Publications by Type: Working Paper

Preferences for redistribution and state intervention in social policies, as well as the generosity of welfare states, differ significantly across countries. In this paper, we test whether there exists a feedback process of the economic regime on individual preferences. We exploit the “experiment” of German separation and reunification to establish exogeneity of the economic system. From 1945 to 1990, East Germans lived under a Communist regime with heavy state intervention and extensive redistribution. We find that, after German reunification, East Germans are more in favor of redistribution and state intervention than West Germans, even after controlling for economic incentives. This effect is especially strong for older cohorts, who lived under Communism for a longer time period. We further find that East Germans’ preferences converge towards those of West Germans. We calculate that it will take one to two generations for preferences to converge completely.

In the last two decades several European countries implemented tax systems that allow for the deduction of imputed equity interest from a company?s tax base. This paper integrates the tax benefits resulting from imputed interest on the stock of equity into business valuation. Three alternative discounted cash flow valuation methods are used to this end: the equity method, the Adjusted Present Value (APV) method, and the entity method. Intertemporal differences in risk require the use of various risk–adjusted discount rates in the equity method as well as the APV method. Using the equity method we show that the well–known, market–to–book ratio of the constant growth dividend discount model also holds in our model. When applying the APV method with imputed equity interest, an adjustment is necessary for each business, also for an unlevered company, to account for the tax shield resulting from equity financing. A closed–form solution is presented for the value of this tax benefit. We furthermore derive the weighted average cost of capital (WACC) under imputed interest on the stock of equity and the adjustment of the cost of equity that is necessary to derive the WACC as a weighted average of cost of equity and debt.

U.S. Latinos–Puerto Ricans and Cuban–Americans excepted in specific instances—have had limited impact on U.S. policy toward Latin America because they lack the interest and the resources to do so, and the capacity to act in concert for foreign policy purposes. Moreover, Latinos as a category do not have a shared Latin American foreign policy agenda. To the extent that they engage at all in the foreign policy arena, they typically do so in relation to their countries of origin. In many cases, however, they dislike the government of their homeland. In those relatively rare cases when U.S. Latino elites have sought to influence U.S. foreign policy, they have characteristically followed the lead of the U.S. government instead of seeking to change the main features of U.S. policy toward Latin America. This paper considers several case studies: the Puerto Rican influence on the Alliance for Progress; the Cuban–American influence on U.S. policy toward Cuba; the Mexican–American behavior relative to the enactment of NAFTA and U.S.–Mexican migration negotiations in 2001; and the Central American impact on U.S. immigration policies in the mid–1990s.

In this paper we review the literature on sovereign debt with particular emphasis on indexation and maturity and the main policy proposals related to these topics. We also advance some implications derived from our work. In Alfaro and Kanczuk (2005a, b, c), we modeled sovereign debt as a contingent claim following the framework developed by Grossman and Van Huyck (1988). Our framework, however, recognizes that contingent debt might be associated with incentive problems. Applying this framework to the study of the sustainability of sovereign debt, the tradeoff between nominal and indexed debt, and the optimal debt maturity, we find some of the proposals advanced in the literature regarding lengthening debt maturity and issuing nominal debt to be unsustainable in emerging (volatile) economies.

To meet the dire need for housing created by the devastation of Hurricane Katrina in August 2005, Mayor Ray Nagin of New Orleans and the staff of the Federal Emergency Management Agency (FEMA) worked to create lists of potential sites for trailer parks. This procedure took place within an environment of Not In My Back Yard-ism, or NIMBYism, where a number of communities and individuals expressed their opposition to hosting such trailer sites both publicly and privately. We analyze the final list of city-approved sites to track which factors were correlated with larger (or smaller) numbers of trailers and trailer sites per zip code bloc. Our data show that areas which displayed greater levels of social capital, as evidenced by voluntaristic activities such as turning out to vote, were slated for fewer trailers, controlling for race, income, flood damage, area, population density, and other relevant factors. Despite theories uncritically connecting denser social capital with more rapid rebuilding, areas of strong civil society weakened the city’s ability to recover quickly by forcing it to invest more effort in locating amenable sites for temporary housing.

