Knowledge that Transforms

Within the international trade literature it is not uncommon to find arguments about whether devaluation will improve the trade balance. It is argued that the flows of goods respond only with time lags to changes in the exchange rate. The terrn is used to describe the movement over time of the trade balance: it may deteriorate at first and improvement may come later. This paper presents a method by which one could detect the existence of the J-Curve. The method is applied to four developing countries. The empirical evidence supports the pattern of movemnent described by the J-Curve. A major policy option for a country facing a persistent balance of payments deficit is said to be devaluation of its currency. Within the international trade literature it is not uncommon to find arguments about whether devaluation will improve the trade balance or the balance of payments. For example, proponents of the elasticities approach describe the necessary and sufficient conditions for an improvement in the trade balance in terms of elasticities of demand and supply referred to as the Marshall-Lerner condition.' While there is abundant empirical evidence to suggest that these conditions are indeed met (at least for industrial countries), there have been circumstances under which 2 devaluation has not been successful. For example, one might wonder why the U.S. trade balance deteriorated so much in 1972 despite the devaluation of the dollar in 1971. This unfavorable effect of devaluation on the trade balance is termed the J-Curve phenomenon Received for publication August 23, 1984. Revision accepted for publication November 26, 1984. *The University of Wisconsin-Milwaukee. I would like to thank two anonymous referees for their valuable comments on the initial draft of this paper. 1 Proponents of the absorption approach (e.g., Alexander, 1952) describe how devaluation may change the terms of trade, increase production, and switch expenditures from foreign to domestic goods, thus improving the trade balance. International monetarists argue that devaluation reduces the real value of cash balances and/or changes the relative price of traded and nontraded goods, thus improving both the trade balance and the balance of payments. 2 For an cstimate of the elasticities, see Houthakker and Magee (1969) and Warner and Kreinin (1983). The former study provides the elasticities estimates under fixed exchange rates and the latter under floating rates. This content downloaded from 157.55.39.17 on Wed, 31 Aug 2016 04:39:37 UTC All use subject to http://about.jstor.org/terms

Results based on pooled time series and cross section data are presented, which indicate that state and local tax increases significantly retard economic growth when the revenue is used to fund transfer payments. However, when the revenue is used instead to finance improved public services (such as education, highways, and public health and safety) the favorable impact on location and production decisions provided by the enhanced services may more than counterbalance the disincentive effects of the associated taxes. These findings underscore the importance of considering the incentives provided by a state's expenditures as well as by its taxes. I N the past several years a number of states have implemented limitations on taxes or expenditures, while others have raised tax rates in response to the revenue shortfalls of the early 1980s. Although much of the ongoing debate over state fiscal structures revolves around expressed preferences over tax-expenditure combinations per se, the question of how state and local taxes may affect economic growth is often central to the discussion. Nonetheless, the empirical evidence remains sparse. Previous studies can be divided into two broad categories: assessments of the magnitudes of tax costs, and statistical analyses of the relationship between tax rates and growth. Cost studies have tended to minimize the role of taxes in business location decisions, either because state and local taxes are a relatively small component of total costs for most businesses, or because interstate tax differences are small relative to other cost differences between states.' Although these results suggest that the role played by taxes is a minor one, describing how large the tax disparities may be is not the same as ascertaining their economic effect. Of the statistical studies many, including Bloom (1955), Thompson and Mattila (1959), and Carlton (1979,1983), find no relationship between taxes and growth. However, Kleine (1977), Grieson (1980) and, generally, Grieson et al. (1977) report negative correlations. Romans and Subrahmanyam (1979) find growth to be negatively related to the fraction of revenues devoted to transfer payments and a variable which they claim measures personal tax progressivity, but positively related to business taxes. With the exception of Carlton (who estimates models of the birth and size of firms within metropolitan areas) and the Grieson et al. (1977) and Grieson (1980) studies (which consider taxes in New York City and Philadelphia), these authors use data from a single cross section of states. More recently, Newman (1983) and Plaut and Pluta (1983) both use cross sectional data from two time periods, the former finding negative effects of corporate tax rates and the latter yielding mixed results. In this study we utilize a time series (from 1965 through 1979) of cross sections of 48 states. Exploiting the richness of this data set, we are able to allow for otherwise unexplained differences between states which could be expected to bias results based on a single cross section. Moreover, this much larger sample provides the statistical power necessary to disentangle the separate effects of different categories of taxes, public expenditures, and transfer payments; a distinguishing feature of this paper is that we explicitly recognize the government budget constraint linking these fiscal variables and the deficit or surplus. In addition, we have taken account of the effects of labor force characteristics by including variables for wage rates, unionization, and population density. Our results indicate that tax increases significantly retard economic growth when the revenue is used to fund transfer payments; as a result, programs of income redistribution are more effectively undertaken at the federal than at the state and local level. On the other hand, when the revenue is Received for publication April 30, 1984. Revision accepted for publication January 22, 1985. *University of California, Davis. I am indebted to the Institute of Governmental Affairs at the University of California, Davis for financial support, to Adrienne Kandel for invaluable research assistance, and to two referees for their helpful comments. 1 See Williams (1967), Morgan and Brownlee (1974), Vasquez and deSeve (1977), and the Advisory Commission on Intergovernmental Relations (1981). See also Due (1961) for a survey of the early literature, including a discussion of the findings and limitations of survey results on this topic. [ 574 1 Copyright ? 1985 This content downloaded from 157.55.39.35 on Mon, 29 Aug 2016 04:45:38 UTC All use subject to http://about.jstor.org/terms STATE AND LOCAL TAXES AND ECONOMIC GROWTH 575 used instead to finance enhanced public services (such as highways, education, and public health and safety), the favorable impact on location and production decisions provided by the improved services may more than counterbalance the disincentive effects of the concomitant taxes. These findings underscore the importance of considering the incentives provided by a state's expenditures as well as by its taxes. We begin by sketching a model which provides the basis for the analysis and discussing appropriate estimation techniques. Then in section II we describe the data used and our hypotheses. The econometric results are presented in section III, followed by brief concluding remarks in the final

