Research Project

THE PRODUCTIVE ADVANTAGES OF CITIES

Firms and workers are more productive in large cities than out of them. Do this productive advantages arise because firms and workers operate differently in dense and diverse urban environments? Or do they simply face fiercer competition, and it is the survival of the fittest in large metropoli that increases the average productivity? If the productive advantages of the cities are due, at least partly, to the so-called economies of agglomeration, that is to say, the advantages that arise when operating near many other firms and workers, what are the main causes of these advantages? The possibility of sharing suppliers with other companies? A free-flowing and stable labour market? Propitious surroundings for innovation and the diffusion of new technologies? Industry and services change location over time.What are the reasons behind this constant evolution of firm location? How important are differences in institutions and geography for the evolution of cities and regional disparities?.

The research program “the productive advantages of cities” studies these questions through a combination of theoretical modelling and empirical studies. The Madrid Institute for Advanced Studies (IMDEA) Social Sciences and the Economics Department of University Carlos III of Madrid participate in the program, alongside researchers from Canada, the United States, Italy and the United Kingdom. The Madrid Regional Government finances the program through its R&D Activities Programme for Madrid-based research groups in Economics and Social Sciences, Humanities, and Law.
(http://prociudad.org/)

Time period: 2008-2011. Research Director: Dr. Diego Puga, Research Professor at IMDEA Social Sciences.

HUMAN CAPITAL, PUBLIC POLICIES, AND THE WEALTH OF NATIONS

It is widely recognized that total factor productivity is at the core of income inequality across countries, yet the magnitude of those productivity differences remains a subject of controversy. One of the main difficulties is that there are no measures of quality of education and productivity across countries. To assess the sources of cross-country income inequality, economists need to assume away cross-country differences in the quality of schooling and to measure productivity as a residual. A second concern is that, even if we had good data, it would be unfeasible to do a standard variance decomposition analysis as economic theory implies that quality of education and total factor productivity are likely to be jointly determined. As a result, there is no consensus among economists on the importance of human capital for economic development. Moreover, without a tight measurement of human capital and its effects on the economy, no sound analyses of the impact of public education policies can be carried out.

This research program aims to develop a structural model of human capital investment decisions, incorporating both quality and quantity of schooling, and then use the model to address the following issues:
- An international quantitative assessment of the importance of human capital in relation to Total Factor Productivity to account for the observed per capita income inequalities across countries.
- A quantitative cross-country investigation of the effects of public policies on the distribution of education and income and on intergenerational mobility.
Finally, the project proposes to use the new theoretical framework to evaluate the aggregate and distributive effects of some recent proposals for reforming taxation and education institutions in O.E.C.D. countries. The research will contribute to our understanding of the poverty of nations and provide policy makers with valuable insights for understanding the aggregate and distributive effects of public policies.

This research project is financed by the European Union within the framework of the Marie Curie International Reintegration Grant Program, Call Identifier FP7-PEOPLE-2007-4-3IRG, Proposal Nº 231096- HUMAN CAPITAL., and it will extend for four years. Research Director: Dr. Andrés Erosa, Research Professor at IMDEA social Sciences.

A THEORY OF LABOR SUPPLY WITH HETEROGENEOUS AGENTS: FROM INDIVIDUAL TO MACRO ELASTICITIES

The aggregate response of labour supply to business cycle shocks is a central element in macroeconomic analysis and is the object of an important debate among economists. This debate matters as our understanding of the business cycle data and of the consequence of tax policies rely critically on the elasticity of aggregate labour supply. While the aggregate data on labour supply exhibit large fluctuations over time, evidence from household level data show relatively small changes in individual labour supply. Because the standard macroeconomic analysis is based on a theory of a single (representative) individual, this analysis cannot distinguish between individual and aggregate labour supply. Based on estimates from aggregate data, macroeconomists typically assume that the representative individual in the theory has a high labour supply elasticity. One critique of these studies is that assumed labour supply elasticity is much higher than the estimates from micro level data. Recent contributions, however, demonstrate that the above critique can be misplaced. In an insightful paper, Chang and Kim (2006) construct a heterogeneous agent economy and find that the macro labour supply elasticity can be significantly larger than the micro elasticity. These authors provide a theoretical example establishing that the mapping from individual to aggregate labour supply is non-trivial.

