Department of Economics
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Subsistence Consumption, Occupational Choice, and the Costs of Poverty
(Updated September 2016). This paper develops an endogenous growth model in which the extent and depth of poverty influence the aggregate outcomes of the economy. Individuals are bound by a subsistence consumption requirement and their risk aversion depends negatively on their distance from the constraint. Agents divide their time between farming and working for a wage. Farm productivity can be improved stochastically through household investment. The impact that subsistence consumption has on household investment and economic growth is decomposed into constraints on disposable income and increased risk aversion. Constraints on disposable income determine the household’s innovation decision when they are extremely poor. However, as incomes rise to levels similar to that of India in the 1980s increased risk aversions starts to dominate household choices. Quantitative work suggests that the subsistence constraint can reduce the annualized growth rate by as much as 65 basis points. Consistent with recent empirical studies, conditional cash transfers outperform unconditional cash transfers in terms of growth outcomes, due to their creation of incentives to invest in higher risk activities.
Inequality and Health Under Heterogenous Aspirations (with Shankha Chakraborty)
(Updated August 2016). How does inequality motivate people and at what cost? In a model of perpetual youth, people have heterogeneous upward-looking aspirations. They value their consumption relative to the conditional mean of those above them in the distribution; their survival depends on health capital produced from time investment and health goods. Higher fundamental inequality, working through the aspirations gap, motivates people to work and save more. Economic outcomes improve but income and consumption inequality worsen because the poor have less capacity to respond. By diverting resources from health production, aspirations also worsen mortality, especially for the poor. Though relative income has a strong negative effect on personal health, inequality has a weak effect on population health, explaining an empirical puzzle on the relative income and health gradient.
Understanding the Informal Sector: Do Informal and Formal Firms Compete? (with Tyler Schipper)
(Updated August 2016). The literature on informality has struggled to characterize the role that informal firms play in the macroeconomy. We seek to address a central component of this confusion: do formal and informal sector firms compete? We highlight survey evidence that strongly suggests competition between the formal and informal sector. Motivated by this finding, we construct a theoretical model that resolves lingering conflicts in the literature. The model predicts different patterns of competition across sectors of the economy. We are able to show that within an industry informal firms tend to be smaller and less productive than formal firms; however, in aggregate terms we are able to qualitatively match the evidence that shows an overlap between the productivity distributions of the formal and informal sectors.
Work In Progress
Aspirations and Socio-Economic Change in the Long Run (with Shankha Chakraborty)
(Updated April 2015). Households with ex ante identical preference and heterogeneous wealth optimally choose whether or not to be aspirational (status-conscious). Aspirations motivate them to accumulate more wealth than the average, the cost of doing so the disutility of falling short. In the early stages of development, fertility is positively related to household wealth, in the later stages, negatively. We establish two main results. First, we show that preference externality and endogenous fertility can lead to polarization and differential status-seeking in the population contrary to the established literature where status seeking is always evolutionarily stable. Secondly, inspired by Gregory Clark's "A Farewell to Alms", we illustrate quantitatively how the model can account for a significant part of socio-economic change before and during the English industrialization. The onset of industrialization is made possible by "survival of the richest" and their pro-capitalist values. Differently from Clark, progress during industrialization depends on "survival of the poorest" who increasingly adopt pro-capitalist values as their aspirations come within reach.
Choosing your Type: Reproductive Success and the Evolution of Aspirations (with Shankha Chakraborty)
(Updated September 2016). Households with ex ante identical preference and ability but different wealth choose whether or not to be aspirational (status conscious). Aspiration motivates them to accumulate wealth but comes at a psychological cost should they fail to to attain their aspiration level. People choose to be aspirational depending on their wealth. That advantage gets transmitted through generations via fertility and bequests. In the early stages of development, fertility is positively related to household wealth, the frequency of aspirational households rises over time, facilitating the transition to more capital-intensive industrial modes of production. With further development, the aspirational rich have fewer children and the non-aspirational poor get more numerous. The first creates a tendency towards persistent inequality, the second makes aspi- rations more attainable. In the long run not everyone becomes aspirational and wealth and fertility differences persist.
How Do Firms Adjust to Energy Shocks? Evidence from Power Outages (with Eric Allen, Sharat Raghavan, and Zuberi)
(Updated September 2016). We know relatively little about how unpredictable access to energy affects production and capacity utilization in firms. Using micro-level data on unscheduled power outages that affect a sample of manufacturing firms in Pakistan, we show that firms respond to energy shocks by differentially adjusting on-grid utilization based on their sensitivities to alternative fuel costs. We incorporate these empirical facts into a dynamic model that characterizes utilization adjustment and self-generation in response to power outages and estimate structural cost parameters. Our results suggest that between January 2010 and March 2012, average cost increase was less than 1%, but when high demand coincides with outages, the quarterly increase can be greater than 10%. We also provide preliminary evidence that communicating outages in advance can help mitigate some of these costs.
Inequality and Economic Growth in the Long-Run.
(Updated September 2016). The empirical literature has shown that the relationship between inequality and economic growth depends upon the time frame being examined (see Halter et al, 2014). The long-run relationship between inequality and growth has been shown to be negative and the theoretical literature has explained this result using various market distortions like borrowing constraints and taxation. This paper contributes to the literature by introducing a simple model of aspirations that does require market distortions in order to explain the long-run empirical result. Households have upward looking aspirations over consumption which cause them to invest less and as a result lowers economic growth.
Aspirations and Redistributive Politics
(Updated September 2013). Macroeconomic research on social aspirations and status-seeking predominately shows it to have a positive effect on economic growth. This paper studies the impact of aspirations when redistribution is added to the model—or, in other words, when preferences over inequality result in economic distortions. Anecdotal evidence seems to suggest that agents not only have preferences over inequality, but that such preferences result in an increased demand for redistribution when there is a rise in inequality. I demonstrate that while the demand for redistribution increases in the presence of social aspirations, the growth rate of the economy falls.