral linkages, sector-specific carbon tax changes can have complex general equilibrium effects. In particular, a carbon tax on the emissions of a sector can lead to an increase in aggregate emissions. We analytically characterise how incremental taxes on the emissions of any set of sectors affect aggregate emissions. We show that carbon tax reforms that target sectors based on their position in the production network can achieve a greater reduction in aggregate emissions than reforms that target sectors based on their direct emissions alone. We illustrate the effects of carbon tax reforms by calibrating our intersectoral network model to the economies of two countries.

Does 'America First' Help America? The Impact of Country Image on Exports and Welfare

This paper estimates the effects of bilateral and time-varying preference bias on trade flows and welfare. We use a unique dataset from the BBC World Opinion Poll that surveys (annually during 2005-2017 with some gaps) the populations from a wide array of countries on their views of whether an evaluated country is having a mainly positive or negative influence in the world. We identify the effects on bilateral preference parameters due to shifts in these country image perceptions, and quantify their general equilibrium effects on bilateral exports and welfare (each time for an evaluated exporting country, assuming that the exporting country's own preference parameters have not changed). We consider fi ve important shifts in country image: the George W. Bush effect, the Donald Trump effect, the Senkaku Islands Dispute effect, the Brexit effect, and the Good-Boy Canadian effect. We fi nd that such changes in bilateral country image perceptions have quantitatively important trade and welfare effects. The negative impact of Donald Trump's America First campaign rhetorics on the US' country image might have cost the US as much as 4% of its total exports and gains from trade. In contrast, the consistent improvement of Canadian country image between 2010 and 2017 has amounted to more than 10% of its total welfare gains from trade.

Systematic Sensitivity Analysis of the Full Economic Impacts of Sea Level Rise

The potential impacts of sea level rise (SLR) due to climate change have been widely studied in the literature. However, the uncertainty and robustness of these estimates has seldom been explored. Here we assess the model input uncertainty regarding the wide effects of SLR on marine navigation from a global economic perspective. We systematically assess the robustness of computable general equilibrium (CGE) estimates to model’s inputs uncertainty. Monte Carlo (MC) and Gaussian quadrature (GQ) methods are used for conducting a Systematic sensitivity analysis (SSA). This design allows to both explore the sensitivity of the CGE model and to compare the MC and GQ methods. Results show that, regardless whether triangular or piecewise linear Probability distributions are used, the welfare losses are higher in the MC SSA than in the original deterministic simulation. This indicates that the CGE economic literature has potentially underestimated the total economic effects of SLR, thus stressing the necessity of SSA when simulating the general equilibrium effects of SLR. The uncertainty decomposition shows that land losses have a smaller effect compared to capital and seaport productivity losses. Capital losses seem to affect the developed regions GDP more than the productivity losses do. Moreover, we show the uncertainty decomposition of the MC results and discuss the convergence of the MC results for a decomposed version of the CGE model. This paper aims to provide standardised guidelines for stochastic simulation in the context of CGE modelling that could be useful for researchers in similar settings.

The macroeconomics of the minimum wage

This paper studies the macroeconomic impact of a statutory minimum wage. I demonstrate by means of a medium-scale DSGE model, which I estimate with US data, how the minimum wage impacts aggregate variables. The model framework enables me to take into account various general-equilibrium effects that the minimum wage can potentially trigger. Under the estimated stance of monetary policy, the model predicts that the minimum wage has a negligible effect on the macroeconomy. However, if the Federal Reserve conducted highly dovish monetary policy, the federal minimum wage would substantially affect the macroeconomy. A minimum-wage hike would even cause an economic expansion. The paper also examines the possibility of indexing the minimum wage to an inflation measure. It compares the indexation to price inflation with the indexation to wage inflation. By considering an alternative estimated model, I present evidence that performance standards are an important adjustment channel through which firms react to changes in the minimum wage.

Bank Runs, Prudential Tools and Social Welfare in a Global Game General Equilibrium Model

The regulatory framework of Basel III features joint requirements on bank capital and liquidity. I study such requirements by developing a general equilibrium model with bank runs in a global game framework. The model highlights the role of noisy information for studying liquidity and shows that bank runs are inevitable. Risk shifting induces excessive leverage and insufficient liquidity, causing an inefficiently high crisis probability. Imposing one requirement only causes risk migration: banks respond by taking more risk in another area, which warrants joint requirements. The design of the optimal joint requirements depends crucially on the model's general equilibrium effect.

