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Industrial Policy

Shen, J.H., 2020. Towards a Dynamic Model of the Industrial Upgrading with Global Value Chains. The World Economy. Publisher's VersionAbstract

This research constructs a simple dynamic model to illustrate the micro‐mechanism of industrial upgrading along the global value chains. Our model predicts that as firms move up from downstream to upstream stages, (a) there is higher profitability if and only if the following three conditions are satisfied. First, the increasing rate of sunk cost (including R&D expenditure) over sequential stages of production cannot be sufficiently large (endogenous sunk cost effect). Second, the decreasing rate of change of intermediate input demand with respect to the price set by firms at a production stage cannot be sufficiently high (intermediate input price effect). Third, the decreasing rate of change of intermediate input demand with respect to the pricing dynamics over the sequential stages of production cannot be sufficiently large (sequential pricing uncertainty effect); (b) total cost is lower if and only if the decreasing rate of change of input demand with respect to the price is sufficiently large; (c) output is higher if and only if and the decreasing rate of change of input demand with respect to the price is not sufficiently large; and (d) the price decreases. We show that the empirical patterns revealed in China are consistent with our model's predictions.

Hausmann, R. & Purfield, C., 2004. The Challenge of Fiscal Adjustment in a Democracy: The Case of India.Abstract
_wp04168.pdf
India’s fiscal problem has deep roots in its federal fiscal system, where multiple players find it difficult to coordinate adjustment. The size and closed nature of the Indian economy, aided by its deep domestic capital market and large captive pool of domestic savings, has disguised the cost of fiscal laxity and complicated the building of a consensus on reform. The new fiscal responsibility act establishes a new rules-based system to overcome this coordination failure. To strengthen the framework, we recommend an autonomous scorekeeper and the extension of similar rules to the state governments as part of a comprehensive reform of the federal system.
Lim, E., Spence, M. & Hausmann, R., 2006. China and the Global Economy: Medium-term Issues and Options - A Synthesis Report.Abstract

China’s economic and social achievements since the beginning of reform and opening are unprecedented in global history. Managing the growth process in this continuously changing environment has required great skill and the use of unconventional economic policy. Now China has entered a new era in its development process with a set of challenges largely different from those of the recent past. Some problems - such as growing internal and external structural imbalances, increasing income and regional inequality – have arisen from, or been exacerbated by, the very pattern and success of high growth since reforms began. Others are newly posed by rapid changes in the global economy. These challenges can best be tackled in an integrated and coordinated fashion. This report, supported by the China Economic Research and Advisory Programme (CERAP), identifies the primary challenges facing China today and presents options for meeting them.

Hausmann, R., Rodrik, D. & Rodriguez-Clare, A., 2005. Toward a Strategy for Economic Growth in Uruguay. Publisher's VersionAbstract
towards-strategy-economic-growth-uruguay.pdf
The Uruguayan economy is recovering from the 2002 financial crisis that disrupted its banking system, caused a collapse of its currency and seriously affected its fiscal solvency. The crisis was clearly associated with the collapse of the Argentine economy and its concomitant currency, banking and debt crises. Both were also related to the sudden stop that followed the Russian crisis of 1998, which prompted an important realignment of the real in January 1999, a fact that had exerted enormous pressure on bilateral exchange rates within Mercosur. In this post-crisis period, Uruguay now faces several challenges to attain a sustainable growth path. This report proposes a series of recommendations towards this end. Implementing a strategy to accelerate growth inevitably involves interventions at both the macro and the micro level. The macro level involves the maintenance of a stable and competitive real exchange rate, so as to create a stable and encouraging environment for export growth. The authors take up each of these elements of the growth strategy. They first focus on the design of incentive policies for economic diversification and promotion. Then they discuss next the macroeconomic complements, with special emphasis on maintaining a competitive and stable real exchange rate.
Hausmann, R. & Schetter, U., 2020. Horrible Trade-offs in a Pandemic: Lockdowns, Transfers, Fiscal Space, and Compliance.Abstract
2020-06-cid-wp-382-pandemic-trade-offs.pdf