Four models of direct investment are analyzed assuming various relationships between foreign and domestic production. The direct effect of risk-adjusted expected real foreign currency appreciation is to lower foreign capital cost, thus stimulating direct investment. However, when costs of other inputs are also affected, induced productivity changes or output price changes may offset the direct effect, reducing direct investment. Pooled estimation results for U.S. annual, bilateral direct investment flows to five industrialized countries show significant reductions associated with expected appreciation of real foreign currency and significant increases associated with risk. These results are consistent with the model where, in response to risk, the multinational firm reduces exports to the foreign country but offsets this somewhat by increasing foreign capital input and production.

Robert I. Lerman, Shlomo Yitzhaki, Income Inequality Effects by Income Source: A New Approach and Applications to the United States, The Review of Economics and Statistics, Vol. 67, No. 1 (Feb., 1985), pp. 151-156

Orley Ashenfelter, David Card, Using the Longitudinal Structure of Earnings to Estimate the Effect of Training Programs, The Review of Economics and Statistics, Vol. 67, No. 4 (Nov., 1985), pp. 648-660

Jeffrey H. Bergstrand, The Gravity Equation in International Trade: Some Microeconomic Foundations and Empirical Evidence, The Review of Economics and Statistics, Vol. 67, No. 3 (Aug., 1985), pp. 474-481

A class of three good (output, labour, money), one consumer private ownership economies is studied. With an exogenous number of identical, increasing or decreasing returns firms necessary and sufficient conditions for globally unique, non-trivial, uniform rationing non-Walrasian equilibria are obtained in terms of suitably defined “marginal propensities”. Following Weddepohl a non-Walrasian equilibrium at a set of parameters with m firms producing is stable if there is no equilibrium at those parameters with m + 1 firms producing. Under the global uniqueness conditions only trivial stable equilibria occur under decreasing returns; under increasing returns multiple, non-trivial stable equilibria can occur.

A model is studied where firms advertise prices and buyers play a noncooperative search game in an attempt to secure output from firms at the advertised prices. Firms face rising marginal costs and may not be willing to supply everything demanded at their price if they wind up with many buyers. It is shown that rationing will occur in equilibrium no matter how averse buyers are to this possibility. The result is specialised to a case where rationing occurs with probability one. The equilibrium price and outputs are characterised for this case.

This paper attempts to provide a unified analysis of the effects of taxation on the equilibrium value of marginal q under alternative financial policies. It is shown that the q approach does not avoid all the specification problems associated with analyses based on the cost of capital. The (theoretically and empirically) crucial relationship between average and marginal q is also examined, and it is shown that, under UK and US tax rules, the possibility of winding up precludes persistent undervaluation in equilibrium.