This paper examines the effect of reduced transaction costs in the international trading of assets on the ability of governments to issue debt. We examine a model in which governments care about the welfare of their citizens, and thus are more inclined to default if a large proportion of their debt is held by foreigners. Reductions in transaction costs make it easier for domestic citizens to share risk by selling debt to foreigners. This may increase tendencies for governments to default, and thus raise their cost of credit and reduce welfare. We find that even in the absence of transaction costs, home bias in placement of government debt may persist, because in the presence of default risk the return on government debt is correlated with the tax burden required to pay the debt. Asset inequality may reduce this home bias, and by increasing foreign ownership, increase incentives for default. Finally, if foreign creditors are less risk averse than domestic creditors, there may be one equilibrium in which domestic creditors hold the asset and default risk is low, and another in which foreign creditors hold the asset and default risk is high.
Developing countries with highly unequal income distributions, such as Brazil or South Africa, face an uphill battle in reducing inequality. Educated workers in these countries have a much lower birthrate than uneducated workers. Assuming children of educated workers are more likely to become educated, this tends to increase the proportion of unskilled workers, reducing their wages, and thus their opportunity cost of having children, creating a vicious cycle. A model incorporating this effect generates multiple steady–state levels of inequality, suggesting that in some circumstances, temporarily increasing access to educational opportunities could permanently reduce inequality. Empirical evidence suggests that the fertility differential between the educated and uneducated is greater in less equal countries, consistent with the model.
Today, the United States government spurs research mainly through direct funding and the granting of patents. Both methods are vitally important, but each causes serious problems–and each has proved inadequate in spurring the research needed to develop effective vaccines against HIV, tuberculosis and malaria.
Ten years have passed since the publication of my book The Road to a Free Economy: Shifting from a Socialist System–the Example of Hungary. It was the first book in the international literature to put forward comprehensive proposals for the post–socialist transition. This paper sets out to assess the book as the author sees it ten years later.
Malaria, tuberculosis, and the strains of HIV common in Africa kill approximately 5 million people each year. Yet research on vaccines for these diseases remains minimal—largely because potential vaccine developers fear that they would not be able to sell enough vaccine at a sufficient price to recoup their research expenditures. Enhancing markets for new vaccines could create incentives for vaccine research and increase accessibility of any vaccines developed. For example, the World Bank has proposed establishing a fund to help developing countries finance purchases of specified vaccines if they are invented. The U.S. administration’s budget proposal includes a tax credit for new vaccines that would match each dollar of vaccine sales with a dollar of tax credits. This paper examines the rationale for such proposals. Private firms currently conduct little research on vaccines against malaria, tuberculosis, and the strains of HIV common in Africa. This is not only because these diseases primarily affect poor countries, but also because vaccines are subject to severe market failures. Once vaccine developers have invested in developing vaccines, government are tempted to use their powers as regulators, major purchasers, and arbiters of intellectual property rights to force prices to levels that do not cover research costs. Research on vaccines is an international public good, and none of the many small countries that would benefit from a malaria, tuberculosis, or HIV vaccine has an incentive to encourage research by unilaterally offering to pay higher prices. In fact, most vaccines sold in developing countries are priced at pennies per dose, a tiny fraction of their social value. More expensive, on–patent vaccines are typically not purchased by the poorest countries. Hence, private developers lack incentives to pursue socially valuable research opportunities. Large public purchases could potentially enlarge the market for vaccines, benefiting both vaccine producers and the public at large.
