Regional business cycle and growth features of Japan

The objective of this paper is to construct a dataset of Japanese prefecture level production, income and expenditure data and analyze the Japanese regional growth and business cycle features. The 47 prefectures are analyzed individually and also as 10 regional groups; Hokkaido, Tohoku, Kanto, Chubu, Kinki, Chugoku, Shikoku, Kyushu and Okinawa.

Our dataset is based on the System of National Accounts (SNA) from the Cabinet Office Economic and Social Research Institute (ESRI). From expenditure data, we construct series of the prefectural per capita GDP, private consumption, private investment, government consumption and government investment in 2000 yen over the 1955-2008 period. From income data we construct series of the prefectural labor income share and depreciation rate over the 1975-2008 period. We construct the prefectural net capital stock series over the 1975-2008 period in 2000 yen from the ESRI Prefecture Private Capital Stock data and Private and Public Sector Balance Sheet data along with the SNA data on investment and depreciation. We construct the prefectural total hours worked series over the 1975-2008 period from the Research Institute of Economy, Trade and Industry (RIETI) R-JIP database and the SNA employment data. Finally, we construct the prefectural total factor productivity (TFP) series from the prefectural output, net capital stock and total hours worked series along with the average prefectural labor share.

In terms of regional growth, we find that over the 1955-2008 period, the Tohoku region and Okinawa region, which had the lowest average income per capita, experienced the highest growth. This is evidence of regional convergence in which poor regions grow faster than rich regions so that the income levels of all regions converge to similar levels over time. We formally test this using the framework introduced by Barro (1991) and find that convergence exists in the prefecture level in Japan over the 1955-2008 period. The convergence during the post oil-shock period 1975-2008 is less obvious but we still find regional convergence after controlling for prefectural characteristics such as TFP level gaps, population growth rates, private investment rates and TFP growth rates.

In terms of business cycles, we focus on the post oil-shock period 1975-2008 and find that the bilateral correlation of per capita output is negatively affected by the distance and the similarity of industrial structure and positively affected by the size of the total output of the pair. We further document that the bilateral correlation of output is higher than that of consumption in 847 out of the total 1081 pairs. This phenomenon frequently documented in open economy macroeconomic literature is puzzling since prefectures should want to smooth their consumption path against income shocks through borrowing and lending among each other. We decompose the consumption risk sharing into 3 steps: i) the net factor payments across prefectures capturing the income risk sharing through the capital market, ii) the government transfer across prefectures capturing the income risk sharing at the personal disposable income level, and iii) the consumption risk sharing of households through the financial market. The results show that the highest contributor to consumption risk-sharing is the government transfer which implies that financial market imperfection might be contributing to the low cross-prefecture correlation of consumption.

This is the non-technical summary for a new discussion paper by Masaru Inaba and Keisuke Otsu, KDPE 1705, March 2017.


Targeted fiscal policy to increase employment and wages of unskilled workers

The evolution of inequality has been well documented in the data. Inequality in earnings has increased in recent decades and, in particular, wage inequality has increased dramatically since the beginning of the 20th century. As a result of this rise and its deleterious implications for the welfare of a large part of the population, societies and policymakers at large are paying increasing attention to better understanding causes and consequences of inequality.

This paper aims to contribute to the inequality literature by studying the difference in employment opportunities and labour productivities for workers with (skilled) and without (unskilled) college education which is a main contributor to wage and earnings inequality. The paper, in particular, focuses on the U.S. economy. The literature on the skill premium has demonstrated that there are significant differences in the wages between skilled and unskilled labour, and that the skill premium has increased in recent decades to its highest levels in a century. We investigate the so-called “college premium” or “skill premium” in the U.S. and its relationship with basic earnings inequality.

To this end, we model inequality in wages jointly with differences in employment opportunities between skilled and unskilled workers over the business cycle, with the aim of evaluating the effects of supply side fiscal interventions which intend to increase labour productivity and employment for the unskilled and to reduce inequality. We employ a standard approach to modeling unemployment using a setup with search and matching frictions that belongs to the Mortensen-Pissarides (MP) family, and extend this by allowing for ex ante heterogeneous workers who are employed in skilled or unskilled jobs and produce output under capital-skill complementarity. While their skill type is given, workers productivity benefits from lifelong learning associated with working experience and on-the-job learning (OJL), so that workers productivity is endogenous and a positive function of employment. As a result, differences in employment opportunities and inequality in wages are closely linked. This paper also allows for capital-skill complementarity in production. These extensions capture key characteristics of skilled and unskilled labour markets in the data.

