Intermediate Goods Sector Research Articles

Sector specific foreign investment, labour inflow, economies of scale and welfare

This paper argues that the impact of foreign investment on welfare depends on the sector that attracts the investment and certain characteristics of the economy. It is shown that, as long as the intermediate good is non-traded, foreign investment in a sector that is subject to economies of scale increases welfare by increasing the size of the intermediate good sector. On the other hand, foreign investment in a sector that is subject to constant returns to scale decreases welfare by decreasing the size of the intermediate good sector. The impact of foreign investment (in either sector) on welfare depends on relative factor intensities when the intermediate good is traded.

Why Lisbon Fails

This article looks at the political economy of structural reforms and growth in the European Union. As the EU's; economy approaches the world technology frontier, structural reforms that increase competition in intermediate goods sectors are necessary to boost innovation and productivity growth—the main objective of the Lisbon Agenda. Such reforms, however, raise the opposition of incumbents and, therefore, are politically difficult to implement. When there are important policy spillover effects, national governments are more easily captured by vested interests, as they fail to internalize the benefits of reforms on the rest of the Union. This suggests that the weak political governance of the Lisbon Agenda, which is centred on the peer pressure of national governments, and the ensuing inability to complete the single market in non-manufacturing sectors, explains the Lisbon failure. (JEL classification: D72, F42, O30, O40)

Externalities and development of heavy industry

In the framework of a dynamic general equilibrium model, this paper studies how vertical externalities affect the development of heavy industry in a developing economy. The model is comprised of an intermediate and a consumer product sector. The production of both types of goods has pecuniary externalities as they are featured by increasing return to scale. However, the production of an intermediate product has an additional advantage to have externalities through its technological linkage with the production of consumer goods. This is related to the nature of the roundabout production of consumer goods: a larger number of intermediate products lead to higher productivity in the production of consumer goods than do more inputs of a fixed number of intermediate products. Therefore, private investment in the intermediate sector is below the social optimal level. Government subsidies can restore the economy to the social optimum, but they become less needed as the consumer sector grows larger and the advantage of the intermediate good sector diminishes.

Fiscal policy, monopolistic competition, and finite lives

This paper studies the short-run, transitional, and long-run output effects of permanent and temporary shocks in public consumption under various financing methods. To this end, a dynamic macroeconomic model for a closed economy is developed, which features a perfectly competitive final goods sector and a monopolistically competitive intermediate goods sector. Finitely lived households consume final goods, supply labor, and save part of their income. Amongst the findings for a permanent rise in public consumption are: (i) monopolistic competition increases the absolute value of the balanced-budget output multiplier; (ii) positive long-run output multipliers are obtained only if the generational turnover effect is dominated by the intertemporal labor supply effect; (iii) short-run output multipliers under lump-sum tax financing are smaller than long-run output multipliers if labor supply is elastic; and (iv) bond financing reduces the size of long-run output multipliers as compared to lump-sum tax financing and may give rise to non-monotonic adjustment paths if labor supply is sufficiently elastic and the speed of adjustment of lump-sum taxes is not too high. Temporary bond-financed fiscal shocks are shown to yield: (i) permanent effects on output; and (ii) negative long-run output multipliers.

Fiscal Policy, Monopolistic Competition, and Finite Lives

The paper studies the short-run, transitional, and long-run output effects of permanent and temporary shocks in public consumption under various financing methods. To this end, a dynamic macroeconomic model for a closed economy is developed, which features a perfectly competitive final goods sector and a monopolistically competitive intermediate goods sector. Finitely lived households consume final goods, supply labor, and save part of their income. Amongst the findings for a permanent rise in public consumption are: (i) monopolistic competition increases the absolute value of the balanced-budget output multiplier; (ii) positive long-run output multipliers are obtained only if the generational turnover effect is dominated by the intertemporal labor supply effect; (iii) short-run output multipliers under lump-sum tax financing are smaller than long-run output multipliers if labor supply is elastic; and (iv) bond financing reduces the size of long-run output multipliers as compared to lump-sum tax financing and may give rise to non-monotonic adjustment paths if labor supply is sufficiently elastic and the speed of adjustment of lump-sum taxes is not too high. Temporary bond-financed fiscal shocks are shown to yield: (i) permanent effects on output; and (ii) negative long-run output multipliers.

