Advanced economies undergo three transitions during their development: 1. They transition from a rural to an urban economy. 2. They transition from low income growth to high income growth. 3. Their demographics transition from initially high fertility and mortality rates to low modern levels. The timings of these transitions are correlated in the historical development of most advanced economies. I unify complementary theories of the transitions into a nonlinear model of endogenous long run economic and demographic change. The model reproduces the timing and magnitude of the transitions. Because the model captures the interactions between all three transitions, it is able to explain three additional empirical patterns: a declining urban-rural wage gap, a declining rural-urban family size ratio, and most surprisingly, that early urbanization slows development. This third prediction distinguishes the model from other theories of long-run growth, so I test and confirm it in cross-country data.
Complete markets models predict large positive correlations of consumption and the exchange rate. In the data this correlation is small and negative. We show that a simple asset market restriction can resolve this puzzle in two-country model with tradeable goods. Previous attempts investigate this explanation failed to generate quantitatively large deviations from the complete markets solution. We argue that this occurred because perturbation solution techniques shut down the mechanism through which market incompleteness can resolve this puzzle; namely portfolio optimization in the face of exchange rate risk. In our model this mechanism operates because households can only hold non-contingent bonds denominated in units of the two countries' production good. Households are therefore exposed to exchange rate risk on their overseas asset holdings. In equilibrium, they adjust their asset holdings until the consumption-real exchange rate correlation is very small and, when risk aversion is large, negative. We employ a novel global solution method generalizing the approach of Maliar and Maliar (2015) to solve the model. Our preliminary results show that the global solution to equilibrium produces a small, negative correlation of consumption and real exchange rates. We also make three secondary contributions to the literature: the model generates home bias of bond holdings; it also produces failure of uncovered interest rate parity; and we illustrate that global solution methods can easily and accurately solve models where local perturbation methods fail.
The share of aggregate income paid as compensation to labor is frequently used as a proxy for income inequality. If capital holdings are very concentrated among high income individuals, increasing their share of GDP, all else equal, widens the gap with poorer workers. Indeed, two striking features over the last three decades of many advanced and developing economies are the declining labor shares in income and the rise in income inequality. The relationship between factor shares and inequality, however, is not so simple in a richer world with realistic features such as endogenous home decisions and capital-skill complementarity. In such a world, total inequality will change with (i) the labor share, (ii) the amount of within-labor and within-capital income inequality, and (iii) the degree to which the highest wage earners are also those earning the highest capital incomes. Macroeconomic trends and shocks that impact any one of these three moments are likely to impact simultaneously all of them. We develop a framework where all these terms are jointly determined and estimate the model to clarify the roles of changing technology, policies, and factor proportions on labor shares and total income inequality around the globe.
For a thousand years, income growth was associated with a rising military employment share. But this share peaked in the early 20th century, after which military employment shares fell with income growth. This paper presents evidence that the rising military shares were driven by structural change out of agriculture, and the recent declines are driven by a substitution effect from soldiers towards military goods. The substitution effect is supported in the data, as the ratio of the military expenditure share to the military employment share rises over time. A game theoretic model of growth and warfare is calibrated to micro data on war returns. It reproduces the time-series patterns of military expenditure and employment. The model correctly predicts that the time series pattern does not hold in the current cross-section of countries, where military employment shares are increasing in income. Finally, when the war decision is endogenous, the frequency of wars falls as income grows.
Why is growth slowing? Two facts are documented: 1. Richer countries spend a greater share of their income on research and development, and 2. Countries with high spending on research and development grow slower. These facts are evident in both the US time series and in the cross-section of countries. The paper proposes a model that explains these two facts, driven by declining returns to research and development. As technology advances, it costs a greater share of output to increase at the same rate; innovators compensate by spending more in R&D, but cannot compensate fully. In the long run, the R&D share of output asymptotes to 3.0-3.9%, and the per capita GDP growth rate declines to 1.0-1.5%.