We find that increases in public spending to enhance unskilled productivity via OJL are beneficial to employed unskilled workers and reduce earnings in-equality between employed skilled and unskilled labour. However, unskilled unemployment and labour income inequality within the group of unskilled labour rises. We next find that vacancy subsidies work to increase employment and returns to unskilled workers. However, unemployment for skilled workers rises and skilled wages and labour income fall in the short-run. We finally show that it is possible to increase skilled vacancy subsidies to nullify the negative effects on skilled employment following an increase in unskilled vacancy subsidies.

This is the non-technical summary for a new discussion paper by Konstantinos Angelopoulos, Wei Jiang and James Malley, KDPE 1704, January 2017.

Why does the productivity of investment vary across countries?

‘New’ (endogenous) growth theory seeks to explain growth rate differences between countries outside the confines of orthodox neoclassical growth theory, but also to rehabilitate the neoclassical model with diminishing returns to capital by introducing other variables into the equations to explain why there has not been unconditional convergence of per capita incomes across the world as predicted by the basic neoclassical (Solow) growth model.

It is argued that because output growth is by definition equal to a country’s ratio of investment to GDP times the productivity of investment, if the investment ratio is included in a new growth theory equation, all that new growth theory is doing is testing for why the productivity of investment differs between countries. But the productivity of investment is never treated as the dependent variable. It is easy to do so, however, by dividing the whole equation by the investment ratio. This has the added advantage of being able to test directly the hypothesis that the productivity of investment falls as investment rises and as countries get richer (the neoclassical assumption of diminishing returns to capital), without relying on the sign on the initial per capita income variable, a negative sign on which could be the result of catch-up or faster structural change in poor countries than rich and not diminishing returns. The model is tested using the general-to-specific model selection algorithm, Autometrics, taking a sample of 84 countries over the period 1980-2011 and 19 different independent variables that have been highlighted in the growth literature.  Nine of the independent variables turn out to be significant, the most important of which turn out to be export growth; education; latitude, and political rights. There is no evidence of diminishing returns to capital i.e. that the productivity of investment in rich countries is lower than in poor countries.

This is the non-technical summary for a new discussion paper by Kevin S. Nell and A. P. Thirlwall, KDPE 1703, March 2017.

Choosy consumers drive a near 1000% spike in vanilla prices

“If you had been a canny investor back in 2008, you could have done a lot worse than make a substantial bet on upmarket ice cream futures. The price of vanilla beans has rocketed from as little as US$25 per kilo eight years ago up to US$240 at the end of 2016. Some forecasts predict it will reach as much as US$450 per kilo by the middle of 2017. Even by the standards of volatile prices in agricultural commodities such as rice and grains this is exceptional.

Unlike other price increases that were shortlived and the result of policy decisions, the price of vanilla beans is being driven by something else. In short, it is all down to us, the fickle consumer and our love of authentic cones, custard and crème brûlée…”

This is an excerpt from an article by the School’s Professor Iain Fraser, published in The Conversation on 27 February 2017. Click here to read the full article.


Economics PhD student to join World Bank

Economics PhD student, Sashana Whyte, has been selected to join the Young Professionals Program of the World Bank from September this year.

Since its inception in 1963, the World Bank’s Young Professionals Program has recruited over 1,700 people from nearly 120 countries, who now range from new recruits to senior management in the World Bank Group. The program was established and still is in place to attract outstanding, highly qualified, diverse, experienced and motivated younger individuals who have demonstrated a commitment to international development, supported by academic success, professional achievement and potential for leadership. The Program recruits through a highly selective and competitive process and then facilitates the rapid integration of the newly recruited Young Professionals into the World Bank Group’™s business and culture.