Using Emissions Trading Schemes to Reduce Heterogeneous Distortionary Taxes: the Case of Recycling Carbon Auction Revenues to Support Renewable Energy

While emissions trading schemes are developed by nations to mitigate their greenhouse gas emissions, behavioural studies have shown that the political and public acceptability of these market-based instruments depends on the way the associated revenues are used. One option the general public approves of is to use them to support renewable energy. If this consists in reducing a pre-existing electricity levy that heterogeneously applies to the various sectors of the economy, the reduction of this distortionary tax thanks to the carbon revenues results in general equilibrium effects that may have unequal sectoral impacts. This is what we examine in the case of the European Union. With a modelling approach including a detailed disaggregation of European sectors, we find that using auction revenues from the Emissions Trading Scheme (ETS) to support electricity generation from renewable sources results in a 2% rise in electricity demand in the whole economy due to the reduced electricity levy that electricity consumers have to pay to support renewable energy. This results in a 1.8% ETS carbon price increase. The carbon constraint for the non-ETS sectors is 5.9% looser as a consequence of the larger electricity use by these sectors. While the energy intensive sectors generally benefit from electricity levy exemptions, we observe that, due to the energy and ETS price increase, the combination of these exemptions and of the use of carbon auction revenues to support renewable energy makes the ETS sectors worse off than if carbon revenues are transferred to households. In aggregate, the recycling option analysed here results in a GDP gain due to its impacts on the non-ETS sectors, the reduction of the electricity levy and associated distortionary effects.

A Sufficient Statistics Approach for Aggregating Firm-Level Experiments

We propose a method to estimate the effect of firm policies (e.g., bankruptcy laws or subsidized credit) on allocative efficiency using (quasi-) experimental evidence. Our approach takes general equilibrium effects into account and requires neither a structural estimation nor a precise assumption on how the experiment affects firms. Our aggregation formula relies on treatment effects of the policy on the distribution of output-to-capital ratios, which are easily estimated in (quasi-) experimental data. We show that this method is valid as long as the true data-generating process belongs to a large class of commonly-used models in macro-finance. Finally, we apply this method to the French banking deregulation episode of the mid-1980s and find that this reform led to an increase in aggregate TFP of 2.7%.

Search and Bargaining in the Product Market and Price Rigidities

We introduce business-to-business (B2B) relationships into an otherwise standard model to revisit two aspects of price dynamics in a unified analysis. On one side, the pass-through of cost shocks to prices is empirically incomplete. On the other side, the literature contains conjectures that long-term relationships may reduce the allocative role of price changes. After a partial equilibrium analysis of these aspects, we consider the general equilibrium effects. The formation of B2B relationships implies that the trade of intermediate goods depends on search, bargaining and the adjustment along the intensive margin as opposed to the extensive margin. We find that, when this adjustment is costly, retailers have a relatively high bargaining power, and mismatch shocks are possible, the model can account for the second moments of the U.S. producer price index and other variables. In this case, although its allocative role is low, the intermediate goods price affects the allocation of goods through the search externalities and is sufficiently volatile. The analysis includes several sensitivity tests and comparisons.

Capital Flows Across Developing Countries: Is There an Allocation Puzzle?

Foreign direct investment inflows are positively related to economic growth across developing countries — but so are savings in excess of investment. This paper develops an explanation for these known empirical findings by focusing on the limited availability of consumer credit in developing countries, together with general equilibrium effects. In the model, fast-growing developing countries scale up their holdings of debt assets, which creates net capital outflows — despite inflows of foreign direct investment — and reduces the world interest rate. Slow-growing developing countries reduce their holdings of debt assets in response, which creates net capital inflows despite outflows of foreign direct investment.

