Economic Thoughts and Essays

By Rhys Williams

Development Accounting

Development accounting is the manipulation of a production function to examine whether cross-country income differences arise from differences in total factor productivity (TFP), or due to factor accumulation. It is useful to find this information out so that we can correctly inform policy decisions and let developing countries know if they need to simply increase quantity of factors of production (i.e. promote higher fertility, immigration, labour market inclusion and capital appreciation), whether they need to increase the quality of the factors of production (better education and more efficient use of investment funds) or if they need to increase efficiency and technological adoption.

Harris-Todaro Model

The Harris-Todaro model was created to explain how internal migration occurs from rural to urban sectors through the difference in the expected wage. Pritchett points out that migration can benefit developing countries and their population much more significantly than any aid attempts. Industrial world transfer are around $70bn a year in aid, but by simply allowing a 3% rise in their labour force (taken up by migrants), the gains would be $300 billion: 4.5x greater. Fundamentally it was used to explain migration within an economy, but we attempt to expand the model to an international level. The model begins by accepting that the assumption of (near) full employment in urban labour markets isn’t particularly appropriate for developing countries which are beset by a chronic (under/)unemployment problem whereby many uneducated and unskilled rural migrants cannot find a job in the formal sector so become unemployed or join the informal sector. Thus in deciding whether to move to the city or stay at home on the farm, an individual has to weigh up the probability and risks of being unemployed for a considerable period of time against the positive urban-rural real income differential.

The Household Demand Model

We may be interested in understanding fertility decisions, because it is generally believed that population growth is detrimental to economic development (c.f. the Solow growth model and lessons from the British Industrial Revolution) and so we would advise policymakers to try and reduce population growth. The death rate has been falling across the globe since the 1960s (by 50% according to Schultz) as a result in medical advancements and the cheapening of drugs (as well as globalisation which meant this knowledge could diffuse across the world more easily), yet many LDCs have not followed the same transition path with respect to birth rates as developed countries did. By understanding why a couple decide to have a child (at the margin) we may be able to reduce these incentives, so as to limit population growth.

Interpreting regression coefficients

In this article I will explain how to interpret regression coefficients when dealing with variables that have been logged.

Why would we work with logged variables? Firstly, we might take the log of a non-linear model, to make it linear in parameters, to satisfy the Gauss-Markov assumptions (these are required for the OLS method of estimation to be the BLUE – the best linear unbiased estimator). Secondly, as we will see below, it can sometimes be easier to interpret coefficients which have been logged, as we can talk about percentage changes, which might make more sense than talking about unit changes, in some contexts. [...]

The SSNIP Test

Each product that exists can be classified into a market in which it competes with other products for the attention of consumers. For instance, apples might be considered a snack-fruit and compete with items including pears and bananas. In other words, if the price of apples increased then demand would substitute towards one of these other products. The market for apples, would thus include these other fruits which substitution can easily happen.

Such substitution means that apple producers are restricted in their ability to increase prices. Increasing prices too much would result in this demand substitution towards other products.

On the other hand, other products might have a more restricted market. [...]

Wage compression and the decline in inequality in Latin America

This blog posts explores some questions behind an article written by Levy Yeyati and Pienknagura – Wage compression and the decline in inequality in Latin America: Good or bad?“. We summarise the authors claims behind the decline in Latin American income inequality, and explain whether the decline is good or bad for Latin America.

The authors claim that there are 3 possible factors behind the decline in Latin American income inequality: increasing access to education, a decline in the demand for skill-intensive industries or a worsening of the educational system. Before we analyse these effects, it is important to note that the compression of the educational premium only accounts for half of the decline in inequality, so other factors must also be involved. [...]

Price Discrimination and Social Welfare

Standard texts of price discrimination see it as beneficial in a social welfare sense: consumer surplus is transferred to producer surplus, but the fact that quantity increases is good for social welfare (as it reduces the deadweight loss triangle). Interestingly, this isn’t the whole story. Tullock pointed out, a number of years ago, that social welfare loss can originate from the rent-seeking activities of those that are trying to capture these rents.

For instance, in a monopoly setting, standard economic theory would say that the cost of monopolies comes from the reduction in quantity sold (as a result of higher prices), leading to a loss of social welfare. [...]

The Adaptive Investment Effect: Evidence from Chinese Provinces

A paper of mine, “The Adaptive Investment Effect: Evidence from Chinese Provinces“, co-authored with Dr Kamiar Mohaddes, has recently been published in Economic Letters.

In the paper, we outline that the Adaptive Investment Effect (AIE) is the diversion of investment resources from productive to adaptive capital in response to the effects of climate change. We would expect this diversion to reduce the productivity of investment on economic growth.

For instance, we can imagine that climate change might increase temperatures in some areas. It is well known that higher temperatures reduce labour productivity and so to ameliorate this loss in productivity, firms might invest in air-conditioning units in offices. [...]

Trade Agreements and Reciprocity

Reciprocity, a mutual or reciprocal reduction in tariffs, is a key feature of trade agreements between large countries. Explain why reciprocity is a necessary feature for a trade agreement to yield higher welfare to both parties. Can a trade agreement be sustainable (or “self-enforcing”) if it is not characterized by reciprocity?

Following McLaren, let us consider two large countries, A and B which are symmetric both countries produce goods a and b, but A has a comparative advantage in the production of a whilst B has a comparative advantage in the production of b. To placate the domestic industry country A has an incentive to impose a tariff on good b which imposes a terms of trade loss for B and efficiency loses for both countries, whilst B has an incentive to impose a tariff on good a causing a terms of trade loss for A and efficiency losses for both country. [...]

Social Interactions and Fertility Behaviour

The most important macro externality that high fertility can have is its effect on economic development. If high fertility leads to more rapid economic growth and development then we may consider the externality positive, if not we would say it is negative. This works if we consider the mortality rate to be below high fertility, such that high fertility means high population growth.