Many low skilled jobs have been substituted away for machines in Europe, or eliminated, much more so than in the US, while technological progress at the “top”, i.e. at the high-tech sector, is faster in the US than in Europe. This paper suggests that the main difference between Europe and the US in this respect is their different labor market policies. European countries reduce wage flexibility and inequality through a host of labor market regulations, like binding minimum wage laws, permanent unemployment subsidies, firing costs, etc. Such policies create incentives to develop and adopt labor saving capital intensive technologies at the low end of the skill distribution. At the same time technical progress in the US is more skill biased than in Europe, since American skilled wages are higher.

The globalization debate has largely been fought between those who prophesize a "race to the bottom" in government expenditure and those who foresee continued divergence, with some states better shielded from global economic volatility. However, over the past few decades there has, in fact, been "upward convergence" in the percentage of national income governments devote to public education, albeit amidst considerable cross–national variance. This phenomenon has an enormous distributional impact, yet it has been largely neglected by political scientists. What explains this tremendous shift? This paper argues that two forces in particular shape the aggregate pattern of human capital expenditure: the level of democracy and the level of openness of any given state. By developing a model of the political economy of education investment, and testing its implications over a dataset of 115 countries from 1960 to 2002, this paper provides a first cut at explaining this critical issue.

Can a country grow faster by saving more? We address this question both theoretically and empirically. In our model, growth results from innovations that allow local sectors to catch up with the frontier technology. In relatively poor countries, catching up with the frontier requires the involvement of a foreign investor, who is familiar with the frontier technology, together with effort on the part of a local bank, who can directly monitor local projects to which the technology must be adapted. In such a country, local saving matters for innovation, and therefore growth, because it allows the domestic bank to cofinance projects and thus to attract foreign investment. But in countries close to the frontier, local firms are familiar with the frontier technology, and therefore do not need to attract foreign investment to undertake an innovation project, so local saving does not matter for growth. In our empirical exploration we show that lagged savings is significantly associated with productivity growth for poor but not for rich countries. This effect operates entirely through TFP rather than through capital accumulation. Further, we show that savings is significantly associated with higher levels of FDI inflows and equipment imports and that the effect that these have on growth is significantly larger for poor countries than rich.

Why do countries delay stabilizations of large and increasing budget deficits and inflation? And what explains the timing of reforms? We use the war of attrition model as a guidance for our empirical study on a vast sample of countries. We find that stabilizations are more likely to occur when time of crisis occur, at the beginning of term of office of a new government, in countries with "strong" governments, (i.e. presidential systems and unified governments with a large majority of the party in office), and when the executive faces less constraints. The role of external inducements like IMF programs has at best a weak effect, but problems of reverse causality are possible.

We examine the empirical role of different explanations for the lack of flows of capital from rich to poor countries–the "Lucas Paradox." The theoretical explanations include differences in fundamentals across countries and capital market imperfections. We show that during 1970–2000 low institutional quality is the leading explanation for the lack of capital flows. For example, improving Peru?s institutional quality to Australia?s level, implies a quadrupling of foreign investment. Recent studies emphasize the role of institutions for achieving higher levels of income but remain silent on the specific mechanisms. Our results indicate that foreign investment might be a channel through which institutions affect long–run development.

Fiscal policy is procyclical in many countries, and especially in developing ones. We explain this policy failure with a political agency problem. Procyclicality is driven by voters who seek to "starve the Leviathan" to reduce political rents. Voters observe the state of the economy but not the rents appropriated by corrupt governments. When they observe a boom, voters optimally demand more public goods or fewer taxes, and this induces a procyclical bias in fiscal policy. The empirical evidence is consistent with this explanation: procyclicality of fiscal policy is more pronounced in more corrupt democracies.

The Bank for International Settlements (BIS) was created in 1930 primarily to administer the Young Plan, including reparations loan repayments from Germany. But the first objective of the BIS, as defined in its statutes, is to "promote the cooperation of central banks…"—to provide a place of meeting for central bankers to exchange information, discuss common problems, agree on shared aims, set common standards, and possibly even provide mutual support. This objective must be viewed against the background of the 1920s, when there had been episodic, typically bilateral cooperation among central banks. Indeed episodes of such cooperation can be found in the pre–1914 period, for example a gold loan by the Bank of France to the Bank of England during the Baring Crisis of 1890, or discounting of English bills by the Bank of France in 1906, 1907, 1909, and 1910, thereby relieving pressure on the gold reserves of the Bank of England. Indeed, examples can be found from even earlier, including the Latin and Scandinavian currency unions.