Sashana was selected for one of 40 positions from 4,000 applicants. This is a considerable achievement on her part and she deserves our warmest congratulations and very best wishes for her future career.



The willingness to pay for organic attributes in the UK

The main objective of the present project is to analyse and understand what drives purchases of organic food in the UK and how much UK consumers are willing to pay for organic food products so that new perspectives can be developed and proposed to policy makers. This is important since there has been almost no recent formal economic analysis of the willingness to pay for organic products in the UK. The existing organic markets in the UK allow us to understand real purchasing behaviour but this is limited to current market conditions. Stated preferences techniques allow to explore new, yet inexistent aspects of the market in a controlled, experimental way. However, by far the strongest criticism brought to stated preferences techniques is the hypothetical bias derived from the hypothetical nature of the experiment. The present study is intending to resolve this issue by collecting data on both real and hypothetical behaviour.

The analysis is important for the design of a strategic policy for the development of the UK organic food sector. The UK was one of the countries that recovered most slowly after the financial crisis with respect to organic sales. In 2013, while worldwide the sales of organic products were surging, the UK accounted a negative growth (Organic Market Report 2013). At present, the demand seems to have recovered and the organic food market seems to increase more than any other food market in the UK. However, the organically farmed area is still decreasing and UK organic farmers are converting back to conventional production (IFOAM 2012, DEFRA 2015, Organic market Report 2016). This implies that the organic food imports have increased which in return implies that the UK is missing important environmental and economic growth opportunities.

This is the non-technical summary for a new discussion paper by Adelina Gschwandtner and Michael Burton, KDPE 1702, January 2017.

Spatial differencing for sample selection models

This paper offers an identification strategy in the situation when researchers work with crosssectional data, face unobserved heterogeneity causing endogeneity problem, lack instrumental variables and, on top of it, face sample selection problem. To accomplish that, we take advantage of recent advances of spatial econometrics. What motives us to consider the case of cross-sectional data which data generating process involves sample selection and seemingly unsolvable problem of endogeneity and no instrumental variables?

Recent decades have witnessed a rise of panel data sets which was accompanied by the proliferation of estimation techniques attempting to take advantage of the time and cross section dimension to identify the causal effect of regressors on the variables of interest. Similarly, considerable advances were made in the areas of weak instrumental variable estimation techniques and imperfect instruments. All of this offers researchers various identification strategies which help them to identify vast variety of empirical models even in the situations when strong instrumental variables are not available or exclusion restrictions would not necessarily hold. But what if panel data sets or instrumental variables are not readily available to researchers?

There are three broad possibilities. One is to dispense of causality claim and consider the regression results as sophisticated correlations. Second solution is offered by the literature identifying causal effect with higher moments. Third solution is spatial differencing in which empirical model takes advantage of the spatial dimension of the data to control for unobserved heterogeneity that might render estimator biased and inconsistent. Our paper contributes to that literature. Spatial differencing has been used only in the context of linear regressions so far. We extend this approach to cross-section data with sample-selection. Specifically, we offer a solution to the problem of differencing out spatial unobserved effects when nonlinear element – in our case Mill’s ratio – is present, propose estimation procedure, and derive formula for estimating standard errors.

This is the non-technical summary for a new discussion paper by Alex Klein and Guy Tchuente, KDPE 1701, December 2016.

Appropriate technology and balanced growth

In macroeconomics, we typically model production by specifying a ‘production function,’ which tells us how much output is produced with given quantities of the ‘factors of production,’ often taken simply as capital and labour. Factor shares refer to the proportion of the income earned by production that goes to each factor, so the labour share is the proportion of this income that is earned by workers through supplying labour. There are various issues with how we measure factor shares, but a key aspect of what is known as ‘balanced growth’ is the idea that as income grows over long periods of time, the labour share remains approximately constant.

Some researchers dispute the idea of balanced growth, arguing for example that the labour share is currently declining. What there is no disagreement about is the fact that these factor shares are far more stable in the long run than they are in the short run. This creates a problem in the way we specify production functions. For example, the assumption of balanced growth has led Cobb- Douglas production functions to become standard in macroeconomic models because they imply constant factor shares with perfectly competitive markets. This, however, makes it more difficult to capture short- and medium-run fluctuations in factor shares. Market failures such as wage and price rigidities allow us to explain some of these fluctuations, but it is unlikely that they account for all of the fluctuations we see in factor shares, particularly in the medium run.