Provision of public infrastructure, foreign investment and welfare in the presence of specialisation-based external economies

It is widely believed that provision of production infrastructure, among other things, attracts foreign investment. In the context of a small open economy model where monopolistic competition prevails in the intermediate good sector, this paper focuses on the impact of changes in the supply of a public good on foreign investment and welfare. From the point of view of producers, the public good is akin to public infrastructure that reduces the fixed cost associated with the production of the intermediate good. The presence of monopolistic competition in the intermediate good sector gives rise to specialisation-based external economies in the industrial good. The size of these economies affects the magnitude of all comparative static responses presented in this paper. It is shown that an increase in the supply of the public good decreases foreign investment as long as the public good is more (or equally) capital intensive as compared to the agricultural good and the industrial good is more (or equally) capital intensive as compared to the intermediate good. In the absence of specialisation-based external economies, an increase in the supply of the public good leads to an unambiguous decrease in welfare.

Inflation targeting: What inflation rate to target?

In an economy with nominal rigidities in both an intermediate good sector and a finished good sector, and thus with a natural distinction between CPI and PPI inflation rates, a benevolent central bank faces a tradeoff between stabilizing the two measures of inflation, a final output gap and, unique to our model, a real marginal cost gap in the intermediate sector, so that optimal monetary policy is second-best. We discuss how to implement the optimal policy with minimal information requirement and evaluate the robustness of these simple rules when the central bank may not know the exact sources of shocks or nominal rigidities. A main finding is that a simple hybrid rule under which the short-term interest rate responds to CPI inflation and PPI inflation results in a welfare level close to the optimum, whereas policy rules that ignore PPI inflation or PPI sector shocks can result in significant welfare losses.

Global Intermediate-Good Price Stickiness and the Determinants of the Real Effects of Monetary and Government Spending Shocks

As industrialization and globalization are spread across the world, price competition is growing fierce in the final-good sector while many intermediate goods are enjoying global imperfect competition. Hence, when prices of intermediate goods are globally sticky in LCP (local-currency pricing) but consumer prices are flexible, the determinants of the short-run real effects of monetary and government spending shocks are explored in an open economy model with labor market inefficiency and global sourcing. Major findings are as follows: first, in the presence of a structural inefficiency in labor market, monetary and government spending shocks have ambiguous effects on the demand for domestic intermediate goods; second, even if there is price stickiness in the intermediate-good sector, monetary and government spending shocks may not affect final output in the short run; third, the natural rate of unemployment, the natural rate of productivity growth, and the trade-off between unemployment and inflation play a key role for exchange rate changes to bring forth beneficial real effects.

Specialisation-based external economies, supply of primary factors and government size

This paper examines the impact of changes in the supply of primary factors on the size of government and welfare. Unlike the existing studies, this paper utilises a model where the presence of monopolistic in the intermediate good sector gives rise to specialisation-based external economies in the final good sector. The size of theses external economies affects the magnitude of most comparative static results presented in this paper. For example, it is shown that, in the presence of specialisation-based external economies, an increase in the supply of either primary factor (i.e., capital or labour) decreases the size of governments even if the private and public sectors were equally capital intensive. Due to the presence of specialisation-based external economies, an increase in the size of the country decreases the size of government. In addition, an increase in the size of the country leads to a larger increase in welfare as long as external economies are present.

Globalization, the Volatility of Intermediate Goods Prices, and Economic Growth

We set up a dynamic stochastic model of a stylized economy comprising a final output sector (with traditional and modern firms) and an intermediate goods sector. It is shown that market integration reduces the volatility of the rate of return of capital invested in modern firms. The induced portfolio decision of households leads to a reallocation of capital from traditional to modern firms. Despite the presence of a reverse precautionary saving channel, the growth rate unambiguously increases due to the reallocation of capital. Empirical estimates for OECD countries confirm the theoretical results.

