Parantap Basu

Foreign direct investment and growth in India: a cointegration approach

The two-way link between foreign direct investment and growth for India is explored using a structural cointegration model with vector error correction mechanism. The existence of two cointegrating vectors between GDP, FDI, the unit labour cost and the share of import duty in tax revenue is found, which captures the long run relationship between FDI and GDP. A parsimonious vector error correction model (VECM) is then estimated to find the short run dynamics of FDI and growth. Our VECM model reveals three important features: (a) GDP in India is not Granger caused by FDI; the causality runs more from GDP to FDI; (b) trade liberalization policy of the Indian government had some positive short run impact on the FDI flow; and (c) FDI tends to lower the unit labour cost suggesting that FDI in India is labour displacing.

Foreign Direct Investment, Inequality, and Growth

This paper examines the interactions between Foreign Direct Investment (FDI), inequality, and growth, both from an empirical and a theoretical point of view. Using a panel of 119 developing countries, we observe that FDI promotes both inequality and growth, and tends to reduce the share of agriculture to GDP in the recipient country. We than set up a growth model of a dual economy in which the traditional (agricultural) sector uses a diminishing returns technology, while FDI is the engine of growth in the modern (industrial) sector. The main predictions of the model are consistent with the stylized facts observed in the data.

Terms of trade fluctuations and economic growth in developing economies

Abstract The effect of terms of trade fluctuations on capital accumulation is investigated in a simple open economy stochastic growth model. Imported inputs make domestic capital more productive, but export prices are uncertain. The models output process has a random walk component so even transient price shocks have permanent effects on output levels. The size of the random walk component depends on the countrys trade share, the supply response of exports and other structural parameters. Also, more variable export prices generally reduce expected domestic investment. These results are consistent with the estimated variance ratios and impulse response functions for a number of LDCs.

Reserve Ratio, Seigniorage and Growth

A monetary endogenous growth model is developed by explicitly taking into account the growth-enhancing effects of reserve-augmented seigniorage. The seigniorage is generated by imposing a reserve requirement on the banking sector. The benevolent government then spends all the seigniorage revenue on the provision of a public input which has positive externality on the private sectors production. The growth effect of an increase in reserve requirement is then analyzed. An increase in reserve requirement has two opposing effects on growth. One is the well-known distortionary effect on the asset mix of the banks as well as the firms input mix between intermediated and unintermediated capital. The other is a positive supply-side effect which arises due to the externality of public spending. A growth Laffer-curve type relationship is thus obtained between reserve ratio and growth. The model admits a second best reserve ratio.

An Adjustment Cost Model of Asset Pricing

An intertemporal asset-pricing model is constructed incorporating an explicit adjustment-cost technology. The capital stock can be altered by investment, but there are adjustment costs whi ch lower the marginal return of investment. In a model involving an i nfinitely-lived representative agent, it is shown how changes in adju stment costs influence asset prices, the term structure of real inter est rates, and risk premia. The results suggest that adjustment cost, by causing an intertemporal consumption substitution, raises the pri ces of risky stocks and risk premia and reduces long-term real intere st rates. Copyright 1987 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

What drives the cross-country growth and inequality correlation ?

We present a neo-classical model that explores the determinants of growth-inequality correlation and attempts to reconcile the seemingly conflicting evidence on the nature of the growth-inequality relationship. The initial distribution of human capital determines the long-run income distribution and the growth rate by influencing the occupational choice of the agents. The steady-state proportion of adults that innovates and updates human capital is path dependent. The output elasticity of skilled-labour, barriers to knowledge spillovers, and the degree of redistribution determine the range of steady-state equilibria. From a calibration experiment we report that a skill-intensive technology, low barriers to knowledge spillovers, and high degrees of redistribution characterize the industrial countries with a positive growth-inequality correlation. A negative correlation between growth and inequality arises for the group of non-industrial countries with the opposite characteristics.

Mean Reversion in Stock Prices: Implications from a Production Based Asset Pricing Model

A production-based asset pricing model explores the relationship between technological returns to scale and the time-series behavior of equilibrium asset returns. The authors find that stock prices are mean-reverting if there are strict diminishing returns in the underlying production technology. In economies where the technology displays increasing or constant returns, stock prices do not tend to revert to the mean. In view of this, the authors establish that consumption smoothing is necessary but not sufficient for mean-reversion in stock prices. Their unit root tests involving stock prices and returns reject the restrictions imposed by an increasing returns technology. Copyright 1994 by The editors of the Scandinavian Journal of Economics.

Productive Government Purchases and the Real Exchange Rate

Empirical research documents that an exogenous rise in government purchases in a given country triggers a depreciation of its real exchange rate. This raises an important puzzle, as standard macro theories predict an appreciation of the real exchange rate. We argue that this prediction reflects the assumption that government purchases are unproductive. Using a simple model, we show that the real exchange rate may depreciate in response to a rise in government purchases, if those purchases increase domestic private sector productivity. A very small dose of public sector externality is sufficient to generate this result.

International business cycles and the relative price of investment goods

Is the relative price of investment goods a good proxy for investment specific technology? We model this relative price in a flexible price international economy with two fundamental shocks, namely, the total factor productivity (TFP) shock and the investment-specific technology (IST) shock. We show that the one-to-one correspondence between the IST shock and the relative price of investment goods breaks down in an international economy because of the short-run correlation between the terms of trade and the relative price of investment goods. The data congruent negative correlation between the investment rate and the relative price of investment goods thus does not necessarily reflect decline in investment frictions (rise in IST), as suggested by many studies. A calibration experiment with the US data demonstrates that such an inverse relation between rate of investment and the relative price of investment goods basically reflects the positive effect of TFP on the terms of trade for a broad range of economies where the home bias in consumption exceeds investment and there is a sizable adjustment cost of investment.

Interest rate risk, labor supply and unemployment

Abstract When the rate of return on an individual’s savings is risky, the access to a labor market to work for a riskless wage provides a means of hedging this capital income risk by working more. In a non-expected utility maximizing framework using Selden’s OCE preference we investigate the effects of a change in the rate of return risk on such precautionary labor supply decision. It is shown that an increase in the rate of return risk leads to an increase (a decrease) in the optimal labor supply only when the elasticity of intertemporal substitution for consumption falls short of (exceeds) unity. An empirical analysis, using a GARCH model to estimate the interest rate risk, reveals that in the US, unemployment rate has responded positively to an increase in time-varying real interest rate risk.