In this paper, we develop a heterogeneous agent general equilibrium framework to analyze optimal joint policies of a lockdown and transfer payments in times of a pandemic. In our model, the effectiveness of a lockdown in mitigating the pandemic depends on endogenous compliance. A more stringent lockdown deepens the recession which implies that poorer parts of society find it harder to subsist. This reduces their compliance with the lockdown, and may cause deprivation of the very poor, giving rise to an excruciating trade-off between saving lives from the pandemic and from deprivation. Lump-sum transfers help mitigate this trade-off. We identify and discuss key trade-offs involved and provide comparative statics for optimal policy. We show that, ceteris paribus, the optimal lockdown is stricter for more severe pandemics and in richer countries. We then consider a government borrowing constraint and show that limited fiscal space lowers the optimal lockdown and welfare, and increases the aggregate death burden during the pandemic. We finally discuss distributional consequences and the political economy of fighting a pandemic.

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Cortes, P., Kasoolu, S. & Pan, C., 2020. Labor Market Nationalization Policies and Firm Outcomes: Evidence from Saudi Arabia.Abstract
2020-07-cid-wp-381-saudi-policies-outcomes.pdf
Saudi Arabia is home to the world’s third largest migrant population. Under mounting pressure to increase the private sector employment of Saudis during the last decade, a series of nationalization policies on the labor force have been imposed since late 2011. In this paper, we study how the first nationalization policy, Nitaqat, affected the overall labor market and non-oil firms in the private sector, especially exporting firms. Our rich and novel data allow us to assess the effect of the policy on a wide set of outcomes: employment decisions by composition and size, the output and productivity of exporting firms, labor costs, and exit from the market. Using a difference-in-difference analysis, we compare the 2011 to 2012 change in outcomes between firms above and firms below the threshold required for the minimum share of Saudi workers in a firm. Our results suggest that the policy succeeded in encouraging firms to increase the share of Saudis in private firms. It also increased the share of Saudi women in the workforce, suggesting that the policy had a positive effect on increasing female labor force participation. However, these gains came at a very high cost to firms: our findings suggest that the policy led to a reduced firm size, reduced productivity and output of exporting firms, increased wage bill, increased share of low-skilled Saudi workers, and higher firm exit rates.
Shen, J.H., et al., 2020. Profit Sharing, Industrial Upgrading, and Global Supply Chains: Theory and Evidence.Abstract
2020-02-cid-fellows-wp-123-global-supply-chain-revised-may.pdf

This paper constructed a simple model to illustrate the global supply chain profit sharing and industrial upgrading mechanism, from which it was found that the average profitability distribution in the different supply chain stages was determined by two main factors: (1) the average product of the labor in the firms at each production stage; and (2) the ratio of the output elasticity of capital to the output elasticity of labor in each stage. This paper also proposed a new industrial upgrading mechanism, the ‘inter-supply chain upgrading’, for supply chain firms. Rises in production complexity and increased factor intensity in each production stage were found to be the two essential conditions for the inter-supply chain upgrading. The empirical study results were found to be broadly consistent with the proposed theories.

Revised May 2020.
Fernandez-Arias, E., Hausmann, R. & Panizza, U., 2020. Smart Development Banks. Journal of Industry, Competition and Trade , 19 (69). Publisher's VersionAbstract
The conventional paradigm about development banks is that these institutions exist to target well-identified market failures. However, market failures are not directly observable and can only be ascertained with a suitable learning process. Hence, the question is how do the policymakers know what activities should be promoted; how do they learn about the obstacles to the creation of new activities? Rather than assuming that the government has arrived at the right list of market failures and uses development banks to close some well-identified market gaps, we suggest that development banks can be in charge of identifying these market failures through their loan-screening and lending activities to guide their operations and provide critical inputs for the design of productive development policies. In fact, they can also identify government failures that stand in the way of development and call for needed public inputs. This intelligence role of development banks is similar to the role that modern theories of financial intermediation assign to banks as institutions with a comparative advantage in producing and processing information. However, while private banks focus on information on private returns, development banks would potentially produce and organize information about social returns.
Schetter, U., Gersbach, H. & Schneider, M.T., 2019. Taxation, Innovation, and Entrepreneurship. The Economic Journal , 129 (620) , pp. 1731-1781. Publisher's VersionAbstract
We explore optimal and politically feasible growth policies consisting of basic research investments and taxation. We show that the impact of basic research on the general economy rationalises a taxation pecking order with high labour taxes and low profit taxes. This scheme induces a significant proportion of agents to become entrepreneurs, thereby rationalising substantial investments in basic research fostering their innovation prospects. These entrepreneurial economies, however, may make a majority of workers worse off, giving rise to a conflict between efficiency and equality. We discuss ways of mitigating this conflict, and thus strengthening political support for growth policies.
Rama, M., 2019. Converge and European Value Chains: How Deep Integration Can Reignite Convergence in the EU.Abstract
2019-09-cid-fellows-wp-116-eu-convergence.pdf

