Hawtreyan “Credit Deadlock” or Keynesian “Liquidity Trap”? Lessons for Japan from the Great Depression

This paper outlines the ideas of Ralph Hawtrey and Lauchlin Currie on the need for monetised fiscal deficit spending in 1930s USA to combat the deep depression into which the economy had been allowed to sink. In such exceptional circumstances of “credit deadlock” in which banks were afraid to lend and households and business afraid to borrow, the deadlock could best be broken through the spending of new money into circulation via large fiscal deficits. This complementarity of fiscal and monetary policy was shown to be essential, and as such indicates the potential power of monetary policy – in contrast to the Keynesian “liquidity trap” view that it is powerless This lesson was not learned by the Japanese authorities in their response to the asset price collapse of 1991-92, resulting in a lost decade as ballooning fiscal deficits were neutralised throughout the 1990s by unhelpfully tight monetary policy with the Bank of Japan refusing to monetise the deficits.

Are two tax rates better than one?

Abstract: Should two–band income taxes be progressive given a general income distribution? We provide a negative answer under utilitarian and max-min welfare functions. While this result clarifies some ambiguities in the literature, it does not rule out progressive taxes in general. If we maximize total or weighted utility of the poor, as often intended by the society, progressive taxes can be justified, especially when the ‘rich’ are very rich. Under these objectives we obtain new necessary conditions for progressive taxes, which only depend on aggregate features of income distributions. The validity of these conditions is examined using plausible income distributions.

Short-Run Strategies For Attracting Foreign Direct Investment

This paper empirically investigates the effectiveness and feasibility of two FDI policies, fiscal incentives and deregulation, aimed at improving the attractiveness of a country in the short run. Using disaggregated data on sales by US MNEs’ foreign affiliates in 43 developed and developing countries over the 1982-1994 period, results show that the provision of fiscal incentives or the deregulation of the labour market would exert a positive impact on total FDI. Given the drawbacks frequently associated with the use of incentive packages, economy-wide policies which ease firing procedures and reduce severance payments would certainly be the best policy option. This paper also highlights the different aggregation and omitted variable biases that have affected results of previous studies and provides some support to recent theoretical models of FDI by showing that third country effects and spatial interdependence influence respectively the location of export-platform FDI and vertical FDI.

Booms, Recessions and Financial Turmoil: A Fresh Look at Investment Decisions under Cyclical Uncertainty

The paper studies the interaction between cyclical uncertainty and investment in a stochastic real option framework where demand shifts stochastically between three different states, each with different rates of drift and volatility. In our setting the shifts are governed by a three-state Markov switching model with constant transition probabilities. The magnitude of the link between cyclical uncertainty and investment is quantified using simulations of the model. The chief implication of the model is that recessions and financial turmoil are important catalysts for waiting. In other words, our model shows that macroeconomic risk acts as an important deterrent to investments.

Strategic investment and international outsourcing in unionised oligopoly

We critically consider the conventional belief that the attractiveness of international outsourcing lies in cheaper labour costs overseas and that it offers a means to ‘escape’ the power of unions. We develop an oligopoly model in which firms facing unionised domestic labour market choose between producing an intermediate in-house or outsourcing it to a non-unionised foreign supplier that makes a relationship specific investment in developing the intermediate. We show that outsourcing typically results in higher wages and does not always reduce marginal costs. Trade liberalisation favours outsourcing particularly for the relatively less efficient firms.

Short-Run Strategies For Attracting Foreign Direct Investment

This paper empirically investigates the effectiveness and feasibility of two FDI policies, fiscal incentives and deregulation, aimed at improving the attractiveness of a country in the short run. Using disaggregated data on sales by US MNEs’ foreign affiliates in 43 developed and developing countries over the 1982-1994 period, results show that the provision of fiscal incentives or the deregulation of the labour market would exert a positive impact on total FDI. Given the drawbacks frequently associated with the use of incentive packages, economy-wide policies which ease firing procedures and reduce severance payments would certainly be the best policy option. This paper also highlights the different aggregation and omitted variable biases that have affected results of previous studies and provides some support to recent theoretical models of FDI by showing that third country effects and spatial interdependence influence respectively the location of export-platform FDI and vertical FDI.

On the FDI-attracting property of privatizatio

In this paper, we provide an explanation of why privatization may attract foreign investors willing to enter a regional market. Privatization turns the formerly-public firm into a less aggressive competitor since profit-maximizing output is lower than the welfaremaximizing one. The drawback is that social welfare generally decreases. We also investigate tax/subsidy competition for FDI and put forward its potentially positive role. On the one hand, it may reduce the negative impact on welfare of an FDI-attracting privatization. On the other hand, it may prevent a welfare-reducing investment by the foreign firm. This sheds light on the substitute/complementary relationship between the two policies and the two objectives of governments.