Several programs have been proposed to improve incentives for research on vaccines for malaria, tuberculosis, and HIV, and to help increase accessibility of vaccines once they are developed. The U.S. administration's budget proposes a tax credit that would match each dollar of vaccine sales with a dollar of tax credit. The World Bank has proposed a $1 billion fund to provide concessional loans to countries to purchase vaccines if and when they are developed. European political leaders have spoken favorably about the concept of a vaccine purchase fund. This paper explores the design of such programs, focusing on commitments to purchase new vaccines. For vaccine purchase commitments to spur research, potential vaccine developers must believe that the sponsor will not renege on the commitment once vaccines have been developed and research costs sunk. Courts have ruled that similar commitments are legally binding contracts. Given appropriate legal language, the key determinant of credibility will therefore be eligibility and pricing rules, rather than whether funds are physically set aside in separate accounts. The credibility of purchase commitments can be enhanced by specifying rules governing eligibility and pricing of vaccines in advance and insulating those interpreting these rules from political pressure through long terms. Requiring candidate vaccines to meet basic technical requirements, normally including approval by some regulatory agency, such as the U.S. FDA, would help ensure that funds were spent only on effective vaccines. Requiring developing to contribute co–payments would help ensure that they felt that the vaccines were useful given the conditions in their countries. The U.S. Orphan Drug Act's success in stimulating research and development is widely attributed to a provision awarding market exclusivity to the developer of the first drug for a condition unless subsequent drugs are clinically superior. Purchases under a vaccine purchase program could be governed by a similar market exclusivity provision. A purchase commitment program could start by offering a fairly modest price. If this proved inadequate to spur sufficient research, the promised price could be increased. This procedure mimics auctions, which are often efficient procurement methods when costs are unknown. As long as prices do not rise at a rate substantially greater than the interest rate, vaccine developers would not have incentives to withhold vaccines from the market. The World Bank has termed health interventions costing less than $100 per year of life saved as highly cost effective for poor countries. If donors pledge approximately $250 million per year for each vaccine for ten years, vaccine purchases would cost approximately $10 per year of life saved. It is unlikely that vaccines for all three diseases would be developed simultaneously, but if donors wanted to limit their exposure, they could cap their total promised vaccine spending under the program, for example at $520 million annually. No funds would be spent or pledges called unless a vaccine were developed.
The Vaccines for the New Millennium Act (HR 3812; SR 2132) includes both enhanced R&D tax credits and a tax credit for sales of vaccines to non–profits and international organizations. The combination is likely to be effective. The enhanced R & D tax credit will provide an immediate benefit for firms doing research in the area. The tax credits for sales will provide incentives for firms to follow through by designing appropriate vaccines for the regions where the diseases are most deadly and will help increase accessability of any vaccines developed. There are several reasons why tax credits for sales of vaccines are an essential element of any package to promote vaccine R&D.
What is the economic significance of "grey market" payments to physicians in Hungary? Let us look at the question first from the angle of theconsumer of medical provisions, the "buyer" in this unusual market transaction.
The study finds that positive and statistically significant abnormal returns occur around the announcement date of foreign direct investments. The finding suggests that security prices in the Korean stock market do reflect firm-specific information, and that FDI by Korean MNCs are, on average, value increasing investment decisions. The finding is consistent with the studies of Doukas and Travlos (1988) and Fatemi (1984) which found similar results for U.S. MNCs. Interestingly, however, the speed of price adjustment is not instantaneous as has been observed in event studies of the U.S. market. The price adjustment to firm–specific information is slower, and the magnitude of abnormal returns is greater, for the firms that are subject to investor herding behavior.
Kim, Wi Saeng. "Does FDI Increase Firm Value in Emerging Markets?" Working Paper 00–03, Weatherhead Center for International Affairs, Harvard University, 2000.Download PDF
Although international institutions are a ubiquitous feature of international life, little is know about their trajectories of change. This paper attempts to address this lacuna by examining processes of change in international institutions, in particular the subset of international institutions known as inter–governmental organizations. The purpose of this paper is not to develop a general theory of change in international institutions but rather to develop limited generalizations about causal mechanisms and their consequences. It first examines the rationale and purposes of international organizations – before we can ask how and why particular types of organizations change, we need to understand why they exist in the first place. It then examines the trajectories of change in international organizations by posing three, interrelated, questions. One, what factors drive (or hinder) change in international institutions and organizations and what are the principal instruments and mechanisms that leverage change? Two, what factors explain variations in the pace and direction of change? And three, what are the consequences of change both for the institutions themselves and for their members? Finally the paper outlines a research agenda to develop a broad theoretical framework for understanding causal mechanisms of change in international organizations.
Kapur, Devesh. "Processes of Change in International Organizations." Working Paper 00–02, Weatherhead Center for International Affairs, Harvard University, 2000.Download PDF
Our argument, in short, is that most of the risks being generated in modern industrialized societies are the product of technologically induced structural transformations inside na–tional labor markets. Increasing productivity, changing consumption patterns, and saturated demand for products from the traditional sectors of the economy are the main forces of change. It is these structural sources of risk that fuel demands for state compensation and risk sharing.