The absence of a regional military alliance in Asia, and the related tendency of Asian regional institutions to avoid multilateral defence cooperation constitute a key puzzle of Asian regional order. Available theoretical explanations of this puzzle tend to focus heavily on the US role, either the nature and extent of US power, or its perceptions of collective identity. Challenging this, this paper offers a normative explanation. The absence of a "NATO in Asia", argues this paper, is explained by a norm against collective defence which emerged and evolved through early post–war regional interactions. These interactions, which have been ignored in the theoretical literature on international organization, were shaped by the interplay of the ideas of key local agents, and the evolving global norm of non–intervention. The paper's investigation into the normative origins Asian multilateralism contributes to the theoretical literature on the diffusion of sovereignty norms in the international system. International relations scholars generally assume that the "history of sovereignty is largely the history of Westphalia's geographic extension," but ignore the crucial agency of local actors in the developing world in translating the idea of sovereignty into norms of conduct in a regional setting. This article shows how regional interactions in early post–War Asia that led to a regional norm against collective defence, also helped to strengthen the global norm of non–intervention, and shaped subsequent regional institutions in Asia. In this process, Asian interactions made a distinctive contribution to the evolution of post–war international order, which has been seldom acknowledged, much less analyzed, by scholars of international relations.

Easing immigration restrictions for the highly skilled in developed countries portend a future of increased human capital outflows from developing countries. The myriad consequences of these developments for developing countries include the direct loss of the fiscal contributions of these highly skilled individuals. This paper analyzes the fiscal impact of this loss of talent for a developing country by examining human capital flows from India to the U.S. The escalation of the emigration of highly skilled professionals from India to the U.S is examined by surveying evidence on the changing nature of the Indian–born in the U.S. during the 1990s. The loss of talent to India during the 1990s was dramatic and highly concentrated amongst the prime–age work force, the highly educated and high earners. In order to estimate the fiscal losses associated with these emigrants, this paper first estimates what these emigrants would have earned in India, and then integrates the resulting counterfactual distributions with details of the Indian fiscal system to estimate fiscal impacts. Two distinct methods to estimate the counterfactual earnings distributions are implemented: a translation of actual U.S. incomes in purchasing power parity terms and an income simulation based on a jointly estimated model of Indian earnings and participation in the workforce. The PPP methods indicate that the foregone income tax revenues associated with the Indian–born residents of the U.S. comprise one–third of current Indian individual income tax receipts. Depending on the method for estimating expenditures saved by the absence of these emigrants, the net fiscal loss associated with the U.S. Indian–born resident population ranges from 0.24% to 0.58% of Indian GDP in 2001.

Fears that globalization hurts the environment are not well–founded. A survey reveals little statistical evidence, on average across countries, that openness to international trade undermines national attempts at environmental regulation through a "race to the bottom" effect. If anything, favorable "gains from trade" effects dominate, for measures of air pollution such as SO2 concentrations. Perceptions that WTO panel rulings have interfered with the ability of individual countries to pursue environmental goals are also poorly informed. Recent rulings have in fact confirmed that countries can enact environmental measures, even if they affect trade and even if they concern others? Processes and Production Methods (PPMs), provided the measures do not discriminate among producer countries.

People care about both the environment and the economy. As real incomes rise, their demand for environmental quality rises. This translates into environmental progress under the right conditions–democracy, effective regulation, and externalities that are largely confined within national borders and are therefore amenable to national regulation. Increasingly, however, environmental problems spill across borders. Global externalities include climate change and ozone depletion. Economic growth alone will not address such problems, in a system where each country acts individually, due to the free rider problem. Multilateral institutions are needed, and national sovereignty is the obstacle, not the other way around.

Genetically modified (GM) foods are widely produced in the United States and in two other Western Hemisphere countries (Argentina and Canada) but almost nowhere else. In most other wealthy industrial countries, including Europe and Japan, it is legal for farmers to plant these crops, but they voluntarily refrain from doing so because consumers are averse to eating GM. In most developing countries it is not yet legal for farmers to grow GM foods, on biological safety grounds. Yet biosafety is not the real issue. Poor countries are now trying to stay "GM–free" so as to retain the option of exporting food to Europe and Japan.