Torn Apart? The Impact of Manufacturing Employment Decline on Black and White Americans

This paper examines the impact of manufacturing employment decline on the socio-economic outcomes within and between black and white Americans from 1960 to 2010. Exploiting variation across cities and over time, the analysis shows that manufacturing decline negatively impacted blacks (men, women, and children) in terms of their wages, employment, marriage rates, house values, poverty rates, death rates, single parenthood, teen motherhood, child poverty, and child mortality. In addition, the decline in manufacturing increased inequality within the black community in terms of overall wages and the gaps between education groups in wages, employment, and marriage rates. Many of the same patterns are found for whites, but to a lesser degree leading to larger gaps between whites and blacks in wages, marriage patterns, poverty, single-parenthood, and death rates. The results are robust to the inclusion or exclusion of several control variables, and the use of a shift-share instrument for the local manufacturing employment share. Overall, the decline in manufacturing is reducing socio-economic conditions in general while increasing inequality within and between racial groups which is consistent with a stronger general equilibrium effect of the loss of highly-paid, lower-skilled jobs on the less-educated segments of the population.

Who Will Win the $50 Trillion Pot? Curing the Paradox of Cartelized Producers and Fragmented Consumers in the Oil Industry by Forming the Organization for Rational Energy Policy (OREP) and the Use of the GELCOE Metric for Policy Making by Oil Importing Countries

1) The market for oil has an asymmetry, whereas the producers are cartelized , the consumers are fragmented. If this situation persists, the forecasted wealth transfer (measured as the excess price paid by consumers over production cost) out of oil-importing countries is about $50 trillion or even more over the next 60 years. Notably, at current levels of oil imports, the wealth transfer (loss) will be for the US $8.4 trillion, for China $7.3 trillion, for India $4.5 trillion, for Japan $4.1 trillion, for South Korea $3.5 trillion, for Germany $2.2 trillion, for Philippines $1.8 trillion, for Italy $1.7 trillion, for Spain and Netherlands $1.4 trillion each, for France and Britain $1.3 trillion each, and for Singapore $1.2 trillion. 2) The currently fragmented consumers of the oil-importing countries need to be organized to obtain the bargaining power necessary for reducing or even eliminating the forecasted wealth transfer. This can happen if their governments band together, say into an Organization for Rational Energy Policy (OREP) to counter OPEC. 3) There are three possible plans for OREP to reduce the wealth transfer. First, a move to alternative sources of energy. Second, OREP can negotiate with oil producers to fix a price for a certain quantity of oil which it releases to the market. Third, the OREP countries can coordinate tax increases on oil to the “optimal tariff” level. 4) Of the above 3 plans, about a decade ago the third plan had the best chance of success. However, due to price of photovoltaic cells (solar energy) having fallen by about 90% over the last decade, the most promising plan currently seems to be the first plan. 5) OREP can speed the process of adoption of solar as an alternative to oil. Each year of delay in making this transition results in a wealth transfer (loss): for the US $147 billion, for China $151 billion, for India $94 billion, for Japan $71.1 billion, for South Korea $60.9 billion, for Germany $38 billion a year, for Philippines $37 billion, for Italy $29 billion, for Spain $25 billion, for Netherlands $25 billion, for France $23 billion, for Britain $23 billion, and for Singapore $21 billion. These are the costs these countries are incurring every year they delay the switch from oil to solar energy. The net impact over decades is of course much greater. 6) The Levelized Cost of Electricity (LCOE) for alternative power sources such as oil, natural gas, solar, wind, nuclear etc. is calculated as the sum of discounted costs divided by sum of discounted energy. This calculation is, as an economist would say, a partial equilibrium analysis. It misses two important general equilibrium issues. Firstly, the impact of reduction in oil demand on international oil prices. Secondly, the expenditure on energy domestically has a different economic impact to an expenditure for imports. We name the cost calculation that also considers the general equilibrium effects the General Equilibrium LCOE, or GELCOE. While plain LCOE is the proper metric to use for an individual or a firm, a government policy maker of an oil-importing country should use GELCOE, which can be substantially lower than LCOE for solar energy. 7) Possibly the most contentious scientific/political/economic question of the past few decades is “Are greenhouse gas emissions from the burning fossil fuels driving deleterious climate change?”. Is the answer yes or is it no? It doesn't matter! The question is now moot. For oil-importing countries replacing imported oil by solar energy will save them almost a trillion dollars a year. This is sufficient reason for oil-importing countries to replace oil by solar. Pollution is a worldwide problem, and especially so for rapidly industrializing countries like China and India. It is important to note that the recommendation of this paper that oil-importing countries make a transition from oil to solar is simply based on cancellation of wealth transfer losses, it does not require the accompanying environmental benefits.