Convergence, the process by which poorer countries ‘catch-up’ to rich ones in terms of real incomes, is at the core of the promise of the European Union and the Eurozone. It was enshrined in the founding treaty of the EU and is at the center of policy-making today. However, after several decades of strong European growth, convergence across many core countries has come to a halt. Policymaking has focused on promoting greater integration between EU countries and in particular within the Eurozone to foster further convergence but the political gridlock has stopped these initiatives from moving forward. 

Further economic and political integration is not necessary for, and may in fact be orthogonal to, greater convergence in the EU. EU countries have converged at roughly the same rate as non-EU countries since the 1950s, suggesting EU membership is not responsible for convergence. Further, there is no statistically significant difference in the rate of convergence between EA 12 or EA19 members before and after the introduction of the Euro. Finally, many current Eurozone members have converged in the last 10 years suggesting that the Euro structure does not impede convergence. Still, further integration may be desirable in the EU – not least to restore the union to its democratic ideals. 

The only variable that is associated with greater convergence in European countries is value chain integration, particularly upstream integration. Upstream integration is domestic value added embodied in intermediate exports that are re-processed abroad. High upstream integration indicates strong participation in value chains and integration into regional production networks. The level of upstream integration varies tremendously within the EU, going from 10% of GDP in Spain to 28% of GDP in Estonia. Once we control for the level of upstream integration, the rate of converge in European countries goes from 1.25% to 4.5%. 

High growth countries are deeply integrated in sub-regional supply chains within Europe. Europe is often thought of as a single supply chain but, in fact, there are several sub-regional supply chains within Europe. These sub-regional supply chains are based on strong bilateral ties between neighboring countries. Participation in one of these supply chains appears to matter more for growth than integration with any particular country (e.g. Germany) or to any specific region. Participation in these supply chains is independent of EU membership – it is due to historical ties and deliberate national policymaking. 

The EU must put cross-country collaboration at the core Horizon Europe– its €100B mission driven innovation programme – to future-proof European supply chains and reintegrate lagging countries. Horizon Europe is the EU’s bet to become a global technology leader. Leading in technology involves not only innovation but also developing the supply chains of the future that allow innovation to be commercially successful. Horizon Europe will not succeed if innovation spending continues occur in national siloes as it did in the Horizon 2020 programme. The EU must pro-actively manage and integrate innovation efforts across the Union and ensure that commercialization occurs at the EU level. Only then can we hope to achieve both EU technological leadership and convergence within the EU. 

Levy-Yeyati, E. & Gomez, J.-F., 2019. The Cost of Holding Foreign Exchange Reserves.Abstract
2019-05-cid-wp-353-holding-exchange-reserves.pdf
Recent studies that have emphasized the costs of accumulating reserves for self-insurance purposes have overlooked two potentially important side-effects. First, the impact of the resulting lower spreads on the service costs of the stock of sovereign debt, which could substantially reduce the marginal cost of holding reserves. Second, when reserve accumulation reflects countercyclical LAW central bank interventions, the actual cost of reserves should be measured as the sum of valuation effects due to exchange rate changes and the local-to-foreign currency exchange rate differential (the inverse of a carry trade profit and loss total return flow), which yields a cost that is typically smaller than the one arising from traditional estimates based on the sovereign credit risk spreads. We document those effects empirically to illustrate that the cost of holding reserves may have been considerably smaller than usually assumed in both the academic literature and the policy debate.
Fernandez-Arias, E., Hausmann, R. & Panizza, U., 2019. Smart Development Banks.Abstract
2019-04-cid-wp-350-smart-development-banks.pdf
The conventional paradigm about development banks is that these institutions exist to target well-identified market failures. However, market failures are not directly observable and can only be ascertained with a suitable learning process. Hence, the question is how do the policymakers know what activities should be promoted, how do they learn about the obstacles to the creation of new activities? Rather than assuming that the government has arrived at the right list of market failures and uses development banks to close some well-identified market gaps, we suggest that development banks can be in charge of identifying these market failures through their loan-screening and lending activities to guide their operations and provide critical inputs for the design of productive development policies. In fact, they can also identify government failures that stand in the way of development and call for needed public inputs. This intelligence role of development banks is similar to the role that modern theories of financial intermediation assign to banks as institutions with a comparative advantage in producing and processing information. However, while private banks focus on information on private returns, development banks would potentially produce and organize information about social returns.
Abante, K., 2019. Minimizing Smuggling and Restoring Public Trust in the Philippine Bureau of Customs.Abstract
2019-03-cid-fellows-wp-113-philippine-customs.pdf
This policy analysis attempts to answer three questions: First, what is the extent of smuggling and customs tax evasion in the Philippines? Second, how can customs improve its risk management system in the short term to minimize officers’ discretion and improve trade facilitation without abdicating its other mandates of revenue generation and border control? Third, what types of reforms and political commitment are necessary in the long term to restore public trust in the Bureau of Customs?
Barrios, D., et al., 2018. Tabasco: Diagnóstico Industrial.Abstract
tabasco_diagnosticoindustrial_cidrfwp105.pdf

