Pietro F. Peretto Associate Professor Department of Economics Duke University Room 241, Department of Economics Duke University, Durham, NC 27708 (USA) Phone: (919) 660-1807 Fax: (919) 684-8974 Email: peretto@econ.duke.edu   Office Hours: T, Th. 10-12 or by appointment

Fields

Growth, Macroeconomics, Industrial Organization, International Economics

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Current Research

This paper takes a new look at the long-run implications of resource abundance. Using a Schumpeterian growth model that yields an analyitical solution for the transition path, it derives conditions under which the "curse of natural resources" occurs and is in fact a curse, meaning that welfare falls, conditions under which it occurs but it is not a curse, meaning that growth slows down but welfare rises nevertheless, and conditions under which it does not occur at all. An effective way to summarize the results is to picture growth and welfare as hump-shaped functions of resource abundance. The property that the peak of growth occurs earlier than the peak of welfare captures the crucial role of initial consumption, which rises with resource abundance, and is an important reminder that the welfare effect of resource abundance depends on the whole path of consumption, not on a summary statistic of its slope. Growth regressions that ignore the endogeneity of initial income do not provide sufficient information to assess whether resource abundance is bad even if one could prove beyond reasonable doubt that the relation is indeed negative and causal. Recent evidence that the correlation is actually positive should make us even more skeptical of policy advice based on the "curse" logic.

Endogenous growth requires that non-reproducible factors of production be either augmented or eliminated. Attention heretofore has focused almost exclusively on augmentation. In contrast, we study factor elimination. Maximizing agents decide when to reduce the importance of non-reproducible factors. We use a Cobb-Douglas production function with two factors of production, one reproducible ("capital") and one not ("labor"). There is no augmenting progress of any kind, thus excluding the standard engine of growth. What is new is the possibility of changing factor intensities endogenously by spending resources on R&D. The economy starts with no capital and no knowledge of how to use it. By conducting R&D, the economy learns new technologies that use capital, which then is built. There are two possible ultimate outcomes: the economy may achieve perpetual growth, or it may stagnate with no growth. The first outcome is an asymptotic version of the AK model of endogenous growth, and the second outcome is the standard Solow model in the absence of any exogenous sources of growth. Which outcome is achieved depends on parameter values of saving and production, and there always is a feasible saving rate that will give the perpetual growth outcome. The model thus provides a theory of the endogenous emergence of a production technology with constant returns to the reproducible factors, that is, one that is capable of supporting perpetual economic growth. The model also allows derivation of the full transition dynamics, which have interesting properties. One especially notable feature is that the origin is not a steady state. An economy that starts with pure labor production becomes industrialized through its own efforts. The theory thus offers a purely endogenous explanation for the transition from a primitive to a developed economy, in contrast to other existing theories. Several aspects of the transition paths accord with the evidence, suggesting that the theory is reasonable. In contrast to almost all the existing endogenous growth literature, neither monopoly power nor an externality is a necessary condition for endogenous growth. It is sufficient that firms be able to appropriate the results of their research and development efforts.

This paper studies the effects of a tax on energy use in a growth model where market structure is endogenous and jointly determined with the rate of technological change. Because this economy does not exhibit the scale effect (a positive relation between TFP growth and aggregate R&D), the tax has no effect on the steady-state growth rate. It has, however, important transitional effects that give rise to surprising results. Specifically, under the plausible assumption that energy demand is inelastic, there exists a hump-shaped relation between the energy tax and welfare. This shape stems from the fact that the reallocation of resources from energy production to manufacturing triggers a temporary acceleration of TFP growth that generates a ✓-shaped time profile of consumption. If endogenous technological change raises consumption sufficiently fast and by a sufficient amount in the long run, the tax raises welfare despite the fact that -- in line with standard intuition -- it lowers consumption in the short run.

A Schumpeterian Analysis of Deficit-Financed Dividend Tax Cuts NEW (first posted January 07; revised May 07)

I propose a Schumpeterian analysis of the growth and welfare effects of a deficit-financed cut of the tax rate on distributed dividends. I find that income per capita growth initially accelerates and then decelerates, eventually converging to a long-run value lower than the starting one. Interestingly, lower steady-state growth occurs despite the fact that -- in line with intuition -- the economy's saving ratio rises. Most importantly, I find that the policy's effect on welfare is negative. The mechanism that delivers these results is that taxes on distributed dividends affect differently the returns to investing in the growth of existing product lines and in the development of new product lines, and thus reallocate resources across activities that have different growth opportunity. The analysis is particularly relevant to the current debate about the Job Growth and Taxpayer Relief reconciliation Act of 2003 (JGTRRA), a real-world large-scale experiment in fiscal policy. A surprising implication is that the JGTRRA targeted the wrong tax rate: Holding the financing method (debt) equal, it should have cut the tax rate on corporate income, thereby reducing the distortions of the internal investment decisions of firms and improving growth and welfare.

The Employment (and Output) of Nations: Theory and Policy Implications

I study the effects of product and labor market frictions in a dynamic general equilibrium model with a three-state representation of the labor market. Firms bargain with unions over wages and employment levels. This generates unemployment. Households take the associated unemployment risk as given in making participation and consumption-saving decisions. Unemployment harms output because it inserts a wedge between labor supply (participation) and employment. New firms make entry decisions based on expected future profitability as determined by macroeconomic conditions. The model produces dynamics consistent with the long-run trends exhibited by the US and EU15 economies over the last 40-50 years. It also features feedback mechanisms linking the two markets that amplify the adverse effects on output of labor and product market frictions. These multiplier effects have interesting policy implications.

