Essays on the Economics of Heterogeneity
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The analysis of the effects of heterogeneity on aggregate economic outcomes has seen a resurgence in the recent macroeconomic literature. The exponential increase in computer power over the last decades has allowed researchers to solve ever more complex theoretical models with meaningful heterogeneity along various dimensions, while at the same time bringing ever more granular microlevel data to the table when testing the model predictions. This thesis explores two varieties of this recent vintage of models of heterogeneity. The first part of the thesis investigates the implications for wealth distributions of combining the standard lifecycle incomplete markets model of household consumption with income processes featuring heterogeneity in individual-specific growth rates, which households can learn about over the course of their working life. To this extent, first the recent literature on partial insurance and models of wealth inequality is reviewed. Then, income processes with profile heterogeneity are estimated from PSID and BHPS data. The results confirm the findings of previous studies that allowing for profile heterogeneity significantly lowers the estimated persistence and innovation variance of persistent shocks to household income, and documents substantial variation in the estimated parameters of the income process across time periods and measures of household income. The estimated income processes obtained are then used in a quantitative model of household consumption and saving in order to investigate the implications for the model predictions on the wealth distribution. The model is calibrated to empirical wealth distributions obtained from the SCF and the BHPS, and it is shown that the inclusion of individual-specific growth rate heterogeneity in income severely deteriorates the model’s ability to fit the shape of the data. Comparative statics exercises are performed to identify the drivers in the model’s failure to match the empirical profile of wealth holdings, which show that it is precisely the two key parameters which differ between the standard AR(1) model and the heterogeneous profile model, the persistence and variance of the permanent shock to household income, which drive model fit. The second part of the thesis looks at heterogeneity on the production side of the economy and its implications for international trade. Following an existing approach in the literature, we develop testable implications of the Melitz and Ottaviano (2008) model of trade, in which firms differ in their productivity and have to make production and exporting decisions in the face of costs to trade. Applying an estimation strategy previously used in the literature, we find weak support of the model’s predictions in data for 64 manufacturing industries in the NAFTA member countries Canada, Mexico and USA. We then test additional model predictions by constructing a measure of entry conditions by industry based on firm turnover, which allows us to divide our sample into fixed and free entry industries. Furthermore, we include the effects of third country tariff barriers on the relative performance of two trading partners’ industries. While the results are broadly in line with model predictions, we find some evidence of violations of the predictions in the data.
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