This research program aims to develop a theory of labour supply decisions of heterogeneous individuals that is consistent with micro level data. This will allow the researcher to be explicit about the aggregation driving the mapping from individual to aggregate labour supply elasticity. The theory will be used to study issues in macroeconomic analyses that depend critically on the elasticity of labour supply:
- Can differences in income taxation account for the large differences in labour supply between North America and Europe?
- How does income taxation affect labour supply decisions across the heterogeneous individuals?
- Existing business cycle theory cannot account for the relative volatility of employment and hours per worker. Can heterogeneity in the labour force resolve this puzzle?
- How responsive are retirement decisions to changes in the social security system and in the tax code? How should the social security system be reformed to confront the demographic imbalances threatening its sustainability?
This research project is financed by the European Union within the framework of the Marie Curie International Reintegration Grant Program, Call Identifier FP7-PEOPLE-2007-4-3-IRG, Proposal Nº 231099-LASUT, and it will extend for four years. Research Director: Dr. Luisa Fuster, Research Professor at IMDEA social Sciences.

TRANSMISSION OF INFORMATION IN FINANCIAL MARKETS

The efficient allocation of resources in the economy requires asset prices to contain all available and relevant information. This information is incorporated into prices through the trading activity of agents in possession of superior information. Corporate insiders are a very peculiar type of traders, as they are in possession of relevant and privileged information on the future performance of their companies. Hence, the trading activity of insiders constitutes a key variable for the analysis of financial markets as institutions in which prices aggregate and convey information. This project focuses on the analysis of the trading activity by insiders and its impact on asset prices.

More specifically, insiders’ trading activity is related to three key issues in finance: (1) crashes and booms –is there a systematic pattern of sales (purchases) by insiders before crashes (booms)?; (2) liquidity provision –is there a systematic pattern of purchases (sales) by insiders after crashes (booms)?; and (3) risk premium determination –does the risk premium change as a function insiders’ trading activity? The nature of the study is eminently empirical.

This project is financed by the Spanish Ministry of Education and Science (ref. ECO2008-05140). The group is integrated by researchers from IMDEA Social Sciences, HEC-Paris Business School, Stockholm School of Economics and Universidad Autónoma de Madrid. Research Director: Dr José María Marín, Research Professor at IMDEA Social Sciences.

THE EXPORT DECISIONS OF INDIVIDUAL FIRMS: MARKET SIZE, FRICTIONS AND INNOVATION

Only a handful of “superstar” firms are actively engaged in international trade. Among those, 10 percent of exporters account for 80 percent or more of all exports in both developed and developing countries. Exporters are special along many dimensions: they are more productive, larger, more innovative, and employ a more skilled workforce. When a country expands its exports, most of the growth takes place through the entry of new firms into export markets, rather than through larger shipments by existing exporters. Thus, to improve its ability to sell goods and services to the rest of the world, a country needs to figure out how to get more of its firms above the critical levels of productivity and size that allow them to compete in international markets.

Traditional trade theories have little to say about these issues. They focus on countries, sectors or skill groups, but rarely come down to the level of individual firms. As a result, they cannot deal with the fact that firms are very heterogeneous and that studying differences between firms is key to understanding their behavior in international markets. Over the last few years, important progress has been made with new theories that incorporate heterogeneous firms and with the empirical analysis of rich new firm-level data sources. This recent research has already given us a good understanding of, for instance, why trade tends to grow by mostly incorporating new exporters. However, turning domestic firms into exporters is much more complex than a mechanical lowering of the productivity threshold required to survive in international markets. The decision to export goes hand in hand with complex changes in firms’ behavior and is both affected and feeds back into the local environment.

This research project will address key questions about changes in the behavior of firms that start to export, and how their decisions interact with those of other firms and with the characteristics of their location. What determines the firms’ decisions to export? How do the availability of foreign markets and the resulting export decisions influence the firms’ incentives to innovate and expand the technological frontier? If exporting firms have to be larger and more productive, how important are the size and structure of the domestic markets? How do labor and credit market frictions and government policies that shape international transactions interact with the firms’ decisions to engage in international activities?

We structure our approach along two broad and interrelated research lines. First, we explore how actual market size and its anticipated growth affect the firms’ incentives to innovate and their ability to compete in international markets. Second, we study how market frictions and local externalities – positive and negative – alter the expected consequences of trade liberalization. Both lines are closely interrelated and involve the entire research team. A combination of theoretical modeling and empirical analysis of rich firm-level data sources will ensure that our analysis is conceptually sound and policy-relevant.

This research program, together with the collaboration between the Madrid Institute for Advanced Studies (IMDEA) and Universidad Carlos III de Madrid in organizing Europe’s main trade conference (CEPR’s ERWIT) and in providing a trade course sequence and PhD supervision, aims to make Madrid a center of excellence and training in international trade.

The research is financed by the Bank of Spain through its program Program of Research Excellence in Banking, Monetaryand Financial Economics, Research director: Dr. Diego Puga. Research length, 2009-2012.

Bank of Spain

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