On the desirability of capital controls

November 24, 2015

By Fabrizio Perri and Jonathan Heathcote


In a standard two country international macro model we ask whether shutting down the market for international non-contingent borrowing and lending is ever desirable. The answer is yes. Imposing capital controls is unilaterally desirable when initial conditions are such that ruling out bond trade generates a sufficiently favorable change in the expected path for the terms of trade. Imposing capital controls can be welfare improving for both countries for calibrations in which changes in equilibrium terms of trade movements induced by the controls improve insurance against country specific shocks.

Nice paper that goes against general intuition that capital controls are always bad. It is remarkable that the model can show that they can be beneficial to both countries under some conditions. And those conditions are likely broader than what the authors indicate, as this type of model typically understates the volatility of the terms of trade.

Unions in a Frictional Labor Market

November 18, 2015

By Leena Rudanko and Per Krusell


We analyze a labor market with search and matching frictions where wage setting is controlled by a monopoly union. Frictions render existing matches a form of firm-specific capital which is subject to a hold-up problem in a unionized labor market. We study how this hold-up problem manifests itself in a dynamic infinite horizon model, with fully rational agents. We find that wage solidarity, seemingly an important norm governing union operations, leaves the unionized labor market vulnerable to potentially substantial distortions due to hold-up. Introducing a tenure premium in wages may allow the union to avoid the problem entirely, however, potentially allowing efficient hiring. Under an egalitarian wage policy, the degree of commitment to future wages is important for outcomes: with full commitment to future wages, the union achieves efficient hiring in the long run, but hikes up wages in the short run to appropriate rents from firms. Without commitment, and in a Markov-perfect equilibrium, hiring is well below its efficient level both in the short and the long run. We demonstrate the quantitative impact of the union in an extended model with partial union coverage and multi-period union contracting.

I find this paper quite surprising. First because it shows that a monopoly union can be efficient. Second that this involves a seniority premium. For the latter, it was known that a seniority premium can be a good thing if it allows to pay new hires below their marginal productivity in a limited information environment, but in this paper it has rather to do with the union hold-up problem.

Optimal Unemployment Insurance and Cyclical Fluctuations

November 13, 2015

By Rui Li and Noah Williams


The authors study the design of optimal unemployment insurance in an environment with moral hazard and cyclical fluctuations. The optimal unemployment insurance contract balances the insurance motive to provide consumption for the unemployed with the provision of incentives to search for a job. This balance is affected by aggregate conditions, as recessions are characterized by reductions in job finding rates. We show how benefits should vary with aggregate conditions in an optimal contract. In a special case of the model, the optimal contract can be solved in closed form. We show how this contract can be implemented in a rather simple way by allowing unemployed workers to borrow and save in a bond (whose return depends on the state of the economy), providing flow payments that are constant over an unemployment spell but vary with the aggregate state, and giving additional lump-sum payments (or charges) upon finding a job or when the aggregate state switches. We then consider a calibrated version of the model and study the quantitative impact of changing from the current unemployment system to the optimal one. In a recession, the optimal system reduces unemployment rates by roughly 2.5 percentage points and shortens the duration of unemployment by about 50 percent.

This is an awesome paper, and I say this as someone who has dabbled in the optimal unemployment insurance literature. I wonder though how you can convince the public and politicians that this is a good idea. The schema is quite complex.

Disciplining the Human Capital Model: Learning By Doing, Ben-Porath, and Policy Analysis

November 10, 2015

By Adam Blandin


The human capital literature is largely split between two models of human capital investment: Learning By Doing (LBD) and Ben-Porath (BP). Given the importance of human capital investment for a host of policy issues, I ask whether observable macroeconomic moments are informative about the relative importance of LBD investment versus BP investment. A life-cycle human capital model is constructed which nests both LBD and BP as extreme special cases. I find: (1) Both the BP and LBD versions of the model are consistent with the aggregate distribution of earnings, hourly wages, and hours worked for men in the PSID. (2) Conditional on matching these aggregate levels facts, the BP version of the model is more consistent with the variance in earnings growth rates in the data. (3) Policies which decrease the return to human capital investment, such as a progressive earnings tax, decrease aggregate human capital investment and earnings substantially more in a BP world than in a LBD world. Taken together my findings suggest that within a plausibly parametrized model of human capital accumulation, government policies which reduce the return to human capital investment will generate large decreases in human capital investment and earnings.

There is surprisingly little discipline in how to model human capital accumulation. In large part, this is due to the fact that it is not directly observable. Hence, this paper is looking at some indirect evidence, and the results is of course going to be model-dependent. But at least some effort is spent determining which process is more likely to be correct.

Wage Dispersion, Job Creation and Development: Evidence from Sub-Saharan Africa

November 6, 2015

By Juan Pablo Rud and Ija Trapeznikova


Labor markets in least developed countries are characterised by small wage sectors and low productivity and wages. Using household level data for many countries in Sub-Saharan Africa, we document that they also show a greater level of wage dispersion. This is in stark contrast with the positive correlation between income mean and income inequality for the same countries. We propose a labor search and matching framework with entry costs and firm heterogeneity that delivers endogenously the negative correlation between (i) wage dispersion and size of the wage sector and (ii) wage dispersion and wage mean. We also show that this model can reconcile the differences between wage and income inequality by accounting for labor reallocations between wage and self-employment sectors. We focus on three channels to explain these phenomena in Sub-Saharan Africa: entry costs (e.g. regulations, financial constraints to starting a business), differences in countries’ underlying productivity distribution (e.g. due to lower capital intensity, or poor infrastructure) and labor market frictions. A numerical simulation shows that the model does a good job in reproducing the main stylised facts and reveals how these different constraints interact to reduce labor market performance.

This kind of work is really useful in understanding understudied labor markets. In particular, this should be great for determining which frictions are the most important and where there is the most bang for the buck in terms of labor market reform. The paper does not yet include estimation results, but the simulations results already provided look very promising.