Industrialization and substitutability: a note

This paper analyzes the relationship between industrialization and technology in detail. Three main conclusions are obtained: (i) the crucial factor for the existence of a poverty trap is the degree of substitutability among intermediate inputs; (ii) the effects of technological progress in the manufactured good sector and the intermediate goods sector on industrialization differ with the degree of substitutability among intermediate inputs; (iii) technological progress in the manufactured good sector and the intermediate goods sector weakens the lock-in effect of historical events while strengthening the role of expectations. These suggest that the degree of substitutability among intermediate inputs should be an important factor when we plan a development strategy.

A Dynamic Model with Vertical Specialization, Credit Chains, and Incomplete Enforcement

Abstract: This paper sets up a model to account for differences in total factor productivity due to differences in enforcement of contracts. Vertical specialization generates the need for intra-period credit, because final goods producers cannot pay their intermediate goods suppliers before they produce their final good. The paper shows that if there are enforcement problems, the capital distribution is skewed in the sense that intermediate goods producers operate at lower capital levels and higher marginal products of capital than final goods producers. This wedge is created by the price for intermediate goods, which is lower in economies with bad enforcement. For this reason, the high-productivity firms in the intermediate goods sector have no incentive to grow and the low-productivity firms in the final goods sector, benefiting from low intermediate goods prices, have no incentive to shrink, which causes productivity to be lower in countries with bad enforcement. JEL classification: E10, E23 Key words: vertical specialization, limited enforcement, productivity 1 Introduction Why are certain countries poor and stay that way? The neoclassical growth model predicts that poor countries, even if living in autarky from the rest of the world, should rapidly catch up to industrialized countries. In the presence of perfect international capital markets this process would even take place instantaneously as capital flows to the countries with low capital endowment and high interest rates in order to equalize interest rates across countries. All this requires that technology across countries is identical. Prescott (1997) therefore raises the point that a theory explaining differences in production functions across nations, in particular differences in total factor productivity, is needed. This paper attempts to develop a theory of differences in TFP that have their origin in incomplete contract enforcement. We set up a dynamic general equilibrium model to examine the role played by incomplete enforcement of intra-period trade credit contracts. Output is produced in a sequence of intermediate production stages. Due to a benefit to specialization every firm concentrates its activity to the production of one single stage. Firms in each stage except the initial one purchase the intermediate good of the previous stage using trade credit and sell their output to the firms in the next stage, receiving trade credit of that firm in exchange. That is, rather than looking at enforcement problems pertaining to long term borrowing contracts we look at default risk within the chain of intra-period trade credit. A real world example for this chain of credit would be the two intermediate goods: iron ore and steel, and the final good automobiles. Iron ore is an input in the steel production and steel is an input in the automobile production. The model implicitly assumes that there is a benefit to specialization, that is, every firm in this economy specializes in only one sector of the economy. Car producers, therefore, would never buy iron ore to produce the steel themselves. Instead they purchase steel in the intermediate goods market. There is, by the way, plenty of evidence that vertical specialization in the real world is far more advanced than the relatively coarse grid of intermediate stages iron ore--steel--automobiles. Kei-Mu Yi (2001) shows that there is specialization even across countries that can account for the recent boost to international trade. He shows that effects of declines in tariffs are magnified if intermediate goods cross the border several times. Given that producers are even willing to pay tariffs by shipping goods across borders several times clearly indicates that there must be some payoff to specialization. Why do firms use trade credit? Notice that in a standard macro model with a sequence of intermediate goods as described above there would be no borrowing and lending other than potential long term borrowing contracts for financing of firms. …

Local content requirements and urban unemployment

Local content requirements (LCRs) are extensively employed in many developing countries that intend to develop the domestic intermediate good sectors as well as the final good sectors. This article investigates the effects of LCRs on the domestic intermediate-good-producing sector, urban unemployment, and welfare.