When the relative price of capital (to labour) rises, firms hire relatively less capital and more labour. The elasticity of substitution between capital and labour quantifies this effect; it tells us by how many percent the capital-labour ratio declines when the relative price of capital goes up by 1%. With Cobb-Douglas production functions, this elasticity is always one. However, much of the empirical evidence finds support for an elasticity below one. Indeed, production functions with an elasticity below 1 typically capture short-run fluctuations in factor shares significantly better than Cobb-Douglas. However, they have very important long-run consequences for income distribution. If the elasticity is different to one, productivity changes can cause the labour share to change. Since we have observed permanent changes in the productivity of investment goods in the last 30 years, an elasticity below one would lead to unbalanced growth with an increasing labour share, whereas typically researchers think that it is either constant or declining.

In this paper we propose a solution to this problem, using the idea of “appropriate technology.” This is the idea that firms not only choose the quantities of capital and labour to employ, but also make a technology choice – how labour- or capital-intensive they want production methods to be. This trade-off is expressed graphically by a technology frontier: technologies that are more efficient in using labour are less efficient in using capital and vice-versa. Given a change in factor prices, firms change their position on the frontier. We show how the shape of the frontier determines the long-run elasticity of substitution and long-run factor shares. Importantly, if firms face adjustment costs when changing their choice of technology, the short-run elasticity will be lower than the long-run elasticity. This provides a way of modelling production that is very easy to implement in macroeconomic models but that is flexible enough to be compatible with both short- and long-run data. The short-run elasticity can be calibrated to capture short-run fluctuations in factor shares in line with the evidence, while the shape of the frontier captures the properties of long-run growth. There is a specific shape of frontier that implies balanced growth. Here elasticity of substitution is below one in the short-run but adjusts towards one in the long run. We use this to provide a quantitative example for the US economy. The results support the use of this new production function because it improves the model’s ability to explain the business cycle and medium-run behaviour of the labour share.

This is the non-technical summary for a new discussion paper by Miguel A. León-Ledesma and Mathan Satchi, KDPE 1614, November 2016.

Autumn term newsletter 2016

The Kent School of Economics Autumn term newsletter is now available on our website. We produce a newsletter at the end of the Autumn and Spring terms to highlight some of the events and research that have taken place in the School.

If you would like to contribute an article to a future newsletter, please contact Tracey Girling.

Harmful effects of the ageing population on the economy

A study from the School of Economics has found that an increase in Asian elderly population share will significantly lower economic growth due to decreased labour participation in the region.

The results of the study implies that governments facing population ageing have a challenging task to provide social security and public services for the aged while maintaining economic growth. This fundamental issue is common across all economies around the world.

Many Asian economies are currently faced with the challenge of rapidly ageing population, which can be harmful to the economy in the long run. The study, conducted by Dr Keisuke Otsu and Dr Katsuyuki Shibayama from the University’s School of Economics with the results published in Asian Development Review , analysed the effects of projected population ageing on potential growth in Asian economies over the period 2015–2050 using quantitative assessment.

Population ageing could lead to an increase in government consumption due to the rise in the demand for health care. The study estimates the future increase in government expenditure in Asia and finds that the increase in aggregate demand would lead to a 0.05 percentage point increase in annual per capita GDP growth rate above its potential.

However, the increase in government consumption can lead to a decline in aggregate productivity by shifting away economic activity in the more productive private manufacturing sector to the service sector. The study estimates the effect of population ageing on future productivity growth in Asia and finds that this effect could reduce the annual per capita GDP growth rate by 0.40 percentage points below its potential.

The paper concludes that population ageing is harmful for economic growth due to the decline in labour participation rate and its negative effect is significantly magnified through the increase in social security tax and the slowdown in productivity growth. This provides quantitative support for arguments for social security reform and innovation policies in ageing economies.

Dr Keisuke Otsu describes some of these trends in his Think Kent video. The Think Kent series are short videos which give an overview of Kent academics and their research and teaching expertise.