The Manhattan Metaphor (with Michelle Connolly), Journal of Economic Growth (2007), 12, 329-350. 

Fixed operating costs draw a sharp distinction between endogenous growth based on horizontal and vertical innovation: a larger number of product lines puts pressure on an economy's resources; greater productivity of existing product lines does not. Consequently, the only plausible engine of growth is vertical innovation whereby progress along the quality or cost ladder does not require the replication of fixed costs. Is, then, product variety expansion irrelevant? No. The two dimensions of technology are complementary in that using one and the other produces a more comprehensive theory of economic growth. The vertical dimension allows growth unconstrained by endowments, the horizontal provides the mechanism that translates changes in aggregate variables into changes in product-level variables, which ultimately drive incentives to push the technological frontier in the vertical dimension. We show that the potential for exponential growth due to an externality that makes entry costs fall linearly with the number of products, combined with the limited carrying capacity of the system due to fixed operating costs, yields logistic dynamics for the number of products. This desirable property allows us to provide a closed-form solution for the model's transition path and thereby derive analytically the welfare effects of changes in parameters and policy variables. Our Manhattan Metaphor illustrates conceptually why we obtain this mathematical representation when we simply add fixed operating costs to the standard modeling of variety expansion.

Corporate Taxes, Growth and Welfare in a Schumpeterian Economy, Journal of Economic Theory (2007), 137, 353-382. (available online 13 November 2007)

I take a new look at the long-run implications of taxation through the lens of modern Schumpeterian growth theory. I focus on the latest vintage of models that sterilize the scale effect through a process of product proliferation that fragments the aggregate market into submarkets whose size does not increase with the size of the workforce. I show that the following interventions raise welfare: (a) Granting full expensibility of R&D to incorporated firms; (b) Eliminating the corporate income tax and/or the capital gains tax; (c) Reducing taxes on labor and/or consumption. What makes these results remarkable is that in all three cases the endogenous increase in the tax on dividends necessary to balance the budget has a positive effect on growth. A general implication of my analysis is that corporate taxation plays a special role in Schumpeterian economies and provides novel insights on how to design welfare-enhancing tax reforms.

Effluent Taxes, Market Structure and the Rate and Direction of Endogenous Technological Change, Environmental and Resource Economics (2008), 39, 113-138. (available online 12 April 2007)

This paper studies the effects of effluent taxes on firms' allocation of resources to cost-reducing and emission-reducing R&D, and on entrepreneurs' decisions to develop new goods and enter the market. A tax set at an exogenous rate that does not depend on the state of technology reduces growth, the level of consumption of each good, and raises the number of firms. The induced increase in the variety of goods is a benefit not considered in previous analyses. In terms of environmental benefits, the tax induces a positive rate of pollution abatement that offsets the "dirty" side of economic growth. A tax set at an endogenous rate that holds constant the tax burden per unit of output, in contrast, has ambiguous effects on growth, the scale of activity of each firm and the number of firms. Besides being novel, the potential positive growth effect of this type of effluent tax is precisely what makes this instrument effective for welfare-maximizing purposes. The socially optimal policy, in fact, requires the tax burden per unit of output to equal the marginal rate of substitution between the growth rate of consumption and abatement. Moreover, a tax/subsidy on entry is needed, depending on whether the contribution of product variety to pollution dominates consumers' love of variety.

Schumpeterian Growth with Productive Public Spending and Distortionary Taxation, Review of Development Economics (2007), 11, 699-722. 

The latest version of Schumpeterian growth theory eliminates the scale effect by positing a process of development of new product lines that fragments the aggregate market in submarkets whose size does not increase with population. A key feature of this process is the sterilization of the effect of the size of the aggregate market on firms' incentives to invest in the growth of a given product line. In this paper I apply this insight to shed new light on the workings of fiscal policy. I analyze the role of distortionary taxes on consumption, household labor and assets income, corporate income, and public spending. The framework allows me to show which of these fiscal variables have permanent (steady-state) growth effects, and which ones have only transitory effects. It also allows me to solve the transitional dynamics analytically, and thus to analyze in detail the welfare effects of tax rates and public spending, and investigate the effects of revenue-neutral changes in tax structure. Pair wise comparisons reveal that replacing taxes that distort labor supply with taxes that distort saving/investment choices raises welfare. I discuss the intuition behind this surprising finding.

Scale Effects in Endogenous Growth Theory: An Error of Aggregation, Not Specification (with Chris Laincz), Journal of Economic Growth (2006), 11, 263-288.

Modern Schumpeterian growth theory focuses on the product line as the main locus of innovation and exploits endogenous product proliferation to sterilize the scale effect. The empirical core of the theory consists of two claims: (i) growth depends on average employment (i.e., employment per product line); (ii) average employment is scale-invariant. We show that data on employment, R&D personnel, and the number of establishments in the US for the period 1964-2001 provide strong support for these claims. While employment and the total number of R&D workers increase with no apparent matching change in the long-run trend of productivity growth, employment and R&D employment per establishment exhibit no long-run trend. We also document that the number of establishments, employment and population exhibit a positive trend, while the ratio employment/establishments does not. Finally, we provide results of time series tests consistent with the predictions of these models.

Market Power, Unemployment, and Growth, under revision

Oligopoly Banking and Capital Accumulation (with N. Cetorelli), under revision

Teaching 

Econ 395: Advanced Macroeconomics I (Graduate)

Econ 322: Macroeconomic Analysis II (Graduate)

Econ 161: Economic Growth (Undergraduate)