New regulations in the EU on the labeling and traceability of imported GM foods and feeds will only increase the potential cost to exporters of planting GM seeds. The United States has considered challenging EU regulations as illegal under the WTO, and a serious trade conflict now looms. The EU, not the United States, is better positioned to prevail in this conflict. In international food markets, safety and labeling standards tend to be set by big importers rather than big exporters.

This study reconceptualizes theories of the state in light of post–communist developments. After the collapse of communist regimes across Eastern Europe and the former Soviet Union, scholars overlooked a central aspect of the transition: the need to reconstruct public authority, or state–building. Likewise, theorists of the state have largely ignored the post–communist challenge to existing theories of state capacity and development. Post–communist state development is characterized by the need to reconstruct public authority, or state–building. Two aspects of this process determine subsequent state trajectories: a) the representativeness of elite competition (that is, whether elites compete by representing constituencies, or in self-contained elite conflicts), and b) the mechanisms of elite competition (that is, whether it is channeled via formal institutions, or informal networks and ties.)

Scholars, activists, and policy makers have argued that the route to economic growth in Africa runs through political reform. In particular, they prescribe electoral accountability as a step toward economic reform, seeing it as inducing the choice of publicly beneficial as opposed to privately profitable economic policies. To assess the validity of such arguments, we first characterize a set of political institutions that render political elites accountable and derive their expected impact on the policy choices of governments. Using ratings of macro–economic policy produced by the World Bank and ratings of corrupt practices produced for private investors, we explore the relationship between institutional forms and policy choices on both an African and global sample. While key elements of the model find empirical support, the central argument receives mixed support in the data. Political institutions have a stronger influence on policy making in Africa than elsewhere and variation in African institutions and in the structure of African economies account for differences between policy choices in Africa and those made in the rest of the world. Political accountability however does not influence the choice of macro–economic policies in the manner suggested by reformist arguments; although it does appear to lead to less political predation.

The debate over monetary standards and exchange rate regimes for developing countries is as wide open as ever. On the one hand, the big selling points of floating exchange rates—monetary independence and accommodation of terms of trade shocks—have not lived up to their promise. On the other hand, proposals for credible institutional monetary commitments to nominal anchors have each run aground on their own peculiar shoals. Rigid pegs to the dollar, for example, are dangerous when the dollar appreciates relative to other export markets.

This study explores a new proposal: that countries specialized in the export of a particular commodity should peg their currency to that commodity. When the dollar price of the commodity on world markets falls, the dollar exchange rate of the local currency would fall in tandem. The country would thus reap the best of both worlds: the advantage of a nominal anchor for monetary policy, together with the automatic accommodation to terms of trade shocks that floating rates claim to deliver. The paper conducts a set of counter-factual experiments. For each of a list of countries specialized in particular mineral or agricultural commodities, what would have happened, over the last 30 years, if it had pegged its currency to that commodity, as compared to pegging to the dollar, yen, or mark, or as compared to whatever exchange rate policy it actually followed historically? We compute under these scenarios the price of the commodity in local terms, and we then simulate the implications for exports. Illustrative of the results is that some victims of financial difficulties in the late 1990s might have achieved a stimulus to exports precisely when it was most needed, without having to go through wrenching currency collapses, if they had been on regimes of pegging to their export commodity: South Africa to gold or platinum, Nigeria and Indonesia to oil, Chile to copper, Argentina to wheat, Colombia to coffee, and so on.

Not all countries will benefit from a peg to their export commodity, and none will benefit in all time periods. Nonetheless, the results suggest that the proposal that some countries peg their currency to their principle export commodity deserves to take its place alongside pegs to major currencies and the other monetary regimes that countries consider.

This paper argues that cross–border human capital flows from developing countries to developed countries over the next half–century will demand a new set of policy responses from developing countries. The paper examines the forces that are making immigration policies more skill–focused, the effect of both flows (emigration) and stocks (diasporas) on the source countries, and the range of taxation instruments available to source countries to manage the consequences of those flows. This paper emphasizes the example of India, a large source country for human capital flows, and the United States, an important destination for these human capital flows and an example of how a country can tax its citizens abroad. In combination, these examples point to the significant advantage to developing countries of potential tax schemes for managing the flows and stocks of citizens who reside abroad. Finally, this paper concludes with a research agenda for the many questions raised by the prospect of large flows of skilled workers and the policy alternatives, including tax instruments, available to source countries.