Agglomeration and growth with innovation in the intermediate goods sector

A Romer-type [J. Polit. Econ. 98 (1990) 71] endogenous-growth model is developed with two countries in which the production of a manufactured good requires differentiated intermediate goods and the invention of a variety of intermediate goods demands the manufactured good. The economy yields two types of steady states: the existence or non-existence of the international trade of a manufactured good when the transportation cost of this good is sufficiently low or high. In the former case, firms of the intermediate goods sector fully agglomerate in one country, and the growth rate is maximized. In the latter case, the manufactured goods are produced in both countries, and firms agglomerate incompletely. In particular, when the transportation cost of the intermediate goods is too high, the economy achieves no growth. Finally, multiple equilibria are observed when these two types of steady states emerge simultaneously.

Optimal Product Variety and Economic Growth: The Trade-off between Internal and External Economies of Scale

We develop a model to analyze the social optimality of growth and product variety. The model contains two sectors, one assembly sector producing a homogeneous consumption good, and one intermediate goods sector producing differentiated inputs. Both growth which results from R & D performed in the intermediate goods sector and the variety of differentiated intermediate goods are determined endogenously. We disentangle three effects of changes in variety: (i) a productivity effect, (ii) a business stealing effect, and (iii) a growth effect. The market provides too little variety and sub-optimally high growth if the productivity effect of variety is large relative to the market power of intermediate goods producers. If varieties are not very productive, the market provides a too low rate of growth, whereas variety may either be too low as well as too high. Decentralization of both the first-best and a second-best is considered. The model is calibrated to US data to assess the magnitude of required policy interventions and the degree of sub-optimality of growth and product variety. We show that in this framework growth in the market can indeed be sub-optimally high for plausible parameter values.

Trade Liberalization and Productivity Growth: Evidence from Indian Manufacturing

The impact of trade liberalization on productivity growth is still an empirical issue; the theoretical literature is as yet unclear on the direction of any such association. This paper develops an analytical framework and employs it to empirically test whether trade liberalization in Indian manufacturing has raised total factor productivity (TFP) growth. The answer is in the affirmative. The results also support a key postulate of the new growth theories, that liberalization of the intermediate‐good sectors has a larger favorable impact on TFP growth than that of the final‐good sectors.

The Vertical Multinational Enterprise and International Trade

This paper analyzes an endogenous vertical multinational enterprise by explicitly modeling a distortion in the intermediate goods sector. Firms invest abroad to lower the cost of multistage production. The implications for international trade and investment differ markedly from the conventional wisdom of multinationals. Particularly, intrafirm trade in intermediates implies vertical investment complements rather than substitutes for trade. The decision to become a multinational depends on the level on foreign factor prices, the nature of the competition with foreign suppliers, transport, tariffs, and subsidiary plant costs. Marginal change in tariff may result in unintended welfare jumps as firm configuration shifts.

Government Size, Product Diversity and International Trade

This paper develops a simple general equilibrium model to examine the impact on pattern of trade and product diversity of an increase in the size of the government. It extends the existing literature, relying on the limiting assumption of perfect competition on all markets by introducing Chamberlin-type monopolistic competition in the intermediate good sector. The analysis shows that in the context of a two (identical) countries world, an increase in the size of the government in the home country can induce specialization in the production of the intermediate good. The size of the government is measured by the quantity supply of a public good.

Imperfect competition and capital accumulation: the role of price normalization

We consider a capital-accumulation model with infinitely lived households and two production sectors. The intermediate-good sector is characterized by perfect competition, a constant-returns-to-scale technology, and production externalities. The final-good sector is a monopoly operating under constant returns to scale. We analyze the general equilibrium in the sense of Gabszewicz and Vial [Journal of Economic Theory (1972) 4: 381–400] for this economy and different price-normalization rules. It is shown that the qualitative behavior of the equilibrium paths depends crucially on the chosen normalization rule. In particular, whether equilibria are monotonic or oscillating and whether indeterminacy occurs or not may depend on the choice of the numeraire.

THE URBAN ENTERPRISE ZONE*

ABSTRACT This paper provides an analytical framework of urban enterprise zones in a context of regional development. The direct and indirect impacts of urban enterprise zones on regional economies such as job creation, urban unemployment, agricultural wage and changes in the regional economic structure are analyzed by incorporating the intermediate goods sector. The study suggests that the establishment of urban enterprise zones is a beneficial and effective policy instrument which can be used in promoting urban renewal and regional economic growth.