En este estudio se consideraron los productos priorizados en el Reporte de Complejidad Económica de Tabasco y se procedió a evaluar su potencial a partir de un conjunto de consideraciones de mercado. Luego, se agregó el potencial de cada producto en distintas colecciones de producto, y se seleccionó una industria cuya estimulación y desarrollo constituya una apuesta de desarrollo prometedora el estado. Respecto de éste se detallaron algunas estadísticas generales como una forma de evaluar su potencial de crecimiento e impacto para la economía local, estatal y nacional.

Para el objeto de este estudio, el sector industrial escogido para el análisis de cuellos de botella fue el de “Químicos” y, más puntualmente, los productos: “Agentes de limpieza orgánicos (ex. Jabón)”, “Aprestos y aceleradores de tintura”, “Mezclas de sustancias odoríferas”, “Placas fotográficas” y “Tinta”. El desarrollo de esta colección de productos representa una importante oportunidad, la que, a la fecha, los productores mexicanos no han podido aprovechar del todo. Sin embargo, estos productos han presentado un gran dinamismo dentro de México en los años recientes. Entre 2004 y 2014, las exportaciones de México en estos productos se han duplicado, el empleo en los sectores asociados a estos productos ha aumentado un 20%, y el salario promedio en estos sectores ha aumentado entre 40% y 50%.

Barrios, D., et al., 2018. Campeche: Diagnóstico Industrial.Abstract
campeche_diagnosticoindustrial_cidrfwp104.pdf

En este estudio se consideraron los productos priorizados en el Reporte de Complejidad Económica de Campeche y se procedió a evaluar su potencial a partir de un conjunto de consideraciones de mercado. Luego, se agregó el potencial de cada producto en distintas colecciones de producto, y se seleccionó una industria cuya estimulación y desarrollo constituya una apuesta de desarrollo prometedora el estado. Respecto de éste se detallaron algunas estadísticas generales como una forma de evaluar su potencial de crecimiento e impacto para la economía local, estatal y nacional.

Para el objeto de este estudio, el sector industrial escogido para el análisis de cuellos de botella fue el de “Textiles” y, más puntualmente, los productos: “Abrigos para mujeres, de punto”, “Calzoncillos para hombres, de punto”, “Camisas para hombres, de punto”, “Camisas para mujeres”, “Camisas para mujeres, de punto” , “Las demás prendas de vestir, de punto”, “Suéteres (jerseys) y artículos similares, de punto”, “Sostenes y artículos similares”, “Trajes para hombres, de punto”, “Trajes para mujeres, de punto”, “Trajes y pantalones para hombres”, “Trajes y pantalones para mujeres” y “Trapos y cordajes textiles en desperdicios”. El desarrollo de esta colección de productos puede representar una oportunidad. Sin embargo, recientemente las exportaciones de estos productos por parte de México han venido perdiendo espacios en el mercado global, siendo el valor de las exportaciones mexicanas de estos productos en la actualidad menos de la mitad de lo que era en 2004.

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