Monetary rules matter for the equilibrium rate of employment when the number of price–wage setters is small. If the central bank is non–accommodating, sufficiently large unions, bargaining independently, have an incentive to moderate sectoral money wages, and thereby expected real wages. The result is an increase in the real money supply, and hence higher demand and employment. This does not hold, however, with accommodating monetary policy since unions? wage decisions cannot then affect the real money supply. A similar argument holds for large monopolistically–competitive price setters. Rational expectations, complete information, central bank pre–commitment and absence of nominal rigidities are assumed.
Countries that are classified as having floating exchange rate systems (or very wide bands) show strikingly different patterns of behavior. They hold very different levels of international reserves and allow very different volatilities in the movements of the exchange rate relative to the volatility that they tolerate either on the level of reserves or in interest rates. We document these differences and present a model that explains them as the optimal response of a Central Bank that attempts to minimize a standard loss function, in an environment in which firms are credit–constrained and incomplete markets limit their ability to avoid currency mismatches. This model suggests that the difference in the way countries float could be related to their differing levels of exchange rate pass–through and differences in their ability to avoid currency mismatches. We test these implications and find a very strong and robust relationship between the pattern of floating and the ability of a country to borrow internationally in its own currency. We find weaker and less robust evidence on the importance of pass–through to account for differences across countries with respect to their exchange rate/monetary management.
This paper investigates the design of an exchange rate policy for an economy where the domestic capital market is segmented from the global financial market, producers rely on credit to finance working capital needs, and the labor market is characterized by nominal contracts. We show that the choice of an exchange rate regime is intertwined with the financial structure — greater reliance on working capital to finance input needs, and greater segmentation of the domestic capital market increase the desirable exchange rate stability. This result follows from the observation that greater exchange rate stability is likely to reduce the real interest rate facing the producer, thereby increasing output. Hence, greater reliance on working capital increases the welfare gain attached to the lower interest rate associated with lower flexibility of the exchange rate, thereby increasing the desirability of a fixed exchange rate. Similarly, greater integration with the global capital market reduces the real interest rate benefits from exchange rate stability, increasing thereby the optimal flexibility of the exchange rate, and reducing the demand for international reserves.
This article discusses this "political economy" side of redesigning the international financial architecture. It draws heavily from our previous work (Fernández–Arias and Hausmann 2000a, 2000b). The next section reviews the problems of international financial markets. We subsequently assess their importance in light of the evidence and discuss for whom they are crucial. The last section reviews the solutions that are being proposed and discusses the distribution of their costs and benefits. Concluding remarks follow.
This paper discusses different views about what is wrong with the world, or as an economist would say, the principal distortions that are present. The intent is to clarify the logic behind the proposals for reforming the international financial architecture and provide a means of assessing them. (The actual assessment is performed in the companion paper "Getting it Right: What to Reform in International Financial Markets," Fernández–Arias and Hausmann, 2000.)
This paper asks whether the composition of capital flows is at all related to the likelihood of crises. The dominant view is quite straightforward. FDI involves a long–term commitment to a country and is "bolted down" in such a way that it cannot leave at the first sign of trouble. Hence, it is unlikely to be associated with crises for two reasons: first, because there must be something right about the country if capital is coming in as FDI; second, because even if there were problems, FDI does not have the explosive characteristics of other flows. As expressed by the World Bank (1999) "FDI also is less subject to capital reversals and contagion that affect other flows, since the presence of large, fixed, illiquid assets makes rapid disinvestment more difficult than the withdrawal of short–term bank lending or the sale of stock holdings."
This paper studies the proposition that capital inflows tend to take the form of FDI (i.e. the share of FDI in total liabilities tends to be higher) in countries that are safer, more promising and with better institutions and policies. It finds that this view is patently wrong since it stands the historical record on its head. It then uses alternative theories to make sense of the facts. It begins by studying the determinants of the size and composition of the flows of private capital across countries. It finds that while capital flows tend to go to countries that are safer and have better institutions and financial markets, the share of FDI in total flows is not an indication of good health. On the contrary, countries that are riskier, less financially developed and have weaker institutions tend to attract less capital but more of it in the form of FDI. Hence, interpreting the rising share of FDI, as a sign of good health is unwarranted.