Inverted Haavelmo Effects in a General Equilibrium Analysis of the Impact of Implementing the Scottish Variable Rate of Income Tax.

The Scottish Parliament has the authority to make a balanced-budget expansion or contraction in public expenditure, funded by corresponding local changes in the basic rate of income tax of up to 3p in the pound. This fiscal adjustment is known as the Scottish Variable Rate of income tax, though it has never, as yet, been used. In this paper we attempt to identify the impact on aggregate economic activity in Scotland of implementing these devolved fiscal powers. This is achieved through theoretical analysis and simulation using a Computable General Equilibrium (CGE) model for Scotland. This analysis generalises the conventional Keynesian model so that negative balanced-budget multipliers values are possible, reflecting a regional “inverted Haavelmo effect”. Key parameters determining the aggregate economic impact are the extent to which the Scottish Government create local amenities valuable to the Scottish population and the extent to which this is incorporated into local wage bargaining.

Negative investment in China: financing constraints and restructuring versus growth

This paper attempts to address a puzzle in China’s investment pattern: despite high aggregate investment and remarkable economic growth, negative net investment is commonly found at the microeconomic level. Using a large firm-level dataset, we test three hypotheses to explain the existence and extent of negative investment in each ownership group: what we term the efficiency (or restructuring) hypothesis, the (lack of) financing hypothesis, and the (slow) growth hypothesis. Our panel data probit estimations shows that negative investment by state-owned firms can be explained mainly by inefficiency: owing to over-investment or mis-investment in the past, these firms have had to restructure and to get rid of obsolete capital in the face of increasing competition and hardening budgets. The financing explanation holds for private firms, which have had to divest in order to raise capital. However, rapid economic growth weighs against both effects in all types of firms, with a larger impact for firms in the private and foreign sectors. A tobit model, estimated to examine the determinants of the amount of negative investment, yields similar conclusions.

Investment and financing constraints in China: does working capital management make a difference?

We use a panel of over 120,000 Chinese firms of different ownership types over the period 2000-2007 to analyze the linkages between investment in fixed and working capital and financing constraints. We find that those firms characterized by high working capital display high sensitivities of investment in working capital to cash flow (WKS) and low sensitivities of investment in fixed capital to cash flow (FKS). We then construct and analyze firm-level FKS and WKS measures and find that, despite severe external financing constraints, those firms with low FKS and high WKS exhibit the highest fixed investment rates. This suggests that good working capital management may help firms to alleviate the effects of financing constraints on fixed investment.

Understanding Liquidity and Credit Risks in the Financial Crisis

This paper develops a structured dynamic factor model for the spreads between London Interbank Offered Rate (LIBOR) and overnight index swap (OIS) rates for a panel of banks. Our model involves latent factors which reflect liquidity and credit risk. Our empirical results show that surges in the short term LIBOR-OIS spreads during the 2007-2009 fi nancial crisis were largely driven by liquidity risk. However, credit risk played a more signifi cant role in the longer term (twelve-month) LIBOR-OIS spread. The liquidity risk factors are more volatile than the credit risk factor. Most of the familiar events in the financial crisis are linked more to movements in liquidity risk than credit risk.

The Budget 2009 Tax Proposals and Activity in the UK Continental Shelf (UKCS)

NORTH SEA STUDY OCCASIONAL PAPER No. 113

Incentivising Investment in the UKCS: a Response to Supporting Investment: a Consultation on the North Sea Fiscal Regime

NORTH SEA STUDY OCCASIONAL PAPER No. 111

An Optimised Illustrative Investment Model Of The Economics Of Integrated Returns From CCS Deployment In The UK/UKCS

NORTH SEA STUDY OCCASIONAL PAPER No. 118

The distributional consequences of tax reforms under market distortions

In this paper we examine the importance of imperfect competition in product and labour markets in determining the long-run welfare e¤ects of tax reforms assuming agent heterogeneneity in capital hold- ings. Each of these market failures, independently, results in welfare losses for at least a segment of the population, after a capital tax cut and a concurrent labour tax increase. However, when combined in a realistic calibration to the UK economy, they imply that a capital tax cut will be Pareto improving in the long run. Consistent with the the- ory of second-best, the two distortions in this context work to correct the negative distributional e¤ects of a capital tax cut that each one, on its own, creates.