Understanding UK Productivity Using a Macroeconomic Lens (with Jagjit S. Chadha) : Forthcoming, Journal of Economic Surveys
Link to Cambridge Working Paper (new version)
Link to TPI Working Paper (initial version)
Long Abstract
We survey UK productivity performance over the long run across countries and focus on the sharp slowdown since the global financial crisis. There has been a predominant role for total factor productivity (TFP) when accounting for productivity performance, but capital shallowing may also be critical, even more so if capital accumulation is endogenous to current and prospective trends in productivity. Two macroeconomic trends deepen this puzzle, there has been a decline in real interest rates over the past 30 years and an increase in labour supply after 2008. And yet the ratio of (nominal) private and public investments to GDP has fallen over time. The fall in real rates has been accompanied by an increase in the preponderance of consumption-led expansions. The so-called secular stagnation was thus not the result of demand deficiency but a failure to address long-term structural supply-side issues.
We examine the demographic debate and ask whether an ageing population may be less inclined to innovate, preferring to guard assets, but also whether it may adopt AI and other forms of automation that enhance labour productivity. We note that labour participation amongst older workers is the predominant factor in explaining the growth in total hours worked. The question then is why firms did not increase the ratio of capital services to labour employed. We consider four explanations. The first is the shortfall of funding available to new or growing SMEs. The second is whether there is an increasingly significant fraction of unprofitable firms with a low stock market valuation who do not invest, so-called zombies. Third, a low-interest rates environment may inadvertently favour more industry concentration and rations credit to entrepreneurs by magnifying the impact of rents or worsening the unequal access to financing among firms. Fourth, we consider the role of burgeoning public debt in holding back growth with the threat of future taxes and whether there has been a misallocation of public expenditure that has prevented the provision of public goods, which may enhance growth prospects. These points may be acting to bring about an interaction of aggregate supply and demand in a low-growth trap.
Value-at-Risk, Bank Leverage and the Business Cycle: Submitted
Link to NIESR Working Paper (new version)
Link to NIESR Working Paper (initial version)
Abstract
I propose a general equilibrium model with endogenous defaults among producers and a Value-at-Risk rule designed to stabilise insolvency risk in the banking sector. Bank equity fluctuates with aggregate default rates, affecting banks' lending capacity. The Value-at-Risk constraint induces procyclical leverage, amplifying the impact of bank equity fluctuations on credit supply. This mechanism generates countercyclical risk premia in lending rates, thus intensifying economic shocks. Analytical exploration identifies three channels driving the dynamics of bank leverage and credit spreads: (a) the credit demand channel, (b) the bank equity channel, and (c) a risk channel that captures the interaction between default expectations and the Value-at-Risk constraint. The model is calibrated to quantitatively replicate fluctuations in banks' balance sheets, credit spreads, and real business cycle variables.
Profits, Firm Ownership and Aggregate Demand Externalities (with Yunus Aksoy and Arup Daripa): Submitted
Abstract
In a backdrop of high corporate profits and decreasing labour share in advanced economies, questions about market power and firm behaviour have become salient.
We consider the role of firm ownership and remuneration structures in addressing such concerns within a standard dynamic general equilibrium model with monopolistic competition. In such models, profits are accounted for as a lump-sum payment to the representative agent, precluding substitution effects. We label this an ``incentive leakage.'' We show this to be a general phenomenon associated with firm-optimal arrangements and investigate alternative institutional settings that eliminate the leakage. While perfect competition features zero leakage, this is through eliminating monopoly power, which regulation typically cannot attain. We preserve market power, but show that resulting profits can be harnessed by alternative zero-leakage structures such as shareholder-operated or worker-operated firms to generate within-firm incentives that effectively lead to a lower exploitation of monopoly power by a firm in equilibrium. When all firms operate similarly, an additional general equilibrium effect arises through the internalization of an aggregate demand externality. We characterize steady-state welfare across institutional structures, and show how zero-leakage institutions lead to aggregate improvements towards the steady-state Golden Rule benchmark, with certain structures resolving the monopoly welfare distortion completely. Overall, our paper takes the first step towards an analysis of the macroeconomics of institutions without incentive leakage and its significant welfare implications.
Macroeconomic Effects of Firms' Underspending in Times of Abundant Credit
Abstract
Firms typically decide their financing before starting the implementation of a new project. The firm's management may become more pessimistic about the project's profitability after financing is raised and reduce spending accordingly. Following an unpredicted negative aggregate productivity shock, the productive sector can enter a low-spending mode, thus depressing output further. I use firm-level financial data to provide some empirical justification for this mechanism. I then study the mechanism in a general equilibrium model with money and a supply sector subject to uninsured idiosyncratic productivity shocks.
Credit Markets, Intermediate Production and the Business Cycle
Abstract
This paper builds an RBC model with an endogenous mechanism for firm defaults and credit spreads. The model assumes a productive sector made of a class of intermediate producers and a class of final producers. The intermediate producers borrow to fund their operations and can default when large enough negative shocks affect their revenues. The intermediate/final production structure implies that during periods of low economic activity, the demand for the intermediate good is lower. This depresses the price of the intermediate good and, in turn, depresses the revenues of the borrowing firms. Hence higher default rates during the lows of the business cycle. Inversely, default rates are lower when the economy is improving: default rates are countercyclical. Intermediate producers are financed by banks that take future defaults into account when setting lending rates. This guarantees that credit spreads are countercyclical too.
Heterogeneous Labour Supply, Urban Effects and Productivity
Abstract
This paper develops a model to analyse labour supply decisions in urban settings, focusing on how urban costs affect both the extent of labour supply and the spatial distribution of productivity. In a single-city framework, workers of varying abilities live at different distances from a central business district (CBD), where all employment is located. Commuting time reduces both leisure and work hours, impacting labour supply choices and encouraging more productive workers to reside closer to the CBD, while less productive or unemployed workers settle at the periphery. Urban costs, including transport expenses and time lost to commuting, increase with the size of the city, creating spatial patterns reflected in land rents. With increasing returns to scale in production, wages increase in cities with larger and more productive workforces, attracting more skilled workers to cities with better transport infrastructure. Extending the model to multiple cities shows that transport improvements enhance a city’s attractiveness to high-productivity workers, increasing both its size and urban costs. The findings of this study contribute to understanding the role of urban costs in shaping the distribution and productivity of the workforce in cities, providing information for economic geography and urban policy.
Urban Adjustments and Regional Capital in a General Equilibrium Model (with Jagjit S. Chadha)
Abstract
We develop a general equilibrium model of regionally distributed traded and non-traded sector firms that reproduces the following stylised facts in the United Kingdom: (i) workers in large cities receive higher wages while incurring greater urban costs than workers in smaller cities; (ii) workers in large cities are more productive than their smaller city counterparts; and (iii) production is less capital-intensive in large cities. Building on agglomeration effects, this model makes the following predictions on the behaviour of the economy as the size of large cities grows larger: (a) workers become more productive in increasingly larger cities; (b) urban rents increase in these cities; (c) a small number of megacities can push workers to live in less labour-productive, smaller cities that benefit from lower urban costs; and (d) this can lead to lower productivity and average wages in aggregate as the number of large cities decreases while their average size increases. We deploy this framework to assess the impact on productivity of the three shocks that have dominated the UK economy over the last two decades: trade, fiscal consolidation and low-interest rates.